225: How to be a Successful Syndication Passive Investor

SHOW NOTES FOR EPISODE 225: HOW TO BE A SUCCESSFUL SYNDICATION PASSIVE INVESTOR

Real estate is one of the best investments out there.  But how do you invest?  Do you have to deal with tenants, toilets and trash?  Or, is there a easier way?  Real estate syndications are a great way for you to tap into high-yielding real estate investments without ever having to be a landlord.  In this podcast episode, passive real estate investor Hunter Thompson, who has invested in over 30 passive syndications to amass more than $25 million in commercial assets, shares how he did it and how others can do the same.

What You Will Learn

• What is a syndication passive investor?
• How to invest while mitigating the risk
• How to invest in a commercial asset with a potential value add through syndication
• How to identify a good passive investment
• What is the #1 most important thing to look at when assessing a potential real estate syndication investment
• What type of business structure is best for syndication
• Learn how a major paradigm shift in investing has created great new opportunities for investors
• What kind of investor are you?
• 7 key things every passive investor should know about an investment

About Our Guest

Hunter Thompson

Hunter Thompson, who was featured on podcast episode #133, Investing in Self Storage Facilities, is a full-time real estate investor and founder of Cash Flow Connections.  Since starting CFC, Hunter has personally invested in over 30 passive syndications and his firm has purchased more than $25 million of commercial assets in 2017.  He has helped investors allocate capital to over 100 properties, which have a combined asset value of more than $350,000,000.

His experience includes investments in self-storage facilities, residential mortgage notes, mobile home parks, single-family acquisitions, hard money loans, office buildings, and multi-family real estate syndications. In connection with these investments, he has worked with some of the most experienced and well- respected asset teams across the United States and Canada.

Hunter is also the host of the Cash Flow Connections Real Estate podcast, which helps investors learn the intricacies of commercial real estate from the comfort of their home.

More About Hunter

How did Hunter Got Involved in Real Estate?

• Hunter started in real estate investing around year 2008, a life changing season for a lot of people.
• Hunter was thankful enough that he was not heavily involved in equities during the collapse.
• He was very bullish on the US economy as a whole.  And he figured, because prices collapsed, he anticipated there would be great buying opportunities without really having a good signal or good understanding or market expertise.
• He was originally focused on stocks (that’s what he was most familiar with), until the European bond crisis.
• This was really the defining moment for him.
• Europe was struggling very similar in 2010  to what happened in America in 2008, with the stock market collapse.
• But what European bonds were doing, e.g. German bond yields and Greece bond yields, if they went below 7%, the Standard and Poor (S&P 500) was going to collapse.  He thought, this is impossible, that something that obscure, un-mitigatable, and unpredictable was going to play a significant role in his financial portfolio.
• So, Hunter started looking at ways that he could mitigate those risks, and a lot of this led to the simplicity of investing in real estate,  with its ability to provide cash flow, acquire leverage, favorable tax, etc.
• This led Hunter to his introduction to real estate.  It was really a  diversion from financial assets.

Hard Money Lending

• His actual first investment was a hard money loan where he would loans up to $60,000 on properties that were worth $100,000.
• Back then, you can get 11%- 13% interest rates over long-term debt for a 60% Loan-To-Value (LTV) fully rehabbed-property in a relatively non-volatile market, which is basically the risk profile of Certificate of Deposit (CD).
• Hunter was really blown away with what was possible when you get outside of the stock market and focus on more niche alternative investments.
• Hunter, being a successful entrepreneur and having a family in business, started with modest beginnings.
• The original investments started with friends and families.
• It has grew significantly, from a small family office, to a growing private equity forum, with 250 investors and $21 million in real estate, with a goal of $45 million of real estate in 2018.
• He was able to do this through syndication.

From Hard Money Lending to Multi-family Syndication

• Hunter’s first investments were in debt, for the main reason that he wanted to be as far from the asset as possible, knowing that if something went wrong with the loan or asset, e.g. toilet breaks, etc., you don’t call “the bank” to fix it.
• Hunter tried to find a way to separate himself from the asset and still achieve a return.
• He did invest in single family properties in the $30,000 – $50,000 range, with rents of $500-$700 a month.  But if you are investing out-of-state, (which he had to living in California), you net maybe $200 per property or $2,400 a year, and if something happened, (flood, A/C unit. etc.) you basically wipe out your income for the year.
• Looking at it at a proportional basis, the single family business is relatively a simple business in the sense that there’s none that big of a difference between a highly sophisticated operator-owner and a mom and pop owner.
• His real big “light bulb moment” was when he realized, for him, that he had the ability, through syndication, to invest in extremely complicated multi-moving-part businesses where there’s a lot of ways to add value.
• He found that, in commercial assets, there are so many moving parts that there is such a variation, such a delta between a mom and pop owner and a best in class owner, that you can identify those best in class owners, leverage their expertise access to capital and liability, with your investment capital, even if they are taking a percentage of the proceeds, you can put yourself in a very good position, without incorporating that time component — which is very important.
• Hunter started looking at investments that were uncorrelated with the overall economy or, at least inversely correlated with the overall economy.
• His goal was to “de-risk” and rely primarily on cash flow.  He wanted to sleep well at night, not worrying about losing his investment dollars.
• With a lot of research, invested in a lot if different asset classes.  But, one that really stood out as a driving factor, coming out of the recession, was mobile home parks.
• Mobile Home Parks is an asset class where the worst the economy, the more demand there is for the product.
• He didn’t want to buy his own park because the tenant base alone for Mobile Home Parks is very unique and there are many nuances to the business.
• So, Hunter looked for operators who specialized in this asset class, that had decade of experience and knew exactly what they were doing and had gone through this over and over, with a high level of expertise.
• This is on his very first syndications.
• His approach:
  • Identify an operator who is best in class in their particular niche
  • Leverage their expertise with his investment capital

Investor not Owner

• Early on in Hunter’s investment career, he chose not to be the person who put the deals together but, rather, to be the person who invests in those deals and let other people do all the work.
• But later on, a big part of his business was helping accredited investors to invest in syndications -from passive approach, to completely integrating with the sponsor and conducting significant due diligence.
• Currently, Hunter’s business is focused is leveraging the investor group with their sponsor expertise to provide passive investment.
• There is a spectrum of what they do as a company.
• Generally, they create a fund where there will be a General Partnership (GP) and Limited Partnership (LP).  Investors investing into LP will be the owners of the LP and partial owners of the GP.
• They will joint venture with the sponsors (the people overseeing the day-to-day operations). They are usually the ones signing for the loans and have with relationships with the brokers.
• They joint-venture with those companies and individuals.  They leverage their investor group with the sponsor expertise to provide them with a passive investment.

Classification of Investors

• In 2012, the U.S. Securities and Exchange Commission (SEC) created a law, Rule 506 (c), which allows for the public solicitation of accredited and sophisticated investors
• In a Rule 506 (b) structure, which has been around for a while, friends and families or people who knew each other, could market deals to each other.  No public solicitation allowed.  So if you have a pre-existing relationship with someone, you can say, “please invest” or “are you interested in investing in this particular security?” – which is not a “publicly traded” security.  There is a complete different set of risks that is associated with it as opposed to investing in a publicly traded security.  You can invest in this security of you are a a sophisticated or accredited investor.
• Two classifications of investor
  • Accredited Investor
    • $200,000 annual income for the last two years
    • $1,000,000 in net worth (excluding your primary residence)
    • If married, $300,000 combined income over the last 2 years or $1,000,000 in net worth (excluding your primary residence)
  • Sophisticated
    • If you understand financial matters to a certain degree
• Verification process is self-accreditation – sign a document saying that saying you are accredited and there isn’t any other level of scrutiny
• Rule 506 (c) Structure
  • Scrutiny level is much higher, and investors provide their financial documents to their CPA or a third party provider who signs the letter for them which basically says that the said investor is accredited and is allowed to invest
  • General solicitation and advertising can be used
• Hunter uses a third-party firm that helps qualify investors

Finding Good Investment Deals

• He he first started looking for good deals to invest in, there was a lot of trial and error in terms of reviewing deals
• You have to learn how to have access to these deals and how to review these deals, and if you review enough of them, you’ll get a good sense of the balance in certain things.
• Search “Real Estate Crowd Funding” websites, sign up and have access,
  • Not really to invest on any of these, because there is a big variance between a good and bad deal.
  • But, by going over these deals, you will have a good sense of what is good and what’s not
• What Hunter looks for in a good deal:
  • He does the typical property due diligence, but his main focus is on the sponsor
  • If the sponsor is good, then it’s likely to be a good deal
  • Incentive Alignment –
    • Sponsors – verify what claim the sponsor makes and their position on lifelong relationship that they build with their investors
    • Upfront fees
    • Risk of the asset class
  • What to look for in legal documents
  • What underwriting assumptions would be appropriate
• For Hunter, the whole focus of due diligence, as a passive investor, is to look at the sponsor.  “Read between the lines to see who you are betting on.”  You can invest in the highest quality of asset imaginable but if the sponsor commits fraud, investors will fail.
• How he does due diligence on sponsors:
  • First he determines who really is making the decisions in the ongoing management and control of the asset.  The people who can directly influence decisions are in the “sponsor” category for Hunter
  • He looks to verify the claims the sponsor is making
  • He looks at how the sponsor is putting himself in a position to build lifelong relationships with his investors
  • Specifics:
    • Background checks
    • Criminal checks
    • Flew back and forth across the country to meet the sponsor onsite.  Onsite is a great place to get to know a sponsor – 6-8 hours onsite, asking 100s of questions.  Asking questions more than once to see if they change answers.

Structure of a Typical Syndication Deal

• Typical structure, there is a preferred return between 6%-10% depending on factors e.g. the expertise of the operator, how profitable is the business, etc.
• Anything above is split somewhere between 50%-50% split or 80%-20% split. The 80% goes to investor and 20% goes to sponsor.  For a sponsor to earn the “split” or the “promote,” they need to bring expertise.  Expertise means a significant amount of background in the business, or a strong dedication to one particular area e.g. mobile home parks, self-storage, multifamily,  etc.
• They will use their expertise in time to validate their ownership of the some of the proceeds of a particular deal.
• Delineation between General Partnership and Limited Partnership on a Passive Investment
  • General Partners are sponsors and they are taking on all of the liability.  If it’s a $5 million loan, they have to have $5 million of funds that are liquid
  • Limited Partners are passive Investors.  They do not have the ability to make decisions on on-going basis and are extremely limited in their liability

Minimum Criteria/Metrics Required to Move Forward on a Deal

• $100 million in assets under management by the company offering the deal.  This is achievable by raising $30 Million of equity at 3 to 1
• With retail, one million square feet or more under management
• Are their principals involved in any state trade organizations?
• Track record – the number of years they’ve had in the business.  When did the company get started in relationship to the market cycle.  Have they have been through a recession?
• To be able to verify their claims that they make – e.g. pull the title on properties they claim to own, follow the chain of title to make sure that the entities that they claim to own are actually the entities that they own.  Call lender’s, insurers, construction companies, or any third party, to ask how many companies they have.
• Is the sponsor someone you can make a bet on for the next 10 years?

7  Key Things an Investor Should Focus on (in order of importance)

1. Sponsor
2. On-sight Manager
3. The Loan
4. The Pro-Forma and Property Performance
5. The Market
6. Property Specific Due Diligence (actual physical property itself)
7. Legal Documents

Biggest Mistakes

• Every year, Hunter wants to be a better investor.  He is constantly questioning himself, especially right now, given what happened to the market place.  It is really important to look in the mirror and what he is assuming are a lot of relatively significant successes
  • How did this go so right?
  • Is there something that could have done differently in the market place that could have resulted in a negative answer.
  • Could he have achieved similar return without significant cap rate compression that we have seen over the last 10 years?   What would those returns look like?
  • What would it look like if we invested now in a cap rate expansion similarly significant?
• Mistakes Hunter made have been rather mitigated in terms of the great market.
• Hunter experienced some principal losses prior to being turned on to syndication which was related to his investment in single family homes, not exactly principal losses but, basically, he just broke even.  What he really lost was lots of time and energy trying to clean things up.
• His real mistake was not relying on experts that are best in class.  He wants to rely on himself, in the sense that, with the thought that if he bought some single family houses, got a property manager and will make $50 a month would be a great real estate investment.  The problem is $50 a month is not enough to hire an absolute best in class experts.  So, he would much rather defer to people who are in the position to literally make millions or even tens of millions of dollars.  You can actually do that, but you don’t have to invest that much.  You can invest in those types of assets for $25,000 – $50,000, where the sponsor is a highly sophisticated individual who is in the position to make millions and can deliver their promises.  They have incentive to make millions for themselves and their investors.  Put $50k in a single family home vs $50k invest in a syndication

Biggest Success

• Self-storage is one of Hunter’s favorite asset classes.  Self-storage and mobile home parks are both presenting consistent opportunities on a regular basis.
• His biggest wins:
  • There were 8 properties that he recently invested in the self-storage asset class. Three (3) of these properties recently all sold at basically the same time to the same buyer.  The model was to buy these properties that were really under-performing on ancillary income, that were under-rents, and under-market in terms of occupancy.  Originally, they planned on holding these properties for 7 – 10 years.  These were purchased in 2013 – 2015, and all of them were sold in end of 2017 – beginning of 2018.  He was able to add U-Haul, leverage their relationship with U-Haul and allow to park their trucks in their facility to rent the trucks out.  They get a commission for facilitating the transaction.  That one line item went from $0 to $3,800 a month.  So, if you are looking at that on a cap rate basis, then that goes all directly to bottom line.  They did not pay anything for it, just implemented strategy.  You are talking about $750,000 value just for that one strategy.  So for all these properties across the board, they were literally able to add millions of dollars by using strategies similar to that and end up buying properties averaging about to 6-6.5 range and selling it in the 9.6 range, in average.  This ended up net of the split, resulting in 20% plus returns all to investors.  In his opinion, this is spectacular on a return basis but a complete home-run on a risk-adjusted basis.  Because they are not going in and developing units, they were not committing significant capital expenditures and exposing investors to delays and zoning requirements, etc.  It was just a matter of more successful management strategies.
  • However, part of that return is entirely due to cap rate compression, which, mathematically, cannot take place at this stage of the cycle, to the same degree.  If you see a 250 basis point cap rate compression, basically it is going to be below rate, which doesn’t make sense.  But, from an NOI perspective, adding real value to the income, that is what knocked it out of the park – that is what he focuses in — that is replicatable and it doesn’t rely on market conditions to the same extent.
• Hunter is looking forward to do more and the industry is providing opportunities to do so.

Advice to Audience

• First of all, there is a paradigm shift that’s taking place.  People are simultaneously becoming more comfortable with relationships that they have developed over the internet.  And, at the same time, there are also some laws changing that allow facilitation of this kind of relationship in a legal structure that makes sense.
• While this may be a relatively new way to invest, this is how wealthy people have been maintaining and growing their wealth for decades and centuries.  By pooling investors’ capital together, buying high quality commercial assets.
• Historically, before this multi-trillion-dollar change has taken place, the only real people that were able to experience these types of investments were the institutions.  People that had $5 Million+ liquid capital sitting in their bank account, that were able to invest a minimum of $1 million – $2 million to companies like Blackstone and Black Rock.
• Now, the paradigm is shifting because now, everyday accredited investors have the opportunity to do so by buying similarly quality institutional products and can rely on institutional quality sponsors, etc.
• Thus, Hunter suggests to take a look at the potential investments between above a typical family office (a high net worth family of $1 million plus and aren’t willing to purchase a $10 Million self-storage facility, and below the large institutions (who may have a $100 Million fund and aren’t willing to purchase less than a $15 Million property).
• Take a look at syndication passive investing as a potential investment.  It’s a great way to diversify and do it passively.
• As a passive investor, to change the strategy as the market conditions change.  As an active investor, you may need to for the sake of economies of scale, focus on one particular asset class.

Where He Sees His Business in the Future

• To continue to take advantage of the opportunities that are presented in the market place.  Hunter likes to be able to be nimble.
• Right now, he is looking at a lot of opportunities in mobile home parks and self-storage.  They have a fund that is $10 million committed and probably close the fund at $15 Million.
• To have 400 investors that are willing to build a lifelong relationship in the investment community to accomplish a magnificent staff in the industry.

How to Reach Hunter

• Website: www.cashflowconnections.com
• Email: hunterthompson@cashflowconnections.com
• Mentorship Program: www.cfcmentorshipprogram.com
• Podcast: https://itunes.apple.com/us/podcast/cash-flow-connections-real-estate-podcast/id1193877994?mt=2

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