Is Your Real Estate Investment Structured To Lower Risks While Increasing Profits?
One of my most prized skills as a professional investor is my ability to sniff out amazing real estate investment opportunities and then engineer creative and lucrative deal structures to lower investment risks while increasing investor profits.
While choosing a strong market and property are certainly important pre-requisites to a successful real estate investment, I view individual properties as pawns in a larger game of financial strategy; the financial and ownership structures surrounding a real estate investment have more impact on my bottom line than the sticks and bricks in the transaction.
I've simplified some of these strategies into sound bites to help you do this. Even though investing tends to be based on each investor's personal investment philosophy than universal rules, I call these sound bites "Hassle-Free Cashflow Investing Rules" .
Hassle-Free Cashflow Investing Rule: Buy what tenants want. It's a lot easier to purchase a real estate investment your tenant wants to live or do business in than it is to convince a tenant to want to live or do business in a property you already own.
In today's buyer's market, there are a lot distressed commercial properties that need to be repurposed to a higher and better use. The economic collapse of the community banking business model as well as technological advances in online banking have resulted in a slew of vacant bank properties and very few banking tenants looking to lease them.
It would be a bad business plan to acquire a vacant bank and try to release it to another bank. My partners and I recently acquired a vacant bank property we are converting to a Class A medical office building because that what tenants in this area are looking for. We started with the tenant and then located the property. My team brought the active management / sponsorship / development resources to the project and several of my clients provided the passive equity for the project.
Hassle-Free Cashflow Investing Rule: Start with a real estate investment business plan not with a property.
Our business plan is to purchase vacant (bank) buildings and convert them into medical office. Our real estate investment strategy was to identify a strong primary care physician group to be the anchor tenant and then go shopping for a desirable property together. The anchor tenant physician located a vacant bank building in a fantastic location where he would love to locate his business.
The property is on a major thoroughfare with good signage visibility, close to a hospital and in a large population center. These are promising attributes for any medical office, but there were positive attributes about this particular property that appealed to the tenant which I would have never thought of. First, the tenant needed a property that could easily accommodate ambulance access. Second, the tenant wanted a property in a "health professional shortage area" (HPSA) with a specific HPSA score that increased the amount of government subsidies doctor tenants in this building would receive.
If your HPSA score isn't strong enough you may have difficulty attracting doctors to your building and you may have to lower your rents to do it. HPSA scores change street by street based on census data. In effect there is an invisible line down the street that says "this property is more valuable as medical office than the property next door" because of where the line is drawn.
Hassle-Free Cashflow Investing Rule: It's essential for a prospective landlord to listen to their tenants and discover what they value most.
I steer new investors towards owning houses as their first investment because it is fairly intuitive to understand the amenities residential tenants will pay for and what they won't pay for (number of bedrooms, proximity to jobs, etc.). When you are in the world of commercial real estate, prospective tenants are fewer and their needs are more exact. Instead of starting with a property, it can be much more lucrative to go shopping for a property with a prospective tenant or buy a property with a strong anchor tenant in place and fill up the surrounding vacancies with those types of tenants who have a proven history of success co-locating with your anchor.
Hassle-Free Cashflow Investing Rule: For a real estate investment partnership to be successful each partner needs to offer a resource the other does not possess.
The basis of my value proposition to the primary care "anchor tenant" looks like this: "You become the anchor tenant in our multi-tenant office building and invite the doctors who receive your patient referrals to lease additional space. My team will put up most of the money as well as the real estate skills needed to purchase a vacant property, redevelop it into a large multi-tenant office, and then manage the mechanics of the property and a complex financial transaction.
We each bring something unique to the partnership and we'll co-own the property in partnership together." By partnering with my anchor tenant, I am 100% confident our building will have higher rents and a higher rate of occupancy than if I were trying to do this real estate investment on my own.
Hassle-Free Cashflow Investing Rule: Privacy can be a valuable tool in your real estate investment arsenal.
My anchor tenant physician located the property he felt was perfect for his practice. It became my team's job as the real estate professionals to negotiate a favorable price and terms with the seller. We put on our best poker faces and made sure the seller did not know the identity of our high profile physician tenant by writing the offer in the name of an entity controlled by my team.
It appeared the seller was distressed because the property was vacant and the seller's prospects for finding another bank tenant were slim, but if the seller knew who our tenant was our intended use of the property the price would have surely gone up. It was easier for my team to negotiate aggressively with the property seller because we were not as emotionally involved with that specific property, as our anchor tenant was.
Although we had a property identified and an anchor tenant lined up, there were still miles and miles to go before we had a viable project. It took a lot of time and resources for my team to develop financial forecasts based on rental income, operating expenses, redevelopment costs, availability and costs of capital, etc. It took months to create architectural drawings and use those drawings to entice prospective tenants to sign binding leases in our property.
It took weeks to get our building permits and change of use permits approved by local government. And then there was the financing! A huge risk in purchasing any property in this economy is the availability of conventional financing. A lot of banks that issue attractive terms sheets for commercial loans only to back out at the closing table, leaving you scrambling.
Hassle-Free Cashflow Investing Rule: Shift as many financial risks as possible from the Buyer (you) to the most motivated party in the real estate investment transaction (usually the Seller).
In our project, we were able to negotiate a four month escrow with the ability to extend the escrow an additional three months if required by our lender. We used this extended escrow to complete all of our pre-development activities. Architectural plans were drawn, leases were signed, permits were approved, guaranteed maximum price bids were solidified with our construction contractors, and we had time to shop the debt and equity we needed for this project.
Our long escrow period shifted all of our pre-development carrying costs onto the seller and more importantly we drastically reduced investor risk. In the event we were unsuccessful leasing the building during the escrow period, we structured the purchase contact such that we could cancel with no penalty and thus dodge the bullet of purchasing a vacant, unleaseable building.
We eventually closed escrow on the property without ever putting a dollar of earnest money at risk and all of our architectural fees were paid at closing after we'd raised all of the capital through syndication!
This business plan worked out well and I am grateful to have a strong team and partners to work with which is why I can write this newsletter with a smile on my face, but not every real estate investment is smooth sailing. I invest a lot of resources into real estate investment projects that never go anywhere; that is just part of the cost of doing business. As a professional investor, it is my job to forecast where the hurdles of each real estate investment might be and determine the probability of clearing these hurdles while putting the least amount of capital at risk.
Hassle-Free Cashflow Investing Rule: Novice investors will make mistakes and that's OK as long as you've started small.
A great place for new investors to start is the acquisition of like new construction, entry level single family homes purchased from a developer who offers a builder's warranty and investor-friendly terms is. The process is not complicated, you can do your due diligence while putting little or no capital at risk, and the opportunity to learn from the experience is high while the risk is low. This is more than a shameless plug for my homebuilding company that sells positive cashflow, like new homes with creative investor financing.
I really want you to take this paragraph to heart and not overextend yourself on your first few deals. When you are a new investor, your first few deals should be as simple as possible so you gain experience, confidence, and a positive track record to set you up for future deals.
As you grow and diversify your real estate investment portfolio into more complex transactions, consider becoming a passive investor in group investments with sponsor who can mentor you through the process. My first venture into medical office development was simply writing a check to another developer who did all the work and mentored me through the process.
You can read about real estate investing all you want, but until you've jumped into a deal with both feet, you're still a newbie who doesn't know what he doesn't know. If you want to lower your real estate investment risk while simultaneously venturing into potentially more lucrative ventures, let's talk.
I am a teacher at heart and I love mentoring new and part-time investors. If you are looking for a real estate investment to work hard so you don't have to, my team can also help you become more of an armchair investor.
Regardless of your real estate investment style. If you'd like help lowering your investing risks while increasing your real estate profits, please reach out to me and I'd be happy to help.
David Campbell is formerly a member of the teaching faculty of California State University Fullerton, Santa Ana College, Azusa Pacific University, and has taught on the eight day Investor Summit at Sea with Rich Dad Advisors Ken McElroy (author of ABCs of Real Estate Investing) and Wayne Palmer (Real Book of Real Estate).
David is a Real Estate Investment Strategist and he can be reached at: (866) 931-9149 or by emailing him at: [email protected]
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