Real estate can have a high barrier of entry because most deals require a lot of capital. This is a good thing for people who have cash because it reduces the amount of competition. However, this is a big problem for those of us who want to become real estate owners for the first time.
I remember calling a random bank during my senior year of college (in the midst of the greatest recession since the Great Depression) and telling the banker that my goal was to buy twenty houses or so. The banker was stoked and asked me how much cash I had available for such purchases. When I told her I had about $2,500 in savings, she laughed and then hung up. I was devastated!
I realized that I would need to cultivate investor relationships using my network if I wanted to achieve my real estate goals. I have been incredibly fortunate to find great capital partners (aka investors) over the past five years, and I have learned a lot about how to structure an agreement. Structure is important because it is going to determine how you get paid for all of your hard work and entrepreneurism. It is also important to structure deals appropriately so that you can get the right investors.
Related: How to Structure Syndicated Investor Deals: What Kind of Legal Entity Should I Use?
Below is the process I use when structuring my real estate deals:
6 Steps to Structuring an Investor Deal
1. Figure Out Your Goal for the Project
In a lot of ways, this can be the hardest step. The easy answer is, “I want to make money!” However, it needs to be more sophisticated than that because no investor is going to invest in a project whose stated goal is so vague. It is likely helpful to put each project into one of the following two categories: long-term hold or short-term flip. The time periods for each goal can vary. For example, a short-term flip for an apartment building may take two to three years, whereas a short-term flip of a single family house can take as little as 45 days.
The main point of figuring out your goal is to give your investor a sense of when they can expect a return on their money. It also gives you a foundation upon which to make operational decisions. For instance, if it is a long-term hold for an apartment building, then you are going to look for a tenant who will stay a long time, even if they pay a little less than another tenant. For a short-term apartment flip, it is important to bump NOI and so you are more likely to take a riskier tenant if they will pay a little bit more in rent.
2. Create a Property Level Financial Model for the Deal
A property level financial model just looks at the return that the property generates without regard for investor structure and payouts. I look at this type of model as a first hurdle because it gives me a sense as to whether or not I’m getting a good deal.
My property level summary sheet usually looks something like what is below:
Total Investor Capital
Stabilized NOI (Year 2)
Monthly Loan Payment
Annual Loan Payment
Free Cash Flow
Cash on Cash Return