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Rick Mazur: I have Brad shepherd on the podcast show with me today. Brad has been investing in real estate. It’s been part of his life since his college days.
He’s earned his undergraduate degree in finance with an eye toward commercial real estate, interning with one of the premier large commercial property portfolio companies in the Northwest. He purchased his first rental property within months of graduating college and quickly added several more. His experiences include managing hotel and vacation property, developing retail and hospitality space, and raising capital from domestic and international investors. He’s been exclusively focused on capital raising for commercial syndication since 2017. And on that note, good day Brad.
Brad Shepherd: Hey, Rick. Good day. Great to be here.
Rick Mazur: Everything’s going great.
Brad Shepherd: Absolutely. Yep. Life is good.
Rick Mazur: so. We’re talking real estate investing today, and I know you’re primarily focusing on passive investing through syndication deals. And I just want to take a quick introduction here
I know most people have heard about real estate investing in general but maybe not so much syndication.
So can we just first discuss, explain the differences between passive and active.
Brad Shepherd: absolutely. It’s one of my favorite topics because, yes, investors know how beneficial real estate can be to a portfolio; when they think about their options, it’s landlord, it’s flipping, or some REITs, right? They don’t, and lots of people don’t want to deal with the landlord side and all the hassles that come from that, or going out there and doing the fix and flips and dealing with contractors and paint and tile and all that stuff.
And so then I think about just REIT. Still, the syndications allow investors to participate directly in these real estate properties without being involved in their day-to-day management like a landlord would be. Even if you got a good property manager, right? You’re still going to have stuff float to the top, but I can tell you some current nightmare scenario that I’m dealing with a good property manager in place, but I still get the stuff floating up from the tenants and code enforcement and yadda.
So the syndications, that’s simply a fancy word that means group investments. That’s it. And you generally have what’s called an operator or a syndicator or a general partner. Those all mean the same thing. That’s the individual, or the entity is generally individuals who are running the show.
They’re the ones dealing with property management. They’re the ones dealing with the day-to-day stuff. And then we sit in on the limited partner side or the passive investor side, where we’ve simply provided capital to those general partners to execute this business plan, to buy this asset more often than not for us.
It’s apartment complexes or self-storage units, or mobile home parks. But, it’s simply putting your bet on the table and then watching the managers go, not unlike what we’re used to in the stock market, right? You don’t have to control yourself. You are what; you’re putting your faith in these managers to execute their business plan.
Same thing with commercial syndications. And so you’re not dealing with any drama. We use the phrase all the time, “hassle-free real estate,” and that’s what the passive syndications provide.
Rick Mazur: Basically, the idea is that while you could do it yourself and be the landlord, do all the flipping on your own and theoretically make a little bit more of a return. You’re also going to put a lot more of your time in as well. with the syndication
Brad Shepherd: Right.
Rick Mazur: deals, you’re going to make a very good return still, ideally, hopefully, but you’re going to be doing it more passively.
So it’s just you’re collecting the money, and that’s it. And you don’t have to deal with all the headaches.
Brad Shepherd: And yes, you might; I’ve done some fix and flips where we’ve hit it out of the park. We’ve done well. We’ve had some fixes and flips that have completely flopped and did horribly with those. And that’s provided a great capital for us that we’ve now deployed elsewhere.
And then the same thing on the rental side, we have some rentals that are pretty easy to run. I’ve got a fourplex in a town in Texas, just north of Austin, pretty simple to run C class, got good property management there. And then I’ve got a fourplex down in San Antonio. I don’t ever hear about it.
It’s a D class and a good property manager, tons of drama. And on paper, the returns look phenomenal in reality; it’s pulling teeth to get. Two or three of them to pay each month. So it’s, the returns, to counter piece that you said there, I looking over the last four years now we have done better the passive syndication that has a passive investor than even what I’m doing on the, on my portfolio of single-family, which, 1, 2, 3, or four-unit rental properties.
And doing better on the returns plus it’s hassle-free for me, it’s a win-win, it’s a no brainer,
Rick Mazur: especially if you’re a busy professional and
Brad Shepherd: right?
Rick Mazur: some extra capital, you might not want to run on the weekends and start fixing drywall and doing all that kind of stuff. So this offers another alternative,
Brad Shepherd: Exactly. That point, I shared it before we jumped on here that my family and I just moved from Texas up to Idaho our, one of our last weekends there, we wanted to go down and hang out in San Antonio for a bit. As we were down on a Friday night, a bunch of drama popped up at that one, that fourplex that I was talking about.
So I spent, instead of doing, hanging out with the family that Saturday like we had planned, I spent three or four hours over that property dealing with nonsense. And it just solidified for me why I want out of that.
Rick Mazur: no, I I get it, me too. I had a couple of them myself, and I’m, I’m personally, I’m just at an age where just let somebody else deal with that and Sure,
The general partners will make a little more, but they’re all; they’re also getting the loans. They’re finding the deals they’re dealing with the management company and all that stuff.
And we’ll talk about more of that in a little bit. What about, because a lot of people. They invest in the stock market. That’s the thing you do; you invest in the stock market, you’ll let your money grow. Theoretically. What are the differences between real estate versus the stock market?
Why would somebody, besides just passive investing, do real estate in general versus the stock market? Do you believe there should be an equal mix, or are you more heavily weighted towards real estate?
Brad Shepherd: I am certainly biased, and I am more heavily weighted towards real estate. I do have, as, a small stock portfolio, and it’s fun for me. I’ve got some in ETFs, automatic, automated investing, and I’d have another account to pick the stocks. That’s my play money.
And again, for me, that’s just the fun money. For me, real estate is much more, much simpler as far as the principles then—the stock trading, especially the day trading. I look at some of the graphs, and the charts that the traders and stock pickers are using go over my head.
And that’s on me as a finance major, right? Real estate is pretty simple. You buy an asset. The product is a place for people to live or a place for people to store their stuff, and they pay you monthly for that. And then. Over time, both the value of that property goes up while these individuals have been paying down your mortgage and providing monthly cash flow; it’s pretty simple stuff.
And I do having physical assets; it’s not theoretical; a stock can go to zero. I’ve had that happen. Early two thousand. I owned many Delta stocks, and they declared bankruptcy that stock went to zero with a piece of real estate. I’ve got a physical piece of ass of a physical asset that I can drive to put my hands on and say, I own this.
And if it burns down, I’ve got insurance these passive deals, if an operator ran away with the money or whatever, we still have this physical asset right here. For me, there’s just a lot of safety nets that come with real estate and the returns; I can be an index fund.
These passive investment deals beat the historical averages for the stock for an S&P 500 fund, or what have you. Yeah, you can go; maybe your audience has honed in on picking out some winners in the stock market. But for the average individual the general index funds, we can beat that on the passive side, passive real estate investing side as well.
Rick Mazur: Sometimes I feel like it’s not so clear cut because, for example, I was listening to a podcast the other day, and a guy came out with some, not an indicator, but some oscillator or something like that. That’s supposed to tell the difference between gold and real estate and oil and all that kind of stuff.
And they were talking about how, if you bought oil at the same time as real estate, 20, 30, 40 years, You would have done better just investing in oil and gold then versus the cost of buying a home. But they’re not really giving you the whole picture because I don’t know if you remember, but we certainly do because we trade it, oil went zero.
Brad Shepherd: Right.
Rick Mazur: So what are you going to do if you’re holding your oil? It’s just real estate that doesn’t happen. I Real estate can crash. It can go down, of course, but there’s a big difference between oil going from 60, 70, $80 to negative $10, which went negative, and real estate,
Brad Shepherd: Okay.
Rick Mazur: 30% or even 40% in the worst-case scenario.
Real estate. Again, not the be-all-end-all, but it is a very solid thing to be in, and I’m to skew my stuff more towards that as well. But what about the tax implementations? Because people say I can invest in an IRA, and it’s, tax-free it grows. So I think people need to keep that in mind.
What’s the difference between that and why would somebody want to choose real estate?
Brad Shepherd: Yeah, that’s a great question. And just real quick touching on oil, I just lived in Texas for the last ten years. And in that ten years, I saw several cycles. I have plenty of friends and family down in Houston. It’s a boom and bust cycle. And how would that be if you had a lot of money there, just a year or two before you went to retire, which, we all saw in 2007, 2008, so many near-retirees, their portfolios just got wiped out. We experienced a lot less volatility in the real estate scene. As far as the tax implication goes, the tax code is written very favorably to real estate investing.
That’s what the tax code is all about. It’s providing incentives. What does Congress want us to do? And apparently, they want us to invest in real estate cause they provide a lot of tax benefits. And suppose I’m doing this outside of a retirement account. In that case, there are a lot of tax advantages that can come through just investing in passive syndication like this, where there’s depreciation that all the investors participate in. So you’re getting monthly cash flow, you’re getting money in your bank account, but at the end of the year, you’re getting a K-1 that shows a passive loss.
And then, yeah. I’ve used my IRA, both my wife and me; we use our self-directed IRAs to invest in these passive syndications as well. And I’m not going to provide tax advice here. Still, you can hand that to your CPA, which could potentially offset a lot of tax liability, especially if you’re doing passive investing in other places where you’ve experienced a gain.
So you can do that. And that’s one of my favorite things to educate people about is, you’ve got your IRA. Most people are only familiar with the options available to them through a fidelity or Schwab account or what have you. You can take that same IRA and move it over to a different custodian.
We call a self-directed custodian that custodian can place in alternative investments, including real estate; I own a rental property and sold it six weeks ago. That is a Roth IRA. I owned a rental property inside my IRA sold that and had zero tax implications. So tax-free growth.
We use these ROTHS for these syndications as well. And let it ride so fantastic tax benefits. But whether you’re doing it inside or outside of an IRA, both options are on the table, and there are significant tax advantages. We could get into accelerated depreciation, which we do on all of our commercial real estate. We can dive into that if you want, but those tax advantages pass through to general and passive investors.
Rick Mazur: A lot of people have heard of REITs real estate investment trusts. And would you say that the only difference between investing in just a REIT or a REIT fund and a real estate syndication is potential bigger returns, or are there other advantages of why somebody would want to do syndication over just a regular REIT?
Brad Shepherd: Yeah. From what I have seen, we’ve been able to do better on the syndication size and go into a REIT as far as the return goes. I like knowing who I’m in business with. That’s one reason I do like real estate as opposed to investing in a mutual fund that I have to dig into the perspectives pretty deeply to understand what companies we’re invested in here and who’s running those. I like knowing who I’m in business with and where my, what my dollars are accomplishing. I like providing housing, good quality housing to people, or good quality storage units. What have you? And the big downside to this, as opposed to the syndications, compared to are, is liquidity; you can be in and out the same day, right?
A couple of clicks of a button. You can be in the investment a couple more clicks, and you’re out of the investment. These syndications are not liquid like that. They’re meant to be longer. The term generally holds three to five, maybe seven years for some. And so there’s a commitment there, and there, there may be some redemption opportunities where you can get your money out.
But by and large, you’ve got to plan on being in there for several years. So that could be a downside to some people. It’s a pro to others, but that’s something to consider for sure.
Rick Mazur: well, and with the REITs, you’re investing in a big basket. So you have to take every, you have to take all of their deals in the fund, correct. You can’t pick and choose, individually, if you like a particular area or different particular state that you want to invest in for the property or, and we’ll get into it in a little bit, the different types of deals that they have.
You don’t have that opportunity
Brad Shepherd: Yeah,
Rick Mazur: It’s not as flexible.
Brad Shepherd: Exactly right. Yeah. A REIT is they have their predetermined parameters, and you look at that, and you can take it or leave it, you don’t have a lot of flexibility in that with the syndications, you can choose your operator, where are they based?
Who, who are these principles? And then you look at the asset that we bring to the table. Okay. It’s a 300 unit multifamily, 1985, built apartment complex in a suburb of Dallas. Do you like that market? Do you like that business plan so that you can be much more selective in the approach?
Rick Mazur: why your real estate trust returns in some cases, maybe a little bit lower because you’re getting good with the bad, not the good with the bad, you’re. It’s a big pool of deals and not, everyone’s going to be a winner; you can’t
Brad Shepherd: right, yeah.
Rick Mazur: something for people to consider. Now, you had mentioned one thing investing with your IRA and that there were custodian companies that will help people do that.
Brad Shepherd: Yes.
Rick Mazur: that’s important to touch on because I think many people don’t know that now does your company, can your company assist.
That you have somebody, you could recommend for those custodian accounts
Brad Shepherd: Sure.
Rick Mazur: people in the right. Direction.
Brad Shepherd: Yeah.
There’s a lot out there. If anybody is listening, if you Google self-directed IRA custodian, you’ll find a bunch. And it comes down to, like most things in life, fees and service, So there are higher fees and custodians than fidelity or Schwab for managing that account because it is a lot more paperwork to keep track of.
These assets, as opposed to just a handful of mutual funds or whatnot. But yeah, so we have the ones that my wife and I we’ve worked with personally. There are a couple of others out there that I know of that some of our investors use, and we’ve liked working with them as well.
So yeah, we can certainly recommend some that we use quest trust out of Houston. Direct is another one that a lot of our investors use. It’s the letter U direct IRA. And those are the ones that your listeners can start with; yeah, an IRA is an IRA. As far as tax code goes, an IRA is A Roth. The difference is simply a custodian. We use that term. Self-directed, really to clarify, what does a custodian allow you to do? That’s about it. It’s not like there are different tax implications are different. These aren’t different types of accounts. It’s just a matter of whether that custodian only offers stocks and mutual funds or if a custodian will let you. The alternative assets, like real estate and others, other collectibles, or investment vehicles could be put into those IRAs as allowed by the tax code.
Rick Mazur: I think it’s important because if you’re going to go open up a stock brokerage account, for example, and you hear fidelity, or you hear TD Ameritrade, people are comfortable with that. They know the
Brad Shepherd: Right,
Rick Mazur: but when you start talking about let’s move my IRA over here.
Typically these are smaller companies that most people haven’t heard of before, and that they may be a for some people. And of course, you have to select the right company, but sometimes people are like, oh, I’m going to Google this. It shouldn’t be necessary, but they need to understand this is a very normal thing.
And there’s a list of a hundred companies. Do you know what I’m trying to say? So I figure there has to be a certain level of trust, especially if they’re coming to somebody like yourself, obviously, right?
Brad Shepherd: And, self-directed IRAs are getting more and more popular. They popped into the news last month in a big way, trending on Twitter. There’s not one custodian self-directed custodian out there that has the type of name recognition as fidelity or Schwab. Of course, there’s just not that same scale.
Recently I can’t remember what the magazine was, salon or vanity fair. One of those is a write-up on Peter Thiel and how he has taken his self-directed Roth IRA from a few thousand dollars, 20 years ago or whatever it was when they first launched PayPal. And there’s $5 billion inside of his Roth IRA that was only possible inside of a self-directed account.
And so when that piece came out, it was a hit piece. They were trying to say, look at how bad this guy is. And I’m looking at it like, holy cow, that’s awesome.
Rick Mazur: And the reason for that is because are certain things that you cannot do if it’s not a self-directed IRA, correct.
Brad Shepherd: right.
Rick Mazur: as far as the type of investments, you can get more alpha and return on your money.
Brad Shepherd: Okay.
Rick Mazur: But if it’s self-directed, then you’re able to do different things. I know even on the trading side, there’s options and futures and different things you can’t trade in a regular account
So it’s not a bad thing. What was it put there originally to protect people? Huh?
Brad Shepherd: Right.
Rick Mazur: up the self-directed part
Brad Shepherd: What he put in there was when they first launched PayPal, he put his founder shares inside of the Roth IRA, which meant that the tax implications the growth on that is going to be tax-free. Of course, we all know what happened with PayPal. He made millions, if not billions, on that.
And then, he used those dollars inside of his Roth IRA to invest in other startup companies. And he did fantastic with those. And again, you could invest in startup pre IPO founder shares using a fidelity or Schwab IRA account. And they’ll share it becoming became extremely valuable.
But inside of a self-directed account, you can
Rick Mazur: Okay. So lets in into it a little bit as far as more details, so what type of investors are qualified to invest in a real estate syndication deal? Typically,
Brad Shepherd: question.
Rick Mazur says, Hey, I’m looking at this, and sounds good. Let me see if this is for me.
Brad Shepherd: Sure.
Rick Mazur: What type of person do they have to be?
Brad Shepherd: Yeah, the tax code on this, or the sec regulations define two different for our purposes today, they define two different investment classes that we use 5 0 6 B and 5 0 6 C more often than not our investment opportunities are 5 0 6 C, which does mean that they’re open only to accredited investors.
And that means you have a net worth of at least a million dollars, not including your primary residence, or you make at least $200,000 per year. And you’ve been doing that for the last couple of years, with the expectation of that to continue. And so, those are the two most common ways that people qualify as an accredited investors.
We have to verify that; we have to honor those sec regulations, but with under a 5 0 6 C, we don’t have to know you. We can advertise, we can talk about it on the radio. We can talk about it on Facebook. We don’t have to have a prior existing relationship. And so, as soon as you come to us, you verify that you’re accredited you’re in.
We can put you right into the deal a few times a year; we do a 5 0 6 B offering, which means there are going to be it’s a few dozen 35 seats available for non-accredited investors. Those go pretty quickly. We like to do those here and there. They become a little bit more cumbersome.
We have to show we know this non-accredited individual we, we have a prior existing relationship. We can; we’ve had enough conversations. I know that this investment opportunity is suitable for this individual. So those opportunities do come, but by and large, most of these opportunities are available to accredited investors only.
It’s a shame, to be honest; this is how the rich get richer—a lot of money in these syndications. In the sec is eyes want to make sure that we’re not out there praying P R E Y preying on individuals who aren’t qualified, don’t have the knowledge or expertise to vet these deals properly, or could not withstand a loss. They want to push them more towards the public markets where there are more where these are called private placements. They’re not as liquid. They’re not; they’re evaluated, et cetera. So there are reasons why but it is how the rich get richer, kind of a tool.
But that’s why, like when we have those 5 0 6 B offerings, I can get some more folks in there who might not otherwise have the opportunity.
Rick Mazur: and I know it’s typically up to the sponsor is the person who’s bringing in the deal, but
Brad Shepherd: Okay.
Rick Mazur: This is why they wouldn’t offer all their deals to those 35 people. Is there a reason?
Brad Shepherd: It is simplicity. It can advertise and work with individuals that we don’t have a prior existing relationship. It can become it’s simpler at the end of the day. It’s simpler. There are those hoops that we have to jump through on a 5 0 6 B to make sure that we’ve taken steps to verify that we weren’t that this individual, this isn’t their last or only $25,000, right?
Or they’re only $50,000. If they lose this, going to go homeless. We have to take steps to ensure that’s not going to be the case, and we do have to provide proof of suitability at a different level than on a 5 0 6 C.
Rick Mazur: so it’s just more work, and you can’t open it up to every deal like that just for time, reasons, and
Brad Shepherd: Exactly as bandwidth.
Rick Mazur: It’s nice that it’s at least offered, like you said, in some of the cases to that point about somebody not having their last 25,000, let’s say somebody sitting on a nest egg of some money and they want to put in, is there a recommended amount somebody should put into any one deal of their net worth that you personally, either for you?
Or is it, let’s say somebody is sitting on, a million dollars they’re accredited, and they’re sitting on a million dollars. Is there a percentage that you would recommend somebody put into any one deal as a maximum?
Brad Shepherd: I’m going to go very broad on this because, of course, in your model, you want to make sure you’ve got your emergency fund. You’ve got your life insurance, your disability insurance in place, all those other things. You’re not,
Rick Mazur: course
Brad Shepherd: bleeding money on a house payment or car payment or a boat payment or whatnot.
But as far as that investment portfolio goes and a number that we get, we toss around a bit, 20 to 30% of your portfolio in real estate. That’s probably pretty safe. For me, again, I’m biased. And I go way above that. I have a portion in the public markets because I do have that strong preference for real estate.
I thought you were going to ask is what are the minimums; as far as the people can put in these deals, that’s going to be more operator-specific more often than not. They’re around $50,000 as a minimum. We have a deal right now; we’re raising right for that. We have a $25,000 minimum, so that can vary.
But yeah, as far as a percentage of an investor’s portfolio, assuming all the defensive postures are in place, then, at 2025, 30% percentage of the portfolio is pretty, I’d say it’s safe.
Rick Mazur: So if somebody wanted to go 30%, they had a million, just for example, for throwing the numbers out 300,000, and then you would recommend breaking that up. You’re not going to put 300,000 into one deal, right? You probably recommend spreading it around.
Brad Shepherd: do have investors that will put in large amounts like that with one deal with one operator. I like working with multiple different operators because, and being in multiple different deals, some of them will be home runs, and some of them are doubles. And so I like to spread them around a little bit, and I like having some geographic diversification as well.
So I work with operators. I partner with operators. One, for example, focuses exclusively on Phoenix. Another one focuses exclusively on the Carolinas. Another does Florida, Georgia, and Texas. And so I can get some geographic diversification in placing my money with different operators and deals as they come along.
Rick Mazur: you had touched on it a little bit in one of your other answers about the REIT being able, where you could just click a button and move your money out. So I want to talk since we’re talking more about syndications here liquidities in these deals, just so people fully understand them. They can’t just get their money back.
This is a long-term investment, so for example, the sponsor will say we’re anticipating holding for five years, and here’s the cash flow. Here are the distributions. What happens after the years? If they just say we didn’t keep it.
I’m asking because I don’t know.
I’m just like a listener like I’m saying, what do you do? Or what are your options?
Brad Shepherd: Sure. So there’s a contractual agreement in place, and the terminology we use it’s a PPM private placement memorandum. So when I’m first talking to a potential investor about a deal, I’m going to put in front of them the investment summary deck that’s a pretty presentation with all the nice graphics talking about here’s all the great things that can happen and why you should invest in this. And then they say, Hey, yeah, I’m interested. Send me the PPM. Now I send them that document. It’s 125 pages of legal ease, trying to scare them away. So that’s where we can sit down and review in detail what the contractual obligations and rights for everybody involved here are?
And that’s going to specify, Hey, that we’re expecting a five-year hold. And here are some opportunities where the general partners could choose to extend what those parameters would be. They could extend maybe for another 12 months or 18 months at a maximum. And at that point, they’d just have to sell the asset.
And so would look at the PPM for those specifications. What you’re, what we’re trying to accomplish in that PPM is giving the general partner some latitude to choose when is the best time to sell and not forcing their hand to sell in a downmarket after a windstorm came through and put the property in a bad state. Now we’re up against the gun to sell the property off too because of the PPM.
So we want to give the general partner some latitude to make good decisions. And most of our deals, when they’re a single asset deal, we’re projecting a five-year hold with how hot the market has been and how quickly prices are rising. It’s rare that we’re getting deals past three years because then an offer comes in and a fantastic offer. And the general partners, look at it and say, all right, this makes sense for everybody involved, let’s sell it. We’ve had one in and out in 18 months, and we all did fantastic on it. And so you’ve got that latitude, but we go in there with a mindset.
Let’s just put it away in our brain for five years. I’m not going to see this capital again for five years. It might even push out to six months, depending on what’s going on in the market at that point. And you just set it to the side okay, I’m not going to see that capital again for several years and just set that expectation going in
Rick Mazur: so it is outlined in the PPM essentially then.
Brad Shepherd: PPM is where all those parameters get paid when who’s the first in line, Cetera, et cetera. It’s all in that PPM.
Rick Mazur: And is there ever such a thing, or have you ever heard of such a deal where at the end of the five years, a general partner may say, Hey, look, we want to keep this thing for another five years, but we’ll allow you to exit if you want to, or you have the opportunity to keep your shares and keep cash flowing.
Brad Shepherd: Yeah
Rick Mazur: that ever happens?
Brad Shepherd: So they would have to recapitalize it at that point. Because the original PPM said, we have to dispose of it at this timeframe, but then they say, Hey, we could do a refinance on this property, give everybody their capital back. Those who want to stay with us could continue to do so under a new PPM and a new entity.
Rick Mazur: a new deal, essentially, a
Brad Shepherd: Exactly. And some are structured ahead of time. I know of several syndicators that work that way, where the plan is never to sell. Still, somewhere along the way, they do some refinances to get that original capital contribution back to their limited partners so that they’re still part of the deal and the returns come. Still, they’ve been refinanced out of that original capital contribution. And there are where that’s the plan going forward. Hey, we’re not going to sell this thing. We’re just going to refinance it and keep it for the foreseeable future.
Rick Mazur: I get the liquidity question a lot, and I want to ask you about something relatively new in the industry that involves tokenization. I don’t know if you’re very familiar with that.
I do have a deal that was brought to me actually about that. And it’s an interesting concept, but I just wanted to hear you explain what it is first of all, and then explain your thoughts on it.
Brad Shepherd: Yeah. You know what, Rick, I’m going to be a poor one to answer that one. I’m familiar with the concept of NFTs. And I know a fund of funds. They’re just about to launch here in the next six months, where a third of the fund will be tokenized. People are going to be able to invest it through crypto. So it’s happening; it’s going on right now. I don’t see us going down that path because it’s just not who we are. And again, I like simple, like tangible.
So it’s out there.
Rick Mazur: This company that brought me the deals, actually I think having a little bit of problem doing their raise because of it. And basically, what they’re just saying is that they’re trying to solve the liquidity issue for some people by saying, look, you’re going to go into the deal as a normal syndication deal.
At any time, if you want to sell your shares, you can sell your shares through the market, through the tokenization system. Whereas people can then buy, buy them from you in that fashion. But I, again, I think, like you said, simple, I think people are getting more confused by that whole deal, to begin with, but I’ve gotten some emails on it, and I just wanted to address it here.
It is very new; I’m assuming there are risks to that as well because now you’re dealing with it. You’re selling your shares to somebody, and you’re getting tokens or crypto or whatever it’s going to be. Again, that’s, it’s not something people might want to get into.
Brad Shepherd: With how heavily regulated these syndications are and how it’s going to come. But right now, the regulations around crypto and tokenization are pretty light to me. It doesn’t feel like they line up very well. And there’s so much volatility around in the crypto market still for me; I’m not a Luddite by any means.
Because it is an issue that the liquidity piece is a con when it comes to these deals, and it’s a problem. That’s, if people can solve it, great. I’m all for it, but I’ll be a slow adopter on that front.
Rick Mazur: And just because there is a market for it doesn’t mean it will be a very big market for it.
Brad Shepherd: Sure.
Rick Mazur: theoretically think you have that option, you might not get a, you might not get a taker if you’re trying to sell your shares on that.
Brad Shepherd: Right. Right,
Rick Mazur: So there is no guarantee in that regard until maybe years and years go by, and it may be, it becomes a standard.
Maybe it is who knows, but
Brad Shepherd: right.
Rick Mazur: Right. Now, it’s not there yet. So you decide, let’s say somebody decides they want to do a deal and they looking for properties. Can you talk a little bit about the different types of deals? There are yield plays; there’s a value add plays; there’s new construction.
What are your thoughts
Brad Shepherd: Whoa.
Rick Mazur: about the different types of deals? Are there deals that you particularly like better than others?
Brad Shepherd: Yes. And I can share; I was thinking about this one specific asset that my wife and I are invested in. We used her IRA dollars with a style or a business plan that we learned a lot on, and I’m not ever going to invest in that type of approach. Again, it plays into the liquidity plus the potential returns, but there are different approaches.
We let the majority of our deals are in apartment complexes, and then we also do self-storage and mobile home parks. And you can see almost all of these; we’re going in to do some turnaround., the jargon is value. Add where’s the value that we can go in there and contribute to this deal, whether it’s bringing, updating these units to current expectations of what the market’s demanding, and then raising the rent accordingly to match that.
Some of them are operational where mom and pop operators property managers haven’t raised rents in 7, 8, 10 years. They haven’t put in; they haven’t updated the laundromat. They haven’t put in the Amazon Amazon lockers or the dog park. We know we can go in there and input some operational efficiencies to increase the property’s value.
So we’re generally looking at value, add B, B minus type properties, maybe built mid-eighties, mid-nineties, those kinds of deals. There is a lot of money to be made on new construction. And I know some folks here in Boise, and the construction here is just going gangbusters, and they’re killing it 30, 40% IRR, but you’re going to be sitting there for two years, three years without any cash. That’s the trade-off, worth with the deals that we do. We’re buying existing streams of income month, one; we’re all getting distributions. And I do like that. Most of our investors like that; if you go into the new development, you’re going to have at least a couple of years, 18 months, at least where you’re not getting any distributions until those are properties leased up and stabilized.
The very first deal that we did, the one I was thinking about when we were talking. Illiquidity we went in strictly as a limited partner. When I first started thinking about, okay, getting back into the commercial real estate scene, how do I do this? I want to learn.
So I’m going to go in as a passive investor here, and it went horribly, and it was supposed to be. I think it was supposed to be originally 18 months. Four years later, we don’t have our money back. We’re waiting for the general partner to sell. And so it’s been a rough one, and we’re locked in.
We’re getting monthly updates, so he’s tried to tell us all the nonsense that’s gone on with this, but it was a deep value ad playing in a market. I shouldn’t have invested it. It’s about an hour and a half south of Houston. So it’s outside of the main population growth center, far from the coast.
And with the idea of going in and building several new unit buildings on this property, hurricane Harvey came through and wiped it all out. We’ve gone through three different property managers there. So insurance came into plays, bad zoning has come into play. The bad management has come into play, and it’s just been a perfect storm of nonsense.
And here we are four years later, and we still have our dollars locked in there. The protection is we still have that physical asset. We can still sell that what we’re. And we’re in a position there where the dividends are accruing. So when we sell, we haven’t been receiving distributions on those for the last two years, but when we’re, when it sells, those will be made up.
And so we’ll be made whole when it does sell it, but it is. Illiquid. And so we’ve just been sitting there waiting and waiting. And so, what we learned from that is no deep value. Add, get closer to the higher density population centers, value increases in places where many people want to live rinse and repeat.
Rick Mazur: talk a little bit about the value adds and things like that. People who don’t understand will probably hear terms about class, a class, B class C type of properties. Can you give us an overview of the differences between a, B and C? Do you like a particular type of brother better or not?
Brad Shepherd: Right class, a newly built, got all the fancy amenities. You can think of the fancy pool, probably close to downtown, or maybe the sub downtowns that are lots of Metro areas. It just feels nice, right? Premium rents., they’re new enough that there’s not an opportunity to go in there to buy those to turn them around to fix them up, to increase the value they’re already valued very highly. B class is where most of us would feel comfortable living there, maybe 10, 15, or 20 years old. And they’ve gotten, they’ve got the clubhouse, they’ve got some, the playground out in the area. Maybe they have some storage that people can rent as well. And then see.
It’s all subjective; you can look at it and see maybe the parking lot hasn’t been updated for ten years. It’s pretty cracked and ugly. And maybe some of the fixtures and the signage upfront are falling apart a little rougher neighborhood, whatnot. And so it’s not a war zone by any means.
And there’s a lot of money to be made, and they’ll see class properties. And most of us could also be comfortable there if we go in there and do some updating. So it’s, those definitions are very subjective. But we like the B minus C plus type arena where there’s an opportunity to go in there and do some updating and not; we’re not necessarily trying to change the classification, but optimize for that.
Rick Mazur: okay.
Brad Shepherd: Was that helpful.
Rick Mazur: Yeah. Yeah. That makes sense. Because like you said, there is B minus there’s they call them AB or BC. And you can do a lot of research online and on Google, or they can call you and, of course, ask you as well. So there’s just a general ballpark of people who have to understand what type of buildings they’re dealing with and the pitfalls.
I’m assuming. But there are differences in there. I want to go back for a second to the minimum investment. You had said that typically they’re around 50, but some are as low as 25, 35. Is that correct?
Brad Shepherd: right. The vast majority of our deals and that we see in the market are $50,000 minimums. We, we do have one deal we’re working on right now. It’s a fund it’s with a single multifamily operator. We’re buying five to seven assets inside of this fund, and because of the fund structure, it allowed us to be more flexible, and we were able to do it at a $25,000 minimum.
And, so that’s been nice. I’ve been able to get many people into that one that we’re more comfortable at that dollar amount, or just that’s what they had available. But yeah, by and large, $50,000 is the common floor.
Rick Mazur: and they could invest more if they wanted to. Of course, but that would be the minimum,
Brad Shepherd: Yes, please.
There’s a cap. There might be like a $3 million maximum just for various reasons. There’s generally a cap, but yeah, the 50,000 is the floor with the option to go anywhere between that floor on the cap?
Rick Mazur: and you like those self-storage units. Huh?
Brad Shepherd: Yeah,
Rick Mazur: 30 years ago, I saw self-storage units pop up, and I’m like, geez Louise, what a gold mine. I didn’t have any money.
Brad Shepherd: Yeah,
Rick Mazur: I wanted to build on my own.
Brad Shepherd: right.
Rick Mazur: this is unbelievable. I didn’t have any money. Is there still an opportunity there through syndication to make money with the cause? I have not done anything with it, but now that I’m seeing that they’re doing it and syndication deals, I may look into it.
Brad Shepherd: Yeah. We partner with a called reliant. They’re one of the top 20, as far as unit count self-storage operators in the country. And we’re doing fantastic. That
Rick Mazur: really.
Brad Shepherd: yeah, where we’ve been really happy with having our dollars and our investors in those as well.
It depends on the market. In some markets, it makes more sense to be the one to go out there and build, in just like mobile home parks and with self-storage, there’s a lot of mom and pop operators and, they’ve got 200 units, and they’re collecting checks every month. 200 tenants
Rick Mazur: right.
Brad Shepherd: it’s, okay, there’s lots of room to go in there, and Hey, let’s put in some security cameras, let’s put in some features here.
Let’s make it so people can pay us through a monthly debt auto-debit. What has you, to go in there and turn it around, add some nice features. Maybe we do some HVAC control, climate control. And yeah, there’s just money to be made, especially when you can find the mom and pop operators that are looking to sell.
Rick Mazur: All right, this next question. It could be a little confusing, but I want to address it because, again, we have had this question before, and it can be a little complicated for people. Can you talk a little bit about cap rates? What is a cap rate? First of all, purchase cap rates reversion cap rates, which is typically your exit cap rate and what those should be at, what the differences are, what somebody should be looking for in those regards.
Brad Shepherd: Sure. Yeah, that’s a popular discussion topic right now because cap rates are so low, which means you’re paying premiums for properties to find out a cap rate is a function that is the commercial world’s equivalent of getting an appraisal on your house there where you’re determined.
Your value is determined by what’s going on in your neighborhood, what your neighbors had done to their houses, and how well they negotiated the sales price. So the cap rate. It’s simply what is the average property, similar property in this market going for? So you would talk to a commercial broker, okay, I’m looking at C class in this neighborhood; what is the cap rate in that area?
Commercial deals are valued by how much money do they earn. The net operating income brought in this much revenue after all your expenses; you’re left with this much leftover, multiply that into your cap rate. And that cap rate is a function of determining the value of that property, unlike your single-family houses, which were determined by that appraisal based on what your neighbors have done.
Now, what is that asset market value? What could we sell that for today? And. If it’s small, the lower the cap rate, the more expensive the property is. And so that can be something to look for the underwriting of the deal is, sometimes operators will say, Hey, we’re going to buy it at this cap rate.
So let’s say we were going to buy it at a five cap. And then, at three years after our turnaround, we’re going to sell it for three caps. Yeah. That’s a pretty big leap. Why do you feel like you can buy it for five and sell it for three? What’s the justification there. Do that’s projecting a really hot market.
And we do generally see that we’ve got a better exit cap rate because we’ve done some turnaround on this deal, but a three to five, that’s a pretty big or five to three. That’s a pretty big leap. And so it is; it’s not something that you can Google or look up. You have to talk to commercial brokers in the area who can see, okay.
That, that last deal that sold. It was, the NOI was this, and the sales price was that. And so now we can determine the cap rate, look at that sales history to determine that, and then we can use that cap rate as we’re evaluating the deals and whether upon the purchase or the exit.
Rick Mazur: You’re leaving it up to the syndicator, though, and I think the question becomes when they’re giving you a prospectus of the deal and they’re estimating what your IRR is, for example, your internal rate of return or your cashflow. They’re probably projecting that off of exit cap rate
Brad Shepherd: Absolutely.
Rick Mazur: cap rate. So if they’re off in the cap rate, that’s going to be off. So you don’t know nobody’s going to know; it’s not like it’s not an exact science. I’m not trying to say these people are trying to trick anybody or anything like that. It’s just; you have to be very aware of that when you’re looking at the deal and saying, Hey, I’m buying in this area, and I could potentially get a whatever 15% return, whatever the number is. But if that cap rate, as you said, five to three is in there, it may be a little bit too much of an ask for, for it to be reality.
Brad Shepherd: When you’re underwriting any of these deals, many assumptions must be made, right? You see some that will write really aggressively, the business plan is to go in there and update from the Formica countertops to the granite install, the backyard patios, the dog runs, then the Amazon lockers or what have you. It’s not an exact science, but we want to go in there with very conservative assumptions.
And they say, now by doing so, we can increase the. Each month by 200, $250. That’s a pretty big jump, 250 bucks; I’d like to see somebody who’s underwriting. What, if we can increase, what if we could only increase the rents $50 a month or a hundred dollars a month?
Why do you think you can jump $250? That’s a pretty big leap. So those are the areas you want to look at; what are the assumptions that they’re making? They’re telling you, they’re going to buy it at a five cap, sell to three caps again at a that’s a pretty big jump.
What are those assumptions? And that would be somebody doing 200, 250, $300 rent increases. Can you do that? There are only so many expenses you can trim. So, where are you going to make up that revenue? So it’s those conservative assumptions I guess I should say those can make or break a deal.
We want conservative ones,
Rick Mazur: so with what you do, for example, you’re trying to raise the capital for these deals, and will you walk through with potential investors, like a particular deal, and say, here’s the deal. Here are the pros; here are the cons. Here’s what I think about it.
We work with them on that, or is it just basically like here’s an offering. Here’s what we offer. I want the audience to get a better feel for what you’re doing to help them decide to get into the deal.
You can’t promise anything. I know you’re not an advisor or anything like that, but
Brad Shepherd: Yeah. My job is vetting the sponsors first, sure that these individuals, these groups, these entities have the track record, have the experience, have the teams in place do what they say they can do. So So I’m vetting sponsors. Anden as they have deals that come through, I’m also vetting that deal and the sponsor; I know they must go through that apartment complex or that self-storage unit by unit, not just a sampling, they, I want them to go through every single apartment in that complex.
And they do as well. Any operator we work with does, and then we’re getting an idea of the budget to turn these things around? And that’s just part of the due diligence there. And for most of these deals, I’ll also fly out to the property, walk through it, with it, with the general operators based on the day I’m there.
I might be able to walk through a handful of the units as well. But I’m going out there and seeing this is the asset that we’re buying. Now I can turn it around to our potential investor that we work with through Sugarhouse investments to tell them about the operator, what the business plan is what that deal looks like.
And yes, get into the weeds with them a little bit. I drove next door to the apartment complex, which in that sense is a competitor, talked to those people, did some ghost shopping there, told them I was interested in a unit, got their floor plans and their market rates, and can see, okay.
They did some updating three years ago, and they’re getting this much more rent than the property across the street that we’re going to look into buying, so I can start doing some of that comparison as well. I can take that back to my investors and share—that type of insight with them.
And so that’s my job. And the value that I bring is that pre-vetting. And that’s what we call them. We pre-vet these hassle-free, hassle-free real estate opportunities.
Rick Mazur: okay. Cause people might not understand that, especially if they’re new to the game, like that. So you’re not listing them on your website to begin with until you’ve gone and done all this work. And then if somebody has a follow-up question about one of the particulars that they may have a concern about, they can discuss it with you and
get your feedback on it.
Or if it’s, something’s not clear or whatever.
Brad Shepherd: Exactly. Exactly. We’ll do it. We’ll do a conference call with the operators. Most of our deals are monthly, but some of them are quarterly reporting and financials and distributions, and at any time, I can jump on the phone with one of my investors to go through what’s going on in the property; COVID was a busy 20, 20, it was a lot of questions.
So there were lots of times where we were jumping in to answer questions about occupancy and delinquent rents and renters that just skipped out on their leases. And we were having those conversations, yeah, that’s my job to once we’ve got this deal in place, my exclusive focus is on the investors, which is what I love.
And so call it investor liaison, investor relations. What have you, but that’s, I’m meant to be that guy that these investors can turn to anytime with questions.
Rick Mazur: Part of the reason that I think people try to do these deals by themself is, let’s say you’re buying a single-family home and you’re going to flip it, and you do the closing, and you have the physical asset, you have the keys, you can go you can change your mind if you want to or not.
But more, more importantly than that, you have something that you’re like, Hey if I want to get out of this, I can go and sell it. I know I have it. It’s here. Like it’s 55 Wilsher street, whatever it is with these syndication deals. I think people are a little hesitant because they’re turning 35, $50,000 at a minimum to somebody, and they don’t know who these people are. Is there a way that I want people to understand? These are legal documents. So to walk through what typically happens, is there a, what an LLC formed for each deal is that typically the way it
Brad Shepherd: That’s the most common. Yes.
Rick Mazur: Okay.
Brad Shepherd: Yeah.
Rick Mazur: to give your money.
But again, it’s one of these things. Who am I giving mine to? You know what I’m trying to say, you have to get this question before. How do you address that with people to alleviate that concern? Because I want people to understand it’s a legitimate thing. It’s not like some scam or anything like that, but there are bad players in every market, but how can somebody go about getting to see that they can at least make sure they’re putting their money in with somebody who isn’t going to fly off in the middle of the night?
That’s, I think, the real concern.
Brad Shepherd: That’s a great question. And in my personal experience, I’ve only seen one bad actor operator space, and it was there in Texas. It was a small deal. I think it was a 30 to 40 unit apartment complex; five or six people put their money in there.
Not big enough to have professional property management, the guy who was the lead on it ran off with a bunch of the cash. Others who were intended to be passive investors suddenly had to step up, finished some portion of the business plan and got it sold to recover just their capital, and forgot about any positive returns.
They just wanted to get their original contributions back out. So that, that one I saw, I just felt horrible for those people looking back. I knew that guy, and I knew that operator, and I had looked at him as maybe a property manager for some of my rental units. So I was shocked.
But that’s why I like the bigger deals that are they get into the professional aspect. The professional realm we’re talking about. Not, it’s not just some Joe blow guy. Who says he can put this together. It’s an organization. It’s an entity. There are acquisitions. There’s the accountant.
There’s the CPA. There’s the sec attorney. There’s the in-house attorney. What have you? And then when you’re talking about 150 unit, 200 unit property, those are large enough. Excuse me. Those are large enough to have professional property managers in place. Many property management companies we use are listed on the stock exchanges, and your audience may be familiar with some of them.
Large organizations. That’s what they do. They do property management. So it’s a different level of visibility than what you could get in a fourplex, two Plex, eight Plex, 30 Plex. What has you and at the end of the day? Yeah. You, there’s some trust to be put that has to be earned.
It would be so scandalous and visible for any bad actors in these types of deals where they’re this large and this many; there are 50 or 60 investors in each one of these., it would be really hard for anybody to get away with anything.
What you’re looking for is can this group execute the business plan? I’m more worried about that than them trying to run off with the money. I’m just more. Are they going to make mistakes? Which mistakes are they going to make, and how badly? It’s more about their skillset than how they could get away with running off with the cash?
Rick Mazur: and what do they give you? Let’s say, so you go into a deal like this, is there a portal? Do they give you, for example, do you see the closing documents? Do you see proof that the property is actually? I’m just asking. I don’t know. I’m saying just thinking of questions off the top of my head.
So that somebody could be assured, like, Hey, we acquired this property. Anybody can get on a webinar and say, yeah, we closed. We acquired the property. Who’s to say, I.
Brad Shepherd: The answer is yes, there is a portal. That’s where we house all the documents. That’s where people can see their returns. The monthly reporting that gets put there, the financial documents get put there. As far as seeing the closing documents, I’m, I don’t think so.
I don’t know that’s the case. I don’t think that’s there, but these are securities that securities attorneys write up. So you see the entity name, who the attorneys are, that are involved, that PPM, the legal ease there. That’s the contractual obligation.
And has their copy of the securities paperwork, which is that PPM. It shows you what the entity is, what the bank account is. That’s where you’re going to wire the money. You’re not wiring the money. The operator’s direct account, you’re wiring into this entity that was just formed to purchase this asset into that bank account.
And then, from there, you’ve got enough visibility into the operations of that asset that provides me comfort. There’s not that pool of cash that’s just sitting there to be mishandled. It’s now deployed into that asset. But yeah, obviously, there’s some level of trust.
Rick Mazur: And so part of the reason for that too, and this is actually to protect the limited partner, would typically correct me if I’m wrong. There are typically two different LLCs. There’s an LLC set up for the limited partner, and then there’s a separate LLC for the general partners. Isn’t that.
Brad Shepherd: No. It is a
Rick Mazur: It’s the same. Okay.
It’s a single LLC, okay. Oh, it’s different classes. Okay.
Brad Shepherd: right.
Rick Mazur: Okay. So Yeah, no, again, real estate syndication is a real thing. Most people are legitimate in it. I’m just saying we get these questions a lot from people, guys, busy professionals, or we do trading and things like that.
I got an extra 50 grand here, and I want to invest in what should I do? And then you start talking about it, and they’re like, yeah, but what about, I don’t know who these people are, it’s a common question. And I think people have to get over somebody like you, who’s done many of these deals.
It’s a no-brainer. You’re just like, Hey, this is, why didn’t I discover this sooner until you can get over that hump? It’s a little bit of a leap of faith, but the potential reward at the end is also worth it. Obviously
Brad Shepherd: you an idea. Of Who some of the players are in many of these deals that we’re trying to win, and when we’re going out there, and a commercial broker has listed this property for sale, we’re going in there with our bid, trying to win. And we’re going up against a hedge fund or a private equity firm that is also looking to purchase this asset.
And that’s who’s involved. And then frequently the buyers, when we execute the business plan, we’ve completely optimized. This asset, which likes to buy already optimized assets, is the REITs and other hedge funds. So that’s what we end up selling to because they like this. Yeah.
They don’t want to go and do a rehab turnaround. They want, we were looking for a 15% IRR. They might be looking for a seven or an eight, and we can turn that asset over to them at a seven or an eight because we’ve already completed that value-added work. And that’s, those are the institutions that happily pick up these assets on the backend.
Rick Mazur: that’s interesting. That’s interesting. To me, a little bit about capital calls.
Brad Shepherd: Never had one pray and prayed that never to do it
Rick Mazur: Why because you see those in a lot of the deals if they’re in the event, there’s a capital call, and everybody says that they’ve never had one, I guess it’s just, they’re putting it In there just in case they need more funds or if they did, how would that work? For example, typically in the PPMS, how is it structured?
Brad Shepherd: In the syndication world, if something had to go wrong for a capital call to happen. I would look at that as a black mark, against an operator, either in their skillset, projections, assumptions, or ability to execute the business plan. It shouldn’t happen that is part of the capital raise. We’re raising funds to acquire the property, as well as the projected budget, what it’s going to take to turn that property around.
That said, there may be some legitimate reasons, even that first one that we’ve been involved in, and it’s gone so horribly wrong, the general partners there are well-capitalized. And that should be sufficient. And there should never be a reason to need the limited partners to contribute more cash. It just shouldn’t happen.
And so they’ve been able to weather that storm. We’ve never had to put more money in to protect our investment. It’s in theory; it could happen. It just really shouldn’t.
Rick Mazur: Yeah.
I was going to say, because if you’re a general partner, especially if you’ve done many deals in the past, the last thing you want to do is go to your investors with capital. You’ll come up with some other way to get the money. Probably I would have assumed that you would do that only as a last resort, right?
Because certain people won’t feel great about it, especially if it’s not commonplace.
Brad Shepherd: Me personally, Brad and my wife, if that were our experience, yep, I’m not going to working with that operator again. And I
Rick Mazur: it’s important to get in with somebody good. Who knows how to vet these deals and works with high-quality people like yourself, and then get comfortable, do a deal, maybe two deals sit with it for a while. And then once you become to trust the sponsors and the people that you’re dealing with, you’ll feel more comfortable with doing that
Brad Shepherd: Right. Right.
Rick Mazur: The general partners are bringing some or a percentage of their own money to the deal. In other words, you want them to have some skin in the game. Is there a typical percentage that you would look for in that regard? Do you care how much they’re bringing?
Brad Shepherd: Yeah, it’s a good question to ask. The general partners should have some skin in the game of their money, not just what they’re going to get off of the asset or the acquisition
Rick Mazur: fee
Brad Shepherd: Sometimes they can sneak it in that way, but what are they contributing as part of their funds?
Yeah. I don’t know that there’s a percentage worth benchmarking, but if the minimum for everybody, else’s 50,000. I don’t want to see that the general partners, key principals, have a hundred thousand, 150, 200,000 in there of their own money as well.
So enough that they’re in it, they’re stuck in it as well, riding alongside right next to the rest of us.
Rick Mazur: and what do you mean by the statement that you made about? Getting it back on the back end is typical during the closings; they will typically get a percentage. And if you’re backing that out of what they’re putting in, they may put into two million or a million, but they might get a million back at the closing, and essentially, they have nothing in.
Brad Shepherd: Right. Exactly.
Rick Mazur: What about when you take some of the money raised, but there are typically loans on the property. If it’s a value-add property, is there a particular thing that somebody would look for in terms of, say, we expect a hold time of five years? Still, there’s only a two-year loan that they’ve gotten from the bank, and then you worry about them being able to refinance it and stuff like that. Is there any sort of, that you would want to look at in terms of, are those loans in place already before you do the deal?
Or how do you personally look at something like that
Brad Shepherd: Yeah, that’s a good question; by the point that we’re out there raising capital, the loan terms should be agreed upon, but we’re working, the down payment, right? In reality, that’s what this is.
We’re all raising the down payment. So that loan isn’t in effect. Yet once we raise that down payment, we get to the closing table, documents are signed. Now the loan is in place. That’s the lender who has loaned maybe 75 to 80% of the purchase price. And we’ve come to the table with our 20, 25% plus the capital budget to do the value add play. But what are those terms? We already know the terms while we begin raising. And so if somebody has got, they’ve got a five-year project, but on their loan that is only good for two years. Yeah. I’d be asking about that. It’s not uncommon to get these deals with interest-only loans for three to four to five-year periods.
And then they switched to typical amortization and, that’s, that can be beneficial, especially when you’re talking about, we’re only going to be holding this thing for three to four to five years. We don’t need to be worrying about paying down the debt.
Let’s optimize the cash flow while we’re doing the rehab project. And so that’s pretty common as well; it should be pretty clear and disclose what those loan terms are and what happens when it does convert to now we have to start paying principal as well. And what is that going to do cash flows at that point?
They’ll be in that projections; there should be a clear table investment summary of when those things kick in. What does now, what is that annual, or what does that annual return look like at that point? But yeah, making sure that those debt terms are favorable is certainly a worthwhile conversation to be having.
Rick Mazur: And would you be looking more favorable on a deal, for example, all things considered, if let’s say the loan to value that they were borrowing was more along the lines of 50, 60, 70% instead of 80%, or does it matter?
Brad Shepherd: It’s, pros and cons it’s if it’s 50, 60% where’s that extra portion coming from, meaning are the general partners putting that in? Is it, does that dilute the rest of our own on the limited partner side? Because we have that many people involved. What has your pros and cons there? Of course, a big pro being that we’re, it’s, we’ve got that much equity going into the deal and protect us from any downside, any in the market.
So it, I would say, evaluate that asset by asset and understanding where those are coming from. Why are we putting in that much money when we don’t do what we have to? And what is that going to do to everybody’s equity?
Rick Mazur: That’s a good point that you mentioned. Because I want to be clear to people too, so when you’re investing in limited partner shares, you’re typically not buying a percentage of a hundred percent of the deal, Right. Typically it’s a split with the general partners. The general partners are getting a certain percent, and then you’re getting a certain percent for your That’s the difference between the class, a class B shares, or however they split it
Brad Shepherd: Exactly. So of that LLC that was created for this deal, the general partners might own 20% or 30% of it. And then the limited partners are buying 70% or 80% of it, depending on how that The investment summary is going to say that as well as the PPM. So generally, the really common scenarios are 80, 20, or 70 30.
And then there very well may be different classes of limited partner shares that can play to limited, passive investors desires for more predictable, steady cash flow, or maybe more exposure to the upside when the property is sold. And so there can be differentiators just in that limited partner set as well.
But again, all that is spelled out clearly in both the investment summary, the pretty version, and the detailed terminology of the PPM.
Rick Mazur: So a few more things I wanted to touch on here. And one of them is this term that comes up all the time—cost segregation study.
Brad Shepherd: Yes.
Rick Mazur: How important is that? And what are your thoughts
Brad Shepherd: A big one, and that’s important. All of our operators do those. So it just boils down to depreciation, right? These are physical assets that the IRS has stipulated can be depreciated over time; like many properties, you’ve typically got like a weird number, 27 and a half years of this house or this apartment complex can how much, what, how quickly it can be valued down to zero.
Cost segregation is; it’s an engineering report. An engineering firm goes in there and looks at all the various components of this property, the HVAC systems, the flooring, the gym, the roofs, and some of those can be depreciated. What portion of it and how quickly that can be done.
Faster timelines than 27 years. And that’s so the cost segregation, that’s the name of the study that the engineering report will tell you what portion of this property can you depreciate on different timelines? So then we call that bonus or accelerated depreciation, and then what does it increases passive losses in those, in short, holding period.
So if in years 1, 2, 3, 4, and five, while we own this thing, we’re taking advantage of that accelerated depreciation. We’re getting the monthly cash flows, but we get that K-1, that income statement that generally shows a passive loss at the end of the year. Our portion as that
passive investor, what is my portion of that accelerated depreciation that I can then take a passive loss against? So it’s just the cost. Segregation is simply a way to capture higher amounts of that depreciation more quickly,
Rick Mazur: So do they give you these reports at the end of the year so that you can use them for your taxes, and do all sponsors do them?
Brad Shepherd: not every sponsor does them; every sponsor I work with does what we make the. We can make that engineering report in that cost segregation study available to anybody. But where that shows up is on the K-1, all of the investors receive. So that’s the tax statement, that’s the statement that you would take to your CPA as they’re putting together your tax return at the end of the year, that K-1 is where your portion of that accelerated depreciation would show up.
Rick Mazur: If a particular sponsor does not do the cost segregation studies, number one, would you not do a deal if they don’t do the cost segregation?
Brad Shepherd: I don’t know that’s a hard line in the sand, but I, I can’t imagine why they wouldn’t do it. They’d have to have a very good reason as to why Noah.
Rick Mazur: Cause you said not all of them do
Brad Shepherd: they’re expensive; they cost 7, 8, 9, 10, $15,000, depending on the size of the asset to, to do these. And so if it’s a 200 unit deal, it likely makes sense.
If it’s a 60 unit deal, it’s not likely to make sense to do one of these studies. So it has to have the scale involved, and it’s simply a matter of, you’re going to get better tax treatment showing up with, with this significant passive loss. And again, depending on your scenario, do you have passive gains offset?
And if that’s not important to you, then maybe that’s not a hard line in the sand.
Rick Mazur: but you want those tax breaks, right? That’s part of the reason why people do this. So if they don’t provide this, the study will probably cost you a lot more because of you or your accountants. Cause somebody will have to go through these documents and determine how to write it off themselves, correct?
Brad Shepherd: No, really, you’re just going to get that K-1 will tell your accountant everything that they need to know about this investment vehicle, that you’re, you’ve put your money into that. And the general partnership for this entity has already done the depreciation bank made for that asset, whether that, whether there is a cost segregation study done or not, that’s going to be a reflection the K-1 So theo the only thing that your accountant has to do is input that K-1 into their software. It’s just a matter of, do you want that K-1 showing a gain or a loss, and if you’ve got other passive income, Hey, it’d be nice to offset that with some passive loss as
Rick Mazur: Right,
Brad Shepherd: Not everybody has passive income. But that’s and, there are other ways you can use that if, for example, being a designated estate professional, and that’s a topic for another day
Rick Mazur: right.
Brad Shepherd: active income with passive losses, that’s powerful. But it’s a very individualized scenario.
Rick Mazur: So then you’re going basically to get a K-1, and it’s going to say essentially, here’s the distribution you got for the year, and here’s what you can write off.
Brad Shepherd: Exactly.
Rick Mazur: net, net, this is the loss of your game,
Brad Shepherd: Exactly, you got it. Yep. It should be a pretty simple statement that your accountant knows exactly what to do with.
Rick Mazur: Okay. Somebody looks at a deal. They’ve considered all these things. They’ve decided they’re going to sign. They signed the PPM. Assuming then they send the funds, what am I doing now? I’m waiting for the close, or what do I do at that point?
Brad Shepherd: Yeah, it’s a sit back and watch the money come in at that point,
Rick Mazur: Okay. Do you hope?
Brad Shepherd: exactly.
Rick Mazur: Yeah.
Brad Shepherd: Well, we’re buying the cash-flowing asset. And so there is going to be cash coming in from if we close. On the property, June 10th, the first distribution might be September 1st, right?
As you get that first partial month, and then a complete month is done. Now the distribution starts coming in every month. Some of our deals do quarterly. Most of them are monthly. But yeah, we’ll send out an update saying, Hey, congratulations, we have closed. You are now an owner of this asset holler with any questions, but congratulations.
Then, expect to see monthly updates from us in the future. That’s what we’ll share. We’ll be putting the monthly or quarterly financials that get posted into the investor portal. And then most of our investors we pay via ACH deposits. And so they should see that just on a regular cadence going.
Rick Mazur: You’re saying that the updates are typically monthly, and are the distributions monthly, or are they more quarterly?
Brad Shepherd: Most of our partners, most of our operators, yes. We’re doing monthly reports with monthly distributions. do have
Rick Mazur: Okay.
Brad Shepherd: self-storage. One that I mentioned, the fund that we’re doing with them is a quarterly reporting. Quarterly distribution.
Rick Mazur: And sometimes depending on what they’re going to do with the property, whether they’re going to fix up a bunch of units maybe when they first start, maybe you get a little bit less of a percentage in the first few quarters or first year until they ramp it up and rehab those. But that’s a typically normal type of thing as well. Probably I assume.
Brad Shepherd: Yeah. That’s the typical cadence year one, 18 months, 24 months. Those cash flows are going to be pretty small. And then that’s going to grow over time as we’ve executed this business
Rick Mazur: Okay.
Brad Shepherd: and optimizing the rents, increasing the revenue, decreasing the expenses, then those will grow over time.
But a big chunk of that return is going to come from the equity event. When we all, we sell them all.
Rick Mazur: What about this idea? Let’s say they’re going to hold for five years, and sometimes you’ll see it where they’ll say we’re going to refi out in two or three years and try to return most of your capital. Is that a reality in a lot of cases or?
Brad Shepherd: we’ve had that happen multiple times and
Rick Mazur: Okay.
Brad Shepherd: great scenario. To be honest,
Rick Mazur: That’s something you want to look for, you would say
Brad Shepherd: as an option, it’s not going to be possible on every deal. And it’s, I would look for as a nice bonus surprise when it does happen, to be honest, it’s it means, you put 50,000 in also in, in a month, 18, 24 months, whatever.
It makes sense to refinance based on, Hey, we’ve got this, the value of this property has increased significantly. Rates are still low. Let’s go ahead and refinance, now everybody gets half of their equity back out, but you’re still sitting in your capital contribution. However, you’re still sitting in that same equity position, getting that monthly cash flow in the future.
Everybody’s happy, you’ve got
Rick Mazur: Of
Brad Shepherd: reduce your exposure. So it significantly increases the IRR. ABut I look at those as just a nice bonus. Nd you’re looking for the next deal right away to in wow, how do I do this again?
Rick Mazur: so one more question. So I know that years ago, the gold standard, so to speak for IRR, is used to be, and this is not typically for new construction. This is typically more for flowing, existing properties used to be 20%. And they said in the recent years that’d been lowered. So maybe around 15 or something like that, is that true?
Or is there something you look for other numbers you look for on a particular deal?
Brad Shepherd: Yeah. It’s 15, 16, 17 is pretty common. It’s pretty hard to project, and I would be nervous of anybody projecting anywhere above that right now because the real estate market is so hot, and there’s a lot of dollars at play looking for deals. And so it’s competitive, and people are willing to pay premium dollars for it.
So over a five-year hold a 15% IRR, 15 to 17%, we should say a two X equity, multiple-meaning simply, okay. You put 50,000 in. we run for five years, a two X meaning we should be able to double that contribution based on the monthly cash flows and then the gains from the sale of the sell the property.
So that’s a pretty common scenario, 15 to 17% IRR 2X equity, multiple that’s where most of our deals are sitting at,
Rick Mazur: okay. That’s good to know. So I think that this is answered a lot of questions that people have. And so if they’re looking for another option to invest in, or maybe they’re even working with different syndicators, and they want to see what you have to offer, how does the, how do they reach you so that they can talk to you more about your current offers?
Brad Shepherd: Yeah, the best way to do that. If you’re accredited, we can talk about the live deals that are going on right now. And to see what we have coming down the pipeline is connect with us at our website where you can see some of our past deals, put your email address in there, and you’ll be able to see the future deals that come down the pipeline.
If you’re not accredited, Hey, well, let’s jump on the phone and get to know each other a little bit. And can let you know about future deals as that comedown, the appropriate pipeline, but yeah, sugarhouse investments.com is the best place.
Rick Mazur: are you on social media as well?
Brad Shepherd: I’ve got company pages out there for all the different platforms, but the place where I’m most active is on Twitter.
And I signed up for Twitter probably 12 years ago. I never used it. And about seven, eight months ago, discovered there’s a whole lot of activity with really smart people going on in, on Twitter right now. So I’ve been active there, and it’s been really fun. So I’m @on twitter
Rick Mazur: Okay. Now on your website, is this something where they’re going to be able to see everything about the deal to start, or do they have to register with you first to get more details about a particular investment? And we’ll post all that on the website episode, page, and in the show notes and everything like that.
Or do you see everything right out of the gate?
Brad Shepherd: So we generally work if people have signed up for our email list. It’s not something we’re going to be spamming people with a bunch of about. It’s just as we have important updates and new deals coming down the pipeline for those who have told us that they’re accredited; we’ll put it in the body of that email. Here’s the deal? Here are the basic parameters. It fits in the body of an email, basically just five bullet points of what the deal is and why we like it. Just raise your hand, saying, Hey, I’m curious. you’re interested in learning more, you think you might want to participate?
I’m in, can meet that minimum, and then I’ll send you that full investment summary from there, and then we can provide more details. Should you want to move forward? But yeah, so it’s a soft approach. Real quick highlights. Your hand if interested, we’ll get you more details.
Rick Mazur: and about how many deals are you on average? Are you doing a year or bringing it to the table?
Brad Shepherd: It’s not a high-volume market. We look at hundreds, but an average year, maybe 10 to 12.
Rick Mazur: okay. That’s a good amount.
Brad Shepherd: We almost always have something that we’re raising for. But yeah, it’s not like a deal-a-week kind of scenario. We are very selective on what we are—work on.
Rick Mazur: Well, Brad, this is again a whirlwind of information, and I think people are going to love it, especially if they’re interested in this and are looking to invest. So it’s great having you on.
Brad Shepherd: Thank
Rick Mazur: maybe we’ll have you on again and talk about some other stuff down the road, hopefully. And we’ll go from there.
Brad Shepherd: Hey, thank you very much, Rick. And enjoyed it. Great questions. I need to get a drink; my throat is scratchy. I hope some of those answers were helpful, but I would love to be back on anytime to your listeners.
Rick Mazur: Absolutely. Have a great day.
Brad Shepherd: Thanks, Rick. You as well.
Rick Mazur: Talk to you soon. Bye. bye.
Brad Shepherd: Bye.