Theo is back with another Syndication School episode and this time he will be going over the 11 questions most passive investors will ask you before they invest in your deals. Theo hopes he can arm you with the right mindset when answering these questions to put you in a good position to find investors.
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“Making sure you let them know what your financial review process is very important because if you aren’t reviewing your financials your investors are not going to like that.” – Theo Hicks
TRANSCRIPTION
Joe Fairless: There needed to be a resource on apartment syndication that not only talked about each aspect of the syndication process, but how to actually do each of the things, and go into it in detail… And we thought “Hey, why not make it free, too?” That’s why we launched Syndication School.
Theo Hicks will go through a particular aspect of apartment syndication on today’s episode, and get into the details of how to do that particular thing. Enjoy this episode, and for more on apartment syndication and how to do things, go to apartmentsyndication.com, or to learn more about the Apartment Syndication School, go to syndicationschool.com, so you can listen to all the previous episodes.
Theo Hicks: Hello, Best Ever listeners, and welcome to another episode of the Syndication School series, a free resource focused on the how-to’s of apartment syndication. As always, I’m your host, Theo Hicks. Each week we air two podcast episodes that focus on a specific aspect of the apartment syndication investment strategy.
For the majority of these episodes – sometimes they’re part of a larger series – we offer a free resource. These are Power Point presentation templates, Excel template calculators, PDF how-to guides, something that accompanies the episodes that will help you on your apartment syndication journey. All of these free documents from past episodes and series, as well as those past episodes and series can be found at SyndicationSchool.com.
In this episode we are going to talk about some of the questions you should be prepared to answer when you are speaking with potential passive investors. Way back in the day when we did the original series, we did an episode that talked about how to prepare for potential objections from investors, especially when you’re first starting out. So you’ll definitely wanna check out that episode. I think it’s over 50 objections, and we go through those in multiple episodes, and talk about “Hey, these are things that your passive investors might ask you either upfront, or when you actually have a deal.” Then we talked about the ways you should be responding to those questions.
This episode we are going to go over 11 more questions. Some of them are repeats from before, some of them are new, but these are questions that the Ashcroft investor relations person has come across more recently, with the Coronavirus pandemic. So these aren’t specific to the Coronavirus pandemic, but these are the types of questions that you should expect investors to ask whenever there’s a looming recession, or thoughts of a looming recession, or something is going on that’s not your economic boom, whenever things are just kind of naturally going well. So let’s just jump right into those questions. We should be able to get through all of them today, in this episode.
The first one, and probably the most important question that you’re gonna get asked during potential recession times is “How are you adding value or hedging against valuation reductions and rent reductions.
More specific to the Coronavirus, in January everything looked great. In February everything was fine; it was a normal year as an apartment investor. And even the beginning of March was pretty normal. But by about mid-March things started to change, and by the end of March there were stay-at-home orders, businesses were closing or shutting down, or at least reducing their hours of operation… Some sort of change that affected the workforce.
Obviously, as an apartment investor the residents are able to pay for rent and pay you by their jobs. So if they can’t leave their homes or if they lost their jobs, then how are they gonna pay rent? So these are things that passive investors are definitely thinking about right now. How are you ensuring that you’re going to be able to collect rent, and in turn make sure that you’re able to maintain the value of the apartment? So you need to have an answer to that, you need to have specific answers to what exactly you are doing.
We’ve talked about ways to do that in previous episodes, where I talked about how to make sure you’re able to collect rent, so definitely check that out… But you’re gonna wanna have a specific answer to that proactively, because your investors are gonna be asking you that question.
Number two – and this is more of a general one, but “Can I run a background check on your key people?” Obviously, you should always answer yes to this question without hesitation. These people are investing a large amount of money with you, and they wanna make sure that there are no red flags for you or other sponsors on the deal. Basically, the same way that you would be screening a potential resident, they’re gonna be screening you, because it’s even more important, because they’re giving you a lot more money proportionally than the residents are.
Next question, how frequently are you communicating with your investors? This is on an ongoing basis, so proactive communication, but also how quickly do you commit to responding to investor inquiries?
Right now, in a time like the Coronavirus, investors are probably reaching out to sponsors a lot more than they usually do. So you’ve gotta make sure that in times of economic certainty, if you say that you’re gonna be replying to questions within 24 hours, and then something like the Coronavirus happens and you’re no longer responding to questions in 24 hours – well, then that’s not gonna reflect good on you and your business.
This applies to all these questions, but when you’re replying to investor questions, you wanna make sure that your replies apply to times of economic expansions and recessions. And if they don’t, you need to make sure that you’re distinguishing between the two, because if you are getting a new investor during an expansion, and you say “Oh yeah, I send out emails every month, and then I’ll reply to you within 24 hours”, and then a recession occurs and you’ve got all these investors reaching out to you and it’s actually impossible for you to reach out within 24 hours, what are you gonna do in that situation? Probably let your investors know that “Hey, I’m not gonna be able to reply to you as soon.” But having some sort of communication and letting them know what’s typical, and then obviously if something happens, here’s how it will change.
Next question, “What is your financial review process?” Every month or every quarter – ideally every month; maybe even every week – you should be reviewing the financials of the deal. These are the T12’s, the rent rolls, the bank statements, making sure that all of your i’s are dotted and t’s are crossed… So make sure that you let your investors know specifically what you do when you’re reviewing the financials. So what financials do you look at? Who else is able to look at these financials? Is it also being checked by some third-party? Is your property management company look at it? Do you have someone on the team that specifically analyzes these financials? What do you look for? Typically, you wanna look for the variance between your projections and your actuals… Things like that.
So making sure you let them know what your financial review process is is very important… Because if you aren’t’ reviewing your financials, your investors are not going to like that, because you won’t be able to catch issues sooner.
Next question, “What is the worst-case scenario, and how do you try to mitigate that?” Obviously, the worst-case scenario is you lose their money, and then you do a capital call, and you lose their money again. So what types of things have you put in place to make sure that that doesn’t happen? What types of things have you put in place to make sure you don’t need to do a capital call? What types of things are you doing to make sure that you’re able to preserve your investors’ capital? We’ve talked about this countless times on Syndication School. Obviously, it starts with the 3 Immutable Laws of Real Estate Investing, which is buy for cashflow, not appreciation, make sure you secure long-term debt, and make sure you’ve got adequate cash reserves. So those are the three most important and best ways to make sure you’re conserving investor capital. So again, not making the money, but also not losing their initial capital.
So they don’t really care what the worst-case scenario is, they care how that worst-case scenario affects them; how much money could they lose. And again, the answer is they could lose the money they invested, you ask for more money, and they lose that. And I guess the worst-case scenario is they give you more money and you lose it again. So what types of things are you doing to mitigate the risk of that happening?
Next, “Can you send me investor references? Current, and on deals that have sold.” That’s also important. Typically, when you think of references, you think of just the current deals, but also investors that maybe invested on a deal that sold, and did not reinvest. So make sure that if they ask for references, you say yes. If they ask specifically for people who no longer invest with you, then give them those references as well.
Next, “In your return projections, are the numbers presented project-level, or net to LP?” Obviously, whenever you are underwriting your deals – and we’ve talked about this on the Syndication School before – you’ve got your overall cash-on-cash return and your IRR, which are the two most important metrics… And then you’ve got your LP level IRR and cash on cash return. Those are not gonna be the exact same, because even if the investors invested all of the capital into the deal and the GPs had no money invested into the deal, you as a GP are still getting fees upfront, you’re getting ongoing fees and profits, and you’re getting fees and profits at sale. So not all the profits are gonna go to the limited partners.
So if you’re presenting project-level returns, and you aren’t projecting LP-level returns, then you’re not setting yourself up for success, because what’s gonna happen is once you begin to send out distributions, or maybe even all the way up until you sell the deal, and the investors are getting returns that are below the project projections, because the project projections are going to be different than the LP projections, they’re gonna be confused and ask you “Hey, you told me that the returns are gonna be 20%, but they’re actually 15%. What’s going on?” And obviously, one of the answers could be that you didn’t meet your projections… But another answer could be that “Oh, I gave you the wrong projections”, which is probably even worse.
So make sure that whenever you are sending numbers or projections or returns to your investors, you’re sending them returns to them. They don’t really care what the overall project returns are, they wanna know what money they actually get.
Next, “How much liquidity do you keep as reserves in each deal?” Right now that’s huge. People who did not have liquidity are struggling right now, and those who had liquidity and reserves are not struggling as much. So how much money are you saving upfront, at closing, when you purchase the deal, and how much money are you saving on an ongoing basis? Because if something happens unexpected, you’ve got enough cash in reserves to cover the expense of that, or to cover any reductions in income, reductions in rent collections that come from some sort of event like the Coronavirus.
So the rule of thumb is about 1% to 5% of the purchase price as an operating account upfront, and then $250 to $300 per unit per year in reserves. So the first one is upfront, the second one is like an operating expense that comes out before you calculate your cashflow.
Next question, “How much do the principals or company invest in each deal, and at what level?” I’m pretty sure when I originally talked about the GPs investing in the deals, Ashcroft was not doing the class A, class B. So there’s an extra layer to this question, which is 1) how much money are they investing, and 2) are they as class A or class B?
Actually, I had a conversation with Frank, who’s one of the founders of Ashcroft, at the Best Ever conference, and I was asking him about class A and class B, and he mentioned that he invests as class B, because that creates a lot more alignment of interests… Because for the class A they get the 10%, but they do’t participate in any upside. Whereas class B gets a lower preferred return, but they do participate in the upside. So if the deal does really well, they do really well. If the deal doesn’t do very well, then they don’t do very well.
So when you are thinking about whether or not you wanna invest in your own deals, the answer should obviously be “Yes. You need to invest in your own deals, so that you have skin in the game, so that you have alignment of interests.” Because if an investor asks you “Are you in investing in your own deals?” and you say “No”, you’d better have a good answer — and I don’t even know what a good answer could be that would alleviate any concerns that they had.
But going above and beyond that, not only do you wanna invest, but you wanna invest in the class that is benefitted by the deal doing well, and suffer from the deal not doing well, which creates even more alignment of interests. So let them know how much money you have in the deal that you’re investing as the class of investor that participates in the upside and the downside.
Next, “Who will be managing the property, and how long have you been working with them?” So we’ve done countless episodes on property management companies. Obviously, the property management company is going to be managing the property, and the one question they’re asking here is “How long have you known them?” So obviously let them know how long you’ve known them for and how long you’ve worked with them for, how many deals you’ve done with them… Check out the Syndication School about “The ultimate guide for finding a property management company” for more on that, because that was basically the entire episode, or maybe two episodes talking about how to find a property management company, how to screen the property management company, and also how to be prepared to answer the questions that they have about you.
But obviously, the property management company is the most important team member besides the members of the general partnership, because they’re the ones that are responsible for the day-to-day operations of managing the day-to-day operations at the property. And especially at times like Coronavirus, you wanna make sure you’ve got a property management company that’s rock-solid, because a lot of adjustments need to be made in a health crisis like this, and if you don’t have a rockstar property management company, you’re gonna be in trouble… Especially when it’s harder to collect rent, people are working from home, so you can’t really do in-person tours, things like that. So you wanna make sure you have a property management company who’s flexible enough to handle these types of unknown events that occur.
Last question is “How many deals have gone south or sideways, and how do those affect your strategy?” Obviously, if you haven’t done many deals before, then you aren’t going to have an answer of a deal that’s gone south or sideways… But I guess if you have only done one deal and that deal went south or sideways — they don’t really want a horror story; you’re not supposed to scare them about what went wrong. What they wanna know is what was the mistake that was made or what was the problem, and was it your fault or was it not your fault, and then what did you do to solve that problem?
So if it was a really small or minor mistake, then let them know that it was a small, minor mistake. “We’ve implemented the solution and we’re still able to provide our investors with returns.”
Essentially, all these questions – they wanna know “Is my money safe?” and “Will I be able to make money?” So when you’re replying to these questions, keep that in mind. Remember that that’s why they’re asking these questions. They’re not asking it because they wanna know a funny story about a deal that went sideways, they wanna know “Okay, what happened to people’s money in that deal? Is this something that could potentially happen again?”
So those are 11 questions that every passive investor is most likely going to ask you before investing in a deal with you, especially if they’re not a family or a friend. Obviously, if you’re doing 505(b) you need to have a pre-existing substantive relationship, but maybe you only know them for a year, and they’re gonna ask you these questions.
Families and friends will probably ask you most of these questions too, but basically what you wanna do is make sure that you’ve got answers to all these questions. You don’t wanna read a script to these people. If they ask you “What is your financial review process?”, you don’t wanna go to your Word document and read “Well, my financial review process is…” You don’t wanna read it to them, you wanna just sound natural and genuine, but at the same time you also don’t want to not have an answer, or not have a clear answer, or have one of those runaround answers, where you don’t necessarily work your way around the answer, but you don’t actually answer the question…
So have everything written out in bullet point forms before you hop on a call, or before you even start doing calls; make sure you know exactly how you wanna answer each question, or at least the main points you wanna hit for each question. That way, when they come up you have an answer that, again, is actually hitting at what they’re actually asking you, which is “How are you gonna protect my money?”
So that concludes this episode. Until next time, make sure you check out some of our other Syndication School series, as well as all the free documents that we have. Those are at SyndicationSchool.com. Check out our Coronavirus blog landing page, where all of our blog posts related to the Coronavirus are. That’s joefairless.com/coronavirus.
Thank you for listening, have a best ever day, and we will talk to you tomorrow.
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