How to Invest in Commercial Real Estate

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Episode #039 - FAQ's Review - How to NOT GET SCAMMED Investing in Commercial Real Estate

by Criterion, Braden Cheek, Brian Duck
August 25th 2021

Today our hosts Brian Duck, Braden Cheek & Joel Thompson from The Criterion Fund review the most Frequently Asked Questions we receive from people getting started investing in commercial real e... More

people when you ask them to part with their hard earned dollars. Their their first reaction is why are you trying to scam me? What are you gonna do with my money? Never came back. And I love to contrast that with political giving because it just seems so easy in the current times that we live in for people to raise money for political candidates where they're getting a 0% return and a guaranteed 100% loss of capital and yet people part with it. But something psychologically when I come to them and I said, hey guys I've been doing this for almost 20 years and we have a great track record of delivering 20% returns on people's invested capital. And the first thing they look at me like whoa man we're trying to scam me bro, Master. All right guys we are back with how to invest in CRE dot com. It's been a little while congrats to my man Brandon who just had his third child insulation. Uh he's been at the house doing dad duty and helping out his beautiful wife getting settled with all three kiddos.

But we are back today and the topic today we're gonna be going over some of your most frequently asked questions brian, why are we doing that? Well we're doing that because whenever some we ask someone to give us some money, they are a little apprehensive. They don't want to part with their money. And so they always have a bunch of questions for us and we decided to go ahead and answer those today. Yeah but it's kind of your duty. You know, when you go to give somebody a large sum of money and you know right now, average check size could be well north of $100,000. So when you're thinking about, you know that potential amount of money they're gonna ask you a few questions. It's like buying a house. It's you know, typically massive purchase. Um and they want to understand how it works at least a high level so they can come home, tell their partner, tell their spouse, you know, know how it works, sleep better at night, everything like that makes sense. It's so interesting to me. You know, we've talked about it before, people when you ask them to part with their hard earned dollars, what their their first reaction is, why are you trying to scam me?

What are you gonna do with my money? I'm never going back. And I love to contrast that with political giving because it just seems so easy in the current times that we live in for people to raise money for political candidates where they're getting a 0% return and a guaranteed 100% loss of capital. And yet people part with it. Uh but something psychologically when I come to them and I said, hey guys, I've been doing this for almost 20 years And we have a great track record of delivering 20% returns on people's invested capital. And the first thing they look at me like whoa man, we're trying to scam me bro, where's the catch? And I'm thinking, what are you talking about? But that's that's the reality of it. When we go to try to make our investors money, they're gonna be more skeptical of us than if we just ask them to support our our non profit or our political cause. And they say, hey Joel, here's here's the money, go, go do with it what you want, you know, because they're making a decision that it's gone as soon as there's an expectation of return, uh then you gotta, you gotta put them at ease that you're going to actually perform. Yeah, I mean, I'll just start off here, one of the first ones I get typically every single time is what, what the heck am I investing in?

Like what, what is it, is it a reit or is it a partnership? How does this work? Do I? You know, is it like tenants in common? Are we joint tenants? How does this work? I'm not sure most investors are going to know what exactly joint tenants are versus tenants in common, but to win a little too far on that. Yeah. To put it as simply as possible, you are buying shares in a company that's going to actually own real estate. So this LLC limited liability company is going to own property and you're gonna actually have ownership shares in that company. So it's real ownership and property. So give me, give me some quick pros and cons on the difference between a reit and direct investing in an LLC that actually owns the real estate. I mean, what what what's the biggest? Okay, well, I don't know the negatives of a reit. So you'll have to handle that benefit. The benefit of of direct uh ownership is all the tax advantages that you get, those get all passed down through, all the uh the profits those are passed down through. So essentially you're you're investing in a company and all the advantages that come with that you get to participate in all those.

Exactly. So the biggest downfall with a read is that you're not investing in real estate, you're investing in a company that owns a bunch of real estate and they're legally mandated to distribute 90% of the profits. That's a that's a reit, you don't get a lot of the tax advantages like depreciation, which is a massive one. And that's huge. That's one of the biggest reasons to invest in commercial real estate is to kind of shelter some of that passive income you get. Yeah, I agree. I didn't know you didn't get that in a raid. I've never invested in a reach. So I don't know. Well, compared that I didn't Yeah. Compared to direct investing in real estate. Redskins suck. Yeah. Okay. So now that they know what they're investing in? The first thing, The next thing they're going to ask is, well, how much money do I need to invest? Um, That's typically do get a lot. They don't know is there a half a million dollars minimum? Maybe they've got 25,000. Is that enough? You guys not taking people of that size? So Brayden with criterion. What are you, what are you telling them? Yeah. So our minimum, that criterion is the $25,000 investment. And that's just uh, you know, the minimum to get in the door.

You can do any number above that. Um, but the minimum investor is 25,000 dollars. So a precision equity, we've done a minimum of 50 before. Uh, now we typically try to do a minimum of 25 because we want to get people participating because if we can get them familiar with investing in real estate, chances are, we're gonna make the money and they're going to come back over and over and I get them in the game. Uh, and some people, if you put it to high minimum there, they're not going to pull the trigger. So we, we've essentially lowered to 25 guess every deal is different. But Yeah, and the reason why people set their minimum tires to not just get more money out of you. It's, it's the burden of investing all the paperwork and the paperwork. You know, our, our last stack of paperwork for the criterion building in. Wasow was 102 pages, 100 pages. And you don't have to read every page and fill in every page. And you know, it's a lot of paperwork. You have to file A. K. One for that person. You have to, um, you know, handle their tax problems. You have to answer the phone calls. You have to, I mean it's a decent amount of work of having 50 investors versus 10 investors on the same.

I'd rather have 10. You've got to limit the number of investors to to keep all those costs down Really. Yeah. But at the same time, it's such a high barrier to entry. A lot of people can't go buy an apartment complex. Last apartment complex I looked at was $39 million. And I mean that's shocked the crap out of me because it was so expensive. But it's the general idea of your aggregating a ton of people's money together to go and buy this because that's more beneficial. You get a Nicer property. So part of the pitches for our investors is they may have 100,000 or 200,000 and do they want to put that all down in their first commercial deal and try to figure that out? Well if they're investing with us or with one of these companies that we own. Now they can spread that 200,000 over eight deals. Um, Now they get some diversification may be over even different asset classes, different states and, and there with a group that has a proven track record versus betting all of that on their first commercial deal more risk and more work. So it's pretty appealing to most people. Okay. Yeah. Going back to diversification. You also have, you know, in addition to the States and asset classes, you've got different timings of allocating the money in the market.

You've got all of the different pay box. Some might not be paying cash flow. There will be a development or a lump sum at the end. Some may be paying quarterly cash loan. It's just the idea that you should try to be in, on, on almost every single deal is kind of what I say, let's get an amount that you can kind of do quarterly or maybe once or twice a year. I would say a lot of our investors do invest in most offerings just to get their investment um, diversified. So they've invested, they know they're buying a ownership shares in a company is going to own real estate. What is the payback schedule and how do you pay that back? Yeah, that's that's a great question. Another question is, how do you initially get the money to, you know, is a check? Is it wire both of those and then payback is different. You know, you're going to have some different time frames. I mean we've got a couple different time frame of deals right now. And I mean, all all different types of deals have a different payback period. Yeah. If we're just buying some cash flow, then it's typically quarterly dividends. Um, but like you said, sometimes we do some other development projects where we're not gonna realize cashflow at first.

And so that's more of uh, sometimes it's a buy and hold, but sometimes it's a buy and, and, and we sell quickly and just just uh, it's one lump sum check at the end of the deal. Exactly. Might just be, uh, 18 to 24 months, all that's going to be outlined upfront, I would say a majority of precision equity deals have been cash flow producing deals. So let's say we close, uh, in august, um, you know, we're probably paying a pro rated dividend at the beginning of october for that third quarter. Maybe it's maybe it's half of a distribution. If we planned on paying 12% annually, then quarterly, it's it's 3% maybe they get a point and a half for that first quarter? Uh, but generally we're trying to pay quarterly distributions in line with what we projected after the pitch of the deal. Okay, So, who, uh, so can everybody invest in every deal? Are there any um, sometimes we've done some deals where you have to be accredited investor. And so does that mean, yes, there's, there's two main buckets that. I want to focus on for the purpose of this question.

There's a lot more levels of sophistication when it comes to being an investor, you can be a qualified investor, you can be a qualified purchaser, you can be Bunch of things, but the two I want to focus on a sophisticated and accredited, so sophisticated means you're not a millionaire and you don't make $200,000 a year credit. It means you're a millionaire excluding your personal home And you make $200,000 a year. Or you and your spouse jointly make $300,000 a year. And boom, you're in a credit investor. And really what the sec is just trying to protect is the, you know, the blue collar worker. Um a lot of regulation comes down to, you know, like residential real estate and a lot of the consumer they want to protect from being defrauded. Whereas when you start to get to be a sophisticated investor and a millionaire and and that sort of annual income amount, it's a higher level of sophistication. And you started a mass enough wealth to where you're typically investing in other places outside of yourself. So you become more comfortable more aware of the term and the jargon and you may have an attorney, you may have a sepa you've got more behind you than just, you know, you can't go out to walmart and hold a sign and says, I'll take your money.

You know, if you can be in a credit investor. Yeah, I think the important thing is people that have $1 million $100,000 year, they can afford to lose some amount of money of that and still be okay. Uh, and also, like you said, they have access to professionals that can give them guidance, education information where the average person that, that is a blue collar worker that works hard for their money, but just doesn't have a lot of spare money. They don't want people like us trying to take advantage of those people getting their their only $5,000 life savings and putting that at risk. And so that's really the difference between accredited, which can invest in anything and, and the normal person that is not really these investments aren't geared toward that person. Sophistication, it's kind of an in between where they're educated. Uh, there they can prove some familiarity with investing. Maybe they have a relationship with you and they have to sign a disclaimer. Typically saying they acknowledge the risks, They acknowledge the risk, they understand what they're getting themselves into. And so that's really, and in between step and our investments, you can only have a certain number of those.

You can't do all sophisticated investors. You need to have some accredited in some sophisticated. Um, but that's another show. Probably, yes. So the black and white as if you're advertising, if you're advertising, if you have a billboard, if you have a facebook campaign, if you're advertising people, you don't know, you can't take sophisticated people's money, they have to be a millionaire. If you, if you see an advertisement on facebook, hey invest with our invest in this deal, it's got to be for the deal, which is, you know, kind of an important point because they can advertise themselves as sponsors on general deals all they want. They can't advertise this specific caution anyway, keep going. So what I was gonna say is, okay, so now I've gotten paid and by you guys and so it comes up to the end of the year, Um what am I going to get for my taxes? And also the big question I get is why did you guys send me $10,000 during the year? But now my tax form that I get to K11 has a loss on it. And why is that? And how does that benefit me, first of all? Yeah. Um You get a K. One because you're investing in a partnership in a partnership distributes K.

One. It's just, yeah, the form is called a K. One and it literally just passed through, pass through right to your personal return through an L. C. That's an LLC taxes partnership. So if it reports profit and loss, correct? Okay, yep. And depreciation is written off as a loss, You pay it back when you sell the property. Um and you pay the tax at that point, but today you get to write it off, which is a massive tax advantage. So like you said, you could potentially get distributed, you know, $1000 every month, maybe you got $12,000 that year. And distributions and you get your K. One and it says you lost $15,000. And the first thing you're gonna do is you're gonna call me up and you're gonna say, hey, I don't understand the capital balance has been reduced, it says, I'm losing money, you guys paid me money, you know what, what's going on here, We're just going to say, okay, that's from depreciation, we're gonna pay this back when we sell and that's the beauty about investing. Commercial real estate Mr smith is a lot of these distributions are tax shelter, especially in the beginning because accelerated appreciation, accelerated appreciation right now. It's just one of those things in the tax code that isn't always, there hasn't always been there.

Maybe is not always there, but it's this awesome awesome way to just appreciate the crap out of the property really, if it's a paper loss, because you're saying, hey, this building is worth less this year than it was last year. And so we're gonna allow you to take that depreciation upfront offset it versus the income that we gave you. And it just allows you to get that tax free income or partially tax free income until we recapture When we sell and it's recaptured at 25%. So if you're in a high tax bracket and we give you distributions, you're gonna save, uh, let's say you're in a 40% tax bracket plus, you know, state and federal, maybe almost 50% you'd lose half of the money that we gave you. Well in this case for the first few years, you're not gonna lose any of it or lose very little of it. And even when you do recapture it will be at half your normal rate. So really good tax advantages. But that's how the K. Ones are explained. I think, okay, speaking of tax advantages, Another question we get a lot is can I invest using my 401K. Money? Yeah, that's a that's a great question.

Uh, So what's the answer? Can can people do that? Can they use 41 K. Or Ira money? Absolutely, absolutely. Got to be a self directed account. There's tons of them out there now. It's it's super easy reach out. There's one called custodian trust company. I think they're located in Ohio, we have several investors use them. They're great to work with. It's an annual fee thing. Um, you felt a forum and then boom, they send us money from your 41 K. We send your distributions back to them because they're the custodian just directed by you. That's why they call it a self directed account. But yeah, we've helped several investors get those set up and invest with us and we've gotten great feedback from it. Couple questions I get frequently is how much money am I investing in the deal? There's looking and I huh? Okay. You wanna you want 25 grand, where's your 25 grand bro? And okay. Yeah we're direct investing as well. We typically are 10 to a third. Maybe more of the money we're trying to raise. So if we're trying to raise a million dollars were at least investing that 1 to $300,000 were.

Typically the largest investor criterion is usually the large or our own money. Personal money is typically the largest investor are equal to some of the other couple of largest investors. It's treated payer pursue which literally is just a fancy word for the same. I just like to say it because it's fun para pursue Yeah, precision equities. Also, typically the largest investor, I would say some of the best feedback I can give investors on why they should invest with the criterion fund or with precision equity is we invest a ton of our own capital. We believe in the deal. We are signing on the debt. So we're that was my other question. That was so we're signing on the debt. Were typically were personally guaranteeing the debt which means that the deal doesn't go well it's coming back on all of our personal assets. So it's gonna give us extra motivation to hang in there. Make that deal work. Even put personal assets in on the deal in order to get through a rough patch. They like hearing that because we're not walking from the deal in the event, there is an issue. Uh And so those are two big things.

The other thing I tell people which is a real benefit is I'm putting my friends and family and coworkers money in these deals. Uh We're not raising money from people that we don't know that we've never met. It's really, really important to us that these deals work and and that's got to be a benefit because I've invested on in several online investments. Two of the first three, I did have turned out fraudulent. These are real estate, get real estate deals getting indicted by the FBI or mishandling investor funds. Several of the other ones are bigger funds. So I thought, well let's go big with these big companies. Surely they're going to do well, find like a fun forest. Yeah. And they don't uh they haven't hit their their numbers and they haven't, you know, those haven't lost my money haven't been fraudulent, but they have not met their performance standards. Well, they don't care about me or the other people they met because they invested on online through crowdfunding. They don't know us well for me if if our deals don't hit our marks, I've got to sit around the table with my friends and family and tell them why what happened.

So it's uncomfortable. So for us, we have to believe in every deal we do before we're gonna commit our own funds and before we're gonna commit our friends and families funds. So I think it's if you're going to invest uh, in these types of deals, get to know your sponsor, get to know their track record and get to know, you know, previous investors and what kind of experiences have they had. I think that's a real valuable too. I think so too. And like you said, literally in this group, we have to tell our moms and dads why we lost their money. Our brothers and sisters, our uncles and aunts and our kids, why we lost their money, literally. So I don't want to do that. I don't want to do it now. I would rather not do it. So if it happens that we have to do that, that's I want to make sure that I I took every precaution I knew about every risk and I I did my best uh, as a fiduciary to make sure that deal worked last one and then we may be able to call unless you guys have something else. But how do you how do you what are you doing this? You're doing this for free? Just doing this for me? Just doing this to help me out As the investor.

Like why why that sponsor? What's like what's kind of in it for you. You know, that's a that's a good question to ask most people ask it, how do you get paid? And we've got to disclose this, you know, two ways to Tuesday. And that 103 page document, we've gone over this in another podcast. There's so many ways that a syndicator makes money. I mean, there are deals that I have done on our own without investors. Let's focus on the breath. Let's focus on the press and the benefit of the pref. Yeah, well, we take fees up front, but then we pay a prep to the investor. So before the sponsor takes any split of the cash flow, We pay 8% on the invested capital to the investor. Um It's pro rated quarterly. And then only when we exceed that target. Do we do we split what's left and not by split? I mean, maybe the investors get 65% of what's left over after 8% and we take 35% is the sponsor. So the the investor has to win first before the sponsor can win To the tune of 8%,, which is, I mean, in the grand scheme of things, and not bad. Especially. No, no.

To put it, let's let's let's take a typical deal. If it's a if it's a 14% cash on cash deal, 8% to the investor. That means you got six left over. And if it's a 65, split, maybe it's approximately four to the investor and to to the sponsor. So the investor or the money is getting 12% and the sponsors getting 2%. If you look at it on a cash flow split split basis, So that investors should feel pretty good. That's a good split for the investor. And that's gonna really, uh, make the sponsor try to exceed the targets because that's when he starts winning more, getting 8%. He doesn't when he gets nothing. So he's really motivated to to earn you more. That's the only way he can earn more. He can't earn unless he gets you over the hurdle of 8%. You know, the investors should want to sponsor to be incentivized to do as much as we can. So, by getting some of that split on the, on the end, that's that's our motivation Last one. Also. And when do they get their money back? Yeah. And so there's a couple different ways.

First. We can do a refinance and under our docs to refinance a re capital event, we have to pay back 100% of the investor capital first, and only then can we split the profit after that, that's a refinancing on a sale. Obviously 100% of the capital has to go back to the investor. And if we haven't been meeting the eight pref we have to we have to bring that eight Kreft current and then after the capital's been paid back and an eight press been paid back only then do we split on whatever the situation is, 65 to the money, 35 to the sponsor and that typically we typically go on a five year old, but we've we've done longer and it really just depends on market conditions and we're constantly evaluating those to make sure we make the best decision for the investor. Thanks for checking out how to invest in CRE make sure like and subscribe share if it helps you learn anything and we will see you next time. Thanks guys. Mm. Yeah.

Episode #039 - FAQ's Review - How to NOT GET SCAMMED Investing in Commercial Real Estate
Episode #039 - FAQ's Review - How to NOT GET SCAMMED Investing in Commercial Real Estate
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