How to Invest in Commercial Real Estate

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Episode #057- It's DISTRIBUTION TIME! The Criterion Fund Recaps Q1 of 2022!

by Criterion, Braden Cheek, Brian Duck
April 15th 2022
00:00:00
Description

Today our hosts Braden Cheek & Brian Duck from The Criterion Fund, and Joel Thompson from Precision Equity recap the first quarter of 2022 as they talk about their favorite part of investing in... More

can somebody negotiate this Mr limited investor? They're coming up. You bring the deal says eight pref 50 50 split. Like, you know what Joel, I'm feeling that can they do that? Uh they can do it and here's how it would work. Uh If let's say that investor has a war chest of money. Uh there we go. And they say Joel, you know what I got, I got $100,000 for each one of these deals. But I'm I'm kind of interested in more. I want, you know, I want a piece of the a shares I want I don't want an eight pref. I want I want a 10 or 12 pref. So yeah, if you like. And you know in order to get that I'm gonna commit half a million dollars of equity to each deal. Okay. You know, or a million dollars in equity to each deal. So, there's always a way for investors to get preferential treatment if they bring more value to the sponsor. All right, welcome back to how to invest in commercial real estate. We are here again, it is the end of the quarter. It is our favorite time. End of the first quarter of 2022 brian.

Why is this our favorite time? Because its distribution time time. I was just signing checks today. My favorite thing, a stack of checks. We may be up to 175 now. Probably over $6,700,000. 1 175 checks that you send out. Yes. And I love it because there are people that I know uh most of them, not all uh people that I know that took a chance invested on me and they, you know, maybe they're in multiple deals and I just keep seeing their name 1000 $15,000 checks. And that's a great thing. And that's really what we're selling here is guys get involved in commercial real estate because most people have never had uh, an avenue to passive income in their lifetime. They only associate uh, income with work in time. So how much time does it take me? How hard is the work? What do I get paid for that work? And we want everyone to know there's a different way to do it. And it comes through through passive income, through investing in assets and in this case, real estate.

Yeah. The hardest you're gonna work investing with us is listening to this podcast, figuring out the questions to ask us before you give us your money. Having to listen to us is the hardest part about making money with us. So there's so many properties, there's so many different investors and you know, everyone really gets to look forward to these times. It's, it's a group effort. It's um, you get your investment report for the property, you're looking over the financials for the property, you're seeing, you know what lisa's need renewed, You're, you're driving by them locally and when you're cashing that check, it makes it so much easier than reading the report? Sometimes if you're getting a bigger check than you've ever gotten on that deal? How's the deal doing? Doing great. Doing absolutely great. So we thought we'd at least and we've done it some before, but we think it's always valuable to talk about the returns investors get. How do they get those returns? What do the terms mean? And we say things like cash on cash and we, we say things like preferred return. Our oi waterfall. What the heck is a waterfall And why do I want it? Yeah. And, and specifically what is the preferred return?

And why do you want that as an investor? Right. So as an example if we raised a million dollars, we probably bought round, you know, big round numbers here, a 4 to $5 million deals, probably a $1 million equity raise if we're raising a million dollars and we have $100,000 in distributions in that year. That year we have $100,000 to kick out to investors. We raised a million. So that's 10%. The investors get the 1st 8%. The 1st 8% always goes to the investors. We always put an 8% deal, call it what preferred return And a preferred return could be any number. We typically use eight, but I've seen six, I've, I've seen a bunch of numbers, but we typically use eight. Yes. So one of the biggest questions I get from prospective investors is I'm gonna give you $50,000. And how much do I own in this company? How much do I own? Like, I don't even I don't even know why should you care? Well, They might want to care. But that's a more sophisticated question. They think it's a simple question. It's a more sophisticated question because I may say, well that 50,000 that buys you 3% of the deal or whatever and like 3%.

That's not a lot. But really in order to understand if that's a good deal or not a good deal, you would have to be pretty sophisticated to understand what the equity structure is, how big the deal was, what the promote was when they're like, what does it promote? I wouldn't even know what you're saying right now. Okay, so that's why it's a sophisticated question. What's more is you should say what's my preferred return? And the reason you should ask that is because that's the money. That's the return on your investment you get before the sponsor takes any profit. Exactly. So going back to our example here, we're distributing $100,000. Let's just say it's an eight pref in a 5050 split to make it super easy deal. Made 100,000. You raised a million. It's a 10% return and the investors getting the first eight. So you've got 2% left over. So the sponsor gets 50% of the 2% and you get 50% of the 2%? So you're each getting a point, right? So the investor gets nine, nine points or 90,000 of the 100,000 cash flow And the sponsor gets 10. So, uh, if someone comes and they say, hey guys, I want to syndicate a deal and we're just gonna do a straight ownership split and I'm gonna you're gonna take 60 and I'm gonna take 40.

Let's let's compound let's compare that to the prep scenario. So we have 100,000 in cash flow. In your example, if it's just a straight equity split between the sponsor 40% and the investor 60% did have that 100. The investor gets 60,000 and sponsor gets 40,000. Really good for the sponsor. Okay. For the investor. So how we're doing it just so you know, as we do at eight prep. So we're paying 8% before we take any money. And then, for example, we're splitting the difference. So, yeah. Now, if $100,000 dollars in cash flow, investors get 90,000 of it. We only get 10 as a sponsor. So I I generally I found a deal I put it together, I I managed it and we worked the deal to the best of our ability and then we we generated $100,000 income. I only get to keep $10,000 of that. That's why a good preferred return protects the investors investment. Okay, so what happens if you don't make the 8% preferred return in a given year? Does that carry over? It depends, it depends on how the operating agreement is written. That would be an accruing preferred return.

The crew over the calendar year. Sometimes they accrue and sometimes they don't. Typically, what we do is if it's a cash flow deal, we're not typically accruing, uh, year to year. And if it's a non cash flow deal, let's say it's a development deal or something and you're in it for three years and yeah, we just a crew that 8%. We're not paying it. Yeah, but but a sponsor can do it any way that they want. Yeah, prime example. We're building a building in Owasso. It has been accruing preferred return because you know from the time you give the money we have to go build the building for a year and then we have to lease it up. Then we have to stabilize it. So you know that return is accruing. I have a great question which I get all the time. All the time. Why? Eight? Why not? Why not? Seven Joel? Why not? 10 brian, why why why eight Are you giving me 8? That's interesting that people ask that question a lot. I don't get it that much. Um, I think there's kind of an industry standard? uh, and I would say it's 6-8 typically, you know, But theoretically, what is the eight, what is the purpose of, of the 68, I mean, why, why, why is it that number?

I mean, why is it that number? I mean, it's, it's a number. To me, it's a number that's ah, well ahead of anything you could put your money in in terms of just a savings account. Maybe it's somewhere around what you might get back on an average for investing in stocks. Yeah, I think that's the case is you're trying to compete, you're competing with other investments. And let's say the stock market averages 8 to 10% a year. So then you're saying, hey guys, before I'm going to take a profit on, on the deal, I'm gonna make sure I get you an equivalent return that you would get in the stock market, for example. So you got 8%. Now, some people, uh, they have like, let's say downtown Dallas super nice. Brand new apartment complex. Well, that may only generate a 66 pref because the deal just has less return, Right? But you could argue that it's safer. It's newer. Uh, and so that, that may compensate for the lower return our deals, We've had a lot of success with, with investors getting comfortable with us saying, Hey, we will pay you 8% before we take any money on this investment.

They feel good about that. And then, hey, all I ask is that if I get you ate anything over that number, we get to take a share of, I've seen some, some tearing even more than that though. Sometimes can't you have like, Okay, it's an 8% preferred return and then there's another tier where, okay now we're gonna pay you and make sure you get a 12% IR are when we sell and once we get over, well maybe not when we sell but at 12% then the promote is, is say 20% or so. Then if you get to another guaranteed return then then you get another larger promote. Aren't there other tears that can happen? Ours is pretty simple but sometimes don't aren't there other tiers to try to incentivize the general partner to do better and better on the returns. Yeah. So I love the way you worded that it was, could you could you do that, is there anything, you can do anything. And that, that's what I'm getting to here is in the operating agreement. We could write in that when, if the deal hits a 99% return and then we get everything over that.

You can, you can write in that when you sell it, you get 10%. I've seen sponsors that that had a clause in there that basically they could buy out the investors, uh, At a 14 or an 18% return. They can just buy them out and they're just out. Yeah. So I really need to read the agreement right? You've got to read, understand and, and there's parts of the agreement that are, that are boilerplate ID, you know, copy and paste, you know, like what are the risks during covid, you know, Oh my gosh, they're obvious. But you need to go to the section ours, paragraph four, section four. Every single time you go to section four, it says distributions and it says a, here's what happens first. B that's what happens second. If this happens, that happens and you can read less than one page and that's the legal binding rules. That's the operating agreement. That's the rules of the company that we're all legally bound to and signed up for, we have to follow that. And if we don't, we get sued to oblivion, it's not good. Yeah. And to answer brian's question about the tearing that goes back to the term waterfall.

So some people will use the term waterfall and you kind of just imagine in your mind a waterfall that goes over one hump, which is the eight pref, then there's, there's a certain split And then you continue to cascade down the waterfall. If you get over 12% return, then the split goes, you know, from 60 40 to 5050 and then let's say you get them over 15% to the investor. Then it could switch, you know to a 40% investor, 60% sponsor. And so that's what's the waterfall is how, what hurdles does the sponsor need to make and, and how does the investor's return or their percentage of the return vary as those targets are hit. I gotta give one. I got a good one. I just thought of this. Can somebody negotiate this Mr limited investor? They're coming up. You bring the deal says a pref 50 50 split and like you know what Joel, I'm not feeling that. Can they do that? They can do it And here's how it would work. Uh, if let's say that investor has a war chest of money. Uh Oh and they say Joel, you know what I got, I got $100,000 for each one of these deals.

But I'm kind of interested in more. I want, you know, I want a piece of the a shares. I want, I don't want an eight pref. I want, I want a 10 or 12 pref. So yeah, if you like. And you know, in order to get that, I'm gonna commit half a million dollars of equity to each deal. Okay, you know, or a million dollars in equity to each deal. So there's always a way for investors to get preferential treatment if they bring more value to the sponsor. And it also depends on if the sponsor has the ability to raise the money, let's say we got a big equity raise and its $3 million bucks and I've only raised a million so far and I'm kind of struggling. Yeah, I mean, I may have to increase the terms in order to solicit more investors. So you, so, uh, that big investor, you'd have a different agreement with that person than you do with the rest of the investors possibly. You could, you could write and I wasn't asking it to start a civil war and have all of my investors coming down, right? Hey Brandon, I want to renegotiate. Just so all our investors know the answer is no. When you try to, what, what I was, what I would say is that in most circumstances I'm going to try to avoid having two different return structures for investors.

It only creates, uh, animosity or jealousy or, uh, you know, whatever. And, and I didn't get the best deal. Why did Joel give So and so a better deal. So I don't, and I don't want every investor to say, well, I've got to be the best negotiator and try to negotiate my prep. What we try to do Is find really good deals and pick a prep number 8% and a total return number, let's say 12% cash on cash. 20% ir where the investors all feel good and they're not just trying to negotiate the heck out of the deal and that I feel comfortable that I can go raise the amount of money I want to raise. Uh, so yes, everything is possible. But I would say personally, if you want to take the whole deal. So for negotiation, right? Like if you were raising a million bucks and you say, hey, I, I love this deal. I can write that check. What does it look like if I'm, if I'm buying the whole thing? Yeah, we definitely can definitely arrange something because why is that valuable to us? Right. Is that not only can I make my promote on that deal? Um, but you say, well, I could have raised the money from other investors.

Sure. But then what? By having his million or her million dollars on that one deal? Now I've kept that other powder from other investors available for me to go buy more deals. And so the more deals I by both the richer the investors get, but the richer we get. And so anybody that provides us an opportunity to buy more deals is valuable. And so we can, you know, hopefully give them some preferred return. This is the perfect segue into something super exciting that we're gonna work on the entire month of april. We will close it in the first week of May and is a brand new deal we're launching in slidell Louisiana and we're talking about adding value based on, on value added. And this is the perfect example. We have partners that we've done several deals with and, and we're starting to both look at at bigger and bigger deals as our comfort with raising equity and, and you know, buying those bigger deals gets better. There's a big deal down in slidell and can we, can we tell people where the heck is slide out? Because I'm already a pass? Yeah, it's north of New Orleans. North of New Orleans. It's like 20 minutes.

I think it's just right across the lake from New Orleans. If I was looking at the map, right, that sounds better. It's, it's kind of a suburb. But there's, there's that, I don't know if it's Lake Lake pontchartrain or something. That's a big river there. The demographics on paper, there's an ocean there somewhere. So the demographics look great. We're definitely gonna fly down like we do, um, every to every other deal. But the purpose of this is we're essentially taking this massive deal and we're chopping in half. We're partnering up with another general partner who has the capability to get similar debt terms, who has the capability to get similar investors. And we're saying, hey, Would I buy this at $13.5 million dollar total cost? I don't know. It's a lot. It's a, it's a decent raise slight l again and it, it changes your perception because you're thinking about is $13 million when you really could think of it as, oh, we can just cut this in half. You do half of it. I'll do half of it. You guarantee you half to death. I'll guarantee you half to death and then boom, you've got this massive deal that you essentially have have mitigated the risk almost in half.

I mean, you're still at risk of loss at the same, but not at the same amount of money for sure. There's the risk of losses there. But yeah, what I like about it is now you've got two capable sponsors that have access to equity, access to tenants, all the experience, all working for the success of the deal instead of just having Brandon and brian and I working on the deal now, we've got us and we've got our partners out of Fort Worth all focused on the success of the deal and we're both going to guarantee the debt. Uh, and both of our reputations are on this deal. So yeah, I think it reduces the risk somewhat. It doesn't eliminate it, but, but to have more experience and more capital uh, and more investors backing a deal, it's better agree. We've got tons of closings in april I think 43, maybe, maybe one is kicking into me. But the Kiddie Academy fund, we talked about that, that was fulfilled up immediately. The ST LoUIS fund, we closed on the first property of that already. It's doing incredible. Um, the second one is gonna close soon, but this deal is about to open, its about to launch, it may have just launched.

If you're seeing this, it's only think of 1.71 point $8 million equity raise exactly what the ST louis fund was and that filled up in a week. So I'm telling you guys, if you want in, if you saw the last one, you're like, oh man, I missed. This is your opportunity, this is your chance. I don't know when there's gonna be another, there's gonna be another one really have a lot of people who want to get in on that they couldn't get in. So at least, yeah, a lot a lot 67 people at least just waiting on the sidelines for that deal. And this is an amazing deal. Tell us a little bit about the deal. Who's in it. I'll talk about the deal. You talk about your slide, I'll deal. So it's uh, what do you mean? Who's, who's in it? I wouldn't even know who's in it. Well, I'm in, I don't know, I didn't know what that question wants in. So the deal is a community shopping center in slidell, its shadow anchored by a walmart Supercenter, a sam's club, there's a brand new, all these next door. But it's funny when you look at the map of this uh retail corridor, you've got shopping centers behind and you've got pad sites upfront, shopping centers behind pad sites up front, we have Grant on from the Woodmont company, our partner in this deal on the podcast.

I don't know what episode it is, but we'll plug it in somewhere. And the premise of the show was that there's so much over parking. If you just carve off little pads and sell it to a Taco Bell or KFC or Logan's Roadhouse or whatever. You know, those are million dollar bills just sitting there and you can probably have three of them on this site and this is the only site in the corridor that hasn't sold their pads. So when you look at it from that perspective, you're gonna see, oh, this is a no brainer. A bunch of other people didn't look at it from that perspective. They're trying to underwrite this eight cap shopping center that they're not in love with and we see it as an act cap shopping center on the downside. But The upside is these $3 million dollar bills sitting here, pat sides that you're going to offload and sell. So it's a great little deal. We believe in it, We're going to be investing in it. We're gonna be guaranteeing the debt. So what, let's let's let them know what is the cash on cash expectation Expectation, the first year 11%. It goes up pretty significantly from there with the pad side sales. Okay. 11%. And so just just to remind everybody, because we don't know what people know about cash on cash and and preferred return, we've talked about the preferred return, that's what you get before the sponsor takes the split the cash on cash is what the investor makes on their cash invested in in a year.

So 8% preferred return on this deal. Is that what we're paying? Okay. So then the deal must the deal level cash flow must be 14 15%. Because you give the investors the first eight, 70 30 split on the back end. Yeah. Okay. And then 70% of whatever's left goes to the investor after the eight. So, yeah, it probably does in 16. Uh, yeah. And then, You know, they're getting 11%, that's probably 14, total cash on cash 11 to the investor and how we structure and how it aggressively gets up is we start underwriting pad site sales in year two pad side sales, Year three pad site sales, year for pad thai sales. There's three staggering one per year, starting in year two. And what we're doing with the funds from that, the bank is requiring any release of or principal pay down to release those pads, which I will tell you does not happen very often. Great negotiating point from our partners. So, we're gonna take that money. The first one is a million dollars. And we're gonna distribute, we're gonna pay the equity back with 90% of that sponsor gets 10% of that. So now your equity balance, that 1.8 has been reduced.

You know, almost by half from that 1st. 1st pad site sales. So now you're 11% cash on cash. Even if you're receiving the same cash dollar amount, let's say you received $100,000 and that got you to 11%. Well now your $100,000 is gonna get you 16. It's gonna get you 14 15 because we paid a big chunk of your capital back. Same thing with the rest of the pad side sales and then eventually you've got hardly what are are we pitching 22.09 And a five year, 5 year and a 2.05 equity multiple. It could easily be done in three again five year deal, five year debt, six months interest only to go in and stabilize the deal. Put our management in place. Um And yeah I I think it's gonna be a great little deal. All right. What else do you want to say on preferred returns? It's once again the end of the quarter, we're paying the distributions if you want to get checks in the mail hit us up. Let's get you invested in a deal. Yeah. The best way to do that is to go to the website. Um How to invest in CRE dot tv. Which isn't anything to do with Tv has to do with tell Aviv.

Don't even know please cut that out. The first one is how to invest and C. R. E. T. V. And the next one is our website. Fuck if you want to get our Narva. Yeah can you do this? Yeah. So what's the best way that someone can find out about this deal? Once it launches, go to our website, how to invest in serie dot tv join our investor list. It asked for your first name, last name, email address. And if you're accredited, which isn't even required, you hit submit boom. You're on the email list. We're going to send it out probably two days before you saw it and you're gonna get it All right. We have lost Brandon. Thanks everybody. Well, make sure to like and subscribe and share with your friends. Um, If you've got a topic for the next episode, literally today's topic came from john Dillinger. So thank you, john If you've got a topic, send us a DM. Send us a message and we will cover it next week on how to invest in commercial real estate. Check you guys next week.

Episode #057- It's DISTRIBUTION TIME! The Criterion Fund Recaps Q1 of 2022!
Episode #057- It's DISTRIBUTION TIME! The Criterion Fund Recaps Q1 of 2022!
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