This week we're going to focus on the investor summary. This is an all-in marketing piece that outlines the core business plan, explains the underwriting assumptions, along with sharing photos and the overall strategy of the investment. This is an essential document and a key element that you need to understand and have a solid grasp of when investing with an operator. So join me and The Investor Mindset community as we dive deep into this subject to get a true understanding of what the investor summary is and how you can use it to your advantage.
This week we're going to focus on the investor summary. This is an all-in marketing piece that outlines the core business plan, explains the underwriting assumptions, along with sharing photos and the overall strategy of the investment. This is an essential document and a key element that you need to understand and have a solid grasp of when investing with an operator.
So join me and The Investor Mindset community as we dive deep into this subject to get a true understanding of what the investor summary is and how you can use it to your advantage.
KEY TAKEAWAYS
1. Understand what your investment goals actually are and then look at the investment opportunity and analyze how it aligns with those goals.
2. An equity model typically returns 50% to 75% to the investor. The return percentage is tied to the profit that is expected from the deal. With this model you can benefit greatly but there's also risk of losing capital.
3. A preferred return model means that you get paid out before anyone else. For example: a 6% preferred return would mean that you receive the first 6% return and management take the remaining percentage.
4. There's also a hybrid model where you have a prefered return on the front end and another that's paid out on equity gain. This is a more conservative approach or for investors who want to take a high risk but still have some level of security.
5. Another strategy is called the performance hardle. AKA "waterfalls" are when a certain level of return is being provided to investors, at that point in the return structure changes. So if you have 6% preferred return, then no one else will see returns until you have that 6% in full.
6. Look at how the sponsors are compensated when it comes to fees. Management will receive fees to "keep the lights on" and manage the property and this is normal... but if they are high... ask why.
BOOKS
The Passive Investing Playbook - https://theinvestormindset.com/passive
LINKS
Learn more about investing with Steven at
https://theinvestormindset.com/invest
Title: E139: Investment Summary - Track Record & Deal Structure - Steven Pesavento
Host: Steven Pesavento
Duration: 14:14
Narrator (00:00):
Welcome back to this week's mindset minutes episode on the investor mindset. I'm your host, Steven Pesavento and each week I share mindset tips and investing strategies to help take your real estate investing career to the next level. And this week we're focused on the investor summary, which is an all in marketing piece that is used when promoting or understanding commercial real estate deals. And so make sure to join us each week where I share more mindset tips, and investing strategies to help you reach true financial freedom and you can do that by hitting the subscribe button and never missing another episode. And remember to grab the full Ultimate Guide to Passive Real Estate Investing at theinvestormindset.com/passive, we've also got the link right down below in the show notes so, you're going to grab that take advantage of it cause it's chocked full of great information, lay a really solid foundation or help level you up no matter what level of investor you are.
This is the Investor Mindset podcast and I'm Stephen PesaVento. For as long as I can remember, I've been obsessed with understanding how we can think better, how we can be better, and how we can do better. And, on each episode, we explore lessons on motivation and mindset for the most successful real estate investors and entrepreneurs in the nation.
Steven (01:26):
So diving right into it, the investor summary is an all in one marketing package for commercial real estate deals. It outlines the core business plan, explains the underwriting assumptions and shares photos and the overall strategy of what an investor can expect by investing in this opportunity. You know, these documents are essentially the playbook and the overall makeup of the team, executing the plan, all the information that you need to know if you're going to go in and invest alongside one of these operators. And so one of the first places that I like to look when I'm diving in the investment summary is directly to the track record. I think track record and experience are incredibly important. And it's one of the reasons why I personally only invest with people who have an experienced track record and have built a team of people that have that experience to be able to execute.
And some of the things that you're gonna look for is, you're going to look at, what type of assets have these sponsors done before? What asset class and what markets have they worked in? Are those markets and are those assets and those asset classes in alignment with the deal that they're doing today? Is it slightly adjacent or is it completely different than what they've done in the past? If it happens to be completely different or even slightly different, it's important to look a little bit further and make sure that the team is made up of people who have that experience and that they're a part of making those decisions on a consistent basis. It is so, so, so important because, even though the past performance does not predict future results, it sure does help reduce execution risk because at the end of the day, what you're going to learn is that once you've done something once, you learn a lot about how to do it, once you've done it 20 times, you know the ins and outs, once you've done it a hundred times, it's almost like a habit. You're able to recreate that and reproduce it at a much lower risk type level and that's the way that I recommend people invest. And that's why I like to invest with operators that have a lot, a lot of experience. So, you know, you'll look at past examples of past projects, you'll look and see how have those projects done. Have they gone full cycle? Where are they at currently right now? And what have been the results? You know, you ask questions like this when you're talking to a sponsor, but when you're looking at the investment package, this is a great place to begin.
The next thing that I like to look at is the deal structure. How is the deal structured for investors? And how's it structured for the operator, for the manager, for the sponsor? You know, in an equity structure, your return is aligned with the performance of the asset, meaning that somewhere all the returns are tied directly to how the deal performs. In a debt structure, your investment is treated much like a loan where the return that you're receiving is at a set rate, where you know exactly what to expect. And then there's a hybrid approach where you know exactly what to expect, it's at a much more conservative type place, but maybe you don't have quite the same upside, but you got a blend of both where you’re able to take advantage of owning equity and some of the tax benefits that come along with that. So as we're diving into each of these, it's important to understand that there's no right or wrong deal structure. There are ones that are more advantageous depending on people's investment goals and what you want to do is look at this investment opportunity and understand how it actually aligns with your investment goals. And that's why, as we mentioned before, in an earlier episode, if you haven't definitely go back and listen, where we get into investment goals is because you've got to know where you want to go in order to get there, in order to plan the right route and take the right roads in the right vehicle to end up getting to that place. And so if we're going to go down the road of an equity model, you know, it's going to typically be a situation where, you know, it's a 50 to 75 split investor to manager, meaning that the investor is going to take a large portion of the, the upside on the deal and the manager is going to take a portion of the upside on that deal as well. Now, in a strict equity model, the percentage of equity is typically tied to the amount of return that's expected. So, you know, managers know what type of return investors are expecting. They provide that type of return and typically in an equity model, if the deal does really well, great, it's a huge success. If the deal is a complete failure, then you would expect to either have a loss on your capital or potentially even, you know, you'd be happy if you just broke even. So it depends right on the details of the specific deal, but with the equity model, what's great about it is you've got upside potential. You've got the upside potential of where could this go if things go really well? Now you might not have as low of a floor where, you know, hey, this is the ledge that I know that I'm going to get paid out on before management gets paid anything.
And that's when we go into the next section, which is called a preferred return, this is very popular. And one of the benefits of our preferred return is what it says is, these preferred shares are going to get paid out in advance of anyone else. So if, for example, there was a 6% preferred return then the investors with that class of shares would get paid up to that 6% preferred return and the management would take their remaining or the rest of the shares would take the remaining. Now it's important to understand that the benefit of the preferred return is actually that the incentive alignment says, hey, as the manager, as other levels of shares, I'm going to get paid out first and foremost, first, the debt then the preferred equity preferred shares. So the benefit is, you know, what you're going to expect to get as long as the deal is performing in a great place. Now, what can then come at the end is that maybe it's a preferred return with an equity piece where you've got your preferred, and then you're getting a split of the upside after that point. This can be really great for investors and managers because they get to know that, hey, up until this point, the managers aren't going to make any money so they're incentivized to work really hard to give us a return. And then at that point we share in the profits in some kind of, you know, equitable split.
An additional model is where you've got a set of preferred returns - it's almost like a hybrid where you've got a preferred return on the front end - where, hey, this is what you're expected to get, no one else is going to get paid until this point on, maybe, on cash flow. And then you might have another preferred return that's paid out on equity gain that says, hey, up until this point, you're going to get paid that preferred return and no other shares are going to get paid out before you, including management until you hit that place. It's a much more conservative model and it's really focused on how are you going to make a consistent income and then benefit from some of the upside. But one of the benefits is that, it's really great for people who like more of a conservative approach. They want to know what they're getting in and they're going to take on investments that are more conservative. Or for high risk investors, people who want to, you know, shoot for the moon or swing for the fences, but they really need some stability or balance in their portfolio. So that's a couple of the different ways that those returns can work out.
The other piece is something called a performance hurdle, you know, additional performance hurdles, AKA waterfalls. You'll hear this term quite a bit in the industry. And a waterfall essentially means that once we hit a certain level, certain preferred return or a certain hurdle as they call it a certain, you know, level of the return that's being provided to investors at that point, the return structure changes and it steps into a new waterfall. And so if you think about a waterfall, like a set of buckets, as you're filling up the bucket, it starts overflowing to the other bucket. So if you've got a 6% preferred return, nobody at the lower ends of the buckets, whether that's class B shares or a management or anyone else is going to have their bucket filled until your bucket is full of the return or the water, and then that's going to trickle over and then the next level is going to start getting paid out. And so on this waterfall, you know, you might see a split change from a 70, 30 split to a 50, 50 split, essentially really creating an incentive structure for management to work really hard to deliver an exceptional return, to deliver a return that's much higher than maybe something you would expect. And if they do that, then they end up getting a much better share of the pie after that point.
Another big thing that you're wanting to look for when it comes to deal structure is how the sponsors are compensated when it comes to fees. Fees are a normal part of the syndication, they're a normal part of any kind of joint venture or partnership structure where the management is taking on a lot of responsibilities for acquiring the property, for managing the property, for selling the property or doing construction. And they typically receive some type of fee compensation that'll help keep the lights on. Now, the majority of their income typically is paid out on, you know, the success of a sale or paid out on cash flow based on performance. But these fees are really a way to ensure that for the work that's going in to manage the property or acquire it, that they're getting paid upfront. So things you want to look out for is really, really high fees. But even with high fees, you really want to dig in, why are the fees high? Why are they higher? Is there a specific reason? Was this an off market deal and they worked on it for 6, 12, 18 months, they've been following up with the seller for a really, really long time in order to get this phenomenal deal and therefore they've got a lot of expenses and costs up front? Maybe there's a justification to the fees, maybe one or 2% higher than normal, or maybe on the management side, maybe there's some piece of it where they're able to execute a plan that isn't going to end up returning better to investors, and maybe their fees are higher there. At the end of the day, the most important part as a passive investor is to ask these questions to understand, okay, are these fees in alignment with what I'm seeing in the industry? Are they higher? If they're higher, why are they? If they're lower, why are they right? It's important that management is compensated because if a lot of their income isn't going to come until the sale of the property, you want to make sure that they're not hungry, you know, or you want to keep them incentivized. You also don't want them to be getting fat on your money just based on fees. So it's really, really important to look at that.
Now we're going to continue this and dive into a few other important areas in next week's episode. So you're definitely going to want to tune in, you're definitely gonna want to check this out where we're going to pick up and continue to talk about the investment summary and how to get the most out of what to review when you're looking at this. So definitely check back on that coming up very soon. And as a reminder, if you want to dive deep into everything that we're talking about here, you can go and grab your free guide, The Ultimate Guide to Passive Real Estate Investing where we dive deep into the topics we're talking about right now. 40, 50 pages full of graphs and graphics and great lessons that we're able to share with you guys so that you can understand, hey, how do I vet other sponsors? How do I go find sponsors to work with? How do I really determine what are some of the advantages of real estate if I want to share that with friends or family? This is a great place to really build that foundation so go make sure you grab a copy of that, the link’s down in the show notes below, and that's at theinvestormindset.com/passive.
And as a reminder, you guys, if you guys have been listening to more than two episodes of the investor mindset and you like it, or you don't like it, but you felt like you've got some value, it's time to pay the Piper. We do this show completely for free so head over to theinvestormindset.com/apple, or head over on your favorite podcasting app and go drop a review. Write up a review, you know, and let us know, Hey, what do you think about it? What do you love about it? What would you like to see more of? Because those reviews truly help us reach more people. So please do that, I would definitely appreciate it. And thank you guys so much, I look forward to seeing you on the next episode,
Narrator (13:47):
Thank you for listening to the investor mindset podcast. If you like, what you heard, make sure to rate, review, subscribe, and share with a friend, head over to the investor mindset.com to join the insider club, where we share tools and strategies from the top investors and entrepreneurs and how to take it to the next level.