Perhaps you're looking for passive income, retire early, quit your job or leave a financial legacy for your children. And you're considering investing in multifamily properties – AWESOME!
The only problem is, you don't have enough or even any cash or credit, and so you're stuck. But it doesn't have to be this way.
The solution is to raise money from private investors. In this article I teach you how.
You may not necessarily agree that raising money from private individuals is the best way to go, so let’s talk about this first.
There are many advantages to raising money from others versus using your own money:
- You can get more deals done. Even if you have your own money to invest, there is only so many deals you can get done. On the other hand, if you are able to raise money from others, the sky is the limit. Your ability to accumulate property is then only limited by your ability to find good deals. The ability to raise money is an incredibly valuable skill to have.
- You have more eyes on the deal. Richard Feynman, the famous physicist, once said that “the first principle is that you must not fool yourself and you are the easiest person to fool.” When you’re using your own money, no one else is looking over your shoulder, and you’re more likely to make mistakes. If you can convince others to invest in your deal, chances are, you actually have a good deal.
There are some disadvantages:
- You now need to report to your “bosses”. Chances are you’ll have to report to your investors in one form or another. You may have to give updates and financial reports to your investors to keep them posted. This certainly is more work than if it were just you in the deal. On the other hand, analyzing the Profit & Loss (P&L) statements and sending out reports make you pay more attention to the deal. You should do the same if there are no investors, but few of us have this kind of discipline, and as a result we don’t pay as much attention to the investment like we should.
- You may lose some control. You may not be able to make all of the decisions without a vote from your investors. As we’ll discuss in later chapters, there are ways to mitigate this risk with how you structure the deal.
All in all, though, the advantages of using other people’s money far outweigh the disadvantages.
OK, here it is, the secret to raising money revealed, the moment you’ve been waiting for -;)
The Secret to getting financial commitments from your investors long before you have your first deal under contract is to … Create a Sample Deal Package.
The “Sample Deal Package” is a document that contains everything about a potential deal including photos, information about the building and area, actual financials, your business plan, projected financials and returns. The Deal Package is used with potential investors and even with other professionals you’re trying to recruit to your team (like commercial real estate brokers, lenders, insurance agents, etc).
The difference with a Sample Deal Package is that everything about the building is accurate (photos, location, financials, etc), except that you don't have it under contract. You may also lower the price so that you achieve the desired returns for the investors. In other words, you approach your potential investors with a deal package that looks like the real thing.
Having this Deal Package does several things for you:
- It allows you to better visualize your deal. This is critical as you expand your own comfort zone with doing your first commercial real estate deal, or doing bigger ones than before. Seeing the photos, visiting the property, writing and talking about it make this deal real for you. The more real it seems to you, the more comfortable you become and the more confidently you can talk about it.
- It gives you a reason to talk with your potential investors now. You can now schedule meetings with potential investors and say, “I don't have a deal right now, but when I do, it'll look substantially like this” and then you show them the Deal Package.
- It will allow you to get financial commitments from your investors long before you actually have a deal under contract. By the time you get a building under contract, you've already primed your investors, which will allow you to raise the money quickly.
To download a Sample Deal Package, check out my free ebook “The Secret to Raising Money To Buy Your First Apartment Building”. The Sample Deal Package is in the Appendix. Download eBook Now.
Do this now, and then let’s talk about how to create one.
This is how you create a Deal Package yourself.
The first step is to find a property that is being marketed for sale. This property should be about the same size and in the same area that you are looking for. It should have a good marketing package, i.e. it should have photos, financials, rent roll, unit mix, and maybe some information about the area and demographics.
There are a variety of web sites that list multi-family properties for sale (just do an online search!). For the purposes of creating the Sample Deal Package, I suggest you use Loopnet because it’s free and easily searchable.
Go to www.loopnet.com, create an account (it’s free), log in, and search for properties that match your criteria. Sometimes you can just download the marketing and financial package. Many times you need to contact the broker and complete a non-disclosure agreement to get access to the financials.
Look for a property that has a marketing package with at least photos, financials, rent roll, and unit mix. It’s a bonus if it has extra goodies like demographic information or rental and sold comps.
The marketing package you downloaded should contain the actual and projected financials for the property. Create your own 5- and 10-year projections in Excel and use it to calculate the potential returns for investors. I choose 5 and 10 year time frames because your investors should be committed to the deal for at least 5 years. You will need to structure the deal in such a way to achieve the desired returns for your investors and also to compensate yourself. Again, I cover all of this in detail in the course, but you can put together a pretty good Sample Deal Package without this.
If the marketing package you downloaded contains financial projections you can just re-use those, either by copying them into a spreadsheet or by doing a screen capture and then copying and pasting them.
Most of the time, the financials in the marketing package are gross exaggerations of the truth. So it’s important to create your version of the truth for any real Deal Package you create (I cover this in detail in xxx).
However, for our sample Deal Package, the accuracy of the financials is less important. What is important is that you have something to talk with your potential investors about. You don’t need to do hours of due diligence to get your projections right – that is not the goal of this step. Your goal with the Sample Deal Package is that it is representative of the kind of deal you want to do and that it emphasizes the terms of the investment.
Use the sample Deal Package of our 12-unit apartment deal from earlier as an example. Here’s the outline of each of the sections.
Executive Summary: This short section (half to full page) contains a summary of the investor terms (preferred rate of return, equity, projected returns, minimum investment, the term of the investment), a description of the property, and an overview of the business plan (renovate and raise rents, exit strategy, etc).
Property Information: This section contains a description of the property, some words about the area, and the unit mix. I also add the business plan for this property. For example, if we're going to renovate the units and make other cosmetic improvements to raise rents, that would go in this section.
Financials: This section contains the rent rolls and actual financials.
Projected Financials and Returns: This section contains the 5- and 10-year financial projections and the estimated returns for your investors.
About the Management Team: Here you have a short bio of yourself as well as for some of your other team members, for example your property manager, attorney and CPA. If you have any other important partners, list them here. This section gives you credibility as someone who will be able to put a deal together and close.
NOTE: To see an example of a finished Sample Deal Package, please download my free ebook “The Secret to Raising Money To Buy Your First Apartment Building” and see the Appendix at the end of that eBook. xxx
For several years before getting involved with multi-family investing, I was renovating houses, fixing them up and reselling them. To finance these “rehabs”, I raised the money from friends and family. The minimum investment was $25,000 and paid I them 12% to 15% simple interest, guaranteed by the house. The title companies took care of the promissory note and recording the deed.
As I was eyeing commercial real estate, I polled my existing investors to see which ones were interested in buy-and-hold commercial real estate. But I was disappointed to find that only a few of my existing investors were interested. From that perspective my pre-existing relationship didn't produce direct results. However, I found that people I knew were able to refer me to people who were interested.
The lesson here is not that you should start small first (with rehabbing houses, for example) before moving into commercial real estate. Rather, the lesson is that you should leverage your existing sphere of influence to achieve what you're looking for – in this case, to raise money for multifamily properties.
It's surprising who your family, friends, neighbors and co-workers know. Never discount anyone – tell everyone you know what you want to do and you will be surprised at what will happen. If someone refers you to someone they know, always follow up. Even if that person will not invest, she may invest later or she may be able to refer you to someone else.
The conversation might go like this after you dispense with the small talk:
You: “I'm working on something new, maybe you can help.”
You: “I'm looking to purchase a multifamily building in the <…> area with a group of investors. The annual returns are expected to be around 13% and the minimum investment is $50,000. You wouldn't happen to know anyone who might be interested, would you?”
Susan might say, “Well, I might be interested,” or she might refer you to someone, or she might say that she doesn't know anyone.
If she is interested herself, schedule a meeting with her. If she knows someone, have her make an introduction and then follow up with that person. Make sure you keep Susan informed about the progress.
Your goal is to have as many in-person meetings with potential investors as possible.
Sometimes when I speak with investors who want to syndicate their deals with investors (good for them!) they tell me they're paying an 8% preferred rate of return and giving the investors 80% equity.
Really?!? So what does that leave over for you? If you pay out an 8% cash on cash return (which is already excellent!) there's either nothing left for you, or worse, there is no 8% cash on cash return and you have to push the obligation into the next year. If the building doesn't perform better, you might never be able to satisfy the liability to your investors and turn the situation into a negatively amortizing loan!
So you're already giving the investor most (if not all) of the cash flow, and then 80% of any upside? Wow, that's rich.
After berating the investor about how they won't get paid ANYTHING ever, I ask them who the investors are they're dealing with. That's when I discover that they're actually dealing with one or more “sophisticated” investors.
What “Sophisticated” Investors Want
Sophisticated investors are investors who invest professionally. These could be “angel” investors or institutional investors. These types of investors have access to lots of capital, see tons of deals, and can therefore be very selective about the deals they do. They've probably also been burned a few times, and so they construct the terms of a deal so that they are very much in their favor.
They will ask for high preferred rates of return and for a big chunk of any upside. They want to make sure they are paid before anyone else, including the entrepreneur (i.e. you). If things go wrong, they will be first in line to take the asset (and most probably your house).
I've dealt with “sophisticated” investors before and I've never taken their money because I didn't feel like there was a fit with me and the investment.
I think sophisticated investors most definitely have their place, but I'm just not ready for them at the moment. If you're buying a 150 unit for $7M and you need to give up 80% of the cash flow and equity, that still leaves a good amount for you as the syndicator. But apply that same logic to a $1M deal and it's hardly worth doing the deal.
Based on my experience, sophisticated investors become more relevant after you've done a few deals and your deal size grows. That's because sophisticated investors almost always insist on track record. The more track record you have, the less you have to give up. That's why when you're first starting out, you would need to give up way too much to a sophisticated investor to make it worth your while.
But don't despair! There is an alternative.
Friends & Family
We've already talked about this investor: these are the people you already know: your friends, family, neighbors and co-workers. These people trust you for the person you are, and they will care less about the deal itself. They will invest with you simply because they trust you'll do a good job for them. Friends & family can typically invest or loan you around $25,000 and often have that capital in their IRA.
Friends and Family will NOT ask you for a preferred rate of return, so don't volunteer it! Preferred rates of return are good for the investor and bad for you. Unless an investor “forces” you to have one, then don't use it! Use a straight equity split instead. The equity split to use depends on the deal and on whatever it takes to achieve the 10% – 15% return for your investors. You can give your investors up to 80% of the deal (even though I shoot for less). If you have to give up more, then maybe you need to keep looking for another deal!
Also don't talk about any confusing investing concepts with this kind of investor. For example, don't mention “IRR” (internal rate of return) because your friends aren't going to know what to do with that. Talk instead about the “average annual return” which is much simpler to understand.
Your friend will ask you, “if I give you $50,000, what will I get back in 5 years?”. That question is answered not with IRR but with the average annual return. In simple terms, if after 5 years, the combination of cash flow, loan amortization, and profit at sale equals 50%, then 50% divided by 5 years is an average annual return of 10% simple interest return.
That's something that your friend will understand.
Your friend will also understand “cash on cash return”, so it's OK to talk about that. They'll want to know what they can expect to be paid every year while they're investing in you.
Now, what if you want to raise more money than in $25,000 increments? You'll probably want to talk with higher-net worth individuals.
The Higher Net Worth Investor
The higher net worth investors is oftentimes a successful business person or professional. This person can invest at a $100,000 or higher level and has made some alternative investments outside of the stock market.
Most likely, this type of investors will not ask for a preferred rate of return or what the IRR will be, so don't volunteer this information. Basically, treat these individuals just like you would your family and friends.
The only difference will be the amount of minimum investment.
Be aware that you may have to deal with concerns and objections you didn't have to address with your friends and family. Higher net worth investors may ask you about more control of the entity that you will create for the investment.
With your friends and family, you can probably create an LLC where you have all the say and your investors have really no say whatsoever.
The higher net worth individual may ask for more control. They may allow you to make certain day-to-day decision but they will want a vote for decisions of a more strategic nature. This means you may have to give up more control and your investors will act more like a board of directors that could actually disagree with what you might want to do.
Here's the bottom-line: unless you've done 4+ deals and are looking to raise tons of capital, you will most likely not be dealing with sophisticated investors. So don't volunteer a preferred rate of return and don't use confusing concepts like IRR. Keep it simple and focus like a laser on achieving the returns for your investors you projected, and they will invest more with you and tell all their friends.
By this point you will have completed your sample Deal Package and have several meetings scheduled with potential investors.
What should be the desired outcome of your meeting? Ideally, you should get some level of commitment from your investor.
In order to get a commitment from a person, you have to understand and address their greatest fear, which is that they will lose part or all of their principal investment.
In order to address this fear, you will need to identify the main risk factors and how you plan to mitigate them.
If an investor hears that this is an “unbelievably safe investment without any real risks” they will rightly grow suspicious. You will be much more credible if you are upfront about the risks and how you plan to address them.
Let’s start by discussing the # 1 risk factor: You.
You have two strikes against you as far as the investor is concerned. First, he doesn't know and trust you (yet) and second, you probably don't have a track record (yet).
You will spend most of the meeting making the investor comfortable with you. Only then can you address other objections and the deal itself.
Your goal in the meeting, then, is to build rapport with the investor and demonstrate to him that you will be successful even though you don't have a portfolio of successful deals.
I start by talking about my life. Where I was born, about my family, where I grew up, and went to school. Remember, your goal is to build rapport, and sharing personal information like this will achieve just that. Chances are you'll discover things you have in common.
Then describe your professional experience. Focus on a track record of success in whatever you have accomplished professionally. People can then see that you tend to succeed in whatever you do. If you had a failure, you can turn that into a strength by talking about what you learned.
Talk about your interest in multi-family investing. Why are you interested? What have you done so far to build your team? Talk about your team. Talk about deals you've looked at so far but passed on because the numbers didn't work.
At this point, you've done most of the talking, but that's OK. You shared about your life and your passion about building long-term wealth for you and your investors with multifamily investing. If you've done your job, your investor will say that he knows you a lot better and has become more comfortable with the prospect of doing business with you.
It's now time to shift the conversation to how you might do business together.
You: “I have a deal for us to look at. I don't actually have this building under contract, but when I do have a deal, it will look substantially like this. I wanted to get your feedback on the terms and projected returns, would that be OK?”
Next, review the Executive Summary page with the investor, focusing specifically on the investor terms and addressing objections upfront.
You: “The deal I'm looking for should produce an average annual return of 9% to 13% over the life of the investment, how interesting would that be to you?”
Investor: “That would be interesting to me. How long would the money be locked up?”
You: “I'm telling investors that they should be prepared to keep their money in for at least 7 years – this would allow us to build the value we're looking for. I realize this is a long time. In order to address that, after 4 years I would allow an investor to pull out by offering to sell their shares to other investors. The LLC operating agreement would spell out exactly how that would be done. How would you feel about that?”
Investor: “That would be fine. Would there be any cash flow distributions?”
You: “Yes. Typically, we will pay out distributions once per quarter, how would that work for you?”
Investor: “That sounds reasonable. What do you see as the greatest risks?”
You: “It would depend on the deal. I think the greatest risk is our ability to execute our business plan. We could fall short of our projected returns or it might take more time to achieve. For example, let's say our plan calls for the renovation of half of the units so that we can raise rents by 30%. We would make sure we have the money in the bank account to fund the renovations. But maybe the tenants won't move out as quickly as we think and it will take longer to raise the rents.
Having said all that, my goal with the first few properties we buy will be to keep these kinds of risks to a minimum. In other words, I don't want a completely vacant building or a building with all kinds of problems. I'm going to look for a good deal for a relatively stable building.
Once I have a building under contract, I will outline the plan in more detail and identify the risks so that you can make a better decision.
Before we look at the Deal Package, what other questions or concerns do you have regarding the returns and terms we talked about so far?”
At this point, the investor should be relatively comfortable with you as a person as well as with the risks, returns, and terms of the investment.
Next, spend a little bit of time reviewing the Deal Package itself. Don't spend too much time because you probably don't have too much time left in the meeting anyway, and the numbers aren't for a real deal.
You: “Let's take a few minutes and look at the Deal Package. Like I said before, this is not a deal I currently have under contract, but when I do, it will look a lot like this.”
Then briefly go through each section of the Deal Package, just enough to orient the investor and answer any questions. Don't focus on the numbers since these will change.
Finally, you want to close by describing the logistics of closing on a deal from the investor's perspective:
You: “I appreciate your time today! Here's what will happen next from my side. I'll keep you posted and when I have a property under contract, I'll email you the Deal Package. If you're interested in investing, you just have to tell me the amount you're interested in and I will reserve that amount. Once I get commitments from all of the investors and the due diligence is satisfactory, I will instruct the attorney to begin the closing process.
You will receive an LLC operating agreement and a private placement memorandum. You sign the operating agreement and a subscription agreement that documents the investment amount. A day or so before closing you wire the funds to the closing attorney.
My goal will be to send an email report to the investors once per month in the beginning, and once things have stabilized, I will send out quarterly reports with any distributions.
What questions or concerns do you have about this?”
The investor may have questions about the structure of the LLC and about the documents you referenced. In the next chapter, I’ll outline different ways you can structure the investment.
Here’s what we covered in this article on raising money from private individuals:
- Why Raise Money to Fund Your Deals?
- The # 1 Secret to Raising Money
- How to Find Potential Investors and What to Say to Them
- Who Your Ideal Investor Is (And Who to Avoid)
- What Investors Want and How to Give it to Them
- How to Conduct your Meeting with an Investor
If you're dying for more, attend my next Webinar on Raising Money. I'm currently shooting for the firs Tuesday of the month.
You may feel overwhelmed right now — but don’t be! I’ve found that whenever you feel overwhelmed, make a list of the next three things you should do. That’s it. Just three.
Here’s a suggestion of the next three things you should do:
- Create your Sample Deal Package.
- Set a meeting with your first potential investor. Make this a trusted friend or family member. Worst case they won’t invest but be great practice for you and give you confidence. Best case they will want to invest or know someone who will!
- Continue to learn. Identify the next book to read or seminar to attend.
And when you’ve done those three, make the next list of three things to do next. After a while, you will be absolutely amazed at what you can accomplish.
It’s been a privilege to be able to share some of my experience and hope you have found it motivating. I would be thrilled if it compelled you to take action.