I read several books this year on real estate. I'm going to talk about three of them today.
#1 Raising Private Capital
One of the most interesting for me was called Raising Private Capital by Matt Faircloth. This comes from the Bigger Pockets folks and isn't actually geared at the investor, it's written for the syndicator. It is geared at the person who wants to invest my money in real estate. It was interesting because it gave me insight into the way these folks think or at least should be thinking.
I had to chuckle at one section though. The book calls the two parts of the party “deal providers” and “cash providers”, then gives advice on finding yourself one of these “cash providers.” Here are the six sources:
- People with retirement accounts that can be turned into self-directed IRAs
- People with home equity
- Savvy Investors
- High-income Earners
Guess which one most of you are? That's right, # 6. Here's what Joe says about you:
Most of you probably figure that people who earn a lot of money have a lot of money. This can be true, but it's not always the case. The could be living paycheck to paycheck; they just have more expenses to absorb all that income they have. There are other high-income earners who live below their means and have money to put to work but not the time to manage it. Some of my best investors are people who went through years of training to do what they do for a living and get paid well for doing it. Dentists and doctors are good examples of this. They went to school for more than ten years, in some cases, to get to their position. They are not going to leave that job anytime soon, but they get paid very well for doing what they do and are often looking for opportunities to grow their wealth. If you have a solid relationship with someone like that, he or she may even be willing to act as a sponsor for you on a loan.
Ha ha. Pro tip: If the person you're hiring to manage your money needs you to sign for the loan, that's probably a bad sign. But in general, the book talks about treating the passive investors well. That's a widely applicable business principle–you don't stay in business long by treating people poorly. Thieves just don't get that rich because they have no repeat or referral business and repeat/referral business is how you build a big, successful business.
I also enjoyed the section where he talks about structuring the deal, and how much of the profits go to the deal provider and how much to the cash provider.
There is a bit of an art when it comes to calculating how much of a deal to give to your investors and how much you want to keep for yourself. I find it helpful to approach this from their perspective and give them a return I know they will be comfortable with, leaving the rest for myself.
But he talks in simple terms about preferred returns, waterfalls, fees, IRRs and preferred equity. It is one of the best simple discussions of these terms I've seen. If you're sick of reading investing book after investing book that all say the same thing, you might really like this one.
#2 The Doctors Guide to Real Estate Investing for Busy Professionals
The second real estate investing book I read this year was written by everyone's favorite general surgeon turned author, Cory Fawcett. His fourth book is called Real Estate Investing for Busy Professionals. For those who don't know his story, a few years into his surgery career, he decided to start buying apartment complexes in his small Oregon town. By his early 50s, he was not only living entirely off the proceeds of 5 or 6 small apartment complexes, but he had automated the processes well enough to be able to really step away from them. In fact, he says he never once had that feared 3 am toilet call.
If It Doesn't Cash Flow, Don't Buy It
The book isn't super applicable to me, just because I don't plan to directly invest in real estate any time soon, but if you do, you should definitely read this book. At any rate, I thought one of the most important lessons out of the book was Chapter 7, titled “Cash Flow Method of Evaluating Real Estate Investments–The Gold Standard“. I think the lesson here is pretty obvious, but based on the number of people who apparently understand it, it isn't obvious at all. Let me quote from the book:
Cash flow is the only method I use to determine the value of the property to me and it is my decision-making tool. Cash flow is how I determine the price I'm willing to pay. It is the only way to fully evaluate the property as an investment, and it will take some of your time to compute. It also takes into consideration how the property is financed–which none of the other methods care about, but you certainly should. When I buy an investment property, the idea is to make money. That's the definition of an investment.: a place to put your money so it will make you more money. There are two ways real estate makes money. One is appreciation, which I can't predict well, and the other is cash flow, which is much more predictable. In order for you to compute the cash flow, you will need two pieces of information already discussed: income and expenses, which make up the [Net Operating Income] (NOI). The final piece of information is the financing terms…
It is very important that the money coming from the property, the NOI, can fully cover the mortgage payments…With an investment property mortgage, the property is responsible for earning the money to make the payments. You can then put the leftovers in your pocket: a positive cash flow….The cash flow calculations determine if you will have an investment that puts money into your pocket or takes money out….
Once you have calculated the estimated gross income and subtracted the total expenses, you will have the net operating income for the property. This is the amount of profit you would make if you paid cash for the property. Since it is less common to pay cash for this type of property, the NOI represents the total amount of money available to finance the property. For every property you purchase, you must have a positive cash flow. To establish what your cash flow from the property would be, subtract the mortgage payments from the NOI…
If you make the initial calculations and the cash flow is negative, you have at least three choices to turn it to positive. How much above your expenses , including financing, that you want it will be up to you. The more the better, but everyone will have a different comfort zone.
#1 Lower the Purchase Price: Knowing what NOI you have to work with, you can determine at what price you can afford to buy the property for it to be a positive cash flow.
#2 Make a Bigger Down Payment: [This still] gives the seller the purchase price she wants and gives you the loan amount you need based on the NOI.
#3 Get Better Terms on the Loan: If the seller won't come down…you can still swing the deal….if you can negotiate a lower interest rate on the loan.
#3 Do the Work Once, Get Paid Forever
The third real estate book I'll be reviewing today is called Do the Work Once, Get Paid Forever. The author is a, well, deal provider. Like so many of the investing books for doctors written by a financial advisor targeting doctors as clients that I have read and reviewed over the years, this one is written by a real estate deal provider who would love to have a bunch of doctors as clients. But it's a pretty soft sell.
The Case For PPMs
PPM stands for Private Placement Memorandum, the 100+ page document an accredited reads (supposedly) before buying into a private real estate fund or syndication. Like every one of his peers, he believes that these deals are much better investments than stocks, REITs, and direct real estate investing and tells you not to worry about the fees and just concentrate on whether you like the person putting together the deal. To make matters worse, he uses all kinds of analogies to doctors which sometimes make sense and sometimes don't.
- How to evaluate a sponsor (aka deal provider aka syndicator aka fund manager) and
- How to evaluate a deal
This book doesn't really get into # 2 much, but it does get into # 1 very, very well.
How to Pick a Sponsor
He actually gives some really specific information about choosing a sponsor. Now, that isn't all that different from the books that tell you how to find an advisor that basically describe the advisor writing the book, but I still think there are some pearls there, so I'm going to list them:
# 1 Make sure the sponsor is using a recourse loan. That means the sponsor is personally on the hook if the deal doesn't work out. It also means the sponsor is wealthy, or the bank would not have approved the loan. Both are good things for you.
# 2 Beware of rosy projections and high leverage. Avoid people using more than 75% leverage.
# 3 Make sure their money (or that of friends and family) is in the deal
# 4 Make sure they're at least in their 30s and preferably 50s (and in their first career)
# 5 Make sure they're crazy transparent.
# 6 Make sure you're directly connected to them without a middle man
# 7 Make sure they're motivated by making deals, not just money. All the best ones already have plenty of money already, so that can't be the only motivation.
A Few Interesting Pearlszero debt on your residence, for instance. He also recommends you put 25% of your money into real estate, 25% into an index fund, 25% into paying down your debts, and 25% into cash. I'm just pleased to see a real estate guy that actually knows why index funds work, as they too often view anything stock related as simply gambling. And he emphasizes a point I frequently make, that just being accredited doesn't make you smart.
If you want to learn more, check out Do the Work Once, Get Paid Forever today!
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What do you think? Have you read any good real estate books this year? Which ones? Do you invest in real estate? Do you buy properties yourself or invest in PPMs? Comment below!