Working Capital The Real Estate Podcast
The Hands-Off Investor with Brian Burke | EP49
Apr 14, 2021
In This Episode
Brian Burke is President & CEO of Praxis Capital, Inc., a vertically integrated real estate private equity investment firm. Brian invested over half a billion dollars into the real estate including over 3000 multifamily units and more than 700 single family homes. Brian is also the author of “The hands-off investor” – an insider`s guide to investing in passive real estate syndications and is a frequent speaker at Real Estate investment Forums and Conferences across the country.
In this episode we talked about:
- The changes in real estate over the last 6 months
- Recovery from pandemic
- Pros and cons of funds and syndication
- Importance of diversification
- Property management
- Brian’s background and his first steps in Real Estate
- “The hands-off investor” book. Why did Brian write it?
- Passive investment
- Limited partnership
- Brian’s thoughts on interest rates, inflation and economy of 2021
Resources and Links:
Intro (0s): Welcome to the working capital real estate podcast. My name is Jesse Fragale. And on this show, we discuss all things real estate with investors and experts in a variety of industries that impact real estate. Whether you’re looking at your first investment or raising your first fund, join me and let’s build that portfolio one square foot at a time.
Jesse (24s): All right, ladies and gentlemen, welcome to working capital the real estate podcast. We have a returning guest. His name is Brian Burke. He’s the president and CEO of Praxis capital Inc. A vertically integrated real estate. Private equity firm. Brian has acquired over half a billion dollars worth of real estate over a 30 year career, including over 3000 multi-family units and more than 700 single family homes. Brian is also the author of the hands-off investor, an insider’s guide to investing in passive real estate syndications and is a frequent speaker at real estate investment forums and conferences across the country.
Brian, how’s it going?
Brian (58s): It’s going great. Thanks for having me here today.
Jesse (60s): My pleasure. So we were just talking before we came on here. It’s a, it’s been almost a year, so time flies. So I thought it’d be great to have you back on and talk a little bit about the book and, and what you’ve been up to.
Brian (1m 12s): I know it’s hard to believe it’s been almost a year, has passed and a year of COVID. So it’s been an interesting year at that probably the longest year ever.
Jesse (1m 20s): Yeah, it definitely feels that way. I can comfortably say and you know, maybe I should be, you know, knocking on wood here that it looks like we’re slowly coming into a little bit of light at the end of the tunnel. So fingers crossed there, but how are things going in your world, anything new on, on the real estate side or just given, given the environment over the past 10 months?
Brian (1m 43s): You know, since we last spoke, you know, we we’ve been actively in the markets, you know, when about the time we last recorded with you, we weren’t really buying much, you know, we were, we were out there in the market looking around, but due to all the unknowns that were related to the pandemic, we didn’t know exactly what the market was going to give us. We didn’t know if cap rates were going to decompress. We didn’t know if rent growth was going to come to a stand still. We didn’t know if anybody was even going to pay their rent since that we’ve, we’ve learned a lot.
We’ve learned that, yes, in fact, most people are paying their rent. There’s a few that have decided that taking advantage of eviction, moratoriums is a great way to keep their money rather than spend it. So we certainly have seen that have an impact to, to our income. But outside of that boy cap rates have actually compressed, even further market activity has, has been just as robust as ever. And we’ve just been out there trying to find a smart investments to make.
So we, we began that effort by launching a $50 million discretionary fund, which we, we fully committed that fund about a month and a half ago. So the fund is now full and we’re out buying assets for it. So we bought our first two properties for that fund. And, and now we are trying to get number three. So it’s just been an active, an active bicycle. And then on the sell side, we’ve actually sold since we recorded, we’ve sold two properties and we have a third listed and we’ve been finding real robust activity on the resale side.
So it’s a, it actually, despite everything and all the craziness, it’s actually been a pretty decent year.
Jesse (3m 35s): Yeah. Well, I know just from knowing you and talking to you guys, take a very conservative approach when it comes to selecting the right properties. So I can only imagine, you know, things have come across your desk that you just didn’t meet the bar for you and you kind of hung tight and waited for the right opportunity. It sounds like,
Brian (3m 53s): Well, we have, and you know, even, even the best of us gets a, a lemon every once in awhile and we’ve had our share. And one of the things that we found is, you know, we found that, especially when you get kind of into the C to C minus tier, that resident profile has had the biggest challenges related to COVID. They also, I think have a higher incidents of folks who want to take advantage of the rules against, you know, eviction, moratoriums and so on.
So those properties have certainly seen a tougher time and that’s caused us to just elevate our acquisition criteria yet even further. So if we were conservative before we’re even worse now and, you know, looking at newer product, even stronger markets, and there’s a lot of deals that we would have done even a year ago that now we just, we won’t do so it’s, it’s definitely a continued to allow our criteria to evolve
Jesse (4m 49s): From the practical point of view. What does that mean at the asset level? D you know, is that the, the capital reserve is larger, that you’re fixing interest rates. What does that mean at the property level for, for the team?
Brian (5m 2s): Well, it primarily means we’re looking at areas that have maybe a little bit higher median income in the immediate sub-market or within a, a, you know, two to three to five mile radius. It, it seems like, you know, this recovery out of the pandemic has been a bit of a K shape recovery where, you know, more of the middle to upper tiers of income have actually done really, really well while the, the lower tier of income has really suffered the most. And so it’s difficult to predict the performance of assets that are geared towards the lower income segment of the population.
It’s just been very difficult to predict whether those are going to perform or not. So we’ve, we’ve been staying out of that side of the market and just focusing more on a little bit better incomes, a little bit better school districts, some of the nuances of a market that maybe before seemed a little bit less important, but now we’ve, we’ve found that they’re a lot more important than we otherwise would’ve felt.
Jesse (6m 6s): Hm. So I think correct me if I’m wrong. I don’t think this was the first one that you had done, but predominantly before that it was, it was syndication asset specific deals. Is that correct?
Brian (6m 16s): For the most part? Yeah. This fund that we did, even though we, the, this latest fund was called fund number six, it’s actually, I think our 11th fund, or maybe even our 12th fund that we’ve done. And we, there was a time we, we weren’t numbering them. So, so we picked, when we picked up numbering funds, we had already had funds that didn’t have numbers. When we got to fund number two, we had, it’s probably our fifth fund and it’s like, Oh, wait, now our numbering is off. So we’ve done a number of funds, but primarily our funds were centered more in the, in the single family space.
And on the multi-family side, we were doing everything on an asset by asset allocation. And then that lasted up until about three years ago when we started doing everything on kind of like a two-pack model where we would acquire two properties and, and raise one funding vehicle for the two assets. And then now, now we’ve shifted more to just a strictly fund model.
Jesse (7m 9s): And you, you, the presentation I last saw you, you know, you went over the, the pros and cons of funds and the pros and cons of syndications for the listeners. Would you be able to share that with them and give them kind of an overview?
Brian (7m 23s): Yeah, sure. I probably had some really good prepared notes when you saw that presentation. So I probably went into a lot of detail, but, you know, just off the top of my head, a few things that are reported, I think are the most important features, a single asset allocation or a single asset syndication, whatever this is the conventional syndication, most people are used to seeing they have advantages. And the advantages are that you can see the asset you’re investing in. You can underwrite that asset alongside the sponsor to make sure that you agree with all their assumptions.
You can pick and choose the markets you want to be in. You can pick and choose the assets you want to be in. And so for someone that really likes to have that level of control, those have a lot of advantages. If the sponsor that’s a that’s, that’s bringing you this opportunity, doesn’t have an extensive track record or a ton of experience. A single asset model is really the only thing that could possibly work, because you really do need to have that level of personal oversight where you’re actually double checking everything to make sure that they did everything right.
The fund has, you know, the, the distinct characteristic, the disadvantage of the fund is you have to completely trust the sponsor that you’re investing with to make the right decisions, because you’re handing off that control to them in a fun scenario, you’re investing in a vehicle that doesn’t necessarily have any assets under contract yet, and you don’t know what those assets are going to be. You might have an idea of what they might be, or their might be like over a hundred units, class a and B you know, Southeast markets, whatever the kind of box is so to speak, but on the individual asset level, you don’t get that level of transparency.
So, you know, the disadvantage of course, is the opposite of the syndications. You don’t get to underwrite those deals and so on. But the advantage that you get is if you’re investing with a, you know, a experienced sponsor is, you know, you get that a little bit more scale sponsors that do funds tend to have more scale than ones that don’t, but most importantly, what you get, and this is the big feature of a fund as you get diversification. And it’s, it’s incredibly important, incredibly interesting how important diversification is because, you know, we have a couple of deals in our portfolio.
Everybody gets them that they’re just a complete thorn in your side, right? And no matter how hard you work on them, you just never get the result that you’re looking for. And you can dedicate tons of time and resources to them, but, you know, you’re just banging your head against the wall. Everybody gets those well, if you’re investing in a single asset deal, and that’s the only one you invested in a hundred percent of your investing world is, is mired up in some muck. But if you’re, if you’re invested in a fund, it’s one of many, and you get to distribute that amongst a portfolio of assets where, you know, it’s all you hate to have like two different investors, one invested in a single asset that didn’t do all that great.
And another one invested in the one that generated a 40% return. And if the two of them were to talk to each other, you know, one of them going to be like, you know, ha you know, and the other ones, you know, so to avoid that, you know, the fund smooth that out so that everybody gets the benefit. And, you know, the, the really, really, you know, grand slam deals will prop up some of the subpar performance of the strugglers. And in generally speaking, most deals performed somewhere in the middle and it just helps to smooth all of that out, so that the whole fund as a whole performed somewhere in the middle, and it’s really more of a misread mitigation tool than anything else.
Jesse (10m 56s): Yeah. So you’ve got two guys that have totally different views of a Brian Burke.
Brian (11m 1s): It happens to everyone. It’s, it’s, it’s very true. You know, you’ll have somebody there and they’re in a tough deal and they have a different experience than someone that just comes out of a massive, you know, 40% exit.
Jesse (11m 16s): And when you’re, when you’re raising money for the fund, how has the, if, if at all, I assume it is, how is the, the investor profile different than the syndications you’ve done?
Brian (11m 27s): It’s interesting. The fund investors, a lot of them tend to invest more because they have a deeper pocket. You know, they we’ve, we’ve found the average net worth of our fund. Investors has been substantially higher than the average net worth of our single asset investors. We found that we got a lot more larger. We had, you know, it’s very rare to find somebody that would go over $500,000 on a single asset deal, but we had many of them in the fund that went into the multiple millions.
So it’s, it’s, it’s a little bit different. It’s a little bit different investor.
Jesse (12m 11s): And I assume the, the code GP, or, or maybe a joint ventures with others is, is, is largely different when you get it to the fund level where you can partner with, with maybe institutional capital.
Brian (12m 22s): Yeah. That’s, that’s more of our focus. You know, there’s a lot of groups out there that partner with other groups and do a variety of different things. We don’t do any of that. We have a hundred percent control over, over our portfolio. And, you know, we basically do everything in house here, but we are seeking out relationships with institutional capital that can come in as passive investors and co-invest with our funds. So that has elevated our game to another level where now, for example, on one of our fund deals, we have a single check writer coming in with $5 million. It’s a, it’s still a minority position, but it’s a sidecar minority position where they’re basically co-investing with the fund.
We’ve had a lot of conversations with groups that, you know, can bring in 75 to 90% of the equity stack for other fund acquisitions. And we’re certainly interested in, in, in doing some deals like that as well. So you
Jesse (13m 14s): And your partners, you have a number of years of experience now, you know, it’s not your first time doing these type of investments when it comes to actually scaling geographically. And, you know, when you are actually building out your team, how does that, how does that all play in, you know, with, with the actual building of the business itself, and, and maybe even you could talk a little bit about property management and how you know, is, is that all vertically integrated?
Brian (13m 39s): Yeah, we are vertically integrated. We weren’t, when we started, you know, when we first launched into the multifamily space, we did it like anybody else would, you know, when you buy your first large multi-family project, you got to get somebody to manage it. The most logical choice is a really good local property management company that has experience in that asset class. And that’s, that’s how we did it probably for the first 10 or more years. Maybe even, maybe even the first 15 years, we would use local property management companies in each of our markets. And they would, they would oversee those assets.
We had several management companies cause we were in several markets and, and that model works great. And it’s also a model by necessity because it to build out an infrastructure of vertical integration to buy your first a hundred unit deal is pretty challenging to do so. We grew organically when we got past about 1500 units, we, we recognize that was the time for us to make the move to vertical integration. And we did it for two reasons. One is we felt that the, we had enough scale and that it would, it would benefit us to have full control over the process and be able to integrate all of our financial systems and everything else into one into one enterprise level solution.
But the other reason was, is, you know, as, as our goal was to start seeking out institutional trust venture partners, we’ve come to find out that they have learned through, you know, their long history in the business. These investors have figured out that groups that have vertical integration tend to perform better than those that don’t and rely on third-party management. So it was important for us to be able to fill that, you know, kind of investment mandate for the coach GPS.
Jesse (15m 22s): And how does that play into if you want to be, you know, out of state or in a particular geography, is it that you, you know, your management company, you have the capacity to, to go out to these markets or is there still that, that off, you know, property or investment where you have to use local?
Brian (15m 36s): Cool. Yeah, we, we do. And, but we were really fortunate. In fact, I wouldn’t even go so far as to say we were completely lucky. You know, I got, I got contacted by a guy who had been in the institutional world, in C-suite roles, in the institutional world, working for household names for a couple of decades and had two other colleagues that were kind of friendly competitors for other household name institutions that all wanted to get out of the corporate rat race and become more entrepreneurial.
And they ultimately decided to join Praxis and bring 106,000 units of multifamily experience with them. One of the guys that, that joined us was the president of one of these institutions, property management company. And he had founded that management company for them and he helped. And it was the fifth time he had done a national multifamily footprint. So when we set out to establish our own vertical integration, this was his sixth turn at bat at forming a national multifamily management platform.
You know, in his most recent assignment, I think he took something like 25,000 or 35,000 units from third-party property management to in-house management in 90 days. And this was a portfolio that was all across the country. So we’ve got, we’re very fortunate to have on our bench, someone with a lot of experience in building this kind of national footprint. So now we can go anywhere and, and successfully manage our assets.
Jesse (17m 11s): That’s great. So it’s not just yourself. We’ve had other people on a, we just recently had on the head of, or a former head of Deloitte Canadian real estate arm. And, and basically you hear the same story, time and time again with the, these owners or partners in these firms in that when it comes to raising capital, you know, they all started with friends and family and they, they built that they pushed that snowball down the Hill. It has that been your experience and, and, you know, maybe you could take us through a little bit of your path of, you know, when you first started in the business and how those types of things developed and maybe how your outreach might’ve changed over time.
But I’d love to hear that, that background.
Brian (17m 48s): Yeah. You know, the, you hear that as such a common threat is because in my view, it’s really the only way that works. You know, there’s a, I hear all the time guys are telling me like, Oh, I want to go buy my first property. I want to buy a 500 unit multifamily and I’m going to go find a bunch of accredited investors to throw money at me. And it’s like, yeah, good luck because they’re not gonna do it. You know, I, I started very modest means, you know, when I, when I first got into the quote unquote fund business, I was still working a job in law enforcement.
And I had just decided to get out into real estate as a full-time career. And I put in my notice to my employer, and then I told everybody at the station what I was doing. And I said, by the way, I rented out the room with the community center, I’m going to give a talk on real estate. Why don’t you all come? And they all did. And I told them about what I was doing. And I took, you know, talked about real estate and house flipping and media and home prices and all these other kinds of things. And I said, if you guys will invest with me, I’ll set a minimum of $5,000 and I’ll split the profits 50 50 with you guys.
I’ll do all the work. You’re just contribute the money. And I’ll be damned if I didn’t walk out of that room with $500,000 in commitments. But you know, there’s, there’s a couple of caveats here. Now, the most important thing about the most important lesson here is every one of these guys knew me. So, you know, it’s like, you know, people only trusted me because they trusted me for other reasons. You know, they knew who I was and all that kind of stuff. The, the other reason is they were all cops and they all carried guns.
And they knew that if I absconded with the money, I was a dead man and I knew it too. So, so a little bit less fear. They would chase me down. They knew I’d be hunted. So that taught me early on not to lose anybody’s money. So from that point, you know, I just started doing investments and just doing more and more and more and more and more. And, and every time I did one, it, it built my track record. And the more I did it, the more people would hear about it and would contact me and say, Oh, I heard you’re doing this.
And that, you know, is there a way for me to invest? And it just grew just like that over time. And I’ve, I’ve grown from that first set of 28 investors that invested a half million dollars at $5,000 minimums to now we’re over 1500 or 2000 investors over a way over a hundred million dollars raised and, you know, and a half a billion dollars in real estate purchase. And it, it all started as that tiny little snowball that I rolled downhill.
Jesse (20m 26s): Yeah. And I’m curious about the, the, you know, that zero to one, you hear, you know, oftentimes I hear people that come on the show that that is, that is definitely a milestone it’s getting to that for. And I’m not talking about buying your first investment. I’m talking about raising outside capital for the first time, you know, the, the first to five. So, you know, you’ve did that first one. How was that experience for you? You know, once you got that first track record, was that at the point where, you know, you’re still hustling to get investors, or you have the odd person saying, Hey, I heard about, you know, what you’re doing, you know, let’s, let’s book a presentation or something.
Brian (20m 58s): Yeah. Well, you know, at the time that, that was really all, I kind of needed to do what I was doing and I was happy. And then, you know, there was a point where I wanted to, you know, I, that probably lasted me. I don’t know, two, three, four years, well, two or three or four years meant, you know, almost a hundred real estate deals because I was doing single family homes. And you know, what I was doing is I would take, you know, the 500,000 I raised from my investors, I’d go to the courthouse steps. I buy a house at the foreclosure auction, I pay all cash. Then I would go to a hard money lender. I borrow the money back and I had 500,000 again, and I would go and buy again and again, and again and again, and I was, you know, so when you, when now I’m out there and I’ve done a hundred deals and it’s like, I want to do something different.
You know, I want to, you know, expand and do commercial properties, whatever, you know, now I got to go out and find investors. And so I like my first multi-family syndication, I needed to raise $400,000. And it was weird how it happened. I mean, literally like the day I got into the contract, I got a call from someone that was like, Oh, Hey, you know, I heard what you were doing in real estate. You know, I want to invest 50,000. And that’s literally how I got that deal done. I had just a series of calls that happened in a two week time period. And so it literally is kind of that law of attraction when you’re out there doing things and people hear about it and they tell people that was really how it was.
I’ve never hustled for money. I’ve never gone out and done, like, you know, Oh, put your money in a self-directed IRA and invest in real estate. I’ve never done that. It’s always been more people coming to me because they heard about it.
Jesse (22m 28s): Yeah. And you know, it’s, it’s funny at the time before I started actually going through the process, it’s always like, you got a guy that’s like, yeah, we need that big investor. We need that set the guy that’s going to put at 70% into the, into the fund. And I just find that I, my experience and people that have been on the show have just been like, yeah, it usually doesn’t work out like that. Definitely not on the first few. So yeah, it, it’s, it’s interesting to hear, but Brian, I do want to switch over to, to this book, the hands-off investor, first of all, you know, it’s a lot of work to write a book. Why’d you write a book.
Brian (22m 59s): Yeah. It’s a ton of work to write a book. Know, maybe I was just a glutton for punishment. I’m not really sure, but you know, for years my wife told me that I should write a book and I never did. I always, I always kind of, you know, rejected the idea cause I didn’t have time or whatever, but I, I was, I was talking with a friend of mine. Who’s written several books and, and I, I, you know, we were just talking about his experience in writing them. And I thought, you know, one day, one day maybe I’ll do it, but I don’t even know how to get started. And he goes, Oh, this is what you do.
So, you know, he tells me like three easy steps on how to get started writing a book so that all I could do that. So finally, I came up with an idea of what I wanted the book to be about. And I sat down and, and kind of went through the three easy steps then realized that’s like, step zero five. And then there’s like 900 other steps after that. But beyond the point of no return now. So I just kept writing. But really what it was is I re I realized after doing a bunch of research, that there was no book out there that was that I could find it was a comprehensive guide to teach passive investors what to look for in a passive investment offering.
And I had a friend of mine that I worked with way back when I was like 16 years old, I had a job at a grocery store. And this lady I worked with had a fourplex and I was so odd by that, like, Oh my gosh, she owns like a fourplex. I would love to do something like that. You know, what did I know? And she sold the fourplex and invested all of the money in a passive real estate offering. And it turned out that the guy that she invested with was the complete crook and basically stole all the money and she lost her entire life savings.
And, you know, she would call me crying and you know, about what had happened. And now she’s got to work, you know, driving rideshare just to make ends meet when she would have been set for life. And, you know, I got to thinking like, you know, if there was just some way that somebody could have prevented her from making that mistake, you know, so I felt like I could write a book to teach people the, kind of the insider tricks. Like what can a sponsor do to fool you screw you, you know, pull the wool over your eyes. Let me just expose all the secrets of the industry to the passive investor so that they can see what they’re investing in and know what to look for.
If I could do that, maybe I could save one person from going through that same experience that she went through and that made the book worth it to me
Jesse (25m 27s): Right on. And now that it’s a, I mean, it’s, I guess it’s been a year now or close to, has the response from the book been equal from the limited partners and the general partners. And the reason I asked that is because I saw the book and I was like, Oh man, this is, I need to know what they’re thinking on the other side and, and know all the questions and, and know how to answer all of them. And it’s almost like it’s a little bit of insight to what you could possibly get asked and make sure that you really know your stuff.
Brian (25m 55s): Well, it’s funny you say that because when I pitched the book to the publisher, I said, you know, look, this book really has two audiences. It has the passive investor audience who needs to read this material before they make an investment. But at the same time, the sponsor side is another audience. Because really, if you think about it, if you were to begin a new college level course of a semester long course, and you knew at the end of the course, there was going to be a final exam. Would you do better on that final exam? If you had all of the questions in advance at the very beginning of the course with the answers and I felt, yes, you would do much better.
So really that’s what this book is. The, in the world of being a sponsor, the Proctor of your final exam is your investor. They’re going to be asking the questions and they’re going to be evaluating the answers. So if you know what those are going to be, and you know what the answer should be, you know, how to structure your business so that you’re operating in a way that elevates your game and that you have the answers to people’s questions and hopefully anticipate their questions and answered them before they even ask them. It kind of elevates the entire industry as a whole, I believe.
Jesse (27m 1s): Yeah, I think it’s a great point. You know, I wouldn’t say obviously limited partners. Aren’t, aren’t the GPS opponents, but to me from just like a, a sports analogy where, you know, you have an opponent, you, you have to understand what they’re experiencing or maybe a better analogy is, is a racetrack. You know, if you’re, if you have the car, you want to understand the track, you want to understand the pitfalls. So I’m curious the, the organization for the book. So you’re at point 0.05 in those three steps, what was your approach to be, to basically give clarity and organize, you know, these are the major things, you know, do, do we start with these things first?
And then these are all the details that you need to know, what was your process in, in organizing it?
Brian (27m 40s): Yeah. And organizing the writing of it. Yeah. So it’s, it’s an interesting process how that evolves. I mean, I just started with an outline and I just covered all the topics that I wanted to cover in general. And it’s interesting how much different the final book looks from the first outline. Cause you find that, you know, you’re re reorganizing things and you’re adding additional points and taking things off. So it really was an evolutionary process that, you know, it came down to just realizing like all I, you know, how do you find an investment to start with, what is this passive investment?
I have to assume that the reader of this book may never have invested in a passive real estate offering has no idea what even are. So first I got to explain what it is then I got to explain how to find them, because it is a little bit of a sneaky business. You can’t just put it on a billboard on the side of the freeway. You know, this is a no advertising kind of business where it’s mostly word of mouth and hush hush. So, you know, you have to, you have to be able to figure that part out some of the legal framework. And then you know what to look for in a sponsor, what to look for in real estate, what to look for in the underwriting, you know, what to, what to expect in the investment process in terms of what documents you will be required to fill out what are the tax implications and, you know, in what kind of tax documents do you get and just kind of all of those things.
And then what happens when the deal is all done and over with. And, and I just felt like I needed, I needed to walk people through kind of the entire process a to Z. And so it really was a combination of all of that research, coupled with thinking back to like every question an investor has ever asked and not man, when I was first in this business, I’d be like, what are they asking that for? That’s a weird question, but it’s like, you know, over time you realize like, Hey, that’s cool, let’s get answers to all of these things. And so, you know, people, I can answer all those questions in the book and that’s, that’s what I did.
I just kind of put it all together in one spot.
Jesse (29m 32s): And are there individuals that should or should not be limited partners?
Brian (29m 37s): Absolutely. You know, I think, I think anybody that’s trying to build and preserve wealth should consider real estate passive real estate offerings. As a component of their portfolio. There was a study done by a national real estate investor online a number of years ago that said, like, I think it was 54% of all high net worth individuals that own real estate own real estate through passive real estate offerings. So the wealthiest among us know the value of this strategy.
And I think everybody needs to know the value of this strategy. But having said that there’s a, I put a whole chapter in the book called suitability. And it’s a very important concept because neither a, an investment sponsor doesn’t want investors in an investment that they have that they’re offering that are unsuitable for that offering any more than an investor would want to invest in an offering that was unsuitable for them because then no one is happy. So suitability is an important consideration and suitability has a couple of different forks.
One is, is investing path in, in real estate, syndications suitable for you at all. In other words, you have capital that you’re going to need access to in a year, but most of these offerings are going to lock your money up for three, five, seven or 10 years with really no way out. So automatically most passive offerings are not suitable for at least that portion of your portfolio that you need access to on a short-term basis. So that’s kind of the overall suitability question, but then there’s a more smaller level of suitability, which is, you know, I am retiree and I need flow.
Well, a development deal, a ground up development deal is probably not a suitable investment for you because there’s no cashflow or you’re, you know, a young person that has a really good net worth, but you have a great income. You don’t need income, you want growth. Well, in that case, you know, a class, a performing coupon, clipper, you know, income style, multifamily deal, probably isn’t suitable for you because it’s not going to produce the results that you want. So it’s important that you match the investment that you’re seeking with the capital that you have so that the two are cohesive.
Other, otherwise people are just looking like, how can I get out? And nobody wants that.
Jesse (32m 5s): And how do you solve the, what I think is a bit of a chicken and egg situation where when a general partner, a sponsors is really trying to start raising capital, he’s trying to do his first, or she’s trying to do her first or second deal from it. And maybe this goes back to the friends and family from the limiters part limited partners, point of view, you know, it’s probably somewhere in your book, you know, just be very wary of, of somebody that has no track record. How do you get around that to give enough comfort to the limited partner that you know, we’re, we’re making sure we’re aligned we’re in alignment and, and then give the ability for the sponsor to find those limited partners that first time that they’re raising outside capital.
Brian (32m 42s): Well, raising capital is an evolutionary process, right? And when I was in high school, I got my pilot’s license. And I went out with an instructor for hours and hours and hours and practice maneuvers and engine failures. And you know, what happens if this goes wrong? What happens if that goes wrong? And I was only granted my license after I was able to demonstrate I had a certain level of skill. And then I went up with an egg, a federal examiner, and did a practical test that showed that I could handle the situation only then was I granted the ability to go fly an airplane out all by myself.
But what I could not do still is I couldn’t go jump in the left seat of an airliner and go take 200 passengers over the Pacific. My license didn’t allow me to do that. There’s another process you have to go through to get to that level. This is the same thing. You know, I, I kind of equate this to, if, if you show up at the gate to board your flight and the gate agent tells you that your, your pilots today are both student pilots, are you going to board the plane? Chances are, you’re probably going to ask for a, you know, a tickets to the next flight, right?
You’re not getting on that plane. And there’s a good reason for that. And, and so yes, new sponsors have a chicken and the egg scenario. There’s no question about it. I was stuck in a chicken and the egg scenario for years, and there’s really only one way out. And that is to gain experience and track record. And however, whatever that form that looks like for me, the form it took was I went out and did any deal. I could, whether it was single family, duplex, fourplex, however I could cobble together. It didn’t need much money, but at least I could say I did it. I produced a result.
Here’s some before and after pictures, you know? And then the, and then I slowly went up the rungs of the ladder until I had gotten to the point where I am now, another method to use is to partner with someone else that has a lot more experience and have a, maybe a more minority role. So that then you can say, after you’ve done, you know, 5,000 units with somebody else, like, you know, Hey, I was a minority partner in a 5,000 unit multifamily business, and now I’m going out on my own. It’s not like this is the first time I’ve ever done anything. So you’ve got to take that growth path.
You can’t just say, Oh, this is my first deal. I’m going to go buy 500 units. And I’m going to go find somebody with $10 million and have them write me a check because it’s, unless you have an uncle that has $10 million, it’s probably not going to happen. Yeah.
Jesse (35m 6s): And it was interesting to me because I think we talked about this last time of, you know, over the last five years, 10 years, maybe there’s just been a lot of people that have come out saying, take my course, I’m a sponsor, do this. And I found a lot of them li recently have been, you know, we figure out how you can find operators and, you know, you raise the money and it’s a fund to funds model. And, and it’s almost like it gets, it gets to the point of like, who exactly is running the thing? You know, you say you have 10,000 units, but there’s, there’s, it’s just so it’s opaque. So for limited partners, you know, that are looking to partner with somebody, how do you clear up some of that and understand who you’re dealing with?
Cause usually, you know, and, and it’s sometimes it’s completely legitimate. You have one person that their role is to raise capital and a couple other people have different, different attributes, but you want to know as an LP, well, one second, who’s operating. Like who’s actually the asset manager, who are they using as a P as a property manager? How do you kind of de-mystify that?
Brian (36m 0s): Well, certainly asking all those questions is fair game, but here’s one that you didn’t ask. Who’s signing the mortgage. Hmm. You know, when this thing, when this thing is ready to close, the lender is going to have somebody signing that mortgage document, who is that person? And I’ll tell you in all the deals I own, it’s my name on there you go look at the public records on the recording. You’re going to see my name. When this property sells, who’s signing the deed. And that’s going to tell you who’s really in charge.
You know, that’s, there’s no if ands or buts about it, but all the questions you asked are fair game. You know, who’s really in charge here. It is important because there is a lot of people out. There are a lot of people out there raising money and, and some of them legitimately, Hey, you know, they’re raising money, they’re partnering with people on deals. That’s fine. But there’s others that are out there raising money and are saying, Oh, I’ve, I’ve got 5,000 units. It’s like, no, you raised $200,000. And you put $10,000 into 15 different syndications with other operators who are all in control.
And you’re using that as your quote unquote portfolio to boost your track record. And while there’s nothing really wrong with that, it’s very important that the investor understands the distinction and knows which category the person they’re investing with fits in. And if they’re making the conscious decision that yes, that’s, that’s the structure and the person I want to be investing with, that’s fine. That’s between those two parties. But if somebody thinks they’re investing with an operator, that’s actually purchased 5,000 units and it turns out that’s entirely not the case.
That’s misleading and you need to get to the bottom of it and know, you know, what the lay of the land is. Yeah,
Jesse (37m 41s): For sure. And I think that distinction is even like, the reason I brought up courses is because sometimes you’re, you’re listening to people talk about their course and really it’s, it’s exactly what you said. It’s, it’s, they’re teaching you how to raise money as a fund to be just a larger LP on a, on ideal, maybe
Brian (37m 57s): Additional the teachers deal. Yeah. Yeah.
Jesse (37m 59s): Teachers deal and that’s. Yeah. And that’s, and that’s, you know, we talked about this a few months ago where I, you know, I asked a suggestion, you know, asked surely for your, you know, what your thoughts were on a deal. And, and part of the thing was it was a fund to funds model. And it was, it wasn’t clear to me that there was a property and here’s the property, but we could also use your funds if we want to, you know, find other deals and the, the, just how opaque it was. And then what, you know, when you brought it up, you said, well, one sec now, not only are there fees here, there’s going to be fees on that deal.
Your fees have to be higher because they, they are LPs on, on some other deal. So like, do you see that a lot that you see these kinds of fund to funds model where they, you know, you’re getting double, you know, fees and how do you legitimately mitigate that?
Brian (38m 46s): Well, yeah, there’s not only double fees, but there’s also a double promote because, you know, oftentimes the, the vehicle that you’re investing in has a promote to the person that’s raising the capital, but that’s after the promoted interest has already occurred at the, at the, at the deal level. And for those that aren’t familiar with the term promote what that means, basically what I’m saying here is if, if the property, if the sponsor that’s buying the property is offering a 70, 30 split, for example, and then you’re investing with someone and they’re offering you an 80, 20 split and they’re investing in the other guy’s deal.
You’re not getting 80% of the profits from the property. You’re getting 80% of the 70%. So, you know, you’re really getting closer to 50%. And so it’s funny because I’ve actually, I’ve actually been in this scenario and this is what I actually wrote a little bit about this in the book, because I got such a good laugh out of it. We had a guy call us one time and he said, you know, I can’t decide whether I’m going to invest with you guys, or if I’m going to invest with this other group, he’s like, but I’m leaning towards the other group because you know, their splits are higher. They’re offering an 80 20 split.
And, you know, your split is 70, 30 over a preferred return. And the, what was so funny to me was I knew the other investment that he was considering, and it was a fund to funds. So while their split was an 80 20, and ours was a 70, 30, his was 80% of whatever deals that they invested in, which were probably either 80 twenties or 70 30. So he was getting 80% of 80 or 70%, not 80% of a hundred percent. And ours is getting 70% of a hundred percent. And that’s, that’s a better, that’s a better outcome for him, but yet he chose the other investment, but it was because he didn’t understand what he was investing in.
And so again, it just comes down to understanding what the deal really is. Yeah.
Jesse (40m 33s): And I think that’s a good point. Like, you know, I’ve, it just happens to be my day job that I’m in commercial real estate as a broker. So even me, if I’m getting confused by, by some of these fees, you know, not that I’m the brightest guy in the world, but I’m sure people that aren’t in our industry are going, you know, what the hell is going on with the fees, because the other piece of it was okay, there’s an acquisition fee at the asset level. Okay, wait a minute. What’s this 3% or 4% or 2% equity raise your equity acquisition fee, which was just like you said, now you have the other guy basically taking his quote unquote acquisition fee by raising, raising the fund.
Brian (41m 8s): Yeah. You know, it’s funny back in like 2008, nine, 10, 11, and 12, the economy was, you know, in the earlier part of those years, I quoted in the toilet and real estate was considered toxic. It was like, you know, everybody thought you were catching a falling knife, et cetera, et cetera. Nevertheless, we were out there, you know, actively raising money. And we were buying foreclose real estate of time and, you know, fixing it up and reselling it. And we were doing really, really well.
But what was interesting was even though that was probably the absolute best time to be buying real estate, it was the worst time to try to raise money. It was so difficult to, it was so hard to raise money because, you know, everybody thought, Oh, you know, that’s no good and real estate is toxic and so on and so forth. But there was no one out there doing these like little fun to fund things where they were raising money for other people’s deals. You never saw that. Then, then when the market began to mature and you know, it was not as good a time to buy real estate, but it was a real easy time to raise capital.
These guys start coming out of the woodwork and now everywhere you turn, there’s another capital raiser out there raising money. Well, the reason that that cottage industry has proliferated in the way that it has is because the easier it is to raise money, the easier it is for those guys to raise it because no, one’s really paying attention. No one’s looking under the hood to see what’s really going on. Everybody’s just clamoring to get into real estate. And maybe they aren’t paying attention to the details, but it’s always the details that matter.
Jesse (42m 45s): Yeah. It’s, it’s definitely something I think even more so now that I’ve, I’ve, I’ve noticed in the market and just keeping an eye on it and really understanding what you’re investing in and who really like the operator to me is a big deal because being in real estate and having my career in real estate, I know at the end of the day, th th there is going to be a gentleman or a lady there that runs the deal that operates the property that operates the operators. And, you know, if you don’t know who that is, you’re, you’re probably in trouble there.
Brian (43m 14s): Well, that’s exactly right. And you know, that’s why that question of who signs the mortgage is probably not a bad question because ultimately that is the person that’s on the hook and responsible for what’s going on. I mean, look, all we want is accountability, right? Any investor that’s investing in wants somebody to be there, to answer for them. Now, one of the big challenges that happens if we get calls like this all the time from our investors that have invested in some of these other, maybe more questionable assets is they’ll call us and say stuff like, Hey, I, you know, I invested with, you know, this guy and the deal isn’t going so well.
And you know, I’ve, I’ve sent him like 20 emails. I’ve left him like 15 voicemails. And I haven’t heard a word, what should I do? And that’s a real problem. And the problem is, is that who is really accountable, you know, who was the real person behind this, the guy you invested with mine, I don’t really have anything to do with this deal at all, other than to raise the capital for it. And so he doesn’t even have any of the answers, you know, for, for our investors, you know, they know who’s responsible. They know all the, all the bricks fall right here on my desk.
And w we have a deal that isn’t going well. And they sent an email wondering like, what the hell are you guys doing? You know, I can give them a two page email response and walk them through the whole. And then after the, after the fact we get emails going like, Oh my God, you guys are working like crazy. I had no idea how much effort you were putting into this. You’re doing great. Thanks. That’s all they want. All they want is communication information. And you know, what’s happening. But if you just disappear, that’s a really bad sign. And unfortunately, if you don’t know, who’s responsible, you don’t know who’s going to be disappearing.
Jesse (44m 56s): Yeah. It’s, it’s a nice a lesson you learn early in brokerage, the communication aspect from the customer service point of view, where bad information, get it to them quick, they will appreciate it. They might be pissed off at that time, but they, those are your, your long-term clients that end up sticking around with you for a number of years. Brian, I want to be mindful of your time here. So I thought we could just ended off with, you know, on that point about Oh eight, you know, money credit was really tough to come by. We’re in a different environment today, you know, despite bonds going up earlier this year, there still seems to be a lot of capital out there in the market.
What are your thoughts on, on 2021? How we’re going to cap off the year would love to hear your thoughts on interest rates or, you know, the big, the big conversation around inflation. Yeah. I’d love to get your thoughts.
Brian (45m 45s): Yeah. You know, 2021 is going to be an interesting year. I think 20, 22 is going to be even more interesting. I think that’s when we’re going to start to see some, some real growth coming into the marketplace, 21 is going to be a time of, everybody’s still kind of figuring things out and, you know, sellers deciding whether or not this is really the time to come on market or not. And, and hopefully realizing that this is a good time to sell. So the transaction velocity can get back to kind of more normal levels. I think we’ll start to see that happened throughout the year. You know, inflation may become a real thing.
It may not, you know, it’s when you, when you think about how many people were out of work and you think about how many jobs got compromised, you know, one example I always go back to is like, you know, the, in Las Vegas, the big business, there was the convention business. You know, it’s like, think about how many people were ticket takers, ushers, caterers, food, prep, people, you know, there’s just countless jobs that were not only vanished for a while, but we’ll probably take a while to come back because it’s, it’s just going to be, it’s going to take time for people to feel comfortable getting together and those big, large group settings and that sort of stuff.
And, you know, there’s good. It’s gonna, zoom has changed business travel. So, you know, it’s going to take a while for air travel to get back to its previous levels, which is going to have an impact on hotels and the service sector in general. So there’s going to be a lot of drags on the economy too, but at the same time, you know, I think the economy had some legs underneath it before all this happened. And I think a lot of that energy is going to come back. I just don’t know if it’s going to come back to the level that creates inflation at least problematic inflation.
Now, certainly there could be some, cause I think there’s pressure on wages. There’s a, there’s drives to raise the minimum wage to $15, which so far hasn’t been successful. But you know, that those kinds of pressures pushes all wages up and as wages go up and that gives more room for, you know, now the prices have to go up because they have to companies have to pay their workers and that sort of thing. So I think you’re going to see some inflationary pressure. I don’t think that’s a negative for real estate per se because generally, you know, real, estate’s some fixed inflation, two rents go up prices go up.
So I think that’s a net positive. I consider real estate to be a hedge for inflation. I think interest rates are sent on a little bit of a wild ride right now, thanks to bond traders, but certainly the fed has no interest in seeing rates go up. So I think that, you know, we’ll see some stability and rates, at least in the nearer term. And you know, that’s going to have some state stability and borrowing costs for real estate owners. I think we’re not going to see too many challenges there and capital’s widely available.
And to the extent that the agencies don’t make loans, there’s debt funds out there hungry to make loans. And I think, I think the market’s going to be fully open for business
Jesse (48m 43s): On the, on the inflation side. Just, just cause, you know, it’s funny now that we talked about the limited partners asking the right questions, you know, I have people asking me inflation, you know, and then to not just get even nerdier, I start looking up, you know, like I do office predominantly and I was looking at the different asset classes, apartment retail, industrial, an office, and how they had, and not surprisingly apartments are one of the top in terms of hedging yield and value. So you’re, you know, you have somebody asks, well, what about inflation? And then to your exact point, you know, well is net operating income increasing because of inflation, you know, is, does that balance out that maybe we do have cap rate decompression, but, but then we have rents going up, but I just think taking a step back, you know, especially in the States Canada, it’s the same scenario where you have a lot of quantity of money increasing an output, not, not really pushing at, at all cylinders.
You think that would be where you start seeing potentially that, that inflation, but it sounds like, you know, it, it doesn’t seem to be at the point where you’d be worried about it yet.
Brian (49m 49s): Yeah. I, I, I’m not that concerned about it. I mean, I think you’re going to where I see inflation becoming a potential issue is in things like food service, you know, and especially in businesses that rely on lower wage tiers because there there’s so much pressure right now to increase the low end of the wage scale that when you think about it in percentage terms, it’s a lot like when the federal minimum wage is at $7 and whatever, seven 50 or seven 25, whatever it is.
And there’s a push to raise it to 15, that’s a 100% increase in wages, right? So now on the low end of the scale, that’s a big hit to like a restaurant or a chicken processing plant or any of those kinds of businesses that rely on some of the lower segment of the wage here versus, you know, a financial services company that has a bunch of, you know, $150,000 a year, employees who, you know, get a smaller bump in their wages.
You know, that business, isn’t seeing the same shift in their cost of doing business. So for, for people that rely on that lower scale, I think you’re going to see a shift in the cost of doing business and that has to get transferred to the customer. So, you know, you might not be able to get that McDonald’s hamburger for a dollar 99. You know, it might be two 99, you know, there’s some, there is going to be pressure there I feel, but you know, is our oil prices and gasoline prices going to skyrocket.
Probably not. You know, there’s, there’s other SEG segments of the economy that I just don’t think you’re going to get hit in the same way.
Jesse (51m 28s): Yeah. Yeah. I guess we’ll, we’ll see how it goes in. Yeah. That’ll be an interesting 2021 and 2022, Brian, the hands-off investor, where can listeners go to grab a copy of that book?
Brian (51m 41s): They can go directly to the publisher and get it biggerpockets.com forward slash syndication book. If you order it there, they give you some bonus content. That includes a few extra things that are kind of cool to have, or you can order it from amazon.com or you can go to your local bookstore if they’re open.
Jesse (52m 2s): My guest today has been again, Brian Burke, Brian, thanks for joining working capital. Thanks for having me on Jesse. Thank you so much for listening to working capital the real estate podcast. I’m your host, Jesse Fragale. If you liked the episode, head on to iTunes and leave us a five star review and share on social media, it really helps us out. If you have any questions, feel free to reach out to me on Instagram, Jesse Fragale, have a good one take care.