**Today, we’re going to be diving into How To Raise Investment Capital For Commercial
real estate investments. In this video, we’ll touch on what investment capital is, how to
decide if you really need it, getting yourself mentally prepared for raising capital, potential
legal structures for the acquisition, how to pitch the investors on your opportunity,
and more. ________________
Money is a finite resource. Investing in commercial real estate is expensive,
so chances are good you’ll run out of your own capital quickly.
Learning when and how to properly raise capital is crucial if you’re looking to grow.
In fact, most of the largest investment and development groups utilize raised capital
from investors in order to take down continue to scale.
Here’s our guide on how to raise capital (and equity) for commercial real estate.
**First, What Is Investment Capital? ________________
Investment capital is the money you use to fund your commercial real estate investments.
That capital can be raised to cover: * Down Payments
* Closing Costs * Renovations
* Tenant Improvements * Operating Costs
* And More There are two different types of investment
capital: equity and debt. *Equity
Equity is the amount of money that you would receive from selling an investment.
Lenders will typically require you to have around 20%-30% equity in the deal.
The higher your equity is in a project, the lower your risk will be.
*Debt Debt is capital borrowed from a lender to
purchase an asset. Investment groups will utilize leverage to
buy larger properties than they could with only their equity contribution.
The higher your debt is in a project, the higher your risk will be.
We won’t be covering debt too much in this article.
**Now - Do You Really Need To Raise Capital? ________________
Before you start raising capital, you need to ask yourself this question.
Once you’ve taken other people’s money, they’re going to have a vested interest
in the project. That means you aren’t the only one calling
the shots. Sure, you may cover responsibilities with
an operating agreement, but that won’t keep you from having to answer to your investors.
There are many pros for taking on investors, but you should consider the cons, too.
*The Pros Of Raising Capital * Scalability - Third-party capital can fuel
the growth of your real estate portfolio faster than you could ever scale on your own. More
money = more deals. Scalability can also increase your profitability, too.
* Experience - If you’re raising capital from partners with investment experience,
they can help ensure the success of the project and bring their expertise to the table.
* Another Set of Eyes - It never hurts to have others take a look at your deal. They
may find positives and negatives that you had overseen.
*The Cons Of Raising Capital * It’s Expensive - Investors will expect
a significant portion of the equity in the deal since they’re putting up the majority
of the capital. It’s not uncommon for investors to own 70%+ of the equity of these offerings.
* You Don’t Call All the Shots - Once you’ve taken capital from an investor, they will
expect you to utilize that capital responsibly to get them a return. You may not actually
work for them, but you really do. * Additional Complexity - Once you’re no
longer the only investor in your deals, they become more complex. You’ll need to decide
on a deal structure, put together an operating agreement, decide how to report financials,
etc. **Let’s talk about headspace.
________________ You need to have the right mentality for raising
capital. If you feel uncomfortable with this process,
you need to find a way to get over that quickly because it’s very difficult to scale your
investment portfolio without raising third-party capital.
Here’s how to get your mind right. *1st - You’re Not “Asking” For Money
The most common objection I hear: “I’m not comfortable asking people for money.”
Good. Don’t ask anyone for money. You’re offering them an opportunity to multiply
their money. That’s exactly why they became investors
in the first place! Operators that find investment opportunities
are very valuable to investors because they often don’t have the time to find and operate
these investments on their own. You’re collaborating with your investors.
*2nd - Every Deal Won’t Fit Every Investor Don’t take rejection personally.
Not every deal will hit every investor’s criteria.
And it may have nothing to do with you. Maybe they need their capital returned faster.
Maybe they need it invested longer. Or maybe they prefer to a different side of town.
You shouldn’t let that discourage you when you’re raising equity.
Move on to the next investor and keep that one on the list for next time.
*3rd - Think Bigger I see far too many investors thinking too
small. If you don’t swing for the fences, you’ll
never hit them. Commercial real estate investing is clearly
something you’re passionate about, so think bigger.
Don’t be afraid to take on a project that’s larger than what you’ve accomplished previously.
When setting out to raise capital, don’t raise based on the amount of equity needed.
Think bigger. You’ll need to over-raise to be safe, so I typically increase my capital
raise by about 20% more than what I believe is necessary.
**Once you’ve gotten your mindset right, it’s time to decide on a deal structure.
________________ When taking on investors, you need to decide
early on how the deal will be structured. And this structure will vary depending on
how you approach the capital raise. Not only will you need to choose a legal entity,
but you should also have an operating agreement that governs the deal.
Operating agreements typically cover: * The Equity Structure
* Management and Operations * Voting Protocol
* Books and Records * Transfers and Liquidation
* And Distributions Below are the most common deal structures
in commercial real estate. *Your first option is the Joint Venture
A Joint Venture (JV) a partnership between two or more entities.
Each party will be actively contributing in the deal.
There are different reasons that groups may choose to JV instead of one of the other partnership
structures, such as one of the partners already owning the land or tax purposes.
However, it’s very easy to find too many cooks in the kitchen with a JV.
*Next, a Limited Liability Company (LLC) The Limited Liability Company (LLC) is the
most common structure I’ve seen. Investors will take the LLC route because
of tax benefits and the liability limitations the structure offers.
Many investors will own each property in its own LLC so that if one investment goes awry
or faces a lawsuit, the other properties won’t get dragged down.
If you’re planning on investing in real estate with a few close friends, this may
be the best option for you. *Then, there’s the Limited Partnership
A Limited Partnership (LP) is an entity that requires two or more people to form.
These partnerships are made up of General Partners and Limited Partners, each with their
own responsibilities and contributions. General partners typically operate the deal
while limited partners contribute capital. Unlike an LLC, partners can be personally
liable for any mishaps on the deal. *Finally, you have Syndication.
A syndication may be formed as any of the entities above.
The main difference here is how the capital raise is treated.
If you intend to raise capital from third-parties, you’ll likely take the syndicate route and
the investment will be treated as a security. You will have to adhere to very strict rules
and regulations with regards to how and from whom you can raise capital.
Syndicates may be further classified as: * 506(b) - Operators can raise money from
accredited investors and up to 35 unaccredited, but “sophisticated” investors. You should
have the ability to prove a pre-existing relationship with each investor.
* 506(c) - Operators can raise capital from anyone, including investors without a pre-existing
relationship, but must take reasonable steps to verify the accredited investor status of
each investor. * *Of course, Consult your Professionals.
When deciding which structure is best for you, I recommend that you consult your attorney
and your CPA. There are various legal and tax implications
of each structure, so it’s important that you fully understand the path you’ve chosen.
**Pitching the Investment ________________
So you’ve found a good opportunity. Now, it’s time to put together your investment
pitch. If you intend to raise capital, it’s crucial
that you present yourself in the most professional, competent light possible.
Don’t just tell an investor you have a deal and give them the address.
Here’s what your pitch must include: *Compile An Offering Memorandum
An offering memorandum is a legal document that describes:
* Your Objectives * The Risks Involved
* Terms for Investment * The Team
* And Financials My last offering memorandum was around 11
pages, as these documents should be very thorough and cover any and all information about the
property possible. Remember - investors will be reviewing your
OM to decide whether or not they should invest capital with you.
Make the most of each opportunity. *Show Your Experience
Your offering memorandum ought to highlight your operational history.
Your track record. Investors need to not only trust you as an
individual, but also have faith that you know how to accomplish the goals for the investment.
Experience is everything when taking on these projects.
But how do you show off experience if you’re just getting started?
You could get a job in property management or as a commercial real estate broker for
a few years, which will help you learn different investment strategies from the ground up.
Or, you could build a team. *Introduce Your Team
Your team might just be the most important factor by which an investor determines to
give you capital or not. This all goes back to trust and relationships.
Investors are often placing their capital with the team, not the deal.
Surprising? It actually makes sense, though. Barbara Corcoran chooses to invest in people
over products in Shark Tank. Because, at the end of the day, everyone recognizes
that proformas are subject to change. If zoning laws change or economic environments
shift, trustworthy operators full of grit will find a way to make the deal work.
*Explain The Investment Offering As I said earlier, don’t just give an investor
the address and tell them your general idea. Show them.
Explain to them how you’re going to return their capital with the expected gains.
Questions you need to answer when explaining the investment offering:
* Why do you like this property? * What is your investment strategy?
* Why is that your chosen strategy? * Why will that work with this location?
Framing your pitch with those questions in mind will help you focus on the benefits,
not the features, of your real estate offering. *The Proforma
Show your financial calculations for the investment. How much will renovations costs? When will
cash flow reach stabilization? What are the anticipated operating expenses for the property?
Investors like to see that you’ve thought through all of the numbers.
The better you know your numbers, the better of a chance you’ll have at raising capital.
I also like to give my investors a good, better, best case scenario so they can see the different
possible outcomes and what we’re aiming to achieve.
**Let’s Cover Preparing Yourself To Raise Capital
________________ *Focus On Relationships First
Investors want to place their capital with people they know.
Your first step to raising capital is to focus on that relationship.
Be. Genuine. I cannot stress that enough.
No one wants to invest their hard-earned money with someone they can’t trust.
If you build strong relationships the right way, investors may ask you if they can place
capital in your deals once they see who you are and how you operate.
*Take Your Time Building relationships takes time.
So does building up your track record. If you’re looking to raise capital from
new relationships in the next couple of weeks, you’re already destined for failure.
Why do you think most start-ups have a “friends and family” investing round?
Investors that don’t know you want to see a proof of concept - your ability to utilize
outside capital responsibly and successfully. Laying the groundwork for raising capital
takes time. Start now! Before you have a deal to pitch.
*Understand Your Investors’ Goals If your goals and your investors’ goals
don’t align, you’re going to have problems. Setting expectations upfront is important
when working with investors. If they want their money returned in 2 years
but your investment timeline is closer to 5, they may not be a fit for your offering.
The last thing you want to worry about when making a deal successful is having to handle
an angry investor that had a different opinion of how the investment should be handled.
Have a discovery session with each of your investors to figure out why their investing
their capital and what their goals are. **How To Structure Your Investment Offering
________________ There are an infinite number of variations
you can take when deciding how you want to compensate investors for their capital in
your deal. The most common question I get:
“How do I structure my deal so that it’s attractive to investors?”
Well, just like your particular investment, one size does not fit all.
Here are a few different ways to structure your investors’ returns:
*Straight Equity Depending on how lucrative the deal may be,
you could simply offer equity. If the property is likely going to cash flow
from day one and you can easily begin investor distributions early in the project, this could
be an easy route for you. It’s certainly the simplest.
Limited partners will typically expect to receive anywhere from 50% to 90% of the equity
of a project since they’re putting up the cash and taking a fair amount of risk.
This number will vary from deal to deal. At the end of the day, it’s more about their
annual return on their capital. In this case, you might see 90% to the LP,
10% to the GP * *Preferred Returns With Equity
A preferred return (pref) is a minimum return on invested capital that the limited partners
will receive for a project. Typically, the general partners will not receive
any distributions from the investment until this threshold is met and exceeded.
For example, if your investors require an 8% pref with 30% equity, your project will
need to return them 8% on their capital before you, as the general partner, receive any profits.
Preferred returns may also accrue and can be useful when raising capital on a development
or value-add project that may not cash flow for the first year.
The investors will still own equity in addition to receiving a preferred return.
As you can see in the charts below, investors receive 100% of the distributions until they’ve
received an 8% return on their capital. After that, distributions are made on a 30/70 basis,
which is the equity split for this example. *Waterfall Returns With Equity
Waterfall returns can be the most complicated of the profit distribution structures.
In the most basic terms, waterfalls are distributions made to general partners and limited partners
that step-up as income increases. This model may waterfall as many times as
the operator likes or could be as simple as a single step-up.
Be careful here - investors can get spooked by an investment if the returns structure
is overly complicated. They may think they’re getting taken advantage of somewhere.
Similar to preferred returns with equity, investors will still own equity in a waterfall
model, too. Here’s a simplified example of how the waterfall
model works: First $80,000 In Distributions would be split
80% to the Limited Partners and 20% to the General Partners.
After the first $80,000 In Distributions, that may flip to a 50% / 50% share.
**Sources Of Capital ________________
There are a few different sources of investment funds for real estate deals.
Any of these could be a good option for you depending on your goals and your connections.
Here are a few options for finding capital to invest in commercial real estate.
*Private Money / Investors Private money is the most common source of
investment capital. Essentially, you’re raising money from any
individual that has a pile of cash that they’d like to deploy into a real estate investment.
Depending on how you decide to structure your investments, the capital these investors place
with you can be either debt or equity - both of which have their advantages and disadvantages.
*Self-Directed IRAs IRAs may be converted into self-directed IRAs,
which can then invest in alternative investments. And real estate is an excellent alternative
investment - especially for investors seeking more better returns on their investment accounts.
Keep in mind that there are tax implications and red tape when working with self-directed
IRAs and the custodians will need plenty of time to set everything up on their end before
deploying the capital. *Crowdfunding
Crowdfunding for commercial real estate has grown in popularity in recent years.
There are various platforms that you can utilize to help you:
* Set up the investment offering * Connect with potential investors
* Raise capital While they do take a fee, these services can
be very beneficial to investors interested in raising capital outside of their circle
of influence. *Hard Money
Hard money, also referred to as “bridge capital,” is a fine short-term solution
when acquiring assets. This money is often given based off of the
project or building instead of the operating partner’s financial situation.
This funding can be rather expensive on the front end and comes with a higher annual interest
rate, but can assist you in closing quickly on a deal so that you can refinance later.
**How To Find Investors ________________
Now that you know how to raise capital, it’s time to find investors.
Unfortunately, they can be difficult to find for most newer operators since most people
don’t go around talking about money. However, here are the most effective ways
I’ve found potential investors. *Current Investors
Investors that have placed capital with you before will be your easiest cash raise.
They will also recommend their friends and family to join in with them if they feel that
it is in everyone’s best interests. However, you do have to have a track record
and perform before you will reap the benefits here, but soon you’ll be able to raise capital
through your network with ease. *Friends And Family
Friends and family should be your first call when looking to raise money.
They’re often more forgiving on your pitch, as long as the deal makes sense, and will
invest in you because they know, like, and trust you.
Your immediate circle of influence will know more about you and your background than any
stranger. Use that to your advantage, since they’ve
likely been with you on your journey since day one.
*IRA Custodians As I mentioned, self-directed IRAs are under
the watch of a custodian. These custodians don’t actually make the
call on whether or not the money can be placed with you, but they can get you in contact
with any of their clients that have expressed interest in real estate.
Network with local IRA custodians and let them know that you have investment offerings
available from time to time for their clients. *Other Real Estate Professionals
My attorney, CPA, bookkeeper - everyone around me knows what I do.
And they send me any of their clients that are interested in investing in commercial
real estate deals because they trust me and know my track record.
Let other real estate professionals know that you’re looking to raise capital and they
can help facilitate introductions to potential investors.
*Philanthropic Events Philanthropy tends to attract individuals
with money. Join charities and attend philanthropic events
that are inline with your ideals. If you join just to find capital, you will
quickly find yourself with a poor reputation in that community and will be seen as someone
simply looking to use other people. As I said earlier, these methods take time
and they will pay off, but you need to commit and be genuine.
*Real Estate Investors Groups My first move when I got into real estate
was to join a real estate investors group. Not only was I able to learn more about investing,
but I was also able to rub elbows with local real estate professionals in my market that
were actively doing and seeking more deals. There are a number of different organizations
you could join, but my number one tip (regardless of the organization): volunteer.
Be the door greeter. Help set up for events. You’ll have the opportunity to meet everyone
coming through the door. **Some Final Thoughts On Fundraising
There you have it - you now know what investment capital is, whether or not you need it for
your deals, how to structure your offering, and how to raise capital for commercial properties.
Becoming an excellent fundraiser will allow you to scale your investment portfolio far
beyond what you could likely achieve on your own - and faster.
Money flows to great deals and great operators, so protect your reputation, even if that means
making personal sacrifices for the benefit of your investors and hunt down those deals.
*