htg

[The Real Estate God @TheRealEstateG6]

I’ve lost a lot of money over the course of my life. Here are some guardrails so that you can avoid that:

- never invest in an asset that isn’t backed by cashflow

- consult 3-5 people you trust before making an investment that constitutes more than 10% of your net worth

- never give a loan that isn’t backed by *sellable* (within 3 months) collateral

- never put more than 10% of your net worth into assets you don’t personally control (“personally control” means you have decision-making-rights and bank account access)

- if losing the amount of money you’re investing would materially change your life, scale back the investment

- set a firm limit on how much money you’re setting aside for a particular investment. Once that limit is hit, put $0 more in, regardless of any change in circumstances. Be willing to lose everything up to that limit but nothing more

- if you can’t easily explain the investment and how it works, you don’t know enough to put your money in. This doesn’t mean that you “sort of” know. It means you *actually* know. Have a friend quiz you on the investment. If you answer “I don’t know” to anything, you’re not allowed to put a dollar in until you do know

- your default position should be “in cash”, not fully invested. If you’re ever between the two, stick to holding the cash

- investing in new assets should actually be your last option with your capital. First should be investing in yourself, second should be starting a business/reinvesting into your business

- anytime you get an investment opportunity, ask yourself how many people said “no” before you. Why are you so blessed to be getting this opportunity? Write down why you think they said no. Just because other people said no doesn’t mean you shouldn’t invest, but it does mean that you need to figure out why they said no and make sure that reason is an acceptable risk

- when you have a core competency in investing that you consistently make money with (real estate, small businesses, whatever), your threshold for investing in something outside of that competency should be insanely high. Almost never makes sense. You have a proven system, stick with it

- no single opportunity or deal is ever that important. If you feel pressured into making a quick decision, pass. They’ll always be another deal

Finally - if something does pass all of these tests, you diligence it and have extremely high conviction, don’t be afraid to size up. Those type of opportunities don’t come along often and they’re usually multi-baggers

[The Real Estate God @TheRealEstateG6]

https://t.co/B3sXfAlgg3

[The Real Estate God @TheRealEstateG6]

There are 3 main debt metrics in real estate:

1. Debt Service Coverage Ratio (DSCR)
2. Loan to Value (LTV)
3. Debt Yield

Here’s how to view each from both a buyer’s perspective & a lender’s perspective:

1. DSCR

Definition: The DSCR is the ratio between the net operating income (NOI) from the property & the debt service associated with the loan

Formula: NOI / Debt Service

Example: A property has an NOI of $100k/yr & a debt service (inclusive of principal and interest) of $65k/yr. $100k / $65k = 1.67. So we would say the DSCR is 1.67x which is healthy - the property can easily service its debt

Buyer Perspective: This metric is probably the most helpful to understand how risky your deal is. It essentially asks the question: can the cashflow from the property satisfy the debt payments? If the answer is no & the DSCR is below 1x, you’ll need to come out of pocket to pay the loan, which is obviously a disaster. A deal like that inherently carries quite a bit of risk & you can lose more than just your initial investment

Lender Perspective: A traditional bank will likely not be interested in providing a loan unless the DSCR is at least 1.25x. Remember, the DSCR is inclusive of the principal payment, so even if you’re in an interest only period, the lender will calculate the DSCR as if the loan is amortizing. If you know the DSCR will be below 1.25x you will likely need to find a bridge, or hard money lender who specializes in transitional properties to give you a loan (or lower the leverage).

2. Loan to Value (LTV)

Definition: The LTV is the ratio between the total loan amount and the purchase price.

Formula: Total Loan Amount / Purchase Price

Example: A property valued at $2MM currently has a $1MM loan. $1MM / $2MM = 50%. So the LTV would be 50%

Buyer Perspective: LTV can serve as a proxy for how much additional risk you want added to the deal. More leverage will amplify the return (both positively & negatively). Below 50% leverage is seen as conservative, 50% to 70% as moderate, & anything over 70% is aggressive. This only applies, however, if the appraised value is accurate at the time the loan is made. Often, the appraised value simply matches the purchase price even when the buyer has secured an above or below market price. When a property is worth more or less than the appraised value the LTV can be a “fake metric” that overstates or understates the risk

Lender Perspective: Lenders heavily anchor the amount they are willing to lend on the LTV. During good times, traditional banks are generally open to lending roughly 75% of the appraised value (whether for an acquisition or refinancing). More recently, banks have pulled back and achieving leverage this high is more difficult (although the main constraint these days is usually from a DSCR perspective rather than an LTV perspective). Like with the DSCR, if you want higher leverage than a traditional bank is willing to offer, you will most likely have to find a bridge or hard money lender

3. Debt Yield

Definition: The debt yield is the ratio between the NOI and the total loan amount

Formula: NOI / Total Loan Amount

Example: A property has an NOI of $100k with a total loan outstanding of $1MM. $100k / $1MM = 10%. So the loan has a DY of 10%. The higher the DY is, the better for the lender

Buyer Perspective: Minimal value for the buyer

Lender Perspective: The DY is essentially the market clearing price of the loan. For example, if the DY is 10%, the maximum the market cap rate can be is 10% in order for the lender to be made whole (obviously the higher the maximum cap rate, the better for the lender). So the higher the DY, the higher the margin of safety. A 12% DY means the property can sell for as high as a 12% cap rate (which is extremely high) and the lender would still not lose money

That’s really it, debt metrics are mostly basic math - the hard part is applying them correctly to reduce risk

[The Real Estate God @TheRealEstateG6]

How to analyze a real estate deal in 5 minutes:

Basically what you’ll be doing is

1. Multiplying market rents by the property’s unit count
2. Applying a vacancy factor to get total revenue
3. Multiplying the total revenue by the market NOI margin to get NOI
4. Dividing the NOI by your total cost in the deal to get your stabilized yield
5. Comparing your stabilized yield to the market cap rate (greater than 150 bp spread means it pencils)

Here’s an example:

Let’s assume that you’re underwriting a 10-unit deal in a market with a 5% vacancy rate where market rents are $1,000, the NOI margin is 65% and the market cap rate is 7%. You’d be buying the property for $700k and spending $100k on renovations

10 units * 12 months * $1,000 market rents = $120,000 $120,000 * 95% occupancy = $114,000 total revenue

$114,000 total revenue * 65% NOI margin = $74,100 NOI

$74,100 NOI / $800k total cost = 9.3% stabilized yield

9.3% is 230 basis points above the 7% market cap rate, which means the deal pencils

Why does it pencil?

The property would be worth $74,100 / 7% market cap rate = $1,058,571, which would be over $250k of profit

Simple. Didn’t even take 5 minutes - you’ve analyzed the deal in about 30 seconds So what’s the catch?

The hard part of the process is making sure you have the right assumptions. If the market rent, market NOI margin or market cap rate is off, your numbers are going to be wildly inaccurate

That’s why you have to know your market cold when you’re buying real estate. The math is as simple as it gets, the money is in having the right process to arrive at the correct assumptions

If you’d like to learn how to underwrite and buy deals like this (or even smaller deals, my first deal was $200k and I only used $2,500 of my own capital) apply in the next tweet for the Acquisitions Bootcamp to work 1-on-1 with me

[The Real Estate God @TheRealEstateG6]

People drastically overestimate the risk of running a business and drastically underestimate the risk of having a job from which you can be fired at any moment

[The Real Estate God @TheRealEstateG6]

Majority of your yield is locked in at acquisition, which is why buying well is so important

Even an accretive, high return-on-cost value-add action only represents a fraction of the purchase price - which is why having great deal flow (good purchase price) is so important

For example:

Say you buy a building for $10MM at a 5% cap rate, meaning the NOI is $500k

The building is 100 units and you plan on spending $1MM renovating it to increase the rents by $1,200/year in each unit ($120k revenue increase in total)

That's a 12% return on cost ($120k/$1MM) - which is pretty good, considering you bought the building for a 5% cap rate

After the renovations at the property are complete, the stabilized yield will be $620k/$11MM = 5.64%

So even though the return on cost is highly accretive (more than double the in-place yield), it's still only moving the stabilized yield 64 bps (~10% above the in-place yield)

That's because the denominator (the purchase price), weighs down the calculation

Putting it another way, the wide majority of your yield is locked in at acquisition

And this is precisely why great deal flow is so important

If you could pick up the property for a 10% discount, you're locking in a far higher yield and still keeping the future upside

Using that same example, if you bought the above property for $9MM, your going-in cap rate would be 5.55% - around same as above except with zero extra work

And if you choose to execute additional same value-add strategy, your denominator is now lower, so it has a larger effect

$500k + $120k additional revenue = $620k NOI
$9MM +$1MM renovations = $10MM

$620k/$10MM = 6.2%

65 basis point increase rather than 64 basis point increase. So even your work during the hold period is "easier"

I know this seems like common sense (buying for a discount obviously makes the deal better) but it's very important

With a bad purchase price, there's not much you can do about the rest of the deal since the majority of your yield is already gone

You could be the best operator in the world and still struggle to do well

Meanwhile, if you have great deal flow and can consistently pick up properties for a discount, you could be a horrible operator and still be swimming in cash

Which is why Deal Flow is King

[The Real Estate God @TheRealEstateG6]

Probably the most common question I get from younger guys is “How would you do it all again if you were my age?”

I’ll do you one better. Here’s an extremely realistic gameplan to get from ~$0 to $1MM in 5 yrs

I’m going to assume that you have a W2, are roughly 22 and have limited capital coming out of college

We’re going to get you from $0 to $1MM in just 3 deals

[The Real Estate God @TheRealEstateG6]

https://t.co/cOFzv1Vdbn

[The Real Estate God @TheRealEstateG6]

https://t.co/gRjbNuCMQV

[The Real Estate God @TheRealEstateG6]

Let’s say you just bought a new deal.

You’re getting ready to add value but you want to make sure every dollar you invest into the property has as big of an impact as possible

So how do you maximize the ROI of a renovation?

There are basically 2 different types of renovations you can do on a property:
- cosmetic
- practical

Let's get into it:

In order to maximize ROI, you want to focus on cosmetic renovations

*Cosmetic* renos make the property seem nicer but don't actually enhance the operations of the property

Ex: paint, flooring, bathroom & kitchen

*Practical* renos are needed for the operation of the property

Ex: roof, plumbing, electrical

Practical renos are costly (updating electrical is expensive) while cosmetic renos are relatively cheap

Personally, I only fix practical items when I absolutely need to. Tenants notice when you change the floors. No one notices when you update the plumbing. How could they? It's in the wall - they can't even see it

So you don't really get "paid" for practical upgrades

It’s funny - you'd rather buy a building from someone who's done practical renos than from someone who's made cosmetic renos (better infrastructure). But personally, you'd rather only make cosmetic renos rather than practical renos because you don't really get "paid" for practical upgrades

What does this mean?

Let's take 2 examples

// Cosmetic Renovation //

If you own a 10-unit building & you *cosmetically* reno 5 units for $15k each, a new buyer will back that cost out of his purchase price. Why? Because those renos directly drive rent increases. The unrenovated units that previously rented for $1,000 now rent for $1,250. That’s $15k of added NOI ($250 * 5 units * 12 mths) & $214k of value at a 7 cap

So not only does the next buyer not have to spend $75k now, but the property is actually $214k more valuable. You spent $75k & made $139k in profit. This is why cosmetic renos are attractive

Spend money, NOI increases, building value increases - you make $ directly

// Practical Renovation //

Practical renos don’t drive revenue or NOI. So they don't technically drive stabilized value either. When you update the plumbing, tenants aren’t willing to pay more rent. So, because it's more difficult to draw a line between the reno done & the value added, it's difficult for a buyer to ascribe value to a practical reno

Let's say you have a 10-unit building that's worth $1MM stabilized based on the stabilized NOI after you spend $15k/unit to achieve the market rent. But, instead of cosmetically renovating the units, you take $75k & upgrade the plumbing

Do you get "paid" for these upgrades? Not really. Property is still worth $1MM stabilized. Rent still the same, NOI still the same

And in order to stabilize the building, buyer still needs to invest $150k to reno the 10 units so he can achieve higher rents & the higher stabilized NOI. The $150k of revenue-generating (cosmetic) reno costs didn't just "go away". So he's actually not willing to pay more than $850k ($1MM stabilized value - $150k in reno costs to stabilize)

But you just spent $75k on practical renos. That $75k is essentially lost. You don't get "paid" for it. New buyer may assume lower capex in the future, but you're not going to get credit for the full $75k

Stabilized value remains the same because the market rent remains the same. Regardless of how many practical renos you do, the market rent remains the same. All that's changing is your basis in the property is going up & your profit is going down. Counterintuitive, but true

So there's a huge incentive for owners to do the bare minimum on the practical side & only do true renos on the cosmetic side

Obviously eventually this leads to serious issues with backend systems but it almost becomes a game of hot potato - you sell the property before you get stuck with a major capex bill

Basically if you want to maximize ROI, focus on cosmetic renos that directly drive tenants to pay more rent

[The Real Estate God @TheRealEstateG6]

How “The Game” works in Institutional Real Estate Private Equity

A lot of people know that when cap rates go down RE investors make a lot of money. Most investors rely on a lucky market to do it

But what if you were able to “force” that cap rate compression?

Here’s how it works…

In institutional REPE, most of the game is “forcing” cap rate compression

Buy for market cap rate of 5%, increase the cap rate (stabilized yield) over the hold period to 7.5%, sell for a 5% cap rate

250 bps of “forced compression”, allows you to make serious money very quickly

This forced compression allows you to make money rapidly, even if the cashflow is minimal over the hold period

Instead of waiting for the cap rate to drop due to market forces, REPE funds force that decrease themselves

It’s how REPE funds multiply capital in only 3-5 years

Diving into the numbers:

- buy for $50MM at a 5% cap rate (meaning that the NOI is $2.5MM)
- assume zero cashflow during the hold period
- increase NOI to $4.5MM (7.5% cap rate) with $10MM in improvements
- $4.5MM/5% cap = $90MM
- $90MM sale price - $50MM - $10MM = $30MM profit

But what about leverage? If you levered the deal with 70% debt and only used 30% equity, that means you only put in $18MM ($60MM*30%=$18MM)

$18MM + $30MM profit = $48MM total proceeds

$48MM/$18MM = ~2.7x equity multiple

You just multiplied your equity ~3x in a very short time

The higher you can move the stabilized yield, the more cap rate compression you force, and the more money you make

This is why the return on cost of any capital improvement project is so important

In the example above, the $10MM capital improvement yielded a $2MM increase in NOI

This means that the return on cost of that particular action was 20% ($2MM/$10MM)

That $10MM gets added to the denominator of your cap rate calculation (now your “stabilized yield”) and that $2MM gets added to the numerator

$4.5MM/$60MM = 7.5% stabilized yield

This stabilized yield is then compressed down on your sale back down to the market cap rate of 5%

So, if you were able to push the NOI increase even higher with capital improvements, your return on cost would be even higher, your stabilized yield would be even higher and your cap rate compression would be even bigger, meaning you’d make far more money

This is an extremely powerful process that you can use in your own deals as well

It’s also very simple. Establish market cap rate, increase stabilized yield, resell for market cap rate

Figure out a standardized process for this and you’ve created a license to print money

[The Real Estate God @TheRealEstateG6]

In real estate there are $200,000 job opportunities and there are $5MM job opportunities

The key is knowing what to look for

Here are the questions you should be asking:

(There are 6 main things to focus on)

1. The organizational structure of the firm (very important in terms of what you'll learn, what your potential comp could be, and what your responsibilities at the firm will be)
2. Triangulating what your in-place comp will be
3. How stable the company is
4. What the potential for growth is (no growth = stagnant compensation)
5. What headwinds face the company
6. If the management is competent (it's impossible to learn from idiots and idiots also typically run firms into the ground)

Let’s get into it

[The Real Estate God @TheRealEstateG6]

After college I joined a $500MM+ AUM real estate private equity firm. Within just 2 years, I became a junior partner

I won't deny luck played a part, but I'd like to think there was some skill involved as well

Most important part by far was office politics

Here's how I did it:

First thing you want to do when you join a company is fully understand the scope of their operations

Many people silo themselves into 1 role & then put their head down. This isn't smart

Need to understand everything

So what was the "big picture" of the firm?

Firm had ~$500MM AUM & operated mainly in NYC/SF. Office side of the portfolio made money. Hospitality side didn't

So at my first review (after I’d performed well), I told my MD that I didn't love working on hospitality & that I'd prefer to work on office

I was hoping to only get staffed on the office deals

He said that was interesting as they’d been thinking about bringing an analyst on to solely service the office side of the portfolio

In fact, he told me, they were building out a new SF office - would I like to join?

Founding members of the office would be the CEO, CIO & me

It’d mean moving across the country from NYC to SF

It’d also mean direct access to the entire C-suite. I said yes in a heartbeat

So within 6 months of starting my job I moved out to SF, had my own personal office & worked directly with the CEO/CIO

From there, things only got better

Office portfolio continued to crush it. And the hospitality portfolio continued to do poorly

Every time we exited a profitable office deal (even if it was bought before I got there), I was given the credit

Meanwhile everyone else had their rep tied to the bad hotel deals

Bad for them, good for me

Now that my positioning & rep in the firm couldn't be better, I focused all my time on things that moved the needle

In the RE, that means 2 things:

1. Deals
2. Equity

On the deal side, I reached out to every broker possible

On the equity side, I had a lot of college friends working at big firms. I’d reach out to them constantly to see if they were interested in doing JVs or if they were interested in buying any of our buildings

Due to all of these factors, by the end of my 2nd year I was made a junior partner

Combo of luck & skill. Opportunities presented themselves & I took advantage of them. I learned 5 invaluable rules about office politics along the way:

1. Never be associated w/ a business line that's losing money

People are dumb. If you're associated w/ a business line that's losing money, they'll blame it on you, even if it's not your fault

This *will* affect their opinion of you & your ability to be promoted

Assess the business, find out the most profitable sectors of it & only work in those sectors

2. Always get as close as you can to the top people

In my case, I had to move across the country to do it. Worth it. When you have daily exposure to the top decision-makers (& you work hard), you'll progress extremely quickly

3. Make sure the head of every departments likes you

Top people all talk. Whenever I got work from the head of any department, I'd drop everything & do it immediately. They all loved me. Did wonders for my rep
4. Act older than your age

Can't just stick your nose in the #'s & expect to get promoted

Take initiative, drive new business, have opinions

I don't believe anyone takes you seriously until you firmly disagree with them

So yes, you should disagree with your boss. Do it respectfully & in private, but you need to have your own opinions

No one gets promoted quickly in the investment world if they don't have their own opinions

5. Make sure the firm you're at actually allows for rapid upward promotion (need to be at a firm that's small enough to be flexible w/ promotions)

[The Real Estate God @TheRealEstateG6]

In September 2021, I bought a deal for $2.6MM. In July 2023, I sold it for $6.4MM. Turned $800k into $4.1MM in less than 2 yrs

I wrote a 3,000 word case-study explaining the exact process I used step-by-step

To get a copy of this 7-pg case-study, click the link below

[The Real Estate God @TheRealEstateG6]

Started a substack. Will be focused on

- real estate
- running a business
- how to make money

Can subscribe in the below tweet

[The Real Estate God @TheRealEstateG6]

https://t.co/raRoxfeET5

[The Real Estate God @TheRealEstateG6]

Pay Up

In life, it’s always better to pay up. Over course most people do the opposite.

https://t.co/w6gfZZ8X1n

[The Real Estate God @TheRealEstateG6]

A Different Way of Looking at Real Estate https://t.co/2tY5P9Y84L

[htg @highticketsguy]

@ianncushing Cheat code

[The Real Estate God @TheRealEstateG6]

How do I underwrite deals to ensure that (if I get my offer price) the deal ends up being a home-run?

This is how. This is a real deal I submitted an offer on a while ago. 56 units, priced at $3.75MM

If I got this deal at my price, it would’ve been nearly guaranteed to be a home-run

I’ll walk you though how I priced my offer & how high I’m willing to go

Let’s get into it

At a base level, this is a deal with minimal in-place cashflow but one that works on a stabilized yield basis

The seller bought the deal for $2.2MM in 2021 & I have no idea how they’ve operated it so poorly since then. The expenses are insanely high & the in-place rents are massively below market. Lot of owners are just incompetent - creates great buying opportunities

Overall, the property is currently operating at a 4% NOI margin, which is comical

There’s no way the seller is covering his debt service with $22k of NOI, which means he’s in distress, which puts the buyer in the driver’s seat

// The Underwriting //

The renovated rents at the property should be $1,400 based on comps, which leaves you with roughly $900k of revenue after vacancy once stabilized

The expenses are absurdly high – Admin, Contract Services and Supplies should all be way lower. You don’t need $80k in Contract Services to operate a ~50 unit building

Taxes were kept the same to be conservative but they would actually drop on the next assessment

Utilities seem high as well but I kept them the same to be conservative

Reducing the expenses to $472k takes the NOI to $431k and brings the NOI margin to 48%, which is actually still very low

The in-place income is so low that a bank would never agree to lend on the property (DSCR is below 1.25x)

So you’d have to get bridge debt, which is the reasoning behind the 70% LTV, 12% interest rate bridge debt (in reality you should be able to get a lower rate than this)

$225k of renovation dollars are funded up front for renovations, which should allow for 15-20 renovations. The remainder of the renovations will be funded through cashflow once the expenses have been stabilized

$250k is funded up front for reserves to pay debt service while the property is being stabilized

All of this has been pretty basic so far, so what makes this underwriting result in “home-runs”?

1. The stabilized yield at 13%, 500bps above the market cap rate of 8%. This gives me a wide profit margin if things go right and a massive margin of error if things go wrong

2. My stabilized basis is just $59k/unit. This is extremely low for the market where comps sell for roughly $100k-$120k/unit and new development would cost roughly $250k/unit

3. Exit basis is below comps of ~$100k/unit as well

4. The stabilized DSCR is 1.5x with 70% LTC, 12% interest rate debt in place (actually DSCR will be way higher once I refinance to permanent debt)

End result is sale at an 8 cap, a 2.8x equity multiple and $1.8MM of profit over 3-5 years on a very high margin deal

A few other notes on this deal:
- This market is one of the worst in the state. This means I’m not really willing to pay up for the real estate

- The taxes kill the value of this property. This county has among the highest property taxes in the state. The taxload for this property in the rest of the state would be ~$65k, which is $800k of value at an 8 cap – pretty big deal

- The in-place income is so low that it’s hard to even put more than 70% LTC of bridge debt on the property (more bridge debt you put on, the more reserves you have to fund, which creates a bit of a loop)

// Summary //

I maxed out my offer at just over $3MM, a 12% stabilized yield

Did I win this deal?

No. My offer was received relatively well by the broker but I was outbid. That’s perfectly fine with me, I don’t expect to win them all

I just look to do 2-3 really high quality ‘home-run” deals a year and the reason I’m able to do that is by creating strict underwriting standards, sticking to them and swinging when the right pitch comes