Real Estate Investors - Please Help

[superdog]

Long story short, a buddy from school reached out as he works in real estate. It is his company along with two partners whom I do not know.

Do I trust this guy? As much as I trust anyone else, which is to say, not really. But he is a good guy. Or at least he was. We have kept in touch, but it has been 20 years since school.

That said, he is buying an apartment building and offering shares at $12,500 each. Basically a 10 year payout to regain capital and then it is all gravy. I am fine with all that.

My attorney brought up a few red flags. I am over all of them except one:

2. Additional Capital Contributions – Paragraph 2.5, 2.5.1 of the Operating Agreement (In the event that a Member does not timely pay to the Company that Member’s pro rata share of such Required Additional Contributions, it shall be considered a default…)

Basically, this is saying that if they want more money, and the partners decide collectively that it is necessary, I am responsible to pay potentially double my money or lose my initial investment.

Is this normal? Does anyone have any experience or guidance they can provide on something like this?

It would be appreciated.

Thanks,

[brandrea]

Seth,

I have two thoughts:

1. Buy a REIT instead, you'll save your self the headaches of actually owning the asset and collect a nice steady dividend.

2. Friends and money don't mix IMO.

Just my thoughts based on some personal experience with exactly the same scenario (it was a multiplex house).

Good luck.

[MonBK]

Here's my advice Seth: Stay away.

[Rolex addict]

I would stay away from that.

[ejvette]

Yes most general partnerships have "Cash Call" provisions let's say for whatever reason there's some severe damage that insurance doesn't fully cover you will be required to contribute your pro rata share to cover unfunded exps that's just one of many reasons a cash call can kick in sounds like it's a possible great ROI but it does come with proportionate risks. You can ask to be exempted from the cash call provision (they probably won't do that) and hence if there is one your ownership percentage gets reduced based on the other partners additional capital contributions.


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[Runnin' Rebel]

This says a lot Seth

" Basically, this is saying that if they want more money, and the partners decide collectively that it is necessary, I am responsible to pay potentially double my money or lose my initial investment."

Not a chance you should even consider it. Seth, we need more money and we might need more money every 6 months

[texex91]

Run (the other way).

[Etschell]

yes its normal to some degree. usually you get diluted down if you dont want to participate and not cut out completely - although construction projects are that way if they aren't being financed by debt (which you may have to sign on as personally liable). the question is are you buying into a partnership or is it a single piece of rental property?

that said ROI of 10 years is long for rental real estate but not shocking at that level of investment. you'll get a better ROI if you buy a 116500 ceramic ss white face within 1 day of purchasing it at MSRP. put that in perspective.

basically in commercial, senior housing, rental real estate, etc is valued in three manners - capitalization of income, earnings multiple or comparative sales.

Capitalization of income is done by calculating the net operating income or free cash flow (before interest and principal payments on debt) and standardizing any management fee to 5% or so of revenue. there are other adjustments as well such as reserves for operations. then you use market data to determine a capitalization rate. so if it has NOI of $10,000 per year and the cap rate is 7% it is worth $142,857.

The next way is EBITDA times a multiple, also determined using market data, less debt.

Lastly, comparative sales are good for a litmus test but not ultimately the best indication of value because now two properties are the same.

however, if the real estate is owned by a partnership and you are a minority owner it is worth less as you has no control and it is not as easily sold (lack of marketability).

hope this helps. just a flavor of the complexity of these matters.

[superdog]

Originally Posted by ejvette

Yes most general partnerships have "Cash Call" provisions let's say for whatever reason there's some severe damage that insurance doesn't fully cover you will be required to contribute your pro rata share to cover unfunded exps that's just one of many reasons a cash call can kick in sounds like it's a possible great ROI but it does come with proportionate risks. You can ask to be exempted from the cash call provision (they probably won't do that) and hence if there is one your ownership percentage gets reduced based on the other partners additional capital contributions.


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Interestingly enough, I asked about this. If I do decide to contribute more, in order to not lose my initial investment, my ownership does not change.

I do appreciate your insight. And I think that you are correct in your assessment. If this goes well, there is a nice ROI. And a lot of potential for the future.

But I have to say that I am leaning towards the consensus and likely going to pass on this opportunity.

[superdog]

Originally Posted by Etschell

yes its normal to some degree. usually you get diluted down if you dont want to participate and not cut out completely - although construction projects are that way if they aren't being financed by debt (which you may have to sign on as personally liable). the question is are you buying into a partnership or is it a single piece of rental property?

that said ROI of 10 years is long for rental real estate but not shocking at that level of investment. you'll get a better ROI if you buy a 116500 ceramic ss white face within 1 day of purchasing it at MSRP. put that in perspective.

basically in commercial, senior housing, rental real estate, etc is valued in three manners - capitalization of income, earnings multiple or comparative sales.

Capitalization of income is done by calculating the net operating income or free cash flow (before interest and principal payments on debt) and standardizing any management fee to 5% or so of revenue. there are other adjustments as well such as reserves for operations. then you use market data to determine a capitalization rate. so if it has NOI of $10,000 per year and the cap rate is 7% it is worth $142,857.

The next way is EBITDA times a multiple, also determined using market data, less debt.

Lastly, comparative sales are good for a litmus test but not ultimately the best indication of value because now two properties are the same.

however, if the real estate is owned by a partnership and you are a minority owner it is worth less as you has no control and it is not as easily sold (lack of marketability).

hope this helps. just a flavor of the complexity of these matters.

Hugely helpful. Thank you!!!

I need to read through it a few times. But hugely helpful.

[Etschell]

Originally Posted by superdog

Hugely helpful. Thank you!!!

I need to read through it a few times. But hugely helpful.

yw.

for capitalization of income you also subtract out debt as well at the end. always subtract out debt in real estate valuation obviously.

[mikea]

Good insight in this thread. Another note, are sure you would be on the General Partnership side vs the Limited Partnership? I can' imagine at that level anyone would be included as the GP

[hsfrank]

Originally Posted by brandrea

Seth,

I have two thoughts:

1. Buy a REIT instead, you'll save your self the headaches of actually owning the asset and collect a nice steady dividend.

2. Friends and money don't mix IMO.

Just my thoughts based on some personal experience with exactly the same scenario (it was a multiplex house).

Good luck.

X2 and have diversity of assets

[Etschell]

Originally Posted by mikea

Good insight in this thread. Another note, are sure you would be on the General Partnership side vs the Limited Partnership? I can' imagine at that level anyone would be included as the GP

highly doubt he would be a GP. definitely limited. usually the GPs are a separate partnership which own 1% or so of the limited partnership. good point.

seth just so you know the GP generally makes every single decision and controls your fate as a limited partner. however, if the GP is also a limited partner, which 99% of the time they are, then their decisions also impact themselves so it isn't necessarily a bad thing. basically the GP is the king.

[Star Ferry]

Originally Posted by brandrea

Seth,

I have two thoughts:

1. Buy a REIT instead, you'll save your self the headaches of actually owning the asset and collect a nice steady dividend..

He'd still be a limited partner in the REIT. there are REITs where the GPs paid 2% of initial equity and ended up taking home 40% of profit...

Seth should consider the track records of the GPs in this deal, and also whether their definition of "required additional capital" is reasonable

[rr-nyc]

The "default" is what makes this a no-go. if your shares were merely dilluted in proportion to the additional capital investment others were making, that would be fine

[superdog]

Love the insight guys.

Please keep it coming. I am learning a lot.

At the end of the day, I think I am going to keep it simple. I have been thinking about renting out our townhouse and buying something smaller for the wife and I.

It's just us, and we don't need the space.

We also want a yard for the dogs. I am figuring just under 2,000 feet is plenty of space.

My new thought is again, keeping it simple, take the loot out of my investment accounts and pay cash.

It will hit my investment accounts hard, but not terribly. And this too is an investment. Then I can begin building those back up again.

I know I should probably take a loan out, but I hate loans.....

[Old Geezer]

Seth,
You haven't been in contact 20 years and he suddenly offers you an investment opportunity. I would be very leery. I'm sure you can find other investments not encumbered by old friendships. You yourself already said you don't trust him implicitly. Save yourself the money and potential aggravation.

[brandrea]

Originally Posted by Star Ferry

He'd still be a limited partner in the REIT. there are REITs where the GPs paid 2% of initial equity and ended up taking home 40% of profit...

Seth should consider the track records of the GPs in this deal, and also whether their definition of "required additional capital" is reasonable

True there is a management fee, but a REIT is liquid like any stock. Buy it today, sell it tomorrow.

The management fee is upfront and you know the cost going forward. I've invested in REIT's for over 20 years and the returns have been steady and predictable.

The added plus is there is no stress over what's going to go wrong with the asset (repairs, maintenance etc), and your money is spread out over 100's of properties.

No right or wrong answer here but you have to have an interest in being more of an active partner in something like Seth is talking about, (which maybe he is

[toxicavenger]

Friends/family + Money = disaster

[Etschell]

Originally Posted by brandrea

True there is a management fee, but a REIT is liquid like any stock. Buy it today, sell it tomorrow.

The management fee is upfront and you know the cost going forward. I've invested in REIT's for over 20 years and the returns have been steady and predictable.

The added plus is there is no stress over what's going to go wrong with the asset (repairs, maintenance etc), and your money is spread out over 100's of properties.

No right or wrong answer here but you have to have an interest in being more of an active partner in something like Seth is talking about, (which maybe he is

100% correct, anyone who manages real estate takes a fee. owner operators still take management fees.

[Danny83]

Sounds like too much red tape for me.

[GB-man]

As explained above...politely pass on this deal. If you want to invest in real estate do it on your own. Analyze, get funding (if needed), screen the tenants, manage the property on your own.

[superdog]

Thanks EVERYONE!!

I just emailed him that I was out.

Appreciate all the feedback.

[returntorolex]

Originally Posted by Old Geezer

Seth,
You haven't been in contact 20 years and he suddenly offers you an investment opportunity. I would be very leery. I'm sure you can find other investments not encumbered by old friendships. You yourself already said you don't trust him implicitly. Save yourself the money and potential aggravation.

I agree.

Even before getting into the numbers, the buy in seems very low. If you still have interest, ask for 5 or 6 references of investors that have put in a similar amount. Then proceed cautiously.

Good luck!

[Chewbacca]

Great insight by all but Brian simplifies it. You can tell he probably has kids.

[brandrea]

Originally Posted by Chewbacca

Great insight by all but Brian simplifies it. You can tell he probably has kids.

In fact I do

[CamSLC]

Great advice here. I'm involved with two separate real estate development groups. In our opp agreements we have a clause for additional capital calls, but nothing about losing your principal if you don't make them.

[mastermixer]

I saw you passed.

Just curious. What % of ownership do you get with %12,500? How many partners are they expecting? What is the total price of the building?

Is the idea to buy the building outright with cash, or have a loan?

[jhilly8982]

Originally Posted by superdog

My new thought is again, keeping it simple, take the loot out of my investment accounts and pay cash.

It will hit my investment accounts hard, but not terribly. And this too is an investment. Then I can begin building those back up again.

Yes, take out a loan! You can deduct the interest and still keep that money in your investment accounts earning interest.