Kick-Start Your Investing Career
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How does one begin the process of investing in commercial real estate? Without a doubt, this is the question that I often hear from first-time prospective investors as well as new and seasoned brokers.
“Do I roll my commission into the transaction for an equity position in the property being acquired by my client? I don’t have the cash to buy property, and the seller knows me as a broker, not an investor—and so will not take me seriously. A lender will not loan money to me because I do not have the financial strength to secure a loan.” These are just a few of the numerous questions, concerns, and perceived obstacles posed by the prospective first-time investor in commercial real estate.
Simply stated, if you do not have the funds to acquire a property and qualify for an acquisition loan, you must bring perceived value to the transaction to earn an interest in the property. This value brought to the transaction and the resulting earned equity position are referred to as “Sweat Equity.”
In our Broker Estate Building Class, we teach that the first step in determining your value in a transaction is to clearly understand what skill sets you already possess. Much like the process of attempting to choose a major or subject to study in college or choosing a career path upon graduation, it is highly important to select a subject or field that you are passionate about. As the saying goes, if you work in a field you are passionate about, it will not feel like a job but rather an exciting and rewarding opportunity to live out your dreams every day of your life.
The first step is to write down the things you are passionate about. These can be interests related to real estate or unrelated to real estate. Most important, write down what clearly makes you happy and the things that interest and excite you.
Next, make a thorough list of all the skill sets and talents that you already possess and supplement that list with the skills and talents that you do not already possess but are interested in and want to learn.
Examples of skill sets and talents that may offer sweat equity opportunities in transactions include the following:
Sourcing Transactions
Property Management
Asset Management
Leasing
Financial Accounting
Construction Expertise
Development Expertise
Finance
Environmental Remediation
Control of the property is the most important issue when it comes to putting together the investment opportunity. I learned this lesson twice through the school of hard knocks.
Instinctually, most beginner investors needing to find financial partners tend to identify a property to buy and then start talking about the property to prospective financial partners prior to having it under contract and under control. Why? Because of the relatively short due diligence periods typically available while under contract, many inexperienced investors want to know that they have interested potential financial partners who can invest in their transactions. Unfortunately, this approach can hurt you in a number of ways. First, it makes others aware of the property and makes it possible that another buyer will step in and purchase it before you do. Second, when you do not have control of the property, you are dealing with the situation from a position of weakness, and therefore, you likely will not be able to negotiate the best deal structure.
Once you have identified and contracted to buy the property, structure the transaction in a manner that protects and prioritizes the return of invested capital to the financial partner investor first. The investor will receive a negotiated preferential return on his or her invested cash; and you, as the sweat equity partner, will share the cash flow at a negotiated percentage of ownership of the cash flow and proceeds from the sale or refinancing. The key thing to remember is that the investor receives his or her preferential return on his or her cash plus the return of his or her invested cash prior to your receiving your share of the cash flow.
When you can offer substantial talents and skills from list above, you will generally be able to structure high-quality win-win deals as you are adding value to the transaction. Also, the more scarce the talents that you are offering, the more likely you will be able to negotiate deal terms in your favor.
Last, don’t talk yourself out of a deal. Don’t assume the seller won’t take you seriously as a first-time buyer. Don’t assume a lender won’t loan to you. The lender may underwrite the loan on the merits of the property. Credit enhancement for lender purposes can always be addressed either with the investor partner or another party if needed.
In summary, as a new investor who wants to acquire commercial real estate, remember to first get control of the property; assess and determine the skill sets you will utilize to add value to the ownership group; proceed carefully but confidently; secure a financial partner and lender; and utilize the safety-first approach in structuring your acquisition, protecting the investor’s cash first and foremost ahead of your sweat equity position.
