April 8, 2018

JF1314: Raising Capital & Finding Funding #SkillSetSunday with Lee Arnold

Lee has raised more than $400 million for projects through his different companies. As real estate investors we can almost always use more money for deals. Getting creative with how you structure deals and partnerships can also be equally important. Lee has been through that process many times and has great advice on how to structure deals and partnerships, and also how to make sure you keep your investors happy. If you enjoyed today’s episode remember to subscribe in iTunes and leave us a review!

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Lee Arnold Real Estate Background:

  • CEO at Secured Investment Corp & Manager of the Secured Investment High Yield Fund
  • Secured Investment Corp is one of the fastest growing companies in the private money marketplaces in the United States
  • Lee connects investors to lenders from all over the United States and Canada
  • Featured as an investment strategy expert by Forbes, the Boston Globe, Market Watch, Reuters and Business Week & taught for Donald Trump Companies
  • Based in Coeur D Alene, Idaho
  • Say hi to him at: www.securedinvestmentcorp.com

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Joe Fairless: Best Ever listeners, how are you doing?  Welcome to the best real estate investing advice ever show. I’m Joe Fairless, and this is the world’s longest-running daily real estate investing podcast. We only talk about the best advice ever, we don’t get into any of that fluffy stuff.

With us today, Lee Arnold. How are you doing, Lee?

Lee Arnold: I’m doing fantastic, Joe. Thanks for having me.

Joe Fairless: Yeah, my pleasure. Nice to have you on the show. Well, Best Ever listeners, first and foremost, I hope you’re having a best ever weekend, and because it is Sunday, we’ve got a special segment for you, Skillset Sunday, where we’re going to talk to you – or I’m going to ask questions, and our guest, Lee Arnold, will talk to you about the skill of raising capital, so that you can hone this skill, and either acquire it, or hone it if you don’t have that skill yet.

Lee has raised more than approximately 400 million dollars in equity for deals they’re working on. He’s working on a 50 million dollar development deal right now, and also more as an equity broker lender to fund other individual investors deals. If you wanna hear his best ever advice, then go to episode 1009; it’s titled “Need money for your deals? Talk to this guy!”

Today we’re gonna be specifically and strictly focused on the skill of raising capital, so Lee, how shall we begin?

Lee Arnold: Well, as far as raising capital, Joe, I have found over the years that one of the greatest errors that investors who are looking for any sum of capital make is they go in search of capital long before they ever have identified the investment opportunity, and it’s contrary to what we’ve been taught, because conventional wisdom says “If you need to borrow money, you first go down to the bank and you see how much you can qualify for”, and then based on your credit score, your income, past experience, then they give you some number, and then you go out and you shop for something that fits within that criteria.

Well, those rules only exist for the end user, owner-occupant that doesn’t subscribe to your show and doesn’t have access to the tools that say that all of that is completely false. To raise capital efficiently, you first have to identify what is the opportunity, as in are you buying something that you’re gonna renovate and bring the value up through forced appreciation through sweat equity? Are you finding a piece of vacant land and developing something on there that’s gonna produce a preferred rate of return to an investor, and if so what is that return? And you do your financial modeling, you do your acquisition costs, you do your rehab costs, you do your time costs, so that there’s an understanding of return on investment of capital.

Once you’ve identified all of those numbers and put them together, now you go out seeking funding, because one of my favorite quotes in business is “Money is attracted to opportunity, not people”, and the mistake that investors make – and this is true whether you’re been investing for six months or 60 years – the mistake that most investors make is they seek capital too early, before they’ve identified the opportunity… Because money is not interested in people. People make terrible investments, they skip town, they don’t communicate, they die… Whereas when my money is secure to get in first lien position against real property, and I have a deeded ownership interest in that asset, no matter what happens to the person, my money is safe and my money is secure, and that’s what money is attracted to.

So  to successfully raise capital, you have to be concerned with what is your investor gonna get on their money? There’s one question that investors care more about than anything else – do you have any idea what the question is, Joe?

Joe Fairless: Well, what are the risks involved?

Lee Arnold: Okay, what are the risks; any other questions you can think of that an investor might ask? Let me put this in perspective for you, Joe. Let’s say that I come to you and I say “Joe, I need to borrow $500,000.” Do you have any questions for me?

Joe Fairless: Yes, I would ask what is the business plan and what is my money secured by, what type of asset? What type of experience do you have doing what you are projecting you’re going to do? What risks do you believe are associated to the project? Those are some of the top things I can think of.

Lee Arnold: Okay, good. And all of your responses, Joe, are based on what you know to be true as an investor, and they’re all the same questions that I would ask if I was the investor presenting this project to a potential investor, the person that’s gonna write that check. But after 20 years of raising capital and putting deals together, the question that all investors want to know above and beyond any other question is “What is my return of investment?” It’s not return ON investment, and too many investors lead with if I wanna go out and raise $500,000, my lead-in, Joe, is going to be “Hey Joe, if you give me half a million dollars, I’ll give you first lien position on this piece of property, I’m gonna give you an 8% return, or a 12% return.” But for the sophisticated, savvy investor, the person that can write a check for 5-10 million dollars, the number one thing they are concerned with is “How are you going to give them their money back?”

So as you’re building your presentation deck – it’s called a pitch deck in the business – as you’re putting this deck together to explain the investment, to explain the opportunity, the upside, the return, slide number one needs to be “Investors, you’re gonna give me half a million bucks, and this is how I’m gonna give you your money back, this is when I’m gonna give your money back, and this is the return you’re gonna get as a result of allowing me to utilize those funds for X periods of months or years.”

So return of investment is the one thing that every investor misses in their presentation. Exit strategy is everything. You mentioned on the top of the call this 50 million dollar development that we’re working on… I broke this up, so I bought a 13-acre parcel, I’m breaking it up, it’s all zoned commercial, and it’s gonna have on the 13 acres a 50,000 square foot storage facility, a 200-unit apartment building, a 64-room hotel, and two 10,000 square foot commercial pads. So everything involved in this is tied to this development.

Now, the first thing that we’re gonna develop is the storage facility, so what is the return on the investor’s money? Well, we build it, and then we go out and we get a 504 loan, which is a storage unit loan that only requires 15% participation from the developer… So as I’m putting my deck together to raise the 2,5 million dollars necessary to build this out, I’m showing my investors “Look, here’s the blueprints, here’s the plan, here’s the timeline, here’s the return, and here’s the take-out financing”, and I’m gonna show them a pre-approval letter already from the lender that’s doing the take-out, and showing them that we’ve got 15% liquidity, so the take-out of that loan is gonna be no problem.

Now, on the apartment building, FHA has got an amazing program now for large multi-unit – usually 200-300 unit – apartments. FHA has an amazing loan take-out program, so the entire emphasis of the presentation is gonna be based on the take-out financing… First and foremost. Before we show them the proforma, before we show them the rent rolls, before we show them the appreciation based on desirability and demand for that marketplace, we’re gonna show them how they’re getting their money back… And if the listeners here will make it a point to always emphasize return of capital, they’re gonna have a much easier time raising money.

Joe Fairless: Basically, you’ve got to talk a little bit about the business plan at the beginning though, because then you’ve got context for how you’ll return the capital, right?

Lee Arnold: Right, but that comes in a very short, one-page synopsis. That’s slide number one. So when you go in front of a group of investors, you’re gonna say “Investors, I’m here today in search of ten million dollars. I will utilize your funds for 36 months, and I will return it in 36 months based on this take-out financing, this private family home office that’s financing the finalized construction, or this bank is taking you out. Now, with that said, let me tell you about the project.”

See, the minute you settle their nerves about how you’re gonna give them their money back, they suddenly just kind of relax and sit back and listen to the presentation. But if you don’t tell them early how you intend to give them their money back, they are on pins and needles through your entire presentation, and when you get done, the first investor that raises their hand to ask a question is gonna ask “How are you paying us back?” And they didn’t hear a thing you said throughout your 20-minute pitch.

Joe Fairless: Yeah, very true. Capital preservation and return of capital is most important. What if you’re not doing a development deal, and it’s just (let’s say) a fix and flip? I guess it’s just really straightforward, “I’m doing a fix and flip, and I am going to sell to exit you out.” So I guess it’s pretty simple in that scenario…

Lee Arnold: Yeah. And I’ll explain it this way, because as you know, with [unintelligible [00:11:46].17] which is our lending entity – we lend hundreds of millions of dollars and we write thousands of loans… And what’s interesting is when somebody comes to our website and says they wanna borrow money, and let’s say it’s a simple little 3-bedroom 2-bath house in the Midwest, the after-repair value on it is 120k, they’re buying it for 50k, they’re gonna put 20k into it, so they wanna borrow 70k – okay, that seems like a very great deal. Now, they can check one of two boxes. If you look at our application, it says “How are you going to pay us back?” If they check the “I’m gonna sell it” box, all I look at is the comparables for the neighborhood.

I’m gonna look at what they’ve got, versus what the surrounding inventories are, what the inventory counts are, and what is the likelihood or probability that they can indeed sell this house for the 120k price that they’re telling me it’s worth… And within five minutes I can tell you whether or not they’re gonna get the loan.

Now, if they check the box “I’m gonna pay you back by refinancing” – okay, this springs up a whole new can of worms, because if they’re gonna refinance, now I suddenly have to be concerned with their credit score, how much money they have in the bank, whether or not they have a job, whether or not they’ve been filing their taxes, if they’re self-employed and have been showing zero income on their tax returns to avoid paying taxes… There is no way in the world they’re ever gonna be able to refinance that thing, and I’m gonna deny their loan.

So I’m not saying make false representations, but I will say it this way – if you are somebody who’s relatively new to the investment space and you have not done a responsible job of managing your paper resume, and what I mean by that is you don’t show any income on your taxes, you aren’t current on your tax filings, you have multiple banks accounts and you run money through all of them, so there’s no one bank account that has any sizeable inflow or outflow of, do not buy property to hold where your exist strategy is long-term financing… Because everything about that loan is tied to you, the individual.

So better for that particular listener to focus on buying and flipping or buying and wholesaling, or just putting things under contract and wholesaling. The goal we have for our customers is we want you to fix and flip, and take out at least a quarter of a million dollars in liquid capital. Once you’ve got a quarter million dollars in liquid capital, the opportunities are wide open to you, because now you can show somebody that you are who you say you are and you will accomplish what you say you will accomplish.

Money has a strange way of validating people, as in if you’ve got money, you must know what you’re doing. You and I both know that that’s not always true, but this is how most banks look at you. If you can show money and income and tax returns that say you generate revenue, you’re gonna get funding. If you can’t show those things from a paper perspective, then focus and build a business that is cashflow-heavy, that is quick in and out turns where you’re gonna maximize your capital, so that you then can go in and attract cheaper capital to yourself… Because at the end of the day, it’s not the investor that can find the best deal that’s going to win, because there’s too many investors in the marketplace, there’s too much competition… So in most markets, you’re having to pay pretty close to premium pricing to get some of these investment properties, especially if you’re going after low-value apartment buildings – 12, 24, 36 units. There is such an appetite and demand for those types of properties that you’re gonna pay close to retail.

The only way you can make those facilities pencil is if you can attract cheap, cheap capital. And by cheap capital, I’m saying prime +1 or lower. Any private investor out there, whether it be a hedge fund or a family home office is looking for prime +5, prime +6, prime +7. So you’ve got to make sure that you’re structuring your financial portfolio in such a way that you can eventually attract bank financing, cheap financing. Otherwise, you’re always gonna have to give away a dramatic portion of the equity in the deal to attract capital, and now you’re working to get half the profit.

Joe Fairless: And on the exit strategy front, just to come back to that real quick… It’s a thought process that I highly recommend every passive investor go through, and that is “What is the exit that is being proposed to me, and what are the ways that that couldn’t work?”, which is what you did when you talked about the refinance, because that opens up a whole other can of worms, versus being able to sell at whatever they’re projecting it will sell based on market comps.

So when you introduced the refinance option, then you listed out a whole bunch of stuff that could go wrong, or at least you’d have to qualify. So that’s a necessary question that every investor should ask whenever they’re approached about investing in something, is “What is the exit, and then what are the ways that that couldn’t work?”

Lee Arnold: That’s exactly right. And it’s important regardless of what the current status of the listener here today is – I don’t care if you’re a first-time investor or, as I mentioned, you’ve been investing a long time  – the goal of every investor is to eventually become a lender. I just got out of a meeting with one of our private equity fund investors, and I asked him if he was actively buying, fixing and selling real estate. He says “No, Lee. I’m like two years away from death, I don’t wanna hassle with all of that. All I wanna do is put my money into loans and lend it to the guys that wanna go out and actively fix and flip real estate”, because he’s at that stage where he’s just looking for that passive income where he can rely on a pretty consistent 7%-12% return on equity. And that’s where all investors ultimately are looking to go to.

As you look at the bell curve, you start out as an investor, you don’t have a clue what you’re doing, your credit is terrible, you’re living paycheck to paycheck, and all you have is a dream and a drive. So you start to acquire, you start buying, fixing and flipping, you start amassing cashflow. Now you start buying apartment buildings and commercial buildings, and generating massive cashflow. As you come to the other side of that bell curve, you’re gonna realize that “Even though I’ve got property managers in place and all that stuff, I don’t wanna deal with the taxes and with the depreciation and all of the liability and the insurance that comes with owning these assets, so I’m gonna sell them off, I’m gonna get all of my net worth in cash, and I’m gonna put it somewhere where I can get a pretty safe, steady rate of return.”

You’ve gotta know what stage your investor is at when you’re approaching them for that capital, because not always does it make sense to ask somebody to give you money. It might make more sense to ask them to partner with you in a transaction.

Joe Fairless: A lot of the times that will come to the surface, too. They’ll say “I’m not really interested in this, but how about jumping on the GP side and partnering up or doing a joint venture?”

Lee Arnold: Absolutely, and it really depends on that investor’s appetite. It was interesting – in the meeting I was just in, because he was there with his son, who’s now in probably his early 50’s… And his son is very actively engaged in development – buying, fixing, selling, owning rental property… But his dad has absolutely zero interest. So it’s just interesting to kind of see the difference as maturity brings to desirability about investing and what you have an appetite for.

Joe Fairless: This is slightly off-topic for raising capital, but I am curious because you brought it up… On that 13-acre parcel, I was trying to write down as quickly as you were saying it – you said you’re doing hotel, commercial pads, self-storage… Can you just list out the order in which you’re doing each of those and the reason why you’re doing them in that order?

Lee Arnold: Absolutely. We are starting with the storage facility simply because the cost of construction is $45/foot. The cost of construction on the apartment building is $175-$200/foot. So the capital outlay to build apartments is significantly higher than the capital outlay to build the storage facility so the reason to build the storage facility first is we can get the property cash-flowing much more quickly on the storage facility than we can on the apartment community. So that’s the reason. The demand for storage is high, it’s off of a major highway, we’ve got good frontage, good visibility.

From people storing stuff, we will then create a demographic or a constituency, if you will, that will be most likely tailored to apartment living. As people are moving out of homes, or down-sizing or up-sizing  and they’re putting things in the storage, we then wanna attract them to the apartment community. So the land is significantly more valuable and more stable when we can go to an investor on the dirt, showing that we already have income being generated from the storage facility when we go after the capital for the apartment community.

To put it into perspective a different way, the cost of construction on the storage facility is 2,5 million dollars – that’s 50,000 square feet of storage – which will produce $50,000-$60,000/month in revenue. The cost of construction on the apartment building is 35 million. So always pursue the easier money first, because once you start getting traction and momentum on the development, everything else gets exponentially simpler. So the storage facility is going on the back of the lot, the apartment community is going on the middle of the lot – that will come second in the buildout. The third piece to go in will be the motel (or the hotel), because that now attracts dollars from out of town, which then now we will build out the first commercial pad, which is a 10,000 square foot building, it’ll have five 2,000 square foot units, where now we can attract merchants that would cater both to an apartment living community, as well as a hotel occupancy community. And that’s the logic behind why and how we’re building this out.

Joe Fairless: Great stuff, thank you for walking us through that. This has been very informative, as always, and I’m grateful that you were on the show again. How can the Best Ever listeners get in touch with you, Lee?

Lee Arnold: The best place to reach me is at CogoCapital.com.

Joe Fairless: Sweet. Well, thank you again for being on the show. From a raising money standpoint for our deals, the focus as it should be is on “What is the return OF the investment?” I believe Warren Buffet talks about that, and pretty much every other successful investor. And then the exit strategy, if we’re passively investing in deals, please pay close attention to the exit strategy. Then the focus is on what are the ways that couldn’t work and how is the risk being mitigated? There’s risk in any investment, so what are the ways the risk is being mitigated, and are you comfortable with that?

Then also talking us through the development sequence of a large project. Thanks for being on the show. I hope you have a best ever day, and we’ll talk to you soon.

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