October 13, 2021
Joe Fairless

JF2598: Top 3 Characteristics of a Quality GP with Lennon Lee


When Lennon Lee moved from Venezuela in 2010, he knew he wanted to search for passive investment opportunities to provide for his family. Today, Lennon is diving into the difference between being an LP vs. a GP in a deal, the role of the GP with investor communications, and the importance of capital raising through partnership building. 

 

Lennon Lee Real Estate Background: 

  • Invested his family’s life savings into real estate to build a solid future for his parents and siblings
  • Involved as both an LP and GP in the acquisition of over 2,000 multifamily units, with an approximate market value of $200M
  • Based in Miami, FL
  • Say hi to him at: bldcapitalgroup.com

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TRANSCRIPTION

Ash Patel: Hello, Best Ever listeners. Welcome to the Best Real Estate Investing Advice Ever Show. I’m Ash Patel and I’m with today’s guest, Lennon Lee. Lennon is joining us from Miami, Florida. Thank you for joining us, and how are you today?

Lennon Lee: I’m doing wonderful, man. Thanks for having me.

Ash Patel: Fantastic. Lennon has invested his family’s life savings into real estate, to build a solid future for his parents and siblings. He is both an LP and GP in over 2000 multifamily units, with an approximate market value of $200 million.

Lennon, can you tell the Best Ever listeners a little bit more about your background and what you’re focused on now?

Lennon Lee: For sure, man. Originally born and raised in Venezuela, moved to the US in 2010. Immediately when we moved here, we bought a small portfolio of properties on the residential side; that was 2009, actually. Around 2015, we bought all those properties cash, the return on that equity that we had built there wasn’t as attractive anymore, and it was a little bit of hard work on the active side, doing property management and dealing with tenants and the whole thing. So we were looking for vehicles on the more passive side, I found about commercial real estate and how it was valued, I found that multifamily was one of the asset classes that made a lot of sense for a bunch of different reasons that we could spend hours talking about… But we decided we wanted to be passive investors, we wanted to look for it, for that vehicle that allowed us to provide cash flow and build wealth for my family and my parents primarily. And when we started investing as limited partners, I loved what we were doing and I loved the people that we were investing with. We were doing on the active side and doing asset management, sourcing deals and raising capital. So I figured, “I’d like  like to be on the other side.” So I started working actually with Joe initially, and started raising capital, partnering up on the GP side for different deals, we provided risk capital on certain deals, I raised capital as well… Eventually, I partnered up with other investors and sourced for our own deals, we sponsored and syndicated our own opportunities… And basically, we’ve done it all, and right now at this point, with the new company that we launched earlier this year, we decided to—now self-aware of all the work that it takes, we decided, “Listen, we want to stay on the capital raising equity raising side”, and that’s what we’re focused on right now.

Ash Patel: Interesting, and a lot to dive into here. When you transitioned from being an active investor to a passive investor on the LP side, what did you look for specifically in a quality GP?

Lennon Lee: That’s a great question, and actually a loaded one. And I can write about—

Ash Patel: Why is it loaded?

Lennon Lee: Well, it’s loaded because there’s a lot of things that I was looking for and that I think people should look for when vetting or evaluating a potential investment with a certain GP or a certain sponsor.

Ash Patel: Let’s start the list.

Lennon Lee: Okay. Well, a bunch of stuff, right? So first of all, again, the way we evaluate it, it’s actually you have the quantitative side and the qualitative side, right? Like, you have the numbers and the on-paper verifiable stuff. And then you on the other hand, you have the personal side, like the character of the person, how much you like to talk to them and deal with them, regardless of how much track record or how good they are on the business side. We pay a lot of attention to the personal relationship side of things. We want to be doing business with people that we like, and obviously that we trust. Ultimately, you’re getting into a marriage for like at least three to five to seven years, sometimes 10 years with these people… So ultimately, you want to be doing business with people that you like. So that’s on the personal side.

But then of course you have on the more technical side, you want to of course do background checks on these people and then background checks from the potential criminal offenses, to minor stuff. And then obviously doing a background check into their education – where they go to school, how well prepared they are in business; not necessarily in real estate, but then of course also on the real estate side… You want to look at how many deals they’ve done and obviously understand, what’s their specialty in terms of business plans or investment strategy in these deals that they’ve done?

Obviously, you’re looking and asking all these questions so that you can understand if they align with what your goals are and what your strategy is, as an investor; you want to understand, “Okay, are these guys doing deals more for the cash flow or more for the appreciation play?” or “Are they’re doing development deals or stabilized deals?” Again, there’s a bunch of questions, but then generally speaking, there’s that deal side or the investment strategy aspect.

Then, of course, you want to understand the type of deals that they do, but then how do they structure those deals? That’s very, very important as an LP; when you’re evaluating the relationship that you’re getting into, you want to understand exactly, is there alignment of interest? Are the sponsors putting the investors’ interest first before theirs? Is the structure really performance-based, or are they just taking fees and then the rest doesn’t really matter? How are they doing the distributions?

And if we want to get even more technical, you want to obviously read all the legal paperwork, the PPM, the operating agreement of the entity that was created to buy the asset, because ultimately, one of the things that some investors maybe miss or don’t really understand is how are the distributions done, not necessarily in terms of quarterly or monthly, but the actual legal structure of those distributions, meaning when they send you money every month or every quarter, is that a return on capital or a return of your capital? That’s really a big one, because for example, if you see that you have return on capital, then that’s fine, because your initial investment is still in the deal, and all you’re getting is maybe a preferred return.

And then the way we like to see it – and this is an ideal scenario; every deal is going to be different, and we’re going to be flexible, but typically, this is what we like to see – we want to see return on capital in the form of a preferred return, and then up to a certain percentage, right, let’s say 8%. Then above that 8%, then we do go to return of their invested capital. And then after we’ve done all the capital to the investor, then we go into a certain waterfall, right, maybe a 70/30 split, and then we have different hurdles of IRRs, but that’s what we like to see.

What we don’t typically like to see is when you have a return of capital, because what that does is that it decreases your basis or decreases your capital account in the deal. And then that calculation for a preferred return, which is on the second position, will be calculated on the capital that’s invested in the deal. So after a year, if you invested $100,000, you got $8,000 and distributions, now your capital account is $92,000. So your preferred return is going to be calculated on $92,000 versus $100,000. Again, that’s one of the things that we look at, and again, a bunch of other stuff really.

Ash Patel: That is a great distinction, that I don’t know a lot of people actually look for, return on capital and return of capital. Thank you for that.

You started out by mentioning character. Now I have to ask you, if somebody has been doing this for 5, 7 or 10 years, and they’ve got a great track record, do you really have to make sure you get along with them?

Lennon Lee: I do. Again, this is all flexible, right? Like, if it’s that home run deal, where you know the market, and you know these guys – maybe you don’t love them as a person or whatever – yeah, okay, maybe you do it. But generally speaking, I probably won’t do business with people that I just really don’t have a good vibe with, people that honestly, I think are genuine good people. And some of the ways that we kind of look at this is if we’re partnering up with a certain operating partner in a certain market, we will go through that market, obviously understand their operations there, their footprint, and how they operate in that specific area. But what we’re really trying to do is build a personal relationship and understand — okay, maybe we go to lunch, maybe we share with their families eventually, and we understand how these guys or how does people treat their partners, how they treat the waiter when we’re having lunch, how they respond in certain situations that might arise at a personal level when you’re doing daily stuff, versus the type of thing that you don’t really see over a zoom call, because all you’re talking is business.

So ultimately, if they have all the track record that they have on paper and they’re pretty good operator, all of that due diligence that you did on the personal side – it’s going to tell you something about what these people or what this guy is going to do when stuff hits the fan, right? You’re going to see, “Well, okay, if this is his reaction to a certain situation in life, then maybe when things are going wrong with the deal, maybe they’ll react the same way.” Again, just maybe; you don’t really know. But—

Ash Patel: Yeah.

Break: [09:43] to [11:44]

Ash Patel: Right. A stressful situation will bring out somebody’s true character. And maybe if you’re out to lunch and their food order was wrong, and they flip out, that’s a problem. What’s going to happen when the deal goes south? But—

Lennon Lee: I don’t know if it’s red, orange or yellow, but it’s a flag. So that’s why—

Ash Patel: I agree with you. Lennon, let me twist that question around a little bit. If somebody’s got a great character, a great deal, but they don’t have the track record, is that a red flag? Or how do you deep dive into that?

Lennon Lee: Yes, it’s also a flag. And now I’m talking from the — not necessarily strictly as an LP… What I always tell people, everything that we’re doing and building at the company and everything that I am, and my partner is as well [unintelligible [00:12:25].08] we look at everything from the passive investor perspective before anything else. That’s who we are.

But to answer your question, for example, now we’re looking at opportunities — and every LP out there can start thinking about different ways to get into a deal that are not necessarily as an LP, at least not at the beginning of a relationship; [unintelligible [00:12:43].17] a new sponsor or a new operator that’s getting started is going to get his first deal done. Maybe you don’t trust them enough to give them $100,000 as an LP, and that’s it. But maybe you do have some liquidity and you can tell, “Well, I’ll provide the risk capital, or maybe I’ll sign on the loan. I’m not going to be an LP, but I trust your character.” You’re telling me you’re going to raise the capital, and then you’re going to close on that deal, I’ll provide the risk capital, and maybe I’ll participate on the general partnership with you, whatever.

But the point is that there are ways to build those partnerships and then you start evaluating how they do on the operation side, maybe after the first deal; now you feel more confident. Obviously, it’s going to be a little bit different for everyone, but that’s the way I see it. So I do think if there’s someone that you really like, trust, and you think they have a good character, and obviously at least some general understanding or success in previous businesses, you might still want to do a deal and invest with them or build a partnership in a certain way. There’s different ways to do it.

Ash Patel: Lennon, can you define risk capital?

Lennon Lee: Risk capital, basically, it’s the money that you have to put into the deal before actually closing the deal. So we’re talking about the earnest money deposit. This is actually, as you go under contract, you’re going to provide this capital. But it’s called risk capital because especially right now, we’re recording in October 2021, and it’s a very competitive market. It’s a seller’s market, meaning every buyer out there is going to have to put, not only a lot of money as earnest money, but a lot of that or a huge percentage of that is going to go hard the day that you sign a contract, and then maybe the rest of it after a certain period of due diligence. And you’ll also see, in today’s market, people that not even are contingent to anything, day one, $100,000, $200,000, $300,000 [unintelligible [00:14:38].13] What that means is that if you don’t end up closing the deal for whatever reason, or you find out that this is not a good opportunity after doing your due diligence, all that money is at risk, and you’re basically going to lose that money if you back out of the deal. So I guess that’s the definition of it.

Ash Patel: Yeah. So typically, in return for putting up the risk capital, I would assume you’re part of the GP.

Lennon Lee: Yes.

Ash Patel: And you get rewarded heavily for that risk capital.

Lennon Lee: Yes, most general partnerships or sponsor teams or operating partner teams, however you want to call them, it’s a team of people. And you’re not only pulling together equity or money, but also different resources from different people; you bring in someone that’s good at marketing, you bring someone that’s good at the financial and asset management side. The other team member might have been the guy that found the deal, and it’s pretty good at broker relationships and sourcing opportunities… But then you also need people to help you — if it’s a big enough deal, you might not qualify or have the credentials to get the loan on your own. You need net worth, you need liquidity, experience, a bunch of different things. So part of that team is the guy or the person that provides that risk capital, part of that team is the person that signs on the loan as a key principle, and ultimately, yes, you are getting a chair of the general partnership for your contribution to the deal.

And I’m not going to go into talking about percentages, how much percentage you’re going to get, because that really varies. It could go from really 10% on the risk capital side… It all depends on the experience of the sponsor, how the deal is structured, how the actual deal is, if it supports even a little bit more of equity… It depends, like always.

Ash Patel: Lennon, it seems like going from an LP to a GP is like going from the minor leagues to the major leagues, and you transitioned. What are some ways LPs can become GPs? And can you talk about your journey from being a passive investor to now being an active GP?

Lennon Lee: Yes, I have to say, like I mentioned before, we transitioned from—I always say “we” because my partner, Tony, is not here today, obviously. But he has kind of the same story in terms of going from LP, then becoming active and building this company. We are LPs, always, on almost every deal that we do. So we didn’t really go from LPs to GPs. We’re always LPs and we’re always going to be LPs alongside our investors. And again, the way we structure it, the way we evaluate deals, the way we think about everything that we’re building is from the LP perspective.

That being said, yes, we started going into the active side, and this is what we do full-time, because you’ve got to work, you’ve got to do something to not be bored. So ultimately, yeah, this is a passion of ours, and I think I kind of mentioned different ways. For me specifically, the first deal that I did as a GP, I was under Investor Relations and capital raising. I think I raised $700,000 for my first deal as a GP; then I did two deals where – in one of them, I raised a little bit of money, not that much, but I provided the risk capital.

And for the third deal, I didn’t raise any money, I only provided the risk capital. So I started getting my feet wet on the GP side, meaning I was involved in the conversations when the deal was being evaluated and the business plan was being created; I chimed in and obviously, provided some ideas and helped here and there. So I started to understand, “Okay, how are these people putting together the deal? How are they securing the financing? And putting together the team to then execute the business plan.” So I started learning by being involved in these calls and meetings and all that.

Then I raised capital for a couple of deals, and eventually, early 2019, I put together my first deal, meaning from top to bottom. I was the lead sponsor, or however people call them these days. That was me, my partner — there was three of us, actually. We did a lot of work evaluating a deal in the Jacksonville market, which we loved. And then we started sourcing deals, building the relationships with the brokers… Again, the whole story, from sourcing the deal to securing the financing, raising all the equity (we raised $4.2 million for that deal), to the asset management, everything. And right now—actually, we closed yesterday. I thought that—we used to say, “We’re about to close.” We actually closed on that deal, made good money for our investors, and we’re really, really happy.

Ash Patel: So you didn’t go out last night and celebrate?

Lennon Lee: Not last night. I’m still taking it all in and making sure that we’re setting up everything with our investors. Once the money hits their account, after making sure any debt are paid everything, that’s when I think we’ll be able to celebrate confidently.

Ash Patel: So a $4.2 million raise is significant. How did you raise that kind of money?

Lennon Lee: Well, the power of building partnerships as well. And everything that we think about raising capital, we don’t really see our investors as clients. Our clients—we’re buying businesses, right? Like, this is a multifamily property, a commercial real estate deal, it’s a business; there’s income, there’s expenses, and it’s valued on the difference of those two. That’s the bottom line.

So our clients are actually our tenants. So we never really call – or try not to anyway – or look at our investors as clients; these are our partners. So not only do we build partnerships directly with our investors… That process for the capital raising there, it’s been years of hard work, of building relationships and putting ourselves out there in terms of telling people what we do, educating people on the benefits of investing in our deals, and the type of deals that we do. A lot of digital marketing, a lot of in-person meetups and events, and networking… That’s the main way. And then I guess, we’ll take another podcast to go into detail about all of that.

But also, there’s different legal structures that allow you to bring into the deal, actually on the GP side as well, that people that may bring different values to the team on the GP side and on the active side, but then also, they have a certain network of investors that might want to get into the deal. So there’s a specific structure called fund of funds. Basically, people build a small fund, and then they invest your fund, which in this case, typically, we do a deal-by-deal basis.

But the idea is that they create a vehicle for their investors, and that vehicle invests in our deals as LPs. Ultimately, part of those $4 million 0 it’s not all directly from the $50,000 or $100,000 investors that we raised; the majority is like that, but then some of it from these funds of funds. And that’s kind of all based on relationships and all based on spending years out there, talking to people and understanding what capacity do they have, and ultimately, understanding that the real value that they can bring to a transaction to a deal. And it paid off for us on that deal that we did.

Break: [21:39] to [24:18]

Ash Patel: So if I have a number of high net worth friends, I pull all of their money together, and let’s say I raise a million dollars amongst us, and I come to a GP and say, “Hey, I’ve got a million dollars.” Do I get preferential treatment? Do I get a higher percentage return? Do I get part of the GP side? How does that work?

Lennon Lee: Yeah. Ultimately, it’s real estate, but these are private equity deals, right? And they can take any shape or form that the sponsor wants really, and then you put it in front of the investors, if that makes sense for them, then great. And then you also put it in front of certain investors, someone in the scenario that you’re mentioning, then you put it in front of them, they say, “Well, yes, but maybe different terms for my side of the equity.” And ultimately you have what’s called the capital stack, you have the debt and the equity. Typically, the debt is the largest portion. But then on the equity side, typically the most simple way is to have one tier on the equity side, but you can have multiple tiers; you can have common equity, preferred equity or however many tiers you really want. It’s ultimately up to you. Obviously, you don’t want to make it as complicated, but depending on the deal, it might call for it. And you might have a certain class of investors that get the common equity, and then you have a certain class of investors that get preferential treatment. And that might mean a little bit higher returns, or that might mean they’re going to get paid first… It depends. But ultimately, the answer is yes, you can provide preferential treatment to different parts of the equity and different investors.

Ash Patel: And then you being a GP, do you have to communicate with all of my investors, or do you just communicate with me? And is it my responsibility to disseminate that information to my investors?

Lennon Lee: Like always, it depends; whatever you prefer. Ultimately, as a general partner and as managers of these entities leading the charge, we are going to have access to all investors in the deal. So if your investors invested directly in the entity, then I will have access to that information. And obviously, this is all based on the trust and the relationship that we have. It doesn’t mean that I need to talk to them or communicate with them. But I obviously have their information. Legally, it’s what has to happen.

In a fund of funds, for example, it’s a little bit different, because ultimately, the LP in the deal, it’s not a bunch of investors, it’s just one entity. And with that entity as a general partner, is who you communicate with. And you manage that entity, obviously, you distribute all the capital to them, you do all the work that actually we’re doing for our investors. So yeah, it depends.

Ash Patel: Yeah, that answers my question. So if I raise all of the money, it’s my responsibility to make sure my investors receive proper communications, either with me or you.

Lennon Lee: Yeah.

Ash Patel: Yeah. Do you have a specific niche of investors? Is it people with a similar background? Is it doctors? Is it people in a certain geographic location?

Lennon Lee: Yes, great question. So far, it’s pretty diverse. I’ve always said that I’m focused on the Hispanic investors, and just naturally friends and family, and Hispanics down here in Miami. Yes, we do have — not really the majority at this point, but I would say a good 30% of our investors are Hispanics, and down here in Miami or from Latin America. But I wasn’t really focusing on that.

Right now, we are actually working with a new marketing theme that we’re putting together, and the idea is to — yes, to really be thoughtful about the messaging, the brand, and how it’s all done and structured, so that we are targeting the Hispanic accredited investors and helping them and understanding their stories, and obviously, sharing my story, which they will identify with. So that’s going to be our focus moving forward; not exclusively, obviously, but I think we can help a lot of Hispanic investors understand how it works and obviously understand how they think, having parents that sometimes they don’t really think the same way that an American investor would.

Ash Patel: Yeah, it’s a culture that you understand intimately. Lennon, what advice would you give to somebody who’s been on the LP side for years, and now they’re going to actively take down their own deal and raise funds for the very first time?

Lennon Lee: I would say self-awareness is everything. It took me and my partner—I always like to be on the capital-raising side. I knew that was my strength and didn’t really love the operation side. I still went into the operation side, I still went into the deal sourcing and underwriting and the whole thing… But I came back to my quote unquote, “comfort zone” or just my strength zone, I will actually call it in this case. So just make sure if that’s what you want to do. Again, there’s different ways that you can be on the active side of things. Maybe you don’t like to talk to people or brokers or anything, you just want to stay on the underwriting, and then asset management side, financials and all that. Maybe you do like to talk to brokers, you do like to travel and be in different markets and evaluate into the strengths of different markets and all that. So deal sourcing might be a good way you find a deal; you partner up with other people. Maybe you have some liquidity, you do the risk capital; maybe you have a good net worth, you might be a KP on the loan. Maybe you do like capital raising and you have a good network of investors, then you do that.

My point is, there’s different avenues for you to participate and become a general partner and then grow from there. Just understand – or try to anyway, study it and understand what it takes to do each one of those tasks and see where you fit better.

Ash Patel: Self-awareness and focus on your strengths. Lennon, thank you so much for being on the show today and sharing your story from Venezuela, to being an LP, and now a GP. And one thing that really resonated with me was you always look at yourself as an LP first. So rather than looking at how much money you can extract, it’s you look at things from the point of your investors, which I think is very important. So thank you for that advice. How can the Best Ever listeners reach out to you?

Lennon Lee: Well, I’m on social media, all the platforms, Lennon Lee. It’s not necessarily a common name, so you’ll find me, just type “Lennon Lee real estate.” Shoot me an email directly, that’s lennon@passivorei.com because that’s a more direct way. [unintelligible [00:30:28].01] real estate would be to go to passivorei.com/dream. There, you put your email and you’ll get a book that we wrote about the way we think about investments; we called it the 4 Investing Rules For The New American Dream. Once you download it, you’ll be prompted to set up a call with us and get in contact with us. I think that’d be a good way to do it, and that way you will understand a little bit better the way we think about what we do.

Ash Patel: Awesome. Lennon, thank you again for joining us. Best Ever listeners, thank you for joining us and have a best ever day.

Lennon Lee: Thanks, man.

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