One of my students is buying a 48 unit apartment complex in Kentucky. He nursed it from beginning to end. He's got himself a nice property that's going to be a very great launching pad to his 1,000 units. He'd already gone to probably before, but this is a little bigger scale. So that was a great deal.
And another student who should be closing on a much bigger deal next week. Fingers crossed. I think that one crosses the finish line as well. But we had a bunch of topics we talked about, the one that I want to bring to your attention was really cool.
I had two of my most successful students on the call and they both have the exact same investment strategy. But they come about it in different ways. Now, that sounds strange, but let me explain. Their strategy is to refinance the investors out of the deal. So that they own the properties. Who wouldn't want to do that?
I mean, these guys own millions and millions of dollars of property, and they did it all by using other people's money. And as soon as they could, they gave those people their money back and they kept the property. Now, how do they do that strategy entirely differently?
One investor uses debt and the other investor uses equity.
Now for some of you who were on this call, you understand the difference between debt and equity. Let me explain. Your mortgage is debt. Your second mortgage is debt. Your stock in Apple. That's equity.
Your raising of private money in a syndication to have your investors own a membership interest in your LLC is an equity. So how do these two investors do it differently?
Ok, so for the debt investor, what he does is - he goes to his brother-in-law or his father-in-law. He says, “Listen, I want to buy this property. I know you get a lot of money sitting in your IRA. Let me lend the money. I will pay you back on a fixed interest rate on a certain period of time. And I will secure that loan with some form of collateral.”
Ok folks, what I just described to you is a thing that you've heard a million times. That's debt.
The other investor with the equity comes along and says, “Hey, I've got a deal for you. I'm going to offer you a percentage interest in this deal. And look at how much money we're going to be making in this deal as long as we run the numbers correctly. This investment's going to skyrocket. And you're going to own a percentage of that company. That's not secured by anything. You could lose everything. But look at this return that you're going to get.”
So as you can see one's riskier than the other. One is secured, the other is unsecured. One gives you more reward for the risk versus the other one. So that is how these two investors do it. Now how do they cash out refi these two scenarios?
Well, if you're doing it with debt, it's very simple. The terms are already spelled out in the loan instrument, in the note, or in the mortgage. Whatever it is, it's all spelled out. Both parties know exactly what they're getting.
So once that particular debt investor wants the NOI, gets up to a certain point that he's repositioned the property and his cash flow beautifully, he goes back to the bank, borrows his 80% LTV, turns around and pays off the note. Now he's all by himself. He owns a property free and clear.
Now remember that when he was evaluating that deal, he had to make sure that the property could support the two notes : the first note from the bank and the second note from his brother-in-law. So that's how he had to make sure that the property was purchased in such a rate that he could do that.
Now the other equity investor, what he does is - in his private placement memorandum or in his operating agreement, he clearly spells out that this is what happens when we reach a certain point. We're going to go back to the bank. We're going to refinance the deal and all of you class A members will be paid your principal plus a particular return and you're out.
OK, now what they do. As you know, some investors may not want to deal, especially the great investment. They want to stay in. So what these guys have done is they put a kicker by stating that if you don't get out or if you decide to stay in, your membership interest percentage drops. So you own less of a great property. You own less if you decide to stay in. And that's it. That's an incentive to get out.
But here's the real kicker and this is where both these guys can do this. This is where it really is cool. What the equity investor does is he goes out and tells the investors that if you do this, you can get into my next deal. And as long as you're getting that rate of return, they want to get it at his next deal. He has created a perpetual fund for himself.
So that's what we did on one of our Multifamily Investing Academy's OWNER FORUM night calls. It is a great group. We had a lot of fun on the call. You've got to check it out if you're not a member yet. It's the best group of multifamily investors on the internet. And it is such a great lot of fun. We have a good time and we also get deals done. And that's the key!