SUMMARY

Although the concept of a deal structure is fairly simply understood there are some more complex strategies that can put your investment into a much more secure position.  Join Steven as he takes a deeper dive into the deal structure options to help you when looking at your investment opportunities.

Key Takeaways

  1. How deals are structured end up leading to either A, having a higher rate of return, or B, having a lower risk, or C, having the best blend of both worlds. 
  2. A ​​preferred return means they’re getting paid first, prior to anyone else in the capital stack.
  3. It’s a quintessential goal of many very sophisticated investors to want to know how they can keep their downside while still setting themselves up for a great upside.

 

Resources Mentioned

Interested in connecting with other like-minded individuals? Then join our VonFinch Private Capital Network.  Learn more at http://www.vonfinch.com/invest

Episode Transcription

Steven Pesavento 00:05
This is the Investor Mindset podcasts and I'm Steven Pesavento. For as long as I can remember, I've been obsessed with understanding how we can think better, how we can be better, and how we can do better. And each episode we explore lessons on motivation and mindset for the most successful real estate investors and entrepreneurs in the nation.

Steven Pesavento 00:32
Welcome back to the Investor Mindset podcast. I'm your host, Steven Pesavento. Each week, we share mindset tips and real estate investing strategies to help you take your business and your investment portfolio to the next level. Today, I'm going to talk about something that I believe is fairly simply understood. But there's some more complex strategies that can very much so put your investment into a much more secure position. And we're going to talk about exactly what that is, and why it's important to you in this episode. So let's get right into it. We're talking about deal structure today. And when I talk about deal structure, what I'm referring to is a set of terms that outlines the details of how that property is going to be operated, who is going to be responsible for the different decisions that are going to need to be made, who is going to be signing on the guarantors on the debt, thereby taking on that additional risk and liability. And then of course, what is the structure of the capital stack. In other words, how much debt is being placed, how much equity is being placed, and who is going to receive priority payment in that payout in that capital stack when payments are actually made, and how are those payments can be split up. So deal structure, very simply put, it's the terms of the deal, and how deals are structured end up leading to either a having a higher rate of return, or B having a lower risk, or C having the best blend of both worlds. So when you're working in the institutional real estate space deal structure is an extremely valuable and complex tool that investment managers use in order to reduce risk and increase the rate of return for their investors. And when you're in the institutional world, the investor and the investment manager has the most control. And that's something that we really believe in and are looking to create in the opportunities that we set forth, so that we can always put those protections in place for investors. So some of the terms that you've probably heard in the different syndications or funds that you've been invested in probably heard of preferred priority of payment being paid. First, you've probably heard of a preferred return meaning a set return that will be paid prior to somebody else in that investment being paid a return as well probably heard of the term waterfall, which is a tiered return structure that creates an incentive for managers probably heard of things like equity, kickers, fees, and so much more. And so we're gonna talk a little bit about some of those, we may have another episode in the future where we dive much deeper, but I want to talk about two or three, very specific of these terms, that can make a huge difference. So on a typical model, what you're often seeing is you might see in the hedge fund or the institutional real estate space is a two and 20 model, which means the investors or the fund is paying a 2% asset management fee. And they are per year on the equity or on those assets that are being managed, as well as paying 20% of all profits to the manager. Now typically, there is you know, a, a acquisition fee that's often paid, that's between, you know, two 3% Depending on the deal may be higher, or it may be lower. And sometimes you'll also see construction management fees and other types of fees that really go towards supporting the activities that are going to go into managing that project in particular. And in value add deals where there's a lot more work that needs to be executed and therefore a lot more overhead and manpower. You may see operators have a more aggressive waterfall structure than a two and 20 where you might see a 7030 split or you might see some type of tear where it moves from an 8020 to a 6040 to a 5050 based on hitting different routes. Turn parameters. And those different waterfalls will create an incentive so that the sponsor or the operator is going to go out and, and work very hard to be able to deliver an even higher rate of return. Sometimes you'll hear those as cliffs, sometimes you'll hear those referred to by the rate of return at a 17, it'll move to a 5050, something like this. And then you've obviously heard of preferred return. And what that means is that you may receive, say, it's a 6%, preferred return, you may receive that preferred return prior to any other profit, share payments being paid out to you or to other groups, or share classes that are invested within the deal. Now, this priority of payment is very important. And it's a very useful tool, because what it does is it creates this, this bucket of capital that is going to get paid first. And so it can be a very powerful tool, if you're looking for a more conservative approach to investments. So what do I mean by that? Now, you may see in these structures where they have an A class and a B class, or maybe you know, ABCD such classes with different terms, and oftentimes, you'll see something like an eight or a nine or 10% preferred return, and that a class often only participates in that preferred return, therefore, they're getting paid first, prior to anyone else in the capital stack.

Steven Pesavento 06:45
They're being paid their return of capital first, and they're being paid their return on capital. First, why is this important to understand, because in the case that a deal does not go as planned or does not outperform as planned, it's important to know who is going to be paid first, because when you are paid first, you have the highest likelihood of being having your capital returned, and therefore also having the highest opportunity of having a return on your capital, when the worst of the worst happens, you want to be in that preferred position. Now, oftentimes, you'll give up some of the upside to be in that preferred position, because you want to know that your downside is covered. Now, this is the the quintessential goal of many hedge fund managers, it's a quintessential goal of many very sophisticated investors is wanting to know how can I kept my downside, while still setting myself up for great upside. So you may blend your investment, you may invest a portion in a strictly preferred position, you may invest a portion of your investment in the common equity or in the position that is going to participate in the upside, but maybe lower in that priority stack. Now, we've seen a phenomenal opportunity where you can actually invest and participate in both of those types of positions. And we'll talk about that more in the future. If you're interested in learning more about what we do here at VonFinch, I encourage you to head over to Vonfinch.com/invest Get registered. So you're a part of our private investor network. And you can have access to invest right alongside me and my colleagues in the same types of institutional style real estate deals and funds that we put together here at VonFinch. And so it's critically important to understand what is that structure? Where is the risk in that structure and work with investment managers who are looking out for you and the representing your best interest? You know, that's one of the biggest benefits of investing in a fund that is actually going to go place that money on your behalf into different investment opportunities. The that is the way some of the richest investors in the world invest is they'll invest in very large funds like Blackstone, or aw or some of these very large institutional firms. But their check sizes, they typically require a million dollars or $10 million or 100 million dollar investments in order to participate. And so there are other fund managers like VonFinch, who are out there looking for the right opportunities, building relationships with brokers and sponsors and operators in order to set up these deal structures that are very advantageous to investors that put VonFinch in the best position to have control and decision right authority on when a property sold, what the budget is going to be. When to remove the manager and to be able to make these critical decisions the same way a Blackstone or aw would make it but on a scale that's available to retail investors. So very important to understand the power of deal structure, very important to understand the benefit of having or being in a priority position. And it's also very beneficial to understand when it makes sense to take a little bit more risk and participate in that upside, and when in the market and make sense to pull back on that risk, but maybe structure in an equity kicker, which is just a fancy way of saying, Let's Participate somewhat in the profit, but not 100%. Maybe that's 5%. Me That's 10% On top of that high preferred return that we're able to create. So with all of that said, head over to VonFinch.com/invest, to get involved and join our private investor network, we have new opportunities that are coming out on a regular basis. And you have an opportunity to speak with me directly or a member of our team to understand if this is the right fit for you. We work near exclusively with accredited investors and a credit investor as someone who of course earns over $200,000 A year 300,000. If you're married, or has over a million dollars of net worth, we do have some opportunities for you not accredited folks. So please do head over and register even if you don't meet that requirement yet, because there is a long path to building this relationship. And we may have an opportunity available for you in in the future. So with all that said, thank you so much for listening. I look forward to joining or seeing you on next week's episode. And you guys have a great day.

Steven Pesavento 11:39
Thank you for listening to the investor mindset podcast. If you liked what you heard, make sure to rate review, subscribe and share with a friend. Head over to the investor mindset.com to join the insider club where we share tools and strategies from the top investors and entrepreneurs and how to take it to the next level.

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Steven Pesavento

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Steven Pesavento

The Investor Mindset Podcast & President VonFinch Capital

Steven Pesavento has always been obsessed with understanding how we can think better, how we can be better and how we can do better. He is an active real estate investor who curates Commercial Real Estate Investments for clients.

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