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As you know, I recently asked people, ‘If you were sitting down for a cup of coffee with me and could ask just one question, what would be?’ I'm going to tell you, I was totally blown away that the kinds of questions that I’ve gotten. I would never in a million years have dreamed them up myself. Thank you for everyone who has submitted one and don't be afraid if you didn't to send one in.
I'm going to answer one of the wackier ones and answer it for us here today. Bill asks, ‘How do I find and convince investors to invest between 1.5 and $2 million on a large rental complex such as 150 units in Florida with up to $1 million in renovations and have me manage it?’
I spent the last couple of days thinking about this. I'm going to take a stab at it and just so that we’re absolutely clear, I have never done this before. I have, however, pooled investors together before for a mini-storage project. So I am going to draw a lot on those experiences that I had in that project and try to figure out a way that we can do this deal.
Let’s assume that this project, including renovations, is going to be a $5 million dollar deal. The very first thing we have to do is figure out what kind of leverage are we going to be able to apply here. Leverage is borrowing, borrowed money is cheaper money usually than equity, because investors want a big return on their money.
People don't want to take a risk to get 3% back, but a bank with a security interest against the building they might be very happy with 3%. If you’re going to put a whole lot of investors together there probably are not going to be any particular investors that are going to be willing to stick their neck out and be liable on the mortgage. You probably don't want that either.
So our question about leverage is going to have to be something like this; You’re going to have to call banks that service that area of Florida and you’re going to have to say ‘Hello, this is Bill. I represent a group of investors from Canada and we want to buy a $5 million building down there. We’re wondering what sort of loan-to-value you are willing to consider with no personal guarantees strictly the lien on the property.’
Now, I asked that question of a banker that I know here in Canada before, and without batting an eye he said 50%. So as long as they know the building is worth $ million, let's assume that a bank that operates in Florida is going to be willing to lend $2.5 million on that.
We’re halfway there, okay. Now where is the other $2.5 million going to come from? This is going to have to come from investors. This is going to have to be equity. So how are we going to structure this?
Different people are going to be in different situations, your investors may have different tax rates, tax brackets, etc. different earnings from other sources.
Because the investors have such different interests with respect to taxation and income, the limited partnership is a great tool to use.
The features of a limited partnership is that one partner has unlimited liability and then the limited partners, they’re protected just like being shareholders in a corporation. They’re limited, they’re liabilities is limited to the money that they put in.
So let's call this building limited partnership Bill LP. Let's assume that you're here where I am in New Brunswick. So it is going to be New Brunswick limited partnership.
Within Bill’s limited partnership we have to have a general partner. Bill may probably say it should be him, but it shouldn’t. The general partner, the one who faces liability, don't forget it can be any legal person. So what we want to use is a corporation.
Bill will want to create a management company or a investment management company and we are going to call that Bill Co Inc. Bill Co Inc is going to be our general partner and that then leaves room for the limited partners.
The limited partners are going to be the one’s supplying the money and having them be limited partners is great because of the features it provides to them. Number one, if they put in 10 grand and Bill messes things up and the bank wants to sue you down in Florida and tax people are after you or whatever, they can’t be pursued.
They were limited to the money they put in. Number two, in a partnership, earnings flow through. Partnerships don't actually pay any tax. Every individual partner in the partnership has to declare their own tax form for their percentage of the partnership.
So if somebody owned 10% of this whole partnership arrangement and there was $100,000 in cash flow for one year, they would actually declare $10,000 of that cash flow on their own tax return. What's nice about this is that if there are people like retired folks who have very low incomes, they might personally want to be limited partners because they have a lower income tax bracket themselves.
On the other hand, big wheel multimillionaire investor types, they’re going to have family trusts or corporations or something set up to do their investing for tax reasons. They're going to make those entities be the limited partners for their interests.
Basically what you're saying is, ‘give me your money, here's what I think I'm going to do for a cash flow for you and you get to manage your tax consequences to your best advantage with your own advisors in the best way that you can.’
Next what you typically have is a partnership agreement, which outlines the details of how the limited partners are going to interact with the general partner, Bill Co Inc.
So your agreement is going to say that Bill Co Inc. is going to manage the property and the limited partners are going to supply the capital. Bill might want to determine an equity split here. Bill is taking the time to put this whole thing together, dealing with the bank, etc.
Bill will be running all over the countryside talking to investors. So Bill should get something out of this, right? Maybe he decides that he’s going to own 20% of the building and that's going to be his fee for putting all this stuff together. We can now say that the general partner owns 20% of the equity, and the limited partners own 80%.
Bill can sell the limited partnership portions as ‘units’ of $1,000 or $10,000, whatever he thinks will work best for him.
Next the property will have to be identified and put under contract. There needs to be enough time for Bill to gather his investors together and show them his figures for this property.
There are a lot of moving parts to a deal like this… the building, the investors, the paperwork. Bill will have to put together a document outlining all this information and the projected cash flows and appreciation in order to convince his investors.
Limited partnership interest is considered personal property which means that a person who owns one of these units can give it to their heirs, they can sell it, they can treat it just like you would a couch. Some people are going to ask, ‘How do I get my money back?’ If you tell them, ‘You’re never going to get your money back. It's going to cash flow forever, and you’re going to give it to your kids’, some people may not like that.
So what most of the limited partnerships in the world of equipment leasing or in the private mortgage community do is that they actually have a time horizon for the investment.
What they say is ‘we’re going to amortize the bank loan over 20 years. Let's say you put up your 10,000 or $1000 today and in 20 years when that loan is finally paid off the building will go up for sale and we will sell it and divide out the money according to the equity.’
20% goes Bill Co. (as the general partner) and the rest is divided up amongst the limited partners based on their ownership percentage just like the profit every year from this thing is divided up amongst the partners.
That way if you go to someone who's 30 years old for example, they’re going to know that when they’re 50, if everything works well that this whole thing will come back. They’ll get a whole pile of money back out of this deal.
Anyway, great question Bill and I’ve got to tell you in this list there is a bunch more just like it. So stay tuned everyone there’s more to come.
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