FCP 084: 4 Ways To Generate Cash Flow In Multi Family Investing

Man: Welcome to the “Forever Cash Life Real Estate Investing Podcast” with your host Jack and Michelle Bosch. Together let’s uncover the secrets to building true wealth through real estate and living a purpose-driven life.

Jack: Hello and welcome to another episode of the “Forever Cash Life Real Estate Investing Podcast”. Today, finally again with our cohost…

Michelle: Michelle.

Jack: Michelle Bosch. I’m so excited to have her here again with me in this episode.

Michelle: With Jack Bosch, of course.

Jack: Of course, yes. You guys know me anyway. But, I’m excited to have her back on the podcast.

Michelle: I’m excited to be back too.

Jack: Wonderful. So, we’re going to talk multifamily today a little bit.

Michelle: Exciting, yes.

Jack: And we’re going to talk about the four ways of cash flow that you make in multifamily. And then also, perhaps, a little bit of how cash overall flows within a multifamily apartment complex as it’s being operated. So, let’s start with the four ways that as a sponsor, as somebody who wants to put up their own apartment deals you can make money, right? So, this is for you to learn and to be educating about what to look at if you’re an investor. Does the other party make money all four ways or do they only make money two or three ways, right? That’s going to tell you a little bit something. But if you ever want to put up your own investment apartment complex investment strategy, you want to know which ways you can make money. Go ahead, sell this.

Michelle: And being the sponsor, just quickly, means that you are the actual syndicator. You are the, you know, the person bringing the deal together, actually finding the deal and pooling all the investors together, you know, on the equity side. So, there’s four ways or, you know, four, yeah, four ways to make money or to derive cash flow from a multifamily investment project. So, number one is through acquisition fees. You can charge the project an acquisition fee, a percentage of, you know, the actual purchase price or value of the property.

Jack: Right. So, I want to jump in here?

Michelle: Sure.

Jack: Typically, that is 3% to 5% of the purchase price of the property. Now, when we do apartment complex deals, we do charge that because it’s a huge amount of the work to actually get this deal done. The other day I was talking…

Michelle: Just sourcing the deal.

Jack: Just sourcing the deal. Another day I was talking to one of our investors was, kind of, like asking us like, “Well, why are you charging this?” And so, I laid it out to him and once I laid it out, I was like, “Holy cow. Even I had forgotten how much work it is.” And we probably cover that in another podcast. Otherwise, we end up…I start rambling off for the next 10 minutes all the different things that it takes. But it’s, basically, we have had deals that fell through where we lost $20,000. We have fulltime employees that help source these deals that need to be paid. And the acquisition fee is designed to help cover some of that cost so that you don’t just spend, spend, spend, and then not make any money in the beginning of a deal.

Michelle: You also have to hire an attorney to actually create a proper setup, you know, legal documentation, you know, the PPM or private placement memorandum, you know, appraisals, financing, I mean, application fees for the bank.

Jack: Getting through all this effort is a lot.

Michelle: So, the acquisition fees are, basically, designed to cover a lot of those expenses. Yeah.

Jack: Right.

Michelle: And then the second way that you derive cash flow from it or that you make money from a multifamily deal is through management fees. Do you want to talk about management?

Jack: Yes. So as a matter of fact, actually, before to the first one, typically it’s three to five when we do that, we charge the bottom end. We usually charge a 3%, 3.5% acquisition fee because we believe that’s enough. We don’t need to go up to the 5%. There’s no reason for it unless it’s a…and we might change that if it’s like a super mega complicated deal that requires $100,000 something dollars.

Michelle: Complete repositioning of the property.

Jack: And all kinds of different efforts. So, the second thing Michelle just talked about is the, actually, the management.

Michelle: Management.

Jack: The asset management fee. Now, what is an asset management fee? Well, there is the property management that is on the property, which is usually a third-party company that manages the property and they have their staff on a property, usually a leasing manager. If it’s a large enough property, let’s say 140, 150 units, it usually has two people in the leasing office and two people in the maintenance side of things. One does maintenance, one takes units and brings them, makes them rent ready.

Michelle: Turnover.

Jack: So, turnover. Turning. So, this is four people that you have to pay for. And then there’s usually a regional manager that stops by once or twice a week to make sure things are right. This is not what I’m talking about. They are being paid from the operations of the property. But what a lot of syndicators, what a lot of investors, a lot of sponsors, as Michelle defined it, are also doing is they’re charging a 1% or 2% asset management fee. Now, you want to remember that the asset management fee is something that comes off the top. So, if the property throws off $100,000 in the revenue or produces $100,000 in rental revenue a month, then they will take 2% of that and go straight to them. Right.

So, we believe that this is not a good incentive for a syndicator to have. Again, unless it is a major repositioning, rehabbing project where they are involved with it day and night with contractors and meeting things and so on. So, that is certainly legitimate, but…

Michelle: But if it’s a typical value add where you’re, basically, just increasing efficiencies and, you know, optimizing the property, I just feel that that’s, you know, you don’t need it.

Jack: You don’t need it. And what it essentially though means is that you as the sponsor or we in our deals that we’re doing, we do not charge that fee. As a result, we are working for free at the beginning. Now we got our acquisition fee, that covers some of it, but then we work for free until the property performance is so high that it throws off enough money for our investors and there’s something left over for us. Because in our structure, what’s left over for us then goes to us. So, therefore, I believe, or we believe, this is the right strategy because it aligns our investors along with us perfectly because our incentives are completely aligned, right? If we make more money for the property, then eventually we get paid for it too. But we don’t just take off 2% off the top, put up our feet up and then from the rest, perhaps there’s enough left over for the investor.

Michelle: To the investors, absolutely.

Jack: That’s what…if you look at the Reeds, if you look at the big boys in the industry, they…like the guys that have like $1 billion under management or so, those guys, they always charge that because they have a humongous overhead. They have the big expensive office with $1 million sign up on top of the skyscraper in downtown, in the most expensive locations.

Michelle: Absolutely.

Jack: And they have 100 peoples looking over bureaucracy and all this kind of stuff. They need that. But they’re not looking out for you, that’s the thing. They’re looking out for themselves. And at the end, if there’s nothing left after they charge a fee, guess what? You’re not getting paid.

Michelle: No distributions are being made that quarter.

Jack: No distributions are being made. But, guess what? They got their 2% asset management fee. So, keep that in mind when you look at proposals, when somebody gives you a PPM, asked them, “Is there an asset management fee,” right? And unless we do a real total remodeling job where we kick out or, not kick out, but we help all the tenants to leave, right?

Michelle: You liberate them.

Jack: We liberate them into another unit.

Michelle: And you, actually, have work on the physical, you know, property for 6, 8, 9, 10, sometimes even a year in a complete rehab project. Then I think something of that nature and of that magnitude really would justify.

Jack: It makes sense because you’ve got to get paid for…this is a fulltime job for us then and, obviously, we’d need to be paid for that, but then you budget it in and so on. But if it comes from a cash flow, it’s not a…we don’t like it. So, the third way to get paid…

Michelle: The third way is once you have purchased the property and you are in the process of optimizing that property and the property is already throwing cash flow, well, number one, we only buy properties that are 85% or higher, you know, already in occupancy and actual economic occupancy. Not just bodies in the apartment buildings but actually people paying. And so, from day one we know things, you know, that the property is going to cash flow, but as you continue to optimize over, you know, over the course of the first six, you know, however many months, you will have, basically, cash flow that will cover operations. Cash flow that’s going to cover, you know, your debt, which means your mortgage to the bank. And at that point, you know, anything left over is for the investor. And if there’s anything after having paid the investors, then you know, as sponsors you can distribute some.

Jack: So, in our deal…you deal us we often, exactly, as Michelle said, we often offer a…or always offer a preferred return to the investors. In a preferred return the word, preferred means that they get paid before we get paid. So, you pay exactly and that’s part of the cash flow, how cash flow rolls in an apartment complex is, rent comes in, well, payroll needs to be paid. The property management company need to be paid. The four people, let’s say, in a 140-unit apartment complex, the four people need to be paid. The property management company gets paid. All the repairs are being made. Insurance money for the insurance gets put aside. Money for property taxes gets put aside.

Michelle: For taxes.

Jack: Money for reserves gets put aside. All these kinds of things get put aside. And then there’s a net operating income remaining at the end. From that, the mortgage gets paid and then the investors get paid. So, typically, in our deals, the investors then make whatever their preferred return is like 5%, 6%, 7%, whatever the number is, depending on the deal and what the deal throws off. All right. And what our forecast for the deal is. And then after that, only after that, we get paid. So, for example, we picked up a property last year that was mismanaged by an owner for 18 years. It had 90% occupancy, but we soon realized that there was a lot of, kind of, like dead beats in the property in that…

Michelle: People that were on month to month leases.

Jack: Yeah. And we knew that already ahead of time. So, we anticipated a lot of it. We budgeted for it, but we had to evict a lot of people. So, the occupancy went down to just like 68%. It still threw off enough to pay the mortgage and pay our investors. So, our investors always get paid. But it took us…but we haven’t made a dime on this property for the last nine months. No asset management fee. Yes, we did get a small acquisition fee, but other than that, no asset management fee. No dime to us. As a matter of fact, we basically flew out there a few times, even on our own costs, to make sure that everything is going well.
And now after nine months, we’ve cleaned up everything. The spring is here. We went out there, we put with the property management company, all the marketing in place. Now at the end of this month, we’re at 90% occupancy. Now we’re starting to make money for us. So, in almost a full year, we haven’t made any money for ourselves. All right. So, that is super exciting. That’s just how it gets. But, that’s okay because there is a fourth way to make money. And that’s really the way that as a sponsor of a deal…

Michelle: You should be thinking about.

Jack: …you should be thinking about. Being a sponsor of a deal is not making an extra 10 grand a month or 2 grand a month or $1,000 a month, whatever it is from cash flow. Cash flow is nice, but the end game here is cash number four. And that is?

Michelle: And that is, basically, the cash, the money that you make after you exit or sell the property. And you, basically, split profits with your investors.

Jack: Exactly right.

Michelle: And for that, you have to be disciplined. You have to be committed to not just immediate gratification but, you know, have a much longer-term horizon for making money.

Jack: Right. Wonderful. Now, and by the way, if you come across a property that has cash flow, and to exit at the end, that’s even better. So, the one we just talked to you about did not have any cash flow for the first nine months for us. But starting in year two, it will throw off some cash flow for us. Great. We can wait this out. We have other businesses. That’s not a problem. If you are somebody who wants to do your own apartment complexes and you have a job and you cannot afford not to make any money, then only pick properties that cash flow right from day one, and have some cash flow left over for you.

Michelle: Which are, actually, harder and harder to find. Yeah.

Jack: They’re harder and harder to get. But another property we just bought in December of last year is one of these properties. Bought at the 90% occupancy. By the time we put it on contract for 90% occupancy, then we immediately started working with the property managers before we even owned the property. By the time we bought it, which is usually about a two and three-months process, it was already at 95% occupancy. Then we raised rents right away while we were doing improvements to it.
And the property is now at 96% occupied. We have increased the net operating income by an average of over $10,000 every single month. And that’s just the last three months. And that property was already spitting enough, at the beginning enough out to pay everyone. So now this property, we are going to make cash flow right from the beginning, not 10 grand, not 10 grand a month because we’re also keeping reserves and so on and so forth, because there’s always something that’s going to happen, that’s unexpected. So, keeping all those reserves in the side, but in this property within the first three, four or five months, we’re getting already paid a little bit money too.

But the key is to what Michelle said, the exit really matters. And how do you maximize your exit? You maximize your exit by maximizing the income of the property. Because in multifamily or commercial real estate, the value of a property is a direct multiplier of the income.

Michelle: Of the income, yeah.

Jack: So, in other words, if you sell a property, at say, the five-cap rate, and I’ll explain cap rate in a different podcast, but if you say then that it really equals a 20-fold multiplier. So, if you raise the income of a property by $100,000, you just raised the value of the property by $2 million. So, this is the end game. And this is why we also don’t charge the asset management fee because we want our incentives to be 100% aligned with those of our investors. So, first of all…

Michelle: It keeps us honest. It keeps us hungry. It keeps us driven to make…

Jack: And it keeps everyone…this keeps everyone happy because the investors know we’re going to do whatever it takes to get that property to perform on the best possible, highest possible level because when we do that, when we go sell the property and split the profits with our investors, the investors are going to make an insane return on their money.

Michelle: Absolutely.

Jack: Like I’m predicting right now, it’s not a guarantee if you’re watching this, you invested with us, don’t count on it, right? But I’m predicting that on the deal that we bought in December of last year, our investors are going to make over 25%, 30% per year annual average returns on their money. This is crazy. This deal has full. I’m not soliciting anything here. This deal is completely full. We have all the investors we need. I’m just sharing experiences from one of our deals. All right. The other deal will probably make a similar number. It just takes a little longer to get that one going.

So, it took an extra nine months to get it, kind of, like clean up and everything and ready to fully upswing and occupancy, but that is the outcome. That’s what we are working on because we’re not working for the extra 10 or $20,000 in cash flow for the course of the year. We are working on getting the income of that property up by $200,000 a year and then going to sell this property for $4 million more than we sold it, than we purchased it. Because in that case, when we split the profits are investors make a ton of money and guess what? We worked our butts off and we also make very good money.

Michelle: Absolutely.

Jack: And that’s the exit game of it. That’s the four ways of making money in commercial real estate and, particularly, for apartment complexes.

Michelle: Multifamily.

Jack: Right. So, great. In between, we covered the four ways. In between, we covered a little bit of the cash flow as it goes then from the rent to the different operational pieces. We’ll do another one [inaudible 00:16:48].

Michelle: But that will be a great episode of just explaining what is called the waterfall.

Jack: Yeah, we’ll do that. And then the waterfall and the exit is another term. The term, waterfall is something that even very experienced real estate investors don’t know. We didn’t know before we got into commercial real estate investing and…

Michelle: We’ve learned, yea.

Jack: …basically, we learned. So, we’ll have an episode about that, but in short words, it means how the money flows in different situations in the property, particularly upon the exit. So, with that, I’m glad I got my cohost back. Right.

Michelle: I got invited just a minute before the episode started.

Jack: But she knows this stuff anyway. So, if you enjoyed this episode, please leave a comment below.

Michelle: Thank you.

Jack: If you’re watching this on YouTube, if you’re listening to that on iTunes on the other platforms, make sure you go and leave us that five-star review with a comment below. That helps us get more reach out there, particularly with iTunes. And if you’re watching this on YouTube, then on our Jack Bosch Land for Pennies, oh no, not land for pennies. It’s called “Land Profit Generator YouTube Channel”, then go there and also put the thumbs up, leave a comment below. We love your guys’ feedback. All right, with that, see you at the next episode.

Michelle: Yeah. Bye-bye.

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