Growing up, you’re taught to never talk politics or religion at social events-they are personal topics, best to be avoided. Personal finance is right behind, up there at the top of the list of forbidden topics. You just don’t go around asking about or discussing your finances with friends. However, to be successful in our business, you have to buck that rule. If you’re going to be raising private equity for apartment deals, this topic is par for the course.
In the last year, we’ve raised over $16mm by breaking that golden rule a lot. Like every single day. We’ve had over 350 direct one-on-one conversations with investors and potential investors. In each one of these meetings, we discover so much about our investors-their attitudes, specific preferences and investing goals. During these conversations, I feel privileged to get an inside look at many people’s private thoughts about money, wealth creation and investing. After sifting through these conversations, representing a multitude of occupations, net-worths, nationalities, and backgrounds in general, we’ve noticed that there seem to be two predominant, different types of investors looking to invest in real estate.
In this article, we wanted to highlight these two groups of investors with the goal of hearing from you—do you agree with these categorizations? Do you think they’re accurate? Did we miss any? Which one do you identify with? Read on and please do comment below!
Before we dive into the differences, we want to highlight the commonalities–of which there are many. These seem to be true of anyone looking to real estate as an investment (vs say the stock market). In our conversations with investors, they prefer investing in real estate for the following reasons:
- Your investment is backed by a hard asset
You know that there is a tangible asset behind the investment. Many investors feel more secure about their principal sitting in an asset you can see, touch and feel. The reality is that it’s more than just a piece of paper or a ticker on a screen, and our investors like that. - Expect Cash flowThe money that is left over each month or year from the property's income after paying for operating costs, mortgage, taxes, and other expenses. Positive cash flow occurs when the income exceeds the expenses, while negative cash flow indicates that the property's expenses are higher than the income it generates. View Definition
Landlords make money in their sleep via passive income. We call this Cash flow. We only buy assets that cash flow from Day 1, which creates an immediate income stream for our investors. Our investors also like that we are able to increase the cash flow as they own it, by forcing appreciationThe increase in the value of a property over time, usually due to factors such as market demand, economic growth, infrastructure improvements, and inflation. View Definition and finding creative ways to add value. Compared to a stock with an announced target dividend, investors appreciate knowing the cash flow is going to get better as time wears on and the value add plans are executed. - Understand and are comfortable with leverage
The investors who are attracted to Real Estate like, and understand leverage. Again, we compare it with buying a stock. Imagine you have $100 to invest. You could log onto your stock brokerage and buy $100 of stock. Or you could use that $100 as a down payment to purchase $400 worth of real estate. It multiples the power of your investment dollar–and all the investors we talked with understand and enjoy that. Now, don’t get us wrong, you need to remain conservative on your leverage, and your underwriting so as not to get over-leveraged and add undue risk to the investment. In our case, we pursue low leverage debt (usually 65%-70%) and use fixed-rate non-recourse government backed loans. - Understand tax advantages via depreciation
Depreciation is one of those secret weapons that we love. While there are multiple ways to evaluate annual depreciation we like to run a cost segregation study on every property we own. This amounts to depreciation being higher up front and lets investors see a paper loss for the first several years, even though regular distributions are hitting their bank accounts. The tax advantages of owning real estate is a key reason our investors are attracted to this space.
With so much in common, you’re probably asking yourself “Get on with the differences!” Here are the two investor profiles that we’ve identified and what they are looking for:
- The “Rinse and Repeat” Investor
This group of investors are looking for higher overall returns, and shorter-term projects. Typically they tend to be a little more risk tolerant, and they usually prefer anything offering the promise of higher returns–knowing that a higher return is usually tied to a higher amount of risk. They target 16%-20% IRR where their money will grow 2.5 to 3+ times faster than it could in the stock market. These folks are equity multipleEquity multiple measures how much an investor's initial equity investment will grow over the holding period of the investment. It provides a way to understand how much money an investor can expect to receive back compared to what they initially put into the investment. View Definition oriented. I tend to think of this group like I think of house flippers. They are less concerned with getting regular distributions and more concerned with the overall project timeline– knowing in 24-48 months they are going to exit with a chance to take all that earned money and put it back into a new project. Typically we see this group working to create wealth via real estate. - The “Set it and Forget It” Investor
This group of investors are looking for cash-flow and regular distributions. “Mailbox money” matters to them above all else. Often times they value putting their money into higher quality, newer buildings with less chance of unforeseen expenditures (aka risk). They are focused on cash on cash returns and amortizing the loan over 8-10 years, knowing that every month or quarter they are going to get a distribution check for all their efforts. We’ve typically seen many members of this group working with the goal to try and preserve wealth, creating multiple income streams that they can count on. Whereas the other group wants a 16%+ IRRInternal Rate of Return: a financial metric used to evaluate the profitability of a project or investment over time. It represents the discount rate at which the net present value (NPV) of all future cash flows from the investment becomes zero. View Definition, this group is happy with a 10%-12% return– if they can securely count on regular cash distributions totaling ~8% each year. In this group we actually have an investor who told us “let’s buy something together today and you can call me when I’m 70!”. Obviously this is a joke, but it speaks to the longer-term mindset of of this group.
In our pursuit of cash flowing, value add apartment deals, we come across opportunities that uniquely fit into the appetite of both of the above investors. During our (daily) conversations with investors, we’re starting to ask which mindset they are more geared towards so that we can present them opportunities that fit within their criteria. There are more than one ways to skin a cat, and there are multiple ways to make money via real estate investing. We’d love know–which bucket do you fall into?
Written by Andrew Campbell
Andrew Campbell is a native Austinite and Managing Partner at Wildhorn. He is a real estate entrepreneur who first broke into the business in 2008 as a passive investor. In 2010 he transitioned into active investing and management of a personal portfolio that grew to 76 units across Austin and San Antonio. He earned his stripes building and managing his personal portfolio before founding Wildhorn Capital and focusing on larger multifamily buildings. At Wildhorn, he is focused on Acquisitions and maintaining Investor Relations, utilizing his marketing and communications background to build long-term relationships.
