Back to Basics: Understanding Commercial Real Estate Investing

In this episode of How to Invest in Commercial Real Estate, we break down the essential financial metrics every investor should know—cash-on-cash returns, IRR, cap rates, and more. We also discuss how to transition from earned income to passive income through real estate investing, the benefits of commercial real estate over other investment vehicles, and how to maximize returns while minimizing risks. If you're new to investing or looking to refine your strategy, this episode is a must-listen!

(0:09) What is up and welcome back to another amazing episode of how to invest in commercial real (0:13) estate. (0:13) What's up guys? (0:14) Best podcast in Jinx, Oklahoma. (0:16) Still undisputed.

(0:17) Still. (0:18) For now. (0:18) And still.

(0:19) The best podcast in Jinx, Oklahoma. (0:20) What is up? (0:21) What is up? (0:22) Yeah, getting settled into the new year. (0:24) We're staying busy.

(0:25) Went to the Thunder Game earlier this week. (0:27) That was fun. (0:27) Yeah, big shout out to Mabry for getting those tickets to us.

(0:30) Amazing time. (0:31) I mean, we're sitting on the fourth row and the guys are still taller than you. (0:36) I will say that they say they're floor seats, fourth row, but it's really second row because (0:42) the first two rows are the visitor team.

(0:45) Yeah. (0:45) Yeah. (0:46) So it doesn't really feel like fourth row.

(0:48) It feels like second. (0:48) Yeah. (0:49) Very cool experience.

(0:50) Yeah. (0:50) We'll have some video uploaded on the podcast and website here shortly. (0:55) Just to give you an idea of how it was.

(0:58) We had some announcements. (1:00) Yeah. (1:01) Yeah.

(1:01) So latest deal just got launched. (1:03) Build the suit. (1:04) Aspen Dental in Nacogdoches, Texas.

(1:07) Small town in Texas. (1:09) We actually stayed the night there. (1:10) Yeah.

(1:11) It's pretty small, but they do have a university or two there. (1:14) Yeah. (1:14) Stephen F. Austin.

(1:15) Yeah. (1:15) Stephen F. Austin. (1:16) I think there's another smaller college there, too.

(1:18) So. (1:19) Yeah. (1:19) So that went out yesterday.

(1:20) I think it filled up almost immediately. (1:23) It was a fairly small raise. (1:24) It was like half a million dollar raise.

(1:25) So filled up. (1:26) We started a short waiting list for that. (1:29) I doubt we'll get very much through it.

(1:30) But yeah. (1:31) That is a new construction site. (1:34) We already purchased the land.

(1:35) We should be breaking ground here in the next month. (1:37) Six, eight month build timeline. (1:38) Hopefully get it on the market this fall and exit out early spring next year.

(1:42) Maybe sooner. (1:43) Yeah. (1:43) There were a few people that wanted to get in that one, but didn't have a chance.

(1:46) But we've got other ones coming up. (1:48) Yeah. (1:48) We've got a great retail deal in Fluent Suburb of Cincinnati.

(1:52) What's the time on that one? (1:54) We're a week or two into DD. (1:55) I bet it launches out in another week. (1:58) I honestly think we were just waiting until Aspen Dental launched.

(2:02) So it'll probably go out next week, maybe the week after, worst case scenario. (2:06) Lenders working through the debt package. (2:08) We've started the process of getting all the entities set up.

(2:11) We're stressing the deal now in due diligence, waiting on third parties to come back, etc. (2:15) So yeah. (2:16) I bet we close on that beginning of March.

(2:19) Okay. (2:20) And we've got one more in Richmond, Virginia, which I'm excited about as well. (2:24) Yep.

(2:24) We're flying out there next week to do the initial site visit property tour. (2:29) It looks great on paper. (2:30) We've got it under contract.

(2:32) Again, starting due diligence, working through everything with the lender, starting to get (2:36) that out. (2:36) That'll probably go out three, four weeks. (2:39) What we really need is to get all that equity back to everybody so we can fund these new (2:45) equity raises.

(2:46) Yeah. (2:47) Yeah. (2:47) We closed on the gas stations.

(2:49) Yeah. (2:49) The seller financing piece on the Petromax deals, that's being released hopefully next (2:53) week. (2:53) Awesome news there.

(2:54) The perfect auto deal. (2:55) We got that cash out. (2:56) And then more importantly, the fourth quarter distributions, we're finally getting those (3:00) year-end reports.

(3:02) We typically get them back on the 20th, so we try to get them out by the end of the month (3:05) following the end of the quarter. (3:07) But being end of year sometimes takes a little bit longer. (3:10) And then obviously just moving into K-1s from there.

(3:14) I know everyone wants to get started on their taxes as soon as possible. (3:17) All we can say is we don't know when you're going to get them, but we're going to do way (3:20) better than last year. (3:21) Yeah.

(3:21) That's right. (3:22) Yeah. (3:22) Fair? (3:23) Yeah.

(3:23) We're going to say that every year. (3:25) All right. (3:25) So we got a cool show today.

(3:28) And really we're trying to call it maybe back to basics. (3:31) I'm getting kind of hit up by some new investors that just found our podcast and are asking (3:36) me questions like, hey, what do you recommend? (3:38) Which podcast should I go watch? (3:40) Another conversation I was having with a new investor, I'm trying to tell them like, hey, (3:44) we're targeting this equity multiple, and we're targeting this IRR, and the cash on (3:49) cash with this. (3:49) And I just remember them saying, yeah, yeah, I don't, I don't know about all them numbers, (3:53) but just tell me what, you know, and so we don't want you to say, I don't know about (3:57) all those numbers.

(3:58) We want you to know the numbers and we want you to understand what we do. (4:02) So, so to start, we're going to tell you why we think you should get involved and then (4:06) kind of simplify what we do. (4:07) So that's how it's going to go.

(4:09) All right. (4:09) So first things first guys is we think that your life mission should be to take your earned (4:16) income and be converting that to passive income as quickly as possible. (4:21) And then once your passive income exceeds your expenses or your current income, then (4:26) you have the option to quit your day job and get your life back.

(4:30) And I think that's really, that was my goal and we want it to be your goal to where you (4:34) set a plan in place to say, okay, I'm working. (4:37) I may even love my job, but I'm not just going to spend my entire life doing it if I don't (4:42) have to. (4:42) And I'm going to set a target to retire earlier or to quit the day job earlier.

(4:46) Not even to retire, but just to quit the day job earlier. (4:48) And how you do that is either you got to get insanely wealthy or you got to build passive (4:54) income, which will give you the confidence to finally quit. (4:56) Yeah, that's, that's what I decided to do about 10 years ago.

(5:00) I knew that unfortunately I wasn't retiring early, but I knew that retirement was, I wanted (5:04) to retire in about five years, which would have put me at about 60 at the time. (5:08) And so five years prior, I found commercial real estate as the way to do that. (5:12) So I started investing in and learning about commercial real estate and, and lo and behold, (5:16) it happened.

I was able to match my salary, which is what I wanted to do with the passive (5:21) income. (5:22) You know, I don't think it's really reinventing the wheel too much, right? (5:26) At the end of the day, you have to invest money from your active source of income to (5:30) something in order to get passive income. (5:32) The beauty about real estate and what makes it an amazing passive income stream is (5:39) because of the cash flow it sheds.

(5:40) You know, in the stock market, it's very rare to get a dividend worth anything that (5:44) you can live off of. So then you're constantly in the buying and selling stage. (5:48) Whereas real estate, you could hold for decades, right? (5:51) And just live off of the free cash flow.

(5:53) It's going to give you 10, 11, 12, 15, sometimes 20 amazing percent just in cash flow (6:00) again. And you don't even have to sell the deal. (6:03) Yeah, but think about it like this, guys.

(6:05) So let's say that you have a million dollars, you're maybe you're 50, you know, you've (6:09) been saving in your 401k and you have a million dollars and that's that's not enough to (6:13) retire at 50. (6:15) OK, you know, you got to live to your 90. (6:18) But what if you took that million dollars and you were able to get 10 or 12 percent (6:22) cash on cash on that million? (6:24) OK, now you're getting 100,000, 120,000 a year in tax advantaged income.

(6:29) Could you live on 120,000 a year? (6:31) It's just most likely, yes. (6:33) But here's the magic of commercial real estate is you go take that million dollars and (6:37) you buy a five million dollar building with it or a four million dollar building. (6:42) OK, let's say five million dollars and you get a four million dollar mortgage and you (6:45) make 10 percent on that million dollars.

(6:47) OK, so you're getting 100,000 a year and you're living on that. (6:49) But what else is happening? (6:51) You're paying down that four million dollars. (6:53) So if you're 50 by the time you're 70, let's say, or 75, you could have that completely (6:59) paid off.

Now you got you have zero on that five million dollar building. (7:04) But here's the other magic thing is that that five million dollar building is going to (7:08) double in value over that 20 years. (7:10) OK, most likely or close to easy 20 years.

(7:14) So so what did you do? (7:15) Right. You could have stayed at your day job because a million isn't worth retiring. (7:18) And and you can you can work to your 65 and hopes that you have two or three million (7:23) dollars by the time you're 65 and then you can quit or you can quit today.

(7:27) Right. Get the passive income. (7:29) And by the time you're 70, you don't owe anything on a 10 million dollar building.

(7:34) That that's how powerful it is. (7:36) You're supersizing your returns and you're getting the lifestyle you want. (7:39) And that's what we're trying to get people to appreciate.

(7:42) OK, so we we've sold the dream a little bit now. (7:44) Practically, what are we doing? (7:46) How are we doing what we do? (7:47) How do how do we offer these opportunities for people to get invested in commercial real (7:51) estate? Practically. (7:52) I'm glad you asked.

So the facts are that if you're 50 and you don't have any experience (7:57) in real estate, the chances of you going out and successfully placing that million (8:01) dollars into an awesome five million dollar building that's going to double over the (8:04) next 20 years and make no mistakes and have no fluctuations in that income, that's (8:10) going to be difficult. (8:10) You're crazy if you do that. (8:11) You're going to be petrified with fear.

(8:13) You can't do it. Yeah. (8:14) You may not even get the loan.

(8:15) You don't even know where to go to get the loan. (8:17) You don't know where the risks are in the deal. (8:19) You don't have markets to buy in.

(8:21) And so, yes, could you do it? (8:23) Yes. But you might need to take five years to study and learn and get experience in (8:26) order to be ready to do that. (8:27) Well, here's where we come in as a sponsor is I've spent the last 20 years of my life (8:33) and these guys, most of the last 10 to 15 years trying to become experts in exactly (8:38) what we're pitching you to do is to buy these deals, be able to create a situation where (8:43) they can cash flow 10, 12 percent to the investor.

(8:46) And then we make an offer to investors and investors. (8:50) Now they don't have to wait till they're 50 and have a million dollars. (8:52) They can start investing any time and in increments of 50, 100, 200.

(8:58) And so they can get that passive income rolling right now and they can get that (9:03) depreciation benefit. (9:04) They can get the paying down of the debt. (9:05) They can get the appreciation all in bite sized chunks with no experience necessary.

(9:11) That's what we do. Yeah. (9:12) And you get the advantage of our knowledge, right, because you're learning while you (9:15) do that.

We get investors asking us questions all the time, right, and listening to (9:19) podcasts. And pretty soon you're not a rookie at it. (9:22) Right.

And you might be able to go buy your first building. (9:24) Maybe it's not five million, maybe it's something less, but you get the knowledge (9:27) from us. Yeah.

(9:28) And there's we take most of the risk, actually, because we're signing on the debt. (9:31) Yeah, that's very true. (9:32) Right.

Like not only just the risk of loss of capital, but like they're suing the (9:36) crap out of us if we don't perform. (9:38) But I was thinking, you know, I have like no money in Robin Hood and I love looking (9:42) at it. So it's like, oh, is it up? (9:44) Is it down? Is it up? (9:45) Is it down? You know, our commercial real estate deals, the daily check ins, you don't (9:49) even think about.

I don't even think about as as the sponsor. (9:52) Right. Because this is where I was connecting.

(9:54) I'm glad I found the thought. (9:56) There's multiple layers of infrastructure. (9:57) You know, not only are we managing the asset from an asset management perspective, but (10:02) we have property managers.

We have local leasing agents on the ground. (10:05) We you know, we have trained CPAs. (10:08) We have trained professional real estate attorneys.

(10:10) We have specialists that form our documents to make sure, you know, we're not violating (10:14) any restrictions with the SEC and how we're raising money. (10:16) You know, all of these layers. (10:18) Banks, lenders, the bank, the board of the bank, they're reviewing the financials every (10:22) year.

They're the ones that are deciding, hey, do these guys know what they're doing? (10:25) Should we give them a loan? You're getting checks and balances all along the way. (10:29) Right. Right.

We're a big team of subject matter experts, actually. (10:33) Yeah. Larger, not just us.

(10:34) Yeah. Yeah. And that provides a lot of comfort because I think the alternative is (10:39) something that only that person controls.

(10:41) And I think it's almost two types of people. (10:44) There's and I see it a lot when I'm talking to investors. (10:46) There's people who have only ever invested in themselves and something they control.

(10:51) Right. And at some point, I think you're going to have to invest outside of that. (10:55) I mean, at some point.

(10:56) And I think it's great advice in the beginning to invest in yourself and a business and (11:00) earn that, you know, whatever it is, you know, you have to invest in yourself. (11:04) But at some point you want the passiveness. (11:06) You want to buy your time back.

(11:07) You're going to have to let somebody else manage it. (11:10) And commercial real estate is an amazing opportunity for that. (11:12) Yeah, I would say, guys, like I love doing the active sponsor.

(11:16) We we we placed 19 million dollars in deals last year. (11:19) We we love the chase. (11:21) We love the hunt.

We we love taking that risk and making it happen. (11:25) But I don't love it as much as I love the passive income I get from my own personal (11:29) investments and all of these deals across precision equity in the Criterion. (11:33) So that's really what gives me my lifestyle.

(11:35) The rest is it's it's not work in the sense that it's a day job, but it's work in the (11:39) sense that I have to actively show up and figure out how to do it. (11:42) I have to decide to take the risk. (11:43) We've got to, you know, the documents ready.

(11:45) We got to upload them to the portal. (11:47) We got to have the conversation with all that's work passively is where you want to be (11:51) when you get the check in the mail and everything just is done for you. (11:54) And that's the bonus we're trying to provide.

(11:57) And we do make money on these deals, but we don't we don't charge a fee to people to (12:01) go place their money in a sense that if, hey, if you have one hundred thousand, well, if (12:05) you give me, you know, if you give me five thousand dollars and I'll go try to see if (12:09) I can place it. No, you give it to us. (12:12) And if it's a cash flowing shopping center, we're paying out dividends immediately on (12:17) your money and keeping your money safe.

(12:19) So we're not taking a fee out of that one hundred thousand one hundred thousand stays (12:22) one hundred thousand and grows. (12:24) And then we just send you checks. (12:25) It's a little bit different model than paying someone to go do something for you.

(12:29) Yeah, we're not getting paid for a service. (12:31) We have a promoted interest if the property performs. (12:33) So this is where I think we can start to get in some of the technicalities where people (12:36) may not understand.

And the first one is what we like to call is the preferred return. (12:40) And most all of our deals have a preferred return. (12:42) And that simply means that the limited partner or investor, whether that's me, Brian, (12:46) Joel or anybody else, like anybody who puts money into the deals, a limited partner, (12:51) those limited partners get a preferred return, which is eight percent on our deals.

(12:55) Typically, typically eight on the money they invest while the money is invested in the (13:00) deal. So if they invest one hundred thousand dollars, their preferred return would be (13:04) eight, eight. Right.

(13:06) By the way, I don't see a lot of other investments that are offering eight percent. (13:09) There's some that have a preferred return, but a lot of times I see less than eight (13:13) percent, seven. Yeah.

(13:14) Yeah. On the precision side, we just launched an apartment deal that that isn't it's a (13:18) rehab project. So there's going to be some work involved.

(13:20) So the prep only is seven percent, but it builds over time. (13:23) The greed. (13:26) It's not greed.

(13:28) I'm just kidding. We're shooting for almost a three X multiple over five. (13:32) We haven't explained those terms yet.

(13:34) I know. Oh, yeah. (13:35) OK.

So anyway, let's go. (13:37) Let's get going. Our promoted interest.

(13:38) So where we make money is we get 30, 40 percent of every dollar after that eight (13:44) percent. Right. And that's where we criterion and sponsors make money.

(13:47) So if the deal doesn't perform, we're not making money. (13:49) Yeah. Yeah.

Yeah. (13:50) So just just to reiterate that point of how powerful the prep is, is the first eight (13:57) percent to the investor, they get one hundred percent of the first eight and then over (14:01) eight, that's when they get they get 60 to 70 percent of everything over a hundred (14:06) percent to a 60 to 70 percent of everything over eight. (14:10) And then we're taking 30 to 40 percent of anything over eight.

(14:13) The structure is set up to have you guys get a minimum return on your money before we (14:19) really take part in the profit. (14:21) And so our interests are aligned is the key there. (14:24) So that preferred return is just the return off the top.

(14:27) OK. And you just kind of think, hey, if I'm getting my if I'm getting only eight (14:31) percent, that means we're not getting anything on the back end. (14:34) If you're getting something over eight percent, that means we get a share of the (14:38) profit.

Yeah. And so we talked about we were going to talk about waterfall, too. (14:41) But that's basically what the waterfall is.

(14:43) Right. It's all described in the operating agreement. (14:45) And basically it's how the how the return of the money flows down to the investors.

(14:50) Yeah, that's correct. And in ours, it's typically always paragraph four. (14:54) It's the most important paragraph.

(14:55) And there's two different waterfalls. (14:57) Actually, we have a waterfall during what operations like a non capital event (15:01) waterfall, just meaning any operational cash flows distributed as follows. (15:05) Right.

The second waterfall is in the event of a capital event, which is a sale or (15:09) refinance. Here's how we distribute capital. (15:12) As long as you understand both of those things, then you understand the waterfall.

(15:15) The waterfall is arguably the most important part of that entire operating agreement. (15:19) OK, so we told you what preferred return is. (15:21) That's the money you get before we get to participate in the profit.

(15:24) That's usually a percent. (15:26) Now, next one is cash on cash. (15:28) OK, basic cash on cash.

(15:29) What does it mean? (15:30) Yes. So cash on cash is just your percentage of cash flow above your cash (15:36) invested into that deal on an annual basis. (15:38) So if you have one hundred thousand dollars invested in the deal and you got twelve (15:41) thousand that year in cash flow, your cash on cash would be twelve percent.

(15:44) Right. Very, very easy on a cash flowing deal. (15:47) Ten to twelve percent annually paid out quarterly is very normal, very normal.

(15:52) And from a retirement passive investor standpoint, that's what you want, right? (15:58) Like you don't want two million dollars saved up so you can slowly live off of the (16:02) two million dollars. You want two million dollars invested in something that's paying (16:05) you, you know, eight, nine, ten plus percent dividend to where you can live off of (16:09) that. That's hundreds of thousands of dollars a year.

(16:12) And then the two million dollars still grows five to 10 percent a year. (16:16) You know, it's amazing. (16:17) Yeah.

So so I was just trying to do a little math here to give you an example. (16:22) Let's say you were getting 12 percent cash on cash. (16:25) Right.

What that means is the deal, the deal level cash on cash is probably 15. (16:30) You're getting the first eight. (16:32) And then of that other seven, you're taking 60 percent of seven, which is just over (16:36) four.

Add that four to the eight. (16:37) That's a twelve point two percent cash on cash. (16:40) So that's the money that we send you every year on your investment.

(16:45) Using one hundred thousand dollars, it would be twelve thousand. (16:47) And so that's what the cash on cash is. (16:49) So if you get a quarterly check and let's say it's consistent cash flow four times (16:52) that divided by your initial investment, that's how you're going to get your cash on (16:55) cash.

All right. Next term. (16:57) I want to make sure I would say how about IRR? (17:01) Yeah, this is just an annual return.

(17:03) Internal rate of return. (17:04) Yeah. Well, it's not just it's a little more complicated.

(17:07) Super complicated. We're not going to we're not going to you're going to have to (17:09) Google this one because it is a little bit more complicated. (17:12) But how I like to pitch it to people is this is it's most closely aligned with the (17:17) average annual compounding return.

(17:20) OK, so the cash on cash is simple return. (17:22) Twelve percent cash on cash is twelve thousand over one hundred thousand dollar (17:26) investment. But the IRR is a compounded return.

(17:29) And so what it does is it said, hey, how long did I have their money? (17:32) And then when did I pay them their cash on cash and when did I distribute their (17:36) cash back to them? And then it calculates and says, OK, all of those cash flows are (17:40) an equivalent to a 20 percent compounding return every year. (17:43) And so you can you can kind of compare it to your stock portfolio where you say, (17:48) OK, I have one hundred thousand invested and I made 10 percent. (17:51) Well, now I have one hundred and ten next year.

(17:53) I make 10 percent on that hundred and ten. (17:55) Well, now I have one hundred and twenty one thousand because it went up 11 (17:58) percent because I made 10 percent on the initial hundred plus 10 percent on the (18:01) ten. Well, that's what the IRR is doing.

(18:03) Is it saying, hey, you invested one hundred thousand with us. (18:06) If we hit 20 percent IRR at the end of five years, then you can do the (18:09) compounding. And it's like you you got a compound of 20 percent each year.

(18:13) Correct. Yeah. So the easy way to kind of remember it is we're we're trying.

(18:17) We're striving. We're underwriting to do about half and half. (18:20) I'd like to get about half the return out in cash flow and the other half you (18:23) can typically expect in the combination of paying down our mortgage every single (18:27) month and the property appreciating.

(18:30) And remember, the property appreciates not because it's just a building that's (18:33) worth more the next year. (18:34) Like your house property appreciates because the rents are more expensive and (18:37) that stream of cash flow is getting larger and you're just buying it on a (18:41) multiple of a stream of cash flow just like any other business. (18:44) So we we we leverage that.

(18:46) Right. That's that's our most important thing is how do we increase the cash flows (18:50) to increase the profitability? Because we're getting paid on a multiple of that. (18:53) So if you increase it a little bit, you're getting paid a lot at the end.

(18:56) Yeah. And those distributions are included in the rate of return calculations, (19:00) right? Everything is not just at the end. (19:02) It's everything that you is returned.

(19:04) Yeah. All the all the fees, all the expenses, all the mortgage payments, anything (19:08) you could possibly think of, our attorney's fees, the accountant fees, the the (19:12) literally everything, our our promoted interest, just the fees.com. (19:16) Exactly. So everything is baked into that projected (19:20) IRR number.

And how we like to do it is is we stress it. (19:23) Right. We're realizing that these models are kind of living and breathing.

(19:27) And it's never going to be exactly what you think. (19:30) It's going to be similar, a little better, a little worse. (19:33) But we have different case scenarios.

(19:35) And how we do that is your exit market cap rate. (19:38) You know, that's the biggest effect you're going to have is, hey, here's a modest (19:42) assumption of how we're going to grow that NOI or those cash flows. (19:46) But at the at the same thing, here's that multiple or that cap rate.

(19:49) We're going to sell it on at the end. We have three different case scenarios. (19:52) So people can live with kind of a best average and worst case scenario.

(19:57) OK, OK. So the next one that comes to mind, since we said cap rate is the (20:01) this the capitalization rate, we say cap rate all the time. (20:05) We're like, hey, we're buying nine cap, eight cap.

What does that mean? (20:09) And so we've talked about it before. (20:10) But just to reiterate, because we've done a lot of shows now, (20:12) the capitalization rate is your theoretical return year one. (20:18) I can't wait to get comments on this.

(20:20) Yeah, it's technically not a return metric, but you can use it as one. (20:23) Yeah. So it's technically not a return, but it's a theoretical return (20:27) you might make if you paid all cash for the property.

(20:30) And so to keep keep it simple, a million dollar building. (20:33) If you paid all cash, you put a million dollars invested in that building. (20:36) And let's just say at the end of the year, you cash flowed one hundred (20:40) thousand dollars and you paid all cash.

(20:42) You didn't get a loan, didn't have any equity to pay down, just cash. (20:45) That is 10 percent. That would be a 10 cap deal.

Yeah. (20:49) Yeah. So another perspective of of cap rate is is there's just market (20:54) market cap rates, right? (20:56) So it's it's a market by market thing.

(20:57) So you can say, OK, multifamily assets, Class A, the gorgeous brand (21:01) new multifamily assets in Austin typically sell for a market cap (21:06) rate of three to four percent. (21:08) You can do that same thing in every asset class in every market. (21:12) Right.

It's it's kind of a market thing. (21:14) So we know what an eight to nine cap deal looks like, (21:18) because those are the markets that we that we focus on. (21:21) Those are the deals we're kind of looking for.

(21:23) So it's like price per square foot when you're buying a home in certain markets. (21:26) Right. Yeah.

But I mean, again, it is an unleveraged return metric. (21:30) If you look at it as such, it's just nobody's. (21:32) And anyway, well, I still stand by how I think about it, (21:36) because if I have a even a two million dollar building (21:40) and let's say that it's selling at a five cap, it's listed as a five (21:44) capitalization rate.

Well, what does that tell me? (21:47) It tells me that the net operating income currently on that (21:51) that building, after all expenses is what? (21:54) Eighty thousand five percent. (21:56) It's one hundred thousand. Yeah.

One hundred thousand dollars. (21:59) And so and even if they sometimes they don't list the cap rate, (22:02) but they tell you what the purchase price is and they tell you (22:04) the net operating income. (22:05) All you do is divide that net operating income by the purchase price.

(22:08) Yeah. So let's get into the pitfall of doing it that way is in year two. (22:11) The rent doubles.

(22:13) Most people are going to scroll by because they're like a five cap deal. (22:15) That's dumb. (22:16) But the reason it's a five cap deal is or the reason it's different (22:20) than the sub market cap rate is because the rent doubles the very next year.

(22:24) Right. It's similar to some of the deals we bought before. (22:27) You can buy them on a more aggressive cap rate than the standard (22:31) because the rent growth you believe or know it to be substantially increasing.

(22:36) You know what I mean? (22:37) No, that's a that's a really fair point. (22:39) It's only a snapshot at this moment in time. (22:42) It does not factor in any upside, any downside.

(22:46) So, yeah, IRR does. (22:47) Our IRR factors in the rent growth all the way to the exit, beginning to exit. (22:53) So that's why the IRR is a better indicator.

(22:56) Yeah. The cap rate just tells us, is this a potential workable deal for us? (23:01) Yeah. We dive into the numbers.

(23:02) That's it. The IRR is what is it? (23:05) You should compare the IRR to whatever compounding return (23:09) you think you're getting in other investments like a stock portfolio. (23:11) We're getting better at this.

(23:12) This is the best way we've described. (23:14) And we're trying anyway. All right.

(23:15) OK, last one, equity multiple. (23:17) So this is super easy. (23:19) If you give us one hundred thousand dollars, we give you two hundred thousand (23:22) dollars over any period of time.

(23:24) You have a two equity multiple, right? (23:26) You divide the money you got back by the money you gave us. (23:30) That's your equity multiple. (23:31) Yeah, that's that's super easy.

(23:33) So it's typically evaluated over. (23:35) I don't know. People look at it different ways.

(23:37) The most recent way we looked at it is like a six or seven month deal. (23:41) You know, you can get a really skewed IRR. (23:43) It can be like 90 percent or something.

(23:45) But it's really, you know, a 20 percent return (23:48) in like five or six months or whatever it is. (23:51) Yeah. And most of the time, if you're getting an investment (23:54) with any length of time, like a five year, (23:56) I would say most sponsors are trying to hit a two X multiple.

(24:01) At least over that five year term. (24:03) Except this guy. Apparently he's hitting three X multiple.

(24:05) Well, we're trying to hit three X. (24:07) Yeah. So anything in the two range over a five year period (24:11) is going to equate close to 20 percent compounded return. (24:15) Plus or minus a few percent.

(24:17) And so that's what we're trying to hit with most of our deals, (24:19) unless it's a shorter deal and it may be a one point three. (24:23) And you're like, OK, one point three doesn't sound that great. (24:25) You're giving my money back plus a 30 percent return.

(24:28) Yeah. But if we did that in eight months, (24:30) you know, then it's like a it's like a 40 percent IRR or something. (24:34) Yeah.

So it's all about the time with the equity multiple. (24:37) Yeah. The IRR is independent of time.

(24:40) It's an average yearly compounding return. (24:43) Now, the longer you can get that IRR, great. (24:45) But the equity multiple is specifically on time.

(24:48) If someone tells you we're going to give you a two X multiple, (24:50) you have to know how long they took your money, (24:52) because if they had it 18 years, that sucks. Right. (24:55) So so I think it's the opposite.

(24:57) Like IRR is the one factoring in time. (25:00) An equity multiple inherently doesn't factor in time. (25:02) Like I could say, yeah, I gave this guy a 10 X equity multiple.

(25:05) And you could be like, holy cow. (25:07) But in reality, it took me 100 years to do it. (25:08) It's not a good return.

(25:10) Yeah, I guess I maybe I said it wrong. (25:12) But the investor needs to take into it that, yes, the IRR takes into time. (25:17) Yeah.

The equity multiple does not. (25:18) Right. Investor really cares about the time when you're talking equity multiple (25:22) because it gives them more information.

(25:24) Yeah. Or the IRR. (25:25) If I you know, if I tell you I'm going to give you a 20 percent IRR, (25:28) do you really care if it was three years versus eight years? (25:32) I mean, eight years is better, (25:33) but you're still making the same return every year on average.

(25:36) All right. What else? (25:37) Nope. I think that's it.

(25:38) Well, crash course in how to understand one of our pitch decks. (25:41) I like it. Yeah.

(25:42) Hopefully that was informative, guys. (25:44) We're seeing a lot of traction with our investor base (25:47) and we're going to be launching a lot of deals this year. (25:50) So get familiar and get educated and then partner with us.

(25:54) I guess that's it for today. (25:55) And I just say no dumb questions, right? (25:57) Like we did this because we're getting asked a lot of similar questions, (25:59) I think commonly. (26:01) But that just tells me that people are feeling comfortable (26:04) enough to reach out and ask that.

(26:05) I like it. You know, it's it's the first step. (26:08) Knowledge is power.

(26:09) You're not going to get into this unless you understand it, (26:11) at least at a very basic level. (26:12) So hopefully knowledge is power. (26:15) But also one of my favorite sayings is knowledge combats fear.

(26:18) And so whenever you have apprehension in something or you're a little bit scared, (26:23) increase your knowledge and watch that fear dissipate. (26:26) So that's good. Yeah.

(26:27) All righty, guys. We'll see you next week.