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while eliminating the legwork - hence “Armchair
Investing.” IWP! sat down with Michael Morawski and Frank Constant of
Michael Franks, LLC to discuss this growing phenomenon also known as
“passive investing.”
IWP!: What is armchair investing?
Michael Franks, LLC:
Armchair investing, also known as passive investing,
is essentially real estate investing minus the leases, tenants and plugged
up toilets in the middle of the night. It is a turnkey system that allows
the investor to receive the benefits of real estate investing without the
headaches. The way it works is firms will put together, what we refer to
as, syndications. Depending on the firm, the syndication could be set up
to invest in commercial buildings, large apartment complexes, strip malls,
condo conversions, rehabilitation projects, etc. The syndication will
outline the type of investment, the logistics of the property(s), the
income, expenses, and most importantly the estimated return for the
investor. Essentially, armchair investing gives investors an opportunity
to take advantage of great returns and great tax benefits without having
to the deal with the day-to-day management, systems, or operations. They
can invest and continue to do what they do best whether they are doctors,
lawyers, postal workers, professional travelers, etc. We can correlate
armchair investing to investing in the stock market with more stability.
And just like stocks, investors should research the investing firm(s) to
determine if their system/plan makes sense and if the company is going
somewhere they would like to help them get to and get compensated for it.
A good passive investment will yield a return anywhere from 15%-25%.
Armchair investing is an excellent vehicle for everyday people to bridge
the gap from where they see themselves today financially to where they
want to be tomorrow. It is a way to help normal hardworking people create
substantial funds for retirement. In addition, it provides an opportunity
for investors that are financially stable who are looking to increase
their portfolios.
IWP!: How do successful passive investing firms
operate?
Michael Franks, LLC:
Successful firms have systems and/or models in place
that minimize the investment's risk factor. They understand that they are
not just purchasing properties, but that they are buying existing
businesses. In buying businesses, they are looking for those that are
running, or has the potential to run, reasonably well. They will create
systems and implement property management staffs, which makes the business
function profitably. For example, one model that has worked well for us
is that we look for properties that have had the same owner for lengthy
periods of time. Normally with these owners, complacency has set in and
they tend to overlook the increase in a lot of expenses. For example, if
a water bill is gradually going up, they don't pay attention to it over
time. We can go in and make changes, cut the water bill and save pennies
per day. Over the time of syndication, that turns into thousands of
dollars. We can take a property and in the first 30 days find several
thousands of dollars to increase the value of that property. Because they
have owned the property for so long, the money is pouring in. In the
beginning, they were just squeaking by. But now they have been in for so
long that they see the hundred dollars and are not looking for the dollar
bills that they are missing. We go after those dollar bills.
IWP!: What type of involvement does the Investor
have?
Michael Franks, LLC:
With most firms, each investor becomes a member of
the firm's LLC. It is a true passive investment: therefore, the investor
is not involved in the day-to-day operating activities. But they will be
involved in long-term large decisions. For example, we set up a
syndication to hold a particular property for seven years. In the sixth
year, we will come to all of the investors and layout how the property has
performed for the last six years and the expectations for the next five
years. We will ask the investors if they want to remain in the property
or if they want out. If everyone wants out, we will liquidate the
property and be out at the end of term. If one or two people want out, we
will buy them out as a group or the managing members of the LLC will buy
them out and we keep the property. Maybe along the way, we can refinance
and pull out some of the cash and pay the investors their original
deposits and sit in the property another five years. There are a lot of
different options for the investors so that they feel that there is some
flexibility in what is going on. What differentiates us from other firms
is that each of our syndications have a defined exit plan. The investors
know exactly when the project is going to be over. In addition, there are
different options within the syndication.
IWP!: What are the risks involved and how can they
be buffered?
Michael Franks, LLC:
From a risk perspective, money is raised and a
majority of that money goes toward the down payment. The investor becomes
a member of the LLC and the LLC takes possession of the property;
therefore, the investor has ownership interest in the property via the
LLC. The managing members of the LLC will usually take out a considerable
amount of insurance in the event that something happens to them. The goal
is to ensure that the investors are taken care of and the company can
recover from the loss. Reserves should be maintained for each property.
It is always a good idea to raise more than the initial capital needed to
ensure that there are adequate funds available to operate the building.
This also ensures that there are no “cash calls” or requests for
additional monies from the investors if challenges are encountered.
However, it is important to remember that this is an investment and that
there are risks associated with any investment. Although good firms seek
to minimize the risk as much as possible.
IWP!: How to you determine what properties are good
investments?
Michael Franks, LLC:
Successful firms are looking at how much money they
are paying per door. $25-$35,000 per door is the target we use because we
know that with those numbers we can cashflow. Even though the rents are
lower in some areas, paying less results in more cashflow. We are looking
in areas where we can enjoy the appreciation ride. We look for complexes
with 70-300 units with a capitalization rate of 7.75% or above. The
complex should be one where we can go in, re-engineer it and make it run
better. We do the research to determine what is going on in the area that
will have a positive impact on the property(s).
IWP!: Give me an example of what you do to make a
property more profitable.
Michael Franks, LLC:
We have software programs that we utilize. Initially
what we do is go in and look at the current rents and then look at the
rent potential. In one of our buildings, the rent potential was around
$600 - $650 for a 3 bedroom unit. We had tenants who had been living
there for years and were paying $200 for those units. The owner had
gotten lackadaisical and had not adjusted the rents as the market grew.
In addition, we are seeking to make our tenants happy. We have a
toll-free number that they call 24 hours, 7 days a week and get an
immediate response. Again, a happy tenant sticks around. If after a
year, the tenant is disgruntled, they move out. Now I have to spend money
painting, I may have to put in new carpet, and then I have to turn it
over. It may be vacant for a while. However, if I can have a tenant stay
in the property 3-5 years, without having to paint or replace carpet, it
drives my expenses down. We will go in, work with local contractors and
negotiate significant savings. We manage the inventory of the things that
are used - everything from light bulbs to doorknobs. We look at devices
that can maximize water usage in toilets and showers. Essentially, we are
looking to build the rental income and drive down the costs.
IWP!: As the market shifts, what are your
projections for the future of real estate?
Michael Franks, LLC:
Here is the excitement - we know that as the market
has shifted, the sub-prime lenders have had big challenges. Most of the
properties that we have are C-and B-type properties with blue collar
workers renting them. Most of these people were probably hoping that they
could get financing soon to purchase property and unfortunately they are
not going to be able to. So we believe that the shift in the market, from
a lending perspective, is probably the best thing that could've happened
to people that own and operate apartment buildings. In addition, we have
seen a lot of active investors that have gotten stunned. Their profit
margin has gotten eaten up during the holding time required to sale their
properties. These are flippers that are not willing to take a chance in
this market, but who still see the benefits of investing. So why not
invest passively? We don't speculate much. The only speculation we have
is on what our appreciation is going to be. We buy in areas around the
country where we know things are happening economically that will help the
property value. We are not speculating that someone will come buy our
flipped property and in that lies our stability.
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For more information, contact Michael Franks, LLC via
their Keller Williams’ affiliate office at 847-241-2200. |
