Passive Real Estate Investing Strageties: ArmChair Investing

By Anita Clinton

In the past 5-10 years, society has been inundated by the real estate investing craze.  Information can be found blasted over radio, television, and various media outlets.  Many real estate gurus have surfaced and have even made millions simply from the sale of their “how to” material.  We’ve heard about real estate flipping, land lording, tax sales, no money down strategies, etc. Many people have chosen to get involved and they have made lots of money, while others have not.  This is partially due to the major “hands on” component involved with the aspects of the real estate investing methods mentioned above.  This group of people lack knowledge of, are not interested in, or are tired of dealing with tenants, contractors, indecisive sellers and buyers.  Instead, they are seeking alternative ways to take advantage of the real estate investing splurge 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.

For more information, contact Michael Franks, LLC via their Keller Williams’ affiliate office at 847-241-2200.

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