072: An Intro to Due Diligence Process in Real Estate for New Investors with Hans Box

00:00 - 00:42 | Hans Box: A lot of people will spend literally months trying to analyze the perfect 65-inch television to put on their wall, or the next car they're going to buy, right? And that may cost $5,000 for the TV, or I don't even know what TVs are anymore. And a car may be up to, what, $70,000 or whatever. And you're investing $100,000, $200,000 multiple times in these deals, and I see people spend an hour. looking at it you know they hear a webinar and like I'm in no matter what no questions asked right but they spend all this time trying to figure out the best tv to buy for their home and so that to me that's skewed and you need to switch that around you've got to spend the time and you got to grind it out a little bit with with these kind of deals if you're really serious about becoming a true passive investor and generating cash flow like you're talking about and financial freedom
00:45 - 01:39 | Christopher Nelson: Welcome to Tech Equity and Money Talk. I'm your host, Christopher Nelson, and I'm excited this week to introduce you to Hans Box. Hans Box is the founder and owner of Box Wilson Equity Group. They have 90 million of assets under management. And Hans is also an LP in 70 different deals as well, a limited partner. He has a career in real estate and he was also in asset management. And he's here today to talk about due diligence. Welcome, Hans. Thanks for having me and looking forward to it. My pleasure. Let's talk about worst case scenario, right? Let's talk about the fact if, you know, have you heard, have you had a personal experience or have you heard of a firsthand experience of somebody who, because of lack of due diligence, led to, you know, a bad investment?

01:40 - 03:02 | Hans Box: Sure. So, uh, yes, I've had it. Um, and it actually is what got me started in my investing journey as a sponsor with box Wilson equity and where we started raising money with our investors. My, my very first deal I got into, I was, I was with a, uh, PricewaterhouseCoopers CPA background, that kind of thing, got into real estate, made an investment into a passive, uh, multifamily deal back around 2009 or so. And it's a bit of a long story, but myself and another limited partner ended up taking over that deal, were voted in by the other limited partners to take over the deal because the deal wasn't going well. And we were the two vocal limited partners that started, you know, speaking up. We got voted in to take over that deal. hire a new management company and try to turn it around because the sponsor wasn't doing his job. So that other limited partner that I teamed up with at that time is now my business partner at Box Wilson Equity. He's the Wilson, I'm the Box. So it was that deal that actually got me, that was one of my first investments ever. And it's when I didn't know how to do due diligence. So I didn't do a good job of due diligence at that time. I was coming out of professional services firm, but it's completely different. Doing that, even though I was a CPA, that has nothing to do with how to really do true due diligence on a multifamily or commercial real estate deal.

03:02 - 03:43 | Christopher Nelson: That is a phenomenal segue into this whole overview of the process that we want to get into today. You know, many professionals, and I'm witnessing this today coming from technology, is they're very proficient at their jobs. They've become experts at their jobs. They get excited about getting into private equity. They see the income potential. They see the equity growth, the tax advantages. But there is truly a different skill of due diligence that you need to understand to be successful. And so what are some of the core components of due diligence that you think it's fundamental that people understand?

03:43 - 05:13 | Hans Box: Well, I mean, a lot of the skills you just talked about are transferable, but you have to learn them, right? So an engineer or accountant or somebody that is deep into details and analytics is probably going to be pretty good at due diligence if they apply themselves and learn what you have to do to understand a deal. I mean, I think the key parts of, you know, doing due diligence on a deal, our number one is vetting the sponsor. It's all about the jockey, as you probably heard that term. It's all about the jockey. It's more important than the horse. It's really about that person you're investing with, or persons that you're investing with, the sponsor team. Because a good sponsor can turn a mediocre deal into a home run, and a home run deal can be run into the ground by a bad sponsor. So you've got to learn how to vet the sponsor and then you have to learn how to read a P&L You have to learn how to to be able to look at a deal and understand if there's a value-add component, right? You have to learn be able to learn it how to look at debt in different types of compensation structures that sponsors may have. So it's all about, to me, it's all about the skills are there. Most professionals have the skills to do this. It's not rocket science. It's more about following a process and thinking through the details of the certain items that you've gotta spend time on. You gotta treat this, to me, if you're investing 100 grand in a deal, you really need to treat this as your second job. If you have a W-2 now, this should be your second job.

05:14 - 05:54 | Christopher Nelson: I agree. I agree. And I know you've invested in 70 deals as a limited partner and have had the opportunity to hone this and also deploying other people's capital as well. So let's start with the operator. Let's start with the jockey. And I love the analogy, right, is is the the asset is this beautiful animal, this horse that we want to win the race, be successful, achieve the returns. But it is dependent on the jockey. What are Right off the bat, what are some red flags that you look for when you're starting to vet an operator that say, I'm going to actually pass on this because I've seen these few things? Sure.

05:54 - 08:30 | Hans Box: And I think a good way to start this off about an operator is a quote, where is, what is a goldmine? A goldmine is a liar standing next to a hole in the ground. So basically the idea being is I usually start out, not assuming somebody's not telling the truth, but I start out with doubts. And I start out with, you've got to prove to me that this is a good deal. So, you know, red flags to me are, you know, number one, lack of being transparent. I think that no matter whether you're investing 25,000 or half a million into a deal, you should get all your questions answered and they shouldn't act arrogant or put off that you ask questions, even if you're not investing a lot of money. Because that little bit of money that you're investing now could turn into millions later. I've seen it happen with my own investors who invested a little bit now and a ton later. But it speaks to who they are as a person. I have invested in deals where the fund was a hundred million dollar fund and I was maybe putting in a hundred grand. And the guy didn't need my money, and he spent an hour with me on the phone talking me through my questions, because it was their first go-round, so I had quite a few questions for them. And that sold me for life on them, because he was super transparent, and he knew what he was talking about. So the number one thing, red flag with me, is lack of transparency. When I look at a business plan, I can usually tell pretty quickly how sophisticated they are, right? In the way they present the deal, whether they make sure that there's a clear value add component to the deal, and we may get into that when we talk about the deal itself. But it's really, anything that's super salesy to me is an immediate put off. I will, a salesy deck or a salesy video or webinar, I'm immediately pretty much And if not a red flag, I'm a bright yellow flag, right? And it's just not, you know, good sponsors I've noticed over the years. And like you said, I'm over in over 70 plus deals, not including my own. And it, you know, usually the salesy ones are the ones that end up being bad. I had noticed it in the past, you know. Good sponsors don't need to sell themselves. They have a track record they present. You can see the track record. And when they present the deal, and they present it in the right way, in a sophisticated way, in a way that shows the details of the deal and also shows the value-add components of the deal to the investor in a very clear way that's not convoluted. There's no financial engineering. It's just, here's what we're going to do. Here's why we can do it. That's all you need. If it's salesy, I would immediately have a red flag. So really, those are the two big things that jump out at me without, you know.

08:32 - 09:22 | Christopher Nelson: So there's two questions I want to ask here. I think while we're on this topic of salesy, you know, what to you, you know, smells like salesy? Is it leading too much with returns and not truly the substance of the business plan? Is it too many glossy photos in talking about I wanna try and dig into specifics so that people, like I'm imagining, somebody's flipping through their first PPM. And I know for myself that if I'm going through an investor summary and I'm seeing three pages on the return profiles and what it's gonna present to me, and it takes me a while to really understand what's the asset, where is this located, what's the value add plan, how those dollars really gonna realize, I feel like that's,

09:23 - 10:57 | Hans Box: That's a little salesy. Very much so. You know, like, for instance, there's a deck that I looked at a while back and they had a they had a matrix on one of their pages where they said, if you invest with X, Y, Z company 100000 in the next 10 years, here's your value. And it was it was trying to, like, say, OK, we're shooting for X amount of returns. And then they were doubling their money and showing this to somebody that wasn't sophisticated. They'd be like, oh, my God, I could make this amount of money. investing with them and it was complete, the whole thing was basically made up. They don't necessarily have a track record, they're just projecting what they think they can do in the future on deals that they don't even own yet. And so something like that, or you know something like where, you know, red hot deal in the subject line to the to the email you know you're getting tons of email blasts any sponsor where i get multiple email blasts on that i'm done right it's it's just not it's not the the true institutional sponsors the good sponsors they don't need to market because they have returned and they get referrals right right and i totally understand new new uh new sponsors needing to raise money to get investors but You should start small, create a track record. Go do a small deal where you don't need to market to a ton of people and just raise a little bit of money, raise your 500,000, go do a good deal, show a track record, and then use that to slowly grow. You can't just jump into the deep end of the pool as a sponsor. And a lot of these people are because being a GP has become the thing to do, right?

10:57 - 11:41 | Christopher Nelson: Well, and to me, that's a huge red flag is lack of experience. And I think that Plenty of people have seen in the last few years that they've had somebody who had some success in a business over here who thought, I'm going to transfer these skills and now I'm going to become an apartment-level GP. They went through a course, they raised a ton of money, and some of these deals are imploding. Let's talk about what do you look for for experience? Like, okay, now we've seen some red flags, inexperience is one, but if you are looking for that experienced jockey who you know can get the horse where you want it to go, what are things that make sense to you?

11:42 - 13:33 | Hans Box: Yeah, so number one, I want to see a page or two, whatever it takes, showing their track record in a very clear, concise manner. Don't show me you bought a deal for this, and basically you distributed X amount of dollars over the course of the deal. That means nothing. I want to know what your MOIC is, your Multiple Uninvested Capital. I want to know what your IRR was, and I want to know what these are for the investors themselves. Were you a direct GP? Did you have control of the deal, or were you a money raiser, where you brought money to somebody else's deal and you didn't really produce the return? Nothing wrong with partnering with other people, but you need to show that in the track record, right? One thing that I've seen a lot of recently, and this is because of the run-up, especially in multifamily, but in other asset classes as well, because of the run-up in pricing, i.e. cap rates being so low, is that you will see sponsors that have been in the game for three, four years at max, right? And they have average IRR of 45%, right? Well, they bought a deal in 2019, sold it in 2021, bought a deal in 2020, sold it in 2022, right? So they're flipping deals. Right. So they're getting very high IRRs because basically IRRs, the quicker you sell a deal, if you make a decent return, your IRR is gonna shoot through the roof, right? Right. So you can have a really high IRR and maybe not that high of a MOIC. Or, more importantly, you rode cap rate compression, is what you did. That's right. And what I want to see is, OK, that's great. You got a 45% IRR. That's wonderful. I would love to get that, right? But I want to know, what was your projected NOI? And did you hit your projected NOI on your value add? Right. Versus, did cap rates compress after you bought the deal and you just sold it to the next guy?

13:34 - 13:59 | Christopher Nelson: And to translate what Hans is really saying is to make sure that you're not just looking at a sponsor that's showing tailwinds or helping them win in the market. So we've seen the stats that say the deal exited. Well, now let's go look at the business plan and say, were you executing to the business plan or was it truly just the market tailwinds that allowed you to get those great returns?

13:59 - 14:04 | Hans Box: Or even simpler, did you do what you said you were going to do with regards to the value add component? Right.

14:04 - 15:10 | Christopher Nelson: Right. Because that is that's so critical. And I think so then moving on from the operator, you know, the next thing is then really looking at the pro forma. Right. And I think this is something actually it was interesting for me what what transferred for me from corporate to private equity was I was on the buy side of So I worked in IT organizations and software companies and we bought salesforce.com, we bought Workday, we bought a lot of this software. And what comes with those softwares? These contracts that are just so thick and you start understanding, okay, what are the portions of the contract that are just wrote, like I need to read through them once and understand these sections, but then where are the sections where there's the meat of the deal? It's really being negotiated. And so that helped me map over to PPMs or private placement memorandums because that, you know, after the sponsor is really then that's the contract that you're signing to make the investment.

15:10 - 17:43 | Hans Box: That's right. That's right. So, I mean, there's so many things you need to look at when you're looking at the deal. You're asking, like, what do you look at in the deal itself, right? That's right. And so the number one overarching thing if anybody wants to take away from this particular podcast is when you invest in a commercial real estate deal or a commercial real estate syndication there needs to be a value-add component of the deal. There are a lot of people that will buy deals and say, this is a yield play. We're buying it and we're just going to get a coupon payment, or et cetera. But basically what that means is you are buying a deal at market, and you're not adding value because there's no distress in the deal, which is what you just told me, right? There's no distress in the deal, so if the market goes goes down, basically you're buying it here, you get your amount of equities here. If the market goes down, guess who loses money? Equity, right? But if you buy it here, because it's distressed, and you're able to force value into the deal, whether that takes a year or two or three years, now the value of the deal is here. So if the market, things out of your control, drop, you have a gap. So basically, you have a margin of safety for your equity, because your equity is the first thing that goes if you lose money. So there has to be a value-add component or a margin of safety, just like Warren Buffett talks about. There needs to be a margin of safety for your money. So what I want to see when I look at a business plan from a sponsor is, I want it to be extremely clear to me as an investor, I'm looking at it as an LP, what the value-add strategy is. It should be able to say that in two or three sentences. And if you've read a whole business plan and you're not clear what the value-add strategy is yet, and then you go ask a sponsor and they can't articulate that to you in a very clear manner in a way that somebody that's not a professional real estate investor can understand, then that immediately gives me red flag vibes. So it's all about the value-add strategy. There has to be a value-add strategy. And then you have to… be able to understand when they describe it to you, can they prove it out? Can they actually get, you know, if the value of strategy is to raise rents by 15%, good. That's great. But prove to me why you can raise rents to 15%. And the business plan needs to show that. You need to show rent comps. You need to show, why are we below market? What are we going to do to the deal differently than the prior owner did? And why can we raise rents and they couldn't? Things like that. So it's all about the value. And the number one thing is about the value-add strategy. And so that ties into who the sponsor is, too.

17:43 - 17:58 | Christopher Nelson: So how would you then, if somebody brought you a deal and they called it, let's say, a yield or yield plus, meaning that they weren't gonna do any value add or a little, but they were buying it distressed. How would you approach that?

17:58 - 18:41 | Hans Box: Well, I mean, without more information, hard to answer, but number one, buying a yield play and they're buying it distressed, but there's no value add, those all go against each other. Got it. Right? Those don't make any sense, right? So if there is no distress, then there is no value add. When I say distress, you can look at it a million ways. You can say it's dilapidated, needs rehab, things like that. It's low occupancy. But in my mind, distress also means you're not at market rent. You're making below market revenue. So there needs to be, you know, and part of it's definitions, but As an LP, you have to be able to understand where the sponsor is adding value to the deal. That's essentially what you have to look at.

18:41 - 19:43 | Christopher Nelson: And I like that concept. And thank you for walking. I wasn't too descriptive. I was trying to ask something open-ended to understand a little bit more of your strategy and philosophy, which I'm really enjoying this conversation because Even if, and I was thinking of, I was imagining that, again, I'm a tech employee, I'm looking at a new opportunity right now, and especially in this market, people, I think the word distressed is being used a lot, and so I'm trying to sort of unwind that, and distressed can mean bad or a heavy debt load, they purchased very high, and so, I think, though, to your point, even if you're replacing the debt, underneath it there has to be a functioning asset that has to have core operations, that's hitting market rents, that has a strategy to grow rents. and has a strategy to make sure that you're keeping ahead of the depreciation of the building, ultimately, at a bare minimum.

19:43 - 21:00 | Hans Box: Exactly, exactly. And I mean, in today's market, there may be a few opportunities where equity is forced to sell, or there's rescue equity coming in, or things like that, where the property may actually be at market rents, okay, but the distress would be they paid too much money for the deal. And they have a gun at their head because debt maturity is coming up and they've got to get out of the deal. And in that case, maybe they can't raise rents. But if you're buying the deal 40% cheaper than what they paid for it, then there may be an immediate value. The immediate value add is you're getting cash-on-cash returns day one, right? Because another thing to think about is cash-on-cash returns. Eventually, whatever deal that you're investing in, in commercial real estate, in my opinion, unless it's, you know, there are some industrial deals where you're not gonna have a lot of cashflow because you turn over the leases and then immediately wanna sell it. Right. But for the most part, you want cashflow. The deal, once you've implemented your value-add strategy, needs to have cashflow. The bigger, more cashflow there is, the higher percentage to the investors, whether it's five, six, seven, eight, nine, 10%, the more margin of safety there is, because that means basically free cashflow to protect yourself, right, to be able to pay debt, and then, so the higher the cashflow, the safer the deal, typically.

21:01 - 21:19 | Christopher Nelson: And I actually love those deals as well, because then to me, that's the true benefit of commercial real estate, because you're getting the cash flow, you're getting the equity, you know, the appreciation potential, or forced depreciation from a great business plan, and then the depreciation, that's the trifecta.

21:20 - 22:04 | Hans Box: Yeah, I mean, that's exactly right. Where you can get part of your, maybe half your return in cash flow on an annual basis, once they've implemented the value add, I want everyone to know that if you hear somebody saying they got a deep value add and they're going to have cash flow of 8% day one, that i'm not saying that's impossible but you're right there's a big question mark there and i'm like okay how right because the whole point of a value add is that you have to add the value first before you get the cash flow so usually if there is a you know if you're buying a deal that has value at or has distress then you may need a year, two, or even three years to turn the deal around, to reposition the deal as a sponsor before you start producing the income that can produce the cash flow for the investor.

22:04 - 22:42 | Christopher Nelson: And there's an expectation from the investors that it works that way too. Again, the savvy, experienced investors understand that there's going to need to be an investment to get the value to then start returning the cash flow. That's right. And that's important that I think people listening here understand that because getting those returns on day one generally means that somebody is over-raising capital. and that means dilution to the deal and it's not going to be as valuable on the back end. It feels good, sure, it feels great to get those returns happening, but the reality is there's a lot of overdilution there.

22:42 - 23:47 | Hans Box: I'll touch on that because you brought it up. you know it's one of the things I look for in the pro forma is I want to see your P&L and I want to see the cash like I literally want to understand the profit and loss all the way down to NOI then I want to see the debt payments below NOI and then I want to see whatever you know corporate like asset management payments are until you get to true cash flow and then I want to look at that cash flow that they're showing in the P&L and then compare that to what they're promising investors And this is how you do it. You can figure out whether somebody is raising money to basically pay it back to you by doing this. You look at the actual cash flow, the numbers on the deal, and you can figure out, okay, they're going to generate enough cash flow to pay me, say, a 7% preferred return. day one or are they just raising enough money and they're returning it to me right i am immediately red flag and out on any sponsor that raises money to pay it back to me because that to me is is it's false it's it's basically saying i'm going to overraise money and just pay you back money pay back your own money so it looks like I'm producing cash flow when I'm not. Right.

23:47 - 24:14 | Christopher Nelson: Yeah, and to everybody listening, what that does is that adds risk to the deal because, again, what I think Hans is saying is a good business plan that shows you how they're going to generate cash flow from income through operating expenses, non-operating expenses in that direct line, that's going to be a much better investment to have in your portfolio than something that is just has a lot of cash flow and is paying it back to you.

24:14 - 25:10 | Hans Box: Yeah, I mean, and you're basically, like you said, you're getting diluted. That's right. They're raising money, your own money, to pay it back to you, and that means your returns are getting diluted, because you're investing too much money into the deal, only to have them return it to you. So that's why it's imperative that you understand, as an LP, how to read a P&L. You've got to learn. I mean, if anyone listening to this podcast, and they're going to put $50,000 to $100,000 or more money into a commercial real estate syndication, If you're not patient enough and don't have enough diligence to learn how to read a P&L, you should not be investing like this. You need to hand your money to a wealth advisor, let them put it in mutual funds and let you diversify, right? You've got to learn how to basically, just like a lot of people that probably listen to this podcast, they're tech executives, they work in tech, they run departments within tech companies, right? So they know how to read P&Ls because they run their own departments, they run their own budgets. Same idea, you just gotta be able to do this on a bigger scale.

25:11 - 26:18 | Christopher Nelson: That's right. And understanding, and the reality is, is getting to know the different line items. It's not complicated. It just takes some time to understand, being able to ask some questions. And in fact, I, like you, I mean, one of the things for myself to make the transition into private equity is, I read this book by Frank Gallianelli. I don't know if you've ever read it. It's called What Every Real Estate Investor Needs to Know About Cash Flow. And it's a math, it's a math book. Okay. And it's like, I loved it because he just went into all of the underwriting around all the different assets class, everything from starts with single family homes to multifamily to industrial triple net, uh, you know, and you can go to the online and get the, the spreadsheets. And once you understand that and you, you, um, see how the P&L flows, it's relatively straightforward, then I think the next evolution in your due diligence is then saying, where are they getting their assumptions? Where are they getting the data that's going to drive rent growth?

26:18 - 27:13 | Hans Box: Because anybody can have an Excel spreadsheet and hit a home run, right? I can take an Excel spreadsheet, make two tweaks to a deal, and take it from a 10 IRR to a 20 IRR, and somebody that's not sophisticated could never figure it out, right? So you have to be able to actually ask the right question. There are certain things that you want to know, like cap rates. If they're buying the deal at a 5 cap, but they're underwriting to sell it at a 4 cap, red flag immediately. Cap rates typically should expand when you sell the deal 5 to 10 years later, because that's more conservative. As cap rates go up, you know, prices go down. It's an inverse relationship. So those are the kind of things, and we don't have time to get into the details of cap rates and how they're calculated and all that, but it's imperative that you do spend the time to learn this. This is why I said it needs to be, if you're really going to be serious about this, it needs to be a kind of a second job for you.

27:13 - 27:16 | Christopher Nelson: It does. And I think once you get to the learning

27:17 - 27:54 | Hans Box: Once you get through that phase being able to then do the due diligence and see that right it gets quicker It's not the first two or three years You have to actually put in the reps just like you did You're an expert in some area of tech or your doctor or something like that you put in the reps there You got to put in some reps before you can start looking at deals like like we do I can look at a business plan and probably in ten minutes tell you whether or not I really want to dive into it or not right so I can I can I I can move a lot of deals off my desk pretty quickly because of certain red flags that we've spoken about already. That's right. And you just get a feel for it, just like you do in any other line of business.

27:54 - 28:58 | Christopher Nelson: And I was going to take people from that next step of analyzing the P&L. to then understanding where the assumptions come from. So understanding where they're getting rent growth, where they're getting expense increases, and a lot of these cap rates, a lot of these different factors, and it comes down to probably a list of nine or 10 key assumptions, just generally speaking. And if you understand what those are and then you're able to then ask them where they source that data from. To me, the red flag is then if it comes from an in-house source and they're not running a multi-lytics as we know that the origin team is, I'm suspect. I'm like, well, OK, where did this come from? Because what you'll find is you want to find sponsors that are bringing valid third party data to their models that then they can't influence or impact, to your point, that are then supporting their business plan.

28:58 - 29:44 | Hans Box: 100%. And that should be in their business plan, by the way. Right. So if you're going to say you're going to raise rents 10% because we're under market by 10% on rents, then I want to see the comps. And I want to see a comp study. In fact, I just looked at a deal with a very advanced group, actually, that was disappointing to see, where they really couldn't provide me, I asked for, they were gonna raise rents X amount, I remember the numbers, and they gave me generalities of why, right? But I was like, well, didn't you all do a comp study? So I wanna see, I don't wanna just see the CoStar report that you pulled, right? That's great that you use CoStar, although I will say there are other better analytical tools than CoStar, but my point being is they just handed me the CoStar report and then expected me to basically extract how they came to their,

29:45 - 29:46 | Christopher Nelson: Interesting.

29:46 - 33:43 | Hans Box: Rent increases. And I'm like, no. This is part of the reason that I can vet sponsors pretty quickly is they should take that and put it on a page or two pages or three pages, whatever it is in the business plan, and walk me through, like I'm not as sophisticated, why you're going to be able to increase rent. Show me the comps. Show me a scatter graph of the one bedrooms and two bedrooms and where this deal is versus the deals that are above it. Are they same vintage, meaning the same age or close to the same age range? Things like that. So I want to basically have it lined out for me as an investor to see, OK, that makes sense. They said they could raise your interest 10%. Then they walked me through A, B, C, D, why they could do it. They showed me the comps. They showed me the source, like you said. And I'm like, OK, that makes sense. Obviously, I'm not going to drive to XYZ City and do an on-the-ground market study, unless I'm investing $100 million or something. Usually, doing it this way, probably 90% of the time, you're gonna be able to validate, did they actually do the work? That's right. And they'll line it out. And if it's very clear in the business plan, and it makes logical sense to you, and they provide the sources, usually you're pretty good there. Another thing I wanna talk about there, you brought up on assumptions. Yeah. That popped in my head. And this is kind of related is, I always want to see a sensitivity analysis in the deal. I think that's super important. And so what that means is you may, there are the words for it, but it's what we call it as a sensitivity analysis. Meaning if we use your target assumptions, you're going to increase rents by 10% because we're below market. You're going to have organic rent growth just as the market grows, 2%. Expenses grow by 2%, whatever. Cap rate will be X, right? Average occupancy will be 93%, whatever that is. those are your targets like what you think reasonably can happen this is what you're guessing is the best guess because these are all wags right this is all best guess so you and you're going to tell me you're going to make a 15 irr and like okay great those are your base assumptions now I want to see a downside scenario. I want to know, you know, not the apocalypse, you know, not some terrible black swan event, but just on a downside scenario, maybe rents don't increase 2% a year organically. Maybe it's only zero for the first two and maybe only 1%. Maybe property taxes jump. Maybe these other things, you know, basically the more conservative assumptions, right? Change those big knobs that change your IRR. and then tell me what your returns are, tell me what those new assumptions are, and now what are my returns with these new assumptions. So that tells me if the deal is extremely sensitive or not. Some deals you can move a lot of knobs quite a bit and it doesn't change a lot because it already has a lot of built-in value and has a lot of cash flow. But some deals you touch the cap rate by, you know, Quarter point. Quarter point, half a point, and it can really affect the deal. And so that's how you, and that's why it's called a sensitivity analysis, how sensitive it is to downside. So to me, what I want to see is I want to see your target scenario and your target assumptions. Then I want to see a downside scenario, meaning your targeted downside assumptions. And are we still getting to like a, you know, five, six, seven IRR? Am I still at least getting my money back? Right. You know, right? So that to me, all of this in the end, all this is about, Don't lose money. That is the number one thing that I do when I try to invest. When I'm investing in commercial real estate deals, I've taken some moonshots in PE and tech and startups, but that's different. But when you're investing in these kind of deals, I want to figure out how I don't lose money, because that's the fastest way to grow your money is to not lose it first. That's right. Right. So that's why everything comes from that place for me, is a place of conservatism, because that's honestly how I got started. And how do I not lose money? Because singles and doubles add up.

33:43 - 34:16 | Christopher Nelson: Singles and doubles do add up. And this is, again, I think for me, the position in my portfolio of private equity real estate is I want it to be on the medium to very conservative spectrum where I'm diversifying capital into another asset class that's outside of the market that is giving me appreciation, that's giving me income, and then that depreciation, but it all works because of the fact that I'm throwing nine deals in the trash can and I'm just looking at the 10th.

34:16 - 34:38 | Hans Box: That's right, that's right. And that's not how this should be looked at, right? Right. You want every deal to work, right? In commercial, like you said, in the VC world, you hit one home run out of 10, right? And the rest don't do well. But in commercial real estate, my goal is, on all these deals, is to not lose money, number one, and then maybe make a 12 to 20% IRR on the rest. Right.

34:41 - 35:01 | Christopher Nelson: Right, because you're right. If I have that push my portfolio that's constantly hitting singles and doubles, what I think people don't understand is is when everything works together, when you're able to get, you know, you have good cash flowing investments, and I'm not saying above 10 percent, it could be 10, somewhere between 10 and five blended.

35:01 - 35:06 | Hans Box: And right now, honestly, if you find a multifamily deals making five to seven percent, that's pretty darn good.

35:06 - 35:24 | Christopher Nelson: that's kicking off consistently and you have the clarity to where those dollars are coming from, you're doing well, but you're getting that income, you're getting that tax advantaged. And then you're also able to get that equity growth. It's those concepts working together that really allow you to compound.

35:26 - 35:43 | Hans Box: It's a multitude of ways you can make money in real estate. It's inflation protected. It's little things that are adjusted and your money can really grow in real estate if bought right. And hopefully they'll continue these tax breaks as we go in the future.

35:43 - 36:20 | Christopher Nelson: That's right. Yes. Fingers crossed on that one. So I think we've covered off on, I think, some of the core concept of due diligence. Just to sort of recap, it really is about the sponsor. We want to make sure that you're finding an experienced sponsor, you know, who does have skin in the game in these conversations that we're having. Skin in the game is really important, that they're actually putting significant dollars in the deal. That's a given to me. Yeah. That is a given. It is. They're transparent. They really have a good track record of what they've done, a track record of success in real estate, not in something else, and this is their first real estate deal.

36:20 - 36:23 | Hans Box: And preferably in the particular asset class you're investing into.

36:23 - 36:38 | Christopher Nelson: That's correct. And also, if I were going to pause on that too, is I love the specialists. versus people that are sticking within a niche and who understand that very well, who are keeping their businesses very boring.

36:38 - 36:44 | Hans Box: I love that. Boring and non-sexy is my goal here when I invest in commercial real estate.

36:44 - 37:18 | Christopher Nelson: That's right. I get my sexy and my tech investments right. And then it's really then pivoting over and really understanding that business plan, having the ability to read the P&L. And what I love what you said was being able to follow from income to operating expense, non-operating expense to what's my cashflow. Like let me understand how the business plan is going to work, then let's go vet those assumptions. I think that it then leads us to I think this next part which is, What's this gonna cost me?

37:18 - 41:10 | Hans Box: Yeah, what are the fees right? So I mean I could talk an hour about this right and unfortunately, I don't have that much time but uh, so the general macro thought process with compensation for sponsors is you want their compensation to be aligned with your interests, right? Yes. So there are fees in these kind of deals. It's a standard operating procedure and it is valid. I'm a sponsor too, so I understand it from both sides of the table. Sponsors spend a ton of time looking for the right deal, a lot of resources looking for the right deal. They may go six months to a year without doing a deal. They've got employees, they're doing underwriting every day, they're going to view deals all the time, they're flying across the country. So basically, there are going to be fees because you have to be compensated for that. So it's okay to have industry standard fees. That's right. And to be high level, we can't get deep detail, but acquisition fees are standard. Typically, you see those between 1% to 2%. Where I get a little bit antsy is when I see somebody buy a very large deal. And again, the work to buy a $50 million deal and to buy a $10 million deal is the same work. It's just bigger zeros. You have to just raise more money, right? That's right. But when you put an acquisition fee of 2% or 3% on a $50 million deal, or you have a $50 million deal and you're putting $10 million in rehab in it, and you're charging an acquisition fee of 2% on the entire capital stack, so now you made $1.2 million day one the day you closed, versus a guy that's buying a $10 million deal and does a 1% acquisition fee on the $10 million purchase price, $100 grand. That's totally valid. So, it's nothing wrong getting paid more on a bigger deal, but in my mind, and there's no direct answer to this, it's a little bit of an art, it needs to be capped at some point, right? Making 1.2 million day one before the investor makes a dime is just, to me, personally, is too much money. Now, I say that, and then I probably have invested one or two sponsors where they've done that. I've invested in a ton of deals with them in the past. They had a long track record. I knew them personally. I grilled them incessantly. So I got to know them. So in those cases, I felt comfortable because I knew their operations. Big company. They had a lot of overhead to cover. And that overhead actually helped find this deal. Long story short, if you have a relatively new sponsor and they're making over half a million dollars on their first deal on fees, there's a problem there. Basically, the idea is the sponsor should be making most of their money on the back end. When they get you your return, then I would love for the sponsor to make millions of dollars. A lot of people get very caught up in the splits. Right. Um, I don't have a huge problem with large splits after i've made my My return if it's a 15 hour 15 16 is kind of what i'm expecting on this deal And then and if they make and they make a 25 irr and they take 50 of the last Half that deal right great. They made millions, but I made my 18 or 19. I don't care. Um, so i'm, okay as long as my is my interests are aligned with theirs. As I make more money, they make more money, right? That's the way it should be. And there's a million different times to comp models, but the biggest thing that I always want, usually almost 100% of the time, is I want a preferred return. I normally will not invest in a deal that has straight splits, meaning just an 80-20 split. Every dollar profit is 20% to the sponsor, 80% to me as the investor. I want a minimum, say, 8-pref or 9-pref or 7-pref. I want a minimum return on my money before the sponsor starts taking a split of the profits.

41:11 - 41:23 | Christopher Nelson: Right, because that's the risk that we're taking. We're capital partners. We're bringing in money. As limited partners, right, that's our job. We're bringing the dollars to the table. So we need to get that return first and then they get theirs.

41:23 - 41:38 | Hans Box: That's right. That's right. And then as they do better, then the splits typically will get more generous towards a sponsor. And I'm totally fine with that. I want my sponsor to make millions of dollars because that means they're doing well and that means that they're incentivized to hit home runs.

41:39 - 41:41 | Christopher Nelson: Right. And then they're going to want to come back for more.

41:41 - 41:53 | Hans Box: That's right. That's right. And I just don't want them making tons of fees, you know, tons of money on fees that they get no matter how well the deal does or doesn't do.

41:53 - 42:23 | Christopher Nelson: I'm very, very cautious of that, too. And I've seen a lot of deals where there's, you know, marketing fees are billed back. And that's really because they need that to raise capital. There's a lot of questions that that brings up. The fee structure, in my mind, should be very simple, and like you said, should be really easy to understand. Here's the compensation for the work we did up front to get the deal under management. Now that it's under management, there's usually some ongoing operating fees that pay for running.

42:23 - 43:12 | Hans Box: Yeah, standard asset management fee. That's true. Something like, you know, one to two percent of gross receipts per month on a multifamily deal. Sure. That's usually what you'll see. And that's just to keep, because there is a lot of work as a sponsor and I'll take my investor hat off and put my sponsor hat on for a second. But, you know, you spend a lot of time Even though you're not running the day-to-day and I'm not sitting in the manager's office on a 200-unit apartment deal in DFW, I spend a ton of time reading P&Ls every month and asking the right questions to the management company and directing their actions and making decisions on big purchases like insurance and making property tax. protests and things like that. There's a lot of work. You're basically steering a big ship. That's right. And there's a lot of work for that, so I have no problem with them getting compensated.

43:12 - 43:40 | Christopher Nelson: Yeah, it is an executive team managing a business, right? When you look at the size of some of these P&Ls too, it's obvious. Yeah, you're running a business is what you're doing. And again, I think all of those, I think what you said, I love is incentives need to be aligned and then, you know, understand what is standard and everything should fit in there. And if there's, in my mind, if there's a, you know, five or six fees that are outside of the standard, it's probably really fee heavy. You may want to look somewhere else.

43:40 - 45:00 | Hans Box: Yes, very much so. Yeah. And there, that exact, and I'm glad you said that. And I don't know, you know, like, you know, I want to make sure that I make this point. So it may not fit exactly where we are here in our discussion, but. Sure. don't have FOMO on any of this stuff, right? So there, like you just said, there will be another deal. You will be patient, especially if you're a new investor, be extremely patient here. Do not get sucked into, you know, we've only got a million left to raise. We got a week to go. You got to commit now. No, if you're being rushed to commit on anything and you're not ready and you're not 100% sure you want to be in this deal, move on. There are so many deals out there, and once you start investing, you'll get on so many lists, and never be rushed, never have FOMO, be extremely patient, and just try to hit singles and doubles. What's the saying? Most people overestimate what they can do in a year, but underestimate what they can do in five or 10 years. That's right. And you will be amazed if you start investing today and putting 25, 50, 100,000, in I don't know two or three deals a year as you earn money in your job and you do well and you don't lose money five to ten years from now that will have ballooned to a lot more money than you think because of what you talked about all the advantages of real estate investing.

45:00 - 45:50 | Christopher Nelson: It's true and I actually think that that is is probably where we need to be and probably where we could put a bow on this thing is, as honestly as I think that the key element of due diligence is patience. Yes. Being patient. The other thing I want to then go back as we're sort of bringing in, we're sort of going through the potpourri section, just bringing in all sorts of random things here is, you said at the beginning, and one of the things that's critical for my due diligence is a list. is a checklist, is I am going to shoot over to sponsors. I want these questions answered. I want to get to know them. I want to understand a lot of things. And then I have checklists of the way that I analyze the deals, making sure that I ask all these questions. And it's just to make sure that I'm not missing anything.

45:51 - 46:48 | Hans Box: Yeah, 100%. I've done so many of them that I don't personally use a checklist, but I've actually created one for others that have asked me for one. But yes, there are these big items that you don't want to forget, especially if you're a new investor, that you want to make sure you get answered. And a good sponsor will answer 80% of them in the business plan, typically. Another red flag I see is where I read a whole business plan and I have a thousand questions still, that tells me that they weren't comprehensive. I should be able to find everything I need within the business plan and the private placement memorandum and the operating agreement of the limited liability company or the limited partnership agreement. Those are your three documents and you should get, technically all your questions should be able to be answered there. Now there's gonna be subjective things that you wanna ask the sponsor, but usually the better the sponsor, the more comprehensive those documents are, and you'll get most of your questions answered there.

46:48 - 47:10 | Christopher Nelson: It's true, it's true, and this is where I do think that, like we talked about earlier, getting your reps in. You have to grind through some PPMs, and you're gonna understand quickly what are the, sections of it that are really just part of the template? And then what are the sections that you need to go through line by line and understand how it's written and what that means for you?

47:10 - 48:35 | Hans Box: Oh, 100%. I have, I've read a whole business plan, love the deal. Then I looked in the PPM and I found clauses and things in there that I'm like, okay, that is not investor friendly. And then I'll ask the question, why would you have this in there if it's an investor friendly? Oh, well, we meant to remove that, but we, you know, we just hadn't got around to it. I'm like, okay, immediately red flag. And these are good sponsors, right? But if I hadn't gone into the ppm and just kind of scanned it and because I've done it enough I kind of know what to look for things jump out at you and and unfortunately It's some of this is boring But you there's this, uh, you know, a lot of people I say this all the time a lot of people will spend literally months trying to analyze the perfect 65 inch television to put on their wall or the car next car They're gonna buy right and that that may cost five to five thousand for the TV or I don't know TVs are anymore and and a car may be up to what 70,000 or whatever and you're investing a hundred thousand two hundred thousand multiple times in these in these deals and I see people spend an hour and You know, they hear a webinar and like, I'm in, no matter what, no questions asked, right? But they spend all this time trying to figure out the best TV to buy for their home. And so that, to me, that's skewed and you need to switch that around. You've got to spend the time and you got to grind it out a little bit with these kinds of deals. If you're really serious about becoming a true passive investor and generating cashflow, like you're talking about, financial freedom, basically.

48:35 - 49:22 | Christopher Nelson: Exactly, yeah, because I mean, ultimately, and then let's, I mean, I think let's wrap it up with this is, This is the skill, due diligence is the skill that truly unlocks the ability to build out this portion of your portfolio that can do so much for you. And, you know, like you articulated, the work is done up front, like any other skill, you're going to have to put in reps. There are going to be times when you're tired and you're grinding through PPM. It's not going to be perfect. That means that even when you do the work, sometimes you will have overlooked something. And those are going to be the most valuable lessons that you will never, ever forget when you have to pay for it. You never forget it. Yep. You know, but this, this is the work and this is the practice.

49:22 - 50:50 | Hans Box: Yeah. Um, and you know, kind of end it with don't lose money. Yeah. Like it, it really is. I know it's so obvious, but it's not. So like a good example, and I've got a chart that I do a presentation kind of on this subject once in a while. And I got a chart that kind of like puts it in graphics for you. So if you start with a hundred grand and you invest in a deal and it doesn't do well and you only get 75 grand back, okay? You lost 25% of your original investment, but you've only got 75 grand left. You have to make a 33% return on that remaining 75,000 just to get back to even. Just to get back to even, a 33% return. That's not easy to do. And if you lost 50% of your capital in that deal, you have to make 100% return on your remaining 50K just to get back to even. So that's why I keep harping on, I keep saying, I was like, well, obviously I don't wanna lose money. Well, if you actually sit down and do the math, it's much more, I will invest in a deal that I know has a much, it's all about risk adjusted return, right? It's not just about, it has the highest IRR. If I'm looking at two deals, and one has a 20% IRR projection, and another one has a 13% IRR projection, but the one that has a 13, I feel is extremely low risk. and the 20 isn't, I'm almost always gonna go with the lower risk because to me, I will invest in a lower risk deal with a decent return than a high risk deal with a high return.

50:50 - 51:00 | Christopher Nelson: Of course. Yeah. Yeah. And I think you said it well, like it's it's this is a game of singles and doubles and you want those singles and doubles to then add up over time.

51:00 - 51:32 | Hans Box: That's right. Yep. And yeah, it's just and it will add up quicker than you think. So for those of you that are listening to this podcast and probably a lot of them that are quite a bit younger than myself and Chris, you know, I started when I was thirty five. Right. And it's amazing what's happened over the last 10 to 15 years. So, you know, Just be patient and just hit the singles and doubles. Take advantage of what the government gives you in terms of depreciation. That's right. And pick and choose your investments carefully.

51:32 - 51:38 | Christopher Nelson: Thank you so much. Appreciate you joining us today, Hans. Thank you. Enjoyed it. All right. We'll see you next week.