How to Set Up a Join Venture and Raise Other People's Money

The meet up I attended yesterday was really great. Russell Westcott, Former Vice President of REIN, JV & Raising Capital Guru, gave two brilliant presentations. In the first one, he covered key foundational elements of real estate investing. The second topic was Joint Ventures (JV) and raising people's money.

I'd like to summarize JV presentation. I am sure that at a certain point, I'll hit a financial wall and will have to figure out how to get a down payment and financing using someone else's money. In addition, it will be amazing to grow personally and also together with others as a team.

What's Joint Venture 

I loved Russell's definition of a JV. He showed a comic (which unfortunately I can't find to add here) with three kids on a play ground: a girl, with a jug of peanut butter; a boy, with a can of jelly; and another boy with a loaf of bread. The little girl elbows her buddy with the jelly and suggests: "Let's JV that guy for his bread".

Principals of Success (4 G's)

To get started with joint ventures, most important is to have the right mindset. Russell covered 4 G's to recap what he believes is crucial.

Growth Mindset

It's important to recognize that no matter how afraid you might be to get started, the skill of raising money is a just skill and you can master it. Everyone with a growth mindset can change and grow through learning, action and consistent practice.

Grit: Learn and keep going 

Another hurdle many get stumbled upon is getting "no"s. Russell is sure that the person who gets the most no's wins. I agree with him! It's important to remember his tip on learning from every no: just ask what would have to be different in the deal, for the answer to become a yes. Then, adjust course or pitch, and try again. Focus on finding solutions and chop on a problem bit by bit, things will come together.

Giving

Many people are afraid to ask for money and feel awkward just thinking about it. The reality is that you are not asking for money. You are a leader and do-er who opens up opportunities for others, which they'd probably miss out on without you.

For example, I know some of my friends, often tell me: "hey, I don't know how you even do this?" and share that they worry a lot about future, job security, etc., yet can't figure out how to start shifting and taking control of the situation. If the right opportunity presents itself, it will be so great to be able to help them out - get a property together and show that investing is doable.

Find what the person needs, his/her why's, dreams and obstacles. Show them how to get there!

Gratitude

Russell reminded that practicing active gratitude will be helpful along the way. Be grateful for your  partners, team-mates, family and friends and make sure they know.  Gratitude will return to you from everyone around ten-fold. In his book "The Happiness Advantage", Shawn Achor explains that gratitude plays an enormous part in our well-being. It makes people happier, more optimistic, better connected socially, forgiving and energetic. Be more grateful and you will get more done faster.

Negotiating a Joint Venture (4 M's)

Now, in order to actually get the deal done, you'll need to negotiate and align with your partners on 4 aspects and terms behind them:

1) Money - who will be giving the money to cover the down payment and acquisition costs

2) Mortgage - who will put their personal name as the guarantor and qualify for a mortgage

3) Management - who will manage the venture

4) Mastery - who has the right skills, knowledge and experience for the venture to be successful.

I loved the event and feel very inspired. Cheers to building more and better together!

How to get Rental Property with Positive Cash Flow

Here is an example of how to purchase a small income property with positive cash flow. This works for freehold townhouse, semi, single or duplex.

Please use this as a generic simplified template. It doesn't cover everything that can come up. There is always possibility of additional costs and risks. The more properties you review and purchase, the more precise your intuition becomes to steer away from trouble.

1. Find out how much money you have for a down payment. Example, 50K.
2. Subtract 10K since most likely you will need to spend some money on updates: 50K - 10K = 40K. 
3. Divide the result by 22%, of which 20% is your down payment and 2% are the closing costs: 40K / 0.22 = 181K. This is the maximum purchase price you can afford.
4. Go to MLS (realtor.ca) set a filter at your maximum price and look for areas where you can buy a property at this purchase price.
5. Research the location. The goal is to understand that this is not a D market where D is for dead, dying, drugs, deserted, etc.
6. Go to Kijiji and find average rents in this area for 1 bedroom, 2 bedroom and 3 bedroom. If no one rents in the area, look for a different place.
7. Go to Indeed and find out how many jobs there are in this area. If there are no jobs, look for a different area. 
8. Go to Google and find out there are businesses, infrastructure, colleges/universities, retirement homes, and other places to keep people busy in the area. 
9. Find a mortgage broker who does rental property mortgages and get a preliminary quote on interest rate. Submit paperwork to pre-qualify for a mortgage. Confirm if there are any fees they'll charge on top of the interest rates (ex., broker fee).
10. Go to one of major bank's online mortgage calculator, and confirm your monthly mortgage payment.
11. Find a property on MLS with existing tenants. Contact the agent and ask for income and expenses in as much detail as possible. Ask the agent to schedule a day to show you as many similar rentals as possible.
12. Contact your insurance broker and get a rough quote for a property this size. Say, $100 / month.
13. If you don't live near the rental or have no time to self-manage it, contact several property management companies and confirm their prices.
14. Do your math in an Excel template for each of the properties you come across:

Rent 

  - Insurance 

  - Mortgage 

  - Monthly Property Tax 

  - Property Management Fee 

  - $30 for rented water tank 

  - $150 for maintenance (snow / grass / other minor repairs)

= Cash Flow.

Now, assume you get a mortgage at a high interest rate (ex., private 7% interest only). Do your math again. If you are still getting positive cash flow, then go for it!

Pls note that if you have a conventional mortgage, then your actual gain every month also includes the principal that the tenant is paying down for you, which is really nice.

This looks like a lot of work. Take a look - every step is doable. It feels great when you are done. The second rental will seem even easier. 

Rent to Own Example - Double the money in 3 years

I attended a wealth building MeetUp today that covered 5 ways of building wealth in real estate:

1. converting a single home into a legal duplex
2. buy & hold 'first-time home buyer' type of property
3. rent to own
4. multi-unit properties, and
5. commercial real estate.

I found all of the material helpful, but rent to own strategy was presented in most detail, so I wanted to summarize it here.

Key benefits of rent-to-own for real estate investors:

- Tenants care about the house and are happy to maintain and/or improve it

- Tenants pay 15-25% more than the market rent monthly, which gives better cash flow

- Tenants provide a non-refundable deposit of 8-15K (3-5% of current house value)

- There is a pre-defined exit strategy with good ROI

- If tenants can't or chooses not to purchase the house at the end of the lease term, landlord keeps the deposit and the house.

Here is how rent-to-own typically works

• Tenant and landlord sign a standard lease agreement for a rental property. This agreement is governed by Landlord and Tenant board rules, so all typical regulations apply and can be used by the landlord/tenant in case of any issues (ex., landlord can evict a tenant for non-payment).
• Tenant and landlord enter into a separate 'Option to Purchase' agreement outlining an exclusive option for the tenant to buy the rental property at a preset purchase price at the end of the lease. Typically, the term of the lease is 3 years and buy-out price is calculated at 5% annual appreciation of current market value.
• Tenant pays a non-refundable fee up front This fee is the price for the opportunity to buy the house in the future. It's called "option money" Typically, the fee is 3-5% of the current property price. 
• Tenant pays rent plus a 15-25% mark-up on top. The extra money is kept by the landlord as a credit towards future purchase. 
• Landlord puts the tenant in touch with a mortgage broker, who works with the tenant on improving his/her credit history over the course of the contract. This way tenant has a better chance qualifying for a mortgage when the time comes.

Example:

Current market value of the house: 400K

Current market rent: $2,500 / month

Tenant pays up front: 3% of 400K = 12K (option money)

Tenant pays monthly:  $2,500 + 25% = $3,125 (includes credit money of $625 / month)

Lease duration: 3 years

Preset purchase price: 400K + 5% * 3 years = 460K

Credit accumulated by tenant:  $625 * 36 = $22,500 

Note: $22,500 is 4.9% of the purchase price of $460K, so the tenant is in a very good position to qualify for a mortgage with 5% down and become a home owner.

If tenant doesn't purchase the house, landlord will keep $12K of option money and $22,500 of credit money.

Suppose tenant chooses to purchase the house. Assuming the landlord originally bought the property for 400K with 20% down, 2% closing costs, and 3.5% 5-year fixed mortgage with 30-year amortization, he/she will receive:

Principal paid by tenant: ~20K 

+ Preset appreciation: 60K

+ Net cash flow during three years: say, $200 * 36 = $7,200

- Less: mortgage discharge fees of 3K.

Total: 84.2K profit. 95% ROI (more than 30% annual return).

Per above, rent to own strategy is worth considering on my path to 50 doors.

Is it Accounting or am I really just not making much money?

Over the past 3 years, I've come up with a very detailed approach for keeping track of all finances. First, I download all banking transactions into a gigantic Excel template every quarter. Then I assign a "Category" to each line, which automatically puts all transactions into various additional buckets. I then refresh a pivot table and "Voila!" - a chart sorted by property, showing gross, then expenses and the bottom line.

This worked fine initially and I was quite proud. Lately, I noticed that the chart doesn't actually answer a simple question: How much money am I making? or losing? or wasting?

I realized that this is because in my home-made Excel template I treated CapEx the same way as all my operating expenses. I would just subtract capital expenses out of the gross. Because of this, I couldn't tell if the property was profitable on a day-to-day basis or not.

I went through a painful thinking process and came to a simple conclusion. If I put my data into conventional financial statements: "balance sheet" and "income statement", I can see much clearer how the business is doing. I can also see how every improvement I make (capital expense) affects my net income for years to come.

For example, if I get a new roof for 10K this year for cash. The "10K" disappears from Cash on the balance sheet under assets and re-appears under "CAPEX Roof" still on Assets side. Income statement for the same year doesn't include an operating expense for the roof at all. This was counter-intuitive to me initially because I was the one who personally gave away precious dollars to the roof guy. Now, I think of it as if  my "10K" is still with me and re-incarnated as a shiny roof.

Notice that I also pay taxes on the 10K as if my income actually included that cash this year and it wasn't spent on business needs.

However, roofs aren't eternal, so over the next 10 years, I will be deducting 1K "roof expense" on my income statement. This is called depreciation. Depreciation will decrease my income by 1K every year over the next 10 years, and decrease my net income and tax respectively as well. So I make up for the tax I paid.

Now, the benefit of this exercise is that I can see how my properties are doing on a day to day basis given just operating income and expenses. I also know that I have to plan better and have 10K set aside for all upcoming roofs and other big improvements.

Working through depreciation examples on the income statement helped me realize that CapEx for the roof (10K) is a big chunk of money. Even if I set money aside over 10 years, 10K / 10 = 1K is a large portion of my gross.  The reality is I can't pay "fake" money to the roof guy or ask him to give me an interest-free 10 year loan. It's on me to come up with the real money.

Our house was on TV

One Relaxing Christmas Day....

Christmas Day 2014.
We are in the US.
At my sister's.
Kids are playing and running around.
Good times.
Peaceful relaxed joyful afternoon.

Text from the previous owner of one of our rentals: "Hey, the house is on TV." She adds a link to a local news youtube channel.

Holiday Disaster 

I follow the link:

Yellow tapes
Police
Shocked neighbours explaining that this is typically a good quiet street
Our tenant is being seated into a police car
Handcuffed.

It took a couple of minutes for the info to sink in. Luckily, no one got hurt and the house was now vacant. It turned out that our young adventurous tenants had an extra wild Christmas party and put a few bullets through the walls of the house. A bullet zoomed through the backyard wall, across the hallway, and out through the front wall...

How did this happen?

When we got the house, it came with tenants. Tenants soon had to move out and relocate to a different town closer to their parents. Their son was staying behind and wanted to rent the house for himself and his girlfriend.

It is the responsibility of a landlord to screen and carefully select all tenants. We missed these steps and accepted a new tenant without proper verification and multiple check points, which led to the Holiday disaster.

Should've Would've...

Our current application process includes:

- Application form
- Job verification
- College/university enrollment verification
- Income verification
- Banking references
- Character references
- Emergency contacts
- Closest friend in the area
- Guarantor.

On top of this, we give our phone number to several neighbours and ask them to keep an eye on the place and stay in touch with us, if needed.

No matter how a tenant was referred to us, we follow every step of the application process precisely and without exceptions. This saves us lots of trouble and keeps communities happy and safe.

How I financed the first few deals

I recently attended a MeetUp with a very helpful presentation on financing. I learned that it is crucial to have a solid plan on how to finance deals without hitting a 'financing wall' before I reach my 50-doors goal. It is also cost effective and bullet proof to work with a good knowledgeable mortgage broker.

My approach so far was to apply for one mortgage at a time directly with lenders. Now I know this wasn't the smartest way, but hey, it got me through the first few deals and I hope I haven't messed up my financing profile too badly so far. I am starting to work with an amazing broker and will post notes on this process soon.

Below are my notes on how I qualified in the past, directly with A and B lenders.

• Down payment - You have to show where the down payment will be coming from. For example, I show a TFSA statement as a proof of down payment. Gift letter can work as well in some cases.
• Down Payment Available Over 3 Months - Lender will likely ask you for 3 months of bank statements and will want to see that the down payment has been sitting on your account over this time. Depending on your debt to equity ratio, you might have to provide up to 30% down.
• Proof of Income - You'll be asked for a proof of income for the last two years (ex., T1, notice of assessment, pay stubs or all of the above). 
• Proof of Rental Income - You'll have to show current lease agreements with each of your tenants and/or tenant acknowledgement letters. If you are buying an owner occupied property and don't have a lease yet, you will not qualify with some lenders. 
• Latest Tax Bills - You'll have to provide latest tax bill for each of the properties you own and purchasing.
• MPAC - Some lenders ask for an MPAC statement for each of your properties. In this case, they use MPAC assessment as the market value of your rentals. 
• Market Value - Some lenders ask you to provide an estimate of the current market value of your rental properties and use your numbers instead of MPAC.
• MLS listing - You'll have to provide the MLS listing for the new property you are purchasing.
• Signed Purchase and Sale Agreement - You'll have to provide the signed and accepted offer letter (aka Purchase and Sale Agreement).
• Liquid Assets - Some banks might ask you to provide a proof of liquid assets (i.e. TFSA or cash on a bank account in your name). The amount of liquidity you need will depend on your financial ratios. For example, CIBC requires 100K plus 10K for every rental property you own.
• No Outstanding Tax Balance - You might have to provide a proof of payment of your personal taxes and/or tax balances for your properties.
• Lender Application Form - You'll have to fill out lender application form and provide a summary of your existing assets / liabilities. In addition, you'll have to sign permission for a credit check. 
• Assessment - Lender will require an appraiser to assess the property you are buying at your own expense. The selected appraiser must be on the lender's approved appraisers list. The lower of the appraised value and purchase price will be used to calculate the value of the mortgage you qualify for.
• Corporate Documents - If you are buying a property in corporate name, you will have to provide 
• Articles of Incorporation, 
• two years of financial statements, 
• two latest tax returns,
• shareholder structure, 
• list of directors, 
• Bi-Laws 1 and 2 (i.e. borrowing bi-laws). 
• In addition, all shareholders may be asked to be guarantors, in which case they will have to provide all of the supporting documentation listed above for themselves and their properties. 
• In some cases, each shareholder is also required to get Independent Legal Advice (ILA) from a lawyer, who doesn't work with any other shareholder of the corporation. 
• Insurance - You have to provide insurance binder for the new property before closing, with the lender being listed on it as the first beneficiary. Fire insurance is a must.
• Checking Account - The lender might ask you to open a checking account at one of their branches before closing.
• 6-plex and more - Multi-unit rental income property with more than 5 units (i.e. 6-plex and more) is considered a commercial property. Commercial mortgages have different approval process and higher interest rates.
• Verbal approval - Doesn't mean anything. Have a plan B always for every deal and make sure your numbers work even if you have to go for a private financing at a high interest rate.
• Additional approvals - Once you get approval with an A lender, the same lender can potentially finance up to 5 rental income properties for you, assuming you still qualify based on your personal financial situation and performance of your existing properties and the ones you are purchasing. If you purchase properties one after the other, some lenders will use previously provided documentation and some will ask you to re-submit all of the above over again.
• Timing - Most lenders require minimum 45 days between initial contact and closing to process your application.
• Avoid Credit Checks - Since credit checks reflect poorly on your credit rating, it's important to work with the lender to pre-qualify before they go ahead and run your actual check. Some lenders will tell you right away that you don't qualify based on their criteria.

Our first rental income property

When we initially started, we believed so much that if we reach our goal of 50 doors, our life would be awesome, that we had no fear. We just decided to follow the instructions and templates of our RichDad coaches and do whatever it takes to start getting assets (i.e. whatever puts money in our pocket).

The way we looked for properties was very simple: we were looking for properties that were being rented already and had positive cash flow of no less than $200 per month per door. Based on the lecture notes, we were supposed to research 100 properties, then make 10 offers, negotiate 3 of them and buy the one with the best numbers and projections.

It turned out that in 2014 market, buying properties wasn't hard at all. There was lots for sale. We did look at a bunch and populated a large Excel template with data. We drove by about 20. We tried to make some offers in Oshawa and lost them.

Couple of days later, there was a knock on our door... A real estate agent looking for clients and asking if we were planning to sell our house. I said no and asked him to help us find an income rental property instead.

Within a few more days, we made an offer on a triplex in Guelph with an agent who specialized in Toronto/Oshawa but was super eager to help us get what we were looking for. Looking back, there is no doubt - We were super lucky! We now know that we had minimal understanding of potential issues and associated costs, did insufficient very high level due diligence and zero market research.

Nonetheless, stars somehow aligned.  The house happened to be in a good area and location. We had great tenants from the start. The seller provided accurate numbers on the MLS listing and did a good job maintaining the house. So we did end up with a positive cash flow.

The only hiccup was that the 'triplex' is actually a legal non-conforming triplex and its official zoning is a Single Family Residential home. There was a bit of a back and forth at closing since NBC didn't want to provide a loan for a property zoned as Single family home but advertised as a triplex. Ever since that issue, we do check the actual zoning :)

Here is the century home we got. We are very proud of it since it is one of Guelph's beautiful heritage buildings and will be turning 125 soon.