Develop Your FIT: A Guide for Real Estate Syndicators and Real Estate Funds

If you've been following me for any given period of time, you know, one of my favorite things to discuss is this idea of the founders investment theory. The founders investment theory or sometimes we call it the fit is the bedrock for what syndications and funds need to do in order to set themselves up in the right manner, to think about their investments in the right manner. And to present those investment opportunities to the, to their investors in this video, is a blast from the

past. But this is probably the best work that I've done in describing founder investment theory. I think it covers all the bases on why it is so incredibly important to make sure that you've identified your own founder investment theory, I know you'll find it useful. The founder investment theory is the most important thing that you can do. And think about for your syndication or fund. So enjoy this video. The founder investment theory is so important for what we do. It

is really the heart and soul. It gives us guidance, it gives us guidance on what we need to do guidance on what properties we should be looking at, gives us an idea on how we can talk to our investors. And it even gives us an idea on how to better serve our investors and ultimately ourselves at the same time. So that is why it is so important. It is it's what we do. So let's go through founder investment theory. And we're

going to go through it in a slightly different way today. So I want to go through it through the lens of what exactly we mean by these different complex, these different models and strategies, and how we can really leverage those different strategies to really be better served. So let's go ahead and get started. We're going to switch over to the whiteboard. All right, looks like we are there. So before I drew this diagram look like this. We had development, we had stabilized

add value. We had value, value add, I'm sorry. We had undervalued. And we had cashflow. These are the four main types of strategies that exist in any developer in any property, real estate deal. So what I want to do is I want to expand each of those and really kind of dive into each and talk about what we mean by each. So let's go ahead and just gonna actually, let's go ahead and clear the board. That way we can start really, really fresh. And let's start with let's start

with how we earn the money that we do. What are those things and the I've talked about these before, and these are the value add opportunities. But this really comes down to how we make money. How we make money. There's two ways that we make money, right. And there's two ways in every investment that we make money and one is cashflow. And the other is appreciation they're very, very linked and that they're very, very linked. So and this is cashflow of the investment. And this is the

appreciation of what it would be today. And so it all boils down to our idea that value equals noi over cap rate or we could really look at it as Our cash flow equals our value times our cap rate. Or we could look at it as. And this this value here, if that is a value of if, if value, if appreciation is you have to bear with me on this one. I didn't draw this one out. So we're going live appreciation is the delta, the change in value? Which means that, that it would

be the change in and a Y over the change in cap rate. Right, so that that would be the the change that's there. Is that right? Would it be the change in Capri? Now, this actually wouldn't be the correct term, this would be the this will be over the new cap rate. Right, so that would be the change of value. So let's go with that idea. So all we're trying to do, all we're trying to do is we're playing with this algorithm here, or this algorithm, it doesn't particularly matter for our

purposes. So we're playing with that. And that's how we get our getting money. So let's start with, let's start with on the very bottom of this diagram, we have cash flow properties. Now cash flow property, all we're what we're trying to do is we're trying to, we're going to hold these properties for a very long time, we are going to put money into our pocket of our investor. As regularly and as consistently as possible, these are not

complex deals, they're long folds. And so we're trying to just put money in their pocket, and eventually we'll sell it with appreciation. And so that's because we've got the value equals the NOI over cap rate. And so as noi goes up just over time, so if you own a property, that's big, you're paying regular rents, and maybe you're getting maybe it's an apartment building in a really good area, and you're getting rent growth of 5% every single year. Maybe that is that is driving up the

appreciating appreciating value. So when you take that same noi. So the when you take that noi of x, and you add to it that increased noi then Then what you're actually doing is you're you're loading up this equation, so that this number is really, really big. And probably your cap rate is fairly stable and it's not changing much. That's really what is going on underneath the hood of what's there. So in order to make good money on

these properties, what do we have to do? Well, they're always going to be in prime locations and they're going to be in we're going to be basically banking on rent escalate on escalations, but we always increase our noi. So I try to increase it. We need to increase our income and lower our expenses. So this is what we're trying to do. So our income is increasing naturally, because of rent escalations, or this type of strategy.

You'll be looking for other opportunities. But really, that's what you're banking on, this is an audit a very hands on way to increase the value. And then you're going to lower the expenses. But again, this isn't really built into the system for a cash flow strategy. You're really just banking on these rent rent escalations that are very good. And you're hoping that that's that cap rate stays say stays safe, stable, right. So that's all you're trying to do is just your count. So the

your driver here. So let's write that down. So the driver of your proposition of this strategy driver is rent escalations. That's what you're trying to do. What you're trying to do for let's go up the stairs up to here is, is this is also a longer play. But you're really looking at this value add component. And so you're ultimately looking for the increase in value to go up and you're doing that primarily

for this kind of property. You're primarily doing it again from income and, and not really from changing your expenses, or from changing the cap rate. So where does that? Where does that change in income come from? With this, we've got it really coming down to a couple of different strategies that work. So we're looking for expiring leases, right. That's what we're we're looking for here and below market rents.

So which tells us basically what our strategy is, so we're doing that by by looking for, for releasing either to existing tenants or to new tenants is one way to do it. Or we could also as a major play here, we've talked about this before talk about re measuring. So what we're talking about about re measuring re measuring is the strategy where you take a property that's already

generating income, and you re measure that whole space. And measurement standards tend to be in almost every lease I've seen in every state is based around the Building Owners and Managers Association. So the standards that they use change over a period of time. And because it's the Building Owners and Managers Association, they want the space to be as big as possible. So it's no longer just measuring the inside of the space while

the wall figuring out what the square footage is. It's now there are some exterior spaces that count because of overhangs, things like that. There are other ways to measure it that really increase the square footage and I've seen this increased by 10 20% Given and give, that's a huge amount. So if you're getting two bucks a month, let's do it on a year, I'd say you're getting $24 a square foot on, on rent, and you're increasing it by 20%. Let's look at it. So for that

same space, you're getting $28.80. So you're getting you're getting that 20% More TASH, same cap rate. So what's the difference in the amount of money that's there, so that per square foot you've just added and let's say it's at the building is at a six cap you've just added $80 per square foot of value just by re measuring now, so on a 10,000 square foot building, you've now got $800,000 more cash that you've magically created out of nothing. So that's pretty amazing. So it works great. And

it's a great strategy here. So let's put in what the driver is here. So our driver is increased rent dollars over the term. So do you see the distinction there's, there's a nuance here between the driver for stabilized add value and the driver for cash flow properties. So where the big driver for cash flow properties is just the natural rent escalations that are taking place. So in

apartment buildings are a great example. So here in what it sort of near where where we are, right now is a is an area called Van Nuys, you may have heard of it. It is stocked full of apartment buildings, I don't even know how many apartment buildings there are hundreds and hundreds of apartment buildings there. They are a commodity at that point, because they are all basically the same, they all have to charge basically the same rent, there's nothing really differentiating one from

another. Other than some maybe one has a little bit nicer fixtures than the others. But we're talking nuance here, if you go to Van Nuys, you're looking for just an apartment, it's all going to be basically the same cost within a margin of error. So the all that you're banking on there are these rent

escalations. So is that natural rent that's climbing up every year, in order to to appreciate your property, it's a great place to go when as long as the those escalations are high enough that it makes sense, when they're not high, then it then it doesn't really add significant value to your

investors. But here in the stabilized value add, we're talking about how do we take those existing rents, they're gonna, they're gonna escalate as well, but how do we like really shove them up in order to really, really bring them up to the highest level that they can be? So that is the nuance that takes place there. Then we're talking about memory, let's go down here and we'll talk about undervalued properties and undervalued properties, what we're really trying to do here

so remember what an undervalued property is. It's very low cost per square foot and a very high cap and that's probably because of, or that could very well be because of renewing leases. So here we're not so much looking at the NOI as the main driver, what we're looking at is this cap rate. Right? Because what happens when all the leases have like one year left to term on them. And it's, you know, it's a office building or retail building or industrial building, the cap rate is just super,

super high value is super, super low. And so you can buy these properties for very inexpensively, maybe they're selling it now just because they need to, they need cash for some reason. Or maybe it's because they are. They're afraid of what's going to happen if the if, if it turns or whatever. But so you're buying it at this very, very high Capri. And then you are counting on doing things that will decrease that capric things such as renewing leases.

Now, there's a distinction here too, between renewing the lease for an undervalued property, and renewing a lease for the stabilized value add in the stabilized value add you've got, you've got a very normal vacancy factor that's going on, leases

just are naturally expiring. And you're going to be able to release it without much concern in a undervalued property, there's going to be some element of it, where it is that the value of that lease, the fact that it has such little term is pulling that cap rate, or that value down, basically pulling that cap rate up and making it so it's undervalued in the

marketplace. So maybe it was, I mean, imagine that you went in and there was a department store that's not doing very well and they've got one year left on the lease, we have this massive property, and then you've got this, you know, barely anything left on the lease. And that the fact that it's got so little term is just dragging that, that cap rate sky high in order to crush it. So that's what what is really going on in these

undervalued properties is that low low cap rates. And so what are what are driver is your high cap rate actually, well, your your driver of making money is moving cap rate down to where the rest of the market or a normally positioned property would be, you're trying to move it down and that most of the time comes from renewing leases.

So our fourth major category is of course your value add. Now here, you've got a bunch of things going on, right so this could be the what separates it from the stabilized value app is it's really not about just getting the just getting that increased rent dollars, you're really trying to get the increased total dollars coming in. So what you're trying to do is you can do any strategy to you trying to do really any strategy that raises that noi or

lowers that cap rate at the same time. And so here this this is sort of the kitchen sink approach of what kind of fits in here. So we definitely have rent, rent growth and we definitely have renewing leases to change that cap rate. You Make changes. So what I'm trying to do is I'm trying to increase the income. And that can be any of these. So rent square footage, but that's really rent isn't it, or adding other

income. Or here's where we finally see we're trying to lower our expenses, and lower them to such a point where suddenly we've got you know, as few expenses as possible now, that could even come in the form of transferring that risk from a existing lease structure on to a new lease structure that has

different terms for paying operating expenses. So moving somebody from a modified gross to a triple net, moving somebody from a full service gross into a modified gross, that can all decrease those operating expenses, because really, it's just changing how your pool of money is. It's not actually neither of those strategies is actually lowering your expenses, it's actually really increasing your income, and how that comes in. But it also decreases the amount of risk that you're

taking. Some of the other strategies, though, that do lower expenses would be suddenly submetering. other energy sources like solar and or just lowering your property taxes, all in an effort to raise your noi as high as possible. Now, we're also trying to change our cap rate. So we're also trying to lower our cap rate. And so there are a lot of things that affect the cap rate as well. So cap rate

really is all about positioning. And so we've got term is definitely a major factor as we talked about in the undervalued properties. But it's also you know, just how your property is

situated. So it could be your tenant mix. For example, if you have a retail center, that is almost all that's got 10 tenants, and nine of them are service tenants where it's, you know, fix your cell phones, your h&r block, things like that, that is nowhere near going to be as low of a cap rate as something that's like all restaurants, all restaurants is always going to have a better cap rate, because they're just better tenants, and they pay more money, there comes out of a

comes as a matter of rent. But it also comes as just the cash that's available, when you have a restaurant that's earning good money. The rent cost isn't as major of a factor. You know, it's between eight and 12%, normally, of what of their expenses, where it can be, you know, 20 to 30% of a service based business expenses is just the office, not the best way for

them to choose that. But that tends to be the oftentimes the case, I mean, think about the cost of, of an h&r block, and how much that out expensive that rent is just to just in comparison to their operating expense, the only other expenses that they have really is as a as a franchise is the cost of the of labor. So it doesn't really, it doesn't add value to it. So changing that tenant mix can definitely decrease the cap rate, which would be a good thing. And then just changing

perception. So this could be refacing, changing the architecture, making it the new cool hip building, even if it's not new and cool just making it a place that tenants want to go, because every landlord is concerned about vacancy. And so the more sexy that a property is, the more likely they're going to be able to release property and the better the perception is which lowers the cap rate, and then it adds that

value. So So with these are driver is is both so it's it's raising noi by more dollars which can be rent or other income lowering expenses and also let's call it repositioning or a lower cap Okay. So you're really repositioning it for a lower Capri. Now, the the last strategy we talked about is develop and it is us kind of a special thing, but it actually

is it follows the same general model. I mean, what are you trying to do here driver is to create an noi right, you're building a space in order to rent it out and have a cap rate and the lower the better, right? So you want to build the best building you can. So that cap rate is as good and as appealing in the marketplace as possible. If I'm a developer and I've got a chance to build for say a let's say let's say I've got two different facets food companies.

Let's say we've got on one hand we've got a Carl's Jr, which generally does very good. And we've got an Arby's which generally doesn't do very good. The Carl's Jr. is going to make more money, it's going to have a lower cap rate because the marketplace appreciates the Carl's Jr. Much better. So in that's why it is has that higher cap rate. So I think this

probably makes sense. Excuse my allergies today. So we've got a that is what we're doing, when we look at at the strategies and how those different add value strategies kind of play out or value add, I would say add value out of the different value add strategies play out and then in in the same strategies because it's really all the same thing removing the same kinds of things in order to create that value added for our investors. So, what is the next step of building out our our founder

investment theory? It is we start identifying our niche which is property type we started thinking about what our property type is making sure that we understand what it is we should know as many things about it as possible. What how does it how do the main tenants make money what are the main ways that those tenants make money? What is the the main risks for those kinds of tenants? What are the what are the rest of the terms? What are the vacancies

that occur? What are the lease types? How many tenants you're going to be be working out how hands on is it versus off. And, for example, if you've got a apartment building is much, much more hands on than a warehouse, you know, you're, you probably will only show up to the warehouse once you know to rent.

And that's it, you probably don't need to go very often on apartment building, your property manager is going to be there many days a month, visiting the property, visiting tenants, making sure that things get improved, or that the toilets are aren't flushing or leaking or whatever. So those are the kinds of things in the property type. And then we've got our location you know, how far away is it from you where is

it located, those are the things that fall into your niche. The last category is your risk profile. And we talked before about the spectrum, high risk, medium risk, low risk and somewhere on the spectrum is where your investors like to sit and hear to is somewhere on this spectrum is where your is the risk of your cause is part of the risk. So development tends to be high risk. cash flow properties tend to be low risk, stabilized value add tends to be medium risk.

Value Add tends to be medium risk. And the undervalued properties tends to be low risk. So you see what happens here is that on this continuum, between high risk and low risk, we've also got the complexity of the strategy, the more complex the strategy, the higher the risk is going to be. It's just the natural part of what is there. And so that is also part of the risk profile. If you've got a bunch of low risk people, and you're doing development, it's probably not going to work out

very well. If you've got a bunch of high risk, high rollers who like taking big, big chances, doing this deal where you're buying this, this four Plex in, in Beverly Hills at a 3.5 cap and you're just waiting for rents to increase naturally. They're not going to go for it. It's it's boring, and it's not going to happen. So it's this risk profile. I think I told the story of I may not have told it to y'all. So when I was putting a deal together, I went and there was a prominent doctor who

I thought for sure was going to invest in the project. And I wanted to I thought, okay, there's no way that I can't get, say $300,000 from this guy, he's got a ton of money. I know he's sitting on cash right now without anything to do. And he, he doesn't have, he doesn't have anything to go in it. And he likes me, he knows me and trusts me. This was before I came up with founder investment theory. And before I came up with this

idea of a risk profile. So I had lunch with this doctor. And so I said, Dr. S, here's this property, I'm syndicating I've got all this stuff. And then it's a great property, it's gonna make a ton of money and it's gonna make a ton of money because we're buying it at a, you know, at a low cost. We're going to wait for it to appreciate over five years and it looks like we're gonna get a nice 17% Actually, I think that one was actually 50 We're gonna get a nice 15% IRR. The tenant

is safe. They're not going to do they're not going anywhere. It's really going to be superduper you're gonna love it. And he said he looked at me and he was like, Yeah, it sounds like a good deal, but it's not for me. And I was shocked because it was like well, why I mean if you can make if you got cash just sitting around. Why would you not take a deal like this where it's a good thing you know? 15% is a good return on a property with such low risk, I mean, it was 15%. Oops. It was 15% in

risk, but it actually was like fairly low risk profile. In reality, it really sat here. Well, normally, if you're paying 15%, it was higher. And he said, Tilden, I've got three pools of money that I that I use, okay. And this will explain why yours isn't a good fit. So I have this category of money. And this is where a large portion of my money is, is, is pooled. So I've

got is very large pool and I it is super low risk. It's money that you know that a great recession could come that money is really not going anywhere we're talking, it's in like long term bonds, and it really is just going to sit there, and it's going to sit there forever. And it's my money that well, when everything goes to hell in a handbasket. I know that money's there, and I'm going to be very, very comfortable, even if the worst thing happens. So it's very, very low risk

planning. Now I've got a category of money, that's maybe that's about a little bit smaller than my low risk category. But it's, it's a fairly substantial size. And this is my income money. And my income money basically pays for my standard of living so that I make sure that I've got, you know that I've got money coming in for the rest of my life, and I don't have to work or I don't have to really do anything, I get to go on trips, I get to spend money, and my income

money, it pays me, you know, one to $2 million a year. And it's it's very comfortable. No, I'm I'm extremely comfortable. And I've got a great lifestyle. And I don't really have to worry about it. So the bulk of it is my income. And I said, Okay, well, that's two of them. But you know, I know that you put money into other into other projects, and you put money into some businesses, and you've told me about some of these investments that you've made in these venture capital things

that you've been doing. He said, Yeah, that is my full around money, or play money. My play money, I'm not even really expecting to get that money back. You know, if I do, I expect to get like a 50% return or more. But my really my play money is there so that I can have fun, right? I enjoy investing. I like it, it's fun to do. And I like experimenting and seeing what happens. I like finding these these people who need money than just the capital to do these crazy things. And

when they pay off, they're gonna pay off big time. But if they don't pay off, well, ultimately, it'll kind of evens out, because five of them won't pay off, but one will and it will do great. That's my play money. And my play money isn't very big. And I said well, okay, but this, this is one of those product properties to this was one of those projects where, you know, it's really got going to do that it's gonna, you know, it's, it's something where you get to be a part of it, and it's gonna be

fun. And he's shook his head kind of smiled and said, Now, it's not say, it's, it's not play money, it's got, it's got a 50% I'm looking for a 50% minimum return, you're talking about 15%. That's terrible. And this is like 15% In five years, I'm gonna get that money back. You know, if maybe if it was like, six months, I do something like that, but but been in five years, that's five years that I don't have that money to put him in things that are a lot more fun than your project. So it's

not play money. And I said, Okay, well, you know, it's got to, it's going to be paying out dividends. And, and it fits that right. So it should be an income, it should be income money. They said, now, you just told me that the real money is made on the appreciation of the property because you're buying it for a low cost, and you're gonna sell it in five years for an increased cost when the rent bump cups. You know, the the amount that it's getting right now on the income, you know, is

maybe 4%. So it's not not interested in 4% I need to get much better than that in order to live off. This is the money I live off. So it's not income. And we all know that it's real estate. So there's no way this thing's low rents. It just is it's just a property. It's backed by a good tenant, but you know anything good to happen. You know, they're not assigned

as the US government, it's not low risk. So although your project sounds interesting, it's not anything that fits into one of my three categories of play money, income money or low risk. So you see what I did there? I went Dr. S, thinking that, just from the viewpoint of, I've got a really strong sound investment that should make a lot of money, and was really good. And I went into the meeting thinking that investors make a decision based on is this seem like a reasonably logical way in order

to spend money? But that's not the way that investors actually think the investors think first stuff? Well, first, they want to know, does it make sense? Right, they want to know that the deal makes sense, they can kind of understand it, but most of it at least. So we've got this idea of does it make sense. And they do need to know that. But the making sense, is just a small piece of the puzzle. Because most of what how they make the decision is underneath the water. This is

all logic. And this is all emotion. And if you come at it from looking at just as an investment itself, just like one thing, saying, Does this one thing makes sense. But there are a lot of other one things out there. That makes sense. But when you can hit off these kinds of things, and identify where does their natural risk profile lead them? Where do they like to sit? You know, then you're talking about all this stuff down here, all the emotion that it can make sure that it feels

comfortable to them. And when you've got a strategy that they can kind of pick and understand. But it gives them something more than just kind of like, okay, that I understand it, it gives them an idea of something that they feel like they want to be a part of. Now, sometimes people want to feel like they can be part of a value add project, because they're taking a building that's been dilapidated and ugly, and they're being part of that whole thing that read reimagines it and makes it

awesome. And they feel like that's my building, they can point to it and say, Yeah, well, you should have seen it before. Right? That's an emotional thing. It may make sense, in a logical portion. But not only does that in order to make sure that they feel secure about it as an emotional driver. And the

same thing goes for this cash flow properties, right. So here, you've got investors who are afraid of all the things that could happen, they want something very secure, they want something very safe, and they want something Well, boy, those properties have always been good, they're always going to increase at that same level. And it gives them that sense of

comfort. And so if you bring those same people and try and tell them how you can't lose on this development deal, of course, it's risky and a risk, it's all out there something you're appealing to the wrong person, because they don't have the emotions to drive it. And then you've got the you know, and there's the same can be said for the undervalued properties. And for the for the stabilize at Valley, we'll just use the

undervalued properties as an example. You've got an undervalued property, you're going to this person and you're saying, Look, we're gonna get we've got this building for a real steal, we've got a bargain here. This thing is worth pet is worth much, much more than the pennies on the dollar that it's selling for. This thing is going at such a low rate and it's going to it's going to be a real, real great deal. This appeals to your bargain hunters. This is a great property. And

the the logical part of it is really kind of small. I mean, you've met these people, right? You met people who are so in love with finding bargains that you tell them that it's 50% off, and they don't even look at the price tag at that point. And that's 50% off it must be a great deal. And so you're driving to this emotional spark. This is why fear exists. This is what it does, because it every piece of it from strategy to niche. And then we're talking about property type, to

location. And the risk profile all feeds is serves this emotional part, before it even comes close to serving the logical part. So we can serve that. And it still makes sense, because this is why we do the underwriting, right. So we do the logical part. That's why we present good logical part, we have nice underwriting. So it all makes sense. But the whole story behind it is just to get to that emotional side, because once they've made the decision emotionally, they'll do whatever

it takes to make that decision logically. And fit is the only way to really get at it in a way that makes sense to somebody where they can feel okay, doing it, you're trying to give the logical part of them permission to say, okay, to the emote emotional part, or look at it. In the converse, you're trying to do whatever you can, so that the emotional feels okay, so that the logic can just pick up the slack and pull up and the rest of the way there, that is founder investment theory and

why it is so powerful. All right, so we're gonna do a little bit shorter talk today, because we've talked a lot, and I think we've really dived in, good, here's what I want to have happen. I want people to really spend some time thinking about this, because Boughner investment theory is not a light topic, it's not something there just because I think it's important to find the values of your company, and anything like that. It is because this is how you convince investors, this is

how you choose Properties. And this ultimately, is how you yourself are comfortable with it, too. I mean, if you were one of these very, very low risk people and you were doing development deals, you had a very short life, you're gonna be stressed out and freaked out all the time. Or if you're just doing these various, these cash flow deals, and then but you're really like this crazy developer at heart, you are going to be bored out of your mind. So answering the question of

founder investment theory is where you start. So think it through how do you do it for yourself. And then for once you've decided that, now you know how to start talking to investors, and how you can start lining up to their emotional side, but you also know how to start looking for properties. Because now you know, okay, I need something that's value add. And so I'm looking for these kinds of things. I know this is my niche, I know this is my this is my location, this is where I

want things to be. And you can start having that conversation with brokers and start building out your listings and LoopNet and Craxi and wherever else you're looking the MLS and making sure that it all lines up. I know you'll find that useful. Again, it's about found our investment theory. Everything boils down to that that is what is will make you successful as a as a syndication or as a fun if you're thinking about that that fit every time. It's putting yourself into the

right mind of your investor. Now this version of the fit, this was actually put together for people that I would coach on how to get started in real estate syndication. So it's obviously real estate centric, but it applies across the industry. It's an across asset classes. So it's that idea of fit that you have to be thinking of in order to be successful in this business. My name is Tilden Moschetti. I am a syndication

attorney with the Moschetti Syndication Law Group. If we can help you with your Regulation D Rule 506(b) or 506(c) offering, please don't hesitate to give us a call, whether it's real estate, you're raising money for a business, whatever it is, we can help you put that together. We can talk about that your fit, strategize about that all in the context of making your your syndication or fund both investable through using the fit

as well as compliant with the rules of the SEC. And the state regulators.