Financial Engineering Traps Investors Should Watch Out For

Patrick Antrim, CEO of Multifamily Leadership, brings up that timing of money coming in or things like assumptions and expectations can create gaps in this conversation with Tanner Bickelhaupt, CEO and Founder of the Tanbic Company.

Internal Rate of Return Can Be Manipulated

(1:05) – Bickelhaupt says he used to put IRR in his projections.

“If anyone really fully tells you they understand IR, they’re either in finance or whatever. So basically to simplify it, it’s the time value of your money. So the way you can manipulate that is either the money of the time. Those are the valuables.”

Check on things like whether the equity is going in at the exact same time as the rest of the capital. 

Boosting IRR can raise the cap rating. A group can raise debt and have lines of credit. They’ll buy the asset and use certain debt for the value-add things and burn through that, then they’ll call in other capital. If they held a deal for two years and then manipulated things for a year; they can call the equity in for a year and a day, then sell things and the numbers are run as though that equity has been there the whole time.

(3:30) – Just understand the risk parameter. The IRR is a real number. The problem is, the investor might create expectations based on that number.

“I’m putting equity in, but what if the market turns. We’re overpaying for this deal,” Bickelhaupt provides as an example. “You just have to understand when and where your money is going, where you fit into the deal, and if you’re comfortable with all that, then great. But there will be a time, who knows when, when there will be a turn. And the last person holding the bag has the equity.”

(5:00) – Loan covenants came up a lot during the pandemic. There’s a debt service coverage ratio and each lender will write a provision that if you fall below that ratio, it triggers an appraisal. Credible groups will have reserves with debt service coverage ratios. 

(6:35) – Antrim brings up that things are moving fast right now because people are excited about investing. Everyone wants in.

Bickelhaupt points out that people get the PPM, which will tell them ways they might lose their money, but it also brings up fees, where you fall in the capital stack, the lending terms, the rate, and more. It serves as a blueprint. Bickelhaupt warns, there will be things in there that will make you uncomfortable, but it’s important information that might not come up in the business plan. 

Questions to Ask

(8:20) – Bickelhaupt says to start simple.

“Oftentimes, people will see the business plan. The business plan’s going to show growth because there’s NOI growth. I haven’t seen a business plan yet that says, ‘We’re going to buy, cap rates are going to compress, and we’re going to sell and it’s going to do nothing.’ I’m sure that’s happened, but nobody’s putting that on paper. So it’s understanding how they’re going to grow the NOI.”

If you’re an investor, learn the story and make sure you believe it.

Bickelhaupt advises that any and every investor should start with the NOI, then walk through the NOI growth. Don’t buy everything that’s in there, ask questions about how those goals are actually going to be met! Think about how things would work if you were living on that property.

Antrim brings up that listening to the customers or at least putting yourself in their shoes can be a good way to look at things. “Do you see that part of the role of a strong syndicator?” Antrim asks.

“I personally would never own a unit that I wouldn’t live in,” said Bickelhaupt. “I literally have stayed in every one of my deals multiple nights.”

(12:30) – Right now, the Tanbic Company is focused on how to create the best community possible, whatever that might be. Bickelhaupt thinks the property manager plays a big role. 

“We’re in a frothy market, you can do no wrong. But there will be a time when we have to compete on product again.”

Right now, all people need to know is whether something will be available. But soon, properties will have to boast about their features again.

(15:45) – Antrim asks what investors should expect. Bickelhaupt brings up that he invests in LPs often, largely due to timing or the people involved. But he recognizes that investors are just looking for the highest number.

“I tend to lean on the operations,” said Bickelhaupt. “If the syndicator has an in-house management company, sometimes that’s good, sometimes that’s bad. It just depends. But I’m looking at what else they’re managing – who is this group? Again, I will invest in the story not the number. The number is important. That’s what gets your interest. But I think about every deal I’ve invested in that hasn’t gone to plan; it was the biggest number. It was the best-looking business plan. But the ones that were like, ‘Gosh, I think you’re undershooting yourself. I think you could turn 60 units this year, not 30. I think you’re going to get more there because their comps, they’re so much higher.’ When I invest in a story, it goes well. That’s what developers do.”

Reflect on whether everything matches the story you’re telling. The capital stack, the debt, etc.

(20:15) – Invest like you’re broke. That makes you pay attention. 

“I would rather lose my own money than my investors’ money. If you have only so many shekels, it’s so important to you that you get that back. It’s so important that those grow,” said Bickelhaupt. “What happens is you get guys looking at tranches of money saying, ‘That’s not working, that’s not doing anything,’ and again, that works great in the up market. That works good in a steady market. But when something changes, then everybody needs that capital and they want it back, and all of the sudden these questions start coming up again. What happened here, what happened there.”

You have an obligation to grow and give back. Of course, there are things you can’t control, and investors know that. But from an operating standpoint, you maximize value if you operate like you don’t have a lot of capital. 

(22:34) – The operating company has phenomenal data, so you should be looking at it every week. Bickelhaupt says projections 3 years out are much more dependable than those out further than that. Things are unpredictable! You can use data to predict with fair certainty for what’s going to happen in the next several years, but after that, don’t trust it.

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