There’s an old expression that “it takes money to make money”. And the same is often true of self-storage properties as you need some capital for a down payment to put a deal in motion. For many operators, this means finding an investor to contribute money to the deal. In this Self-Storage University podcast we’re going to review the steps to attracting and signing up a capital partner.
Episode 158: How To Get A Capital Partner Transcript
There's an old saying that it takes money to make money. Now, that's not always true. Bill Gates thought up a lot of his computer programming using not a lot of capital. Steve Jobs did the same. Sometimes there are some businesses where just original thinking is all the real capital you need. But in the world of real estate, we can't get around the fact that unless you can get seller financing at zero down, there is some money required to get in the game.
This is Frank Rolfe, the Self Storage University Podcast. We're going to talk about how to get a financial partner, how to get a capital partner, how to get someone to provide the money you need for your down payment, or potentially any kind of infrastructure upgrades. Now, we all have to acknowledge that in every real estate deal, there are typically two components.
One, capital, and two, operational. So the operating partner is someone who can, for example, find the deal, manage the deal, turn it around, and kind of create the profit. But they can't get there often without the capital partner who provides the money. So, as a result, if you want to get in the self-storage investing business, you either have to have some capital or you have to find somebody who has capital to basically be your partner. But that then brings us back to the question: how do you get a financing partner? How do you find someone who will entrust you with their money?
Well, let's start off by going over what the typical configuration is. So in most deals, if you have a financial partner, you have to say, "Okay, here are the roles." The roles of the operating partner, as I just said, are to find the deal and to do the due diligence on it, and to manage the thing, to hit all of the additional targets that everyone agrees that they want to do.
And it's the financial partner simply to put the money in. But you have to think if you are the operating partner and you want to get someone to put their money in, you have to think through what do they want out of the deal. You have to look at things from their viewpoint. Well, there's another old saying in life that before you can have return on capital, you must have return of capital.
That means it makes no sense fantasizing on a 20% return when you don't even get your money back, so you get a negative return. Most capital partners are very pessimistic in their thinking because they're always concerned they won't get their money back. So you have to realize that to get someone to invest in your deal, you're going to have to offer them something that makes it worth doing. Because right now you can go out and put your money in a CD and get a nice, safe 4.5% with no risk at all.
So if you offer a financing partner 4.5%, they'd be crazy to take you up on it. They'd say, "Wait a minute. I can do way better than that. I can get four and a half with no risk at all just by going to my local bank and getting a CD." So then how much do financial partners want?
What financial partners want is typically an interest rate on their money at what's called the preferred rate, significantly higher than what they can get themselves on CDs and Treasury bills. So a number that comes to mind for a lot of these deals and the way they're structured is a 10% preferred rate of return. That means if they put the money in, they will earn at least 10% before there will be any defined profit.
So the priority of payments when you sell the property off, they get all their capital back, number one. Preferred rate of return as long as their money was in, number two. And then a profit split as far as number three. And most investors are hoping between the combination of preferred return and profit split to hit about 20% per year.
That's the norm. That's what most people are trying to hit. Now, will they hit it? No, not always. But if they don't hit that, they're still going to hit something good. They're still going to hit 12, 13, 14, 15. These are not numbers anyone will be ashamed of. That's roughly triple what a CD would pay out. But that's kind of how the structure is. You have preferred rate of return, and then you have profit split.
Now, assuming that someone's going to want probably at least twice what CD rates are paying, which is going to mean a 9% or 10% preferred rate of return, then you come to the profit split. That's all over the map. I've seen every configuration known to man. I've seen capital partner getting 10%, operating 90%, and I've seen capital partner getting 90% and operating partner only getting 10%.
So what is the correct number? It's whatever you can negotiate. That's the answer. So if someone says to you, "Well, gosh, you don't have a lot of experience, so I think I should get 70% of the profits just to make it worth my risk." And if that's the best deal you can do, you better take it because that is something that's simply open to argument and debate. There's no right, there's no wrong. It's basically what the market will bear.
Also, investors want to see how you're going to address issues if there are problems. They want to know that their downside is covered. A lot of people make the mistake of talking only about all of the wonderful things, all the money that can be made. Well, that's all pie in the sky. The capital partner is going to want to hear what do you do when things don't go your way?
What if you can't hit that level of occupancy? What if you can't get the rents as high as you claim? Then what happens to the investment? They're going to know such things as what occupancy you can have in the storage facility and still be able to service the debt. So you've got to have all of those things already analyzed for them.
You also have to be extremely enthusiastic about your deal. If you seem like you just think your deal is average or ho-hum, well, why would they want to invest in it? They'd be crazy to do that. Warren Buffett once said, "Without enthusiasm, there is no energy, and without energy, you have nothing." And most investors ascribe to that same theory that Warren Buffett has. Now, once you find an investor and you lay out the plan of what the preferred rate would be and the profit split, and how you will address downside issues, you have to expect, in many cases, to get some degree of rejection.
Finding a capital partner is a volume business, just like any others. You have to make a list of people you think might work, and then you have to hit many of them before you may find the right person. That rejection you may get does not mean your deal is bad. It doesn't mean that you're bad. It simply means it was not the correct fit.
There are millions of investment options for any given American. Stocks on the New York Stock Exchange, on the NASDAQ, there's penny stocks, there's CDs, there's bonds, there's commercial paper, there's a ton of stuff. Everyone has to gravitate towards what works for them. So when you throw this out to people, sure, there will be some that say, "No, I don't want to do that." But that's not what's important to you. What's important is to find the one person who says, "Yes, that does work for me."
And once you find that person, it's possible they'll also finance your next deal and your next deal and the deal after that. So often, once you find a financial partner and things are working well, that may be the only partner you need for your whole life. At the same time, people's needs change over time, and you may at some point have to get a different financial partner. But remember that as you go, you'll have greater experience. You'll have more of a portfolio, more of a track record. That makes it infinitely easier to find a capital partner. In fact, probably the hardest capital partner to find is, in fact, the very first one.
For that reason, many people find as their capital partner friends and family, relatives, other people that already know them, so the hurdle of character is already over because they know you, and they like you, and they trust you. And that allows you just to focus on the deal at hand. It makes getting a capital partner much easier.
The bottom line to it all is, if you think in the terms of what the financial partner needs, if you hit a lot of people and approach it as a volume business, you should be able to find a capital partner. This is Frank Rolfe with the "Self Storage University Podcast." Hope you enjoyed this. Talk to you again soon.