RPF0345-Leslie_Pappas_Interview
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00:00:31.400 | Welcome to Radical Personal Finance, the show dedicated to providing you with the knowledge, skills,
00:00:36.100 | insight, and encouragement you need to live a rich and meaningful life now
00:00:40.600 | while building a plan for financial freedom in 10 years or less.
00:00:44.000 | My guest today is Leslie Pappas.
00:00:45.900 | Leslie's the author of a book called "Cashing In Tax-Free, Your Ultimate Guide to a Tax-Free Retirement
00:00:52.200 | Using 1031 Exchanges and DSTs," Delaware Statutory Trusts.
00:00:56.600 | Leslie, I'm not sure if I've ever seen a book title that includes nice, good sales language
00:01:02.600 | like "Your Ultimate Guide to a Tax-Free Retirement"
00:01:05.100 | and also includes CPA-speak like "1031 Exchanges and Delaware Statutory Trusts."
00:01:10.900 | Yeah, this is the world in which I balance myself.
00:01:14.600 | Being able to talk financial and be able to speak to people, those two things.
00:01:20.500 | There are two skill sets that don't often go together.
00:01:24.100 | So tell us a little bit about your background and the concept of this book that you've written.
00:01:31.600 | Yeah, my background, I've had three careers at my tender age of 58.
00:01:36.200 | The first was in banking in New York City.
00:01:38.600 | The second was as a consultant and the third in real estate, which I've been doing for the last 15 years or so.
00:01:45.300 | And what I have fashioned for myself is a career where I help investors,
00:01:52.500 | high net worth investors called accredited investors,
00:01:56.700 | basically purchase replacement property when they sell an investment property.
00:02:04.000 | And I help them avoid paying taxes in the process on the sale.
00:02:09.100 | So you're everyone's best friend.
00:02:10.800 | Yeah, everybody loves me.
00:02:13.000 | They always say it's too good to be true. It sounds too good to be true.
00:02:16.800 | Right. And we'll get into a little bit of how you structure it
00:02:18.900 | because basically what I understand of what you're doing is taking some of the rules and regulations that exist
00:02:24.900 | and just simply trying to package them a little bit more into something that is more accessible to more people.
00:02:32.100 | Why did you write a book on the topic?
00:02:34.000 | Well, you know, I've spent so much time educating folks over the years.
00:02:38.400 | It's I guess it's a it's a difference in my practice because this is all I do is work in this field of syndicated real estate.
00:02:45.700 | I spend hours and hours and hours with people because I want to make sure they know what they're doing.
00:02:50.400 | And well, I thought, why don't I just write it down?
00:02:53.500 | I got that idea around April last year and I decided to do that for the rest of the year and publish the book in January.
00:03:01.500 | So it's been really well received.
00:03:05.100 | I'm told it's a really easy read, which is exactly what I wanted it to be.
00:03:10.700 | And it's it's helping people learn, you know, in a different way.
00:03:16.000 | And it was interesting to try and incorporate everything I'd ever said on the topic over the last, you know, 15 years into one book.
00:03:24.400 | But it took me a long time, as I say, and I think it's been very effective for people.
00:03:29.200 | So explain the concept in a framework sense, the overall framework, so that my audience can understand the concept.
00:03:36.400 | Sure. So if a person owns investment property, property they rent, now that could be a house or condo.
00:03:44.800 | It could be land. You don't rent land, but it's held for investment purposes.
00:03:48.500 | It could be a commercial space or any number of different types of rental property.
00:03:53.800 | You can sell that property and avoid paying capital gains tax when you sell using a procedure called 1031 exchange.
00:04:03.000 | And it's been in the IRS code since I believe the 1920s.
00:04:08.700 | When you sell your investment property, you have to meet certain time frames and rules and you must buy replacement property.
00:04:18.300 | And that's how you can avoid the taxes. Say you come out of a transaction with $500,000 in cash.
00:04:27.800 | You have the opportunity to take some cash out and use it for whatever purpose you like,
00:04:33.400 | but you'll pay taxes on the bit that you touch. And that's called a partial exchange.
00:04:38.800 | So if you take $50,000 out of your $500,000 proceeds, you'll pay taxes just on the $50,000.
00:04:45.400 | And $450,000 would go through this process called 1031 exchange.
00:04:51.100 | And fundamentally what I do is I help people buy the new properties.
00:04:58.300 | The investor must be what's called an accredited investor.
00:05:01.600 | I mentioned this earlier. And this is all set up by the Securities and Exchange Commission.
00:05:07.900 | These investments are regulated as securities.
00:05:12.300 | And the investor must have a net worth of $1 million or more, not including the home they live in,
00:05:21.000 | or they have to have a substantial income, $200,000 for an individual or $300,000 for a couple,
00:05:27.600 | for the last two years with the expectation it will continue.
00:05:32.800 | So those people are about 8.5% of the people in the country,
00:05:37.400 | which means that these products are only available to those 8.5%.
00:05:42.600 | So it's a very small little niche.
00:05:45.800 | The reason that the SEC sets up guidelines like this is to protect the investor
00:05:52.100 | because Delaware statutory trusts are private placements.
00:05:57.900 | They're not public offerings. They're not reviewed by third parties like,
00:06:04.300 | you know, Moody's or Standard & Poor's or Morningstar for mutual funds.
00:06:10.300 | The investor has to work with their advisor and use their own smarts
00:06:15.000 | to decide if the investment is good or not for them.
00:06:19.100 | So that's why that protection is in place.
00:06:23.700 | Any questions so far?
00:06:25.100 | Keep going. Lay out the framework first.
00:06:27.500 | Okay. So the idea here is that you're selling a house that you've rented for 20 years.
00:06:32.500 | You have a substantial amount of equity that you've gained over the years from appreciation.
00:06:38.000 | And we're going to take your equity and we're going to buy you several properties
00:06:42.600 | through a 1031 exchange to replace the house investment.
00:06:48.200 | We're going to, let's just use a half a million dollars cash again.
00:06:51.300 | We're going to go buy perhaps three or four properties with our half a million dollars.
00:06:56.900 | And those properties are going to be institutional grade, large-scale commercial properties.
00:07:03.800 | Properties valued from $25 million to $150 million.
00:07:08.800 | Properties that we couldn't buy on our own.
00:07:11.900 | And when we do this, we're diversifying.
00:07:14.700 | And diversification is a good portfolio strategy.
00:07:18.800 | And we're now participating in institutional real estate,
00:07:22.200 | which operates at a whole different level of potential profitability, cash flow, appreciation, all the rest.
00:07:30.600 | Plus, we don't have to do any work. It's completely hands-off.
00:07:35.000 | So in framework, that's what we're doing.
00:07:37.600 | Now we're going to hold these properties on average for five to seven years.
00:07:42.300 | Then they're going to be sold in the market.
00:07:44.400 | We're going to have a liquidity event and we can decide to do another 1031 exchange or cash out and pay the taxes due.
00:07:52.900 | And we do that over and over again until we pass away.
00:07:57.700 | And when we pass away, our heirs inherit the property at the stepped up basis.
00:08:02.800 | Under current tax law, all the capital gains tax disappears.
00:08:08.100 | So it's kind of a beautiful scenario.
00:08:10.500 | So 1031 exchanges are a fairly common topic for new listeners or listeners new to the subject.
00:08:16.500 | It's the IRS Section 1031, which governs the like kind of exchange of business property or investment property.
00:08:24.400 | So if you have business property or investment property, which has increased in value,
00:08:28.800 | if you exchange one piece of like property for another piece of property of a like kind,
00:08:33.700 | you can avoid in taxation on that transaction as long as you get it done within the time period and within the rules.
00:08:38.900 | But Delaware statutory trusts, DSTs, that's a new word to radical personal finance.
00:08:44.700 | Explain the significance of a Delaware statutory trust, please.
00:08:50.000 | Yeah. Well, what it allows us to do is to have accredited investors now have the ability to buy properties.
00:08:58.500 | They couldn't otherwise buy themselves.
00:09:00.500 | I mean, you know, I don't have $50 million to go buy my own 400 unit multifamily apartment complex in suburban Atlanta.
00:09:10.400 | And but I can participate in an offering such as that on a fractional basis.
00:09:16.700 | And I might take $100,000 and go in and buy shares of ownership in the trust and the trust owns the property.
00:09:29.000 | So in execution, that's how it works. And, you know,
00:09:33.600 | I spend a lot of time with folks educating them about what this is and how it works.
00:09:38.500 | But the benefits are pretty clear and simple.
00:09:42.600 | Hands off investing, potentially better cash flow and appreciation, new tax shelters.
00:09:48.900 | Loans are already in place on these properties. So nobody has to qualify, nor are they responsible for the loan.
00:09:55.300 | It's non-recourse lending. Excuse me. So does that answer your question?
00:10:01.900 | Well, so basically this is the structure that works for this type of investment is the is the short answer.
00:10:07.300 | Right. Well, yeah, there's another structure to I should tell you, tenant in common ticks.
00:10:13.700 | And that structure was used widely in the 2000s.
00:10:18.200 | But today, the banks are still really in charge of lending and they don't like lending to ticks because it means they have to underwrite up to 35 owners.
00:10:28.100 | You may have up to 35 owners in a tick and a DST.
00:10:32.000 | Only the sponsor of the offering is responsible for the loan.
00:10:36.600 | The investors aren't. So they're not individually underwritten by the bank.
00:10:42.700 | So why would I consider if I'm an investor and I've got some cash, there are lots of real estate entities, REITs and there's REMIX and what are the RELPS.
00:10:53.100 | Right. So there's all these acronyms that have to do with it, with pooled managed mutual funds, real estate investment trust.
00:11:02.200 | I can go and buy a REIT and many major offers.
00:11:05.200 | What's the why would I consider and what's different and what's the same about a Delaware statutory trust versus a commonly available REIT, which I can buy in my 401k?
00:11:15.400 | Well, fundamentally, REITs don't qualify for 1031 exchange.
00:11:19.600 | So if you want to sell your property and avoid paying the capital gains tax.
00:11:25.600 | You can't buy a REIT. It's not an alternative for you.
00:11:28.900 | 1031 exchange isn't allowed into REIT. But it is allowed into a Delaware statutory trust.
00:11:35.100 | There was a revenue ruling in 2004 that the IRS released, which outlined the structure that a DST would have to have to qualify for the exchange.
00:11:46.000 | And from that guidance, the industry was formed, basically.
00:11:52.200 | And it was a great relief to the people in the industry, working in the industry, because they finally had a word from the IRS for something that they had been doing all along, hoping it was going to be legal.
00:12:04.800 | Now they had the blessing of the IRS on the structure for 1031 exchange.
00:12:10.300 | What else? What are the other similarities and differences between what people are commonly aware of and Delaware statutory trust?
00:12:16.600 | Well, typically a DST is going to be a single property.
00:12:19.500 | It's not always true. But, you know, I would say 70 percent of the offerings out there are for single properties.
00:12:25.700 | REITs are, you know, large portfolios of properties.
00:12:29.900 | REITs can be valued at, you know, a billion dollars, two billion dollars, five billion dollars.
00:12:36.400 | We're not talking about that scale and we're not talking about, you know, owning 100 properties or 250.
00:12:43.800 | We're talking about selecting, carefully selecting, a handful of single properties to have fractional investment in through 1031 exchange.
00:12:56.300 | And, you know, there can be portfolio DSTs.
00:13:00.600 | A DST could have, say, 10 Walgreens in it.
00:13:06.000 | And you own part of all 10 of them when you buy into this DST.
00:13:10.400 | But that's still not a REIT. It doesn't qualify in scale and doesn't compare in scale to a REIT.
00:13:20.900 | So what is your role in the transaction?
00:13:25.300 | Because you're clearly offering a service and helping to be a middle person where you're connecting the investors and the offerors.
00:13:34.300 | What do you do and how do you get involved in the process?
00:13:37.300 | Yeah, what I do is educate people about what this is because mostly many folks don't even know about 1031 exchange.
00:13:45.900 | I mean, I would say easily half the people I speak with aren't aware of it.
00:13:50.300 | And then, you know, Delaware statutory trusts are even far more obscure, right?
00:13:54.700 | So I have to spend a lot of time educating folks, but I help them pick the properties.
00:13:58.900 | Due diligence, I actually go visit the properties that we approve, the single unit properties.
00:14:06.100 | And I can't go visit portfolios of properties because it's too much travel.
00:14:10.800 | But, you know, I always go see the properties that my clients buy into if they're single property investments.
00:14:18.300 | And so I'm a real estate broker in a bunch of states and I have, you know, advanced commercial credentials and such things.
00:14:24.800 | So that's what I do is I help my clients potentially get into the best deals with the best sponsors and ones with track records.
00:14:35.600 | They're bulletproof. And of course, past performance doesn't predict future performance.
00:14:41.600 | But if a sponsor has been pulling a 13% internal rate of return per year on the properties they bought, operated and sold for 40 years,
00:14:55.600 | you get a sense that that sponsor has some idea what they're doing.
00:15:00.200 | Because that's a pretty amazing rate of return on average for their portfolio.
00:15:05.700 | So I guess your perfect client is somebody who has – they need to have – first of all, they need to have an investment property.
00:15:14.400 | So that means they actually need to have investment real estate.
00:15:18.400 | That property, in order for this to be worth pursuing, that property needs to have appreciation built in.
00:15:25.100 | So they need to – it needs to be worth some significant amount in excess of their basis in the property.
00:15:32.100 | So that they actually have some gains which they're trying to shelter.
00:15:36.600 | They also need to not want those – to spend those gains on something else.
00:15:42.100 | They need to want to keep their money in real estate.
00:15:47.100 | But they need to be looking for a more passive type of investment rather than them going out and actively identifying a property that they wish to directly buy and directly own.
00:16:00.100 | Is that accurate so far?
00:16:02.100 | Yeah. Yeah. What you tend to see are people in their 50s and up.
00:16:08.600 | I have younger clients certainly.
00:16:10.600 | But on average I would say most of my clients will fall in the 50 to 80-year range, years old.
00:16:18.600 | Because they will have had to need time to establish the gain in equity through appreciation.
00:16:25.600 | So you have to own a property for around 10 years, 20 years, sometimes 30 years, the clients on them, to have enough equity built up to sell it and want to avoid paying taxes.
00:16:37.600 | So some of the advantages would be their ability to transfer out of active management.
00:16:46.600 | Some of the advantages might be diversification for their real estate portfolio.
00:16:50.600 | They perhaps still own other properties in their local area, but now they might choose to invest in a property elsewhere.
00:16:56.600 | However, there could be some significant disadvantages.
00:17:00.600 | They're going to lose active ownership and control.
00:17:02.600 | Now they're investing into a fund in which they have no active control over the property.
00:17:08.600 | They're basically an investor who has to go based upon the decisions of the manager.
00:17:17.600 | They also – I mean that would be the biggest – that's the biggest disadvantage that stands out to me at this point in time.
00:17:25.600 | What are some of the other gotchas?
00:17:27.600 | What are the other disadvantages that this type of investor needs to be aware of?
00:17:32.600 | Yeah.
00:17:33.600 | Well, fundamentally it's an illiquid investment.
00:17:36.600 | I mean that's – I would say that's the biggest disadvantage.
00:17:38.600 | I don't think it's a disadvantage to have people with decades of background in institutional real estate managing your money for you.
00:17:45.600 | I don't think that's a disadvantage.
00:17:47.600 | But for an investor who absolutely needs control over their money all the time, this investment doesn't work at all.
00:17:55.600 | You have to be willing to let other people who are pros at what they do do it.
00:18:00.600 | But I think the biggest disadvantage is the illiquidity.
00:18:04.600 | If you buy into a DST, it has a business plan and it has a lifecycle.
00:18:10.600 | And that DST could resell where you would have a liquidity event, usually on average in five to seven years.
00:18:19.600 | It could be two years.
00:18:20.600 | It could be 15 years.
00:18:21.600 | But on average it's five to seven.
00:18:24.600 | And people may be unwilling to wait that long, in which case they should not be in an investment like this.
00:18:31.600 | There is no marketplace in which to sell your shares of ownership.
00:18:35.600 | There's no multiple listing service of Delaware statutory trust investments.
00:18:40.600 | And I think that's fundamentally because it's only to the accredited investor.
00:18:45.600 | It just hasn't been developed yet.
00:18:47.600 | It's a very small market.
00:18:49.600 | You can tell by looking at the numbers that only 8.5% of the people in the country even qualify to consider the investment.
00:18:57.600 | Well, they also must own rental property and they also must want to sell it and avoid capital gains tax.
00:19:03.600 | And they must be okay with passive management because many of the people who have an investment portfolio, it's built themselves and they want to maintain control.
00:19:13.600 | Exactly.
00:19:14.600 | So it is possible, I understand, to get out of a DST.
00:19:21.600 | The way it would be done – I've never been asked to do this.
00:19:25.600 | I try and make very sure that my clients understand this is a liquid.
00:19:29.600 | But the way it would be done would be to ask the sponsor to poll the other investors and see if anybody would like to buy the shares that you want to sell.
00:19:40.600 | And it's almost never done, and the sale will happen at a discount to the original purchase price.
00:19:48.600 | So it's not something we go into this planning to do.
00:19:52.600 | But that is the biggest disadvantage, I think, is the illiquidity.
00:19:57.600 | So tell me now about the cash flow because how are these deals structured?
00:20:02.600 | If I come to you and I say, "Hey, I've got $500,000 of capital gain over here that I'm trying to avoid, but I really need cash flow," does that send me to a different unit than does my coming to you and saying, "Hey, I don't need cash flow.
00:20:17.600 | I just want this property to appreciate for the benefit of my kids"?
00:20:20.600 | How is it actually practically structured with regard to cash flow?
00:20:23.600 | Yeah, well, the whole industry is structured around just a couple of goals, fundamentally a couple of few goals.
00:20:31.600 | The first goal is to work to not lose the equity.
00:20:36.600 | And that sounds like a no-brainer to most people, but imagine you are 75 years old and you have a million dollars in investment real estate.
00:20:46.600 | You want an income off it, but you don't want to lose any money, right?
00:20:50.600 | So the industry works very hard to make sure that the properties they're selecting are good properties and potentially not ones that are going to be devastated in some way.
00:21:06.600 | But the second thing that we do is to provide a reasonable and predictable cash flow.
00:21:14.600 | For current offerings, cash flow is anywhere between 5 and 7 percent annually, and depreciation tax shelter will improve that a lot.
00:21:32.600 | And I tend to focus on multifamily and student housing quite a lot because those two segments have more beneficial depreciation schedules.
00:21:43.600 | And we can protect more of our money from taxes that way.
00:21:46.600 | Why do they have more beneficial depreciation schedules?
00:21:49.600 | Residential housing has a 27.5 year depreciation schedule, whereas commercial retail office, the rest, 39 years.
00:22:03.600 | So depreciation is calculated based on the improvements on a property.
00:22:23.600 | So you can take that 60 percent, whatever dollar amount that applies to, and divide it by 27.5 years instead of 39, therefore getting a bigger depreciation deduction.
00:22:42.600 | So I present this in the book and it's something that I usually see light bulbs going over people's heads when I say to them,
00:22:51.600 | "You know, just because this commercial office over here or this portfolio of triple net properties is paying 6 or 6.5 percent,
00:23:00.600 | it doesn't mean you're going to have as much cash in your pocket as this multifamily over here that's projected to pay 5.5 percent.
00:23:08.600 | You may have more cash after taxes in the multifamily because of depreciation."
00:23:17.600 | So walk me through the life cycle. Before I interrupted you, you were talking about cash flow that perhaps it could be 5 to 7 percent.
00:23:28.600 | It's what some of these properties are currently paying. Walk me through the rest of the life cycle of my ownership of a DST.
00:23:34.600 | Yeah. Well, you know, we hope the properties will appreciate. The appreciation belongs to the investor if it happens.
00:23:44.600 | If we have a loan on the property, and 95 percent of the time we do, if there's any pay down in principle, that belongs to the investors when the property is sold.
00:23:54.600 | So every quarter you're going to be getting reporting from the sponsoring firm that's managing your property.
00:24:02.600 | Some even report monthly. Annually, you get a tax package that literally you just hand to your tax advisor and you use it to fill out your Schedule E.
00:24:14.600 | Tax reporting is just the same for DSTs as it is if you own a duplex.
00:24:21.600 | And, you know, the experience is sort of effortless. That's the point.
00:24:27.600 | In fact, a woman wrote a book on this back in the- on ticks back in the 2000s, and her book was titled "Effortless Cash Flow."
00:24:36.600 | And that's how people used to look at it. It was effortless.
00:24:41.600 | So I don't know what more to say about the experience of it. You get direct deposits, monthly cash flow.
00:24:48.600 | There is a business plan. You know, the projections are projections. They're not guarantees.
00:24:55.600 | But it's you know, I mentioned earlier about due diligence. I don't work with every sponsor that there is out there.
00:25:02.600 | I don't work with some of the biggest sponsors. I'm really particular about who I work with.
00:25:09.600 | And it's because so many people were hurt in the recession.
00:25:12.600 | We must be very, very careful. Not just what properties we choose, but the people who are operating them for us, who we choose.
00:25:22.600 | And that's where it all starts, is the investor having faith in the sponsor.
00:25:28.600 | How is the initial valuation determined? If we're going to come in and you've got a $10 million property, which is being determined and managed,
00:25:41.600 | how is it determined how much my million dollar investment is going to buy? What percentage of that property?
00:25:48.600 | How are those initial prices and valuations determined?
00:25:51.600 | Hmm. I don't know if I know how to answer that question. If we have a property, say it was purchased by the sponsor for $50 million.
00:26:01.600 | They're going to package it up in a DST. They're going to put a loan on it.
00:26:06.600 | They're going to offer it out to the investment community. And there is a markup on it, which is called load, L-O-A-D.
00:26:15.600 | And load is generally somewhere between 8 and 12 percent on top of the price they paid for the property.
00:26:22.600 | So let's say it's 10 percent. That means the $50 million property is offered to investors at $55 million.
00:26:31.600 | Usually about 50 percent of the $55 million is a loan. So the remainder would be the equity raise.
00:26:41.600 | And so 55 divided by 2. I'm doing it right now on the computer, so I'm exactly right.
00:26:49.600 | 27 and a half.
00:26:50.600 | 27 and a half million dollars raised. So your $100,000 – or your million dollars invested there, 27.5, is a 3.63 percent ownership of that offering. That's how it works.
00:27:12.600 | So the load, is that going to the corporation who's establishing it in the beginning? Who's receiving the load?
00:27:20.600 | The load goes to many people. Part of it is commissions. You know, like when you sell a house, the seller pays commissions to the real estate brokers.
00:27:31.600 | So that's part of it, a commission to me and to my broker-dealer. Part of it are the costs of the loans, which are hundreds and hundreds of thousands of dollars.
00:27:41.600 | The legal expenses, the marketing expenses. So all these different things go into load.
00:27:48.600 | And, you know, these properties, by and large, are being purchased by sponsors off-market through private relationships.
00:27:59.600 | You know, they're not buying properties off LoopNet. It's all a relationship business. And they're frequently buying properties below appraised value.
00:28:12.600 | And that value is transferred, if that's the case, it's transferred to the investor directly.
00:28:20.600 | But it's absolutely true in almost every case that load will cause the offering to be slightly higher than appraised value.
00:28:33.600 | So we are buying this offering, or the series of offerings, if we're diversifying, slightly higher than market value.
00:28:42.600 | And why would we want to do that? We would only want to do that for the benefits that we might potentially receive, like hands-off management,
00:28:51.600 | like better cash flow than I can get for myself, like better overall returns than I can get for myself.
00:29:00.600 | We're buying a basket of benefits.
00:29:04.600 | And so load is a sort of a controversial thing because, you know, back in the 2000s, some firms were very aggressive and the loads were exorbitant.
00:29:16.600 | And it was not good. It was a very bad thing. And those investors lost money because the people they were working with weren't aware of these things.
00:29:28.600 | The people who do what I do for a living, or didn't care, one or the other.
00:29:34.600 | So I work really hard to protect my clients in that way. Load is a big issue. We have to keep it under control.
00:29:41.600 | We have to keep loan size under control. That's the best way to help people not lose money.
00:29:46.600 | Why are the properties – let's say that somebody comes in, they're establishing a DST, a sponsor setting this up.
00:29:54.600 | Why do they go and take out a loan on 50% of the property when they could just simply finance it with investors?
00:30:01.600 | Why are they establishing the loans on the portfolio?
00:30:03.600 | Yeah. When we do a 1031 exchange – and this is a very good and very important question – when we do a 1031 exchange, we have to buy as much property as we sold.
00:30:13.600 | So if you sold a million-dollar duplex and you had a $500,000 loan on it, you're only going to get about $500,000 out in cash.
00:30:24.600 | You've got to go buy a million dollars' worth of property to have a 1031 exchange that is complete.
00:30:31.600 | You have to buy as much property as we sold.
00:30:35.600 | So the loans come prepackaged because folks need them because folks who are buying into DSTs – I would say easily 60%, 70% of my clientele will have some level of loan on the property they sold.
00:30:50.600 | Now, loans get people in trouble.
00:30:55.600 | Real quick, let me interrupt. So what you're saying is that if I – because I want to make sure I understand this point.
00:31:02.600 | I own a condo. I'm 55 years old. I own a condo on the water here in West Palm Beach.
00:31:08.600 | It's worth $2 million. I have – I bought it for a million dollars and I put a $500,000 loan against it.
00:31:19.600 | Now, it's worth $2 million. So I have a million dollars of taxable gain and I have a $500,000 loan on it, and then I'm going to get back a half a million dollars of my basis at the time.
00:31:29.600 | So I bring – so I've got $500,000 of loans and I've got $2 million of total capital.
00:31:34.600 | So are you saying that if I come – bring that to you and I say I'm going to sell this condo, I'm going to receive $2 million for it, that what I would do in order to maintain the $2 million is I would try to structure it within the DST exactly how it is currently in the condo where I'm being allocated $500,000 of loan and a million five of equity in the DST?
00:31:59.600 | Is that what you're saying?
00:32:00.600 | No, that's not what I'm saying.
00:32:02.600 | Okay.
00:32:03.600 | That's easily misunderstood. So it's a good question.
00:32:06.600 | The DST has a fixed loan on it.
00:32:09.600 | The rate is going to be whatever the rate is for the loan to value.
00:32:14.600 | If they got a 60% loan to value or a 50% loan to value, when you buy your shares into the trust, you are getting a 50% loan on top of the equity you put into it or a 60% loan.
00:32:30.600 | So the loan amount isn't varied by each investor.
00:32:34.600 | Each investor has the same loan allocated to them, although they're not responsible for it, non-recourse.
00:32:40.600 | They have the same ratio allocated to them.
00:32:44.600 | So it's not matched for each person in that way.
00:32:48.600 | But if you need – in the case you just offered, you need 25% loan to value or more.
00:32:54.600 | Why do I need that?
00:32:57.600 | To do an even exchange.
00:32:58.600 | If you have – you said you had a million five, but you had to buy $2 million worth of property.
00:33:05.600 | So that means you need – well, it would be 33%.
00:33:10.600 | 33% leverage in that case to get you from one five to two million.
00:33:17.600 | Got it.
00:33:18.600 | Okay.
00:33:19.600 | So we have to go buy $2 million worth of property.
00:33:23.600 | So any offering out there that has a loan to value over the factor, in this case it's about 30%, anything over that with loan to value, if it's at 50, it's 45, it's at 65, that's going to be acceptable for you.
00:33:40.600 | And if you buy more property than you need to, if you end up buying $2.5 million worth of property and all you need to buy is two for an even exchange,
00:33:52.600 | that new increment is a new depreciation schedule for you.
00:33:57.600 | If you buy two and a half and you needed to buy two, you're getting another half a million of potential depreciation.
00:34:05.600 | Right, right.
00:34:06.600 | So to summarize the answer to the loan question, the reason why the sponsor will go ahead and take a loan out on the portfolio is so that they can attract more investors
00:34:21.600 | because most investors are going to have some amount of leverage on their portfolio that they're getting out of.
00:34:30.600 | That's right.
00:34:31.600 | Got it.
00:34:32.600 | Now some people, it's happened to me twice in all these years I've been doing this, some people insist on all cash, no loan offerings.
00:34:39.600 | And they're very rare.
00:34:41.600 | They do exist, they're very rare.
00:34:44.600 | And in the case that I have a client who wants that, we're not going to be picking the best real estate for them to invest in.
00:34:52.600 | We're going to be picking whatever is an all cash offering, which is not the best real estate necessarily out of everything that's available to me.
00:35:02.600 | So loans can be good, but we just have to control the loan size and the loan terms.
00:35:08.600 | Earlier in the conversation you said that each of these properties has essentially a business plan.
00:35:14.600 | So what is the exit plan for my money?
00:35:18.600 | Well it depends.
00:35:20.600 | It depends on what the business strategy is.
00:35:23.600 | Are we doing a value add?
00:35:25.600 | Are we going in and buying a property that is in some way distressed?
00:35:29.600 | Maybe it's just been ignored, maybe it needs a facelift.
00:35:32.600 | Maybe the firm that owned it and we bought it from, maybe they weren't too careful about who they brought in as tenants.
00:35:39.600 | And they have a lot of slow payers.
00:35:42.600 | You know, what needs to be accomplished and how long is it going to take for us to do that?
00:35:50.600 | That kind of value add is probably going to be owned a little longer than a property that's bought directly from the developer.
00:36:00.600 | Brand new, a year old.
00:36:04.600 | That's probably going to be a little on the shorter time frame.
00:36:11.600 | So they're all different.
00:36:14.600 | And then we're buying portfolios of triple net properties.
00:36:19.600 | The liquidation is probably going to be to sell the whole portfolio to a REIT.
00:36:25.600 | Remember we're in the institutional world now.
00:36:27.600 | So who can afford to buy what we're selling?
00:36:30.600 | It's going to be a big institution.
00:36:32.600 | It's going to be a pension fund, an endowment, a REIT, some big institution like that.
00:36:39.600 | And that could happen quickly.
00:36:43.600 | Two or three years after you purchase into your portfolio of ten Walgreens, it could resell to a REIT.
00:36:50.600 | So they're all different.
00:36:53.600 | You know, the average, in my experience, five to seven year hold.
00:36:58.600 | So the trouble I'm getting into and the question I'm getting to is essentially my next investment decision.
00:37:09.600 | So I'm coming in. I'm buying into an illiquid investment.
00:37:13.600 | My purposes for buying into an illiquid investment is because the characteristics of the opportunity will allow me to save on my tax bill.
00:37:21.600 | Also, I'm hoping for significant appreciation opportunities, steady cash flow, some of the benefits of hands-off management, things like that.
00:37:31.600 | But seven years from now, this sponsor is going to sell out to a REIT.
00:37:36.600 | And so let's say they bought the building or the complex for $100 million and now the goal is they've increased it and they're going to sell it to a REIT for $160 million.
00:37:45.600 | So we're going to have some growth.
00:37:47.600 | At that point in time, do I receive back a check for the full amount and then I make a new investment decision?
00:37:54.600 | Is the DST dissolved?
00:37:55.600 | How do the mechanics of that work?
00:37:57.600 | Yeah.
00:37:58.600 | Well, the property is literally sold.
00:37:59.600 | And just like an escrow that we have to buy or sell a house, it takes longer usually to execute the sale.
00:38:07.600 | It can be 60 days, it can be 90 days, it can be even longer.
00:38:11.600 | But our decisions, once the sale is completed, are exactly the same as they are when we sold the duplex that we bought used to buy the DST seven years ago.
00:38:24.600 | Do we want to cash out and pay the taxes?
00:38:28.600 | Do we want a 1031 exchange?
00:38:30.600 | Those are our only two choices.
00:38:32.600 | And if we 1031 exchange, what do we want to buy next?
00:38:36.600 | Do we want to stick with DSTs?
00:38:38.600 | Do we want to go back into single-family house investing?
00:38:40.600 | Do we want to buy a condo on the beach and rent it for two years and move into it to retire?
00:38:45.600 | We have all the same options available.
00:38:48.600 | What are the mechanics for supervision?
00:38:53.600 | And let me go ahead and get to – let me lay out the concern that I have and you can answer it within that context.
00:39:01.600 | I see that this investment opportunity could have an excellent opportunity for the right fit, and that's what your job is all about.
00:39:09.600 | That's what the job of any professional salesperson is, is to make sure that there's an appropriate fit between the characteristics and attributes of the investment opportunity and the prospective investor.
00:39:20.600 | That's the essence of good professional selling and good professional service.
00:39:24.600 | That's the way to build a portfolio of clients that come back again and again, and your job and my job are easy.
00:39:31.600 | The challenge often with real estate opportunities, with REITs, with any kind of pooled investment opportunity like this is it seems to me that we always run the risk of the companies involved just simply using it as a way to gain access to capital without the same stringent requirements.
00:39:53.600 | So these companies – we've got a few of them involved.
00:39:58.600 | You'll have the construction company originally designing and building the property.
00:40:03.600 | You'll have the management company, and then you'll have the selling company that's engaged with it.
00:40:09.600 | All of these – and obviously every other employee and contractor associated with those functions.
00:40:14.600 | What they're doing is they're creating something, and their primary income is coming from those services that are being offered on the property.
00:40:24.600 | Now, in order to really get on the back end, in order for the construction company to make their money, they've got to have this product sold on the back end.
00:40:33.600 | There's a thin market for $100 million developments.
00:40:36.600 | It's not nearly as ready of a market as there is for $100,000 single-family houses.
00:40:41.600 | So by collateralizing – excuse me – by collateralizing it, they're able to break it up and to have a broader market.
00:40:50.600 | Now, of course, here we're still dealing in the accredited investor marketplace, which is much smaller.
00:40:55.600 | But it's a much bigger market than the number of investors who are ready to buy $100 million properties.
00:41:00.600 | So this is a huge advantage for everybody who's involved in running the property, in selling the property, in building the property.
00:41:09.600 | The concern that I have is that it's easy for the expenses to get a little bit out of hand.
00:41:14.600 | It's easy for things to get a little squishy, and the individual investor has very little leverage once they're in.
00:41:21.600 | Now, of course, a big component of that is the service that you're offering, properly selecting the property, selecting the sponsor.
00:41:30.600 | The sponsor wants to have a good reputation, et cetera.
00:41:33.600 | But are there any mechanisms for actual supervision and accountability for the individual investor?
00:41:42.600 | Well, the investor owns the property.
00:41:46.600 | So there is for every offering, the sponsor has investor services department whose job it is to answer any and all questions that the investor has because the investor is the owner.
00:41:58.600 | If the investor doesn't like what's going on, reads the reports and sees a problem, hears a conference call and sees a problem,
00:42:06.600 | they have the opportunity to certainly give their advice, to speak directly to the asset manager or the management of the sponsor, in general, the whole staff.
00:42:16.600 | All of these people are available to the investor.
00:42:19.600 | That's not why people are buying DSTs.
00:42:22.600 | They're buying DSTs so they don't have to manage it.
00:42:25.600 | But what you're saying is, you know, if we have a market turn or if we end up working with someone who's distractible, how can we control that?
00:42:37.600 | I mean, ultimately, the way we control everything in our country is by suing people, suing, suing, suing.
00:42:43.600 | So that's our final control.
00:42:46.600 | But the access to everybody who's managing the property, everyone who's affecting the property, it's totally transparent to the investor.
00:42:55.600 | The trick in everything you've just asked, and it's a reasonable concern, is to play in the sandbox with the right people, to pick people who are established, have terrific track records, decades of experience.
00:43:12.600 | And then once you've picked who you're going to work with, what properties do they have that you like?
00:43:20.600 | That's a whole different list of how to select things.
00:43:23.600 | But it really is all about people.
00:43:26.600 | And, you know, to this point, it's really important to my investors – well, it's important to me that my investors know their sponsors pretty well before they invest.
00:43:39.600 | I take groups of investors down to L.A. for a day of meetings, and one day we go see three sponsors, and we learn about their business strategies, their track records, and what they have available to invest in.
00:43:55.600 | And at the end of a day of meetings, the clients, the investors, always know a lot more.
00:44:03.600 | They always feel a lot better at having seen the people and developed some level of trust because, you know, trust is what it's all about fundamentally.
00:44:14.600 | That's one of the reasons I wrote the book, is to make it clear to everyone what my philosophy is about buying property, the kinds of things that I talk to folks about, about tax shelters, you know, and diversification and estate planning.
00:44:33.600 | Because this isn't sales. It's investment advisory.
00:44:37.600 | It's not just sales.
00:44:41.600 | So that's my answer to that.
00:44:44.600 | - Leslie, how did you – you mentioned that this was your third career.
00:44:48.600 | How did you wind up moving into this type of business?
00:44:52.600 | - Yeah, it's pretty obscure, isn't it?
00:44:54.600 | - Yeah, it's extremely obscure. I'm fascinated by the story.
00:44:56.600 | - Yeah. Well, the easy answer to that is the dot-com bust in 2001.
00:45:04.600 | I had been a consultant, and of course when you have an entire industry slammed the way it was then, the first people to go were the consultants.
00:45:14.600 | And I was a consultant.
00:45:16.600 | So it was 2001. I was working for Visa and 3Com and a couple of other companies, and all the consultants were like, "So now what do I do?"
00:45:25.600 | It was one of those situations.
00:45:28.600 | And ever since I was in my 30s at this time, 2001, I was 43, 44.
00:45:36.600 | Back in my 30s, I wanted to be a realtor.
00:45:39.600 | I wanted to get involved in real estate.
00:45:41.600 | I just didn't do it.
00:45:43.600 | So now I did it. That's the easy answer.
00:45:46.600 | And all the skills I've developed in banking, financial services, I was a credit officer.
00:45:52.600 | I was a marketing director with Citicorp, with American Express.
00:45:56.600 | Those were really important skills to bring to this real estate investing discipline.
00:46:03.600 | So it's made a big difference.
00:46:05.600 | - So did you start as--go down to the local RE/MAX office and say, "Hey, I want to get an agent," and then you met somebody who was doing this?
00:46:13.600 | Or how did you find out about this specific specialty?
00:46:16.600 | - It was a real evolution.
00:46:18.600 | I went to Cobol Banker in Palo Alto, in the Moose area, Silicon Valley, and signed up with Cobol Banker.
00:46:25.600 | The manager looked at my background.
00:46:26.600 | He said, "You should work with investors."
00:46:28.600 | I said, "Well, I don't know much about investors."
00:46:31.600 | He said, "Well, you have all this financial background. You should work with investors."
00:46:34.600 | So I worked with investors.
00:46:36.600 | Nobody else was working with investors.
00:46:38.600 | I was a top 100 realtor with Cobol Banker in 16 months of beginning just because I chose a marketplace nobody wanted to work with.
00:46:48.600 | And that led to learning about 1031 Exchange, which led me to meet a man named Ron Ricard from IPX, Investment Property Exchange, who introduced me to syndicated real estate.
00:47:03.600 | And that's how I got into syndicated real estate back in 2004.
00:47:08.600 | - That's great.
00:47:09.600 | And do you have--I mean, how many competitors do you have across the country?
00:47:12.600 | Do you have a lot or a few?
00:47:14.600 | - It's funny.
00:47:15.600 | There's not many people who do this full-time.
00:47:18.600 | Anybody with a securities license can sell this stuff, and that's what they're doing.
00:47:23.600 | They're selling this stuff.
00:47:25.600 | But there's only--I would estimate there are fewer than 50 people in the country who do this full-time and actually have any real estate credentials to back up what they're doing.
00:47:38.600 | But, you know, the market--any financial planner can offer these products.
00:47:44.600 | Now, I'll tell you, being a real estate expert, I don't think you want me managing your retirement account because I'm going to screw it up.
00:47:54.600 | I know real estate.
00:47:56.600 | And my feeling is, you know, when you want to invest in DSTs, go to one of these people who knows about real estate, not a generalist financial planner.
00:48:07.600 | Because knowing the people, knowing the players, knowing the history of what's going on in this industry is really, really important.
00:48:14.600 | - Right, right.
00:48:15.600 | Well, it's extremely important because--and that was why I voiced the objections.
00:48:21.600 | The risk is primarily all on the investor.
00:48:26.600 | And there is--there are returns, which in an ideal world are going to compensate the investor for the risk they're taking.
00:48:35.600 | But if the property--if we buy the property for $100 million, we do something poorly, we get hit with lawsuits by our employees, and we face a downturn in the marketplace.
00:48:46.600 | Now, it's worth $50 million.
00:48:48.600 | Well, the construction company got--they got paid.
00:48:54.600 | The management company, they're getting paid all the way through.
00:48:58.600 | The bank is going to call the loan.
00:48:59.600 | They're going to get paid because they've got a first position on the value of the property.
00:49:03.600 | And the investor is the one who has no collateral and no benefit on the back end.
00:49:08.600 | So because the shares become worthless and it was a no liquid market anyway.
00:49:13.600 | So all of the risk is on the investor.
00:49:15.600 | So all of the due diligence has to be on the actual individual deal because the individual deal needs a track record.
00:49:23.600 | All of those agents who are involved need a track record.
00:49:28.600 | So there's got to be a very careful selection in order to mitigate that risk.
00:49:32.600 | Yeah.
00:49:33.600 | But all those risks and all those people making money along the way and the investor holding the bag at the end of it, they're all the same if you own a house or you own a DST.
00:49:42.600 | It's real estate risk.
00:49:44.600 | To a degree, the difference is with the house, I can fire one contractor, hire another.
00:49:52.600 | I have active control over the property.
00:49:55.600 | I also have active responsibility, but I have active control.
00:49:59.600 | I can come in – if I own a $10 million commercial property that's not working, I can come in.
00:50:05.600 | I can end leases.
00:50:06.600 | I can market the property to companies.
00:50:08.600 | I can adjust it.
00:50:10.600 | I have control.
00:50:11.600 | I may not have capacity, and that would be a major problem.
00:50:14.600 | If I don't have capacity, I'm not in that business.
00:50:16.600 | But at least I have control, whereas in a DST, I don't have that control.
00:50:20.600 | I have to trust the professional management company to do that job effectively.
00:50:24.600 | Yeah, that's true.
00:50:25.600 | But I guess the example you gave was about a market downturn and properties worth less than the loan now or whatever.
00:50:32.600 | Correct.
00:50:33.600 | That could happen to you in any real estate.
00:50:35.600 | Right.
00:50:36.600 | And so when we make any investment of any sort, there's risk.
00:50:40.600 | In real estate, how much money can you lose?
00:50:42.600 | You can lose everything you put into it in any kind of real estate.
00:50:45.600 | Absolutely.
00:50:46.600 | What are the chances of losing everything?
00:50:48.600 | Not that big, but there is a chance.
00:50:51.600 | And people need to be aware.
00:50:55.600 | People ask me, "Well, Leslie, how much money could I lose?"
00:50:58.600 | Well, how much are you putting in?
00:51:00.600 | That's the true answer.
00:51:03.600 | And it's the answer if you go buy a stock, and it's not the answer if you go buy a T-bill, I hope.
00:51:09.600 | We're not in that situation yet in our country.
00:51:14.600 | But whenever you move up the risk profile, you have the chance of losing all of it.
00:51:20.600 | Right.
00:51:21.600 | So that's why we have to be so careful.
00:51:23.600 | Right.
00:51:24.600 | I think -- and to your point, 100%, yes, there's always that risk, and there's always a risk of losing all of your money, and it's very important.
00:51:32.600 | I think very few people often consider that.
00:51:35.600 | Few people think about that.
00:51:37.600 | Because investing has become so disconnected from the average person, the average person doesn't have any idea.
00:51:47.600 | Unlike the days when -- perhaps I'm not sure these ever really existed, but unlike the days where you might see your dad pull out the stock section of the local newspaper, read the ticker symbol, and then go and check to see what that company's debt load was or pay attention to the news stories.
00:52:06.600 | Those days are effectively gone for the vast majority of people.
00:52:09.600 | So for most people, investing is something that they do blindly, and the only time they feel the impact of the investment risk is when the market goes wonky and they open their 401(k) statement and all of a sudden it's down by 25%.
00:52:23.600 | So I'm not being unfair to real estate by pointing these out.
00:52:28.600 | These risks exist in every investment opportunity.
00:52:34.600 | But the risks are different depending on how you do it.
00:52:38.600 | And you get benefits and you get advantages.
00:52:41.600 | I could bring you $30 million today and assuming I were suitable, blah, blah, blah, we found everything, you could have my money invested effectively by the end of the week.
00:52:50.600 | But it's a much more challenging thing for me to say, "Where am I going to go and put my $30 million and I got a week to do it?"
00:52:57.600 | Right. Oh, yeah.
00:52:59.600 | And it is true that being up to my eyeballs in this industry, I know exactly what's going on today all over the place.
00:53:07.600 | And if somebody needs help quickly, I can help them quickly.
00:53:10.600 | But I'm still only going to offer them what I believe in.
00:53:12.600 | And that is different from some people out there who do what I do for a living.
00:53:17.600 | That's how you build a business that exists for the long term.
00:53:20.600 | Leslie, tell us where do people buy your book and tell us about any websites that you want to share with the audience, please.
00:53:26.600 | Thank you. The book is cashing in tax-free.
00:53:29.600 | It's available on Amazon.
00:53:31.600 | My website is archerinvestors.com and I'm available to help as you need me.
00:53:42.600 | I really appreciate this opportunity to speak with you. Thank you so much.
00:53:46.600 | For sure. It's an interesting topic and I like to profile interesting things like that.
00:53:49.600 | That was why I brought you on.
00:53:52.600 | Who knows? Maybe somebody in my audience is that perfect client fit.
00:53:57.600 | That would be great.
00:53:58.600 | Thank you so much, Leslie. Have a great day.
00:54:00.600 | Thank you. Best of luck to you. Bye-bye.
00:54:05.600 | Thank you for listening to this episode of Radical Personal Finance.
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