7 Subtle Red Flags That Mean You Shouldn't Invest in That Deal | Ep 81

James: Have you ever looked at a deal and just felt that something didn't feel right? Well, we're gonna talk about that today on the Furlo Capital Real Estate Podcast, where we dive into the intricacies of passive real estate investing, and our mission is to equip people to invest wisely with their guts.

With their minds, everything, so that together we can build wealth while improving housing. And I know there's a middle section, but I can't remember it. And that's okay. That seems to be the new pattern. I can't say it all the way through. Yeah. Anyways, we want to equip people to mess wisely property. I people.

Jessi: May, maybe you're sleep deprived. Oh, I

James: could be sleep de we,

Jessi: we got a new puppy. It's like newborn phase again. Oh, word. Yes. And also that that feeling you're describing, I feel like is like when the puppy is not in the room and you don't know where it is and you're like I have this feeling that like he's doing something he's not supposed to do.

Something's not right.

James: Thankfully, right now he is on a little blanket right over there, chewing on a Kong. And so everything's good. So we can see him. So it's fine. That may not last. There

Jessi: are cords and he loves cords. Oh my gosh. He does love

James: cords, and I am very nervous. There's some XLR cables here that I'm like, well, yep.

Chew on this buddy. Slowly but surely he's learning. Here's another weird thing I got going on with my life, which makes sleep deprived even better, is I end up getting sick. Yeah. And my ear is totally like it got infected or something, and I can't hear out of it right now. Which is one thing, and so everything's mono.

But here's the other really weird part. Everything is slightly higher pitch now, so I feel like I'm talking like this. So strange. Yeah, it just, everything. And, and I have to like, I want to lower my voice to make it sound more normal, but I know that that's not, I'm bad, man. You're a petman. But I'm like, but I just, I don't know.

I feel like I'm talking really nasally. I'm like, ah, I'm not, but it's so funny. It's

Jessi: so weird. The, the weirder thing is. I also got sick. I think we shared this germ happens. I can't hear out of the, the same ear, and yet the filter that it gives me is more base. Huh, man. So I'm, it's just weird. Just, okay.

It messes with your. Auditory filtering or something. It

James: does, it does. Guy, just like Chuck is messing with guy, messing with the set, he's messing with the set. It's all good. That's right. What, what, what I actually wanna talk about, I'm so nervous. What I actually want to talk about is red flags, right? So sometimes you're looking at deals and it looks good until it's not.

Mm. Right? And so like, maybe you've got something and you're like, oh man, it's really strong. IRR. And it's in a great market, got a solid team, but like, something just feels off. Mm-hmm. And so it's not always that a a a, it's not always that a deal is going to be obviously bad. Mm-hmm. And honestly, if a sponsor's doing right, they're gonna make it look good.

Sure. And so you gotta, gotta, like, you gotta, so there's some subtle flags that you gotta pick up on. And so I want to talk about seven signs that the deal may not be right fit for you. Mm-hmm. So it's not necessarily that it's a bad deal, it's just not for you. Does that make sense?

Jessi: Sure. Yeah. And yeah.

'cause there might be certain specifics that just don't work for your finances, your timing, right. Whatever you're, whatever. Yeah. So, yeah, so we're, we'll talk about the seven.

James: Should be seven. Seven. There are seven subtle

Jessi: red flags. Okay. Seven subtle red flags. It's like a tongue twister. So starting off with this first one is, let's start with the most basic one, not understanding the business model.

So if you don't fully understand the business model, why is that so dangerous as a passive investor?

James: Yeah, so I had this situation where I'm looking at a sixplex right now and it's an interesting, it's an interesting deal. It's owned by a nonprofit. They're looking to just offload it. One of the units has some significant foundation issues.

One of the units isn't like perfect, ready to rent condition. The other ones are all in various stages of readiness. And, and I'll be honest, it took me a super long time to wrap my head around like, what are we doing with this thing? Interesting. How are we making money? Yeah. And part of it was I was gone.

And so my partner looked at it alone. Mm-hmm. And he sent some pictures, but like. I don't know. I was struggling to, he just knocked himself out. He was struggling. I was just struggling to wrap my head around what are we gonna do to make money? Is this a flip? Is this a long-term hold? Are we doing something super creative?

Is this a straightforward thing? Like I just couldn't figure it out. Like, okay, it needs a new roof, so it's gonna need some capital up front. Mm-hmm. So it feels like a flip. What are we gonna refinance it and bur it? It's six units, so it's technically commercial, but there's an existing loan on it. That part of it is consumable.

And so there's a whole bunch of different factors that, for me, I just like, I couldn't wrap my head around it. I was like, intuitively, I'm like, there's a good deal here. I know it's a good deal because they're asking way under market value, but. Is it like, what would have to happen to get it to be where it needs to be?

Like I, I just, I was struggling to wrap my head around it, and I think that can happen as a passive investor, if you are not able to, let's just say succinctly write in a paragraph, here's the plan for this thing.

Jessi: Yeah.

James: Right. Where we've done flips, right. Hey, we're gonna take this home that's not in great shape.

We're gonna invest a bunch of capital, make it better, resell it, boom, easy. You can explain that very simply. Or, Hey, we got this multi-family property. And it just, it hasn't been managed well, so we're gonna go in, manage it better, make some minor repairs and just, you know, increase that NOI over time.

Very easy. Okay. And you want to be able to explain things as the, as the passive investor, you wanna get to that point where you go, yeah, I understand it, and if you can't, it may not be

Jessi: a good deal for you. Yeah, which totally makes sense to me. You know, it's like if you had a plan. Even to just,

James: oh, that camera's where it is now.

Jessi: If you had a plan even you know, not even to do like a business deal with, like, if you were going to have, spend a large amount of money Yeah. You would want to know like, what is this being used for? What is it going to get me? Yeah. How am I, you know, how's money gonna get back? Where's it going? What am I getting for it?

So it kind of, it's like. I understand why this is the most basic one, right. Which if you can't see line of sight to like, I'm giving you my money and then you're gonna give me, you know, X, y, z return. Yeah. True. And you're gonna do this with the property. Perfect. Yeah. Got it. Mm-hmm. Mm-hmm. Like then, yeah, that should be a red flag.

Yeah. So, perfect. This one to me is very interesting. Mm-hmm. What if the sponsor, mm-hmm. Like if they are uncomfortable and kind of avoiding some questions that you're giving them. Oh, okay. Like how do you spot that as a red flag?

James: Yeah. Yeah. So sometimes like, yeah, like you said, they just kind of avoid the tough questions, right?

They're either they, they redirect or they get defensive, or their answers seem overly optimistic. Oh, I don't worry about it. It's gonna be great. You know, which I gotta be careful of. And and so what you gotta do in those situations is you really gotta press for the, like, what happens if something goes wrong?

Like ask those types of questions and you're interested not just in the answer itself, but the tone of the answer. Again, are they overly optimistic? Are they defensive? Like, are they just being too extreme on it? And that might be a situation where you're like, oh, all right. There's, there may not be something here, but I don't know if the sponsor knows it.

Interesting.

Jessi: Okay. Yeah. Yeah. You've gotta push a little bit, which yeah. Is why you created, I, I feel like it's what, it's one of the reasons why you created that document with all the questions. Yeah, yeah, yeah. You know, it's like, like good

James: deals only. Yeah. Due diligence checklist. Check it out for a little com.

Exactly.

Jessi: You can ask. And if they don't have answers, that should be a red flag. Yeah. You know? So even if you're not quite sure what questions to ask, then Yeah.

James: But I would say in general, if you're, you know, ask some downside stuff, Hey, what happens if this risk that makes sense? Whatever

Jessi: makes that makes sense.

Another subtle red flag could be if you're feeling kind of rushed. So let's talk about urgency. Like, why is that? Like you're feeling like I gotta make a decision, I gotta move forward, I gotta do something. Why is that a red flag?

James: Yeah. Which for the record sponsors like myself try to do try to rush.

We, we wanna create that feeding frenzy. Oh, okay. The hey, you're gonna miss out if you don't get events. Well,

Jessi: a sense of urgency.

James: Yeah. That's fair. Yeah. And so so like. Things are set up that way on purpose. Part of it's 'cause I don't want people spending forever trying to analyze it. I'm like, look, either it is a good deal.

Sure. Either it makes sense or it doesn't. Yeah. And so you know, ocean's 11, right? Either getting or out right now, not quite that bad, but, you know, pretty close. And but for you personally, that may just be like, oh dude, I can't do this in a week. If I'm like, I need the funds by Friday. Like, if you are not ready for it and you're gonna twist over backwards to make it happen and it's twisting you up in knots, like, yeah dude, just wait.

It's okay. Like there'll be another one out there. Yeah. Get yourself in a position where you could potentially pull the trigger fast, but but that's, that's also okay.

Jessi: Yeah. That, that kind of makes sense to me. It's like, it's kind of like to mitigate this, this potential red flag. Mm-hmm. It's like. Things you've said before is determining your criteria so that you can recognize a deal and take action fast.

Yeah, yeah. You know, so that it's not in the middle of it. You're like, ah, is this good? Is this what I want? I don't know. Yeah. And you might say some

James: rules, right? I never invest in less than seven days Yeah. Or whatever.

Jessi: Sure. I, I know that we've done that before. Not necessarily even in real estate, you know, but we've, we've set a timeline and it's like a timeline or a comfort line almost.

And it's, if this doesn't feel right. Even though it seems like a great deal, like we will pass and that is okay. Mm-hmm. Mm-hmm. And that's hard. Yeah. You know, if you're like, ah, but there's potential, there's something it's like, but yeah, if the timing is not right, if it's not the right deal, like that is okay.

Yep. It's okay to say no.

James: Yep. A hundred percent.

Jessi: So this next one is. It's like covering off the camera. This next one is about poor communication. Yeah. What does it tell you if the sponsor is like silent? If they go silent or they're vague about their answers.

James: Yeah. Which again, like that's not necessarily a, a very bad thing.

It's just indicative of how it's going to be the rest of time. I know I've invested in deals where I send out emails and like, they just never get answered. Yeah. You're like, man, I kind of wanted know, answer to that. Yeah. And you know, and I get it, right, like to some degree sponsors are busy. Mm-hmm.

They're doing stuff, they can't, they're not just sitting on their email and I don't want them just sitting on their email. Mm. But I'm also like, man, if I send a follow up and they don't get back to me. Right. Like, come on and. I hear something and for me it's like I'm not expecting within 24 hours. I, I am.

Like, within a week would be nice. Is

Jessi: that like a, a general timeframe that's acceptable? I mean, I, because to me I'm like, week doesn't, that's crazy. Like I, 24 hours doesn't seem, unreasonably not to get Well, it depends on what it is, right? If you

James: are, okay.

Jessi: All

James: right. Depends on what it's not. Get a full answer if the investment's already gone on.

And now you're like, Hey, I'm looking for an update to do something like that. Sure, yeah. Take a week, get back to me. I don't care. Interesting. Like, but if it's, Hey, I'm thinking about investing in this thing and you've asked for money in the next two weeks and you take a week to get back to me. Yeah, yeah.

That's like, or 24 hours even. Yeah. You're

Jessi: kind of squeezing my timeline, you know? And

James: so you just wanna pay attention to that. It depends. But like, 'cause I know when I'm actively fundraising, like mm-hmm. Yeah. I'll pick, I pick up like. My next available opportunity. Right. I am calling back or replying. Oh, for sure.

Or whatever. Yeah. When we're in the middle of a deal, I slow down a little bit. I'm not like joing on the spot and usually it's, they're asking a little bit more complicated types of question. I'm like, okay, I actually got like, lemme get an update on this and figure it out. Like for the lot that we're splitting, I also, when I had someone ask me a question about it, I was like, man, I don't actually know.

And so I had to talk to the surveyor, figure out from them, and it took me a couple days to get it and then I was able to answer the question. That makes sense. And I guess if I were absolutely perfect, I would send that initial note. Hey, got your question. Working on it,

Jessi: you know, going back Yeah, that's what I would expect is like, I don't, to, not necessarily an answer, but

James: it's hard because I'm kind of like, when I get that question working.

I am, I'm usually like, I'm forwarding it on pretty quickly to the next person, and I'm like, man, they get back to me quick. Like, I'm, I'm within that timeframe. Yeah. Yeah.

Jessi: You are kind of

James: so, I don't know. It's, it's debating, it's weird, which is why, again, if you're in the middle of investment, like it's okay if they're a little bit slower, but man, when you're evaluating a deal, man, they probably should be putting on top.

And if they're not, that either means, A, you're not important. B, the investment isn't important. Or C, like they don't know answers. They know. Yeah. And so there's, there's all sorts of things. Right. All right. All right. And so and I would test it. This is something I didn't do well. I think on one of mine was I didn't send an email to the guy in charge.

I was talking to someone else and he was responsive and still is responsive, but he is also like, I don't know the answers. Right. And it's the other guy. He's not necessarily, so in retrospect, I should have sent a message to him just to see, and I have a hunch he would never responded. And I'm be like, huh, that's weird.

I probably, I probably could have gotten talked into it anyways 'cause the other guy would've sold me on it. But sure. You know.

Jessi: Interesting.

James: Yeah, I don't think he knew either. So, which is another red flag, I guess.

Jessi: Yeah. Yeah. Yes. Alright. This next red flag, you can't clarify the downside scenario. So this one's kind of big, not understanding the downside.

What should passive investors be be looking for here from a sponsor when they're, when they're trying to. Clarify, like, well, what is a potential downside?

James: Yeah. So it's kinda related to that other one we talked about, like if you're asking 'em tough questions and, and it's also kind of the understanding of the business model, right?

Like part of that understanding and asking tough questions is like, man, what happens if this doesn't perform as per, you know, as expected? Like, what are we gonna

Jessi: do? Right? What's the plan B

James: or C? Yeah, yeah, exactly. Doesn't work. And you wanna ask stuff like, well, okay, in that situation, like who does get paid first?

What is the exit plan? Do we have other options that we can do to try to minimize the damage here? And so I think especially in this environment where there's a bunch of unknowns from a macroeconomic standpoint, which I feel like we've been saying this for 10 years, but whatever it seems more dynamic at this point.

I think it's important to know, yeah, you know what, if interest rates do end up skyrocketing on us, what are we gonna do about it? Or whatever. Mm-hmm. If material costs go up big time, what's gonna happen? And so if you can't articulate it, if you can't understand it, or it doesn't even seem like it's addressed.

Jessi: Yeah. That's a red flag. Yeah. Yeah. That totally makes sense. Knowing, knowing what questions to ask and knowing that your sponsor's not avoiding the hard things. Yeah. It's like it's a good thing.

James: Yeah. Which honestly, with like tools like chat CPT these days, like dude. Feed it the document and have it picture.

Jessi: Is there anything in here? Yeah, it looks weird. Yeah,

James: there risks. Anything I should be asked about? I'm like, it is pretty stinking good at like, it, it may not come up with the answer, but it's gonna find, give you places to look. Yeah, it's fantastic at that.

Jessi: I, it could probably help with this next one too.

Feeling like. Like the terms are lopsided. Yeah. What do lopsided terms look like? Even how do you tell if someone is like structuring things in favor of themselves? Too much and lessen your favor.

James: Yeah, yeah, yeah. No, exactly. And that, that should show up in returns and stuff and how those numbers look.

Jessi: Yeah. If you're like, the sponsor's getting 90% Yeah. I'm like, I mean, 2%, which, whatever happen.

James: That's a little extreme. But, and and you want, you just wanna watch out for both, right? Yeah. 'cause you have, you could have at the other end where the sponsors essentially paying them nothing until the very end to make the numbers work for the investors.

Like, we'll give you all the money 'cause you get a better IRR, which is great, but then they're gonna want to terminate the, or complete the investment a lot faster so they finally get paid. Which, you know, I mean, as long as you know it, sure, that's fine. But, but yeah, you wanna make sure that that they're not, that they're not getting paid first.

You know, it's a close second that you know, there aren't a lot of heavy upfront fees. So typically like an asset management fee is gonna be somewhere in that one to 3% range. Mm-hmm. Depend on where it was. There's gonna be an acquisition fee that's also gonna be in that one to 3% range. They usually are gonna have some sort of, the splits gonna be a little more complicated.

If's a straight split. It's the sponsors gonna get somewhere to 20 to 30%. If there's a, a waterfall, you might have the investors getting a preferred return. Somewhere in that six to 10% range. Mm-hmm. First, which means they do get all of the money. Mm-hmm. Except for whatever the, if the sponsors put in capital, they're part of that.

Mm-hmm. Initial group. And then and then there might be a split afterwards that again might be that 20 to 30% goes through the sponsor up until some return, overall return. Like an IR 15% is hit, then it might go to like 50 50 or something like that. We got a whole episode on waterfalls and Right. How complicated it can get.

Jessi: Yeah. Yeah. I remember

James: how gonna check it out.

Jessi: Chasing wa, that's the one. Yeah. And

James: so you just want to like. So I just rattled off some high level ratios. Yes. Just so you can, because I want you to be able to look at it and kind of go like, okay. All right. I kind of got an idea for, so

Jessi: I'm wondering this, this follow up question, I'm.

In my brain is like, okay, is there like a, like a spot or like a resource where I can go that's like, these are the general types of terms that you should be looking for? Hmm. Or is it like way too, too much of a range to do that with?

James: It's a little bit of a range. All right. I think, yeah,

Jessi: because I like there's average what I Rules of thumb's, some returns.

Sure. Yeah, yeah, yeah. I'm just like. I'm so visual. I'm like, man, I wish there was like a spreadsheet. I, I got my check mark. Like I

James: want an R-I-I-R-R that's in the 14%. I want a cash on cash that's in the 7%. I want an average annual return. That, what is that number? I dunno, I got it written down. I feel like that's also, that's a little bit higher maybe in like the, the 18, maybe 16% range.

Mm. And then and then your. Equity multiplier and those are like the four big measures. Okay. That one you want at least one and a half. It's usually gonna be in like the two per the two x range. Yeah. But there's no time value of money. So, like, for example, I got a deal that like, we're gonna hold onto it for the long term.

Yeah. And it's got an equity multiplier of like three of three and a half. Mm-hmm. So I'm saying, we're gonna take your a hundred grand and turn it into 350 grand, which is amazing. That's incredible. It's like also over three, 10 years. Yeah. And so, so the IRR is like 13, 14%. Mm-hmm. You know, 'cause 'cause it all comes at the very end.

Jessi: Yeah, it is. I mean, it is help helpful to have those rules of thumb because otherwise you're, you don't know how to evaluate things. You don't have anything to compare it to. Yeah. And so you're like, I have no idea. This is lopsided or if it's a good deal or a bad deal

James: when that's part of it too. You know, if you're not sure, like look at a bunch of deals, right?

Yeah. When we first got started, right. We looked at a hundred homes in the market. That's true. And the entire point of that was for us to get a feel for what the numbers were. Yeah. Do comps get

Jessi: really good at identifying? Do it as

James: a passive investor can be a little bit hard unless you have multiple sponsors that you're working with.

Sure. So, well you can,

Jessi: I, I mean, I would imagine some stuff

James: like us and we give you the guidelines and then, you know. Yeah.

Jessi: Or I would imagine you could ask your sponsor for some comps. Hopefully could trust, you know, the information that they need. Yeah,

James: yeah. But that's a red flag, right? Yeah. It just feels like, hmm.

I feel like there, yeah. It's like,

Jessi: hmm, if it seems like this is too good to be true for me, or that's my sponsor getting paid so much like Yeah. Yeah, yeah. Either way, lopsided in some direction. Yep. Yep. Alright. Last but not least. Yeah. If you just have that weird spidey sense of like, you feel something's off, which I can't quite pinpoint it.

Yep. How seriously should you take that as a passive investor if something's just like very

James: seriously. 'Cause at the end of the day, you're getting into a longish term relationship. Mm-hmm. Depending on what it's, right. If you're passively investing in a flip, all right. It's less than a year, but Yeah.

You know, if it's a syndication, you know, that's a three to 10 year. Yeah. It's a

Jessi: commitment. A

James: commitment, right? Mm-hmm. And so if there's something off, it's worth listening to. Mm-hmm. And it'd be nice to be able to identify what that is, right. And articulate it. That was my next question

Jessi: was like, well, how do you mitigate that?

Like, do you go, do you just be honest with your sponsor and you're like, something feels off. I don't know what it is, but

James: You could do that. Another one is go to another investor who, you know, is kind of a veteran investor. Mm-hmm. And say sense, Hey, I'm looking at this deal. Like, I can't tell. Yeah. Am I being overly cautious and too picky or Yeah.

What, what do you see here? Is there something here that I need to ask about? Makes and I, that makes sense. I mean, I love looking at deals and I've had people do that, not for bigger ones, but for smaller ones. Sure. Hey, James, check out this. I'm missing something. Yeah. Look at this thing. And I, I love walking people through that.

And I usually, I'm like, yeah, here's my framework. Let's go through it. And, and I'll run through the numbers and I'll say, okay, here's kinda what I'm looking for, blah, blah, blah. Yeah. And, and that usually helps them. Mm-hmm. Kind of figured out. And as a general rule, the answer was, yeah, your gut was right.

It's a marginal deal.

Jessi: Mm-hmm.

James: So, and you're trying to justify it and you like, and you know it.

Jessi: Mm-hmm.

James: And I'm usually like,

Jessi: yeah.

James: Like,

Jessi: oh yeah. I mean, we've all been there before when, like, I think it, it often comes up when we, when we want to overspend on something or indulge in something and it's like, ah, I, this.

Seems like it'd be really fun or really good. Right. Or have an upside, but yeah. Now's not, doesn't make sense for some reason or another. Correct. We try and justify it, so Yep, yep, yep. Yeah.

James: I have that struggle with my food every day.

Jessi: Paying attention to the, the gut feeling.

James: Yeah. So those are the, those are the seven.

It's different red flags. Again, just to kind of review 'em, it's if you don't fully understand the business model. Two, the sponsor is avoiding tough questions. Three. You just feel rushed through the process. Four. Questions that just go unanswered or delayed. Five, you just can't seem to clarify or visualize what that downside scenario is.

Six, the terms feel lopsided and then seven, just something feels off on your gut, you can't explain it. Yeah. Those are the red flags to be looking out for. And again, it's not just that you're necessarily looking for a good deal, you just looking for the right deal for you. And that's what some of these are.

It might still be a good deal for someone else just payment out for you. And so if you do want help, as we've already mentioned. Couple times figuring out what are those questions to ask and what are those areas to look into. I've got a really sweet due diligence guy. It's called Good Deals Only. So you can tell what we're going for and good deals for you only.

And so you could check that out on our website at furlo.com. You can also learn more about us and our investment thesis and the types of deals that we offer, both short term and long term. But yeah, that's what we got. So super fun. Yeah. Type of stuff. Sweet. Thanks for listening and have a great day.