Top Questions Passive Investors Must Ask About Business Plans and Projections | Ep 48

James: Welcome to 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 in both properties and people so that together we can build our wealth while improving housing. I'm James. This is my wife, Jessi.

Jessi: Hey, we save money.

James: Yeah

Jessi: I was kind of annoyed at first The neighbor kid I guess was walking around the neighborhood was like found this dog and that that's when we got home I got home with the kids I was like, oh my gosh, we got to get the piano. Why is there this random dog? Ah And then I was like, okay.

Okay. How would I feel if it was our dog? I would want someone to like take care of it for me and call me and do all the things so we called and Turned out like The humane, it had a humane society tag. Yeah, somehow they tracked the owner down and we got connected And I guess that the ID tag has a has has a code on it Yeah,

James: okay,

Jessi: and that like tracked who adopted it and whatever.

It was our neighbor. So

James: there you go.

Jessi: Felt good. Cool Sweet little pepper got returned. Oh

James: good. I'm so happy to hear that Yeah, it's good when I say sometimes, yes, it is hard when your plans don't go the way that you were thinking, but sometimes it ultimately ends up good for it. And today we're going to be talking about the business plans and projections specifically.

So we're continuing on. Taking our time on the whole due diligence piece. And this is part five of that, where when you are doing due diligence, it's important to look into all different aspects of a deal before you passively invest into it. And so today we're talking about, again, the business plan and projections.

And so other ones that exist are you want to, you want to ask a bunch of questions about that today. The sponsor and the property manager. You want to ask about the surrounding market, about the property itself. This is the business plan. You want to talk, you want to ask about the construction plan. You want to ask about the financing.

You want to ask about the legal documents. And I got them all nice. And so those are all the things that, that you really just want to check into. And so you got your questions, I

Jessi: do have my gave them to you.

James: And so what we're going to do is you're going to kind of roll through them. What makes sense?

What do you love? What questions do you have? And kind of go from there.

Jessi: Awesome. So the overarching question for this whole section is how conservative or realistic are the underlying assumptions on the significant determining factors of the property's performance. So say that sentence in like I don't know, a more simplified, like normal person way.

James: So the business plan, there's a, usually it's a massive spreadsheet with a whole bunch of numbers in there. And what you want to know is, are they reasonable and by how much? And another way to say it is, are they also conservative? And in what areas? Okay. That's what you're trying to figure out. So. You know, or is it someone just had fun with the spreadsheet and they just kind of went, you know what?

Yeah. They made it look like a really good number. So I'm going to put that in.

Jessi: Yeah. So you're, you're double checking that they actually thought through the numbers and made a plan for how this could be profitable to you.

James: Yeah.

Jessi: Yeah. Okay. So some different questions within that is where has a sponsor intentionally kept assumptions conservative?

James: Yeah.

Jessi: Why would you want to keep things conservative as opposed to like, The maximum benefit or something.

James: Yeah. Cause I've always said like, if the numbers look good when they're conservative, oh my gosh, like

Jessi: they're even better. Yeah. And

James: it really is. It's an under promise over deliver is the, that does feel better

Jessi: than.

Oh, well, we thought we were going to make this, but actually,

James: you want to

Jessi: go up, not down.

James: Correct. Okay. Yeah. That makes sense. Yeah. Yeah. And you want to ask, and they should know where, where they've done that. And like, usually when you ask me, I'm like, well, I did it where the rent values are. I was conservative in the sense that I thought there might be a lot of inflation going forward.

I'd like, so expenses were higher. Maybe rents didn't grow as much.

Jessi: Yeah.

James: Those are areas which I'm conservative. I'm conservative on how much I thought it would cost to do the rehab.

Jessi: I'm

James: conservative on the timing of how long I think it will all take to do. So they should have very specific areas, not just, Oh, you know, I took a conservative approach.

Jessi: Okay, tell me more. Okay, that makes sense. And then you kind of want to ask them what's the strategy. So what are some different types of strategies that they might?

James: Yeah. And so it's just important to know how they intended that, what the business model is, right? Like, are we doing a fix and flip? Is this a short term thing?

You're not going to have any tenants there versus say like a value add syndication where it's like, yeah, we're going to have a bunch of tenants. We're going to have someone managing it. We're going to have it for five years versus man, this is just a long term buy and hold. Are they anticipating doing a refinance?

And. And therefore, like maybe as an investor, you get your capital back and then it's just cashflow over time or they're going to be more like, no, we're going to sell it and you'll get a massive lump sum all at once. Those are things that you just want to know what's the, what's the business plan and at a high level they can, you know, they say, Oh, it's a fix and flip.

You go, okay. All right. All right. And you can start to fill in the gaps easier if you know what kind it is. Sure.

Jessi: That made me think of like a separate question. It's not necessarily in this list, but is there a standard, like, Okay. I don't know. Business plan form that, that like investors use to be like, here is my business plan.

Here's what it looks like. Here's the assumptions I'm making and here's how it kind of plays out. That way as an investor, I know what I'm looking at.

James: Yes. Are they

Jessi: all kind of

James: different? So there's two different ways that you can think about it. There are some cases where like there's some tools that you just go to the websites and you can, Buy 'em and use 'em.

And they're standard in that respect. How to evaluate a property. There's ones like BiggerPockets has the people like me, I'm always like underwhelmed by them. , but they're there fundamentally, they are a very fancy form of some sort of profit and loss statement where it's like you have rent as your income and maybe you have some other income that comes in there, like laundry units or whatever, but you have your income.

Mm-Hmm. . And then you have your expenses. Mm-Hmm. , which are gonna, all the way from insurance, taxes, maintenance, property management. Utilities, whatever. And maybe there's some other stuff in there. Subtract those out. Boom. You get a number. And then, Usually, and there's like, and we're going to spend some more money, a capital expense to, to make this better.

In which case we think it will either a improve the rent or B decrease some expense that we have. Maybe, I don't know, we're going to put in individual water meters everywhere. It's a lot of money, but now that entire line item is gone from our P and L and that kind of thing. And so, but fundamentally it's.

You got revenue at the top expenses, just like any business. And so a lot of them, there's some form of that and where they get tricky or can be more sophisticated is how well those inputs automatically adjust and react to each other. Like, for example, in mine, I have three columns. I have. I'm like, here's what they took, like what the seller told me their number.

So I have it. Then I have what I call in place. This is what it looks like the day that I buy it. Here's what I expect it to look like. And that's already, I'm usually more conservative on the vacancy rate than what they're telling me. And then I have, and once it's stabilized, once I do the thing I want to do to add the value, here's what I think it will look like.

Now for mine. Time passes in between the in place and the stabilized. And so I have, and I have an assumption for expenses and revenue increases, inflation essentially. And so I account for that in the passage of time. I don't assume that it's static. So there's things like that. It's fundamentally the same, but it's a little more sophisticated and bigger pockets, you know, calculators don't do that.

Jessi: Yeah. That makes sense. It's, it's, there's subtleties in there that you account for.

James: Yeah.

Jessi: So there's a couple questions on here about like vacancy and rent rates. Tell me like what those questions, what, what am I asking about when I'm asking about that? So

James: sometimes when you buy a property, especially a value add, rents are going to be low and our vacancies are going to be high.

And oftentimes in a business plan is a, well, we're going to raise rents and we're going to fix vacancy rates, you know? And so you just want to be like, tell me more, how are you going to do that?

Jessi: How

James: does that entail? I remember I was, when I was working for HP, I helped with the go to marketing strategy for this one product that they wanted to launch.

And it was very different product. Essentially mobile phones were now a thing and we had a whole bunch of printers out there that couldn't print from a phone. And it was this little dongle that you plugged into the USB and then it became. Wi Fi enabled and our VP, he, and we'd have, I was like, we're going to sell these many units.

It's like, awesome. How are you going to sell the first one? It's like, that's all I want to know. Tell me how you're going to sell one. And then I will believe you for how we're going to sell 40 million or whatever the number was. It was probably wasn't that many, but it was a lot. And like, that was all I cared about.

And so I think that's that same awesome. Glad you're going to raise the rents. So how are you going to do that? Yeah. What's your process? You know, and usually the answer is going to be somewhere like, well, I We're going to, when someone moves out, we're going to fix it up and then we're going to be able to charge more or we're going to do something else in Oregon.

It's very tricky because you can't just say, and we're going to raise rents, right? You have a cap. And so, and so that's, that has to play into the models on how it works. So I find for all of my, my timing, it's not like nine months, it's more like, and two years, this kind of happens through natural turnover, through some other incentive stuff.

Jessi: That makes sense.

James: It's tricky.

Jessi: So heading back to some of those KPIs. Yeah! Key Performance Indicators. Yep! Yes! I did it! Nice. That's kind of like what you were talking about with the tools and, like, the calculator things that are out there. Yeah. So Like you're asking your sponsor, what are the primary KPIs that you're looking at and the projections?

So walk me through what some of those might be and how I understand them.

James: Yeah, so so again, they might, I mean, they might tell you we're going to make a million dollars. Cool. Did I put in a thousand dollars or did I put in a hundred million dollars? You know, those are two very different returns. How do I determine this?

And so that's often what those KPIs are doing is they're giving you. The primary ones, then you have some secondary ones, but the primary ones, they're giving you more like ratios. So for example, like a classic one is your average annual return. It looks just like a return on investment calculation, but it's done over time.

Just an average of it. And so you can tell like, Oh yeah, okay. If I put in 50, 000 and I get an average annual return of 10%, you know, cool. That means I got five grand. on average

Jessi: every

James: year, you know, which is awesome. For syndications, it's usually not that during the whole period. And then it's just all, it's like a lump sum at the very end, which is why a measurement like the internal rate of return is super valuable because it accounts for that.

It says, yeah, cashflow. Tomorrow is worth less than cashflow today. And so you want to look at that too. And kind of like that kind of gives you a clue for, Oh, if the average annual return is nice and high relative to the IRR, that should tell you instantly, Ooh, almost all the cash flows come in later, which is pretty cool.

Yeah. There's other ones. The cash on cash is a classic one. It's that is your return that you get during the hold period. If you never sold the property, what would your return look like just from the cash flows coming off of it? That's the number that you and I cared a whole lot about when we first got started because we had the assumption we're never going to sell these things.

Jessi: Yeah.

James: And then the equity multiple, that's a simple ratio. If I put in this much money, how much more do I get? You know, if the answer is like a two X, if I put in 50, 000, that means I get 100, 000 when it's done.

Jessi: Okay.

James: So those are just some of the, again, they're, they're ratios, right? And it helps you compare different investments.

Jessi: So if I'm talking with a sponsor you know, I, I should have a fundamental understanding of each one of these, you know, as far as like what this number is telling me. Yeah. But My sponsor should be able to calculate each one of these accurately, right? Yes, okay, they should I mean that's kind of the assumption that I'm making here is saying okay You should have some of these key performance indicators for me.

I have your projection

James: I've had other people approach me about investing with them Like and talking to my investors to say, Hey guys, here's this project. Let's go in it. And I'm instantly like, yeah, gimme some of these KPIs. Yeah, I wanna know what they are and I wanna see your model and I wanna know where, like I very quickly go to these, go to this,

Jessi: the measurables.

James: And if they don't give 'em like, yeah, it's nonstarter. .

Jessi: Alright. Another question you might ask your sponsor is, what are the major risks of this offering? Yeah, that's a big one. So what are some potential. risks that I should be looking out for that they might bring up.

James: Yeah. Like, and that's such a big question because that's at the end of the day, investors, like they don't want to lose their money, which I get.

Jessi: And

James: I mean, they would rather do a bad deal where it breaks even than do a good deal where there's a high risk that they lose their money. And so and so yeah, you gotta be ready to, and it's just, and really what it is, it's you as a sponsor. Be like, yeah, I was able to look at this objectively and see where the risks are.

And you're going to find them all across the business plan. There's going to be a risk on the revenue side where we hit our numbers, right? There's going to be a risk on the expense side. Is there something coming up? Will taxes mess around with us? Will it be some sort of change that affects the, the, that side of it?

You're going to see another risk usually on the construction plan. You know, it's, it takes longer than we thought. It costs more than we thought. It wasn't as good as high quality as we thought. Like so those are going to be your general areas. And ideally what you see is this is a risk. Here's how we mitigated it.

No, things like that I think are.

Jessi: So the bigger, the bigger thing that you're asking is like, have you thought through possible risks and what you might do if they come up?

James: Yeah.

Jessi: That makes sense.

James: Yeah. And those are, I found those to be some of the more fun conversations that I have with investors because they're testing, right?

Yeah. What about this? Oh, a hundred percent. I've sat in meetings with that.

Jessi: Yeah.

James: And, yeah, it's just kind of fun. What if there's a

Jessi: major earthquake?

James: I, yeah, it's a legitimate question. One of the ones that I've answered is what happens if I die?

Jessi: Yeah.

James: That's a risk. I go, well, I got this thing called key man insurance that I get from my deals that it, there's a big payout if I do.

And it's enough to pay someone else to just dispose of the property, call it good. And everyone gets at least a guaranteed return from it. Yeah. And so. Yeah, there's things like that that you wanna have thought through.

Jessi: Yeah, it's all right.

James: It's a, it's a risk. It, it is a risk. It's not

Jessi: one that like jumped right to my head, but it is said, yeah, that's a risk.

Another question, a possible question is like, have you planned to have enough reserves in case something happens? Yeah. And so I think

James: you can see there's kind of a pattern here, right? Yeah. Have you thought about the bad stuff happen? Have you thought about

Jessi: this? What are you gonna do about it?

James: Yeah, I love in Jim Collins book, I believe it's great by choice.

He talks about a concept of productive paranoia. I think that's the one. And he talks specifically about how Bill Gates had that. When Microsoft was top of the world, it was like, he was like, we gotta look out guys, people are coming for us. And he was paranoid about all this stuff, but it was productive.

He was able to do stuff about it, and ultimately set himself up in a really good spot to avoid the death line, is how he talks about it. In terms of like, you lose your money, and you're done. You can't play the game anymore. And so that's what you as an investor are doing right here. You are practicing productive paranoia.

And so asking things like, do you have enough reserves? It's like, are you there just in case? We hope you never have to touch it. Sure. But which I build into all my deals and there's sometimes where it's just like, Oh my gosh, that's such a big number. But like, yeah, I'm,

Jessi: It's better in the end, because when you don't have to touch it, that's good.

James: You

Jessi: have the buffer. Yeah, exactly. You have the extra. And then, just this last area is thinking about, like, different fees or structuring fees and how that's included. So, you would probably want to ask your sponsor something like, Are the sponsor fees included in these projections and what does that look like?

So there's a bunch of kind of sub questions. So maybe touch on that a little bit. If someone were asking about fees,

James: yeah, cause there's different,

Jessi: there's different ways to structure it. I'm sure I was

James: talking about some of those bigger returns. There's different times in which you can calculate them.

Jessi: Like you

James: could have a project level internal rate of return.

Jessi: Okay,

James: but then you as an investor maybe only own a portion of it Like maybe your sponsor owns 20 percent you as the passive investors own 80 percent So you only get 80 percent of that IRR, but you're putting in 100 percent of the money. Mm hmm close to it And so the project rate of return isn't the same as yours.

And so it's just, you got to pay attention to which number am I reading? And sometimes it's unscrupulous sponsors. Sometimes it's just, they make a mistake, man. They grabbed the wrong number. Cause they are looking at all of them because I know I have them all in my spreadsheet. Cause I am curious about like, what is the project level at?

Cause that. Cause that informs one of my dials that I can play with in terms of the return on equity stuff. And so you just got to watch out for it. And yeah, and maybe they have a fee and they probably have a fee. And the question is, when does that number come in and are all those numbers calculated afterwards?

Mine's an easy like, yeah, it's all afterwards.

Jessi: So that just made me think I know my answer. If I were talking with a sponsor and I wanted to see some like behind the curtain, I guess, as to like, how did you do your calculations and what does it look like for the project versus me versus how much you're getting versus all the investors.

Like you as a sponsor, are you willing to share that with investors?

James: Oh yeah.

Jessi: Okay. I'm, I, that's, I mean, I would expect my sponsor to be I would be willing to share that. Otherwise I'd be like, what are you trying to hide? What do you not want me to know? You know, but yeah, I don't, I could see some sponsors being like, I don't want to show you everything.

Yeah.

James: I don't typically just hand out the spreadsheet. Sure. But

Jessi: if they have specific questions, but I will

James: usually make very long videos. Okay. Hey, let's walk through this.

Jessi: Yeah.

James: Here's. Here are my assumptions. Here's how I came to it. And for some of the bigger projects, like, those are half hour long videos.

And people watch the entire thing. I'm always like, whoa, okay, cool.

Jessi: I like the things

James: because I'm amazing at presenting, but.

Jessi: There's probably a piece of that. But, I mean, it's also an investment to them. Yeah, and so they're like, well, if I'm putting 50, 000, 100, 000 into this, I want to make sure that I'm getting the right returns, that I understand the investment, that I can trust that you did your due diligence.

And so that's good.

James: Yeah. And so that's usually, I find that's the most fruitful way to do it. Like, I'll just, I'll just walk through the spreadsheet.

Jessi: Let

James: me show it all to you.

Jessi: Yeah.

James: And here's

Jessi: the plan.

James: Yeah. And, and part of it is I do all the things I'm conservative. I feel good about it. I, I don't, there's nothing to hide.

And so I'm like, yeah, like,

Jessi: yeah.

James: Here it is, right? And there are places where I'm like, yeah, all right, maybe this isn't the most conservative thing ever. All right. Like, it's okay. Yeah, there's a risk. And so yeah, but I'm also like, but I feel like we can do this, you know, that kind of thing. So like a really good one is this is happening right now in Oregon is that there's a bunch of properties out there.

multifamilies where the owner pays for all the utilities because it's just, they're all in a single water, single sewer. They use big trash cans, dumpsters, that kind of thing. And the current thing that because rates are what they are and cap rates are super low and interest rates are high. One of the moves is to say we're going to start billing that back.

It's called rub ratio utility billing back to the tenants. And that's a way where it's suddenly like, dude, you can find tens of thousands of dollars a year just in that. And so you might say, you know, if you got 10 units and your water bill is a thousand bucks, you go, all right, cool. Everyone is now a hundred dollars towards water and you can do the same thing for trash.

Like sure. She's usually, usually split out, but that's something that's currently going through Oregon. I'll ask about a decade and then everyone will just be on the rub system and it won't matter anymore. And that opportunity will be gone, but at least for now, that's one that's there.

Jessi: Interesting.

James: It's a, bye.

Personally, I would love for a deal to make sense without having to do that. And then you can layer that on top and you go, sweet cherry on top. We added it, but the numbers don't work otherwise. And so that is one where I'm like, yeah, we're building that in. Is there a risk here that we're going to get our target rents plus this?

Yeah. That's the risk. This is the only way the math works out. So we have to do this

Jessi: and

James: I've done my research to mitigate by saying this community has a good enough income. There's enough people who are willing to pay for this and there's things that we can do from a community building or just community standpoint to make it a pleasure to live there.

And we have the software to make sure the building all happens like, you know, there's that kind of stuff. So that's kind of, that's kind of what that looks like overall.

Jessi: Nice. Yeah. I love that. I love it.

James: So that's the business plan, man.

Jessi: All right.

James: Oh, you thought we were talking all about spreadsheets and stuff.

Jessi: I'm good. Yeah. I kind of thought it was going to be more spreadsheet y.

James: More technical.

Jessi: More technical, but it's good. Just asking the questions, knowing what to look for and how to look for it.

James: And

Jessi: I'm going to say from now on that I practice productive paranoia instead of pessimism. There

James: you go. As long as it's genuinely productive.

Yes.

Jessi: Oh, it has to be measurable.

James: Oh man. We have to be

Jessi: moving forward, not just

James: stopping. Yes, exactly. Exactly. So there it is. Yeah. And we have an entire, this is like one part of an entire ebook that you can get from our website furlo.com and you can download it. It's free and it's got a ton of questions.

I think it's 196 questions total. And so feel free to check those out and hopefully it will help you as you are evaluating different fields as well. And if you enjoyed this along with yeah, you enjoyed this we would love it if you left a rating wherever it is that you listen to podcasts. And so, yeah, thanks for listening and have a great day.