March 18, 2024 • 40 mins
The legal component of commercial real estate investing can be one of the most important yet daunting elements of any beginner's first few deals. How do you protect yourself in a deal? How do you ensure you receive your fair share of the profit in a partnership? How do you set expectations with tenants and have the proper legal documentation to hold them accountable? In Episode 004, Patrick and Noelle are joined by Ron Rohde, a commercial real estate attorney and investor who has represented over $1B in commercial real estate transactions. Throughout the episode, Ron provides valuable insights into the legal aspects of commercial real estate investing and walks beginners through key legal considerations they should keep in mind throughout their first few deals. In this episode, you'll learn:
- Common mistakes in forming LLCs and PSAs and tips to avoid them.
- How beginners can familiarize themselves with the legal language in commercial leases.
- The concept of recourse vs. non-recourse debt and the implications for personal liability.
- Legal essentials when pulling in limited partners and the importance of proper legal structuring in commercial real estate.
- How your real estate may not be fully protected in some situations (even if you own the property in an LLC)
- And much more!
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Transcript
Episode Transcript
Available transcripts are automatically generated. Complete accuracy is not guaranteed.
(00:22):
Hello and welcome to the active commercialreal estate investing show brought to you
by the one and only school of commercialreal estate investing.
I'm Patrick.
And today we're joined with Ron Rohde, aseasoned real estate attorney specializing
in investment acquisitions, dispositions,and triple net leasing.
(00:42):
What distinguishes Ron is his unique roleas both a legal expert and a successful
industrial triple net investor.
He has represented over 1 billion in realestate transactions across diverse
property classes, including multifamily,industrial, and retail.
As a principal, he currently owns a robustportfolio comprising over 120 ,000 square
feet of industrial triple net propertieswith 15 acres of outdoor storage.
(01:07):
Whether you're new to investing or part ofan established group with hundreds of
units, Ron Rohde offers valuable insightsto help you via YouTube and Twitter.
Ron, welcome to the show and thank you somuch for joining us.
We're so grateful you're here today.
Thanks, Noelle.
Yeah, excited we could get this on thecalendar.
I know we've been trying for a while.
So.
Well, I feel like before we jump intoquestions, it would be good to start with
(01:31):
a little bit of your background.
So the how and the why you got started inreal estate investing and law.
Yeah, I think the how or the why, youknow, the why is I do it for profit and
for fun.
I think real estate is just one of thosethings that's enjoyable.
I love real estate.
(01:52):
It's all I do for work.
It's what I do for my personalinvestments.
And then
When I have any free time, I recordYouTube videos and I'm posting on Twitter.
So that's probably the why and it'sprofitable.
But my parents were investors and so theykind of instilled in me that I thought
(02:12):
when I had a job, I would just save upenough money and I would just buy a house.
That, you know, it was just kind ofingrained to me that I would just buy a
house once a year and just manage arental.
But...
After a while it became too much.
I was starting a young family.
I was starting the law firm.
I just didn't have time even with theproperty manager to manage this many
(02:35):
houses.
And so I sold everything and pivoted intoindustrial triple net investments, which
is what I do in my day job and never lookback and couldn't be happier.
Nice.
Yeah, that's a great segue into whatyou're currently doing, which is
practicing real estate law and investing.
(02:57):
And I think that combination, as we callthat in your bio, is very unique in a lot
of ways, a combination, because the legalcomponent of commercial real estate
investing is a very important component.
And so today we would love to break down.
for the beginning investor, some of thekey steps that they need to be thinking
(03:20):
about or working through as they look toget into commercial real estate investing.
So I'm curious, what essential steps doyou recommend active investors take to
clearly separate church and state, so tospeak, when it comes to their personal
lives and their personal assets, as wellas their commercial real estate investing
business or assets.
(03:41):
I think a lot of people coming fromresidential, there's a lot of debate or
there's a lot of chatter about, do I needLLCs or one LLC per property?
In commercial, it's generally a mucheasier decision because if you have a
loan, the lender is going to require anSPE, which is a single or special purpose
entity.
In order for them to fund the loan, youcan have one piece of property per LLC per
(04:05):
loan.
It's kind of period, end of story.
And it makes sense because it silos therisk, and if you have a partner such as a
lender or another equity partner, theydon't necessarily want to be a part of the
risk— operational risk —of anotherproperty that they're not aware of or not
handling.
And so,
to me, it always starts at that LLC levelfor commercial because if you're gonna
(04:30):
have a partner, lender or equity partner,you're going to have to have an SPE— one
per property.
It's very simple.
So you start with that, you create theLLC, you may make an offer.
The three major steps I would say is theLLC from your formation, the PSA, which is
your purchase and sales agreement, that'sa lot of the due diligence occurs in
(04:53):
commercial prior to closing.
Maybe it's post contract, but pre-closing, you've got to do a lot of work
in that time period, and then finally,your leases.
After you've closed on the property oreven prior to closing, you want to review
and make sure you understand your leaseswith your tenants because that is the
(05:13):
single source of all of your legal rightsand remedies, late fees, and penalties.
Everything derives from that documentbecause again, unlike residential, which
residential leasing has a lot of statutoryoverrides.
And I'm here in Texas, which is even alandlord friendly state, there are still a
(05:36):
lot of situations that your lease in aresidential situation doesn't need to be,
quote, ironclad.
It doesn't need to cover every singlepermutation because the statutory code
covers a lot of those gaps for you.
And it mandates a lot of things.
And so you can't, for example, charge a $5,000 termination fee.
They would probably find thatunconscionable.
(05:59):
And so in commercial, because you cancontract for anything that you want, it's
really critical that you understand thelease.
So that's what I would say is thebeginning and the end of legal LLC, PSA,
and understanding your lease.
And maybe we'll throw in loan docs if youhave a lender, but for the most part,
(06:22):
those are the three primary legal areas tostart with.
And when you talk about understanding yourlease, because obviously that is a binding
contract between you and whoever you'releasing out to and will be the thing
that's, I imagine, upheld in a court oflaw, should anything go wrong.
What are the steps you recommend peopletaking to make sure that they have the
(06:45):
proper language?
I mean, obviously contacting someone whounderstands real estate law, I would
imagine is the first step, but where canpeople find that information?
Should they look locally?
Should they look at the national level?
Yeah, so I think understanding your leasereally starts with the investor
themselves.
(07:06):
You know, these documents are written, Iwon't say in plain English, but they are
written to be very detailed and specific.
They're not meant to be confusing.
So my best clients, they can read leasesand they really understand them.
They can look for base rent, they can lookfor the term, they can look for
termination options.
(07:27):
So they should be able to understandthese,
there are plenty of leases, I would sayyou can just start by going on the
internet and just practicing and lookingat leases and seeing if you understand the
terms or what do you have questionsbecause that's a much better situation,
better for the investor in terms of timespent and delays as well as cost with your
(07:49):
attorney.
You don't want to just send him the leaseand say review this because ...
When we don't have clear instructions,we're just going to review everything top
to bottom to be very robust and thorough.
But the best investors say, hey, Ron, I'velooked at this lease.
The base term is pretty clear, therenewal, blah, blah, blah, all that's
good.
(08:09):
I have specific questions about theirpermitted use and what this would be
interpreted as and why is it written thatway.
That narrows my attention to say, "Okay,I'll skim still the other sections and I
might flag things that I think are crazyor way out of market, but if they draw my
attention to permitted use, I know thatthat's something I can focus on and spend
(08:32):
less time on other areas."
So that really saves the investor tworeally important pieces, which is time of
review as well as cost of the attorney.
Having the ability to read the lease, andagain, they're not complicated documents,
but you should be able to read them andunderstand specific paragraphs that you
have trouble with or you want moreclarification, and that ability to direct
(08:55):
your lawyer's attention is going to be awin-win for everybody.
that's really good advice there.
For the beginner investor who maybe isn'tas familiar with these types of leases and
language, for them to take advantage ofthat piece of advice, what would you
recommend they do or where do they startto become familiar with what type of
(09:18):
language should be expected within atriple net lease or any commercial lease
for that matter?
Yeah, for beginners, my advice is just tostart looking at multiple, multiple deals.
So whether these are online listed,depending on the state you're in, you may
have recorded memorandums of leases.
(09:40):
But the key is to try to just get exposureto as many lease documents as you can that
are within your market or subtype.
Again, I know that sometimes it's hard toget your hands on it, but I guarantee you
they do exist.
They get recorded in litigation.
They're in the sec.gov website.
So there are lots of places to get sampleleases, and you've just got to start
(10:03):
looking at them in your asset type, inyour industry, and start to see what are
the sections, because they do followtypical patterns.
And regarding the other two key componentsthat you mentioned, the LLC and the PSA,
what would you say are common mistakes yousee when people are forming those?
(10:28):
I'll go for the LLCs, people don'tunderstand that the operating agreement is
the only agreement between partners.
And that is your live and die agreement ifwe have partnership.
If it's a single member LLC, I'm much morepermissive.
You don't really need to do as muchbecause you're not gonna sue yourself.
(10:50):
However, if you have a partner,
and you have a bunch of these email chainswhere you guys talk about, "Oh, Patrick's
gonna do this.
I'm gonna do Y.
You're gonna put this money in.
Oh, okay, I fronted this.
Oh, this is a loan.
No, this is gonna count as equity." Youhave all these emails, but if it's not
reflected in the operating agreement,there's difficulty in getting that legally
enforceable.
(11:11):
And if you have a breakup and yourpartnership is forced to dissolve, it puts
everybody in a very bad spot.
You're probably gonna end up litigating todivide up
the equity piece of that LLC.
Mm-hmm.
And then similarly for the PSAs, whatwould you say are common mistakes you see
(11:32):
there?
Uh, PSAs, I usually can come in...
with prior to execution, even if it's kindof last minute.
And I fully recommend this.
I would say if you have a simple deal orif you're starting off, use some of the
promulgated forms.
There's no such thing as a standard PSA,same as no standard lease, no triple net
(11:56):
lease.
But there are certain commercialtransactional forms that you can use for
the acquisition.
And I would say start looking at those.
And it's a mistake not to use the form ifyou don't
every paragraph of a custom contract,right?
Because that's basically your alternative.
You either have a custom PDF contract,which is probably good for, I don't know,
(12:22):
30% of the deals, but it's just not customto your situation.
And then the alternative is to have aMicrosoft Word completely custom contract
that's drafted by an attorney, and thatwill be very clean and logical looking.
But it's really, I think it's harder toget started in a custom contract versus a
(12:45):
form.
So I would say, at least for beginninginvestors, look at the form, read every
paragraph, and see if you understand howto check the boxes.
If you don't know how to check every boxor what numbers to fill in, you've gotta
get some help.
You gotta get an attorney or maybe abroker.
(13:06):
I'm a big fan of relying on theprofessionals, but totally hear you and
think it's really good advice to make surethat you understand the language too,
because even if, Ron, you and I are inpartnership and I have you reviewing
something, I want to be able to understandthe language that you're talking back to
me in as well so that I can be bettereducated moving forward.
So I think that's great and I think it'salways a good idea to call a professional.
(13:30):
Yeah, real estate is a team sport,especially in commercial real estate.
And there's a big difference fromresidential where you're used to having a
agent or a broker do everything.
They, they tell you the sales price, theynegotiate, they look at the tenants, they
look at the lease, they fill out thecontract and they're a one-stop shop for
that 3% commission.
(13:51):
They do everything.
In commercial, you have such specializedroles that you may have an investment
sales broker, you have a debt broker, youhave your loan officer is different, and
then you have a lawyer.
And all three of those people, your CPA,property manager, your construction
manager, you cannot do all of thesefunctions to have one sales agent looking
(14:16):
at a house and be like, "Yep, 20 grand tofix that, we could rent it out for $3,000
a month, and here's a lease, and let mewrite up the contract.
You wanna pay $210k for this?
Okay, great." That process doesn't happenin commercial just because of the
expertise, and it's really a disadvantageif you think
that you can just have one person oryourself do all of those roles that I just
(14:39):
mentioned casually in commercial and ittakes time.
And I think that's kind of related to thePSA.
You've got to build enough time for yourdue diligence phase where you can
terminate because I see people come in.
We want to just summarize the number onemistake I see with people doing their own
contracts is too short of a due diligenceperiod.
(15:00):
They think they can do a quick closebecause
you know, it's a good looking property orit's not that bad.
And they don't have enough time to evenorder an ALTA survey.
And it just limits their choices prettydrastically.
What is the recommended period of timethat you typically like to see in a PSA?
(15:21):
So again, it's gonna vary by asset type,the size of the property, the age of the
property, how it's being used, andultimately kind of the lease too.
But we are seeing in this market probably60 days.
I think in the last two years, buyers hadto compete and they were doing 30 day due
(15:42):
diligence and you had to be really Johnnyon the Spot and order all your surveys,
order all your vendors, all your reports,day two of earnest money
so that you could hit 30 days and decide.
Now we can see 60.
If there's more value add, if you have toget more construction bids, it can be up
to 75, but 45 to 60 I would say is normal.
(16:04):
Okay, that's great.
A great general guideline to have in theback of your head as you're going through
this process.
Shifting gears a little bit, you've talkedabout creating an LLC, a PSA, and your
lease to get going.
How does the legal picture start to shiftwhen you start to pull in limited partners
(16:25):
into the picture?
What type of legal essentials do you seeas being absolutely critical for beginners
to get correct
right off the bat when they start pullingin LPs?
Yeah, so this is how do you form yourcapital stack when you find a deal?
And I think beginners really tend to maybeover-focus on what they don't have.
(16:51):
And what I mean by that is if you lack
subject matter expertise or if you don'thave a great concept of legal, of the way
the US laws work, eviction courts, peoplefocus on what they don't have because they
see it as a weakness.
And that's where partners, I recommend inthe capital stack, you either have solo,
(17:12):
which is just Ron stroking $2 million togo buy this property.
That's the extreme, full risk, but fullreward and full control and nobody to deal
with.
On the other extreme, you kind of hintedat LPs.
So that's gonna be like raising asyndication, doing a reg D, 506 offering.
These are security offerings.
(17:33):
That is the highest level of capitalraising from strangers that you don't
really know, doing an OM, an offeringmemorandum, PPM, private placement
memorandum, subscription agreement, allthat.
But in the middle, there's somethingcalled the active partnership,
or JV agreement, and that's what I usuallyadvise people.
(17:54):
You should at least be aware of this as analternative because maybe the three of us
want to go in on a deal and instead of mestroking a check for 2 million, we can
each go in for 630 or whatever, 633.
and it spreads the risk a lot more, butthen you also have active partners that
(18:14):
are recourse for the debt,
they're knowledgeable and they're able toparticipate in the operations or the due
diligence of the property.
And so in my scenario that I justoutlined, go with the 2 million raise, you
can stroke one person to have a check,deep pockets, full control, least amount
of operational legal risk.
(18:36):
On the middle is joint venture or active,and I really like this one because you're
not doing a securities raise, everybody isactive, they're typically spread
pro rata or pari passu for equitycontributions.
So maybe Patrick and Noelle you guys areat 800,000 each, and I'm 400k, whatever
(18:58):
that works out, but it's pari passu, andso you guys would have the lion's share,
and then I just take a lower spread.
But that can be a really good middleground for people starting off, because
they don't really want to be GPs, right?
You actually want somebody to help you
to be a sounding board and to help youmanage the property.
(19:19):
And another partner may really help withyour balance sheet if you're trying to
personally guarantee debt, for example.
It's more comforting to the lender ifwe've got three guarantors for personal
recourse on a debt.
So that's why, you know, when you'recoming up with your capital stack, you've
got a $5 million purchase price.
(19:39):
How are you gonna fill $5 million andmaybe even more, 5.1 if you have some
working capital or value add.
So 5.1 million plus closing costs plus duediligence fees.
How are we gonna raise that total amount?
3 million in debt and 2.1 in equity.
And then of that 2.1, where's it gonnacome from?
(20:01):
So that's a very simple document, but toyour point, if you're a beginner,
you need to understand where that's comingfrom because it's no longer a automatic
assumption that, hey, I'm myself, I'm justgonna buy this property.
That's fine in residential and there'splenty of people that do that.
And I did that for a while, but incommercial, just because the numbers are
(20:23):
higher and the amount of work is higher,there's a larger volume of work, it's nice
to spread it out.
So that's a very long answer to...
How do you formulate a capital stack as abeginner?
Yeah, thank you for providing the spectrumof risk.
I think that's incredibly helpful just tounderstand almost some of the pros and
(20:45):
cons from a high level on going soloversus JV versus doing a reg D raise.
You mentioned the notion of recourseversus non-recourse, and you put a fairly
positive light on doing
recourse debt.
I'm curious from a legal perspective, canyou dissect the concept of both recourse
(21:09):
and non-recourse debt?
And then as a personal investor, where youlike to source your debt or structure your
debt in that regard and why?
Yeah, so when I refer to recourse, it's apersonal guarantee from an individual that
promises to repay the bank for their costsassociated with the loan.
(21:33):
And
primarily, I think the most commonsituation would be, okay, we buy that
property for $5 million, the bank loans us$3 million, we have horrible issues,
tenant vacates, building gets damaged,whatever.
We have to sell the building and it's onlyworth, well, I guess this has to be worth
below $3 million because we guarantee thatthey get three, but we have our equity as
(21:56):
a cushion.
So
we would have to sell the property for netproceeds of 2.75, which if you're buying a
five million, we're talking about likealmost a 50% haircut on loss of value, and
it's dramatic, but we, the three of us,would have to reimburse the bank for that
(22:17):
shortfall.
So theoretically between 3 million and2.75, 250 would be on top of all the
equity that we lost.
But the idea is you are going to make thebank whole for the amount that they lent
out.
And I typically see it, you know, ithappens if there is just no occupancy or
(22:39):
the building gets damaged and we don't getinsurance for some reason and it's just
gonna cost too much.
Like what if it costs 3 million to rebuildand we didn't get insurance?
That's a situation where I may not say,"Hey guys, I'm not in to rebuild this
building out of pocket.
I would rather sell it for whatever we canget and pay the bank $80,000 instead of
(23:03):
tripling down, to rebuild withoutinsurance." Does that make sense?
And so.
That's what recourse means.
Unfortunately, if you default in some way,that's gonna include the bank's attorney's
fees, that's gonna include interest andlate fees and penalties.
And it can be fairly significant, but theidea is that you can't just give the keys
(23:23):
back to the lender and give them the deedand just walk away.
You have personal liability to make surethe sale happens.
You have a duty or you should befinancially motivated
to get the top sales price.
So we could probably have sold it for twomillion if we just gave them the keys, but
if we work hard, we could sell it for2.75, that sort of scenario.
(23:49):
And it's a big deal.
I think people should understand what apersonal guarantee means, how there's
limits to it.
You know, your net worth kind of driveshow much debt you can guarantee.
And there are limits.
And it's different with each bank.
Sometimes it's like a per bank exposurewhere I've got two loans with one bank
(24:11):
right now, and I was talking to them abouta third, and based on my net worth and the
amount of debt I have, they wouldn'textend another loan of another like two
and a half million dollars.
They said no, for me alone on a deal.
And so you just have to be aware of it asindividuals that you can't just sign a
bunch of personal guarantees if you don'thave the net worth behind it to back it
(24:34):
up.
So your alternative, and this nice segueto talk about non-recourse, you can also
approach those same banks, those samelenders and say, hey, same deal, same $5
million property, what would you offer fornon-recourse debt?
And typically what happens is they willdrop the LTV a little bit to cushion them
(24:59):
even more.
I mean, I think we had 60% LTV.
That's a pretty safe number.
Normally, they're going to be in their 70sor 75%, sometimes 80 when they're
aggressive.
But if you come to them and say you wantnon-recourse, they may drop to 50%, 55%.
And if the three of us say, hey, we havethe cash, we just don't want personal
(25:20):
guarantee.
That protects the bank, but it doesn'timpact our balance sheets that we have
contingent liabilities related to thesepersonal guarantees.
And so,
as a beginner, I think you're gonna haveto be personally guaranteed that.
So you should understand what it means foryour other assets.
(25:40):
Whether they're exempt from, I would saybankruptcy, but if you didn't have the
money, you could file personal bankruptcy.
But what assets do you get to keep?
Your 401k, your retirement, your primaryhome, two cars, your guns, jewelry,
clothes.
There's a lot of things that you can keep.
But what you don't keep is your otherinvestment properties if you filed
(26:02):
bankruptcy
for example.
So given the choice between recourse andnon-recourse, beginners are going to have
to do recourse because they just don'thave any credibility otherwise.
And then you can think about quicklytransitioning to non-recourse to kind of
protect your assets and limit yourdownside.
(26:23):
And can you elaborate on what you justmentioned about what you could potentially
keep in bankruptcy if you had to take outrecourse debt and defaulted?
Yeah.
So again, we'll stick to that like fivemillion scenario.
And let's say you levered up with a littlebit higher.
You know, let's say you got 80% financing.
So four million dollar loan.
(26:43):
And if you personally guarantee that andthe value drops to three million, you will
still, you know, you sell it and then thebank says you have a deficiency.
They're going to sue you for that deltabetween the loan amount plus their losses
minus the cash that you gave them from theclosing.
(27:04):
And what you do is that's basically anunsecured judgment and you file personal
bankruptcy and that will wipe out that, Idon't know, what's the loss?
So if it's just me, say it's like a $2million loss, right?
They loaned you four and you paid backtwo, that's a $2 million judgment.
They will wipe that, but you'll lose allyour other investments, but you get to
(27:24):
keep all the equity in your primary home,you get two cars, you get, you know, you
don't have to like,
be poverty-stricken.
You don't have to sell all your clothes.
You get to keep jewelry, certain number ofguns in Texas, that sort of thing.
But it's a pretty drastic response, butpeople should understand that might be
your best outcome if you don't have $2million somewhat liquid to be able to pay
(27:50):
it off.
What usually happens, I think, is that youwill be forced to liquidate all of your
other...
real estate or other investments, and thenyou try to pay down that two million.
But if it's not enough, you're gonna losethose assets one way or the other, right?
Either you're gonna sell it and try togive it to the bank, or you're gonna file
bankruptcy and lose it to the bankruptcy.
(28:13):
So that's when bankruptcy comes in.
as well to like talking about LLCs andhaving everything in an LLC or at least
one property per LLC that doesn'tnecessarily protect your properties then
in this instance, if you're talking abouta legal structure.
Right, so LLCs do not protect your LLCsfrom yourself.
(28:33):
If you have a personal judgment againstyou, that doesn't matter.
What the LLC does is it protects you fromthird party and your tenants from suing
you.
Because their recourse is limited to theLLC and also third party, we call them
like invitees or trespassers, the slip andfall people that walk onto your property
(28:55):
and get hurt, they don't
have access to suing you personally.
They can only sue the landlord LLC.
But you know that's maybe a perfectexample of if it's a non recourse the
banks recourse is limited to the assets oftheir borrower LLC and they would just eat
the two million dollar loss while you theborrower person get to keep all your other
(29:20):
assets.
Make sense.
on the inverse side of this, let's saythat the three of us have a joint venture
together.
We've taken out recourse debt and one ofus is in a car accident and the person
that we're in the car accident with suesone of us individually.
(29:43):
That JV property is still protected by theLLC, correct?
I mean, it's not protected.
It's not going to get sued, but yourinterest in the LLC of our joint venture
is an asset, and it's an individual assetof you, so that if you actually get a
(30:09):
judgment against you, it is subject to thecreditors of that lawsuit.
So the financial value, I will say, notthe operational control.
We don't wanna be partners with the guy'swife that got hurt in a car accident.
She doesn't get to vote with us, butfinancially, she's our partner, and she
(30:32):
may take that and try to sell it.
She might sell it to us.
She might sell it to somebody else,whatever.
But the idea is yes.
That's why you got to be very careful, Iguess, about individual actions that you
do.
I recommend umbrella insurance.
It is cheap.
Get it because in your scenario, you have$2 million of umbrella.
If you get sued personally, that umbrellainsurance is supposed to protect you from
(30:56):
non-contractual claims.
Again, lawyers talk about privity ofcontract, which is, "Do I have a legal
agreement with this person?" If I don't,
then they're considered just like a randomperson down the street.
How do you protect yourself?
Well, you don't have a contract with them,so you can't limit your liability.
(31:16):
But you can have umbrella insurance, whichcovers it.
But for everything else, you wanna makesure that it's signed in an LLC, so that
you can control and silo the damages.
I don't know if that answers yourquestion, but getting hit by a person from
a car accident does affect all of yourpersonal investments.
(31:37):
There is a solution though, you could moveyour interest into a trust, which gets it
out of your personal name, but then thisconversation is going down a very detailed
asset protection.
And for beginners, you don't wannaovercomplicate it.
I just want you guys to do deals first,make some money, and then worry about
asset protection.
But yes, there's some things that you cando to protect against hitting somebody in
(31:58):
your car, but then not subjecting yourpersonal real estate holdings to that
lawsuit.
Those would be separate.
Yeah.
And thank you for pointing that outbecause one thing that I think I've
learned thus far in our journey is thatthere are many different ways to put each
puzzle together.
It's not like each piece is, you know,predefined out of the box.
(32:22):
As your portfolio grows, these pieces willchange and there's ebb and flow and you
continually need to stay up to date andhave experts to help guide you in terms of
how to mitigate your risk and ensure thatyou're positioning yourself in as strong
of a position as possible.
Yeah, and I think for asset protection, Ialways give different answers.
(32:45):
If a client comes to me and they wannastart in commercial and they have a net
worth of $5 million, my answers aredifferent for them, as opposed to somebody
coming to me and saying, my net worth is$700,000, and I'm gonna put $200k of that
into real estate.
You can be a little bit more risk lovingif that's what your net worth is, because
(33:05):
you can kind of start over.
But somebody with five million, you've gotto be careful that you don't open yourself
up to liability without understanding therisk.
Yeah.
And in terms of partnering with people andthe legal risks that is associated with
that, do you have any, let's call themextreme cases that you could provide as
(33:29):
examples, just to highlight for beginners,why the legal component of investing is
important to take seriously?
Just when you're dealing with large sumsof money, real estate is interesting in
that it's very stable investment becauseyou're buying a tangible hard asset.
And that's what makes real estate capitalintensive.
(33:51):
But at the same time, I think it's lessvolatility but a higher entry price
because your floor is limited.
I mean, again, for the most part.
You could be investing in a business,right?
And if we bought a $5 million business,the value can go to zero.
The value can go negative with contingentliabilities and that sort of thing.
But with real estate, all of our examples,we're only talking about a percentage
(34:15):
loss.
There's a floor that the dirt value, thebuilding has some value, and that's what
the minimum is.
So,
because real estate is like that, I thinkthere's much more of an important emphasis
on the contracts because you're justdealing with larger sums and you need
clarity about how a partnership issupposed to operate, how it's supposed to
(34:36):
manage its funds, how it's supposed tohandle disputes, and ultimately how it's
supposed to dissolve.
You need to have clarity on that becausethere is almost always going to be assets
worth fighting over.
Again,
referring back to my business example, ifwe went together in partners in a business
and the whole thing exploded and ourpartnership fell apart, the value of that
(34:59):
business might go to zero, in which casewe're not really fighting anymore because
there's no assets, right?
There's piles, there's maybe someinventories.
We're not fighting over anything.
With real estate, I can pretty confidentlysay the value of 99% of people's
investments is not going to zero.
So what that means is there's always gonnabe some value there.
(35:22):
And candidly, it's probably gonna be 50,60, 70% of your purchase price.
That's a lot of money.
And so partners will always be fighting totry to figure out how to divvy up that
pie.
And it's just kind of the nature.
I mean, real estate is a little bit legalheavy.
We talked about the lease, but the leaseis critical.
(35:42):
That's the only way you're getting paid.
And some people will ascribe to the...
you're buying a stream of payments and thelease is the only thing that matters.
They could be renting a toothpick standand the lease, if they pay you $10,000 a
month, then that's the lease.
But yeah, I mean, I think ultimately it isreal estate if that lease gets terminated
(36:03):
for some reason and they say, well, it'sAmazon, they're not gonna terminate and
it's ironclad.
I'm like, yeah, well, stranger things havehappened, but if that does happen, what's
the market rent for that toothpick stand?
it's probably gonna be $500, not 10,000.
So you can't pay as if it's gonna be10,000.
So same thing for any other building.
I mean, that's an extreme, but payingabove market rent puts you at risk.
(36:27):
Good insight to have and you always, Imean, we probably get in too much of the
analysis paralysis, at least personallyfor Patrick and I, of thinking about these
things and how to protect yourself.
But I like what you said is like, get inthere, do a deal, figure it out.
I mean, for beginners, for me, probably inmy risk tolerance, I would say do a deal
that doesn't have a high level of risk,you know, if you're going to get started
(36:50):
so that you have those trial runs.
But if you're already investing in singlefamily homes
residential, you might have an idea ofwhat those things look like and, you know,
hurdles that you would just take andexponentially multiply if you're looking
into a bigger unit, whether it's multi,industrial, or any other type.
Yeah, and we didn't go through thisquestion, but what is commercial real
(37:14):
estate?
You know, multi-residential, I think froma lender perspective, they define it as
four units or more.
But candidly, if you're buying a six unit,it's not really commercial.
That's just managing a slightly biggerbuilding.
But, you know, if you get into the 18, 24,that's definitely a commercial.
You got to run that professionally.
(37:34):
But
multifamily, office, retail, multi-tenantretail, industrial, hotel, land, all of
these things are considered commercial.
And my only caveat to getting started is Idon't really like small commercial deals,
like the really small ones, like $600,000for this office condo.
(37:56):
Those are tough deals because they haveall of the fixed costs
of hiring the team that we talked about.
You got to find the specialist, got tohave the CPA, got to have this, got to pay
extra for the lawyer.
But none of the upside, because how muchprofit are you really going to make on an
office condo for $600k?
You would have a great deal if you boughtit for six and sold it for eight, but
(38:18):
you're not really making that much moneyif you have a $200,000 down payment.
So I think the smaller commercial, itreally has to start at a million for a
price point.
So you get a little bit of heft, you get alittle bit of size where the juice is
worth the squeeze for your attention, youhave an hourly return that whatever it is
(38:39):
you do.
So doing too small of commercial actuallyI think discourages people because they're
not going to chase and look into all theproblems or optimizing rent
when it's making a difference of $300 amonth, right?
It's kind of almost the same asresidential.
I'm sure there are people that buyresidential properties that are six or
(39:01):
seven or $800,000, and it's just a house.
But in commercial, you're gonna havecommercial insurance, you're gonna have an
LLC, you're gonna have all these costswith none of the upside.
So with that caveat, yes, just do a dealin the asset class in the market that you
wanna be in, and don't be afraid to justget
into it and you can always sell it.
(39:22):
Yeah.
Great point.
And like you said, 99% of what you'rebuying is not going to go down to zero.
So you're going to be able to make moneyback.
It's a really good thing to be able tofall back on.
But I know we've taken up a lot of yourtime and we're, I'm playing project
manager here since we're running short onthat.
But Ron, I just want to thank you so muchfor joining us.
(39:44):
It's been a pleasure.
We are so appreciative for all of yourinsights and your value and really hope
the listeners will find value in that aswell.
I know you do a lot of education, like yousaid, at the top of this on, on the side,
you record when you can as well.
So we're going to make sure to put all ofyour information in the show notes so that
people can reach out and they can learnmore from you outside of, of this podcast.
(40:09):
And thank you so much for joining ustoday.
Perfect, thank you guys for having me.
Hello and welcome to the active commercialreal estate investing show brought to you
by the one and only school of commercialreal estate investing.
I'm Patrick.
And today we're joined with Ron Rohde, aseasoned real estate attorney specializing
in investment acquisitions, dispositions,and triple net leasing.
(00:42):
What distinguishes Ron is his unique roleas both a legal expert and a successful
industrial triple net investor.
He has represented over 1 billion in realestate transactions across diverse
property classes, including multifamily,industrial, and retail.
As a principal, he currently owns a robustportfolio comprising over 120 ,000 square
feet of industrial triple net propertieswith 15 acres of outdoor storage.
(01:07):
Whether you're new to investing or part ofan established group with hundreds of
units, Ron Rohde offers valuable insightsto help you via YouTube and Twitter.
Ron, welcome to the show and thank you somuch for joining us.
We're so grateful you're here today.
Thanks, Noelle.
Yeah, excited we could get this on thecalendar.
I know we've been trying for a while.
So.
Well, I feel like before we jump intoquestions, it would be good to start with
(01:31):
a little bit of your background.
So the how and the why you got started inreal estate investing and law.
Yeah, I think the how or the why, youknow, the why is I do it for profit and
for fun.
I think real estate is just one of thosethings that's enjoyable.
I love real estate.
(01:52):
It's all I do for work.
It's what I do for my personalinvestments.
And then
When I have any free time, I recordYouTube videos and I'm posting on Twitter.
So that's probably the why and it'sprofitable.
But my parents were investors and so theykind of instilled in me that I thought
(02:12):
when I had a job, I would just save upenough money and I would just buy a house.
That, you know, it was just kind ofingrained to me that I would just buy a
house once a year and just manage arental.
But...
After a while it became too much.
I was starting a young family.
I was starting the law firm.
I just didn't have time even with theproperty manager to manage this many
(02:35):
houses.
And so I sold everything and pivoted intoindustrial triple net investments, which
is what I do in my day job and never lookback and couldn't be happier.
Nice.
Yeah, that's a great segue into whatyou're currently doing, which is
practicing real estate law and investing.
(02:57):
And I think that combination, as we callthat in your bio, is very unique in a lot
of ways, a combination, because the legalcomponent of commercial real estate
investing is a very important component.
And so today we would love to break down.
for the beginning investor, some of thekey steps that they need to be thinking
(03:20):
about or working through as they look toget into commercial real estate investing.
So I'm curious, what essential steps doyou recommend active investors take to
clearly separate church and state, so tospeak, when it comes to their personal
lives and their personal assets, as wellas their commercial real estate investing
business or assets.
(03:41):
I think a lot of people coming fromresidential, there's a lot of debate or
there's a lot of chatter about, do I needLLCs or one LLC per property?
In commercial, it's generally a mucheasier decision because if you have a
loan, the lender is going to require anSPE, which is a single or special purpose
entity.
In order for them to fund the loan, youcan have one piece of property per LLC per
(04:05):
loan.
It's kind of period, end of story.
And it makes sense because it silos therisk, and if you have a partner such as a
lender or another equity partner, theydon't necessarily want to be a part of the
risk— operational risk —of anotherproperty that they're not aware of or not
handling.
And so,
to me, it always starts at that LLC levelfor commercial because if you're gonna
(04:30):
have a partner, lender or equity partner,you're going to have to have an SPE— one
per property.
It's very simple.
So you start with that, you create theLLC, you may make an offer.
The three major steps I would say is theLLC from your formation, the PSA, which is
your purchase and sales agreement, that'sa lot of the due diligence occurs in
(04:53):
commercial prior to closing.
Maybe it's post contract, but pre-closing, you've got to do a lot of work
in that time period, and then finally,your leases.
After you've closed on the property oreven prior to closing, you want to review
and make sure you understand your leaseswith your tenants because that is the
(05:13):
single source of all of your legal rightsand remedies, late fees, and penalties.
Everything derives from that documentbecause again, unlike residential, which
residential leasing has a lot of statutoryoverrides.
And I'm here in Texas, which is even alandlord friendly state, there are still a
(05:36):
lot of situations that your lease in aresidential situation doesn't need to be,
quote, ironclad.
It doesn't need to cover every singlepermutation because the statutory code
covers a lot of those gaps for you.
And it mandates a lot of things.
And so you can't, for example, charge a $5,000 termination fee.
They would probably find thatunconscionable.
(05:59):
And so in commercial, because you cancontract for anything that you want, it's
really critical that you understand thelease.
So that's what I would say is thebeginning and the end of legal LLC, PSA,
and understanding your lease.
And maybe we'll throw in loan docs if youhave a lender, but for the most part,
(06:22):
those are the three primary legal areas tostart with.
And when you talk about understanding yourlease, because obviously that is a binding
contract between you and whoever you'releasing out to and will be the thing
that's, I imagine, upheld in a court oflaw, should anything go wrong.
What are the steps you recommend peopletaking to make sure that they have the
(06:45):
proper language?
I mean, obviously contacting someone whounderstands real estate law, I would
imagine is the first step, but where canpeople find that information?
Should they look locally?
Should they look at the national level?
Yeah, so I think understanding your leasereally starts with the investor
themselves.
(07:06):
You know, these documents are written, Iwon't say in plain English, but they are
written to be very detailed and specific.
They're not meant to be confusing.
So my best clients, they can read leasesand they really understand them.
They can look for base rent, they can lookfor the term, they can look for
termination options.
(07:27):
So they should be able to understandthese,
there are plenty of leases, I would sayyou can just start by going on the
internet and just practicing and lookingat leases and seeing if you understand the
terms or what do you have questionsbecause that's a much better situation,
better for the investor in terms of timespent and delays as well as cost with your
(07:49):
attorney.
You don't want to just send him the leaseand say review this because ...
When we don't have clear instructions,we're just going to review everything top
to bottom to be very robust and thorough.
But the best investors say, hey, Ron, I'velooked at this lease.
The base term is pretty clear, therenewal, blah, blah, blah, all that's
good.
(08:09):
I have specific questions about theirpermitted use and what this would be
interpreted as and why is it written thatway.
That narrows my attention to say, "Okay,I'll skim still the other sections and I
might flag things that I think are crazyor way out of market, but if they draw my
attention to permitted use, I know thatthat's something I can focus on and spend
(08:32):
less time on other areas."
So that really saves the investor tworeally important pieces, which is time of
review as well as cost of the attorney.
Having the ability to read the lease, andagain, they're not complicated documents,
but you should be able to read them andunderstand specific paragraphs that you
have trouble with or you want moreclarification, and that ability to direct
(08:55):
your lawyer's attention is going to be awin-win for everybody.
that's really good advice there.
For the beginner investor who maybe isn'tas familiar with these types of leases and
language, for them to take advantage ofthat piece of advice, what would you
recommend they do or where do they startto become familiar with what type of
(09:18):
language should be expected within atriple net lease or any commercial lease
for that matter?
Yeah, for beginners, my advice is just tostart looking at multiple, multiple deals.
So whether these are online listed,depending on the state you're in, you may
have recorded memorandums of leases.
(09:40):
But the key is to try to just get exposureto as many lease documents as you can that
are within your market or subtype.
Again, I know that sometimes it's hard toget your hands on it, but I guarantee you
they do exist.
They get recorded in litigation.
They're in the sec.gov website.
So there are lots of places to get sampleleases, and you've just got to start
(10:03):
looking at them in your asset type, inyour industry, and start to see what are
the sections, because they do followtypical patterns.
And regarding the other two key componentsthat you mentioned, the LLC and the PSA,
what would you say are common mistakes yousee when people are forming those?
(10:28):
I'll go for the LLCs, people don'tunderstand that the operating agreement is
the only agreement between partners.
And that is your live and die agreement ifwe have partnership.
If it's a single member LLC, I'm much morepermissive.
You don't really need to do as muchbecause you're not gonna sue yourself.
(10:50):
However, if you have a partner,
and you have a bunch of these email chainswhere you guys talk about, "Oh, Patrick's
gonna do this.
I'm gonna do Y.
You're gonna put this money in.
Oh, okay, I fronted this.
Oh, this is a loan.
No, this is gonna count as equity." Youhave all these emails, but if it's not
reflected in the operating agreement,there's difficulty in getting that legally
enforceable.
(11:11):
And if you have a breakup and yourpartnership is forced to dissolve, it puts
everybody in a very bad spot.
You're probably gonna end up litigating todivide up
the equity piece of that LLC.
Mm-hmm.
And then similarly for the PSAs, whatwould you say are common mistakes you see
(11:32):
there?
Uh, PSAs, I usually can come in...
with prior to execution, even if it's kindof last minute.
And I fully recommend this.
I would say if you have a simple deal orif you're starting off, use some of the
promulgated forms.
There's no such thing as a standard PSA,same as no standard lease, no triple net
(11:56):
lease.
But there are certain commercialtransactional forms that you can use for
the acquisition.
And I would say start looking at those.
And it's a mistake not to use the form ifyou don't
every paragraph of a custom contract,right?
Because that's basically your alternative.
You either have a custom PDF contract,which is probably good for, I don't know,
(12:22):
30% of the deals, but it's just not customto your situation.
And then the alternative is to have aMicrosoft Word completely custom contract
that's drafted by an attorney, and thatwill be very clean and logical looking.
But it's really, I think it's harder toget started in a custom contract versus a
(12:45):
form.
So I would say, at least for beginninginvestors, look at the form, read every
paragraph, and see if you understand howto check the boxes.
If you don't know how to check every boxor what numbers to fill in, you've gotta
get some help.
You gotta get an attorney or maybe abroker.
(13:06):
I'm a big fan of relying on theprofessionals, but totally hear you and
think it's really good advice to make surethat you understand the language too,
because even if, Ron, you and I are inpartnership and I have you reviewing
something, I want to be able to understandthe language that you're talking back to
me in as well so that I can be bettereducated moving forward.
So I think that's great and I think it'salways a good idea to call a professional.
(13:30):
Yeah, real estate is a team sport,especially in commercial real estate.
And there's a big difference fromresidential where you're used to having a
agent or a broker do everything.
They, they tell you the sales price, theynegotiate, they look at the tenants, they
look at the lease, they fill out thecontract and they're a one-stop shop for
that 3% commission.
(13:51):
They do everything.
In commercial, you have such specializedroles that you may have an investment
sales broker, you have a debt broker, youhave your loan officer is different, and
then you have a lawyer.
And all three of those people, your CPA,property manager, your construction
manager, you cannot do all of thesefunctions to have one sales agent looking
(14:16):
at a house and be like, "Yep, 20 grand tofix that, we could rent it out for $3,000
a month, and here's a lease, and let mewrite up the contract.
You wanna pay $210k for this?
Okay, great." That process doesn't happenin commercial just because of the
expertise, and it's really a disadvantageif you think
that you can just have one person oryourself do all of those roles that I just
(14:39):
mentioned casually in commercial and ittakes time.
And I think that's kind of related to thePSA.
You've got to build enough time for yourdue diligence phase where you can
terminate because I see people come in.
We want to just summarize the number onemistake I see with people doing their own
contracts is too short of a due diligenceperiod.
(15:00):
They think they can do a quick closebecause
you know, it's a good looking property orit's not that bad.
And they don't have enough time to evenorder an ALTA survey.
And it just limits their choices prettydrastically.
What is the recommended period of timethat you typically like to see in a PSA?
(15:21):
So again, it's gonna vary by asset type,the size of the property, the age of the
property, how it's being used, andultimately kind of the lease too.
But we are seeing in this market probably60 days.
I think in the last two years, buyers hadto compete and they were doing 30 day due
(15:42):
diligence and you had to be really Johnnyon the Spot and order all your surveys,
order all your vendors, all your reports,day two of earnest money
so that you could hit 30 days and decide.
Now we can see 60.
If there's more value add, if you have toget more construction bids, it can be up
to 75, but 45 to 60 I would say is normal.
(16:04):
Okay, that's great.
A great general guideline to have in theback of your head as you're going through
this process.
Shifting gears a little bit, you've talkedabout creating an LLC, a PSA, and your
lease to get going.
How does the legal picture start to shiftwhen you start to pull in limited partners
(16:25):
into the picture?
What type of legal essentials do you seeas being absolutely critical for beginners
to get correct
right off the bat when they start pullingin LPs?
Yeah, so this is how do you form yourcapital stack when you find a deal?
And I think beginners really tend to maybeover-focus on what they don't have.
(16:51):
And what I mean by that is if you lack
subject matter expertise or if you don'thave a great concept of legal, of the way
the US laws work, eviction courts, peoplefocus on what they don't have because they
see it as a weakness.
And that's where partners, I recommend inthe capital stack, you either have solo,
(17:12):
which is just Ron stroking $2 million togo buy this property.
That's the extreme, full risk, but fullreward and full control and nobody to deal
with.
On the other extreme, you kind of hintedat LPs.
So that's gonna be like raising asyndication, doing a reg D, 506 offering.
These are security offerings.
(17:33):
That is the highest level of capitalraising from strangers that you don't
really know, doing an OM, an offeringmemorandum, PPM, private placement
memorandum, subscription agreement, allthat.
But in the middle, there's somethingcalled the active partnership,
or JV agreement, and that's what I usuallyadvise people.
(17:54):
You should at least be aware of this as analternative because maybe the three of us
want to go in on a deal and instead of mestroking a check for 2 million, we can
each go in for 630 or whatever, 633.
and it spreads the risk a lot more, butthen you also have active partners that
(18:14):
are recourse for the debt,
they're knowledgeable and they're able toparticipate in the operations or the due
diligence of the property.
And so in my scenario that I justoutlined, go with the 2 million raise, you
can stroke one person to have a check,deep pockets, full control, least amount
of operational legal risk.
(18:36):
On the middle is joint venture or active,and I really like this one because you're
not doing a securities raise, everybody isactive, they're typically spread
pro rata or pari passu for equitycontributions.
So maybe Patrick and Noelle you guys areat 800,000 each, and I'm 400k, whatever
(18:58):
that works out, but it's pari passu, andso you guys would have the lion's share,
and then I just take a lower spread.
But that can be a really good middleground for people starting off, because
they don't really want to be GPs, right?
You actually want somebody to help you
to be a sounding board and to help youmanage the property.
(19:19):
And another partner may really help withyour balance sheet if you're trying to
personally guarantee debt, for example.
It's more comforting to the lender ifwe've got three guarantors for personal
recourse on a debt.
So that's why, you know, when you'recoming up with your capital stack, you've
got a $5 million purchase price.
(19:39):
How are you gonna fill $5 million andmaybe even more, 5.1 if you have some
working capital or value add.
So 5.1 million plus closing costs plus duediligence fees.
How are we gonna raise that total amount?
3 million in debt and 2.1 in equity.
And then of that 2.1, where's it gonnacome from?
(20:01):
So that's a very simple document, but toyour point, if you're a beginner,
you need to understand where that's comingfrom because it's no longer a automatic
assumption that, hey, I'm myself, I'm justgonna buy this property.
That's fine in residential and there'splenty of people that do that.
And I did that for a while, but incommercial, just because the numbers are
(20:23):
higher and the amount of work is higher,there's a larger volume of work, it's nice
to spread it out.
So that's a very long answer to...
How do you formulate a capital stack as abeginner?
Yeah, thank you for providing the spectrumof risk.
I think that's incredibly helpful just tounderstand almost some of the pros and
(20:45):
cons from a high level on going soloversus JV versus doing a reg D raise.
You mentioned the notion of recourseversus non-recourse, and you put a fairly
positive light on doing
recourse debt.
I'm curious from a legal perspective, canyou dissect the concept of both recourse
(21:09):
and non-recourse debt?
And then as a personal investor, where youlike to source your debt or structure your
debt in that regard and why?
Yeah, so when I refer to recourse, it's apersonal guarantee from an individual that
promises to repay the bank for their costsassociated with the loan.
(21:33):
And
primarily, I think the most commonsituation would be, okay, we buy that
property for $5 million, the bank loans us$3 million, we have horrible issues,
tenant vacates, building gets damaged,whatever.
We have to sell the building and it's onlyworth, well, I guess this has to be worth
below $3 million because we guarantee thatthey get three, but we have our equity as
(21:56):
a cushion.
So
we would have to sell the property for netproceeds of 2.75, which if you're buying a
five million, we're talking about likealmost a 50% haircut on loss of value, and
it's dramatic, but we, the three of us,would have to reimburse the bank for that
(22:17):
shortfall.
So theoretically between 3 million and2.75, 250 would be on top of all the
equity that we lost.
But the idea is you are going to make thebank whole for the amount that they lent
out.
And I typically see it, you know, ithappens if there is just no occupancy or
(22:39):
the building gets damaged and we don't getinsurance for some reason and it's just
gonna cost too much.
Like what if it costs 3 million to rebuildand we didn't get insurance?
That's a situation where I may not say,"Hey guys, I'm not in to rebuild this
building out of pocket.
I would rather sell it for whatever we canget and pay the bank $80,000 instead of
(23:03):
tripling down, to rebuild withoutinsurance." Does that make sense?
And so.
That's what recourse means.
Unfortunately, if you default in some way,that's gonna include the bank's attorney's
fees, that's gonna include interest andlate fees and penalties.
And it can be fairly significant, but theidea is that you can't just give the keys
(23:23):
back to the lender and give them the deedand just walk away.
You have personal liability to make surethe sale happens.
You have a duty or you should befinancially motivated
to get the top sales price.
So we could probably have sold it for twomillion if we just gave them the keys, but
if we work hard, we could sell it for2.75, that sort of scenario.
(23:49):
And it's a big deal.
I think people should understand what apersonal guarantee means, how there's
limits to it.
You know, your net worth kind of driveshow much debt you can guarantee.
And there are limits.
And it's different with each bank.
Sometimes it's like a per bank exposurewhere I've got two loans with one bank
(24:11):
right now, and I was talking to them abouta third, and based on my net worth and the
amount of debt I have, they wouldn'textend another loan of another like two
and a half million dollars.
They said no, for me alone on a deal.
And so you just have to be aware of it asindividuals that you can't just sign a
bunch of personal guarantees if you don'thave the net worth behind it to back it
(24:34):
up.
So your alternative, and this nice segueto talk about non-recourse, you can also
approach those same banks, those samelenders and say, hey, same deal, same $5
million property, what would you offer fornon-recourse debt?
And typically what happens is they willdrop the LTV a little bit to cushion them
(24:59):
even more.
I mean, I think we had 60% LTV.
That's a pretty safe number.
Normally, they're going to be in their 70sor 75%, sometimes 80 when they're
aggressive.
But if you come to them and say you wantnon-recourse, they may drop to 50%, 55%.
And if the three of us say, hey, we havethe cash, we just don't want personal
(25:20):
guarantee.
That protects the bank, but it doesn'timpact our balance sheets that we have
contingent liabilities related to thesepersonal guarantees.
And so,
as a beginner, I think you're gonna haveto be personally guaranteed that.
So you should understand what it means foryour other assets.
(25:40):
Whether they're exempt from, I would saybankruptcy, but if you didn't have the
money, you could file personal bankruptcy.
But what assets do you get to keep?
Your 401k, your retirement, your primaryhome, two cars, your guns, jewelry,
clothes.
There's a lot of things that you can keep.
But what you don't keep is your otherinvestment properties if you filed
(26:02):
bankruptcy
for example.
So given the choice between recourse andnon-recourse, beginners are going to have
to do recourse because they just don'thave any credibility otherwise.
And then you can think about quicklytransitioning to non-recourse to kind of
protect your assets and limit yourdownside.
(26:23):
And can you elaborate on what you justmentioned about what you could potentially
keep in bankruptcy if you had to take outrecourse debt and defaulted?
Yeah.
So again, we'll stick to that like fivemillion scenario.
And let's say you levered up with a littlebit higher.
You know, let's say you got 80% financing.
So four million dollar loan.
(26:43):
And if you personally guarantee that andthe value drops to three million, you will
still, you know, you sell it and then thebank says you have a deficiency.
They're going to sue you for that deltabetween the loan amount plus their losses
minus the cash that you gave them from theclosing.
(27:04):
And what you do is that's basically anunsecured judgment and you file personal
bankruptcy and that will wipe out that, Idon't know, what's the loss?
So if it's just me, say it's like a $2million loss, right?
They loaned you four and you paid backtwo, that's a $2 million judgment.
They will wipe that, but you'll lose allyour other investments, but you get to
(27:24):
keep all the equity in your primary home,you get two cars, you get, you know, you
don't have to like,
be poverty-stricken.
You don't have to sell all your clothes.
You get to keep jewelry, certain number ofguns in Texas, that sort of thing.
But it's a pretty drastic response, butpeople should understand that might be
your best outcome if you don't have $2million somewhat liquid to be able to pay
(27:50):
it off.
What usually happens, I think, is that youwill be forced to liquidate all of your
other...
real estate or other investments, and thenyou try to pay down that two million.
But if it's not enough, you're gonna losethose assets one way or the other, right?
Either you're gonna sell it and try togive it to the bank, or you're gonna file
bankruptcy and lose it to the bankruptcy.
(28:13):
So that's when bankruptcy comes in.
as well to like talking about LLCs andhaving everything in an LLC or at least
one property per LLC that doesn'tnecessarily protect your properties then
in this instance, if you're talking abouta legal structure.
Right, so LLCs do not protect your LLCsfrom yourself.
(28:33):
If you have a personal judgment againstyou, that doesn't matter.
What the LLC does is it protects you fromthird party and your tenants from suing
you.
Because their recourse is limited to theLLC and also third party, we call them
like invitees or trespassers, the slip andfall people that walk onto your property
(28:55):
and get hurt, they don't
have access to suing you personally.
They can only sue the landlord LLC.
But you know that's maybe a perfectexample of if it's a non recourse the
banks recourse is limited to the assets oftheir borrower LLC and they would just eat
the two million dollar loss while you theborrower person get to keep all your other
(29:20):
assets.
Make sense.
on the inverse side of this, let's saythat the three of us have a joint venture
together.
We've taken out recourse debt and one ofus is in a car accident and the person
that we're in the car accident with suesone of us individually.
(29:43):
That JV property is still protected by theLLC, correct?
I mean, it's not protected.
It's not going to get sued, but yourinterest in the LLC of our joint venture
is an asset, and it's an individual assetof you, so that if you actually get a
(30:09):
judgment against you, it is subject to thecreditors of that lawsuit.
So the financial value, I will say, notthe operational control.
We don't wanna be partners with the guy'swife that got hurt in a car accident.
She doesn't get to vote with us, butfinancially, she's our partner, and she
(30:32):
may take that and try to sell it.
She might sell it to us.
She might sell it to somebody else,whatever.
But the idea is yes.
That's why you got to be very careful, Iguess, about individual actions that you
do.
I recommend umbrella insurance.
It is cheap.
Get it because in your scenario, you have$2 million of umbrella.
If you get sued personally, that umbrellainsurance is supposed to protect you from
(30:56):
non-contractual claims.
Again, lawyers talk about privity ofcontract, which is, "Do I have a legal
agreement with this person?" If I don't,
then they're considered just like a randomperson down the street.
How do you protect yourself?
Well, you don't have a contract with them,so you can't limit your liability.
(31:16):
But you can have umbrella insurance, whichcovers it.
But for everything else, you wanna makesure that it's signed in an LLC, so that
you can control and silo the damages.
I don't know if that answers yourquestion, but getting hit by a person from
a car accident does affect all of yourpersonal investments.
(31:37):
There is a solution though, you could moveyour interest into a trust, which gets it
out of your personal name, but then thisconversation is going down a very detailed
asset protection.
And for beginners, you don't wannaovercomplicate it.
I just want you guys to do deals first,make some money, and then worry about
asset protection.
But yes, there's some things that you cando to protect against hitting somebody in
(31:58):
your car, but then not subjecting yourpersonal real estate holdings to that
lawsuit.
Those would be separate.
Yeah.
And thank you for pointing that outbecause one thing that I think I've
learned thus far in our journey is thatthere are many different ways to put each
puzzle together.
It's not like each piece is, you know,predefined out of the box.
(32:22):
As your portfolio grows, these pieces willchange and there's ebb and flow and you
continually need to stay up to date andhave experts to help guide you in terms of
how to mitigate your risk and ensure thatyou're positioning yourself in as strong
of a position as possible.
Yeah, and I think for asset protection, Ialways give different answers.
(32:45):
If a client comes to me and they wannastart in commercial and they have a net
worth of $5 million, my answers aredifferent for them, as opposed to somebody
coming to me and saying, my net worth is$700,000, and I'm gonna put $200k of that
into real estate.
You can be a little bit more risk lovingif that's what your net worth is, because
(33:05):
you can kind of start over.
But somebody with five million, you've gotto be careful that you don't open yourself
up to liability without understanding therisk.
Yeah.
And in terms of partnering with people andthe legal risks that is associated with
that, do you have any, let's call themextreme cases that you could provide as
(33:29):
examples, just to highlight for beginners,why the legal component of investing is
important to take seriously?
Just when you're dealing with large sumsof money, real estate is interesting in
that it's very stable investment becauseyou're buying a tangible hard asset.
And that's what makes real estate capitalintensive.
(33:51):
But at the same time, I think it's lessvolatility but a higher entry price
because your floor is limited.
I mean, again, for the most part.
You could be investing in a business,right?
And if we bought a $5 million business,the value can go to zero.
The value can go negative with contingentliabilities and that sort of thing.
But with real estate, all of our examples,we're only talking about a percentage
(34:15):
loss.
There's a floor that the dirt value, thebuilding has some value, and that's what
the minimum is.
So,
because real estate is like that, I thinkthere's much more of an important emphasis
on the contracts because you're justdealing with larger sums and you need
clarity about how a partnership issupposed to operate, how it's supposed to
(34:36):
manage its funds, how it's supposed tohandle disputes, and ultimately how it's
supposed to dissolve.
You need to have clarity on that becausethere is almost always going to be assets
worth fighting over.
Again,
referring back to my business example, ifwe went together in partners in a business
and the whole thing exploded and ourpartnership fell apart, the value of that
(34:59):
business might go to zero, in which casewe're not really fighting anymore because
there's no assets, right?
There's piles, there's maybe someinventories.
We're not fighting over anything.
With real estate, I can pretty confidentlysay the value of 99% of people's
investments is not going to zero.
So what that means is there's always gonnabe some value there.
(35:22):
And candidly, it's probably gonna be 50,60, 70% of your purchase price.
That's a lot of money.
And so partners will always be fighting totry to figure out how to divvy up that
pie.
And it's just kind of the nature.
I mean, real estate is a little bit legalheavy.
We talked about the lease, but the leaseis critical.
(35:42):
That's the only way you're getting paid.
And some people will ascribe to the...
you're buying a stream of payments and thelease is the only thing that matters.
They could be renting a toothpick standand the lease, if they pay you $10,000 a
month, then that's the lease.
But yeah, I mean, I think ultimately it isreal estate if that lease gets terminated
(36:03):
for some reason and they say, well, it'sAmazon, they're not gonna terminate and
it's ironclad.
I'm like, yeah, well, stranger things havehappened, but if that does happen, what's
the market rent for that toothpick stand?
it's probably gonna be $500, not 10,000.
So you can't pay as if it's gonna be10,000.
So same thing for any other building.
I mean, that's an extreme, but payingabove market rent puts you at risk.
(36:27):
Good insight to have and you always, Imean, we probably get in too much of the
analysis paralysis, at least personallyfor Patrick and I, of thinking about these
things and how to protect yourself.
But I like what you said is like, get inthere, do a deal, figure it out.
I mean, for beginners, for me, probably inmy risk tolerance, I would say do a deal
that doesn't have a high level of risk,you know, if you're going to get started
(36:50):
so that you have those trial runs.
But if you're already investing in singlefamily homes
residential, you might have an idea ofwhat those things look like and, you know,
hurdles that you would just take andexponentially multiply if you're looking
into a bigger unit, whether it's multi,industrial, or any other type.
Yeah, and we didn't go through thisquestion, but what is commercial real
(37:14):
estate?
You know, multi-residential, I think froma lender perspective, they define it as
four units or more.
But candidly, if you're buying a six unit,it's not really commercial.
That's just managing a slightly biggerbuilding.
But, you know, if you get into the 18, 24,that's definitely a commercial.
You got to run that professionally.
(37:34):
But
multifamily, office, retail, multi-tenantretail, industrial, hotel, land, all of
these things are considered commercial.
And my only caveat to getting started is Idon't really like small commercial deals,
like the really small ones, like $600,000for this office condo.
(37:56):
Those are tough deals because they haveall of the fixed costs
of hiring the team that we talked about.
You got to find the specialist, got tohave the CPA, got to have this, got to pay
extra for the lawyer.
But none of the upside, because how muchprofit are you really going to make on an
office condo for $600k?
You would have a great deal if you boughtit for six and sold it for eight, but
(38:18):
you're not really making that much moneyif you have a $200,000 down payment.
So I think the smaller commercial, itreally has to start at a million for a
price point.
So you get a little bit of heft, you get alittle bit of size where the juice is
worth the squeeze for your attention, youhave an hourly return that whatever it is
(38:39):
you do.
So doing too small of commercial actuallyI think discourages people because they're
not going to chase and look into all theproblems or optimizing rent
when it's making a difference of $300 amonth, right?
It's kind of almost the same asresidential.
I'm sure there are people that buyresidential properties that are six or
(39:01):
seven or $800,000, and it's just a house.
But in commercial, you're gonna havecommercial insurance, you're gonna have an
LLC, you're gonna have all these costswith none of the upside.
So with that caveat, yes, just do a dealin the asset class in the market that you
wanna be in, and don't be afraid to justget
into it and you can always sell it.
(39:22):
Yeah.
Great point.
And like you said, 99% of what you'rebuying is not going to go down to zero.
So you're going to be able to make moneyback.
It's a really good thing to be able tofall back on.
But I know we've taken up a lot of yourtime and we're, I'm playing project
manager here since we're running short onthat.
But Ron, I just want to thank you so muchfor joining us.
(39:44):
It's been a pleasure.
We are so appreciative for all of yourinsights and your value and really hope
the listeners will find value in that aswell.
I know you do a lot of education, like yousaid, at the top of this on, on the side,
you record when you can as well.
So we're going to make sure to put all ofyour information in the show notes so that
people can reach out and they can learnmore from you outside of, of this podcast.
(40:09):
And thank you so much for joining ustoday.
Perfect, thank you guys for having me.
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