“Real estate professionals get into the business to be entrepreneurs.” That’s a phrase I use a lot on the blog. I’ve written posts about the entrepreneurial nature of the business, the challenges of starting a real estate investment firm, and how hard it is to start your own firm during a hot market. I want to add a caveat to the phrase; “real estate professionals get into the business to be entrepreneurs, but real estate entrepreneurship is littered with failure.”
This interview is a post mortem on a venture that did not succeed, whose founders are willing to share a candid look at the challenges of real estate entrepreneurship and how their operating principle that “no deal is better than a bad deal” protected their downside financial impact and preserved their investor relationships.
Back in October 2014, I published an interview with Adam Dunn and Tripp Bell, who had recently launched BLDG, a multifamily investment firm. Each partner had deep and varying careers in investments and real estate, they did their diligence and chose a growing market, built trust with investors, and formed relationships with market participants to drum up deal flow. They did everything right, but in the end they didn’t succeed. I asked Adam and Tripp to share what they learned from that process and what they would have done differently. Not surprisingly, they both overwhelmingly agree that it was the best thing they’ve ever done for their careers.
Starting a real estate investment firm was the biggest learning experience thus far into our careers. Although we were unsuccessful in generating enough revenue to sustain and grow the platform, we learned more in the two years that we bootstrapped the start-up than in the past 20 years of formal education. Prior to launching the firm, my business partner and I had great investment and transactional experience – so we thought. My experience included stints in operations at one of the largest owners of multifamily assets in the world and brokerage of institutional multifamily assets with a global real estate services firm. My partner was employed by one of the largest mutual fund firms in the world and worked with a well-regarded hedge fund. We shared a passion for investing in real estate, which served as the foundation for the launch of BLDG.
My partner and I started having coffee and lunches together to discuss the opportunities in multifamily real estate about a year before officially launching the firm. We conducted market research and ultimately determined that Raleigh, NC would be a great place to plant a flag. We drafted a business plan and formulated an investment strategy. Our goal was to buy middle-market Class B and C value-add apartments ($5M-$10M deals) in Raleigh and Charlotte, eventually growing into other desirable secondary submarkets. We planned to hire a best-in-class, third party management firm to manage the deals initially until we created economies of scale at which point we would launch a management platform to self-manage. Initially, we would partner with HNWIs to develop a track record. We would then seek to source evergreen capital from investment managers. We felt that we had a fiduciary responsibility to our potential investment partners to make this our sole focus. After reviewing start-up expenses and our personal budgets, we determined that we had approximately 24 months to get a deal done. We left our secure, salaried jobs to build our platform.
Once we launched the firm, it was full speed ahead. We started meeting every broker in the marketplace creating a steady source of potential opportunities. We also began contacting every owner of apartments in our target markets to solicit off-market opportunities. Simultaneously, we contacted potential investment partners within our network. Within four months we had enough conversations with potential investment partners that we were confident that we could raise $1M-$3M to acquire our first deal.
Then we hit the biggest challenge that we faced while launching the firm… after meeting with multiple lenders, our lack of track record as principals and our limited net worth and liquidity served as a hurdle when qualifying for a $5-$10M loan. We spoke to lenders prior to starting the firm to get a sense of qualifying for an agency loan and all indications pointed to there not being an issue due to our multifamily experience at our prior firms – wrong. After a few conversations with our potential HNWI partners, we were able to overcome this hurdle by having an investment partner qualify for the loan. There was not much hesitation for this because we were only looking at non-recourse loans and the potential recourse of bad-boy carve outs was limited. However, we did agree to concede on some of the deal economics to overcome this hurdle.
After hitting this hurdle, we began to rethink our business strategy. We debated looking at smaller deals in the $1-$3M range. In this scenario we would utilize a local bank to provide us with a loan and we would sign full-recourse. However, the challenge with smaller deals is that the fees generated would not be enough to build a sustainable business model while not having another source of income. So, we determined that continuing pace to land a 100+ unit deal was the best course of action. We had one year at this point to get a deal done before reaching our termination date.
We started making offers on properties, both on and off-market. We created pitch books to solicit investors. We had “roadshows” up and down the east coast with our potential investment partners to pitch deals. We had meaningful conversations and were challenged by our potential partners during our pitches. We made it to the best and final round of offers on multiple assets. The market in the Carolinas became increasingly competitive before we relocated requiring us to revise our pitch almost as quickly as we were able to educate our investors on the market. Cap rates were compressing due to institutional and foreign capital entering the market. We were unable to compete on most deals over $10-12M because our cost of capital was greater than our competition. This trend continued through the life of our firm.
We were successful in procuring several off-market opportunities; however, the challenge was determining which opportunities were real and not just owners kicking tires. We ended up going under contract on an off-market apartment building. We negotiated a purchase and sale agreement and started the loan process as we entered due diligence. Unfortunately, due to undisclosed and material environmental concerns that we were unable to resolve, we dropped the deal. Dropping the deal was a huge setback – emotionally and financially. Furthermore, this was also 18 months into our venture. Terminating the contract gave us the chance to reevaluate the business model and reassess where we were. In order to create a self-sustaining model that we were comfortable with, we needed to close a deal each quarter. Our experience over the prior months forced us to revise the model to closing a deal every nine months, which significantly thinned cash flow. We came to the conclusion that this risk was too great.
We were frequently asked “what is plan B if you don’t succeed?” Our response was, “Plan B is to make Plan A work.” We had reserves in our bank accounts that allowed us to not think about our living expenses for 24 months. However, at the end of this timeframe, we would dissolve the firm to start earning income again. During the first six months after launching the firm, I had to make significant unexpected repairs to my home and vehicle – repairs that could not be delayed. These unforeseen expenses compressed the 24-month timeline to 18 months. We often joked during this time that we could write an entrepreneurship book titled, “Expect the Unexpected.” The decision to ultimately close BLDG was indeed a difficult one. In our opinion, though, we could have acquired a bad deal of which we toured plenty. We also could have continued our conservative path until physically running out of money, personally. From the start, we collectively made the decision to set a termination date, and we exercised the self-control to stick to our timeframe. A case could be made that we succeeded more than we failed.
It’s hard to say what we would have done differently if we had started the firm all over again. On one hand, we wouldn’t change a thing because we learned more about entrepreneurship and the real estate business in the last 18-24 months than during the past 18-24 years. But, on the other hand, there will always be thoughts that perhaps we shouldn’t have left our jobs and that we should have started doing smaller deals on the side until we generated enough revenue to leave our jobs. There will always be questions, but we will never know if the circumstances would have turned out differently. I do know that we had tremendous support from our friends and family throughout the ups and downs. Even after making the difficult decision of dissolving the business, our friends and family were there to pick us up.
My partner and I started interviewing again after dissolving our firm. The biggest concern that we had was that we spent the last two years without making any income and thought we failed at getting the start-up off the ground. What would our potential employers think? Perhaps we could deflect these questions and steer the conversation to focus on our prior experience. To our surprise, every interviewer was most focused on our time spent starting the company. They wanted to know why we started the firm, how we created the investment strategy, how we conducted business development, what we would have done differently and what we learned.
Not to sound cliché, but I wouldn’t have changed anything – everything happens for a reason. Do we wish that the business had been successful? Obviously. There were more positive outcomes than negative when we reflect. When we start the next business, we will have vastly more experience than we did two years ago. We will have a larger network than we did two years ago. And we will definitely have more money than we did when we dissolved the company.
Lessons Learned and Advice (in no particular order):
- Always have an operating agreement
- Network within your network
- Your time is valuable – learn to distinguish low value/probability from high value/probability
- If you have a partner, you should have complimenting skillsets – 1+1=4
- Determine how you will dissolve the business before starting the business
- Determine who (if not you) will guarantee a loan
- Appear like you’ve been in business for years – professional website, email address, etc.
- Negotiate all service contracts – Costar, REIS, etc.
- Don’t sign lengthy office space leases – consider WeWork, Regus, or the like
- Your investment partners are your customers – treat them well and you will be rewarded
- Align interests with skin in the game
- Have a good attorney, but don’t overpay
- Don’t let your emotions talk you into doing a bad deal – remain detached
- Know the deal you’re pitching frontwards and backwards
- You should be rewarded for procuring off-market deals
- Things will not go as planned and you will hit hurdles. How you handle these setbacks is what separates you from “the pack”
- Find a mentor to connect with at least monthly
- Surround yourself with people smarter than you
- Failing will be your biggest learning experience for when you start your next business
- MAKE TIME FOR YOUR FRIENDS AND FAMILY
Additionally, here are 68 challenges of starting and growing a real estate investment firm.
I want to thank Adam and Tripp for candidly sharing their experience and what they learned. Starting a real estate investment firm is hard, and it takes guts to take a run at it. I applaud them for their hustle and discipline and wish them nothing but success.