Everyone has to get good at one of two things: planting in the spring or begging in the fall.
I know the following things to be true: Life is about constant, predictable patterns of change. The only constant factor is our feelings and attitudes toward life. We have the power of attitude, and attitude determines choice, and choice determines results. You cannot change the seasons, but you can change yourself. I am convinced that, as human beings, it is our natural destiny to grow, to succeed, to prosper and to find happiness while we are here. That we must make a constant and conscious effort to improve ourselves in the face of changing circumstances.
Let’s talk about spring. Spring is the season of activity and opportunity that follows the turbulence of winter. It’s the season for entering the fertile fields of life with seed, knowledge, commitment and a determined effort. However, the mere arrival of spring is no sign that things are going to look good in the fall. You must do something with the spring. Everyone has to get good at one of two things: planting in the spring or begging in the fall. Take advantage of the day and the opportunities that spring can bring.
Some people plant in the spring and leave in the summer. If you’ve signed up for a season, see it through. You don’t have to stay forever, but at least stay until you see it through.
It is the promise of spring that as we sow, so shall we also reap. For every disciplined human effort, we will receive a multiple reward. For each cup planted, a bushel reaped. For every good idea given to another, many shall be given to us in return. For every act of love given, a life of love in return. Just remember, it is a natural characteristic of springtime to present itself ever so briefly, or to lull us into inactivity with its bounteous beauty. Do not pause too long to soak in the aroma of the blossoming flowers, lest you awaken to find springtime gone with your seed still in your sack.
With the intelligence, wisdom and freedom of choice given to us as humans, exercise the discipline to plant in spite of the rocks, weeds or other obstacles before you. The rocks, weeds and thorns of the world cannot destroy all your seeds if you plant massively enough and intelligently enough. Choose action, not rest. Choose truth, not fantasy. Choose a smile, not a frown. Choose love, not animosity. Choose the good in life in all things, and choose the opportunity as well as the chance to work when springtime smiles on your life.
Spring shows us that life is truly a constant beginning, a constant opportunity and a constant springtime. We need only to learn to look once again at life as we did as children, letting fascination and curiosity give us welcome cause to look for the miraculous hidden among the common. Get busy quickly on your springs—your opportunities. There are just a handful of springs that have been handed to each of us. Life is brief, even at its longest. Whatever you are going to do with your life, get at it. Don’t just let the seasons pass by.
“Prosperity is like a Jenga tower. Take one piece out and the whole thing can fall.” That’s a direct quote from John Williams, the President of the San Francisco Federal Reserve Bank in a speech he gave a few weeks ago. He could have just as easily been talking about propaganda. The Fed, the White House, Wall Street, the media have a vested interest in peddling a certain narrative about the economy.
The narrative goes something like this: “Everything’s awesome. Stop asking questions”. But if you look at their own data, the numbers tell a different story. My team and I were recently studying US manufacturing indices, something that has traditionally been a strong indicator of recession. This is data collected by the Federal Reserve; they survey manufacturing businesses and ask if factory orders are growing, shrinking, or relatively unchanged. You’d think that based on this “everything is awesome” narrative that all the numbers would be growing. And yet, much of the data show that manufacturing is shrinking. Or to be even more clear, that the US is in a manufacturing recession.
· In Texas, for example, just 4% of businesses report that they are growing. 38% are shrinking.
· The Philadelphia Fed’s Manufacturing Index has been in recession since September of last year.
· The San Francisco Fed’s Total Factor Productivity is also reporting negative growth.
· The New York Fed’s Empire State Manufacturing Index was at minus 16.6 for February. In fact, the last time the index was below -15 was in October 2008, ten months into the Great Recession.
The numbers are all pretty clear: there’s an obvious industrial and manufacturing downturn. But that shouldn’t matter because Fox News, CNN, CNBC, and the White House tell us that consumer spending drives the US economy; industrial production is irrelevant. They run headlines like “RETAIL SALES RISE MORE THAN EXPECTED” as part of the good news narrative. This sounds mysteriously like “FEWER PEOPLE KILLED BY POLICE THAN EXPECTED” or “FEWER AIRLINES DECLARE BANKRUPTCY THAN EXPECTED”.
But the reality is that prosperity isn’t a Jenga puzzle. It’s quite simple. You have to produce more than you consume. Strangely, though, the financial establishment cheers when consumption is up. And they totally ignore the data when production is down. This is the exact opposite of prosperity. And no surprise, if you look at the long-term data you’ll see that a manufacturing downturn (i.e. less production) almost invariably precedes a recession.
There were large downturns in manufacturing and industrial production in 2008, 2001, 1990, 1980-81, 1974, 1970… and every other recession since the Great Depression. More importantly, out of the 17 recessions over the last century, the longest period between them was about 10 years. The average time between recessions at just about 68 months. Bottom line– the economy is due for a recession. And the indicators suggest that one may already be in the works. The bigger challenge is that both the Federal Reserve and the Federal Government are out of ammo.
The US government spent trillions fighting the last recession back in 2008. But back then the US government debt level was “only” $9.5 trillion, so they could the oretically afford the bailouts. Today government debt exceeds $19 trillion, well in excess of 100% of GDP. They don’t have the ability to bail anyone out, including themselves. The Fed doesn’t have any room either. On average, the Fed cuts interest rates by 3.5% in a recession. And the smallest interest rate cut in any recession during the last 60 years was 2%.
Today, interest rates are at 0.25%… next to nothing. They’ve been at near-zero levels since the last recession. That means that even if the next (i.e. current) recession is extremely mild and the Fed cuts by only 2%, interest rates are practically guaranteed to go below zero. And from there, it’s a very short road to capital controls.
Capital controls are a policy tool used by desperate governments to keep money trapped in a failing financial system. Think about it—when rates turn negative, who in his/her right mind would keep money in a savings account that’s going to charge YOU interest for the privilege of letting a banker gamble your funds away on the latest investment fad? A rational person would close his/her account. Or at least maintain a minimal balance and hold cash. But if too many people take their money out of the banks, then the entire system collapses. And governments have shown they will do whatever it takes to prevent this from happening… even if it means restricting what you can/cannot do with your own savings.
We’re already seeing bank withdrawal restrictions in Europe, as well as loud calls to ban cash on both sides of the Atlantic. These things are happening. And with the recession data in particular, we’re not talking about “what if”. We’re talking about “what is”. Even if all the data is wrong and there’s never another recession again until the end of time, you won’t be worse off for having a Plan B that protects your family, your savings, and your livelihood from such obvious risks.
Mixed-use developments have been on the radar for several years, and are increasingly attractive to both domestic and foreign investors. A subtle slowdown in the hot multi-family market may be attributed in part to a preference for the live/work/play environment, especially in urban markets.
Experts point out that as much as 33% of the population desires to live in a walkable, mixed use neighborhood, for a variety of reasons. The national supply of such developments is not nearly enough to meet that demand.
This type of environment, which combines residential, commercial and retail space, offer advantages to each type of tenant, as well as to the investor. Residents enjoy the convenience of having dining, shopping, and parks right near home, and retail establishments can benefit from a built-in customer base.
There are several key factors that contribute to the rising interest in mixed-use developments.
Multi-family demand has dropped
While still brisk in many markets, overall demand for multi-family investments has eased up, causing investors to look elsewhere. This is partly due to demographics. The millennial generation, with its strong preference for central locations and easy access to city amenities, favors the mixed-use model. It enables them to leave a smaller carbon footprint, spend less time commuting, and create a sense of community.
More diversified developments entail less risk
A basic tenet of diversification is that a collection of different types of investment exposes the buyer to less risk than investing in a single type of asset. A key issue in diversification is the correlation between assets, the benefits increasing with lower correlation. Mixed-use developments are diverse by their nature. Residential units can provide steady income in times when retail markets may be struggling, and the longer leases common to commercial properties create more continuity than one-year residential agreements.
Investors can in effect have 2 income streams, and be less vulnerable overall to commercial downturns or population shifts.
Residential tenants fuel demand for retail space
Basically, the mixture of tenant types feed on each other in a mixed-use development. Residential tenants want the convenience of nearby businesses, and the presence of thriving businesses attracts new residents.
Some of the specific benefits to retailers are:
· Greater exposure to customers
· Retail businesses located near residences are seen daily by the people who live there. They’re much more likely than stand-alone stores to attract interest and foot traffic.
· Easier code and safety compliance
· Mixed-use developments are built and maintained to residential standards, and they’re more likely to already comply with the strictest standards for things like fire alarms, wiring, ventilation, sprinklers, handicap access, and elevator codes and inspections
Better property management
Professional management services are necessary for mixed-use properties, to address the diverse needs of the entire community. In general, this means more accessible and responsive performance and support.
As the popularity of mixed-use spaces continues to grow, we look for a corresponding increase in investor interest. Along with their advantages to society –more efficient transportation and parking, less fuel dependency, and more people walking- these developments present solid advantages to real estate investors.
The elevator pitch is the situation in which a person with a business opportunity or idea has a chance opportunity to attract a potential investor--like a short elevator ride with a wealthy investor. Unlike formal meetings where you are able to show data, slides or videos and give a lengthy proposal to investors, the elevator pitch is a brief oral presentation that will hopefully interest the investor enough that he will want to hear more through a full presentation. I've enjoyed (and at times endured) countless investment pitches and made many of my own, so I thought I'd share a few friendly tips on delivering an elevator pitch.
Be Brief and Interesting: The key to a successful elevator pitch is brevity. While you don't want to appear unprofessional by not listing enough real details, a quick outline of your business idea will leave your audience interested. Too often, great opportunities with investors are squandered by a boring, drawn-out presentation which would be better suited for an office than whatever casual setting. Remember, elevator pitches take the investor's time and if it isn't short and interesting, the investor may immediately reject your idea.
Try For a Full Meeting: If the potential investors seems interested in your idea, and most investors make it very clear when they are not, then try to arrange for a full meeting to discuss your idea, or at least offer to send the investor a more detailed business plan. The point of the elevator pitch is not to immediately secure an investment, it is to court potential investors and spark interest in your idea.
Explain Your Idea For the Investor: Your idea may be really exciting to you, but investors are mostly interested in making money from your business. So explain your business plan in terms of benefiting the investor, like how your idea will prevail over your competitors and how that will translate to profits. The point is to not get too wrapped up in your idea that you forget to highlight incentives for the investor too.
The elevator pitch is a great tool for conveying your idea simply to potential investors, and while it may not always work for you, when it does work it can be really great. Silicon Valley is littered with stories (perhaps many embellished for dramatic effect) of chance encounters with venture capitalists or business icons that led to million dollar deals and billion dollar companies.
When you are facing a room full of skeptical private equity executives be prepared or you could hit the lobby with nothing but regret that you didn't practice that pitch.
Developers and real estate operators partnering with 3rd party equity sources typically secure profits larger than the percentage of equity capital they invest into their projects. These outsized profits, often called a promoted interest, allow sponsors (the developer or operator) to get more profits than they would otherwise based solely on their actual ownership or investment in the project. Investors design these incentives around the performance of the project as a way to incentivize the sponsor. For example, a sponsor may only invest 10% of the required equity, but get 40% of the profits if the project performs well.
These promoted interests are structured through a “waterfall,” which in private equity or real estate finance is simply a mathematical architecture / formula for metering out distributions to the partnership. Waterfall tiers increase the incentive or share of the profits to the sponsor as the project meets certain profitability hurdles.
Each tier typically triggers on an IRR calculation, an equity multiple, or the greater of each. This area can get complicated very quickly when we start considering senior positions, catch up provisions, look-back provisions, etc. We aren’t going to get into any of that here. Instead, we aim to clear up frequent confusion over misused industry jargon that references these promoted interests as either a “promote” or a “profit split”.
The Profit Split
Let’s start with an example of “split,” or “profit split.” Assume we have a partnership agreement between an equity investor and sponsor for the development of a 100-unit multifamily project. The investment structure and waterfall structure is as follows:
10% preferred return
70/30 split to a 12% IRR
60/40 split to an 18% IRR
50/50 split thereafter
The language on the 3rd bullet above sounds like “seventy, thirty to a twelve” with 70% of this tiers profit going to the investor and 30% to the sponsor. Parties split each tier according to the division in the waterfall without respect to how much each party invested into the project. While the joint venture should pay out preferred returns based on pro rata ownership, profit splits are not paid the same way.
This second example of a promote tier structure looks very similar at first blush, but it’s actually structured quite differently:
10% preferred return
30% promote to a 12% IRR
40% promote to an 18% IRR
50% promote thereafter
Language on the 3rd bullet here sounds like “thirty percent promote to a twelve” and might appear in a term sheet as “70% to the Joint Venture and 30% to the Sponsor.” I like to imagine that there are actually three parties when talking about promotes. There are the investor and the sponsor who have each invested capital (shareholders), but there is also the developer who has invested nothing (a highly incentivized vendor). Yes, the developer and the sponsor are the same person, but visualizing three buckets instead of two makes the concept easier to understand. The promote is paid to the developer and the remaining percentage is split between the investor and the sponsor according to their co-invest.
Let’s look at the first tier closely. Say that there was $1MM for distribution of this tier before crossing the 12% threshold. Thirty percent would go to the developer so $300,000. The remaining $700,000 is split 90/10, so the investor would get $630,000 and the sponsor would get $70,000. Now since the sponsor and the developer are the same party, their total comes to $370,000. If this were splits instead, the split at this tier would be $700,000 to the investor and $300,000 to the sponsor.
What’s often helpful is translating promotes into splits for comparison. When we have multiple terms sheets on a project, some using promotes and some using splits, we translate everything into splits to make the comparison easy. Our promote example above translates to:
Promote Example as Splits:
10% preferred return
63/37 split to a 12% IRR
54/46 split to an 18% IRR
45/55 split thereafter
As you can see, the structure is very different using promotes instead of splits; now the sponsor’s final tier opens up to 55% of the profit. This would increase greatly if the sponsor increased their co-invest too. For example, increasing the co-invest to 20% here would increase the split to 60% since we are assuming a 50% promote.
Why does this Matter?
At this point you may be thinking that this concept sounds simple enough, so why an entire article on this subject. The reason is because this subject is confused time and time again by experienced professionals. Look at the wording of each of these two phrases:
“70% to the Investor and 30% to the Sponsor”
“70% to the Joint Venture and 30% to the Sponsor”
The only thing that has changed is that the word “Investor” has been replaced by the term “Joint Venture.” Now, sometimes term sheets are clear on what’s meant, but many times it’s just like this where a quick read might lead to the wrong conclusion. It’s a confusing area; to add insult to injury sometimes people say “promotes” and mean “splits,” or vice versa. While this is less frequently confused in the written word, it is misused all of the time in deal chat. Promotes and profit splits are not the same thing.
As a caveat, earlier this year we had a term sheet on the table for one of our client’s projects. After four very experienced individuals reviewed it, all four came to the conclusion that this particular equity group intended for the structure to be profit splits. In this case, that allocation looked pretty bad to our client, to the point that our first reaction was to move on. However, after discussing the proposal with our equity partner it became clear that they intended to use promotes, despite unclear language. Our clients had a significant amount of money already invested into the project so, their co-invest was north of 35%. Switching from splits to promotes made a huge difference; now the term sheet looked very promising.
The lesson here is to be careful and specific with your language. If you say “promote,” make sure you mean “promote” and not profit “split,” because they are in fact very different. Also, when analyzing equity proposals, be aware that even sophisticated equity groups are sometimes guilty of misusing terms. Command of proper real estate terminology, particular in drafting term sheets or negotiating joint venture structures, is key to professionalism and of course successful deal making.