Financial Engineering Traps Investors Should Watch Out For

Tanner Bickelhaupt, CEO and Founder of the Tanbic Company

 

Patrick Antrim, CEO of Multifamily Leadership, brings up that timing of money coming in or things like assumptions and expectations can create gaps.

Internal Rate of Return Can Be Manipulated

(1:05) – Bickelhaupt says he used to put IRR in his projections.

“If anyone really fully tells you they understand IR, they’re either in finance or whatever. So basically to simplify it, it’s the time value of your money. So the way you can manipulate that is either the money of the time. Those are the valuables.”

Check on things like whether the equity is going in at the exact same time as the rest of the capital. 

Boosting IRR can raise the cap rating. A group can raise debt and have lines of credit. They’ll buy the asset and use certain debt for the value-add things and burn through that, then they’ll call in other capital. If they held a deal for two years and then manipulated things for a year; they can call the equity in for a year and a day, then sell things and the numbers are run as though that equity has been there the whole time.

(3:30) – Just understand the risk parameter. The IRR is a real number. The problem is, the investor might create expectations based on that number.

“I’m putting equity in, but what if the market turns. We’re overpaying for this deal,” Bickelhaupt provides as an example. “You just have to understand when and where your money is going, where you fit into the deal, and if you’re comfortable with all that, then great. But there will be a time, who knows when, when there will be a turn. And the last person holding the bag has the equity.”

(5:00) – Loan covenants came up a lot during the pandemic. There’s a debt service coverage ratio and each lender will write a provision that if you fall below that ratio, it triggers an appraisal. Credible groups will have reserves with debt service coverage ratios. 

(6:35) – Antrim brings up that things are moving fast right now because people are excited about investing. Everyone wants in.

Bickelhaupt points out that people get the PPM, which will tell them ways they might lose their money, but it also brings up fees, where you fall in the capital stack, the lending terms, the rate, and more. It serves as a blueprint. Bickelhaupt warns, there will be things in there that will make you uncomfortable, but it’s important information that might not come up in the business plan. 

Questions to Ask

(8:20) – Bickelhaupt says to start simple.

“Oftentimes, people will see the business plan. The business plan’s going to show growth because there’s NOI growth. I haven’t seen a business plan yet that says, ‘We’re going to buy, cap rates are going to compress, and we’re going to sell and it’s going to do nothing.’ I’m sure that’s happened, but nobody’s putting that on paper. So it’s understanding how they’re going to grow the NOI.”

If you’re an investor, learn the story and make sure you believe it.

Bickelhaupt advises that any and every investor should start with the NOI, then walk through the NOI growth. Don’t buy everything that’s in there, ask quest