DE 26: Tax Strategies and Real Estate Investments with Thomas Castelli
Thomas Castelli is a licensed Certified Public Accountant (CPA) in New York. He is certified in Real Estate Financial Modeling and Tax Strategist. He comprehends that putting resources into real estate, joined with tax strategies and arranging are critical to limiting the taxes and building long term riches.
He holds equity positions in several multifamily properties and participated in the syndication of an 82 unit apartment complex as a general partner. All his experience in investing and tax strategies are really helping him in finances.
- Difference Between GP and LP
- Thomas’ First Investment
- How Much Money Is Needed To Invest In Real Estate
- How Many Partners A Partnership Should Contain And How Should The Partnership Split Be.
Connect with Thomas:
Podcast: Real Estate CPA
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Intro: Hey guys! Today I’m going to interview Thomas Castelli, Thomas is a real estate investor. And I think the most interesting thing about him is that he invested in his first real estate deal as a limited partner and that is something that we haven’t discussed yet. A lot of people here don’t know the difference between a limited partner and a general partner, also known as the sponsor or the syndicator. And today we’re going to talk a lot about the difference between these two types of investments and how you can get into real estate as a passive investor with not a whole lot of money and learn a lot about real estate in the process also, while you make money, so that’s a great opportunity. And I think it’s a very important episode for everybody who is considering to invest in real estate. So, let’s get started.
Lady: Welcome to the Commercial Real Estate Investing podcast with Don and Eden, where we cover all aspects of real estate investing with special attention to off-market strategies.
Don: Hey, Thomas, welcome to the show.
Thomas: Hey, Don, thanks so much for having me on today. Happy to be here.
Don: Of course. How’s your day going so far?
Thomas: It’s going great. The weather’s not too great here in New York. It’s been raining for the last few days. But other than that, I can’t complain. It’s a good day.
Don: Yeah. Well, you know, it’s only going to get colder from now on, right?
Thomas: Yeah, yeah, yeah, this the one bad thing about living in New York is it could be really hot in the summer and the nineties, and then go all the way down to the teens if not lower, when you move into the winter months.
Don: Well, you know, I live in Florida, we have warm weather all year round. But then in the summer, you got the hurricanes and you got the rain. That’s just non stop, and you can’t plan anything. And so, you can’t go out and do anything because whatever it is you’re trying to do. There’s going to be rain, and there’s going to be sun and there’s going to be rain and there’s going to be Sun. It’s just super annoying. But yeah, I’ll take that over New York every day of the week.
Don: Yeah, well, I would too. I don’t blame me. Okay, so, tell us a little bit about who you are, how you got into real estate and then what you’re doing currently.
Thomas: My name is Tom Castelli. I’m a CPA. I work for a company called the Real Estate CPA as a tax strategist and I primarily do tax consulting for real estate investors. So, I help them come up with a plan to minimize their tax liability each year. The super exciting job keeps me really in touch with real estate investors and what’s currently going on. Outside of that, I am an investor myself. I got started as an investor on the LP side back in 2015 when I started to make a few Limited Partnership investments with someone who basically would become my mentor. I made my first LP investment in a 48 unit apartment building Class D apartment building and got full renovation in Columbus, Ohio. That was pretty exciting. And from there, I started learning more and more about syndications. That ultimately culminated in me participating as a general partner in the syndication of an 82 unit apartment complex in Jacksonville, Florida, actually down in your state.
On the Investment side what led me to syndication though was when I was in college, I was pretty much saying, ‘Oh, I don’t want to like live the normal nine to five life.’ I need a way out of this and start researching real estate, you know, the Rich Dad, Poor Dad, all that. And then eventually it led me to a meeting of RIA meeting out here on Long Island, and I met a syndication group and I went to their three-day seminar where they went through syndication A to Z, and I fell in love with syndication. That’s where I met my mentor. And that’s the person who I started investing with on the LP side, and it all led up to that eight units GP. Since that point, I haven’t been too active. I’ve made a few investments in LP since then, but at this point, just kind of waiting for us to be putting this property on the market.
Don: I know we already discussed that on previous shows. You know the difference between LP and GP, but I’m sure some people are going to listen to that, and they’re not going to understand really what we’re talking about if they’re new to all the terms. First of all, I like it that your first deal was an LP so you invested with somebody else, and then we’re going to talk about that, but first, how about you give us a brief explanation about the difference between limited partner and a general partner and then the way that a syndication process works.
Thomas: Yeah. So, the limited partner and investment, you’re the passive investor, you’re the silent partner or the money partner some different terms people say. You’re investing with the general partner, and you’re not taking an active role in the business or the investment. You’re just kind of sitting back and collecting your check. I think the biggest aspect for a limited partner when you are investing is to understand who the general partner is, what their track record is, do they have experience with the assets and just have an overall idea of what market you’re investing in that can be pretty important. But for the general partner side, the general partner to deal they are responsible for putting the entire deal together from A to Z.
So, it’s finding the property, going through the acquisition process, including due diligence, and then ultimately overseeing the property management than any renovation plans you have for the property, that entire processes and ultimately selling it. They’re also responsible for raising the capital from investors, the LP’s and making sure that they are handling Investor Relations properly communicating with their investors. They’re also responsible for getting the debt financing working with a bank or perhaps to Fannie/Freddie or mortgage brokers, however, we’re going to go about getting that loan, that is their role. They’re pretty much responsible for the entire thing, which is why as a limited partner, when you don’t have that control when you don’t have that management, say, it’s very important to know who you’re dealing with on the general partnership side.
Don: Yeah. And I would like to add a few things. So as a limited partner, the advantage is that you’re passive and so you don’t have to worry about too many things. So, the only time you have to worry about is when you’re getting into the deal. You have to do some research, you have to know the market, just like you said, that’s pretty much it. You invest the money and you should be getting some nice returns. I always say that if I wanted to retire, I would just invest all my money as a limited partner with other people that I trust and just go to a cruise or something and just have fun forever because you get good returns. You could get, I would say 15%. It’s pretty normal to get on a yearly basis. If you know who you’re investing with, and you have experienced and you could even get a 20% return on an IRR based on for five years. So that’s the advantage as a limited partner.
The advantage for the general partners, also known as the sponsors of the deal, is that essentially, they collect money from investors. So, they raise capital, just like you said. Typically, they have to raise about 30% of the purchase price of 20% for a down payment, and then 10%, for CapX, what is known as the repairs, or the implementing of the value add plants or the property. And so, what happens is that they raise the 30% from other people, and they get a split of 30% of the entire deal. So, let’s say that they improve the building that’s worth 10 million to a point where it’s worth 13 million, so they would make 1 million in profit if they get 30%, roughly 1 million, so 900,000.
Yeah, you are a CPA. And then that is the reason why you decided to invest as a limited partner because you wanted to keep your day job, right? You wanted to be a passive investor. And you also wanted to get into investing in syndications, right? And learn as much as you can.
Thomas: Yeah. One of the things is like when you’re first I guess, taking on this investing adventure that some investors go on is it’s good to have the experience on the LP side first, because you kind of get to see it from the back end angle, and you experience the entire process from A to Z as an investor from the investor’s perspective and you ultimately learn a lot about how to do it if you’re looking to be a general partner. So, that’s one of the reasons why I started there.
Don: Okay, great. So, let’s talk about your first investment. The LP. So, the limited partner investment. So how much money did you invest in that deal and how many units was it?
Thomas: 48 units in Columbus, Ohio. As an LP, I invested about $10,000 into a deal. It wasn’t all that much, my parents invested a lot more but that was just the point where I got my foot in the door. On that deal got a lot of behind the scenes looks at what was going on. I was on a lot of property management calls. So, the property needed a gut renovation. I remember seeing pictures of this thing. It was like we went in there when we first acquired it. And there was, there’s a lot of needles on the ground, bad things going on in there. So, pretty much had to vacate the majority of the property and go in there and do significant renovations to both the interior and the exterior of the property as well as new signage, print to reposition the property, and then leased it back up. And it was overall an exciting deal. We had some issues with the property manager, had to get rid of him and replace them. But overall, great deal, great return, I think we did 32% over 18 months.
Thomas: It was pretty solid.
Don: Wow, that’s nice. What I like about that is that you can get into a real estate deal with $10,000. So that’s for everybody out there. Right? So, it’s exactly what the message that all the internet gurus are trying to say like Grant Cardone and people trying to say just invest in real estate. It’s that easy. So, all you need to have is $10,000 in savings. Even though I know a lot of our sponsors and general partners are trying to raise at least 25,000 typically. So that’s what I see most of the time.
Thomas: Yeah, you know, that’s accurate. You know, at this point, I think it was the relationships I developed with the sponsor that allowed me to get into the deal at that level. I guess it partly depends on the relationships you have. You can build a relationship with people they might allow you to get in at a lower level. I could also look at crowdfunding. I think in crowdfunding thing with the Reg A offerings it is you can get in like with as low as $1,000 into some of these properties.
Don: So, you invested in that LP you made some good money. And then how did you proceed with investing in real estate? Did you invest in it in another LP before you became a sponsor yourself?
Thomas: Yeah, after that I invested in another Limited Partnership investment. It was eight units in Covington, Kentucky. That I was through a coaching program or a mock coaching program like the beta version of it. By investing in that property, I was able to go through the mock coaching program. And that’s where I learned a lot about market research, learned a lot about the acquisitions process, how to underwrite deals, that side of things. And also, we worked very closely together after that, looking for new properties in that market. It was an exciting time building relationships with brokers. So that was my second LP investment. From there, I made another one. And that was in 17 units in Covington, Kentucky. We currently have a duplex left where we’re looking to sell from now on. But then there was the general partnership was next.
Don: Okay, so let’s talk about that phase. I’m sure it’s the most exciting phase of your life being a sponsor of a deal for the first time. So, I know you worked on the acquisition side, which means that you were the one who created the relationship with a broker, you were the one to do all the due diligence and get the deal. So, you got to deal with those are your part right? And that was in Jacksonville in Florida, which is an emerging market. Everybody’s talking about Jacksonville for a while. I’ve looked in that market also myself. I was looking at 80 units over there at a time but then the numbers did not work. I know you did that back in ’17, where it was a little bit easier to find something good in Jacksonville. So that’s about, First of all, I want to know why you chose that market. So that’s the most important thing. Because I know that everybody always says, the first thing you have to do is pick your market. So why, why Jacksonville?
Thomas: There’s a lot of reasons. It was at the time, it was one of the top growing cities. If you look at employment, which is pretty much one of the most important aspects. It had growing employment. It also had diverse employment through multiple sectors. So, it was not really at risk of anyone sector being damaged in the outlook for that was pretty strong. So that’s one of the reasons why I wanted and we looked down there was for that, you know, that reason alone. The second reason was we had a contact with a very, very good property manager who’s already in that market. It was a natural fit to start looking down there. This property manager was great at helping us on the due diligence side and connecting us with brokers. So those are some of the reasons that we started looking down there was primarily for those two reasons I’d say.
Don: Okay, so you’re looking into the deal and then you decide to create connections with brokers right in Jacksonville? So how did you go about that? How did you do that from New York?
Thomas: At this point, I was pretty experienced that cold calling or cold calling basically brokers and sellers directly for other deals we’re looking for in Covington, Kentucky prior, I called the property manager way to contact with and I said, ‘Hey, you know, we’d love to hear about what are the top brokers you’re currently working within the market? Who should I contact if I’m looking to pick up some properties in Jacksonville?’ And she provided me with contact information. So, brokers and I contacted pretty much all of them and one of them we struck up a really good relationship right off the bat. And he started sending me a handful of properties. And from there a lot of the properties were not really what we’re looking for. One of them was all right, but the value add component was completed already. So, it wasn’t much meat on the bone but so he sent me one good property and that was the property with a pursuing.
Don: Okay. So, what made you feel like this property was good? How did you see that?
Thomas: So, the first thing was that it was being managed by this property manager already. So that was the first aspect because we felt very comfortable with this property manager and the level of expertise they had in the market. And because they already managing it, it was just favorable right off the bat to us.
Don: We also saw that they could tell you all the insights and tell you exactly what they see from the inside, right?
Thomas: 100%. That was one of the I would say, if not the primary reason for us going forward on the value add. So, I did see opportunities to fix up some of the exteriors of the property. There’s some curb appeal, that could have been some re-signage and curb appeal that needed to be upgraded on the exteriors. The interiors, weren’t all renovated to the same level at this point. So, there’s a lot of opportunities to go in there. And as the units were turning naturally, it was already stabilized. Think it was 90% or 92% when we purchased it, so it was pretty much as units turned, we were able to go in there and renovate the units to the market standard raise the rents. And that was ultimately LOI driver for us. And one of the reasons why we liked it, we liked the upside potential.
Don: Okay, so you renovated the entire 80 units?
Thomas: Not the entire 80 units. I think it was about half the units needed the interior upgrades, the other half is already in pretty good shape. I walked about half the units on the due diligence side, one of the partners in the deal walked the other half. And overall, some of us were nice. The other ones not so much. So, the ones that weren’t up to standards were the ones we renovated. I believe it was about half.
Don: Okay, so you renovated about 40 units. How much money did you invest after you did all the work in every unit?
Thomas: That is a great question. I don’t have that number offhand. I think it came into a bit around for the unit very, because not all the units need.
Don: You can say roughly. Nobody’s going to check that.
Thomas: Yeah, yeah. I think it was roughly between $3000 and $12,000 per unit. It just depends on how much work that particular unit needed.
Don: Okay, so let’s say that you invested $8000 in each unit. So that would bring us to around $320,000 in CapEx.
Thomas: Yeah, that’s very accurate for the number.
Don: Okay, so you bought the property for how much? What was the purchase price?
Thomas: The purchase price was $3,850,000.
Don: Okay, and then you invest another $320,000. Right?
Thomas: Correct. I think we’re coming under budget with that. We have some CapEx, some money sitting in our CapEx account that we may end up just distributing back to our investors at this point.
Don: Okay. And so, did you reduce the expenses too or just increase the NOI by raising the rents for these improved units?
Thomas: The property on the expense side was pretty much being run pretty efficiently already.
Don: Your managers pretty good over there, right?
Thomas: Yeah, there wasn’t much to lower on the expense side, it was more or less work we did on the upside.
Don: Okay. So how much were you able to push the rents with improvements of the units?
Thomas: Some were one unit, some that were two units, we had three units. Two units to the ones I know offhand was $650 when we got into it and were able to raise them anywhere from $750 to $825 is what we’re pushing right now.
Don: Wow. Okay. So, if you improve to $800, you improve 40 units by $150 Premium per unit, right?
Thomas: Yeah, give or take.
Don: Okay, so that would be $6,000 a month.
Don: Okay, so a year that would be $72,000 increase to the NOI. Now if you divide that just for the listeners to understand the value add here if you buy $6000 every month, that’s the rent premium $150 for 40 units that they improved, times 12. That would be $72000. And then if you divide $72,000 by the cap rate, which is the formula to understand the value, you divide NOI, by the cap rate. So let’s divide the NOI premium here which is $72,000, by the cap rate that you would buy a multifamily market cap rate, I would say 6%. Right? So that would bring an increase of about $1,200,000 to the property. So let’s take out the CapEx, which we improve the property at $320. So, you got an increase of about $880,000, to the property, give or take, am I right?
Thomas: Yeah, give or take. I think that the property being valued right now, around $6,000,000 is what we’re getting some offers on.
Don: Wow. Wow. How is that even possible? That’s even more than…
Thomas: Yeah, yeah. I think you know, what it comes down to is that the markets just so hot down there.
Thomas: That people are willing, perhaps maybe overpay a little bit to get into some of these assets, which is, I guess, a horse of another color.
Don: You know, when I think about that, I can say what I think about that because I’ve had this conversation with one of my friends just recently. So, I think something is going on because there are all these baby boomers now retiring, right, and then you have all these trusts and all these funds and all these institutions are just trying to preserve capital, and they just want to park money anywhere they can. They don’t want to have dollars, they just want to have something real.
Don: So Something is going to happen. But you must have heard it before. So that’s why I think the cap rates are getting so compressed. And I think people are just, the larger institutions and the larger trusts are just buying everything for ridiculous prices. You said you bought this property for how much?
Thomas: We bought it for $3.85. $3,850,000.
Don: Somebody’s overpaying you about $600,000. If you get offers for $6 million.
Thomas: Yeah, yeah, I’d have to go back and check the exact numbers to see exactly where the rents are and everything where the NOI is today. Yeah, I know that we are getting offers that are right now above valuation would be so I just think it’s because of the popularity of the Jacksonville market. Yeah, I mean, I when we’re looking at these assets, we’re looking at cap rates at 6.5% to 7%. Now the cap rates down there like 5% like 5.5%.
Don: Oh it’s 5%, that’s why Yeah, that’s why that makes sense. So, if you increase the NOI by $72,000, right, that’s another $240,000. Yeah, I mean, that’s crazy. But you know what, I think what you did right was the fact that you picked the right market at the right time.
Don: That was the home run for you. Because when I heard about Jacksonville, and how much is booming that was already 2018, late 2018. And you picked it up in 2017. And so that’s why you were able to strike such a good deal because it’s just exploding over there.
Thomas: Yeah. And you know, it’s interesting. One of the reasons why Jacksonville is also our focus is some of our partners had investments in Jacksonville already from 2013. So, they were riding the market up since back then. So, they got in even earlier. And some people were saying that we at that point in 2017, had missed a big run-up, but that’s not the case. It says continue to move up.
Don: Nice. So as a general partner, how much money do you think you’re going to be making on that deal? So just for somebody who’s trying to get into that field, being a limited partner or a general partner, I want our listeners to understand how much money you could be made from just one deal. What’re your estimates?
Thomas: On the front end of the acquisition fee, we had a 1% acquisition fee. So, the acquisition fee came out to be $30,500 roughly, which wasn’t all that much. But in this industry, I’ve always been told that the acquisition fee keeps the lights on, it’s your fee for putting a deal together. But really where you make the most money is absolute pays the bills. And then on the back end is really where you make the most money and were projected, the deal is 80-20. So, we have 20%, the general partners of 20% of the profits on the back end.
Don: So, investors must be very, very happy.
Thomas: Oh, yeah, no, they are. So we had to use crowdfunding we use the crowdfunding site called Realty Shares. And they raised about 90% of the equity for the property. So, their investors are getting should be very happy with what they’re getting from this property and at the act and we’ll sell our management chunk is going to be anywhere from $350,000 to a little bit over $400,000 just estimating how much will be making as a general partnership team on the back end.
Don: So how many partners are you?
Thomas: Five partners. All roughly split the management side equally, so give or take there are some differences in there, but I mean, just for the sake of argument is roughly the same. So, let’s just say we use a round number we make $400,000 each partner that we walk around with roughly $80,000 from one transaction.
Don: Yeah. And that’s at 20% split, which is below what a general partner is typically making. So right now, I know that it used to be 70-30. Those are the general split. So, 30% for the GP and then 70% for the LPs. And it’s even going to the place where it’s going to be 65-35 and 60-40 is what I’m hearing right now because the market is a little bit tighter. So, the sponsors of the deals, they want to make sure that they’re making money because it’s difficult. It’s not easy to find a deal. It’s not easy to find money. So yeah, they want to get paid. And so, I think if you were to do the same deal on a 65-35% you’d be making around 150,000. Right?
Thomas: Sounds about right.
Don: Nice. So that’s great. I’m very happy for you that you struck your first deal. You were able to make a decent amount of money like that. Also, you had partners. Sometimes in a GP, you’d have two partners, three partners but five is a lot, I’ll say.
Thomas: Yeah, you know, the reason why we have along with this one, this is a big learning experience. So, one of the partners does this full time that has a very good business out of it. And the rest of the other four partners, myself included, were mostly in it for the learning experience. So that’s why we were happy taking the lower amount on the general partnership side, just to make sure we saw the entire experience from A to Z, and that we’d be better equipped to do ones ourselves going forward with likely a smaller partnership, because like you said, when you’re splitting that amount of money between five people, it’s still a decent chunk of change, but it’s nowhere near the amount of money you could be making two $300 off of one transaction. Yeah, a group with two people doing a deal.
Don: Yeah, it gets two people doing that kind of deal and today’s market on a 35% 65% split, I’d say that they’d be making about $300,000 each.
Thomas: That’s significant. One of the things my mentor always says just do one of these deals a year, you’re going to set yourself up nicely.
Don: Good. Yeah, yeah, that’s very nice. What are your plans for the future as far as your CPA in a Real Estate company, are you going to keep doing syndications or you’re going to just keep your job and I know you’re 28 years old, which is very young, so you got a whole lot of time.
Thomas: That’s a great question. After I did that deal, I was pretty much planning to go right back into syndication and do another one. But I decided it makes more sense for me to focus on as a CPA, I work directly with real estate investors. So, keeps me very in tune with what’s going on, give me a chance to rebuild my savings basically, to invest in more syndications. And at this point, once we liquidate this building, once this building goes to market, it’s closed down, I’m going to take whatever money I get from it, essentially, and start looking for another syndication. I’ll probably do something smaller with one or two partners or I’m even open to doing JV with no investors if we find the right deal. So that’s pretty much the future and be focused on that in 2020 & 2021.
Don: Nice. So yeah, if you want to JV you’re going to need to have some connections. So, what if people want to connect with you and get to know you, what would be the best way to do that?
Thomas: The best way to get in touch with me would be to shoot me an email. You could reach me at ThomasCastelli@NewBabyloncapital.com -that’s for the real estate side of things. If you’re interested in connecting talking about the services of a CPA or real estate accounting and tax services, you can reach me by checking out the ‘Real Estate CPA’ podcast actually has a great podcast for real estate investors and then also can reach me at Thomas.Castelli@WholeCPALLC.com again, it’s Thomas.Castelli@WholeCPALLC.com.
Don: Nice. Okay, Tom. So, thank you very much for coming to the show today. I hope you’re going to have a great day and good luck in the future.
Lady: Thanks for listening to the Real Estate Investing Podcast with Don and Eden. Stay tuned for more episodes. Till next time!