John McNellis - 45 Years in Real Estate, The Lessons Every Investor Should Know | Real Estate Educators Podcast with Kevin Amolsch

Description

John McNellis has spent more than four decades developing commercial real estate, completing more than 100 projects throughout Northern California. But his real estate career actually began while he was still practicing law, when he turned a $1,500 investment in a duplex into roughly $90,000 through a series of early deals.

In this episode of the Real Estate Educators Podcast, Kevin Amolsch talks with John about his transition from attorney to developer, raising money for his first major shopping center development, and what real estate investing looked like when interest rates and cap rates were dramatically higher than investors became accustomed to over the past decade. John explains why higher rates don't necessarily mean deals stop happening, it may simply take time for buyers and sellers to adjust their expectations.

They also dig into how John evaluates passive real estate investments. His first priority is the sponsor: Do they have their own money invested? What's their track record? Are their interests aligned with investors? And are they making their money from successful investments—or loading the deal with fees? Only after evaluating the "jockey" does John move on to underwriting the "horse."

Timestamps

00:00 – From journalism to law school

03:25 – Why John left litigation for real estate

07:30 – Building deals while working full-time

17:20 – Why higher interest rates don’t kill real estate deals

21:10 – Preferred returns and profit splits explained

26:05 – How to evaluate a real estate sponsor

30:45 – Why experienced investors eventually lose money

32:25 – Underwriting the jockey AND the horse

34:15 – John’s book, Making It in Real Estate

36:20 – Understanding partnership structures and capital calls

40:05 – John’s advice for long-term real estate success

About Making It in Real Estate

John is the author of Making It in Real Estate: Thriving as a Developer. The book grew out of years of columns he wrote about real estate development and focuses on straightforward lessons designed to help investors and developers avoid mistakes he made throughout his career.

John says the book has sold approximately 40,000 copies across three editions and has been used at universities including Stanford, Berkeley, UCLA, Georgetown, Cornell, Clemson, and Vanderbilt. The latest edition also includes a section devoted to some of John's biggest mistakes and ways investors can lose money in real estate.

Connect with John McNellis

John publishes essays on real estate through publications including the San Francisco Business Times and The Registry, and reposts his writing on LinkedIn.

Learn more about John McNellis and McNellis Partners: https://mcnellis.com/

Learn more about Pine Financial Group: https://pinefinancialgroup.com/

Hosted on Ausha. See ausha.co/privacy-policy for more information.

Transcription

Speaker #0
The last one I did before I jumped into the retail development, we bought a warehouse for a million two, and I probably raised three or four hundred thousand dollars among friends and family. Good deals are much harder to find than money. If you have a good deal, the money's always there. So we decided we would rather own 100% of a million dollar deal, you know, of a corner gas station or a McDonald's, than 10% of a $10 million deal and so on. I think about like farmers. You know, we try to do a couple of deals a year. You know, farmers have droughts, you know, that they have too much rain, but it kind of evens out over the years. If you kind of stick with it, it'll even out over the years. You'll get lucky, like I did very early on with that $90,000 profit in a couple of years. And then, you know, some years you won't do so well, but it's just sticking.
Speaker #1
We were in negotiations, investing in real estate. They're winning, they're making money.
Speaker #2
What's up, everyone? Welcome to the Real Estate Educators Podcast, where we provide the education you can build on. I am your host, Kevin Amos. We are back with another exciting episode, something we haven't talked about on this show yet, real estate developing in the retail space. Now, John McNillis, I hope I got that right, former attorney, you decided to get into real estate because you saw that as a great option for you. You didn't really like the law stuff, It sounds like so much. But now you've developed over a hundred properties in the Northern California area. You really niched down into that specific area, it sounds like. I'm really excited to learn from you today. Welcome to the show.
Speaker #0
Thank you, Kevin. Delighted to be with you today.
Speaker #2
All right, John, let's get into it. So law school, right before I hit record, man, you said, I don't really like school, but you went to law school. So take me back.
Speaker #0
Well, I'll take you back just a little bit farther than that. So I was always pretty good at talking and I could type, but I had no other talent. So when I was in college, I was a journalism major. And one of the best things or smartest decisions I ever made a senior year was I don't want to be a journalist. I don't want to write about what other people are doing. Little did I know how journalism would ultimately fall apart in the modern world. But I woke up senior year and said, what the hell am I going to do? I don't want to get a job. I don't have any talent. And I was a pretty good talker. So I went to law school and I go to law school thinking just like everybody else there that I'm going to be Matlock or Perry Mason and free innocent people, you know, and just be the peacock strutting around court. So I got a job with a fancy law firm in San Francisco, very fancy law firm with big firm litigation. And to make a joke of it, it took me. Oh, I don't know. two or three hours to realize I'd made a terrible mistake. It actually took probably a year or two, but litigation is nothing like the way it's portrayed in the movies. It's just ugly, soul-killing, stultifying, and it's just a paper war where you're just pushing paper at the other side and they push it back at you. But fortunately, Kevin, this firm had a real estate department, and so I begged and begged and begged, and finally the managing partner let me switch over to the business side to doing real estate deals. So I was representing buyers and sellers and lenders and equity partners, doing everything from hotels to industrial buildings, office buildings, and so on. And that I loved. And I did that for a number of years. But meanwhile, on the side, like the age of 24, I think I bought a duplex in Southern California. And I got really lucky on the timing. The town had been depressed, but it was on a real rise. So I think I paid about $25,000 for it. And maybe I put down $1,500. But a year later, after some paint and petunias and just a little sprucing up, sold it for $60,000, traded it into a fourplex for that $60,000, sold that a year later for $120,000. spoiler alert, that's the best I've ever done, you know, for $1,500 to $90,000. That was great. So I was doing two things at the same time. I was doing little tiny deals on my own, kind of learning the nuts and bolts of not quite development, but buying and selling. And then I was doing much bigger deals as a lawyer for my clients, which was really helpful getting comfortable with the big deal structures and meeting the right people who had. the money and just seeing how the big leagues played out.
Speaker #2
Wow. That's a really fascinating story. What I find interesting is that you were an associate, right?
Speaker #0
Yes.
Speaker #2
Went from litigation, which my son wants to be in litigation. So I have to tell him not to tell him to call Uncle John. I might. You said soul killing. So that's a pretty powerful statement. So maybe I'll go back and have a conversation with him.
Speaker #0
It's interesting. Just have him listen to this episode. OK,
Speaker #2
I'll do that. Him and I, it's funny because we already talk about like there's risk in law. AI is making an impact in this area. So if you want to go into law, I'm... 100% supportive, but you've got to incorporate AI somehow. So what AI courses are you taking in college? That's the question I'm asking him. And how are they teaching you to incorporate that into... Anyways, I go off on a tangent here. But how did you have time as an associate to go out and find a real estate deal?
Speaker #0
Yeah, nights and weekends. You know, I'm a pretty lazy guy, but there was a time there when I was starting out. when I was practicing law full time. And then I was trying to do development on the side where I was actually really busy. And, you know, you just give things up, you know, instead of going out drinking with the guys or whatever, or playing in the basketball league, you know, I was out trying to do deals.
Speaker #2
And it paid off for you.
Speaker #0
Yeah, yeah, ultimately it did. Ultimately it did, yeah.
Speaker #2
Okay, so you, I'm assuming some of your clients were doing retail development. How did you go from... duplexes and fourplexes and flipping those over time to developing grocery anchored centers?
Speaker #0
Great question. So the little deals I was doing on the side, first I started with my own $1,500. But if you put your thumb and forefinger together, that was putting aside the $1,500, my net worth. So as I was progressing on the little deals, I started taking in partners and kind of getting a little bit larger and a little bit larger. And I think the last one I did Thank you. Before I jumped into the retail development, we bought a warehouse for $1.2 million, and I probably raised $300,000 or $400,000 among friends and family. Okay. Meanwhile, in my day job, then I'm getting pretty good as a real estate lawyer, and I represented the firm's developers. And one developer, remember, I'm in my kind of mid-late 20s at this point. One developer was about 15 years older, and he was a successful. shopping center developer. He worked for a big company, Dillingham out of Hawaii actually, and we did a couple of shopping centers together as lawyer and client. And then several years into it, Dillingham pulled back, went out of the business, and on the books, a deal that we had almost tied up was here in Northern California in Healdsburg, which for those of you listeners who don't know, Healdsburg is now one of the most she-she. chic wine towns. It's about an hour and a half north of San Francisco. Everybody goes there. So he had his deal in Healdsburg tied up for a typical neighborhood shopping center. And by that, guys, I mean about 100,000 feet of buildings on roughly 10 acres, a supermarket at one end and a drugstore at the other. And we used to call those barbell centers. Because you'd have a big market on one end, a big drugstore on the other, and then a skinny row of shops in between, like a barbell. You know, we had that put together on paper. And then my partner said he was going to do the deal and I'd be the lawyer. But he was a good developer. He knew how the parking should be laid out, where the trash should go, how tall the building should be. All the stuff, frankly, that I had no idea about. But he was, let's put it this way, he was charismatically challenged. The guy couldn't sell snow cones in Africa. You know, so.
Speaker #2
He needed a partner.
Speaker #0
Yeah, he needed someone who could raise money. And then, you know, I was his annoying, much younger lawyer, you know, this punk kid. And I said, let me raise the money and I'll be your partner. And he said no. And he went out and tried to raise the money and failed. Ultimately said OK. And so then I went. It's a true story, Kevin. I went like door to door. trying to raise, it was $900,000, trying to raise it at $25,000 a pop. And I tell you, that's not fun. You know, repeating the same story over and over again. Oh, here's some take-home value. Listeners, if you're ever pitching someone on a deal and they say, gee, this sounds interesting. Let me ask my financial advisor about it. Write them off right there. There's no financial advisor. because he's not going to make any money. And all he's going to do is get blamed if it doesn't go well. And he says, you know, why would you invest with this untried kid? But anyway, ultimately, I did raise the money. We built a shopping center. And we opened it in 84. And we still own it today, 42 years later. We still own that center. And all those investors who put up $25,000 originally, they make about $25,000 a year on the deal. It's a great center. We paid it off. And that was my jumpstart from, let's say, rookie ball up to double or triple A. And then he and I were partners for about as long as we needed each other. We were never close friends, but two of the employees that we hired came with me when my first partner and I split up, and they've been with me since 1984. And we've been doing essentially a couple of deals a year, maybe a little more for the last 45 years. All in Northern California, all the development deals are, in fact, they're all within about a two-hour drive of San Francisco.
Speaker #2
That's crazy. It must be a big market because you've done over 100. So I was thinking that right before I hit record here. Like, how far? Like, how many square miles are we talking? Because that's a lot of deals.
Speaker #0
That's a lot of deals. They're not all neighborhood centers. Some are smaller. A couple are larger. You know, some might. Like, now we're doing much smaller deals because ground-up shopping centers, they're not penciling right now. And I think that's also the case everywhere in the country. Definitely not here in Northern California. So some of them might be like a freestanding Chick-fil-A, for example. But yeah, somehow we managed. It's not a lot in any given year, like two a year. Like, gee, what are you doing with the rest of your time? But you add it up over time and there you go.
Speaker #2
You've done really well. And the way I want to get into how you structured the deal, because we're talking about mid-1980s. I know what was going on there. And for the listener, it was extremely high inflation and extremely high interest rates. Like you hear of the 18% mortgage rates. That is the time we're talking about here, I believe, John. Correct me if I'm wrong.
Speaker #0
You're slightly off. That was a couple of years before. That was like 81, 82, when interest rates, they did hit 18%.
Speaker #2
They were still pretty high in 84,
Speaker #0
though. Yeah. And the preferred returns. Here's the point, though. It's kind of interesting. We all did quite well. Guys, in those days, a cap rate on a first quality shopping center was 10%. A cap rate on a gold-plated Walmart with the best credit ever or a U.S. post office, that was 8.5%. For an okay deal, an okay deal that you'd like, it was like 11% or 12%. And interest rates were correspondingly that high. Interest rates were 9%, 10%. The thing is, we all thought that's where interest rates were and that was part of life, you know, like oxygen and air, it's part of life. And so the deals transacted back and forth. What's happened today is that everybody's had this expectation that interest rates are going to drop back to where they were in 2022, you know, at that 3%. And so everybody's sitting on their hands and it's much harder to get deals done right now because rates have done nothing but go up. In fact, remember the beginning of this year, everyone in our world, in CRE, commercial real estate, said, this is going to be a killer year for us. Rates are going to come down and the deals are going to flow like cheap wine. And it didn't happen. You know, the Iran war happened and rates have gone the other way and things are still stuck. I think a lot of it is just the perception of what's reality. And I think finally people are coming around to saying, okay, the reality is the rates are going up and they're going to probably stay there for a while. But I wouldn't be afraid of that. The stuff will trade. If everybody says interest rates are 10% and that's where we are, okay, we're all on the same lifeboat and we'll paddle together and we'll get it done.
Speaker #2
Yeah, you make so many good points. There's so many different directions I could take what you just said. And maybe I come back to that because. The interest rate conversation is real, and people are struggling with that. It is. We're recording this on September 2nd, so by the time you hear this, the Fed would have already met. But it's very interesting to try to understand what the Fed is going to do because we still have the inflation, the sticky inflation, and now we have jobs numbers coming in that it's not good. So now they're getting pulled in two different directions. I don't really know what's going to happen, but it is an interesting conversation. What I would love to do, John, is come back to the first deal. So, okay, I was off on the 18%, but the mid-80s still had extremely high interest rates. And you're telling me a Walmart traded at a 10 cap or an 8 cap. They would be at 4 today, right? That's right. It's still an interesting time that you were getting into this business.
Speaker #0
Yeah, now it's fun.
Speaker #2
The point I want to make is you were syndicating before we even knew what that term meant. So help me understand, how did you structure the deal? You raised a million dollars. How was your capital stack? And how did you figure all that out?
Speaker #0
Sure. First of all, I'll challenge that. I think people have been syndicating deals since Ramsey's the second. I bet he syndicated the pyramids. And it's never really changed, Kevin. The only thing that changes is the numbers. So today, if you were syndicating a deal, the preferred return to the money would probably, I'm guessing, would be about 6% or 7% pref before you do the split between the money and the developer. In those days, it was about 10%. But... And the deal was pretty simple. It was the money, let's call it a million dollars. The money got a 10% preferred return and then a 50-50 split, you know, after that, once we hit that return. So if we had 10 million up as a round number, the first million in, excuse me, a million up rather, it was a $10 million deal, but a million in equity. So the first 100,000 each year of cash flow would go to the investors. If it was 120,000, we'd get 10 and they'd get 110. And that, as far as I can tell, that hasn't changed. Now, you're right in a way, syndications fell out of fashion for quite a while and now they've come back. But it really, other than what the interest rates are and what the splits are, and they've become more complicated with these waterfalls, they call them, and, you know, different splits all the way around the line. But they're really the same. So that was our deal. It was. 10% preferred return to the investors and then a 50-50 split.
Speaker #2
Okay. And your GP group or general partner group was you and your partner?
Speaker #0
Yes.
Speaker #2
One other partner?
Speaker #0
Yes. And then just to dive into a little bit deeper, I had a job as a lawyer and he didn't because he had lost his job with the development company. So what we did, and I was more concerned about the back end than the front. So we took the fees. And again, the fees were pretty typical. I think it was 3% on hard costs and the construction costs were the development fee. And then we also got leasing commissions, standard market leasing commissions, if we did it without an outside broker. But he and I split those fees 80-20, 80 to him, 20 to me. But the back end, which ultimately proved far more important, was a 50-50 split. So my share was... If you think about that, it's 25% of the ultimate profit.
Speaker #2
So if I was a LP, a limited partner, and I was going to invest in a deal with you today, it sounds like you're still doing business. What are some of the things I should be looking for? How do I do my diligence on your project?
Speaker #0
Okay. Well, I'm happy to report, Kevin, that we haven't had a limited partner since 1992.
Speaker #2
Okay. So you're just all on your own now.
Speaker #0
Yeah, we just use our own capital. And one reason, so what we do is out of those hundred odd deals, we probably only have 25 left in the portfolio because we decided, that's a long conversation, which I'm happy to have, but we decided that good deals are much harder to find than money. If you have a good deal, the money's always there. So we decided we would rather own 100% of a million dollar deal, you know, of a corner gas station or a McDonald's. Then 10% of a $10 million deal and so on. So we purposely shifted in that to us was a great recession in the early 90s and said, no more limited partners. We're just going to do it on our own. We'll sell one, fix it up and trade into the next two. And we've been doing that ever since.
Speaker #2
Okay, that's a great way to do it. A lot of people, a lot of these syndicators and when I was said the syndicating, you were doing that before it was a thing. What I meant by that, John, was it wasn't a popular term you heard in real estate. So once you start talking about it on bigger pockets, then everyone's talking about syndications. And so now it's super popular, especially in the multifamily space. What I was trying to communicate to the listener is there's people were syndicating a long time ago, and it's not just multifamily. You can syndicate development or anything really. It's just bringing a group of people together to help you get your project done. This episode is brought to you by Pine Financial Group. Pine Financial is a private lender specializing in short-term rehab lending to real estate investors. Got a property that needs some love? We can help. We are able to offer funding solutions because we raise private money from individual investors. With more than 15 years of experience, Pine offers passive investors an alternative that provides stability, consistency, and security to your portfolio. If you like real estate but want to avoid the ups and downs and effort, A Pine Mortgage Fund could be a perfect fit for you. Accredited investors will experience an 8% preferred return and profit sharing. Diversify your portfolio out of Wall Street and into Main Street with a Pine Financial Group Fund. To get more information at pinefinancialgroup.com, that's pinefinancialgroup.com. So I'm an LP in a lot of different projects. I prefer that because I operate my own business. I don't have time, similar to you when you got started. So I like to be an LP. What should I be looking for when I'm looking at somebody else's deal? What are some of the pitfalls you're seeing right now in the LP positions?
Speaker #0
Sure. I'm happy to go into that. The worst thing you can do, you want to make sure that the general partner truly has an investment in the deal. Too often, I see a deal where the general partner, the promoter says, I'm going to put $100,000 in, let's say, on a million-dollar deal. But then he has fees of $200,000 pretty much right up front. So if the guy has no money in the deal, I don't like it. I mean, if I were looking to invest in LPs, which I'm not, folks, so don't send me any. The first thing, that would be... Right out of the blocks. Okay, I'm not doing that deal. He doesn't have any money in it. Then, you know, I would want to look at his track record or her track record and see how many have they done. What's their success rate? And then I would take a look, hard look. Sometimes you'll see guys that just have fees everywhere. You know, they have an acquisition fee. They have a loan origination fee. They have an asset management fee if they're not doing the property management themselves. They have a refinance fee. They have an exit fee. And anytime I see a deal like that, it's just chock full of fees. I'd say, you know, stay away from that. The other thing I want to have a good idea is how long are they going to hang on to this property? And they usually say three, five, seven years. But, you know, of course, as a limited partner, you give up control and things do change. Now, my limited partners, you know, back in that deal from 42 years ago. I can't get them out with dynamite. I would love to buy them out. Yeah, don't sell. No. And I've gradually over the years bought some of the interest back, but it's such a good deal for them. You know, I'm stuck with them for life. But that's it. And then I would take a hard look at the numbers. One of our jokes here with my partners is that when you almost always see it with like, here's the optimistic case, here's the middle case, and here's the conservative case. And sometimes here's the worst case. And the worst case is always you make a little bit of money, right? It's never bad. Well, so over the last 45 years, we've seen the worst case scenarios turn out to have been wildly optimistic, where things can go really, really bad. And by the way, I'll make this point. And if you do more than a handful of deals, you're going to lose money in real estate. It's hard. It's complicated. It's like the weather. You can't predict it. You and I could have been geniuses along the lines of Newton or Einstein in 2019 or 18. But if we bought office buildings then, which look like brilliant assets, we lost our ass because of COVID, which nobody saw coming. Or same thing with this year. Nope. Who foresaw the Iran war that we'd be in this mess six months later and then the economy is so fragile over it? So you will lose money, folks. Anybody who said I've never lost any money, I would not invest with him. In fact, that's another kind of inside joke. I'd say if you have to show me where you've lost money before, I'd consider investing with you. Now, what I do do is act kind of like a real estate venture capitalist now. And so I'll invest as the sole partner, the 100% financing partner with younger developers. But again, I say, you need to show me where you've lost money before. Because those who haven't lost money, let's say somebody gets in the business the week after the recession ends and then rides it, like the last 10 years or so until this all happened, was a great bull market. So those guys, they start to think they're invincible. They think they, as the expression goes, they mistake luck for brains and they get a little bit too cocky and they're the ones who are going to lose your money.
Speaker #2
Yeah, this is really good advice. Now, I want to get into your book because I'm really excited to talk about that. I want to unpack this just a little bit. I agree with you that everyone loses money in real estate. There's no question about it. Now, we run an evergreen debt fund. John, just so you know what we do as a business. I think you knew that. Okay. Yeah. So no investor that's invested in any of our funds through 17-year track record has ever lost money. I could say that with a fact. But that does not mean that I haven't lost money on individual deals inside the fund. So that is true. So just a clarifying for our listener because we do say that we haven't lost money, which is a fact, but we have lost money on deals.
Speaker #0
Right.
Speaker #2
Quick clarifier there.
Speaker #0
Yeah. Sure.
Speaker #2
Now, what I found very interesting about your approach to underwriting a deal is you only said one item that had to do with the deal itself. So I just want to highlight this for the listener because this is really good information. You're betting on the jockey, not the deal. You want to underwrite the jockey, not the horse, right, with the exception of the fees, which would be the partnership structure and their plan. So you want to write those two things would be the structure of the partnership. But otherwise, you're like, what's their track record? How long have they been doing it? What's the money they're invested? That's all underwriting the sponsor.
Speaker #0
Well, no, let's stick with your metaphor, the horse race. You've got to underwrite both.
Speaker #2
No, you do. But I just wanted to point out, I was paying attention to that. You didn't even know it. But you really started with the sponsor. You have to get that right.
Speaker #0
Yes. Yeah, that's step one. So if it's Kevin, if it's a smart guy with a good track record and he's charging reasonable fees and his financial interests are aligned with mine, that is, I'm going to at least get my money back before he makes any money. OK, step one. That's great. I like the jockey. Now let's take a look at the horse. Yeah. But most LPs, you know, I'm a professional. I've been doing this for a long time, so I can underwrite a retail deal very, very quickly. Most LPs are not in that position. You know, they'll they'll get 30 pages of P&Ls and projections and they're not going to know. So you really have to to basically say Kevin has a good deal. I like Kevin. I trust him. I'm going to go with him as a limited partner. Unless you happen to be totally experienced at it. You know, chances are you don't even know the right questions to ask, you know, let alone the answers. So I guess for someone who isn't an expert. In a limited partner, the jockey is more important than the horse.
Speaker #2
Yeah, I love it. And I'll just share this as well. I agree with everything you're saying. And you should still try to underwrite the deal.
Speaker #0
Yes.
Speaker #2
And try to learn and understand it. And we have AI now. So ask AI what you should ask if you don't know what to ask. At least do something to try to understand the deal as well. At least that's what I would do. All right, let's talk about your book. Sure. This is really exciting, John, because you told me that it's in several different colleges. Total curriculum has been built, syllabus or whatever, been built based on your book that you've had for so many years. So you're holding it up. So if you're watching it on YouTube, you can see it. If you're not watching it, John, tell us what the title is and tell us about the book.
Speaker #0
Yeah, okay. So for you listeners, my last name is spelled M-C-N-E-L-L-I-S, McNellis. The book is called Making It in Real Estate. thriving as a developer. So go back to my ancient history. I was a journalism major. I always loved to write. And I was always writing something. And when I was in law school, I edited my school newspaper and I wrote columns. And then about close to 20 years ago, we were well-established, a real estate magazine, the registry came to me and said, hey, John, you're a smart guy. We'd like to do an interview with you, you know, for our back page. And I said, sure. But I sound a lot smarter on paper than I do in person. So I said, why don't you give me the questions and then I'll write the answers in a conversational tone. So it looks like it's a conversation. And they thought about it for a second and said, sure, why not? So I did that. And then the publisher of the magazine came and said, hey, John, you can really write. Why don't you write a monthly column for us? And this goes back to like 2010 or so. And I said, sure, that's fine. You know, I like to write. So I started writing every month a column on real estate. And some some months it was on some topical subject. Uh, like WeWork, I, I, I was an early critic of WeWork, for example, but some months, you know, I didn't have anything else. So I would write about how to do what I do, you know, how to be, to start, run and succeed as a development company. And then about three or four years into it. And I had, you know, 30 or 40, um, essays, uh, a good friend says, Hey, John, this should be a book. And I said, wow. Okay. That sounds good. Cause I'm lazy. And I've I already got most of it written. So I went to the publisher in 2016, and they said, yes, we like it. They published it, and Making in Real Estate became the publisher's number one selling title. Over the three editions, Kevin has sold 40,000 copies, and it is taught at the best universities in the country. Stanford, Berkeley, UCLA, Georgetown, Cornell, Clemson, Vanderbilt, on and on and on. And I hear from schools all the time. So, and the book is simple. It's the, each chapter makes us a simple point. Like I have one on bankers. The moment you start in our business in a serious way, your banker who lends you money wants you to be exclusive with that banker. Bad idea, folks. You need at least three banks because banks have a way of coming and going. Even the big ones like Wells Fargo, which was our main bank for years, they essentially went out of the lending business for four or five years there after the COVID thing. So you need multiple banks. So I tried to write simple chapters, making simple points that would help someone in the business avoid some of the mistakes that I made. And in this last edition, which is called Thriving as a Developer, you know, I'm at a point in my career where I don't care. So I added a whole section on like. my six worst mistakes. And I kind of jokingly called it, you know, the 10 best ways to lose money in real estate.
Speaker #1
Yeah. I wish we had time, John, to go into that.
Speaker #0
Oh, well we can do it again sometime.
Speaker #1
Well, I may have to have you back on maybe, because I would love to, I would love to talk about that, but I guess teaser for the listener, like, Hey, you want to know what the top 10 ways to lose money? Well, you're going to have to get the book. So the book is Making It in Real Estate. Sounds like it's a pretty easy read. Like wake up in the morning, read a couple of pages and you're through a whole point. And then the next, I love reading books like that. So this is, this is great. Anything else on the book that you want to, you want to mention?
Speaker #0
No, it's, it's, I think it's got more than 20 bucks worth of good advice in it. Oh, and you can buy it, you know, online, Amazon, Barnes and Noble and so on. You can pick it up anywhere.
Speaker #1
All right. Making it in real estate. Is it on Audible?
Speaker #0
Yes. Yeah. And I narrated it on Audible. And of course, there's also an e-book version as well.
Speaker #1
Okay. I might pick that up on Audible. I do read in the mornings, but it's like I said, I read two or three pages. It's hard for me to get all the way through a book. So I consume it in the car.
Speaker #0
I'm going to send you a free Audible copy.
Speaker #1
Okay. You don't have to buy it. It's okay. I can buy it. I just like Audibles in the car.
Speaker #0
No, I'm not in the writing business to make money. I do that for fun. So I'll send you a copy.
Speaker #1
Appreciate that, John. All right. So here's how we like to wrap up the episodes. I've taken some notes. I don't know if you saw me looking down on my paper, but I write down when I learn something through our conversation or something that I think I would like to highlight for the listeners benefit. So I have some notes here. I just would like to go through my notes with you. You tell me what I'm missing, where you want to add some color. And then if you don't mind at the very end, if you can give us one final piece of advice with all of these decades of experience that you have, I would love to get a final piece of advice from you.
Speaker #0
Okay.
Speaker #1
All right. So you started out by telling us about your journey into law school and then litigating and then get into real estate law. And you said soul killer as a litigator. All right. My son will have to hear that. And then you figured out how to take $1,500 into $90,000 by doing just small little real estate deals. And that kind of got you hooked. You did say if you're raising money and you hear the financial advisor role, that go ahead and don't waste any more time on them. I agree with you on that. PREF returns back in the day or PREF returns today you think are around 6 to 7. I'm seeing them a little bit higher, but 6 to 7 today. Back then when you were doing it, it was a 10 PREF and a 50% profit split. So that was a very attractive deal for your investors, and I could see why you still have them today. Go out and find your deal first and then you can get the money. That would be the order of operation there. GP should have an investment in the deal. So now we're talking about getting into an LP position. What are you looking for? GP should have an investment. What's their track record? Look at their fees and their fee structure and what's their plan? And then finally, look at the numbers on the deal itself. And are you comfortable with the deal itself? Okay, go ahead.
Speaker #0
If I can just clarify, the reason it was a 10% 50-50 split, because this was a ground-up multi-year deal. If you said to me, hey, John, we've got this empty office building here, and all it needs is a paint job, and we'll find a tenant for it, and we've got some tenants in mind, that kind of split would be 80-20, 80 to the money, 20. And then it all varies. And if there's no work to be done, then the money partner says, great, I'll pay you a brokerage commission or a consulting fee and I'll get out. But so it's somewhere between zero and 50%. I've never seen it go over 50%, at least on an honorable deal to the development side. But again, deals where let's buy it and paint it and lease it and sell it, that might be an 80-20 split, 20 to the promote side.
Speaker #1
Okay. Yeah. So let me go through the rest of my notes in just a minute. I totally agree. And I think this is another important point for the listener. Like these deals are structured so many different ways and I've seen them structured where the developer will say, well, if I could hit an IRR of 17 or 18%, then I could convert your equity to debt and push you out. So that would be something to look forward to, but some investors are happy with that. Like I'll go for the ride. Unless I get 18%, then I want my money back, right? So my whole point of that is it's structured a thousand different ways. So when you read your operating agreement and your PPM, your private placement memorandum, just make sure you understand the structure of the partnership. Is that fair?
Speaker #0
Yes. In fact, I wish that I had a paragraph like that in my 45-year-old limited partnership agreement where after a certain phenomenal return, we could... buy them out. But we don't. So I'm stuck with that. And that as an event, that would not trouble me. If, if you, Kevin said, John, here's the deal. It's X, Y, Z, but if we hit a home run, we can take you out after your money back plus an 18% annualized return. Sure. I'd do that deal.
Speaker #1
I would do that deal too. Yes.
Speaker #0
You know, it may feel like what, but that's a great deal. Nobody does 18% a year. So.
Speaker #1
I've seen many operating agreements with that structure. I don't know if they're actually hitting the 18. So they might be going on for the ride. But I thought that was an interesting. And there's different things to be careful with here, John. I think about capital call, the capital call provisions in the operating agreement. That's a big one. Be sure you understand that before you invest because not only could you get diluted, you could actually get penalized, right? So just, I guess, be careful.
Speaker #0
Yeah, they're called cram down provisions, you know, where if you don't put the money up, you can get cut back substantially. The other thing to remember, though, because it's these limited partnership agreements, they're non-recourse to you as the limited partner, but they're also non-recourse the other way. So the guy can walk away and you're kind of stuck. But that's a topic for another day.
Speaker #1
Non-recourse above your investment. You could still lose 100 percent of your. Oh, sure.
Speaker #0
Of course.
Speaker #1
Okay. So then we went on after the numbers, you said, usually there's like a base case, a best case and a worst case. And then you have a worst, worst case. And your worst, worst case is usually optimistic. So. Well,
Speaker #0
not usually, but.
Speaker #1
It can be. Everyone has lost money in a deal. So if someone tells you they've never lost money on a real estate transaction, it's probably not the sponsor to invest with. And then your final little nugget that you gave us right there at the very end was have relationships with multiple banks. I would add on to that. You probably want multiple contractors. You want multiple of maybe everything because look, appetites change and people don't want to do the deal. They do. So to have multiple resources is never a bad idea. And if a banker told you that they want exclusivity, I probably wouldn't work with them personally.
Speaker #0
Right. And in fact, I make that point in the book. You think Noah's Ark. You really want two of everything. You want two contractors. two architects, many brokers, but you don't want to rely on any, what's the supply chain issues that are bedeviling industry. You don't want your personal supply chain issue to break down because you only have one contractor, say. So yeah, I make that point multiple times in the book. I think one accountant is probably enough, however.
Speaker #1
Yeah, that's a good point. Maybe, maybe not one attorney. I don't know.
Speaker #0
Yeah. Well, we use multiple attorneys, but they're all specialized. But yeah, one deal or a transaction attorney. But you need a backup because, you know, someone that they go fishing or they have a heart attack. Yeah, you need to have something. You need to get a deal done right away. And this is true with all the service providers. You just need a backup for everybody.
Speaker #1
Agreed. All right. Well, this was a fantastic episode. Is there any last minute piece of advice or wisdom we can pull out of your brain?
Speaker #0
I think you've drained it, but I think. If you work hard, if you're honest and you treat people well and you pay your bills on time, you know, I think about like farmers. You know, we try to do a couple of deals a year. You know, farmers have droughts, you know, that they have too much rain, but it kind of evens out over the years. If you kind of stick with it, it'll even out over the years. You'll get lucky like I did very early on with that $90,000 profit in a couple of years. And then, you know. Some years you won't do so well, but it's just sticking with it.
Speaker #1
Yeah, just stick with it. Great advice. Making it in real estate, you can get it on Amazon. If you would like to, John, share your contact information. If not, totally understand. But this would be the time.
Speaker #0
Well, I'm all over the internet, so it's too little, too late not to. So yeah, it's, you can write me, john at mcnellis.com, M-C-N-E-L-L-I-S. If you want to read my essays. They go out between the San Francisco Business Times and the Registry Magazine, but I also repost them to LinkedIn. So if you want to connect with me on LinkedIn, you can read my stuff there. And I'm always happy to hear from people.
Speaker #1
Well, I know you're super busy and obviously very proud of your book. I'm excited to consume that. And you still jumped on the call with me. I know you got a lot going on. So, John, thank you so much for that.
Speaker #0
My pleasure, Kevin. It's been fun chatting with you today.
Speaker #1
All right. For the listener, you have other podcasts you could be listening to, and you chose the Real Estate Educators podcast. And for that, I am so incredibly grateful. If you got value out of this episode like I did, please five-star review, share it with a friend, and I hope you'd make this day a great one. I really hope you enjoyed this episode as much as I did. If you did, please be sure to follow and leave a five-star review. Oh yeah, and tell a friend.

Description

Timestamps

00:00 – From journalism to law school

03:25 – Why John left litigation for real estate

07:30 – Building deals while working full-time

17:20 – Why higher interest rates don’t kill real estate deals

21:10 – Preferred returns and profit splits explained

26:05 – How to evaluate a real estate sponsor

30:45 – Why experienced investors eventually lose money

32:25 – Underwriting the jockey AND the horse

34:15 – John’s book, Making It in Real Estate

36:20 – Understanding partnership structures and capital calls

40:05 – John’s advice for long-term real estate success

About Making It in Real Estate

Connect with John McNellis

John publishes essays on real estate through publications including the San Francisco Business Times and The Registry, and reposts his writing on LinkedIn.

Learn more about John McNellis and McNellis Partners: https://mcnellis.com/

Learn more about Pine Financial Group: https://pinefinancialgroup.com/

Hosted on Ausha. See ausha.co/privacy-policy for more information.

Transcription

Speaker #0
The last one I did before I jumped into the retail development, we bought a warehouse for a million two, and I probably raised three or four hundred thousand dollars among friends and family. Good deals are much harder to find than money. If you have a good deal, the money's always there. So we decided we would rather own 100% of a million dollar deal, you know, of a corner gas station or a McDonald's, than 10% of a $10 million deal and so on. I think about like farmers. You know, we try to do a couple of deals a year. You know, farmers have droughts, you know, that they have too much rain, but it kind of evens out over the years. If you kind of stick with it, it'll even out over the years. You'll get lucky, like I did very early on with that $90,000 profit in a couple of years. And then, you know, some years you won't do so well, but it's just sticking.
Speaker #1
We were in negotiations, investing in real estate. They're winning, they're making money.
Speaker #2
What's up, everyone? Welcome to the Real Estate Educators Podcast, where we provide the education you can build on. I am your host, Kevin Amos. We are back with another exciting episode, something we haven't talked about on this show yet, real estate developing in the retail space. Now, John McNillis, I hope I got that right, former attorney, you decided to get into real estate because you saw that as a great option for you. You didn't really like the law stuff, It sounds like so much. But now you've developed over a hundred properties in the Northern California area. You really niched down into that specific area, it sounds like. I'm really excited to learn from you today. Welcome to the show.
Speaker #0
Thank you, Kevin. Delighted to be with you today.
Speaker #2
All right, John, let's get into it. So law school, right before I hit record, man, you said, I don't really like school, but you went to law school. So take me back.
Speaker #0
Well, I'll take you back just a little bit farther than that. So I was always pretty good at talking and I could type, but I had no other talent. So when I was in college, I was a journalism major. And one of the best things or smartest decisions I ever made a senior year was I don't want to be a journalist. I don't want to write about what other people are doing. Little did I know how journalism would ultimately fall apart in the modern world. But I woke up senior year and said, what the hell am I going to do? I don't want to get a job. I don't have any talent. And I was a pretty good talker. So I went to law school and I go to law school thinking just like everybody else there that I'm going to be Matlock or Perry Mason and free innocent people, you know, and just be the peacock strutting around court. So I got a job with a fancy law firm in San Francisco, very fancy law firm with big firm litigation. And to make a joke of it, it took me. Oh, I don't know. two or three hours to realize I'd made a terrible mistake. It actually took probably a year or two, but litigation is nothing like the way it's portrayed in the movies. It's just ugly, soul-killing, stultifying, and it's just a paper war where you're just pushing paper at the other side and they push it back at you. But fortunately, Kevin, this firm had a real estate department, and so I begged and begged and begged, and finally the managing partner let me switch over to the business side to doing real estate deals. So I was representing buyers and sellers and lenders and equity partners, doing everything from hotels to industrial buildings, office buildings, and so on. And that I loved. And I did that for a number of years. But meanwhile, on the side, like the age of 24, I think I bought a duplex in Southern California. And I got really lucky on the timing. The town had been depressed, but it was on a real rise. So I think I paid about $25,000 for it. And maybe I put down $1,500. But a year later, after some paint and petunias and just a little sprucing up, sold it for $60,000, traded it into a fourplex for that $60,000, sold that a year later for $120,000. spoiler alert, that's the best I've ever done, you know, for $1,500 to $90,000. That was great. So I was doing two things at the same time. I was doing little tiny deals on my own, kind of learning the nuts and bolts of not quite development, but buying and selling. And then I was doing much bigger deals as a lawyer for my clients, which was really helpful getting comfortable with the big deal structures and meeting the right people who had. the money and just seeing how the big leagues played out.
Speaker #2
Wow. That's a really fascinating story. What I find interesting is that you were an associate, right?
Speaker #0
Yes.
Speaker #2
Went from litigation, which my son wants to be in litigation. So I have to tell him not to tell him to call Uncle John. I might. You said soul killing. So that's a pretty powerful statement. So maybe I'll go back and have a conversation with him.
Speaker #0
It's interesting. Just have him listen to this episode. OK,
Speaker #2
I'll do that. Him and I, it's funny because we already talk about like there's risk in law. AI is making an impact in this area. So if you want to go into law, I'm... 100% supportive, but you've got to incorporate AI somehow. So what AI courses are you taking in college? That's the question I'm asking him. And how are they teaching you to incorporate that into... Anyways, I go off on a tangent here. But how did you have time as an associate to go out and find a real estate deal?
Speaker #0
Yeah, nights and weekends. You know, I'm a pretty lazy guy, but there was a time there when I was starting out. when I was practicing law full time. And then I was trying to do development on the side where I was actually really busy. And, you know, you just give things up, you know, instead of going out drinking with the guys or whatever, or playing in the basketball league, you know, I was out trying to do deals.
Speaker #2
And it paid off for you.
Speaker #0
Yeah, yeah, ultimately it did. Ultimately it did, yeah.
Speaker #2
Okay, so you, I'm assuming some of your clients were doing retail development. How did you go from... duplexes and fourplexes and flipping those over time to developing grocery anchored centers?
Speaker #0
Great question. So the little deals I was doing on the side, first I started with my own $1,500. But if you put your thumb and forefinger together, that was putting aside the $1,500, my net worth. So as I was progressing on the little deals, I started taking in partners and kind of getting a little bit larger and a little bit larger. And I think the last one I did Thank you. Before I jumped into the retail development, we bought a warehouse for $1.2 million, and I probably raised $300,000 or $400,000 among friends and family. Okay. Meanwhile, in my day job, then I'm getting pretty good as a real estate lawyer, and I represented the firm's developers. And one developer, remember, I'm in my kind of mid-late 20s at this point. One developer was about 15 years older, and he was a successful. shopping center developer. He worked for a big company, Dillingham out of Hawaii actually, and we did a couple of shopping centers together as lawyer and client. And then several years into it, Dillingham pulled back, went out of the business, and on the books, a deal that we had almost tied up was here in Northern California in Healdsburg, which for those of you listeners who don't know, Healdsburg is now one of the most she-she. chic wine towns. It's about an hour and a half north of San Francisco. Everybody goes there. So he had his deal in Healdsburg tied up for a typical neighborhood shopping center. And by that, guys, I mean about 100,000 feet of buildings on roughly 10 acres, a supermarket at one end and a drugstore at the other. And we used to call those barbell centers. Because you'd have a big market on one end, a big drugstore on the other, and then a skinny row of shops in between, like a barbell. You know, we had that put together on paper. And then my partner said he was going to do the deal and I'd be the lawyer. But he was a good developer. He knew how the parking should be laid out, where the trash should go, how tall the building should be. All the stuff, frankly, that I had no idea about. But he was, let's put it this way, he was charismatically challenged. The guy couldn't sell snow cones in Africa. You know, so.
Speaker #2
He needed a partner.
Speaker #0
Yeah, he needed someone who could raise money. And then, you know, I was his annoying, much younger lawyer, you know, this punk kid. And I said, let me raise the money and I'll be your partner. And he said no. And he went out and tried to raise the money and failed. Ultimately said OK. And so then I went. It's a true story, Kevin. I went like door to door. trying to raise, it was $900,000, trying to raise it at $25,000 a pop. And I tell you, that's not fun. You know, repeating the same story over and over again. Oh, here's some take-home value. Listeners, if you're ever pitching someone on a deal and they say, gee, this sounds interesting. Let me ask my financial advisor about it. Write them off right there. There's no financial advisor. because he's not going to make any money. And all he's going to do is get blamed if it doesn't go well. And he says, you know, why would you invest with this untried kid? But anyway, ultimately, I did raise the money. We built a shopping center. And we opened it in 84. And we still own it today, 42 years later. We still own that center. And all those investors who put up $25,000 originally, they make about $25,000 a year on the deal. It's a great center. We paid it off. And that was my jumpstart from, let's say, rookie ball up to double or triple A. And then he and I were partners for about as long as we needed each other. We were never close friends, but two of the employees that we hired came with me when my first partner and I split up, and they've been with me since 1984. And we've been doing essentially a couple of deals a year, maybe a little more for the last 45 years. All in Northern California, all the development deals are, in fact, they're all within about a two-hour drive of San Francisco.
Speaker #2
That's crazy. It must be a big market because you've done over 100. So I was thinking that right before I hit record here. Like, how far? Like, how many square miles are we talking? Because that's a lot of deals.
Speaker #0
That's a lot of deals. They're not all neighborhood centers. Some are smaller. A couple are larger. You know, some might. Like, now we're doing much smaller deals because ground-up shopping centers, they're not penciling right now. And I think that's also the case everywhere in the country. Definitely not here in Northern California. So some of them might be like a freestanding Chick-fil-A, for example. But yeah, somehow we managed. It's not a lot in any given year, like two a year. Like, gee, what are you doing with the rest of your time? But you add it up over time and there you go.
Speaker #2
You've done really well. And the way I want to get into how you structured the deal, because we're talking about mid-1980s. I know what was going on there. And for the listener, it was extremely high inflation and extremely high interest rates. Like you hear of the 18% mortgage rates. That is the time we're talking about here, I believe, John. Correct me if I'm wrong.
Speaker #0
You're slightly off. That was a couple of years before. That was like 81, 82, when interest rates, they did hit 18%.
Speaker #2
They were still pretty high in 84,
Speaker #0
though. Yeah. And the preferred returns. Here's the point, though. It's kind of interesting. We all did quite well. Guys, in those days, a cap rate on a first quality shopping center was 10%. A cap rate on a gold-plated Walmart with the best credit ever or a U.S. post office, that was 8.5%. For an okay deal, an okay deal that you'd like, it was like 11% or 12%. And interest rates were correspondingly that high. Interest rates were 9%, 10%. The thing is, we all thought that's where interest rates were and that was part of life, you know, like oxygen and air, it's part of life. And so the deals transacted back and forth. What's happened today is that everybody's had this expectation that interest rates are going to drop back to where they were in 2022, you know, at that 3%. And so everybody's sitting on their hands and it's much harder to get deals done right now because rates have done nothing but go up. In fact, remember the beginning of this year, everyone in our world, in CRE, commercial real estate, said, this is going to be a killer year for us. Rates are going to come down and the deals are going to flow like cheap wine. And it didn't happen. You know, the Iran war happened and rates have gone the other way and things are still stuck. I think a lot of it is just the perception of what's reality. And I think finally people are coming around to saying, okay, the reality is the rates are going up and they're going to probably stay there for a while. But I wouldn't be afraid of that. The stuff will trade. If everybody says interest rates are 10% and that's where we are, okay, we're all on the same lifeboat and we'll paddle together and we'll get it done.
Speaker #2
Yeah, you make so many good points. There's so many different directions I could take what you just said. And maybe I come back to that because. The interest rate conversation is real, and people are struggling with that. It is. We're recording this on September 2nd, so by the time you hear this, the Fed would have already met. But it's very interesting to try to understand what the Fed is going to do because we still have the inflation, the sticky inflation, and now we have jobs numbers coming in that it's not good. So now they're getting pulled in two different directions. I don't really know what's going to happen, but it is an interesting conversation. What I would love to do, John, is come back to the first deal. So, okay, I was off on the 18%, but the mid-80s still had extremely high interest rates. And you're telling me a Walmart traded at a 10 cap or an 8 cap. They would be at 4 today, right? That's right. It's still an interesting time that you were getting into this business.
Speaker #0
Yeah, now it's fun.
Speaker #2
The point I want to make is you were syndicating before we even knew what that term meant. So help me understand, how did you structure the deal? You raised a million dollars. How was your capital stack? And how did you figure all that out?
Speaker #0
Sure. First of all, I'll challenge that. I think people have been syndicating deals since Ramsey's the second. I bet he syndicated the pyramids. And it's never really changed, Kevin. The only thing that changes is the numbers. So today, if you were syndicating a deal, the preferred return to the money would probably, I'm guessing, would be about 6% or 7% pref before you do the split between the money and the developer. In those days, it was about 10%. But... And the deal was pretty simple. It was the money, let's call it a million dollars. The money got a 10% preferred return and then a 50-50 split, you know, after that, once we hit that return. So if we had 10 million up as a round number, the first million in, excuse me, a million up rather, it was a $10 million deal, but a million in equity. So the first 100,000 each year of cash flow would go to the investors. If it was 120,000, we'd get 10 and they'd get 110. And that, as far as I can tell, that hasn't changed. Now, you're right in a way, syndications fell out of fashion for quite a while and now they've come back. But it really, other than what the interest rates are and what the splits are, and they've become more complicated with these waterfalls, they call them, and, you know, different splits all the way around the line. But they're really the same. So that was our deal. It was. 10% preferred return to the investors and then a 50-50 split.
Speaker #2
Okay. And your GP group or general partner group was you and your partner?
Speaker #0
Yes.
Speaker #2
One other partner?
Speaker #0
Yes. And then just to dive into a little bit deeper, I had a job as a lawyer and he didn't because he had lost his job with the development company. So what we did, and I was more concerned about the back end than the front. So we took the fees. And again, the fees were pretty typical. I think it was 3% on hard costs and the construction costs were the development fee. And then we also got leasing commissions, standard market leasing commissions, if we did it without an outside broker. But he and I split those fees 80-20, 80 to him, 20 to me. But the back end, which ultimately proved far more important, was a 50-50 split. So my share was... If you think about that, it's 25% of the ultimate profit.
Speaker #2
So if I was a LP, a limited partner, and I was going to invest in a deal with you today, it sounds like you're still doing business. What are some of the things I should be looking for? How do I do my diligence on your project?
Speaker #0
Okay. Well, I'm happy to report, Kevin, that we haven't had a limited partner since 1992.
Speaker #2
Okay. So you're just all on your own now.
Speaker #0
Yeah, we just use our own capital. And one reason, so what we do is out of those hundred odd deals, we probably only have 25 left in the portfolio because we decided, that's a long conversation, which I'm happy to have, but we decided that good deals are much harder to find than money. If you have a good deal, the money's always there. So we decided we would rather own 100% of a million dollar deal, you know, of a corner gas station or a McDonald's. Then 10% of a $10 million deal and so on. So we purposely shifted in that to us was a great recession in the early 90s and said, no more limited partners. We're just going to do it on our own. We'll sell one, fix it up and trade into the next two. And we've been doing that ever since.
Speaker #2
Okay, that's a great way to do it. A lot of people, a lot of these syndicators and when I was said the syndicating, you were doing that before it was a thing. What I meant by that, John, was it wasn't a popular term you heard in real estate. So once you start talking about it on bigger pockets, then everyone's talking about syndications. And so now it's super popular, especially in the multifamily space. What I was trying to communicate to the listener is there's people were syndicating a long time ago, and it's not just multifamily. You can syndicate development or anything really. It's just bringing a group of people together to help you get your project done. This episode is brought to you by Pine Financial Group. Pine Financial is a private lender specializing in short-term rehab lending to real estate investors. Got a property that needs some love? We can help. We are able to offer funding solutions because we raise private money from individual investors. With more than 15 years of experience, Pine offers passive investors an alternative that provides stability, consistency, and security to your portfolio. If you like real estate but want to avoid the ups and downs and effort, A Pine Mortgage Fund could be a perfect fit for you. Accredited investors will experience an 8% preferred return and profit sharing. Diversify your portfolio out of Wall Street and into Main Street with a Pine Financial Group Fund. To get more information at pinefinancialgroup.com, that's pinefinancialgroup.com. So I'm an LP in a lot of different projects. I prefer that because I operate my own business. I don't have time, similar to you when you got started. So I like to be an LP. What should I be looking for when I'm looking at somebody else's deal? What are some of the pitfalls you're seeing right now in the LP positions?
Speaker #0
Sure. I'm happy to go into that. The worst thing you can do, you want to make sure that the general partner truly has an investment in the deal. Too often, I see a deal where the general partner, the promoter says, I'm going to put $100,000 in, let's say, on a million-dollar deal. But then he has fees of $200,000 pretty much right up front. So if the guy has no money in the deal, I don't like it. I mean, if I were looking to invest in LPs, which I'm not, folks, so don't send me any. The first thing, that would be... Right out of the blocks. Okay, I'm not doing that deal. He doesn't have any money in it. Then, you know, I would want to look at his track record or her track record and see how many have they done. What's their success rate? And then I would take a look, hard look. Sometimes you'll see guys that just have fees everywhere. You know, they have an acquisition fee. They have a loan origination fee. They have an asset management fee if they're not doing the property management themselves. They have a refinance fee. They have an exit fee. And anytime I see a deal like that, it's just chock full of fees. I'd say, you know, stay away from that. The other thing I want to have a good idea is how long are they going to hang on to this property? And they usually say three, five, seven years. But, you know, of course, as a limited partner, you give up control and things do change. Now, my limited partners, you know, back in that deal from 42 years ago. I can't get them out with dynamite. I would love to buy them out. Yeah, don't sell. No. And I've gradually over the years bought some of the interest back, but it's such a good deal for them. You know, I'm stuck with them for life. But that's it. And then I would take a hard look at the numbers. One of our jokes here with my partners is that when you almost always see it with like, here's the optimistic case, here's the middle case, and here's the conservative case. And sometimes here's the worst case. And the worst case is always you make a little bit of money, right? It's never bad. Well, so over the last 45 years, we've seen the worst case scenarios turn out to have been wildly optimistic, where things can go really, really bad. And by the way, I'll make this point. And if you do more than a handful of deals, you're going to lose money in real estate. It's hard. It's complicated. It's like the weather. You can't predict it. You and I could have been geniuses along the lines of Newton or Einstein in 2019 or 18. But if we bought office buildings then, which look like brilliant assets, we lost our ass because of COVID, which nobody saw coming. Or same thing with this year. Nope. Who foresaw the Iran war that we'd be in this mess six months later and then the economy is so fragile over it? So you will lose money, folks. Anybody who said I've never lost any money, I would not invest with him. In fact, that's another kind of inside joke. I'd say if you have to show me where you've lost money before, I'd consider investing with you. Now, what I do do is act kind of like a real estate venture capitalist now. And so I'll invest as the sole partner, the 100% financing partner with younger developers. But again, I say, you need to show me where you've lost money before. Because those who haven't lost money, let's say somebody gets in the business the week after the recession ends and then rides it, like the last 10 years or so until this all happened, was a great bull market. So those guys, they start to think they're invincible. They think they, as the expression goes, they mistake luck for brains and they get a little bit too cocky and they're the ones who are going to lose your money.
Speaker #2
Yeah, this is really good advice. Now, I want to get into your book because I'm really excited to talk about that. I want to unpack this just a little bit. I agree with you that everyone loses money in real estate. There's no question about it. Now, we run an evergreen debt fund. John, just so you know what we do as a business. I think you knew that. Okay. Yeah. So no investor that's invested in any of our funds through 17-year track record has ever lost money. I could say that with a fact. But that does not mean that I haven't lost money on individual deals inside the fund. So that is true. So just a clarifying for our listener because we do say that we haven't lost money, which is a fact, but we have lost money on deals.
Speaker #0
Right.
Speaker #2
Quick clarifier there.
Speaker #0
Yeah. Sure.
Speaker #2
Now, what I found very interesting about your approach to underwriting a deal is you only said one item that had to do with the deal itself. So I just want to highlight this for the listener because this is really good information. You're betting on the jockey, not the deal. You want to underwrite the jockey, not the horse, right, with the exception of the fees, which would be the partnership structure and their plan. So you want to write those two things would be the structure of the partnership. But otherwise, you're like, what's their track record? How long have they been doing it? What's the money they're invested? That's all underwriting the sponsor.
Speaker #0
Well, no, let's stick with your metaphor, the horse race. You've got to underwrite both.
Speaker #2
No, you do. But I just wanted to point out, I was paying attention to that. You didn't even know it. But you really started with the sponsor. You have to get that right.
Speaker #0
Yes. Yeah, that's step one. So if it's Kevin, if it's a smart guy with a good track record and he's charging reasonable fees and his financial interests are aligned with mine, that is, I'm going to at least get my money back before he makes any money. OK, step one. That's great. I like the jockey. Now let's take a look at the horse. Yeah. But most LPs, you know, I'm a professional. I've been doing this for a long time, so I can underwrite a retail deal very, very quickly. Most LPs are not in that position. You know, they'll they'll get 30 pages of P&Ls and projections and they're not going to know. So you really have to to basically say Kevin has a good deal. I like Kevin. I trust him. I'm going to go with him as a limited partner. Unless you happen to be totally experienced at it. You know, chances are you don't even know the right questions to ask, you know, let alone the answers. So I guess for someone who isn't an expert. In a limited partner, the jockey is more important than the horse.
Speaker #2
Yeah, I love it. And I'll just share this as well. I agree with everything you're saying. And you should still try to underwrite the deal.
Speaker #0
Yes.
Speaker #2
And try to learn and understand it. And we have AI now. So ask AI what you should ask if you don't know what to ask. At least do something to try to understand the deal as well. At least that's what I would do. All right, let's talk about your book. Sure. This is really exciting, John, because you told me that it's in several different colleges. Total curriculum has been built, syllabus or whatever, been built based on your book that you've had for so many years. So you're holding it up. So if you're watching it on YouTube, you can see it. If you're not watching it, John, tell us what the title is and tell us about the book.
Speaker #0
Yeah, okay. So for you listeners, my last name is spelled M-C-N-E-L-L-I-S, McNellis. The book is called Making It in Real Estate. thriving as a developer. So go back to my ancient history. I was a journalism major. I always loved to write. And I was always writing something. And when I was in law school, I edited my school newspaper and I wrote columns. And then about close to 20 years ago, we were well-established, a real estate magazine, the registry came to me and said, hey, John, you're a smart guy. We'd like to do an interview with you, you know, for our back page. And I said, sure. But I sound a lot smarter on paper than I do in person. So I said, why don't you give me the questions and then I'll write the answers in a conversational tone. So it looks like it's a conversation. And they thought about it for a second and said, sure, why not? So I did that. And then the publisher of the magazine came and said, hey, John, you can really write. Why don't you write a monthly column for us? And this goes back to like 2010 or so. And I said, sure, that's fine. You know, I like to write. So I started writing every month a column on real estate. And some some months it was on some topical subject. Uh, like WeWork, I, I, I was an early critic of WeWork, for example, but some months, you know, I didn't have anything else. So I would write about how to do what I do, you know, how to be, to start, run and succeed as a development company. And then about three or four years into it. And I had, you know, 30 or 40, um, essays, uh, a good friend says, Hey, John, this should be a book. And I said, wow. Okay. That sounds good. Cause I'm lazy. And I've I already got most of it written. So I went to the publisher in 2016, and they said, yes, we like it. They published it, and Making in Real Estate became the publisher's number one selling title. Over the three editions, Kevin has sold 40,000 copies, and it is taught at the best universities in the country. Stanford, Berkeley, UCLA, Georgetown, Cornell, Clemson, Vanderbilt, on and on and on. And I hear from schools all the time. So, and the book is simple. It's the, each chapter makes us a simple point. Like I have one on bankers. The moment you start in our business in a serious way, your banker who lends you money wants you to be exclusive with that banker. Bad idea, folks. You need at least three banks because banks have a way of coming and going. Even the big ones like Wells Fargo, which was our main bank for years, they essentially went out of the lending business for four or five years there after the COVID thing. So you need multiple banks. So I tried to write simple chapters, making simple points that would help someone in the business avoid some of the mistakes that I made. And in this last edition, which is called Thriving as a Developer, you know, I'm at a point in my career where I don't care. So I added a whole section on like. my six worst mistakes. And I kind of jokingly called it, you know, the 10 best ways to lose money in real estate.
Speaker #1
Yeah. I wish we had time, John, to go into that.
Speaker #0
Oh, well we can do it again sometime.
Speaker #1
Well, I may have to have you back on maybe, because I would love to, I would love to talk about that, but I guess teaser for the listener, like, Hey, you want to know what the top 10 ways to lose money? Well, you're going to have to get the book. So the book is Making It in Real Estate. Sounds like it's a pretty easy read. Like wake up in the morning, read a couple of pages and you're through a whole point. And then the next, I love reading books like that. So this is, this is great. Anything else on the book that you want to, you want to mention?
Speaker #0
No, it's, it's, I think it's got more than 20 bucks worth of good advice in it. Oh, and you can buy it, you know, online, Amazon, Barnes and Noble and so on. You can pick it up anywhere.
Speaker #1
All right. Making it in real estate. Is it on Audible?
Speaker #0
Yes. Yeah. And I narrated it on Audible. And of course, there's also an e-book version as well.
Speaker #1
Okay. I might pick that up on Audible. I do read in the mornings, but it's like I said, I read two or three pages. It's hard for me to get all the way through a book. So I consume it in the car.
Speaker #0
I'm going to send you a free Audible copy.
Speaker #1
Okay. You don't have to buy it. It's okay. I can buy it. I just like Audibles in the car.
Speaker #0
No, I'm not in the writing business to make money. I do that for fun. So I'll send you a copy.
Speaker #1
Appreciate that, John. All right. So here's how we like to wrap up the episodes. I've taken some notes. I don't know if you saw me looking down on my paper, but I write down when I learn something through our conversation or something that I think I would like to highlight for the listeners benefit. So I have some notes here. I just would like to go through my notes with you. You tell me what I'm missing, where you want to add some color. And then if you don't mind at the very end, if you can give us one final piece of advice with all of these decades of experience that you have, I would love to get a final piece of advice from you.
Speaker #0
Okay.
Speaker #1
All right. So you started out by telling us about your journey into law school and then litigating and then get into real estate law. And you said soul killer as a litigator. All right. My son will have to hear that. And then you figured out how to take $1,500 into $90,000 by doing just small little real estate deals. And that kind of got you hooked. You did say if you're raising money and you hear the financial advisor role, that go ahead and don't waste any more time on them. I agree with you on that. PREF returns back in the day or PREF returns today you think are around 6 to 7. I'm seeing them a little bit higher, but 6 to 7 today. Back then when you were doing it, it was a 10 PREF and a 50% profit split. So that was a very attractive deal for your investors, and I could see why you still have them today. Go out and find your deal first and then you can get the money. That would be the order of operation there. GP should have an investment in the deal. So now we're talking about getting into an LP position. What are you looking for? GP should have an investment. What's their track record? Look at their fees and their fee structure and what's their plan? And then finally, look at the numbers on the deal itself. And are you comfortable with the deal itself? Okay, go ahead.
Speaker #0
If I can just clarify, the reason it was a 10% 50-50 split, because this was a ground-up multi-year deal. If you said to me, hey, John, we've got this empty office building here, and all it needs is a paint job, and we'll find a tenant for it, and we've got some tenants in mind, that kind of split would be 80-20, 80 to the money, 20. And then it all varies. And if there's no work to be done, then the money partner says, great, I'll pay you a brokerage commission or a consulting fee and I'll get out. But so it's somewhere between zero and 50%. I've never seen it go over 50%, at least on an honorable deal to the development side. But again, deals where let's buy it and paint it and lease it and sell it, that might be an 80-20 split, 20 to the promote side.
Speaker #1
Okay. Yeah. So let me go through the rest of my notes in just a minute. I totally agree. And I think this is another important point for the listener. Like these deals are structured so many different ways and I've seen them structured where the developer will say, well, if I could hit an IRR of 17 or 18%, then I could convert your equity to debt and push you out. So that would be something to look forward to, but some investors are happy with that. Like I'll go for the ride. Unless I get 18%, then I want my money back, right? So my whole point of that is it's structured a thousand different ways. So when you read your operating agreement and your PPM, your private placement memorandum, just make sure you understand the structure of the partnership. Is that fair?
Speaker #0
Yes. In fact, I wish that I had a paragraph like that in my 45-year-old limited partnership agreement where after a certain phenomenal return, we could... buy them out. But we don't. So I'm stuck with that. And that as an event, that would not trouble me. If, if you, Kevin said, John, here's the deal. It's X, Y, Z, but if we hit a home run, we can take you out after your money back plus an 18% annualized return. Sure. I'd do that deal.
Speaker #1
I would do that deal too. Yes.
Speaker #0
You know, it may feel like what, but that's a great deal. Nobody does 18% a year. So.
Speaker #1
I've seen many operating agreements with that structure. I don't know if they're actually hitting the 18. So they might be going on for the ride. But I thought that was an interesting. And there's different things to be careful with here, John. I think about capital call, the capital call provisions in the operating agreement. That's a big one. Be sure you understand that before you invest because not only could you get diluted, you could actually get penalized, right? So just, I guess, be careful.
Speaker #0
Yeah, they're called cram down provisions, you know, where if you don't put the money up, you can get cut back substantially. The other thing to remember, though, because it's these limited partnership agreements, they're non-recourse to you as the limited partner, but they're also non-recourse the other way. So the guy can walk away and you're kind of stuck. But that's a topic for another day.
Speaker #1
Non-recourse above your investment. You could still lose 100 percent of your. Oh, sure.
Speaker #0
Of course.
Speaker #1
Okay. So then we went on after the numbers, you said, usually there's like a base case, a best case and a worst case. And then you have a worst, worst case. And your worst, worst case is usually optimistic. So. Well,
Speaker #0
not usually, but.
Speaker #1
It can be. Everyone has lost money in a deal. So if someone tells you they've never lost money on a real estate transaction, it's probably not the sponsor to invest with. And then your final little nugget that you gave us right there at the very end was have relationships with multiple banks. I would add on to that. You probably want multiple contractors. You want multiple of maybe everything because look, appetites change and people don't want to do the deal. They do. So to have multiple resources is never a bad idea. And if a banker told you that they want exclusivity, I probably wouldn't work with them personally.
Speaker #0
Right. And in fact, I make that point in the book. You think Noah's Ark. You really want two of everything. You want two contractors. two architects, many brokers, but you don't want to rely on any, what's the supply chain issues that are bedeviling industry. You don't want your personal supply chain issue to break down because you only have one contractor, say. So yeah, I make that point multiple times in the book. I think one accountant is probably enough, however.
Speaker #1
Yeah, that's a good point. Maybe, maybe not one attorney. I don't know.
Speaker #0
Yeah. Well, we use multiple attorneys, but they're all specialized. But yeah, one deal or a transaction attorney. But you need a backup because, you know, someone that they go fishing or they have a heart attack. Yeah, you need to have something. You need to get a deal done right away. And this is true with all the service providers. You just need a backup for everybody.
Speaker #1
Agreed. All right. Well, this was a fantastic episode. Is there any last minute piece of advice or wisdom we can pull out of your brain?
Speaker #0
I think you've drained it, but I think. If you work hard, if you're honest and you treat people well and you pay your bills on time, you know, I think about like farmers. You know, we try to do a couple of deals a year. You know, farmers have droughts, you know, that they have too much rain, but it kind of evens out over the years. If you kind of stick with it, it'll even out over the years. You'll get lucky like I did very early on with that $90,000 profit in a couple of years. And then, you know. Some years you won't do so well, but it's just sticking with it.
Speaker #1
Yeah, just stick with it. Great advice. Making it in real estate, you can get it on Amazon. If you would like to, John, share your contact information. If not, totally understand. But this would be the time.
Speaker #0
Well, I'm all over the internet, so it's too little, too late not to. So yeah, it's, you can write me, john at mcnellis.com, M-C-N-E-L-L-I-S. If you want to read my essays. They go out between the San Francisco Business Times and the Registry Magazine, but I also repost them to LinkedIn. So if you want to connect with me on LinkedIn, you can read my stuff there. And I'm always happy to hear from people.
Speaker #1
Well, I know you're super busy and obviously very proud of your book. I'm excited to consume that. And you still jumped on the call with me. I know you got a lot going on. So, John, thank you so much for that.
Speaker #0
My pleasure, Kevin. It's been fun chatting with you today.
Speaker #1
All right. For the listener, you have other podcasts you could be listening to, and you chose the Real Estate Educators podcast. And for that, I am so incredibly grateful. If you got value out of this episode like I did, please five-star review, share it with a friend, and I hope you'd make this day a great one. I really hope you enjoyed this episode as much as I did. If you did, please be sure to follow and leave a five-star review. Oh yeah, and tell a friend.

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