Creating A Sweat-equity Based Real Estate Investment Company

Hello, my name is Chad Kastel, and I’d like to tell my story of creating a sweat-equity based real estate investment company and strategy, one that I’ve utilized to great success. Before we dive in to all of that, I’d like to tell you a little bit about my background, and the path that lead me here.

I was born and raised in Margate, New Jersey, not far from Atlantic City. My parents spent most of my childhood engaged in a variety of small business endeavors, most notably a luxury shoe and clothing store in nearby Margate. In some ways they had a knack for the business, and they made a good team to boot. My mother was a vivacious and effective salesperson, and ran the front of the store while my father mostly managed the books and rest of the operations.

In some critical ways, however, they indulged the worst in each other. Neither had much in the way of financial literacy or discipline, and that brought out the worst in their management, both in the store and in their lives. They had all the trappings of economic success—the Benz coup, the extravagant vacations, the fine dining—but there was very little undergirding this lifestyle. A few changes to the industry, in the aftermath of the 2008 economic crash, left them unable to keep the business afloat. This was in spite of a devoted, affluent set of clienteles and something of an exclusive setup in their local market. The business folded, and they lost their house.

Looking back, I can see now why things went the way they did, but as a kid you don’t really understand, or maybe things seemed a little off but its hard to question your parent’s explanation. That said, even at an early age I had a sense that they weren’t disciplined about their finances, that the stumbles they encountered were always someone else’s fault, and that they relied on the largesse of their parents to keep everything going, in spite of the outward presentation of tremendous success.

At the time all this collapsed, I was a student at Rutgers University, close to completing my undergraduate work. My parents were floating my rent, but shortly after they lost everything they let me know there would be no more money coming. I had about a half year left on my lease, and was in no position to pay the rent or any other living expense. I was able to strike a deal with my fraternity to pay my rent back over time, and got to work to pay that debt and generally take over my economic destiny. Everything was so sudden and hard, but in the end I paid off my note, and I was proud of myself for taking on a responsibility that wasn’t even supposed to be mine head-on, in contrast to how my parents handled their own affairs.

After graduation, I cobbled together a good earning out of the skills I had, most notably day trading and poker. I’m still an active day trader and I play poker from time to time, but neither are the most stable profession; even the best has days, weeks, or even months of losing money. I was always interested in real estate from afar and it seemed like something potentially stable and equity-creating, as opposed to my other professional endeavors.

My first purchase was a success, but nothing life-changing. I purchased a property in Florida with two livable units on the land. My wife and I took the smaller unit, and we rented out the larger one. We lived this way for a few years, and then sold the property for a nice profit. Like I said, nothing life-changing, but it gave me a taste for diving into real estate more thoroughly, though I didn’t really know where to begin.

This is a little embarrassing, but I started off with a Google search of “How to Invest in Real Estate”. Maybe not the most professional, but a search did turn me onto a website called Bigger Pockets, along with real estate Reddits and other similar forums. I devoured everything I could—both the broad strategies, the minutia of real estate law and financing, and everything in between. It was then that I settled on my first strategy—cash flow rentals.

Cash flow (in contrast to appreciation) is buying properties with an eye towards the best ratio of cost versus rental income, as opposed to the highest rate of return on the value of the property itself. Given my relatively limited resources at the time, I couldn’t afford to sit on properties for years at a time, and most appreciation properties exist in more expensive markets anyway. Armed with my knowledge and a plan, I started researching markets that fit my needs. Binghamton, New York seemed very promising, with properties yielding similar rents to other markets at half the cost of the property. As luck would have it, a friend of mine lived in the area and was himself already investing in real estate, and gave the market his blessing.

I purchased my first unit for $82,500, sight unseen, with an estimated $20,000 budgeted for repairs and improvements to attract the clientele I wanted. I still have not seen the property in person, and I’m in the process of selling it. I have other flourishing properties in Binghamton, but my first buy remains a boondoggle. The details of everything that went wrong with this unit are too boring to unpack fully, but much of it comes back to not having boots on the ground, or local people who I could trust.

In markets like Binghamton, the population is flattening, or even declining. Many of the traditional manufacturing industries that used to sustain these cities are no longer as big as they were, or are even gone altogether. New families aren’t coming and much of the talent is leaving. In these markets, with people working on relatively small margins, it was impossible to find people capable of the work I needed. I fired numerous vendors of all sorts (mortgage underwriters, contractors, property managers, you name it) during my time working in a largely remote capacity.

At the same time, I was starting to get my feet wet with real estate in Florida, in part because the market seemed attractive and in part because I wanted to be working more in-person and on-site after my experiences in New York. Around the same time I met Matt, my future business partner. I initially hired him as something of a property manager and builder, skills I do not possess myself. After time though, I realized that I wanted Matt to work beside me in a permanent and serious capacity, and offered him equity in my business.

Why would I offer equity in my business, which I started from scratch myself? After all, I could have just paid him a salary, an arrangement he was happy with at the time. I saw many benefits at the time, and more have revealed themselves over time.

More cash on hand: This one is obvious—in a business that is about creating leverage with cash on hand, having more of it on hand opens up other opportunities and lowers your risk exposure.

A more honest business relationship: A lot of real estate transactions are about doing a discreet amount of work for a cut—the person flipping a property, the real estate agent finding a buyer, the bank, etc. With these incentives, a party is often trying to do the least amount of work possible to close the deal, which probably isn’t news to anyone reading this who has worked in the field. It is only with the expectation of future business with someone else that the incentives change, and fostering a permanent relationship naturally aligns the incentives the right way.

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The other party is activated: So many of the best deals we’ve discovered in New York is a function of Matt’s local connections or even just cold-calls; we quickly closed on a great off-market unit that we only found because Matt struck up a conversation with a local barista while getting a cup of coffee. There’s no substitute for people who are going out of their way to find opportunities, as opposed to passively waiting for work to arrive as it often goes in more traditional working relationships.

The equity is easily covered by the scale of the business: This is the most important part. We’ve discovered a model that is essentially scalable to infinity; the only cap is the amount of time we have to do the work. Our business could have never scaled in the way it has without Matt’s full investment, and even in the world where the business becomes successful beyond expectations (and ostensibly my equity outlay is at its most costly), I’ll be wealthier and more secure with this path than the alternatives.

To the last point, I’d like to lay out our business model. There are a number of variations of this, but what we’ve created and iterated on has increased our wealth and equity while minimizing both of our risk profiles.

1) When we find a suitable purchase, I put 100% of the cash up front for both the purchase and the renovation, if necessary, which Matt handles the logistics of.

2) Once we have tenants and the property is generating rental revenue, we do a cash-out refi to cover whatever my initial cash costs were.

3) Once I have recovered 100% of my initial investment, Matt receives 40% of the property, including rental income, equity, and liability

4) At this point the property is “cash flow positive”; the rental income easily covers the outstanding balance of the refinance, and eventually that balance is paid off entirely.

5) Repeat, Repeat, Repeat

Of course, this arrangement isn’t for everyone. It’s a lot of trust and work, and it requires a radical commitment to honesty and transparency. But Matt is within reach of wealth he could have never imagined before, and my real estate business is scaling like I never would have imagined even three years ago. It isn’t the most traditional way of working in real estate, but if you find the right person, or people, I can’t recommend a sweat-equity partnership highly enough.

By Chad Kastel
609 705 7332

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