Your Investor Can Earn 5% Doing Nothing: Raising Capital When Treasuries Pay 5%

Yesterday the 10-year Treasury closed at 5.24%, and I checked it again this morning: it is still there. If you are raising money for a deal right now, that number is your real competition.

Put $1 million into a new 10-year Treasury at that yield and you collect about $52,400 a year in interest. Hold it to maturity and the U.S. government guarantees every payment and your money back. You do not have to trust an operator, read a budget, or wait 7 years for a sale.

That is the alternative your investor holds in the other hand while reading your deck.

The comparison your investor is making

Every real estate return has 2 parts: what the investor could earn with almost no risk, and the extra they get paid for taking yours.

In 2021 the 10-year paid less than 2%. A deal projecting a 9% return to its investors paid them about 7 points for the risk. Today the same 9% pays them about 4.

Those 4 points now have to cover everything your investor gives up: money locked up for 5 to 7 years, a loan that has to be refinanced, a business plan that has to work, and trust in you. Some investors will decide 4 points is enough. Many will decide it is not, and they will not tell you why. They will just not invest.

So answer the question before they ask it: why would I take your risk for 4 points over a bond?

Answering it with one $1 million check

Here is the shape of a good answer, on simple numbers.

The bond pays $52,400 a year and returns the $1 million at the end.

Your deal projects a 9% return to the investor after your fees. Say it pays about $50,000 a year in cash. The rest of that 9% depends on the sale.

That is the honest answer. The yearly cash comes up a little short of the bond. The premium is the sale, and the sale is only as good as the exit you tested. Last week I showed what a higher exit cap rate does to a sale price. If you tested your exit at today's rates and can show it, your projection is believable. It is still not guaranteed. If you did not test it, the investor is paying you to hope.

I lived this when I raised equity for my hotels. Treasury rates were at similar levels, and the loan term sheets we had were priced high. The investor stress tested our exit cap rate and asked for a sensitivity analysis: the return at a range of sale values. Their conclusion was that the loan we had chosen was too aggressive. It put too much pressure on the exit value. So I went back out and secured a term sheet from another lender at a lower rate. That gave the deal room at the exit, and I secured the equity.

The investor was not only underwriting the deal. They were underwriting the loan, because the loan decides how much the sale has to carry.

Then show your own check beside theirs. How much of your money is in the deal does not lower their cost, but it tells them you are taking the same risk you are asking them to take.

What changes in the raise

The preferred return. A preferred return is the hurdle investors must reach before you share in profits. It is not a promise of income. An 8% hurdle looked generous when bonds paid 2%. With bonds above 5%, investors will look harder at it, and some will push for more.

Your fees. Fees are why the return your model shows is not the return your investor keeps. If your fees take 1 point a year, a projected 10% becomes 9% to the investor. When the premium over bonds was 7 points, few investors did that math. Now they will.

Cash now versus the sale. Investors will value the cash you pay each year more than the return you promise at the end, because the end is the part that just got worse.

Taxes. They cut both ways. Treasury interest is free of state income tax. Real estate depreciation can shelter much of the cash you pay out. Show the comparison after tax, with the investor's own advisor.

What to do this week

Rewrite your pitch as if the investor has a 5% bond in the other hand, because they do.

1. Show the return your investor keeps, after fees, and the spread over the 10-year. Not the gross number from your model.
2. Show how much of that return is yearly cash and how much depends on the sale. If most of it is the sale, show how you tested the exit.
3. Show your own check. The amount, and what it is as a share of the equity.

If the numbers still work, you now have a stronger pitch than most of the operators your investor will hear this month. If they do not, you found out before your investor did.

If your deal cannot beat the bond by enough

You have 3 honest options.

If you are a smaller operator or have a shorter track record, partner with someone whose record makes the risk worth taking. I wrote about how I do that 2 weeks ago.

If you are an established operator, make the deal cheaper and safer for the investor: fewer fees, more of the return paid as cash along the way, and a larger check of your own so your interests line up with theirs.

Or do not raise right now. A deal that only works when bonds pay 2% is not a deal this market will fund, and walking away from it is a decision, not a failure.

The operators who raise money this fall will not be the ones with the biggest projected returns. They will be the ones who can show, in writing, why their deal is worth more than a Treasury paying 5.24%.

-Damon

Damon C. Healey, Founder, Eternal Companies
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Capital says yes to the operators it can check.
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