Do you remember the OJ Simpson trial?
OJ was an ex-NFL running back who was accused on murdering his wife in 1994. His trial captivated the nation, and many people were certain he did it. Then along came OJ’s Dream Team of lawyers…
They convinced the jury there was enough doubt to not declare OJ guilty.
Those lawyers didn’t out right lie (as far we could tell). Instead they crafted a story by linking the known facts in such a way as to create doubt. They came into the courtroom after a ton of preparation.
They were ready for any objection the prosecution might throw at them.
At some point in your REI life, you probably looked for a lender or investor to finance your projects. Think of that lender or investor as the prosecution. You’re on the Dream Team…
They will bring up all sorts of objections why they should not invest with you. You need to come up with reasons in your “financial story” that overcome those objections – especially if you’ve had some financial setbacks in your past.
You need to be able to explain how those setbacks taught you the hard way how to see problems in projects. Or how those setbacks were completely different than the investment you have now.
Just like those lawyers, you will want to be thoroughly prepared before you go up against the financiers. That means having your detailed financial statements all put together and that you understand them.
Review all your financial dirty laundry and anticipate the objections ahead of time…
When you are in front of those investors, it’s a little worrisome when they bring up problems about your project. It’s even worse when you don’t have an answer for their objections.
IMPORTANT DISCLAIMER: This post does not imply that you invent reasons or a financial story. It’s about taking the facts as they are and reframing and rebooting your financial story in a way that is beneficial to you and them.
What is a financial story, anyway?
Your financial story is your financial picture – your financial documents and your financial statements. These tools tell a story about how successful you are as a business owner or as an investor.
It’s important to know that you already have a financial story…
You just have to craft it and position it in the best possible light, in a way that it makes sense to the key players – the stakeholders who aid you when you are trying to raise money or when you’re dealing with debt or equity.
Your finances are numbers and you’re not going to change them – it is what it is. But people interpret numbers in different ways, and here’s why you need to craft your financial story.
Identifying your financial score in the money game
Crafting a good financial story has a process, and it is broken down into 3 steps:
1. Identifying your score.
2. Understanding your past.
3. Creating your story.
The first 2 steps – identifying your score and understanding your past – are critical because they are the building blocks for your ‘future story.’
1. Identifying Your Present Score
The score pertains to your status in the money game. You make up the score as you see fit.
Are you winning or losing?
If your expenses are greater than your income, would you say you’re winning the game?
If this is the case, your current financial score is low.
You can also determine your score through your net worth. If your net worth is a billion dollars, it generally means a higher score. If your net worth is negative or the like, my guess would be… lower.
These are 4 steps in identifying your score:
1. Fill out a personal financial statement and understand what it means.
Generally, your financial statements (income statement and balance sheet) have everything you need to identify your current score:
- Assets and liabilities
- Net worth
2. Schedule of Real Estate Owned
This data is often listed on your personal financial statements, but for big-time investors who own a lot of property, they need a separate attachment – the schedule of real estate owned. Listed there are all of the properties owned with their corresponding value and debt.
3. Global Rent Roll or Global Pro Forma
For each real estate that you own, the income, expenses, profit and cash flow of every single property you own are listed.
4. Credit Report
I’m pretty sure you’ve seen what a credit report looks like. It has a list of every single personal debt you have.
So, aside from these 4 documents, another important detail banks or lenders look out for when they underwrite your deal is your Debt Service Coverage Ratio or DSCR. Your DSCR compares your net operating income to your mortgage. It basically calculates how likely you can pay back your loan.
When banks compare your DSCR, the magic number is typically around 1.2 or 1.25.
Ideally, when you add up all the income and expenses from all your properties and compare that to your debt payments, you would want to have a minimum DSCR of 1.25. The higher the ratio, the better.
So, if you have a property that has a net operating income of $39,346 and your debt operating income is $19,335, divide the income by the debt operating income. It will give you the DSCR of about 2, which is extremely high…
Meaning lenders will be more comfortable working with you with this ratio.
2. Understanding your past
Part of the problem in understanding your past is that you don’t know what you don’t know. But you want to understand these things so you can communicate well with the bank…
Let’s take into consideration your tax returns. You usually have your accountant compute all the figures and you’ll most likely only care about the end result: how much you owe. But when you present this to a bank, they view everything that’s on the tax return.
90% of the time, an investor’s tax return doesn’t match with the other documents. This is okay, banks are aware that this happens often…
So make sure you understand your tax returns, so you can answer any objections.
It now boils down to crafting your story…
You want to get ahead of the bank or the lenders and have your tax returns match your other documents. Or at least you should be able to explain the differences. You also want to identify other red flags, not just with your tax returns, but all throughout the process.
3. Create your story
Your goal in creating a story is to turn these red flags into a compelling story. Even a notorious credit history can turn into a promising story.
A famous internet meme of Cinderella said, “Says you are the love of his life, forgets what you look like and has to put a shoe on every girl in the Kingdom.” If a girl read a guy’s profile like that on Match.com, they would hardly think of Prince Charming.
But if you take the same story and relay it the way Disney did, now you’ve got the famous Cinderella story.
The point is, you cannot change your facts, but you can find a Cinderella story in your financial story.
Action Items – Do It To It
- Look for free templates online. Not all of us took a financial class or are well-versed with numbers.
- Understand and own your financial story. We really cannot emphasize this enough. When you understand and own your financial story, you know what you’re dealing with. You’ll know your red flags and you’ll know how to counteract them.
- Commit to creating wealth and be financially free. If you understand your story, you’re keeping your score and you’re being accountable for your performance. Try to improve your story every month.
Share your BIG lessons with us!
Got any hard-learned lessons, falters, or good ‘ol fashioned mistakes to warn others about? Share below! We’ll take the best ones and write about them in a future post.