WARNING: Investing in a Syndication is Truly Passive Investing But it is Full of RISK. Do & Don’t

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good morning good afternoon good evening

folks michael zuber one rental at a time

back with his thursday expert good

friend of the channel mr jonathan tumley

how are you i’m doing great michael how

are you i’m doing wonderful man this is

a topic i’ve been wanting to hit for


six months or so

it is something you are uniquely

qualified in my expert series to talk

about and again it is something i have

never done

so i love talking to folks who’ve done

things i’ve never done and this is about

raising uh money as a general partner

more specifically this question’s about

lps right i have raised private money

but it’s always been one investor one

debt they’re the they’re the bank


never never as an lp so let’s think

about all the lps out there there’s a

lot of people looking at being lps

because real estate is sexy again

uh it’s made a lot of money in the last

couple of years so i think there’s a lot

of people there’s huge social media

people pushing come be a part of my deal

come be part of my deal

but what should we tell lp’s uh limited

partners thinking about investing in

2022 what’s some advice we should give

them okay well so before we get into

that let me let me first say

that being an lp can be a really great

opportunity right because

you know you

can get exposed to assets


you couldn’t get exposed to otherwise

yep for for a relatively small amount of

money so maybe

the entry point is 25 000 or maybe 50

000 to get into a deal

whereas the deal itself is a 20 million

deal and like there’s no way that you

can you can get into that deal and maybe

and if you and if you had just 50 000

that you went to spend on a

on an asset yourself

like you could not get the same quality

asset that you can

as fractional and of that you have no

responsibilities at all it’s a

completely passive investment so

i always just like to characterize it as

you know your job is just to write a

check and then wait for the checks to

come back to you there you go i like it

now it’s for the wire transfers but

still same same idea

money shows up in your bank account

that’s all you have to do okay so it is

a great opportunity

however there are things that you also

need to be you know be mindful of um

when you’re doing these investments


there is still risk involved right and a

lot of the risk

has to do you kind of have two layers of

risk here right you’ve got

the risk of the deal itself

um i mean let’s actually maybe even

three layers you’ve got the risk of the

deal itself

you’ve got the risk of the structure of

the deal and you’ve got the risk of the

offer right so those are three things

that you need to

to look at

uh and evaluate when you’re getting into

one of these deals and and i think


the best way

just to get your feet wet in this arena

is not

to go and


you know try to

you know go and like interview a bunch

of sponsors and try to figure out

you know which ones are the best i think

you should talk with other other lp

investors and see who they’ve had a good

experience with yes right and and

build on not just


initially not just

on excuse me the track record or

reputation of the sponsor

but the track record

that the that sponsor has had with

somebody that you know exactly specific

deals and and hopefully not just one

person because that’s his two small

sample size but you do want to

you do want to

find out from people that you know

what their experience has been and so

and it shouldn’t simply be about oh yeah

they made me a lot of money

because that’s not the only

consideration you want to know

are they reporting on time like are you

actually getting financial reports from

them or do you have to call them up and

ask them to send you the financial

reports right are they communicating

when something bad happens on the

property right like right right away you

know so like for instance for me

i always sent out the financial reports

you know properly after i would get

monthly financials from the

property managers and then i would write

up my own analysis

based on them but also based on my

conversations with the manager and send

that out but and i would do that on a

monthly or quarterly basis but

when if something bad happened like we

had a fire i told everybody right away

oh okay like so it wasn’t waiting till

like the end oh yeah by the way we had a

fire three weeks ago like

guys yeah fyi we lost three units we

have insurance we acquire we are insured

you know yeah this is going to be

disruptive but it is not catastrophic

yeah we just want you guys to know yeah

that that’s a big one for me

uh when because i get i get a lot of

people asking me about out-of-state

investing right all the time and it’s

really the same answer i need somebody

on the ground that’s going to tell me

bad news immediately right bad news does

bad news very very rarely gets better

with time

right right so that’s a big one so i’m

glad you brought that up sorry to

interrupt yeah no and i think i think

that there are a lot of

particularly more inexperienced sponsors

who are really worried about


you know what their investors are going

to say or investors might get angry with

them or

or they might lose clients or something

right so they they don’t they’re they’re

not forthcoming with the bad news and

they don’t realize that

telling people bad news actually builds

your credibility with that so

so they’re they’re kind of being you

know backwards about this whole thing

you have to be forthright with people

about that so so those are things you

should look for on the sponsor side so

in terms of the sponsor themselves

you want to find out

your reputation from people that you


there’s a lot of sponsors out there

right so

it’s you don’t have to interview all of

them right you just need to know a

couple sponsors that you like and just

invest with those those people on a

repeated basis but do don’t start with

the sponsors start with start with the

people that you know

who have already invested

right and yeah

don’t don’t necessarily build it because

like you know

you heard some guy in a podcast or you

know whatever you heard me on a podcast

right i mean that’s not that’s not

that’s not the way to do it the way to

do it is go talk to your friends who

have already invested

find out who they had good experiences

with who they had bad experiences with

and and start kind of building your list

that way so that’s sponsor and you want

to look at you also want to look at

if you’re talking to a sponsor you want

to ask them questions like

you know

have you ever had to make a capital call

on one of your

on one of your assets and why why did

you have to make a capital call right

you know

if it turns out it’s because like there

was just something completely out of

left field that nobody could

nobody reasonably could have anticipated

right and they had to make a cap that’s

that’s one thing right but if it’s

something that they should have you know

the the asset was under capitalized they

didn’t have enough of a reserve fund in

the beginning or

you know their underwriting was bad and

they just missed all their projections

things like that where they you know

some some the route they had to replace

a roof and they didn’t know that like

when they did their due diligence they

didn’t yeah

catch the fact that the roof needed to

be replaced in a year right like that

sort of thing

but so if they had to do capital calls

because of that


you know that’s bad if they had to make

the capital call because

you know the great recession hit or

because you know the major employer

in town went belly up or something like

that you know that’s that’s different

um it’s beyond their control and not

really foreseeable


is it fair to say because again a lot of

people come into this again as an lp our

new investor i think most of them

evaluate the opportunity to deal the

wrong direction and you brought it up

for me most people look at the deal


they probably skip deal structure which

is a big deal especially with what i’m

seeing lately

and then the operator last i actually

want them to interview or understand the

operator first i love your advice about

go to your friends to build that list

i think it’s all about the operator oh

it’s i think okay good it’s all about

that i mean

because look

when the market is hot and everything’s

going well

everybody’s going to make money you

can’t really tell one operator from

another the issue is going to be when

something goes wrong right that’s when

you know

you know

and i’m not saying that like necessarily

just because the operator is good that

means that they’re going to be able to

save the deal right

but what it means is like you’re going

to get somebody who’s going to be honest

with you

worth right with you

you know

tell you the facts as they are


and that’s what you know you want

somebody who’s trustworthy right and

who’s going to see it through

right yeah you want you want someone

like you know one of my favorite stories

brian burke who’s a friend of mine who’s

a great great real estate guy

you know he has it

brian had one of his early properties


just sideways just completely sideways



never went to his investors for money he


for years he said he funded this deal

out of his own pocket

right and at the end of the day when

they finally sold it his investors made

money he was made whole but he was like

this is my responsibility i’m seeing

this through he didn’t walk away from it


he didn’t wash his hands and say too bad

like he was like i’m seeing this through

and that always made such an impression

on me

just the kind of guy what was his name

again sorry weinberg

he runs practice capital i mean he’s

he’s gotten big he is able to raise huge

funds and stuff now he’s fine and he’s

all over the pockets we’ve got a bigger

pocket still fine by just a really

stand-up guy right nice and i i’ve done

the same thing not on the same scale

that brian did but i you know


bend over backwards not to make a

capital call and i have to say i’ve

never made a capital call but there was

one deal where i could have

but i was like look we’ve got the money

we’re just gonna fund this and it was

the same thing we funded it we didn’t go

to our investors

when we sold

you know we paid ourselves back and the

investors made plenty of money and they

were very happy at the end of the day

even though they were unhappy as the

thing was going by but we never went and

asked them for money so i think that

shows a lot like are you ready to stand

behind your deals or not and you want so

you want to find that out like if if

they made a capital call

what happened or what would they do

before they would make a capital right

so they should have the property well

capitalized in the first place so they

don’t have to even dip into their own

money but if they have if they blow

through that do they have reserves of

their own to do before they go to

investors right so that’s that’s

something to ask what you know ask them

what was the worst deal you ever did how

did you


that’s i mean that’s the kind of


like you know don’t ask

the investors i talk to like a lot of

times they just want to know like oh

what is your what are your return spend

because they’re just sort of fantasizing

about how much money they’re gonna make

right yeah they’re not thinking about

the downside and they this is your money

you earned it it took you time and

effort to earn this money so you should

be thinking about how likely is it that

i’m going to lose this money and don’t

get all caught up in the hype of like

real estate’s great it’s great it’s

great nothing can happen say listen real

estate is a lot safer than a lot of

other things you can invest in but in a

syndication as we just said you’re

taking on three layers of risk you’ve


the you know

you’ve got your your deal risk your

structural risk and your operator risk

and also just to put this in perspective

like i think a lot of people also make

this mistake

if you buy the property yourself

the operator risk is you yeah people

people are really bad at evaluating that

risk right because everybody thinks that

they’re above average at everything

80 percent of the people think they’re

better than average drivers yeah exactly

yeah no i mean everybody everybody

thinks that they’re better than average

at everything

you and i both included right of course



so you’re taking on a huge amount of

operator risk when you buy it yourself

but you’re very likely not to really ask

the question like am i good at this

right uh so

that that is an advantage to going with

a with a seasoned syndicator that

they’ve done this before they know what

they’re doing they have

systems in place they’ve hired the right

people so there’s a lot less opportunity

for it to go sideways but it still could

okay so let’s let’s talk about then


your your deal risk and we’ll talk about

the structure risk right so

so deal risk is probably what everybody

is a little more familiar with yeah i

think people poke at that one pretty

easily yeah that’s that’s like obvious

thing to understand especially as a new

investor like

is the underwriting good or not and they

can’t really like evaluate the

underwriting most

lps don’t know anything about

underwriting i think it’s a good idea to

get some kind of


familiarity with underwriting or at


try to look at enough deals and sort of

compare them side by side so that you

start getting a sense of

the expenses




you know

how much does it cost to run a unit yeah

sorry to interrupt again that’s the

biggest thing for me that i uncovered

comparing deals was i i can now look at

him and say who’s being


more conservative and less conservative

right i still have not done a deal i

couldn’t really do an analysis but i can

say you’re aggressive and you’re

conservative because i compared enough

and see their uh see their expense

structures and their future um you know

income and expenses and obviously this

kind of may depend on the size of the

property asian property and stuff but

more or less like if you’re if you’re

underwriting you know

six seven thousand dollars a year per


they are being a lot more conservative

than somebody who’s underwriting thirty

five hundred dollars a year

right then listen i have not seen a

large multi-family

anybody able to run

at 3 500 bucks a unit for years

especially if you have

you know the only time that people can

really do that is if

they’re managing themselves and they’re

doing the labor themselves because the


management fees and labor are two of the

biggest expense items on a multi-family

property right the biggest one being

property tax but you got property tax

management fees and labor those are like

your big three and

so if you if you can eliminate two of


obviously you can run it a lot cheaper

but your syndicators are generally not

in that position right this indicators

some of the really really high level

folks may have brought property

management in-house but they’re still

charging in property management

right for sure he is still there and

maybe they have a little bit of labor

savings because they can

they don’t need to have as many

full-time staff because they got

floating like they can do stuff like

that but even there they’re not running

those units of 3 500 they’re probably

running themselves like 5 500 6 000 at

least in this day and age so that’s one

thing to look at another thing you want

to look at is expense ratio right what

that is is what percentage

of your rents is going to get spent or

not rents but what percentage of your

income because there’s other

multi-family you often have other

sources of income not just rents but


percentage of rents


are you spending every month right and

so that’s what’s best ratio so you

really want

you know for a property really to make


dispense ratio needs to be

in the kind of like 50 to 55 range

that’s pretty standard

and lower than that you’re really going

to have a well-performing asset but it’s

very hard to get below that yeah and

sometimes i’ll see people underwriting

you know 35

i’m just going to say that number i’ve

seen some deals in my market at 35

and i have these apartments i actually

just put out a spreadsheet i gave 10 i

have a building that i’ve owned for for

11 years i put out 10 years and it’s

never been below 49

never i’m like but remember i pay

property management so six or seven

percent of that but anyways i’m like why

are you writing at 35 how does that make

sense yeah and and


you can’t run it you can’t i mean

the only


if you you can only do it if you have

like in-house property management and

you have no staff and you’re just and

they’re absorbing the cost of the staff

in the management fee sometimes you can

maybe you might get lucky one year but


or like if you are doing some massive

value add where you’re you’re really

like oh out to the top line yeah your

bottom line expenses are not increasing

because they really don’t have any

reason to like

that can be an issue but you know you’re


over the long term you’re not staying at

that 35

yeah right because you you’re gonna as

the property ages you’re having more

when you do a turn the turn is more

expensive right

things you have to replace it just you


it just it just changes so that’s

another thing

to look out for and i’d say

the but the more the more deals you look

at it just like michael said compare

them side by side you can start to get a

sense for where the expenses really

ought to be right and

another thing

uh to look at is uh the exit cap rate

right okay because

now when you

are trying to forecast the value of a

property ten years from now right this

is a very loosely using thing and this

is not there’s no


precision about this

uh but the way that you do it is you’re

you’re projecting your cash flows over

ten years and typically what how you uh

you should be underwriting that is with

basically some standard underwriting

assumptions like

three percent rent growth

if people have a lot of renko they’re


four percent rent growth over 10 years

red flag right

maybe if they’re saying okay we because

the market is crazy right now we think

we’re gonna get

five this year and four next year and

then over the long term

right that’s that’s okay but if they’re

saying like oh you know we expect four

or five percent rent growth forever

that was that’s funny bringing that up

the last deal i had had five percent i

think it was actually six percent year

one and five percent for the dec or the

next nine years i’m like

are you kidding me

and let me explain to you how

so how this relates to then the cap rate

right so

the way that you so you’re going to have

your expense your

rent growth your expense growth which

should be you know usually the standard

is undivided at two or three percent


and then


you you have that’s going to grow over

time a delta you should be getting more

income over time on those assumptions

you’re you’re after you deduct your

operating expenses but not your capex

you get your net operating income and

the way that you value the property is

you apply a cap rate to that net

operating income so you divide that noi

by the cap rate right and so

if you

remember your basic math as you can


the lower the denominator is

right the higher the result you’re going

to get right

if cap rates are low

you’re going to get you’re going to

wind up with a higher value right so

the exit cap rate is very important you

want to make sure



so the typical underwriting assumption

is that the cap rate is going to

rise by 10 basis points every year you


the age of the property okay

so if you go into five five cap you’re

gonna after five years you’re gonna exit

at a five point five cap after ten years

you’re gonna exit at a six cap now i did

not know that that

in reality may not be true but you’re

trying to be conservative and

underwriting right that’s the point

you’re not trying to like fantasize

about how much money you’re gonna make

you’re trying to be conservative in your

underwriting right so now

as you can imagine as cap rates

fluctuate that exit cap is gonna is

going to

like rise and fall also right but but

the lower it is the better the deal is

going to look because the payment at the

end is bigger right and that’s going to

filter his way through back through the

irr but also you can now imagine if

somebody is forecasting five percent

rent growth a year yeah

that’s going to wind up with a much much

higher noi number than if they’re

forecasting without three because of

course compounds yeah well i mean it’s

enormous so they can really make a deal

look good even if with no cash flow in

the first couple of years

by having really high rent growth and a

really low cap rate of the act yeah it’s

funny you bring that up because again

that was that one piece of information

you just gave us i had never heard or if

i’ve heard it i didn’t remember it

because i don’t remember frankly i don’t

remember a deal that i’ve looked at in

the last month or so where the cap rate

wasn’t actually the same or lower on the

exit yeah and it i would never

underwrite no let’s put it this way i

would underwrite a scenario in which the

cap rate was lower just to see what

would happen but i would not tell my

investors right

that’s the base scenario yeah that’s not

the base scenario that the cap rate is

going to go down yeah even if you think

it’s going to go down it’s a dumb thing

to say oh yeah unrealistic because

because you’re right you take a cap rate

from five to four and you add a big noi

hit i mean that’s just going to explode

the upside it’s going to be massive all

you’re doing is setting up your so

basically that’s someone who’s like

desperate to get funded yeah

and and they’re and they don’t they’re

just going to take they’re just hoping

it’s going to turn out that well so

they’re not disappointed and maybe they

don’t care because they’re going to get

a bunch of fees up front oh yeah they

don’t care most of these guys don’t care

they’re fiat they’re fee hungry at this

point they’re getting paid right so what

do they care how it performs they and

they just think maybe they bought the

kool-aid too they drank the kool-aid too

like oh it’s gonna go up so i don’t know

i think a lot of these people are

today’s flippers from from when when i

was seeing people suffer in 2010 they’re

they’re addicted to it their cost

structure is all out of whack to me a

lot of the syndicators

are like mortgage brokers so let me tell

you what i mean by this the mortgage

industry right now

is suffering because they built this


for a refi environment like we’ve never

seen before refi’s have gone down 50

year on year we reported it yesterday

there are going to be layoffs there are

going to be acquisitions there are go

this the industry was built

when there was a lot of meat on the bone

the meat’s gone

and right now there’s gonna be pain so i

think there’s a lot of syndicators that

came in there’s been a great two years

um the party’s almost over there’s only

one chair left in the musical chair game

and there’s going to be a lot of people

that have pain but they can’t stop their

their employee base says they have to

keep feeding and they know what do they

do they buy deals to feed it

and uh

i haven’t i haven’t seen a good deal in

a while yeah and i so just on the last

point on cap rates it may be so

look we’re in a low capital environment

like i said before an earlier session i

don’t see cap rates really changing much

this year

but i would

i i even if you really believe that cap

rates are only going to decompress a

little bit over five years i’m not

saying this is an unreasonable

assumption but i think it’s it defies


patterns right so what you want to ask

your sponsor is well

what does the deal look like

uh i mean you don’t even have to ask

them get out your calculator right look

at the noi from the the year that

they’re exiting and divide it

rather than by what they’re dividing it

by which is probably you know

a bigger number use a bigger number

divided by

six percent divided by seven percent see

what the see what the line is


where you’re actually losing money on

the sale right yeah because you could


these asset you know c-class property in

southern suburban market traded for an


yeah my market was seven and a half

it’s california so a little bit lower

but still seven and a half the last

c-class building i sold i sold it early

i sold it in late 19. uh was it a five

i’m like get me out i’m i’m

i’m happy in 2014

i was buying c-class property

in south carolina in like in big south

carolina markets for eight percent

capitals right so

it this is and this is where it was

always at now you have to believe that

the market is permanently shifted

for that never to go back here and maybe

it never will go back there but you want

to know

even if it does go back there am i

losing my money or not right and then

and then like and if i am going to lose

my money

right how

likely do i think this is is to actually

happen and am i comfortable with that

level of risk right but you need to be

asking those questions okay so that

that’s the underwriting

uh issue sort of you know quickly then

the last thing i know you’re running out

of time but that’s okay i pushed it

the last uh thing is the structure and

this is something mike and i both

alluded to earlier

you know the best structure debt-wise


to have


you know a 10-year fixed fixed note

mortgage right

that’s the best that’s the best um

because your your debt is fixed and you

don’t worry about refinancing and you

can write out whatever’s coming

but right now

that kind of debt is not competitive and

what’s happening is that everybody’s

getting bridged at because the bridge

the bridge lenders


less stringent underwriting standards



so they are willing to give more years


you know full term

uh interest only

which is the same thing as having more


uh they’re you know the terms are


so it might be

one year two years or three years with

two extensions or whatever

probably if you can get two extensions

you’re probably okay but you’re not

amortizing any of the debt right so

you’re not your payment obligation is

still high and if you are forced to

refinance after five years and the

market is not

in a good place

then uh you know you’re gonna have to

make that capital calling your investors

to to top up yeah

this this debt structure is the one i

think is going to get a lot of people

it’s complex it’s a different

environment and i want to tie something

back that you said earlier when you

talked about the exit i would tell

people to play with the cap rate at the

year of the debt expires if it’s two


do it do it there because i think that’s

the i think that’s where capital calls

come and that’s where people get hurt

is is that first um

yeah that is the date that’s a great

point that is a dangerous point in the

now most people when they’re

underwriting the deal they’re


the debt term and the sale term at the

so you’re selling when you’re instead of

counseling correct

that could be when people would get

caught where

they they have to refinance and the

market is turned against them yeah if

listen so if cap rates go up that means

that your property is worth less money

and you can get less proceeds exactly

refinance your lender is going to say

okay well i can i can’t i’m not giving

you yeah 1.5 million which

would be worth i’m only giving you 1.2

you’ve got to go find the other 300 000

or sell the asset well the asset but

you’re probably but if that’s the case

you’re probably selling it

you’re repairing some capital right if

that’s that’s the that what you just

went through is what i see in a lot of

deals today right the 10-year story is

great the 10-year story might even make

sense but the bad debt structure there’s

going to be this two-year event or that

third year event that nobody’s planning


and people are going to get got


that is so that is that is the structure

issue that you should and there’s

another structure issue to to be aware

of too which is uh the use of preferred


yeah you’ve talked about that before

equity is a it’s a kind of like debt

equity hybrid


the the so it used to be the case like

at the top of the last market when

everyone was trying to squeeze every

penny out of deals because they were

over you know everything was overpriced

people were adding a second mortgage to

commercial deals right so you were


you know

banks were willing to give you up to 85

in those days

and then people were going to what were

called mes lenders mezzanine lenders for

a second

effectively a second mortgage

getting up to like 93 94 coverage right


is great you can make a lot of money

that way but the problem is if the

market turns in the wrong direction you

are screwed right so


now so what happened was

all of the financial institutions said

hell no we ain’t doing that

that hurt but now well now they actually

structured into the debt


this is a non-recourse loan but if you

go get a second mortgage it becomes full

recourse against you right so nobody

wants to get second mortgages anymore

right so what happened this

for a while nothing happened because

nobody needed these second mortgages but

now the prices have gotten so high

that this hybrid has emerged it’s

technically equity

but it is it’s called preferred equity

which means that it is

above you as the lp in the in the

the capital stack so

you still bear the first dollar of loss


you are the cushion for the preferred

equity this is why the preferred equity

lenders love this right

like they’re coming in

and they know that the people who bear

the law the first dollar of loss are not

them right and they are also getting

basically a guaranteed payment so


going the upside

however they’re getting like six seven

eight percent preferred return plus a

kicker when they when they get taken out

and the idea is that they are supposed

to um

you know whenever when all the rosy

projections all work out and you’ve done

your value add and then you do your

refinance at a higher value that’s when

they get taken out and now you know the

lps are back up in the capital position

where they should be and everybody’s

fine and the lps wind up making more

money because

you know they had this debt which is now

gone and and so they’re getting more of

the upside so when everything works out


it’s it’s great for

increasing the lp’s returns however

what you have to understand is this adds

risk to your deal but your deal just got

riskier if you’ve got preferred equity

ahead of you and your capital stack and

oftentimes what the provisions of that

preferred equity

state are if

if the terms are breached

they can replace the sponsor right so

now you may be in a deal

being run by somebody other than the

person that sold you the deal and

frankly between you and me

whoever that private equity firm that

put the preferred equity there brings in

to manage they don’t care about you


their client is that private equity fund

not you right so they will screw you if

they have to because you’re not their

client right i mean they


technically they are but like yeah

they’re not working for you yeah

you’re you’re a tag alone yeah yeah so

you you were the you were like you know

you’re the infantry right you’re you’re

the guys who are like you know what we

know you know they’re doing the battle

projections and we’re like yeah we know

that 50 of these guys are gonna die when

we send them over when we when they go

over the top right you’re you’re that

yeah exactly



that’s that’s sort of my spiel on that

so these are things you just need to be

aware of

i hope i didn’t scare you off from being

lp i still think it is a it is a good

vehicle but you got to know what you’re

doing yeah again yeah this is these are

why we have conversations with experts

because they tell you what’s going on

they give you a lot to chew on this will

probably be a video that some of you got

to watch twice i will go back and watch

this because jonathan brought stuff that

i had not thought about so jonathan

thank you very much how can people find

you well there’s lots of ways but we’ve

already mentioned the group a couple

times so uh

if you guys want to

invest with me you want to get on my

investor list just google tubers two

bridges asset management llc and you’ll

see the investor form and just fill it

out and we’ll be in touch yeah if you

want to see how it’s done folks i

suggest you do it if you’re a credit

investor do it get on the list just see

what it puts out this this is why i am

on it and i like like reviewing the

material so jonathan thank you very much

you’re welcome thank you awesome

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