In prior article, we discussed key questions to ask when vetting a sponsor. In a forthcoming article we will discuss additional resources passive investors can use to pre-screen a sponsor. In today’s quick snippet we will cover five factors passive investors often overlook when screening a sponsor and making a decision on who to invest with.
1. Scaling too fast. Are the sponsors purchasing multiple properties, scaling too fast without proper infrastructure and collecting fees? Doing multiple deals may be ok if they have the people and process infrastructure and can demonstrate that they are thoroughly vetting each deal vs. pursing any deal that crosses their desk. It is not uncommon for certain sponsors to partner with multiple operators. In that scenario, you want to ensure they are properly vetting each operator.
2. Not having skin in the game or a strong track record. Skin in the game incentivizes the sponsor not only to perform detailed upfront diligence, but also to stay engaged throughout the tenor of the investments and focus on operations and execution of the business plan post close. Being a Key Principal is one way to show skin the game, as these are the individuals who often sign on the loan and would ultimately be liable, if the loan converts from non-recourse to recourse. Providing a personal guarantee is another way sponsors can show skin in the game because if such guarantee is called on, the sponsor may have to liquidate personal assets. Lastly, bringing in personal liquidity to a deal also shows commitment to the investment, as such personal investment is at risk, if the deal does not progress as planned.
3. Lack of diversification. While it may feel comfortable to work with a sole sponsor, it is advisable to diversify across sponsors, geographies and asset classes to mitigate the risk of a market or a single sponsor or asset class getting in trouble. Another way to mitigate that is via a (customizable) fund; however, not every sponsor offers that option.
4. Infrequently or not at all monitoring investment performance. While investing passively does not entail running the day to day operations, you want to track your investment’s results over time to see how it performs relative to the returns projected at inception. This also helps the passive investor spot declining trends early and have a conversation with the sponsor, in the event that trend is not discussed in the periodic investor communications. Lastly, if you do not receive monthly or quarterly updates from the sponsor, ask for them from your designated sponsor contact.
5. Not asking for references. It is not uncommon to share current and past investor references, so long as sponsors have permission to do so (certain investors may choose not to be publicly cited for privacy concerns). In most cases, obtaining a reference, should not be an issue however. In addition, passive investors may not be compensated for providing a reference on their sponsor. This helps ensure you are getting an honest view when you reach out to them for a reference on your contemplated sponsor.
The key to a successful investment starts upfront during the vetting process. As a passive investor, you are not expected to be an expert on the market, deal analysis, or property operations. This is why it is even more important to complete diligence on the sponsor and think through your investment strategy.
Should you have any questions or want to learn more about real estate investing or for an overview of our target markets, please reach out to info@dbacapitalgroup.com.
Disclaimer: The information presented does not constitute legal, accounting, tax, or individually tailored investment advice. Past results do not represent or guarantee future performance.