Syndications give you the benefit of investing in real estate without doing the heavy lifting. However, you still want to trust but verify as Ronald Raegan once said. It is your hard earned money after all and you want to invest your time to ensure you properly vet the sponsor, the market, and the deal.
In today’s snippet we offer a few diligence steps you can take yourself to perform your own diligence.
The Sponsor
In addition to key questions to ask when vetting a sponsor, you can do a background check on them using a number of online tools. Meeting with them in person (or via Zoom if geographically it is not feasible) will allow you to get to know them better to and assess if they tend to be more conservative or aggressive in their investment approach. You may be able to also contact third parties the sponsor is working with – e.g. attorney or past investors – and inquire if they know the sponsor and their working history with him/her. The sponsor should also be able to share how many similar properties they have done and their past track record. They can share about past failures and how they managed through them. No one is perfect and anyone who has been in this business long enough can speak about the difficult moments they have gone through – how they navigated through those is more important.
The Neighborhood
If you are investing in a deal specific opportunity (vs. a fund), you can also visit the property (When consulting LPs, we have heard our fair share of stories where a deal was described as a Class B to the investor only for them to visit the property and find out it is a Class C- at best). Some sponsors offer to host property diligence tours. However, if you live in the area or happen to be visiting the area, you can also do a drive by or walk around the property and area yourself to determine if the property class and neighborhood description match the offering memo. There are numerous public data sources you can explore too to study the neighborhood, crime levels, etc. (feel free to reach out to us for a list of such resources).
The Deal
While we have already shared a few key points to keep in mind when analyzing a deal, you do not need to be an expert of dive into the details (unless you want to). When vetting the deal you want to verify the claims the sponsor is making are reasonable, sense whether they tend to be more aggressive or conservative, ensure they are making a good call on the market and area, and evaluate if they have done a detailed job on assessing all risks. It is important that you can validate and get comfortable with their logic on the various rent, vacancy, expense, and cap rate assumptions and the amount of reserves set aside.
You also want to understand the compensation structures: (i) when distributions will begin, how frequent they will be, and if they will be set up as return of investment or return on investment; (ii) how the sponsors will be compensated – while earn outs may not seem like a good idea, you also do not want to see structures where the sponsors starve till the exit as inevitably they will find a way to get compensated in that scenario or will otherwise need to flip/exit the deal early, if market conditions allow in order to get paid.
How will communications be set up – monthly updates and quarterly distributions or monthly distributions and quarterly updates? How do the sponsors communicate and how accessible are they?
How are cash calls structured – are you required to contribute money or can you opt to stay put at the expense of getting your share diluted and if diluted how diluted will you be?
Investing in real estate can be a rewarding journey and doing diligence should be viewed as investment of your time, irrespective of how overwhelming it can be, as such diligence helps protect your own investment principle assuming all else equal and no unexpected exogenous market events. Investing in real estate is a slow and steady (vs. get rich quick) approach. As such, there is something to be said about starting early, being consistent and patients, so you can in the long run enjoy the fruit of your hard earned money working hard for you.
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.