As a passive investor, it can be quite overwhelming to determine what you focus on as you evaluate various investment opportunities. The three key areas to focus on include vetting the sponsor, the market/the submarket, and the deal. In today’s quick snippet I will focus on the ten important questions you can ask a syndicator as you continue to get to know and vet them. The questions are complimentary to the ones we shared in our earlier snippet.
1. Opening Questions. How long have you known the operator? Where did you connect with them – through a reference, at local or virtual meet up, at conference, etc.? Did they have a call with you? Have they made an effort to get to know you and understand your investment objectives? What type of interaction have you had with them – deal presentations, webinars, newsletters, educational content, etc.? How frequent?
All of the above help you get to know the person over time, how they communicate, how they operate, how they interact with others (partners and investors).
2. What is their investment approach? More specifically, understand their risk appetite, what markets and sub-markets they focus on, how they create value (value-add vs. turnkey), investment strategy (cash flow or appreciation) and what asset class they focus on. Then determine how that compares to your personal investing strategy and criteria.
For example, if you are a cash flow investor, like me, then a sponsor focusing on new development (which carries higher risk and the payout is delayed until the time of sale) might not be a good fit for you. If you are more conservative, then a value add strategy (which has cushion against market fluctuations vs. buying a turnkey asset and relying on appreciation) may be a better fit for you.
Take the time to get to know the operator.
3. What is their experience level? It is important to understand their overall background – education, professional background, real estate investing experience (active or passive), experience in the specific asset class, including number of deals and deals gone full cycle.
As you evaluate their experience, it is important to understand the composition and background of the entire deal team too. More specifically, if the sponsor you invest with is strong in underwriting and lives far away from the property, are they partnering with other operators who are boots on the ground and strong in asset management, etc. As operating a property is essentially running a mini-business, it is important for the team to be multifaceted and have a strong extended deal team.
4. What is their track record? You want to understand how large their portfolio is and what it composes of. Are they focused on a single asset class or all over the place? How are their existing deals performing to date and are they on track to hit projected returns? How did past deals perform relative to the original projections? How many of their investors re-invested in a deal? Is the deal sponsor willing to share references from current or past investors? Ultimately you do not want to be a Guinea pig for that sponsor’s/that team’s first deal.
5. Is the sponsor investing in the deal and how much is the management team collectively putting in? It is not uncommon for the sponsorship team to put in between 5% and 10% equity in the deal. Ideally this would be fresh equity vs. rolling in the full or partial acquisition fee raised into the deal. Without stating the obvious, this would show you how much skin in the game they have. If a particular sponsor is not investing, are they guaranteeing the loan? Providing a personal guarantee would be another way to show skin in the game, as essentially that sponsor is putting all of their personal assets and net worth at risk.
6. Why you should NOT do the deal? What can go wrong? Asking this question would help you understand the key risks and how the management team is mitigating those. Unexpected things always happen. Thus you want to see if the sponsor has thought through the potential risks and everything that can go wrong and what actions they are taking today to minimize the adverse impact as well as how they are planning for unexpected events (e.g. via adequate operating and capex reserves).
7. What is their capital call history – did they ever make one and why? Unexpected things happen but it is helpful to understand what drove the capital call – unforeseen exogenous events, poor budgeting, insufficient upfront reserves, mismanagement, etc.?
8. Can they share examples of deals gone wrong and how did they handle those? Can they share examples of full cycle deals and how did those perform vs. the original projections?
Past performance is not always a predictor of future performance. However, it is a helpful indicator. Especially if the operator has been in business long enough, they will have at least one deal that did not go as planned or potentially lost money.
9. How do they communicate?
There are a couple of ways to gage that:
- How frequent is their reporting and of what quality and detail? How easily accessible is it or how is it distributed? You can always request a copy of past communication.
- How timely is their year-end financial and tax reporting – do they send the K-1s by 3/15 or do they file for extensions?
- How do they deliver bad news or handle unforeseen issues? Ask for an example of such past communication, if available.
10. Are they willing to share references from past investors?
While past performance is not a guarantee for future success, it is a helpful indicator. Understanding why that investor did not re-invest can provide valuable insights. Sometimes there could be timing or personal circumstances for their decision. However, if they had a poor experience, they will talk about it.
The investing process starts with being clear on your investing criteria and then doing your prelim diligence. As part of the diligence process, it is important to take the time to get to know the syndicator upfront vs. finding out after you invest in a deal that you may not be a great fit for each other or that they did not have the right background and experience to run the deal. There are always risk with investing but proper diligence upfront can help mitigate those and set you on a path of success as you continue your investing journey.
Download The Busy Professional’s Quick Guide To Investing In Multifamily here.
Disclaimer: The information presented does not constitute legal, accounting, tax, or individually tailored investment advice. Past results do not represent or guarantee future performance.