Questions you should ask every Sponsor before investing with them
Questions about the market:
What is the justification for why this market makes sense? Is it a good area? Class A, B, or C area? What are the crime statistics? Is the area improving or in decline? Does the syndicator provide a compelling investing story for both the market and submarket?
What are the comparable, current and projected rents and thesis on why rents can be increased?
What are the projected jobs and population numbers over the hold period? Are there employers moving into the area? What is the probable effect on housing demand?
Questions about the team:
What is the experience level of the team running this deal?
How many deals has this team done? Have they had any bad deals? Are they conservative in their underwriting?
Has this team seen a full real estate cycle? Are they also investing in the deal personally?
How many exits has this team had? What have been the results? What is the Average Projected Return for the deal? What is the projected IRR and how does this IRR compare with other opportunities I have before me?
How quickly will this deal start paying distributions? (90 Days after closing is the latest you should wait for the first distribution)
How often will they communicate with investors? (Monthly is a good basis for investor communication)
Are there any pending lawsuits or complaints with this syndicator? (Hint: Check SEC)
Questions about the deal:
Is the deal a standard 8% Preferred Return with a 70/30 Equity split? If not, is the investor return a conservative number 17% or above IRR?
What are the rent rates of similar properties in the area that have been renovated. How likely is it that the operator will achieve targeted rents?
Is the cap rate at or better than market? (Market Cap is 4-6%)What is the exit cap rate? Does it take into account rising interest rates?
What is the Equity Multiple over the hold period? (I like seeing 2.0X over 5 years generally)
What is the possibility of a capital call? Does the syndicator have a history of capital calls? Is there sufficient capital in the deal to cover renovations and upgrades?
What are the finance terms? Is there more than a 25% down payment? Is the loan rate competitive and fixed? (I’d be weary of any variable interest rate deal.)
Do the principals have key man insurance? What happens if something tragic happens to the key player on the GP side of the deal? It’s very rare, but I want to know the company is being careful and is thinking about this.
How likely is it that this deal will provide a liquidity event in year 2-5? (A liquidity event or “cash-out”, is when the syndicator gets an appraisal on the deal after the enhancements and renovations are made and uses that higher valuation to either refinance the loan or get a supplemental loan. This extra cash is returned to investors for other investments.) It’s always nice to get your money back sooner and then have nothing but profit for the rest of the hold period.
In summary, the questions offered here provide a framework that can be useful in evaluating syndications. Having a checklist, or a system allows you to make sure you’re not missing anything big. If you’d like a more detailed checklist of questions and information to better equip you for such a hefty decision, check out this other blog post we’ve written just for you! To your success!