If you’re thinking about investing in a passive real estate deal, whether it’s a syndication or a real estate fund, it’s extremely important to learn how to vet the opportunity properly. That way, you know exactly what you’re investing in, & who you’re investing with.
In reality, it takes study, time, and experience to learn how to vet a deal properly. And a lot of people get so caught up in the minutia of looking at the deal, that they forget to even look at the sponsor that they are giving all their money too.
I’ve heard plenty of horror stories from investors saying that they lost everything investing into a deal that made a ton of sense. It was in an upcoming market, the business plan was perfect, the occupancy wasn’t too low, the plan to force appreciation was going to double returns over the life of the hold, and everything looked hunky dory in retrospect to the investment itself. But the syndicator who was in charge of implementing said, business plan, was an absolute crook. They didn’t care about their investors and their money, they didn’t care about the investment itself, they only cared about cashing-in once they received all their investors money.
Now, of course the syndicator has a nice new orange jumpsuit and he’s living behind bars, but what happened to all the investors and their money? They lost ALL of it. Now, this story is not to scare you from ever investing into a syndication in the future, on the contrary, I believe syndications are one of the most lucrative investment opportunities out there - especially for passive investors. Instead, this story is said to hopefully shine some light on the cautious nature you should have when vetting these syndicators.
So, in light of horror stories such as this one, I will be going over what you should look for in a syndicator and in an investment opportunity. The most important one being the syndicator.
Vet, Invest, Then Rest
These types of real estate deals are often referred to as passive deals. That’s because you’re investing as a “limited partner,” which means you have equity in the LLC that owns the real estate, but it’s really the syndicator who is doing all the heavy lifting. They’re the ones managing and operating the deal in order to create returns for the passive investors.
You’ll need to vet the syndicator and the deal, THEN you invest the capital, and sit back, relax, and wait for your money to grow.
I find that many investors tend to do it backwards. They think that because this syndicator has found the deal, analyzed it, and taken the time to put a spreadsheet together, that shows phenomenal returns, that it must be a great investment. “This syndicator obviously has way more time, expertise, & desire then I do to be an active investor, so let’s dive in!”
A lot of passive investors will vet the deal, invest, and THEN vet the syndicator while they see everything crumble and all of their money lost to the abyss. My goal is to help shine a light on the things needed to properly vet a syndicator.
When vetting a syndicator, there isn’t really much that you can measure in terms of their character and willingness/mindset to achieve success for their investors, but without a doubt, their character and your trust in them are the two most important factors when choosing a syndicator to invest with. In the paragraphs to follow, I’ll be going over the things that are easier to measure and then at the end we’ll discuss all the questions you should ask a syndicator before investing with them. Once again I would like to reiterate, TRUST your sponsor 100% before investing with them. It will not only provide peace of mind, but it will also provide better returns since you won’t be investing with a crook!
Their Track Record
The first thing to ask yourself about a potential sponsor is simple. How have they done in the past?
Have they done a good number of deals? Have they ridden through some hard times and learned what to do? How did they treat their investors in past deals?
When it comes down to it, the sponsors are the ones who will be piloting the plane. Sure, they know where they want to land, but if stormy weather comes and there’s turbulence, which is almost guaranteed, will they be able to expertly navigate through it?
Of course, when you fly, you don’t care about the experience of the pilot until things start going bad. But you don't want to wait until that point to know who you're putting your trust in.
Don’t glaze over this step. The questions we go over below will reveal what further things to know when vetting their track record.
How They Mitigate Risk
It’s important to make money when entering into an investment, but I feel it’s way more important not to lose money. You worked hard for that money and sacrificed time with your loved ones. The last thing you want to do is have it poorly managed.
Again, in great economic times, most every sponsor ends up looking great. But the truly great ones will do a better job managing the downside when the economy is poor or when things go unexpectedly, such as right now with COVID-19.
So, needless to say, it’s important to understand how the sponsor is mitigating risk in the investment. How are they preparing in the case of an economic downturn? Do they have cash reserves? Are they staying in communication with you when things go bad?
Are they using conservative projections? Are they taking on financing in a responsible way?
These are all things you should be asking and feeling comfortable about before investing with any syndicator.
What’s In It For Them?
The third thing you should understand is the incentives of the syndicator, and how well they align with your interest as a passive investor.
Basically, the deal should be structured so that they win only when you win. This might seem obvious but you’d be surprised.
Once you dig into the fee structure of a deal and figure out how some syndicators are getting paid, you might find that they’re more incentivized to take on as many deals as possible rather than making sure that each deal provides the best returns for investors.
You might also find that the syndicator’s payouts are structured in a way that they’re incentivized to take big risks because they only do well if they hit home runs. Personally, I don’t recommend investing in real estate deals for home runs – boom or bust.
I recommend investing in deals with a good balance of cash flow, appreciation, and tax benefits. At the end of the day, you want to be sure there are aligning interests before investing with anyone.
Now, some people think that if a syndicator invests some of their own capital into the deal, that of course their interests are aligned. That’s not entirely true. While, yes, that can of course, mean, just that. Sometimes, however, the syndicator can say they are putting their own capital into the deal, but they control all of the finances, right? Couldn’t they just as easily take their money out once the deal closes? I’ve heard of this happening before, and will once again say that trust in your sponsor is absolutely key to everyone’s financial success.
How To Get These Answers
So how do you figure all of this out? What if I don’t know what to ask? What if this is my first time investing into a syndication? Hopefully, you trust your syndicator and they have answered all of your questions as well as explained things you didn't even know to ask.
What are the projections they're making and are they conservative? Have their projections been accurate in the past? What are the different fees involved? How and when do you, the investor, get paid? How and when does the sponsor get paid?
Ultimately, learning all of these things helps you gain confidence in the deal. And if you don’t achieve that confidence, then simply don’t invest. It’s all about trust. These are things that don’t come about by looking at a deal for a few minutes or simply following your friends and hoping for the best.
It comes by spending time educating yourself on the topic, which you can do here on our website, and applying that knowledge to gain experience. You’ll get better and better with each deal you look at, and you’ll gain more confidence in the process & syndicator all along the way.
Questions to Properly Vet Your Sponsor
These questions came directly from an extremely experienced syndicator, of whom I highly recommend reading his brand new book titled “The Hands-Off Investor” by Brian Burke! He has taken the time to sit down and write everything, you, as the passive investor, needs to know before jumping into a multifamily syndication. Once you’ve read his book, and dove into all the resources Ferrari Capital has for you, here on our website, you will be equipped with the knowledge and know-how to vet a deal and a syndicator! All that will be left, is to begin building that trust with your syndicator and you’ll be well on your way to financial freedom!
How they have delegated their roles, and who is responsible for the various disciplines? (Some examples of roles include acquisitions, due diligence, equity and debt structuring, entity and transaction legal, insurance, accounting, asset management, property management, investor relations, investor reporting, and tax matters.)
Who is providing the loan guarantee?
How long have the partners been working together?
Do the partners do all deals together or do the partners switch up from deal to deal?
What plans are in place if one or more partners break off?
Have any principals ever been convicted of a felony or any other financial crime or securities violation?
How do they handle key person risk, and do they have a succession plan?
How long have the principals been investing in real estate, and more specifically, in the type of real estate that is being contemplated for syndication?
How many properties has the team acquired?
If they are in the multifamily business, how many units have they acquired? How many do they currently own?
If they are in the commercial property business, how many square feet? How many hotel rooms, or self storage units, or whatever it is that the fund is investing in?
How long has the sponsor been in the geographical market?
How many units have they owned and managed in that market?
Has the sponsor survived previous adverse market cycles? How did it work out for them? How did they handle it?
How long have they been doing syndications?
How much money have they raised?
How many deals have they done?
How have their previous deals performed?
How have they performed as compared to what they projected?
Why did underperforming deals underperform, what did they learn from that, and what did they change in response?
How many investments have gone full-cycle (bought, managed and sold)? How did those perform relative to their original projections?
What does their current portfolio look like? How many units? Where? Product type? Similarity to what they are buying now?
Have they done similar investments in the past? How many? Where?
Do they specialize in one specific strategy, location, or product type?
Have they ever had to make an unplanned capital call, and why? What did they try to do to remedy the situation prior to issuing an unplanned capital call?
What was their worst deal, and what they did to overcome the challenge?
How do they source their acquisitions?
How do they source their debt?
Ask them to explain their lending relationships. How many loans have they done with this lender? How long have they been working with this lender? DUE DILIGENCE
Ask them to explain their due diligence procedures. REPORTING
Who performs the accounting function at their organization?
What accounting experience does that person possess?
Ask them to explain their accounting experience specific to real estate operations.
Ask to see sample quarterly reports.
Ask how frequently they report and distribute.
Do they have an online investor portal?
When do they typically deliver their K-1s to their investors?
Have their investors ever had to file for an extension because they were waiting for their K-1?
PROPERTY AND ASSET MANAGEMENT
Who will be managing? Third-party company or in-house?
Ask to see a bio on manager’s experience.
How many units has the manager managed? Are those properties similar to the ones being acquired by this sponsor?
How many units are they managing now?
How many units do they or have they managed in this area?
Is their renovation budget based on contractor bids, their past experience, or just a wild guess?
Is there a line item in the budget for contingencies?
CAP RATES AND VALUATION
What is the market cap rate for similar properties in this area?
What exit cap rate is the sponsor assuming for the sale of the asset? How did they arrive at that exit cap rate?
Is the income used for calculating the forecasted exit price adjusted for the next buyer’s property taxes?
What happens if they don’t close?
What will they do if they only raise half of the money and can’t raise the other half?
Do they have someone willing to contribute the difference so the deal closes, and they can continue raising until that lender is repaid?
Can they delay the closing to allow more time to raise the rest of the capital or will they have to cancel the deal?
If they have to cancel, what happens to the money already raised? Do the investors get it back or would it be held by the sponsor for the next offering? Or would the sponsor use it to pay for the cost of the failed deal?
Is there any risk of loss of any or all of your investment if they can’t complete the fundraising?
Who absorbs the costs that were paid for due diligence and other unrecoverable expenses if the deal fails to close?
ALIGNMENT OF INTEREST
Who is signing the loan guarantee or carve-out guarantee?
Does the loan have a large prepayment penalty due if we sell when planned? Is that included in the cost of sale?
What is the plan if there is an adverse market cycle when it comes time to sell?
Does the operating agreement have provisions that allow you to hold for longer than planned if the original sale timing isn’t right?
UNDERWRITING AND PROJECTIONS
Are the forecasted returns gross or net?
What are the terms of the loan?
Are there any prepayment penalties? If so, what, and for how long?
Is this a fund that invests with other operators or is this fund buying real estate directly?
Is there a dual-promote?
How is the asset management fee calculated?
Are all fees accounted for in the financial projections?
Are there any fees that aren’t shown in the marketing or underwriting?
How often do they report to investors?
What do the reports contain?
If the investment is a fund, do the reports include property-level reports or just fund-level reports?
Do they show a comparison of the originally projected performance and actual performance in your quarterly reports?
Or do they show a comparison against the current budget, or no comparison at all?
We’d be happy to answer any of these questions to any of our potential investors and would love the opportunity to get to know you and your financial goals. A lot of these questions are deal specific & won’t be able to be properly answered unless there is a current offering. But if the syndicator has experience, then you can always ask for any previous deal information to get an idea of what can be expected moving forward.