What is more important: The Property or the Sponsor?
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 and 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 to.
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 up and coming 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. 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 to hopefully shine some light on the cautious nature you should have when vetting these operators. 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 operator.
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, and 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.
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. 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.
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, 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 all along the way.
