Due Diligence on the Real Estate Syndicator

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Commercial real estate investing is an art that relies on relationships. At the core of every deal is a carefully crafted agreement between multiple parties that all work in tandem. One of the key figures in this performance is called the deal sponsor. Also known as the syndicator, sponsors are essential players because they attract investments and conduct the complex process of arranging a real estate syndication. Like conductors in a live orchestra, their guidance is critical to the successful performance of the investment. Investors, who might act as members of the orchestra, are responsible for scrutinizing the sponsor’s ability to direct the multiple moving parts of the deal and ensure that there is a fit between the investor’s individual needs and the syndicator’s strategy.

Naturally, coordinating successful real estate syndication can be a difficult task, and generating high market returns is even more difficult. As one of the most critical components involves the sponsor’s credibility, we will provide a framework utilizing our experience in vetting sponsors.

The deal sponsor/syndicator ultimately plays the most significant role in maximizing your chances in having successful real estate syndication. In our experience, a good sponsor can turn around a fair deal but not vice-versa. Therefore, this article provides criteria for how to successfully vet a real estate sponsor.

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, multifamily investing
, multifamily syndication investing, raising money for real estate syndication, commercial real estate multifamily investments

Company, Background, and Team Experience

When you first meet a potential real estate sponsor, a few aspects of their behavior might jump out at you and serve as clues as to whether they would be best to lead your project. Please make a note of their first impression and consider whether they interact professionally and consistently throughout their in personal meetings, online presence, offline presence, and official communications. If you notice that the sponsor is not acting professionally in one of these domains, it is your first red flag that they may be unfit to supervise the syndicate.

After you consider their initial presentation, you can ask yourself a variety of more complex questions that will give you insight into their performance. One of the first questions that you can ask involves their investment strategy. How is it presented? If you are impressed by how brutally efficient their methods are, you may want to take pause. Contrary to popular belief, sponsors who emphasize their efficiency may not be the most suitable choice for your needs. Often, sponsors who develop a reputation for being efficient to have done so because they have developed expertise in a specific niche, and their expertise may not be relevant to your project.

Your attorney should also be practicing in their area of expertise (a divorce attorney does not make a good securities attorney). Sometimes it is best if you work with a sponsor who can clearly articulate their strategy and has niche specialties but be sure that their expertise is tailored to your individual needs. To take the example of our preferred strategy–value-added multifamily investments–one should prefer stable income returns with forced appreciation potential. If you find yourself unsure about whether the sponsor’s efficiency is in-line with your individual needs, you might return to your preferred strategy and values to determine if the sponsor will be a good fit.

apartment syndication
, multifamily investing
, multifamily syndication investing, raising money for real estate syndication, commercial real estate multifamily investments

Another aspect you should carefully consider is how the sponsor’s team operates. Despite the sponsor being a valuable player, they should not bear too much responsibility for the success of the project. In addition to considering the sponsor’s first impression and reputation, you should consider the entire syndication team’s credibility. Your sponsor’s reputation matters a lot, and that also includes the reputation of the group backing them. Ideally, you want to know that enough people are supporting your sponsor to ensure the success of the deal.

Do the key partners have tenure and experience in your type of syndication? How has their performance been in the last few business cycles? Do they appear to be responsible and well rounded? Look for exceptional KPs with long tenures, especially when working with new sponsors because the KP can take the new sponsor under their wing. To determine whether the entire team is suitable for your objectives, perform a Google, LinkedIn, or social media search to understand all the KPs in a syndication team better–and read their profile to understand their experience.

As far as inter-team dynamics go, determine whether the team has cross-functional abilities but clearly defined/delineated roles. Also, look for indicators of credibility: if the team can provide references, if they have a good reputation within the community, and what referrals have to say about them. Be on the lookout for bankruptcies, felonies, and regulatory (SEC or state) violations. A good litmus test is by asking the simple, albeit morbid, question: Will your capital be protected if something were to happen to the syndicator?

Marketing Materials

You may first meet a potential sponsor and their team through their marketing materials. Marketing is a broad term, but some components are commonly used in real estate and other industries, including deal summaries, pitch decks, videos, webinars, conference calls, and social media. Marketing plays a vital role in informing your decision because it not only influences your first impression, but it impacts other potential investors and members of the community. Keep in mind when vetting marketing materials, including whether the documents are professional and if they address significant questions about launching a project.

Also, check to see if business plans are marketed consistently across all different platforms, as inconsistent advertising is an indicator that a sponsor is not credible. When in doubt, a trick that you can use is to ask for a copy of the sponsor’s private placement memorandum (PPM) for past deals. The PPM is a legal document required by the SEC that covers risks, partnership roles and other facets of an investment. Examining a PPM will likely tell you whether a team is legitimate and can deliver on their promises made in the marketing materials.

Investing Strategy

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Once you have determined that your sponsor and their team pass the “litmus test,” your next job is to assess their investment strategy. The first thing to look out for when assessing the viability of the sponsor’s investment strategy is whether they can clearly and concisely articulate it. Sponsors who are experienced and confident in their investment strategy should be able to explain it as second nature, whereas duplicitous sponsors may not be able to explain the finer aspects of their plan. It is important that the sponsor is confident but humble because even the most intricate and cautious plans can be disrupted. It would be best if you worked with a sponsor who has clearly defined niches and can articulate their strategy. Besides, you should assess the strategy for its intellectual rigor. It is important that your sponsor has a forward-looking outlook to determine if the strategy can be consistently applied across deals.

Investigate whether their strategy has been empirically successful, or how it has performed across the business cycle or multiple deals. Finally, you can utilize other metrics to determine whether an investment strategy is right for you. One method is by using detailed performance attribution reporting to understand the multiple factors that can affect net returns. You can also use K1 statements and investor communications to discern how different sponsors handle investment capital.

Sponsor Experience in Asset Class and Sub-Market

One aspect that may be challenging when determining your sponsor’s candidacy is how their previous work will translate into your current project. If you are researching an experienced sponsor, they almost certainly have experience in one (or several) asset classes or sub-markets. However, stellar performance in one of these domains does not guarantee success in your project.

Your sponsor’s future performance will be a function of market fundamentals and basic economics. It is essential that your sponsor be well versed in the local economic drivers where your project is located, and this should take into consideration a 3-5-year outlook. One practical example of this is as follows: A sponsor might have a phenomenal plan for your project that is disrupted when a new, competitive inventory is introduced to your local market. This additional inventory can generate revenue pressure as the sponsor’s asset will compete against the newer supply. A prepared sponsor would have performed research and concluded that the project is not viable due to an immediate competing interest.

Even if you are comfortable with your sponsor and their experience, you should still vet their available resources and support network. Some sponsors might be effective in a solo role or even have a great team surrounding them, but if they lack relationships in the local community, your project might not launch as expected. Strong communal relationships help sponsors secure deals that might not otherwise be available, and they can also help attract a pool of local buyers once the business plan has been implemented. As real estate investing is a community-oriented business, it is critical that your sponsor brings more than a good team to the table.

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Underwriting Discipline

Underwriting plays a significant role in attracting investors and is one of the indicators you should look out for when selecting your sponsor. Underwriting allows financial institutions to assess the creditworthiness (or lack thereof) of potential customers. Successful businesses often tend to be more conservative in their underwriting and predicate their judgments of a customer’s risk on available data.

A sponsor’s risk/return profile is mainly going to be determined by their insurance underwriting, as well as evidence of their capital preservation. Sponsors should be able to provide proof of their capital preservation history without embellishing their past performance. Furthermore, sponsors can provide what is called sensitivity analysis accompanied by reports on the primary drivers of recent success, including vacancy, rent upside, loan terms, and exit valuation. This information allows potential investors to determine whether the deal is right for their portfolio and mitigates their concerns.

Financial Reporting, Legal and Audit

The necessary quality of ongoing financial reporting cannot be overemphasized, as well as information on the legal and auditing teams. If it is possible, it is crucial that you request the sponsor’s financial, legal and auditing packages from past deals. This data will give you the best sense of whether the sponsor’s team has authority and expertise in raising revenue and closing deals. When assessing financial reporting data, it is also essential that you check to see if the sponsor’s team has a history of disciplinary actions or regulatory violations. This pattern of behavior can be nefarious and is almost certainly a sign that you should not trust the sponsor with your investment.