Due Diligence on the Sponsor Syndicator

Create Multi Generational Wealth Through Real Estate

In our previous article, we discussed techniques for finding an appropriate sponsor or syndicator for your project’s needs. Your sponsor is your advocate, and they will play an integral role in ensuring that your real estate syndication is successful. For this reason, the process of finding and vetting a sponsor can feel incredibly high stakes and opaque. Commercial real estate investing is a relationship-oriented industry where reputation, credibility, and reliability are vitally important. Because investors are primarily interested in investing in the deal sponsor first, and then the deal second, serious investors must scrutinize the deal sponsor from multiple angles to determine whether there is a fit between the investor’s need and the syndicator’s strategy.

There are many criteria that investors can use to assess potential sponsors for their quality. In addition to the standard vetting procedures that we explored in our previous article, we hope to shed light on the criteria that investors use to assess sponsors and determine whether they are the perfect match the entire team’s needs.

  1. Fee Structure and Investment Duration

    The first criteria you should use when vetting your sponsor is the fee structure. The fee structure–which is defined as the schedule of fees payable to the borrower in real estate syndication–compensates the sponsor in syndication. Fee structures vary depending on the role of each participant lender but can include the letter of credit fees, commitment fees, and other upfront fees.

    For this reason, the fee structure can be used as a mechanism to evaluate your sponsor. Ideally, a proper fee structure should align the sponsors’, investors’, and participants’ interests. In an airtight structure then, the sponsor should be able to explain the impact of all expenses and fees. There should be a clear connection between gross returns and net returns.

    Some useful questions to ask when assessing the sponsor’s fee structure include:
    • What is the anticipated timing of fees and returns? And
    • What frequency will they be incurred and paid – monthly, quarterly or annually?

  2. Sponsor Fees: Assessing how the Sponsor is Compensated

    As we mentioned above, some fees can factor into your agreement with your sponsor. At the beginning of the syndication, the sponsor will seek compensation for identifying the property, conducting due diligence, and structuring the deal. This fee is called the asset acquisition fee, and it accounts for the expenses associated with the closing, including staff and administration fees, analyst fees, marketing, and online database subscriptions. The acquisition fee is a one-time fee that is generally paid up front, ranging between 1-3% of the purchase price (although sometimes they can be slightly higher), or it can be a flat fee. The acquisition fee is paid to the sponsor at closing. It can also be negotiated by the investors in the deal. It is typically difficult to negotiate acquisition fees because they encapsulate the amount of legwork that is required to close a deal. Remember, for the one deal that you may be completed, your sponsor may be underwriting 50-100 deals at the same time!

    Loan guarantees are another fee that is often required by sponsors. Naturally, when a sponsor takes on a project, they will be subject to financial and reputational risk. If their syndication fails, the reputational damage that results can prevent them from raising capital in the future. Occasionally, the sponsor will issue a personal recourse guarantee on the acquisition loan, and this helps them mitigate future risk. Ask your sponsor questions if you are concerned about the nature of their guarantee.

    Beyond offsetting the risk involved, sponsors may issue fees that cover the cost of the project itself. These types of fees include asset management and construction management fees. The asset management fee is an expense given to the sponsor to manage the company, and it is sometimes calculated as a percentage of the revenue that the company produces. Typically, this fee is around 1-3% of monthly revenues. While it can be paid at any interval, it is generally a fixed annual dollar amount that is paid monthly or quarterly to the sponsor. Alternatively, construction management fees compensate the sponsor for the construction costs and allow them to oversee their capital improvement implementation plan. This fee typically equates to 10-15% of the cost of construction, and it is not included in every deal.

    Finally, there are a couple of additional fees that you should also be aware of. Sponsors typically include a disposition fee (usually 1-3% of the sale price) to compensate for the costs related to selling the asset or property. The refinance fee, sometimes called the “refinance hurdle,” is another fee that compensates the sponsor–once refinancing occurs, a portion of the investor capital is returned to the sponsor. The refinance fee is typically 1-2% of the refinance loan amount, and the return of capital should be in the 40-80% range.

    Because returns should be presented as net of fees, these fees should not impact the projected results. A simple way of checking is to determine how the investor’s returns respond due to fees–ideally, the marketed returned should not plummet from fees.

  3. Property Management

    Because most sponsors lack the expertise needed to manage a property, it is likely that the sponsor will bring on a professional property manager to help them execute their plan promptly. The sponsor will delegate property responsibilities to the property manager and their team throughout the syndication’s lifespan. The property manager’s experience is critically important to your ability to operate a multiple-property syndicate without a hitch. Therefore, it is essential that when you are assessing a potential sponsor, you also ask questions about the team that they will bring on to manage the property.

    When hiring a property manager, the sponsor is primarily interested in the manager’s ability to organize a team that will manage several property units effectively. For the sponsor, the process of hiring a property manager involves reviewing their entire team, performing a background check, and assessing their efficacy and past performance. When the sponsor hires a property manager and their team, they will also review their previous success in operating within a similar class/type of property as the one being acquired. This vetting process on the sponsor’s part involves verifying the property manager’s track record in the specific submarket where the property is being purchased. As property managers can have a class of properties that they specialize in, it is essential that the sponsor select a property manager whose experience overlaps with the needs of the project.

    The property management team that your sponsor hires gives you insight into how your syndication will be managed in the future. If you have doubts about whether the property manager or their team is right for you, ask the sponsor to acquire references and tour their properties to get a feel for their management style,

  4. Asset Management

    In addition to property management, the sponsor is responsible for broader-picture asset management. Because asset management can be tricky and involves multiple parties collaborating toward a common goal, communication is critically important. Effectively communicating with your sponsor will enable you to understand their plans for how they will implement and manage your assets efficiently. When looking for a sponsored team, you should select one that has superior communication skills. While their communication doesn’t have to be extensive, it should be clear, concise, and state what their priorities are. A sponsor who is an effective communicator should explain operational details, including how they plan on handling issues when they inevitably emerge.

    Another critical component of your sponsor’s communications plan involves investor relations. Investor relations broadly describes the sponsor-investor relationship. Investors need to know how their sponsor will manage the capital that they have invested and will take the time to answer all their questions/concerns. Quality sponsors ensure that investors are kept abreast to all developments in the syndication lifespan and should maintain open lines of communication to facilitate a long-term relationship. Moreover, sponsors should be able to answer any question that the investor might have (alternatively, they should also be able to admit when they do not know the answer to an issue but can provide you with resources that will lead you in the right direction). The investor plays a vital role in ensuring the success of the venture, and accordingly should be treated with utmost respect.

  5. References

    References are the final, vital key to the vetting process. An investor should always seek to work with sponsors who have the right personality and background for the project. Initially, it can be difficult to determine whether a sponsor would be the right fit–but by using the proper criteria and asking the right questions, an investor can identify indicators of success, Sponsors should easily provide references. References are a quick and effective way of gauging your sponsor’s credibility and past performance. While you can ask sponsors directly for references, we suggest that you connect with other investors or members of the sponsor group first. Often when we connect new investors with current investors, we have found that investors get a better picture of what to expect from their potential sponsor. By fielding different references, an investor can analyze multiple perspectives to understand if the sponsor is a good match.

Due Diligence on the Sponsor Syndicator

When asking for references, here are some questions to consider:

  1. Has the sponsor reliably met their targets or projected goals in the past? Why or why not?
  2. How communicative is the sponsor? Do they respond to all your questions and concerns quickly?
  3. How easy is it to work with the sponsor’s team? Do they respond to your emails on time, and can they connect you with the right resources and information if you need help?
  4. If an immediate issue arises during the project, is the sponsor equipped to mitigate it?

At the end of the day, your relationship with your sponsor will be useful if they can be easily integrated into your team. Real estate is a complex ecosystem that involves many different actors working together reliably and honestly. Realistically, all members of a syndication–including sponsors, investors, tenants, and the community–should be able to benefit from the proposed project. With effective due diligence, you should be well on your way to establishing a capable team that turns the syndication into a win-win scenario for everyone involved.