In the world of private real estate investing, it’s important to KNOW the sponsor. That individual or group will determine if the deal being considered will be good for you. Ask these four questions of any deal sponsor with whom you are considering investing. Then ask yourself the last one.
“What is your track record?”
A deal sponsor may claim success with his or her last few investments, but what does the long-term track record actually look like? Have there been failures and what were the circumstances? Has there been consistency in the profile of the properties purchased? Or are they just chasing what’s hot?
“What is your proclivity for borrowing?”
Deal risk stems from several areas, one of which is the extent of the financing. High loan to cost ratio, short-term loans, and high interest rates raise the risk substantially. Aggressive terms can boost returns, but jeopardize the deal if the market shifts or the property doesn’t perform as projected. Financial engineering to make a deal work should be a red flag to all investors – especially conservative ones interested in preservation of capital.
“Do you invest in your deals?”
How much money does the deal sponsor invest alongside partners? Is that investment on par with the other equity investors, or is it treated differently? What is the deal sponsor’s capacity or willingness to inject additional equity if the property requires more capital?
“What are your areas of expertise, and what is your professional background?”
Accountants, salespeople, managers, and contractors all can be good sponsors, but they will all pursue, select, manage, and structure deals differently. Different deals require different expertise (i.e., Does the property need leasing, renovation, or better capital structure?). Professional background will also offer clues as to a sponsor’s tendency if something goes wrong. What is it about this person’s skill set makes you feel good about his or her ability to make decisions and provide advice in your best interest?
Ask yourself: What does your gut tell you?
If you’ve ever wrongly placed your trust (or your money) with someone who didn’t live up to your expectations you probably had some apprehension in the beginning. Listen to your gut. Spend some time with the deal sponsor. Ask for references. You should trust this person to make decisions that are in your best interest and aligned with your goals. If you have any doubt about trustworthiness or capability, keep looking.