Hey, everyone.
Mauricio here legal advisor to KenMcElroy.com and today
I wanted to talk to you guys about the top six questions you should ask
every deal sponsor before you invest in one of their deals.
As a real estate syndication attorney, we do about 300 of these every single
year.
And one of the most common questions I get is, Mauricio,
what should a passive investor ask the sponsor prior to investing?
And so I came up with a couple of these questions.
There's actually about ten of them.
And so we're going to put a link in the video
if you want to get the other ten.
But here are the top six that you should absolutely consider.
Number one, what is the level of the deal sponsor's experience and track record?
You know, ask any sophisticated investor and that's probably the number one thing
you should be asking your syndicator and really doing
your deep dove into the due diligence is what is the level of experience
anybody can put together a fancy broker, a fancy business plan,
but can they actually execute on that business plan?
That is what you're really interested in.
And it gets really nuanced if you really think about it,
because not only are you interested,
it is whether they have experience and whether they have a track record.
But do they have experience
in that particular asset class that this particular deal is involved?
So for example,
maybe you have a sponsor
who's got a great experience and great track record on multifamily investments,
for example, and they've purchased a lot of multifamily buildings.
But this particular deal might be on self-storage or mobile home park.
So do they have experience in track record in those asset classes?
Now that doesn't mean that
that particular person that you're talking about
needs to have that experience with somebody on their team,
really needs to have the very little nitty gritty experience on the asset class
and ideally even the submarket that the property is in.
Because just because it's
this syndicator has been in, let's say, the Florida market,
if this investment is in Oklahoma,
you want to know what their level of expertize and track record
is in the state of Oklahoma.
So just think of questions you should ask, like,
do you have any experience in this particular submarket?
Have you taken any of these deals full cycle
and have you gone through like a really big downturn like in 2008?
So again, spend most of your time trying to figure out
what the level experiences is and just ask yourself
whether they can actually execute on the pretty brochure.
Question number two
what is the level of active experience and track record of the asset
management team?
Now some of you may be surprised to learn that the sponsor
in the asset management team sometimes are two different groups.
The person that you're dealing with, the sponsor,
the person that you know, like and trust and have the relationship with.
They may not be involved in the day to day operations.
Once the raise and complete and the property has been closed on.
So it's really important to figure out who is actually doing the work,
who is actually executing on that business plan
to make sure that the person that you're relying on is actually involved.
Because it's not uncommon these days
with so many sponsors that some sponsors tend to sort of fade away
after the deal is closed and you don't get to see them as often.
So as specifically who is going to be asset managing,
what role does everybody on the team have and make sure that the person
that you know, they can trust is part of the asset management team.
Question number three, what is the sponsors investment philosophy?
You want to make sure that your investment philosophy is aligned
with the investment philosophy is the sponsor
because this may be a great deal that may have all the bells and whistles
for everybody else.
But if you're a cash flow investor and what's most important
for you in your philosophy is you want to have monthly cash flow,
consistent monthly cash flow, and this particular deal is a heavy value add.
You're not going to see
cash flow for a while and maybe it's a ground up development.
So you're not going to see cash flow
for 18 or 24 months, then your investment philosophies are not aligned.
And so that's one of the questions
you want to be digging into is what are they really looking for?
Are they conservative on the aggressive or the cash flow?
Investors or the equity investors make sure that there's an alignment
between your investment philosophy and theirs.
Question number four What happens if the sponsor dies?
This is obviously a bigger deal
if you have one sponsor, which many of those indications are.
So you want to make sure that whoever you're entrusting your money
with, the person that you,
you know, like and trust, what happens if they pass away?
But even if there's multiple investors, if the main syndicator passes away,
what's the game plan?
Because the last thing you want to do is have their interest in the syndication
and their controlling interest in the syndication pass to their estate plan.
And suddenly their spouse or their kids
end up owning that percentage ownership of the deal.
And it may have a controlling interest
and they may have completely different expectations or desires.
And you have
and they may just want to liquidate and they may want to get out
and they may want to just get their money back.
So make sure that the sponsor can articulate a succession
plan in the event that they die or even become incapacitated.
Most sponsors will have in their agreements will have what's called
a buy sell agreement, which outlines what happens if one sponsor dies.
Everybody else can buy their interest,
but somebody is going to take over a controlling interest.
And it's really important for you to find out who those individuals are
and whether you're comfortable with that or if nothing else,
that there's actually a plan in place
because a lot of time syndicators don't really have a plan in place.
What happens when they die?
As I mentioned before, their kids or the spouse take over the project,
which I'm sure is not what you want.
Question number five How does a sponsor fees compare
with the industry average and do they have their own money in the deal?
This primarily has to do with alignment.
Again, you want to make sure
that the syndicators goals and results are aligned with yours.
And so you want to have a fee structure that actually encourage them
for the project to succeed, right?
So fees generally are paid in different parts of the syndication.
A lot of them are upfront right prior to the deal.
When you're raising capital, there's some fees there.
There's some fees ongoing during the life of the investment.
You know, from cash flow or some asset management fees.
And then there's fees at the end.
It's okay to have fees on all three,
but you want to be wary about fees that are frontloaded, right?
Because if they're going to get most of their money upfront,
they have very little incentive to do well for the project
as opposed to, let's say, everything's backloaded
where they're not going to get paid unless the project is super successful.
Now, again, I'm not saying that every syndicator has to get paid at the end.
You want to make sure your syndicator is motivated to get up in the morning
and go to work and get a return for you.
So you want to have fees in there built in,
but you want to pay close attention to them,
make sure they're within the industry average
and you want to make sure that they're not front ended
so that your interests and their interests are not aligned.
And maybe just as important is whether they have their own money
in the deal again has to do with alignment.
But if they've got skin in the game,
if they've got two, three, $400,000 in the deal,
then obviously they've got a vested interest
in making sure that the deal goes through and is successful as opposed to,
Hey, no skin in the game.
I've got all my fees up front.
I don't care if this deal goes belly up.
You want to make sure both you and the sponsors are both aligned.
And finally, number six, ask the sponsor
what they believe is the worst case scenario for this particular investment
and how they plan to mitigate that worst case scenario.
You're looking for the weakest link, like how does this thing actually collapse?
Ideally, you go through,
do your due diligence on the project and you should be able to find out
what the weakest link in the deal is and what the worst case scenario is.
So that when you ask the sponsor what they believe it is,
you already have an answer.
And hopefully you guys are either
coming up with the same answer, so it's confirming your due diligence
or maybe they're going to come up with something else
that you hadn't really thought about.
But if the answer or the response to your question
is there are no worst case scenarios or we've thought about everything or
we don't know, you get a blank stare from the sponsor.
That's going to be a red flag.
Every single sponsor worth their weight in gold will be able to tell you exactly
what the weakest link is in this project, what the worst case scenario is,
and what steps they've taken to mitigate that worst case scenario.