7 Ways To Evaluate a Real Estate Sponsor
One of the most frequently asked questions new Passive Investors Circle members ask is how they can go about finding the best real estate deals.
If you’re not familiar with how the process works then yes, that would be a good question to ask.
Except it’s not.
When investing in real estate, especially as a passive investor, you should be asking questions such as:
- What types of properties can I invest in using syndications?
- What downsides are there to syndications?
- What are the projected returns?
But the MAIN question you SHOULD be trying to find an answer to has nothing to do about specific deals or returns.
It should be:
HOW do I find a real estate sponsor I can trust?
If you’ve been going to the same dentist for 20 years and he tells you that one of your teeth needs a root canal, will you question him? No, right?
He’s built up a level of trust with you to the point that you don’t second guess his recommendations.
This is the type of relationship I encourage you build with a real estate sponsor or sponsors of your choice.
My goal on this site is to help guide you through the process of obtaining financial independence via passive real estate and one of the main starting points is finding a real estate sponsor to work with.
Before we get into how to do that, let’s first review what a syndication is and the roles involved in each.
What Is A Real Estate Syndication?
A real estate syndication is when a group of investors pool their funds together in order to purchase a property that’s more expensive than they could afford on their own.
One of the main reasons doctors and other high-income earners participate in these deals has to do with access to deal flow.
Most of our Passive Income Circle members are busy and don’t have the time to research the hundreds of properties a year it takes to find one to invest in.
They’re busy doing what they do best….treating patients.
It’s for this reason that they seek out real estate sponsors they can trust and can provide investments without the hassles of property management.
Who’s Involved In a Syndication?
There are two basic groups involved in a real estate syndication:
- Limited partners
Let’s take a look at how each one is involved:
The sponsor is also known as the operator, syndicator or General Partner (GP).
They have a history of real estate experience and the ability to underwrite and perform due diligence with each property.
Not only does the sponsor invest their time, they also invest their money. Typically this amount can range from 5-20% of the total equity capital for the real estate investment.
Limited partners (LPs) are also known as investors. These individuals are the ones that invest passively with the sponsor and own a percentage of the real estate as a result.
They have no active responsibilities in managing the asset yet they receive all of the benefits of property ownership.
They basically sit back and collect mailbox money!
Now that you know what a syndication is and who is involved, here’s what you should expect from a sponsor.
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What Is The Sponsor’s Role?
Recently I had an endocrinologist reach out after hearing my interview on Rich Dad Poor Dad CPA Tom Wheelwright’s Wealthability Podcast.
He was getting slammed with taxes in his home state of New Jersey and looking to start investing in real estate to help alleviate this problem.
He was excited about learning what the magic of depreciation could potentially do for him but didn’t know where to start with finding a sponsor to work with.
As previously mentioned, the sponsor (General Partner) plays the most critical role in the investment process.
Before investing in any deal, you’ll want to make sure the sponsor has the experience and track record to justify investing with them.
The sponsor performs all of the heavy lifting that most passive investors want to avoid.
Sponsor are the ones that underwrite hundreds of deals or more (hopefully) to find the handful worth making an offer on. These can be either on or off-market deals.
The sponsor then negotiates the terms within the purchase and sale agreement (PSA).
Due to the tremendous amount of work that this entails, they typically charge an acquisition fee to cover their costs plus compensate them too.
#3 Obtain financing
Once a deal is secured, they acquire the necessary financing to purchase and renovate the property along with performing the necessary due diligence before closing.
#4 Property management
Depending on the size of the property, the sponsor may outsource the day-to-day management of the property.
But at the end of the day, they’re ultimately responsible for all aspects of the project including operations, management, planning the renovations, leasing, etc.
During the property’s hold period, the sponsor maintains responsibility for all financial reporting which is passed along to the passive investors.
They also handle making the distribution payments to investors according to the operating agreement and work with accountants to prepare and distribute K-1s during tax season.
Lastly, the sponsor will arrange for the refinance or disposition of the property at the end of the investment period.
Now that we understand who’s involved in syndications and what the sponsor’s role entails, let’s find out the best ways to evaluate a sponsor so you can begin developing extra income streams.
7 Ways To Evaluate a Real Estate Sponsor
The MOST important aspect in a syndication is finding a sponsor you can trust which leads us to the new question: “How do I know if I can trust the sponsor?”
Too often new investors search out the best returns but again, if you find the right sponsor, they’ll get you the returns you’re looking for.
Because sponsors have such a large impact on the trajectory of how the deals are going to perform, here are 7 ways to evaluate them:
#1 Track record
Most of the minimum investment amounts in syndications range from $50K-$75K.
If I’m going to invest that large amount of money then first and foremost I want to know that my investment is in good hands.
One of the first recommendations when evaluating a potential sponsor is evaluating their track record or experience.
Potential questions to ask are:
- How many deals have you closed?
- How many deals have you exited?
It’s important that a sponsor has been around the block a few times and the deal you’re considering isn’t their first one.
It could raise a red flag is the sponsor has only closed one deal or even worse, none.
Of the handful of sponsors that I’ve worked with in the past, I was able to perform background checks from a variety of different sources.
Usually I’d find them on either a podcast interview or an article they had submitted online to top real estate sites.
If interested, then I’d go to their direct website to find out their:
- investment philosophy
- acquisition criteria
- portfolio of past projects
Once I decided that I wanted more information, I then reached out to each one to schedule a call. If I’m going to hand over money to someone to invest for 5-7 years, then I want to know them on a personal level.
#3 Cycle experience
There are four phases of the economic cycle:
- recovery phase
- expansion phase
- hyper supply phase
- recession phase
It’s very important that a sponsor has experience with all four phases rather than only during the expansion phase.
For those sponsors that haven’t yet faced challenges such as a recession phase, a good question to ask about is what they’ve failed on and what have they learned from that failure.
Everyone has had failures so this shouldn’t be a red flag when performing your due diligence. Any sponsor that’s been through multiple real estate cycles will likely have some blemishes on their record. The main thing we want to understand is exactly what happened and what they did about it to prevent future issues.
#4 Risk evaluation
Every real estate deal carries some degree of risk.
Question the sponsor about potential risks in the project they’re promoting along with how they play on mitigating them.
You’ll find that experienced sponsors will be forthcoming about any risks, how they can impact the property and what specific steps they’ll take to help minimize them.
The top sponsors I’ve personally invested with have had the clearest and most consistent communication. This is imperative especially for the new investor that has yet to establish a relationship with them.
The sponsor should communicate potential risks in the:
- anticipated timeline
- business plan
- their fees
- assumptions involving the underwriting
They also should provide potential investors all the information needed so they can make the most informed decision possible.
Regular communication should continue after the project closes to keep investors updated on the distribution schedule and how renovations are coming along.
#6 Tax reduction strategies
For doctors and other high-income earners, one of the primary benefits of investing in real estate is its favorable tax treatment.
Top sponsors understand this and have a thorough understanding of the tax rules that govern a commercial real estate transaction.
#7 Skin in the game
One of the questions you should ask a sponsor is if they also have “skin in the game“. This refers to how much capital they are putting into the deal themselves.
While not required, it’s nice to know that they’re putting their own capital into the deal as well along with their investors.
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