As a passive real estate investor you need to understand several important topics. For example, what asset classes are available via syndications, the differences between share classes, anticipated returns, and potential drawbacks of syndications (like illiquidity).
However, I’d argue that the most important question doesn’t involve a specific offering or projected returns. Your primary goal is to learn how to find reputable, successful real estate sponsors.
Finding a good sponsor is not unlike finding a good massage therapist or barber or dentist. If you’ve found someone you like and trust who suggests a particular need, you’re more apt to feel comfortable relying on that professional opinion. You’ve built up trust over time.
You don’t need dozens of sponsors. Diversifying with a few operator groups that you’ve come to know and trust can reap significant rewards, for years and years. That doesn’t mean there won’t be challenges along the way, and we will tell you to not expect perfection.
However, at this point in my career I know my operators well enough that I don’t feel a need to read every section of the 150 offering document each time. We’ve done well, in good times and bad, and that makes investing in future deals with the same operators a simple proposition.
Our goal is to help you find real estate sponsors that you know, like, and trust working with. From our perspective, this has to be the starting point in your journey of achieving financial freedom through passive real estate investing.
A real estate syndication is simply a number of investors pooling their resources to buy a property that would otherwise be out of reach for individual investors.These deals are typically traded among commercial brokers, and occasionally truly off market by a direct contact with the current owner of the property.
Unless you’re actively seeking properties and building relationships with brokers, you’re not likely going to have access to these deals. As busy professionals, we team up with experienced operators, who are full time players in this space and have the broker relationships, to participate in their deal flow.
You do what you do best in your profession, and the operators do the same, allowing us to participate in the outsized returns and tax advantages of direct real estate ownership without the management responsibility.
A real estate syndication involves two primary groups: General Partners (GPs) and Limited Partners (LPs).
In syndications, the title of GP is synonymous with Sponsor, Syndicator, and Operator. Those terms are used interchangeably, with no meaningful difference in their meanings.
The GP sources the deals, negotiates with the seller, performs the due diligence (underwriting), secures the bank financing, organizes the LP group, and is responsible for the ongoing management of the property.
The sponsor may contract out the day-to-day management of the property, depending on its scale.
However, they are ultimately in charge of all project-related matters, such as leasing, management, planning the improvements, and operations.
The sponsor retains ownership of all financial reports that is provided to passive investors during the property’s hold period.
Along with handling K-1 preparation and distribution throughout tax season, they also take care of providing distribution payments to investors in accordance with the operating agreement.
At the conclusion of the investment period, the sponsor will make arrangements for the refinancing or sale of the property.
The GP invests significant effort just to secure the deal, both in terms of time and money. Then they will financially participate in the deal offering, typically between 2 and 20% of the entire equity invested in the deal.
LP is synonymous with passive investor. This group’s only contribution to the deal is dollars invested. No time commitment, no management, no ongoing influence is expected from them. Along with no control comes no liability. However, the LPs enjoy all the advantages of property ownership. They essentially do nothing but collect money from the ongoing cash flows of the property.
Clearly, a lot hinges on choosing a successful sponsor, as they can (will?) make or break the deal. It is your responsibility, and part of the service we provide, to make sure the sponsor has the expertise and track record to warrant investing with them before.
Now with that basis in place, let’s dig in on how to evaluate a sponsor effectively so you can start creating your own additional income streams.
Six Criteria For Choosing a Real Estate Sponsor
To reiterate, finding a sponsor you can trust is the most critical element of passive investing in real estate. Your experience hinges on how well or poorly the sponsor team does its job.
Here are areas you need to consider before choosing to jump on board with a sponsor’s offering.
1 – Prior Results
If you’re going to invest $50,000 or more with a team, you have to feel confident that the team has the experience to put your money to work wisely. One of the first indicators of their capabilities is their background and prior results.
Of course as the saying goes past results are not an indicator of future performance. But it is helpful to know how the team has performed in the past, how they treated the investors, and how they handled challenges.
How many deals have they already acquired. How many have they taken full cycle to completion. Is this a market they’ve operated in before.
Many operator teams came together well after the 2007-09 crash. It’s been hard not to be successful over the last decade. So it’s hard to get a sense of how a team performed in down markets. A useful question to ask sponsors who haven’t yet encountered recession periods is what they’ve failed at and what they learned from that setback.
Failures are common, thus this by itself shouldn’t raise any red flags when doing your due diligence. The essential thing we need to know is what exactly happened and what they did to address it in order to avoid similar problems in the future.
All that being said, we do like working with relatively new operator teams at times and grow with them. We’ve been working with Ashcroft Capital, one of the most successful and reputable syndicators in the market, since their second deal. While the entity itself was new, the team members brought a lot of experience that made us feel confident in their capabilities.
These questions aren’t meant to automatically shut the door on an operator group. But they’re ones to make sure you know the answer to and are comfortable with the sponsor’s answers.
2 – Professional and Personal Background
You should be able to find a lot of information about the sponsor entity and its principal partners online. I expect a social media presence, a thought leadership platform (blog on their site, Bigger Pockets articles, etc), and podcast interviews. In this day and age, if they haven’t put themselves out their publicly in those types of channels, I feel a bit wary.
With those elements accessible, listen and read to that content to get to know the team and their philosophies. I want to hear about their professional background and hopefully even a bit about their personal and family life.
Again those aren’t make or break topics with hard and fast rules, but they help to paint a picture from which we get to judge whether we’re going to hand over our money or not.
In some instances, even conducting professional background checks is appropriate. A sponsor should put up no resistance to that step.
I was able to conduct background checks on the few sponsors I’ve previously worked with from a variety of different sources.
Remember, you’re entering into a relationship that is intended to last years. You want to make sure you feel comfortable with who you’ll be relying on for that duration.
3 – Risk Assessment
Every investment involves some level of risk. I’ve owned stocks that went to zero (thanks Delta Airlines). Real estate certainly isn’t immune. But there are ways to minimize the inherent risks, and plan for unexpected turns in the future. We want to know how the sponsor looks at those risks and how they have or will address them.
We invest in properties in Florida, including areas affected by hurricanes. That is a risk that isn’t a deal killer because you can reasonably insure against it. But we certainly want to understand the sponsor’s plan for that insurance coverage and how they’ll proceed if the property does sustain damages.
Experienced sponsors will be open and honest about potential dangers, how they might affect the property, and the particular measures they’ll take to try to reduce them.
4 – Communication
This is critical. The sponsors should deliver transparent, frequent, and reliable communication. In good times and especially amidst the challenges. We expect all of our operator partners to deliver monthly communications and have open financials. These are very important elements.
And we expect to hear the good and the bad. We’re all adults. We know challenges happen. The sponsor just needs to be open and direct, and timely.
This includes communication about the acquisition, business plan progress, occupancy rates, financing plans, weather damage…again, the good and the bad. Clear, direct, and timely.
5 – Tax Planning
Real estate investing offers a lot of positive tax incentives. Passive losses via accelerated depreciation from cost segregation studies and tax deferral from 1031 exchanges are two of the big ones.
The sponsor must be well versed in these topics, especially as they apply to commercial real estate transactions. Do they accept 1031 funds? Do they plan to do a cost segregation study? Will they make best efforts to offer a 1031 option at the conclusion of this project you’re considering?
Make sure you don’t leave dollars on the table by investing with a sponsor who doesn’t have a solid plan in place for tax treatment.
6 – Personal Dollars Invested
The sponsor is going to be compensated via acquisition, asset management, and disposition fees. Those elements do not align with the LPs incentives since the operator receives those fees regardless of how the property performs.
However, the bulk of the operator’s return will come from their portion of the equity position, which is referred to as the equity split. The most common one you’ll see from our deals is 70/30. This means 70% of the proceeds go to the investors, and 30% goes to the operator. You’ll also see a preferred return number. For example, 8%. This means the investors have to receive an 8% on their equity before the operators can receive any portion of their 30% share. Now the incentives are aligned.
However, we also like to see the operators contribute investment dollars in the Limited Partner position, so they have skin in the game in the same seats we sit in. It doesn’t need to be millions. But we do want it to be sizeable so that again our incentives remain aligned. This isn’t a deal breaker since the equity split and preferred returns already align incentives, but it is an added measure of comfort.
What Sugarhouse Investments investor club offers to you is this vetting of the sponsors, along with their individual deals. We welcome your added due diligence of course to ensure your required level of comfort. But we get to know these teams intimately long before we put any of their deals in front of our community so that you can feel an added level of confidence before committing funds to a deal.
Jour our Investor Club to learn more about the operators we work with and see our future investment opportunities.