As an investment advisor conducting research and due diligence for your clients, it is critical that you understand several key factors when considering private real estate.
An allocation to private real estate can serve several important roles in an investment portfolio, including improved diversification, a potential hedge against inflation, and a potential alternative source of income.
Yet, many consider private real estate a complex investment market, and we often field inquiries about the most important questions to ask a sponsor when evaluating an offering. Of course, you will want to familiarize yourself with all investment details, but we have found these five questions to be an excellent starting point for most.
What is your track record?
The sponsor serves the most critical role in a private real estate offering, so having a clear view of the sponsor’s experience is imperative. And the discussion about track record should be about more than the firm’s cumulative IRR over multiple deals or years (although you will want to know that too). You’ll also want to ask how long the firm has been in business and what strategies, asset classes, and geographies they favor that can highlight their expertise? Ask how many deals they have taken full-cycle, as well as how many market cycles they have worked through. A great question to ask: What was your most disappointing project, and what did you do to minimize investor frustration?
How is your financial health?
Sponsors that operated, survived, and even thrived in multiple economic and market cycles for years are the ones who will likely be on your selection short-list. You will want to evaluate their balance sheets and the financial projections and actuals of several deals they have sponsored in the last few years. Ensure they are transparent about their finances. And while on the topic of financial strength, it is fair to ask if the sponsor invests in the offering alongside other investors. This is usually a strong indication of the sponsor’s belief and commitment to the investment and can help provide a sense of alignment to investors. A great question to ask: What are your firm’s long-term growth plans, and how long will your senior team be aboard for the ride?
What makes your management team special?
A vertically integrated sponsor, meaning they have in-house expertise in acquisitions, development, optimization, and disposition, should be appealing to you. And while many sponsors out-source certain functions to third parties, a sponsor with a management team that has comprehensive end-to-end skills can often help ensure the success of an offering. But it’s essential that the management team trusts and respects one another and applies their skills in a complementary manner. How will you know? Make an effort to interview more than one team member, preferably all together. A 20-minute Zoom call interview is excellent for this. You’ll get a quick read on a team’s chemistry. Don’t underestimate its importance. Evaluating a management team is about much more than reading bios. A great question to ask: If you ALL (i.e., management team) weren’t doing this, what would you be doing?
Can I speak to a few of your long-term investors?
Third-party validation is a fantastic way to gain an additional perspective into the strength and reputation of a sponsor beyond what the firm may have already told you and what the PPM outlines. So don’t be afraid to ask for references and do yourself the favor of following up with several. Again, the insight will be invaluable. And if the sponsor is not forthcoming with a few names of previous investors, you may want to walk away. A few great questions to ask the references: What do you value most about this sponsor? What could they do better, in your opinion? What is their secret sauce?
Why is this investment suitable for my clients?
This question leads directly into a discussion about the offering. Is it a fund that will hold several investment properties, or is it a single-property Delaware Statutory Trust? What type of strategy will the sponsor pursue with this offering? It could be a conservative “core” approach with premier quality properties or an “opportunistic” approach requiring significant improvements and the potential for capital appreciation. Why is the asset class (multifamily, retail, industrial, etc.) the sponsor’s preferred choice? What data support the geographical decision? Answers to these questions will help you know if this investment is a good fit. A great question to ask: Other than this specific investment, what is your next favorite type, and why?
There is much to consider with any investment, and particularly with an investment in private real estate. Risks, fees, sponsor compensation, estimated hold-times for the investment, and projected rates of return are all topics adequately addressed in the PPM. Make sure you read it thoroughly and get any additional questions answered before investing.
We trust these preliminary questions you can use when interviewing sponsors will prove helpful in finding the investment opportunities best suited for your clients.
Past performance is no guarantee of future results. Real estate investments are intended to be long-term. There are risks associated with real estate investing including changes in economic conditions affecting the demand for real estate and the illiquid nature of investing directly in real estate.