ASSUME YOU LEARNED about an opportunity to invest in a real estate project. The property is in a great location, has quality tenants and the underlying economics appear sound. Better yet, it’s within your range of risk tolerance.
However, the company offering the deal is an unknown—you’ve never heard of it.How can you determine whether the offering is legitimate and the sponsor is trustworthy?
When considering investing in a passive real estate deal, the qualities of the sponsor are arguably more important than the underlying real estate:
If you, a passive investor, want to maximize the success of your investment, then you must rely on the expertise of the syndicator, promoter or sponsor who puts the deal together. 
The sponsor is the party who:
If the sponsor is not honest, experienced and diligent, you could lose some (or all) of your investment.
While many industries rely heavily on user reviews to provide general feedback about quality, this practice is not prevalent in the financial services sector. So how do you get good information to evaluate a sponsor?
Certainly, anecdotal information—such as a referral by a trusted source—is helpful. Here are some other, subjective, criteria that tell you how to evaluate sponsors.
Understanding the sponsor’s experience with the type of offering at issue, both qualitative and quantitative, is a good starting point for your due diligence.
How long has the sponsor been in business? Who are its principals, and what kind of real estate experience do they bring to the project?
What is the nature of the sponsor’s experience with the type of asset in question, and the geographic location?
Experience with retail or office properties does not always translate to knowledge about, for example, managing a multifamily building. Similarly, a sponsor likely has more insight into, or resources in, markets in which it already has offices, employees or investments.
Relatedly, have any of the sponsor’s prior deals gone south? If so, why, and what did the sponsor do about it? A sponsor that has been in business for some time—especially during the Great Recession—should have some blemishes on its track record. Understanding how the sponsor handled difficult situations in the past, including timely and accurately communicating information to investors, provides insight into what you can expect if the new investment does not go according to plan.
While past performance does not guarantee future results, it is helpful to understand how a sponsor’s projected returns compared to what investors actually received. Beware of a sponsor that indicates that all of its prior investments outcomes were favorable!
During the Great Recession, some financial institutions created investment products for other people’s money—not placing any of their own funds at risk. This structure numbed the institutions’ natural instinct to avoid assuming too much risk; economists call this a principal-agent problem.
A sponsor’s investment of its own capital (or its principals’ personal funds) indicates the sponsor’s confidence in its own work product. This is especially true if the sponsor is earning a promote—getting paid ahead of, or hand-in-hand with, investors during the course of the deal (or upon disposition).
When you invest in a syndication, you entrust your capital to the sponsor. You must understand what responsibilities the sponsor agrees to undertake on your behalf—and any rights and remedies you may have if the deal does not progress as originally projected.
You should also determine whether you or any of the other investors can influence major decisions (i.e., a sale or refinance), and to what extent you can liquidate or transfer your interest to someone else.
All of these considerations should be addressed in the offering materials.
Sponsors earn fees for putting investments together. The investment documents should clearly disclose what fees will be paid to the sponsor, and when. Some fees are typically assessed up front, while others may accrue over time—such as an annual asset management fee. There are also fees that may be charged upon disposition or refinance of the property.
Some sponsors make their offerings available to the public through the use of registered representatives or financial advisors.
Others enter into subscriptions with the investor directly, in person or over the Internet.
Note that if you invest through a third party:
Some deals have a promote structure, where the sponsor receives a percentage of cash flow or proceeds ahead of or concurrently with distributions to investors. You should understand whether and to what extent the sponsor is entitled to fees if investors do not receive the projected cash flow (or worse, if they lose their invested principal).
If there are third parties involved with the investment, such as outside property managers or joint venture partners, the prospectus should reflect how their compensation is calculated—especially if they are affiliates of the sponsor, may have conflicts of interest or do not receive a market rate fee or distributions pari passu with investors.
The parties who create and offer the investment opportunity to you are entitled to compensation for their work. As an informed investor, you should be aware of what those fees are, as well as when and how they arise.
A legitimate sponsor will be able to identify legal counsel, financial or tax advisors, and lenders it has worked with to serve as references. Further, the offering documents should include opinions from a reputable, independent law or accounting firm.
Other valuable references include the sponsor’s joint venture partners or investors. Find out who the sponsor worked with and why, particularly partners who played a role in the operation of the project, and let them speak to the character and capabilities of the sponsor.
It may seem like a long list of “satisfied customers” would be a good sign of a reputable sponsor. However, that is not necessarily the case if investors are individuals or family offices rather than institutions.
A good sponsor keeps confidential its investors’ information, and a good sponsor does not reveal its clients’ identities without express permission (do you really want your colleague/neighbor/ex-spouse knowing about your finances?).
Of course, you must always analyze the real estate aspects of any particular investment. Ensure that you are comfortable with the underlying property and deal terms.
Investments in most syndications are illiquid; you should not commit yourself to a project expected to tie up your funds for longer than you are willing to part with them.
Further, the deal should have an exit strategy—a plan to dispose of the asset after a certain period of time, and a fallback plan in case the market, tenancy or some other factor changes during the holding period.?
An investment inconsistent with your personal risk tolerance or time horizon will be a poor choice for you, regardless of the strength of the sponsor.
 I will refer to all of these parties generically as the “sponsor” for simplicity.
Tracy is a Principal at Syndicated Equities where she helps high net worth individuals and family offices to profitably invest in real estate. She also assists investors in identifying appropriate replacement property to complete tax-deferred exchanges under Section 1031 of the Internal Revenue Code. Drawing upon her 20 years of legal experience in the areas…
Legacy of 2012 JOBS Act: Deregulation of Angel Investing
Leonardo DiCaprio Investments Stay Afloat in Spite of Choppy Waters
Justin Timberlake Investments Go Bai, Bai, Bai and Stay N’Sync
How to Invest and Live with Intent: Plant-Based Diets and a Cleaner Climate
Ranking the Top Angel and Venture Capital Fund Managers (Part 1)
Ranking the Top Angel and Venture Capital Fund Managers (Part ll)
Please log in again. The login page will open in a new window. After logging in you can close it and return to this page.