Basics of Investor Due Diligence

As passive investors have realized the tremendous benefits of investing in real estate syndications, the accessibility of these opportunities has grown.  Investors need to be knowledgeable to scrutinize and evaluate the slew of opportunities and determine what is a "worthwhile" deal based on their risk-to-reward profile.  Due diligence is essential because some of the best deals are the ones to be avoided.  Ultimately it is the responsibility of investors to ask the right questions and determine whether an opportunity meets their investment objectives.

There are four general areas that a passive investor should consider in every potential investment, the management, financials, asset, and legal documents.  The most important is the management consisting of the sponsor and property management teams.  Listed below is a potential checklist that a passive investor may review or ask the sponsor.  The checklist is not meant to be comprehensive, but merely a starting point.

Management

Sponsor Team

  • Experience and background

  • Local market knowledge

  • Transparent and relationship-drive

  • Understand their role as a fiduciary to their investors

  • Properly incentivized in the deal ("skin in the game") via co-invest, personal guarantor on loan, and so forth

  • Structure fair deals for everyone involved

  • Highly value their investors and work relentlessly on their behalf

Property Management Team

  • Local market presence and experience

  • Number of similar properties in the same market under same management

  • Relationships with contractors, repairmen and other outside services

Financials

Pro Forma and Financial Performance Metrics

  • Purchase Price/NOI/Cap Rate consistent with comparable sales

  • Breakdown of budgeted capital expenditures and contingency amount

  • Pro-forma assumptions and comparison of Year 1 pro-forma to T12 financials

  • Sale Price (exit cap rate should be higher than the entry cap rate)

  • Projected expense and income growth rates and comparison to market growth rate

  • Internal Rate of Return

  • Cash-on-cash

  • Equity Multiple

  • Preferred return (if applicable)

  • Sensitivity analysis of assumptions on performance metrics

Debt and Financing

  • Loan-to-Value and Loan-to-Cost

  • Repayment schedule

  • Fixed or floating rate

  • DSCR

  • Interest-only period

  • Loan prepayment penalties

  • Projected refinance timeline (if applicable)

Asset

Investment Strategy

  • Strategy consistent with the market and submarket

  • Targeted hold period

  • Time to complete renovations and stabilize asset

  • Strategy confirmed with post-renovated asset in the same market

Market

  • Projected job, population and wage growth over the next three to five years

  • Median income and alignment with projected rents

  • Landlord friendly rental laws

  • Diversification of the employment base

  • Market rental rate and vacancy rate

  • Comparable properties within 3-miles (these are the competitors)

  • Quality of the school district

  • Crime rate

Property

  • Age of the property

  • Property classification and general condition of the property

  • Market type

  • Economic and physical occupancy rates

  • Capital expenditure history

  • Visibility of the property

  • Daily traveled vehicles

Legal Documents

  • Documents prepared by a securities attorney

  • Document package includes a private placement memorandum

  • Documents consistent with executive summary, business plan and conversations with sponsor

  • Capital call provision (ideal if not present)

  • Source and uses in the operating agreement

  • Distribution waterfall

  • Reporting requirements to passive investors

  • Incentive alignment of syndication team and investors

  • Transferability of shares