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