Due Diligence on Real Estate Sponsors
Commercial Real Estate
In earlier posts, we’ve discussed some of the factors that need to be reviewed in performing due diligence on a particular investment. We’ve also reviewed the common transaction structure applicable to passive investing where, in an equity investment, a sponsor syndicates out to investors a large portion of a real estate investment opportunity.
In those buy and hold equity transactions, the character and experience of the real estate company that will syndicate out the opportunity and then operate the project is of paramount importance. Investors will need to be reasonably confident that the operator has a solid reputation, track record, and otherwise has the requisite skill and knowledge to be able to manage commercial real estate in a trustworthy and professional manner. To gain the requisite assurance about a syndicator proposing a project, a number of due diligence steps are advisable.
When introduced to a real estate company, an investor should first establish the company’s experience level and track record. Most reputable companies can serve up an extensive portfolio of past investments, with detailed operating histories and financial results available for investors meeting them for the first time. Do the principals of the company have many years of combined real estate investing experience, and a track record of success? Does the company have a history of sourcing attractive investments? What is the total capitalization of its past commercial real estate investments? What is the company’s relevant experience in underwriting, deal structure, negotiation, and legal/financial strategies?
A subsequent inquiry might be to investigate the company’s general approach to commercial real estate investing. Does it specialize in a particular market sector or niche that is “below the radar” of most competitors? Are there geographical areas that it targets? How capable is the operator in assessing investments and determining the risks? What is its ability to evaluate possible turn-around plans and to analyze future growth potential? Has it established proven systems for handling most or all aspects of real estate investing and property management, such as taking advantage of recent technological advances?
Since a sponsor usually takes some sort of management and other fees in connection with a project, what is the nature of those fees, and how do they compare with the fee structures of other operators? Will it charge financing, property disposition or development fees? Is a management fee based on a percentage of capital actually contributed, or is it based on capital that is committed but not yet delivered (which would result in higher payments)? Are there other special expenses outside for which the operator might expect compensation, and if so is there a maximum to such amount?
After inquiring about the operator’s experience, general strategic approach and typical structural approach, it’s a good idea to follow up with references – firms or individuals with experience working alongside the operator. Does the company have extensive relationships with financial institutions and insurance companies? What are the nature of its contacts with referral sources such as brokers, loan servicers, receivers, accountants, attorneys, and bankruptcy/workout professionals? What do these professionals with past experience of working with the company have to say about it?
There are many more areas of due diligence inquiry that are more specific to the individual project or property. But at Realty Mogul, we take another basic, but crucial, measure – the performance of criminal, background and credit checks on both the company and its principals. While one can never be certain of the innate character of the company’s leaders, past brushes with the law are things to be looked at closely. Credit checks can separately notify us not only of a sponsor’s past issues with financial institutions, but also of contract disputes with contractors (who can place liens on properties that can prevent them from being refinanced or sold) as well as of unpaid taxes owed to governmental authorities (which can place similar liens encumbering property). General background checks may reveal some aspect of a person’s behavior from an area unrelated to his professional life that still may reflect on his character and trustworthiness. While privacy rules prevent Realty Mogul from sharing the results of our criminal, background and credit checks with individual investors, we do obtain them with respect to any sponsor with whom we have not previously worked.
While an investor can never be completely assured that the objectives of any particular equity investment can be realized, an appropriate level of due diligence of the investment’s sponsor is essential. At Realty Mogul, we try to work only with established, reputable operators so that we can provide quality deal flow to our investors. Each investor needs to ultimately do his own due diligence, though – which is why we at Realty Mogul include a significant amount of information about the sponsors in each of our listings. Investors should also try to participate in on the webinars we do for each listing, and to otherwise feel free to contact us with any other questions there might be about the investment opportunities we work with.