The Ultimate List of Questions!
There are many questions to ask your sponsor before deciding to invest in a real estate syndication. You’ll find many of them below, along with some color commentary on what you’re looking to accomplish in each section. Rather than asking your sponsor all of these questions, try to find most of the answers in the offering memorandum and the underwriting model. It will save you both a lot of time and allow you to use the conversation to really hone in your most important questions.
Market / Sub-Market
Your goals for this set of questions are twofold. First, you want to know everything there is to know about the market and sub-market. A great market can bail out a bad investment and turbo charge a good one. Secondly, you want to see how much the operator knows about market. Market knowledge can be very informative when making underwriting assumptions.
Why are you investing in this market?
What are the market’s prospects for population growth and job creation?
What kind of employment base is here?
What does your lease audit tell you about the jobs your tenants have?
What is the crime rate in this sub-market? Is it going up or down?
How many properties do you own in this market?
How many properties does your property manager manage here?
What is the average household income in a 1-mile radius?
Operator Expertise and Track Record
The goal for this set of questions is to find out the depth of operational expertise that the operator possesses. Believe it or not, it’s not that hard to put together a $50M multifamily syndication and many self-proclaimed “gurus” teach people how to do exactly that. You don’t want to invest in a deal that is run by several rookie operators banding together for the first time trying to “figure it out as they go”. The person functioning as the asset manager is of special importance as that person must have experience in reading financial statements, managing the property manager, and construction oversight.
Are you using a 3rd party property manager or doing property management in-house?
How many properties do you own? What returns have passive investors seen so far?
Who is on the GP team? What are their roles and responsibilities?
Have you done real estate investing deals together as a team before?
What happens to the real estate investment if you get hit by a bus?
How much money is the GP team putting into the deal? How about you personally?
Will you allow me to run a background check? May I have your SSN please?
Will you provide references?
Business Plan / Deal Specifics
If you are comfortable with the answers to the preceding sets of questions, then you will want to dive deep into the current project. Your goal for this section is to get to know the business plan and determine if you believe the sponsor can execute on it.
What is the “story” on this property? Why is the owner selling?
What do you like most about this investment?
What is the biggest risk? How will you mitigate that risk?
How does this deal compare in terms of risk/reward compared to other deals you have done?
How did you locate this property? On-market or off-market?
What vintage is this asset?
Can you show me the sales comps to see how this price per unit compares?
How many total units? What’s the unit mix? Does this match the clientele in the area?
What is the rent-to-income ratio of the current tenant base? What about after renovations are done? Can the median household income in the area support those rents?
What’s the current occupancy at the property? How about this sub-market? What are you using for the stabilized occupancy?
What’s the business plan? Renovations? What is the renovation scope? Do you have experience with that scope of work? Capture loss-to-lease? Add washers/dryers?
What are current rents? What are pro forma rents? (The more of an increase in pro forma rents
What is the projected hold period? Have your other deals exited early? (This has been common over the last 5 years. Sponsors make most of their money upon exiting the deal).
Are our interests aligned in terms of when to exit?
What do the first 90 days of operations look like?
Will you re-brand the property?
Underwriting & Due Diligence
A huge piece of picking the right project to invest in is making sure that the projected returns in their underwriting model are based on realistic inputs. Garbage in always equals garbage out. A slight change in the exit cap rate or the amount of projected organic rent growth will have a drastic effect on the projected returns. If you really want to get into the weeds then the sponsor can provide the Costar, Yardi, and Axios reports that they used for those projections. This is what Leap Multifamily does and we also supplement that with economic research data to determine if the deal might have upside that isn’t showing up in the pro forma. Comparing all of the deals we see against each other is what we use our Bluejay model for. We can gauge the relative risk of all of the deals we see against each other.
What are your underwriting assumptions for future rent growth, exit cap rate, and future interest rates?
How did you choose your rent comps?
Did you walk the competing properties for verification?
What kind of sensitivity analysis did you perform? What is the breakeven occupancy rate?
Did you walk every unit? What did you find?
What did your lease audit find? How many current evictions? Average tenant income? Where do the tenants work?
Are you underwriting a refinance or supplemental loan into the projected returns? How much capital would be returned to investors? What happens if we can’t achieve those capital events?
What is the Yield on Cost?
Fees & Cash Flow Waterfall
The questions and answers in this section are pretty straight forward and can usually be found in the investment Offering Memorandum (OM). Your goal is mostly to make sure that the fees aren’t excessive, and the cash flow waterfall is fair. The most common fees are acquisition fees (1-3% of the purchase price with 2% being the average), asset management fee of 1.5% to 2% of gross revenue, and then possibly one more fee related to a capital event like a loan guarantor fee, refinance fee, or disposition fee.
Each deal will offer some sort of cash flow waterfall and generally a preferred return*. Today, “market” is 7-8% preferred return and a 70/30 split thereafter. There may also be a secondary hurdle where there is a 70/30 split up to a certain return, say 15%, and then a 50/50 split on profits after that.
Special Note: It’s very easy to get hung up on the fee and waterfall structures to try and compare one deal to another based on those easy-to-research components. Evaluating an investment needs to go much deeper than that! Furthermore, understand that the sponsor’s profit-sharing structure should have a nice mix of fees and performance-based compensation. If a deal is overloaded with too many fees, the sponsor is motivated to do deals regardless of the outcome. If too much of the profits are tied to performance, then the sponsor will be motivated to take on too much risk.
What fees are you charging? Common fees are acquisition fee of 1-3%, asset management fee of 1.5% to 2.5%, construction fees of 5-6%, refinance fee of 1%, disposition fee of 1-2%. It is NOT common to charge all of these fees in the same deal so this conversation should revolve around what is “market” in this area and why that suite of fees was chosen versus another set of fees.
Is there a preferred return? Common “prefs” are currently 7-8%.*
What is the waterfall after the preferred return? Are there multiple waterfall hurdles?
Are you doing a cost segregation study? What is the estimated first year depreciation?
Where does my equity sit in the capital stack? (Not all equity has equal priority).
Are distributions and equity events counted as return of capital or return on capital? (There’s a big difference in these 2 structures from an accounting standpoint).
Debt
As of today, it’s Q2 2023 and the Fed has been raising rates consistently for almost a year now. This has played havoc with the debt markets and changed the calculus for how to underwrite deals. The debt being placed on the property is more important than ever. There are many potential questions to ask but you should start with the LTV. All things equal, a deal with a higher LTV will carry a higher risk/reward profile than one with a lower LTV.
What kind of debt? Fixed rate agency? Bridge debt? Floating rate? If floating, did you purchase a rate cap? How long does the cap last?
Who is guaranteeing the loan? (Lenders require net worth equal to the loan amount and post-closing liquidity of 10% of the loan amount. You want to know if the sponsors have this type of net worth or if they are “borrowing” the balance sheet of another high-net-worth investor) who is doing the guarantee.
What is the LTV?
Is the lender also loaning money for CapEx? Or is this money being raised as cash?
What is the year 1 debt coverage ratio? What about upon stabilization?
Lender 3rd party reports. Appraisal, property condition assessment, environmental. Are these complete? Any issues?
Subscription Specifics
Is this a 506(b) offering? 506(c)? Depending on your accreditation status, you may or may not be eligible to invest in some offerings.
Is this offering open to non-accredited investors or accredited investors only?
How quickly do your deals oversubscribe? When does the investor portal open?
What is the date I need to wire my money in?
What types of funds are accepted? Cash, SDIRA, etc.
Investor Management
Once you invest your hard-earned money into a multifamily syndication, you’ll want to be kept abreast of the project’s wins and losses. In my experience, there is a high correlation between the quality of the investor experience and the sponsor’s operational expertise.
How often do you pay out passive investor distributions – monthly, or quarterly?
How are investors kept up with the progress?
Which investor portal do you use?
Syndications are illiquid. What happens if I need my cash?
What happens in a capital call? Have you ever had to do that before?
*Preferred returns are part of the deal structure and indicate the sequence of how distributions (from operations or a capital event) are disbursed. They are not guaranteed and should not be considered a financial projection. Actual cash flow projections and distributions from the sponsor may differ from the preferred return.