Real estate syndications can be a great way for passive investors to gain exposure to institutional-grade commercial real estate deals they couldn’t access on their own.
By pooling capital from limited partners, the general partner or sponsor can purchase larger assets like apartments, offices, and warehouses. However, passive investors should take steps to evaluate the opportunity and sponsor before committing funds. Doing proper due diligence is key to making informed investment decisions as a limited partner.
1. Research The Real Estate Sector
Gain foundational knowledge around commercial real estate categories and terminology so you fully grasp the specifics of deals presented. Understand the mechanics driving returns across property types like offices, retail, industrial, apartments, and hotels.
Study prevailing tenant demand and macroeconomic conditions influencing the sector. Familiarity with driving factors, valuation methods, and performance metrics allows insightfully assessing opportunities.
2. Verify The Experience Of The Sponsor
The sponsor is the general partner who originates the syndication deal, raises capital, and manages the asset. One of the first things passive investors will want to assess is the experience of the sponsor.
Look for details on their background investing in commercial real estate, preferably in the same asset class they are syndicating. Ask for references from past deals and examples of previous projects they successfully executed.
A skilled sponsor with direct experience buying and managing the type of asset being syndicated can instill confidence in passive investors considering the opportunity.
3. Review Offering Documents And Financial Projections
Passive investors should thoroughly review all offering documents and financial projections before investing. The private placement memorandum or investment summary should provide specifics on the deal such as business plan details, fees, minimum investment amount, projected returns, and risk factors.
Make sure you understand how the sponsor intends to drive returns and the assumptions baked into their projections. Also carefully assess the projected income and expenses over the hold period. This will help you gauge if the sponsor’s assumptions are realistic.
4. Conduct Due Diligence On The Asset
Beyond reviewing the paperwork, passive investors should conduct outside due diligence on the specific asset being syndicated. Study the market the property is located in by looking at factors like job growth, population changes, and similar property sales. Drive by the property and assess the area.
Research local real estate brokers to get their perspective on the asset class and location. Evaluate nearby competing properties as well. This independent due diligence will help you develop an informed opinion on the strength of the investment opportunity itself.
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5. Verify Licenses and Registrations
Confirm the sponsor holds active real estate licenses, registrations, and corporate standing required in the states where they operate and raise capital. Check for any outstanding tax liens or legal actions against their entities.
Validate proper business registrations like an LLC or LLP structure by searching official state-level corporate records. This ensures syndicating legally.
6. Assess The Business Plan Risks
Carefully examine the expected financial outcomes as outlined in the business plan, accounting for potential risks and challenges inherent in the strategy. Assess factors such as overreliance on raising rental rates, changes to tenant profiles, or substantial capital improvements to units.
Also, evaluate how the plan addresses difficult circumstances like extended vacancies or a slower-than-anticipated lease-up period. Determine whether the financial projections and projected exit strategy established by the business owners sufficiently take into consideration possible risks, setbacks, or delays.
Comprehensively considering worst-case scenarios will help provide a balanced perspective on the viability and robustness of the overall proposal.
7. Review Track Record Of Previous Deals
The sponsor’s track record with previous syndications can offer valuable insight into their capabilities. Whenever possible, passive investors should review the performance of past deals the sponsor executed. Did previous projects achieve their targeted returns? Were capital distributions made consistently?
How smooth were previous exits? Get references and speak to investors in previous deals. A sponsor’s history of syndicating real estate can help gauge their skills in finding deals, managing assets, and executing exits. Sponsors with a strong track record instill more confidence.
8. Diversify Within Limits
While diversification reduces risk, Requires sufficient capital to diversify equitably. Spreading smaller investments too thinly across too many sponsors diminishes returns through excessive fees.
Focus on 2-3 sponsors with deals in distinct markets for balanced exposure rather than attempting broad diversification with limited capital. Diversify thoughtfully based on deals, not quotas.
9. Vet Third-Party Professionals
Just as the sponsor matters, so do their third-party professionals like lenders, property managers, title companies, and escrow agents involved. Verify those counterparties have solid reputations and expertise in the property niche and location.
Seasoned third parties boost credibility. Multi-family lenders may lack hotel financing expertise, for example. Optimal players should align across the syndication.
10. Understand The Exit Strategy
Typically real estate syndication aims to sell or recapitalize the asset after several years. Understand when and how the sponsor plans to exit. Common exit strategies include selling the property outright, recapitalizing it with new financing, or refinancing it.
Look at the sponsor’s projected timeline for holding the asset and what assumptions they are making about proceeds at the sale. Often exit timing and capitalization rates at sale significantly impact overall projected returns. Evaluate if the sponsor’s expectations for exiting the asset are realistic.
11. Set Realistic Return Expectations
Target returns sounding too good to be true often are. Seek sensible projections between 10-20% for the asset type and strategy rather than empty hype and promises. The sponsor should demonstrate measured projections, not unsubstantiated, inflated projections exuding naivety. Lofty projected returns belie the inherent risks in commercial real estate investing.
To Wrap Up
Real estate syndication allows passive investors to participate in large commercial real estate deals they otherwise couldn’t access. However, you are trusting the sponsor to execute the business plan successfully. Thorough due diligence is critical before investing hard-earned capital.
Following these steps enables passive investors to make informed decisions on opportunities matching their risk tolerance and return objectives. Putting in work upfront provides greater transparency and understanding of the syndicator, deal, and strategy before committing funds.