Before choosing a market or the asset itself, you’ll want to know who is in charge and whether they are capable of executing the plan they’ve envisioned. The sponsor can make or break the returns you receive on your hard earned money. They can become the difference between passive income that supports your lifestyle or a loss of principal that puts you in a hole.
Imagine a NFL team with a stacked roster. A solid offense line, great route running receivers, a downhill running tailback, and a stingy defense – all the makings of Super Bowl team. Except, they are missing one key component – a quarterback. Alternatively, many above average teams have been able to hoist The Lombardi Trophy at years end, due in large part to a great signal caller making the rest of the team around him better.
It’s no different when it comes to a real estate syndication. Managing an asset is like running a business. Who you have running a business matters. It’s often said that a great sponsor can make an average deal a major success, while a bad sponsor can turn a great deal into a disaster.
Before we talk about what to look for in a sponsor we need to identify some key players within the sponsorship team and define what those players do.
Who’s on the General Partnership Team
You’ll hear a few terms, often used interchangeably to refer to those on the general partnership team – sponsor, operator, or general partner. However there are nuances to these players and what role each plays.
Anyone on the leadership team is a “general partner.” A “sponsor” is sometimes also an “operator,” but not always. Sponsors are typically involved in sourcing and underwriting deals and signing on the loan. There is often a “key principal” – a sponsor who has the net worth and liquidity to back the loan.
An operator is responsible for executing the business plan, working with property management, and overseeing renovations to make sure things stay within budget and on schedule. Ideally the sponsor and operator are the same person or are partners in a company that has a track record of successful deals.
We’ll do a deeper dive into these responsibilities in the next section.
There’s also, what are referred to often as, “co-sponsors.” Acquisitions can be large in size, both in monetary figures and unit count. As such, large amounts of capital are needed to fund the equity for the acquisition. Many times, sponsors need help to source this capital from limited partners. A co-sponsor can help fill this void. Here’s a watch-out though – co-sponsors are also sometimes called “capital raisers.” While everyone on the general partnership team likely is responsible for raising money, the SEC has rules specifically against this being the ONLY role one has. An exception is when this group or individual has their broker-dealer license.
When I’m interviewing sponsors I’ve not previously invested with in the past, I always ask what’s their role on the GP team? If they say they are “raising capital,” I’m usually not interested in pursuing a further relationship directly. I’m interested in investing in people that understand the inter-workings of real estate and have boots on the ground experience, along with a strong financial acumen. Often co-sponsors do not have these traits.
A co-sponsor may also be involved in the management of the asset, or have due diligence responsibility, for example. This is a perfectly fine structure. However, I still want to know more about the leader, their track record, and trust them prior to investing.
In today’s market, far too often I am seeing deals that have six, seven, or more co-sponsors on one deal! This makes me wonder – if the sponsor is so established, why do they require so much help in attracting capital to their deals? Is it possible for this many co-sponsors to have active roles beyond just bringing capital to the deal? The SEC may take notice someday. You’ll want to stay clear of any gray areas.
For the remainder of this article, I will be using the term “sponsor” to describe these nuanced roles.
What does a sponsor do?
A sponsorship team has a lot of responsibilities. Their day-to-day consists of:
- Building relationships with brokers to source potential deals
- Underwriting assets using complex financial models
- Touring properties
- Submitting offers (letter’s of intent) and working with attorneys to draft purchase agreements
- Securing earnest money
- Conducting due diligence – coordinating property inspections, environmental studies, surveys, lease and financial audits, etc.
- Building relationships with lenders and sourcing the best and most appropriate debt/terms for the business plan
- Raising capital and building relationships with limited partners
- Working with attorneys, accountants, and title agencies to push the deal across the finish line and close
- Property management or oversight of a third party property management company
- Asset management – financial analysis and making sure the numbers are tracking to pro forma projections
- Project management – overseeing the execution of the rehab and planned improvements
- On-going investor relations through communication with LPs invested in each deal
- Paying distributions
- Evaluation of market conditions
- Timing the exit (sale) of assets to maximize returns for investors
Now you can see why being a limited partner is an attractive proposition! It’s a lot of work to sponsor deals. As a LP you get all the benefits of direct ownership in real estate, without all the aforementioned responsibility. You just need to make sure you’ve found a good sponsor to invest alongside.
What to look for in a sponsor?
Do you know the sponsor you are investing with personally? If so, do you like them? Most importantly, do you TRUST them? All three questions are relevant, but you may not have the chance to really get to know someone after a conversation or two. Liking someone has little to do with their ability to “get it done.” However, trusting them is paramount to you being able to sleep at night knowing your investment dollars are protected.
There’s a qualitative element in what you should look for in a sponsor. There is no legal requirement for a sponsor to be a fiduciary of your money, like a financial advisor. Maybe someday regulation will require such. In the meantime, I only invest with those that I feel have my interests in mind above their own. That comes from the gut.
You want to consider the sponsors communication style, and whether it meets your definition of adequate. Sometimes things don’t go as planned. You’ll want to hear about it, whether its good or bad news. How a sponsor stays in touch and updates you will become important, as your investment is illiquid and you may be invested together for 5-7 years or longer. I’ve received unfavorable news in the past. However difficult it may be, it helped me better understand what was being done to correct course, through solid sponsor communication. When that course correction comes to fruition, trust is built. The last thing you want is radio silence. Ask a perspective sponsor what their communication cadence is and have them provide examples.
You’ll want to understand your risk tolerance and how it matches to your sponsor’s as well. Are they a speculator? Speculators require the market to “bail out” their business plan. Sometimes it works, leading to massive returns. Other times, things don’t work at all. Hope is not a strategy. When you interview your perspective sponsor, try to understand how they evaluate risk, how they underwrite to it, and how they protect against downside scenarios. We’ll discuss this in great depth in further editions of this publication.
Additionally, you’ll want to do some due diligence on the sponsors track record. How long have they been investing? What type of property and asset class have they had success with? If their track record is repositioning multifamily apartments and they are sponsoring an industrial ground-up development project, there’s reason to question if their experience aligns with the asset and plan. How many deals have they closed and how many have gone full cycle (been sold and met or exceeded return expectations). Check their website. Do a Google search of their name online and see what you find. I’ve even heard of some passive investors requesting a background check prior to investing. It’s obvious that trust can be built quicker with a sponsor who has an excellent track record, a veteran team, and a proven process.
Lastly, you’ll want to invest with sponsors who have a strong financial acumen and are versed on current trends in the economy and other assets, like stocks, bonds, and commodities. Real estate is connected to the greater economy and how money flows. It’s inherently a cyclical asset, highly correlated with interest rates, supply/demand, bank liquidity, etc. When using leverage, it is critical to measure risk and buffer with a margin of safety. Hard work gets you very far in life, but the truth is that timing matters. Over the last 10 years, many sponsors have made a fortune for their investors, and themselves, albeit making lots of mistakes along the way. A raging bull market can cover-up a lot of errors. However, the market is much tighter now. Subsequently, you’ll want to invest with those that acknowledge risk and know how to protect your investment from market and interest rate fluctuations.
Don’t be afraid to ask tough questions.
How to find them?
How you find sponsors to invest with is different from investing in traditional assets like stocks and bonds. There’s no retail store front to stop into and talk with an advisor, like through Fidelity Investments for example. You’ll have to take a more active role in identifying those with who you align. For this reason, the phrase “passive investing” is somewhat misleading when investing in syndicated real estate. While passive once the asset is closed, you’ll still need to find and align with sponsors, then vet individual deals as they present themselves.
A great place to start is through two groups, where you can network with other passive investors, ask questions through forums, hear about good and bad experiences with sponsors, and learn more about real estate syndication.
One is called 506 Investor Group (506investorgroup.com). I’m less familiar with this group, but have heard they have over 1,000 members, making them the largest network of passive investors out there. They keep it exclusive by not allowing any sponsors to be a part of their group.
The other is a newer group that I am active with, called Leftfield Investors (leftfieldinvestors.com). The “Left Fielders” have regular Zoom meetings, inviting on industry experts to discuss topics related to syndication, tax strategy, and wealth building. Often times, they will invite sponsors to discuss their specialties, like farm land investments, ATM machines, equipment rental syndications, apartments, etc. They have a forum for questions and topics, where investors share ideas, knowledge and experiences. I have personally invested in some fantastic offerings, in investments I didn’t even know existed because of the insights shared within this group. Check them out.
Other outlets to meet and network directly with syndicators include in-person and virtual conferences, on-line meet-ups, and local gatherings in your town. Check out linkedin.com and biggerpockets.com to search for local events and topics that interest you. Networking on both these platforms has been immensely helpful for me.
As powerful as social media can be, approach it with caution. As with any business, there are some bad actors. It’s always helpful to use the aforementioned resources to check and verify who you meet. I’m also occasionally weary of a sponsor’s business that has become more about marketing and acquiring, than that of actually operating real estate. Just remember that marketing is necessary to attract capital, but has very little to do with successfully managing real estate and generating returns for investors.
Wrap-Up
Now you have a better idea of what roles make up the general partnership team, what a sponsor does, what to look for in a sponsor, and how to find them. As you’ve discovered, there’s a little bit of work on the front-end to make these investments passive, but if you invest with the right team, you’ll be glad you did. As with all investments, diversification is key. Don’t put all your eggs in one basket. That means don’t invest all your money with one sponsor or in one market. It also means, don’t invest all your money in syndications! In my opinion real estate is the best asset class in the world. Investing as a limited partner in syndications is a great way to participate without the headaches. Remember, however, not everything goes up…and up…and up, all the time.