.
This month we look at a topic that has come up a lot in recent investment forums, whether it was on Reddit, Bogleheads, or another on-line discussion – Syndications, and more importantly the Sponsor of Real Estate Syndications. Deals that have bad actors – whether a real estate fund or syndication, give our business a bad name because guilty parties tend to be inexperienced, illiquid, or fly by night shops (or a combination). While we all can debate the differences between a fund and syndication, or pros and cons between the two – the primary difference is this: A fund invests in more than one asset, and a syndication is usually deal specific. That’s it – that’s the main difference.
With that – regardless of which you choose to work with – our advice to all investors is to get to know your sponsors. Read what they write – look at their track record, understand how they structure deals, and talk to them.
These points aside – there are other factors to look at. The importance of a sponsor’s co-investment into their real estate projects, the ability to provide all necessary debt guarantees, investor communications, and fees.
What is the role of a Sponsor in a Project?
Being a sponsor in a real estate project involves leading and managing a group of investors to acquire, operate and generate returns from a real estate property. This role requires significant experience and knowledge in the industry, as well as strong leadership skills, communication abilities, financial acumen, and integrity.
A sponsor is responsible for sourcing potential deals, conducting thorough due diligence, negotiating contracts and debt, coordinating with attorneys and other professionals, raising capital from investors, overseeing property management activities, and regularly reporting performance updates to investors.
Additionally, sponsors are accountable for establishing legal and tax structures for the investment entity and providing ongoing investment management until exit. By leveraging their expertise in real estate investment, project management, financial analysis, and marketing skills, experienced sponsors can create substantial returns on investments for their partners while mitigating property acquisition and management risks.
Why is it important for Sponsors to Co-Invest in a Project?
In the world of multifamily real estate investments, the phrase of having “skin in the game” refers to the sponsor investing their money alongside their investors. It is particularly important that sponsors invest some percentage (typically 5-10%) of the total capital raise to show investors that they have something on the line and thus are motivated to successfully maximize the returns of a project.
The thought here is that if the sponsor doesn’t invest alongside their investors, then their risk is limited only to the split of profits they have and fees as detailed in the investor terms of such deals. In addition, some firms take an acquisition/management fee so it’s easy to think that once they close the deal and collect the fees, they are less motivated to maximize the returns for the deal on behalf of their investors. From an investor’s perspective, this line of thinking is warranted, hence why it should be an industry standard for sponsors to invest in their own deals.
Why is it important for Sponsors to provide Debt Guarantees in a Project?
The financial robustness of a sponsor and the project can make or break its success. It is essential to review how the operator manages finances, including their track record with loans and ability to secure and honor guarantees.
Real Estate Investments consistently secure favorable loan terms, where the sponsor qualifies to issue the loan guarantees to the lender, generally can demonstrate a stable financial foundation. Sponsors who must bring in an outside loan guarantor in exchange for a fee don’t offer the same financial strength as those with strong enough balance sheets to qualify on their own.
A sponsor which has been operating successfully for over 20 years with minimal changes in leadership, indicates deep industry knowledge and operational stability. This tenure has allowed the sponsor to build extensive network connections and leverage economies of scale, enhancing their investment capabilities. This speaks to their financial capabilities on the ability to execute on a deal from a financial standpoint.
How does the Sponsor communicate with Investors?
Communication is often overlooked, but it is essential to a successful sponsor / investor relationship. Its important at all phases of a project, but especially when the market hits a downturn. Good managers should provide timely and accurate reporting because there is nothing worse than being in the dark and not knowing where your investment is, or how it’s doing. Investors should ask for sample reports from sponsors’ recent deals and make sure they are delivered quarterly. Take note of what the reports cover and if the manager updates investors about both good and bad news.
Another aspect is how is the information available, or where is it kept? Does the manager have an investor portal, that is secure, where investors can have access to all their documents when they need them.
What fees do you charge?
An important part of evaluating a sponsor is to understand the fees charged in a deal. Real estate investing requires a dedicated team of people to be successful and transaction fees help pay for that team, so fees are essential – but they should be understood by all investors.
In real estate investment management, there are usually two types of fees: transaction fees, which are secured and used to operate the investment over the life or term of the asset, and performance-based fees, which are paid at the end of the project cycle, based on success of how well the investment does.
Performance-based fees tend to be similar across most investments or sponsorship structures, but transactional fees can vary and be very different from deal to deal. Most investors would prefer to have all fees back ended and based on performance, and sponsors would love to have all the fees guaranteed, but that misaligns interests on both ends. The right balance is a combination of both, so the sponsor can keep the office running, build and keep a great team, and be incentivized to do well.
When a sponsor is invested alongside his investors, it shows that their interests are aligned with their investors. When a sponsor also guarantees a loan from a personal and completion standpoint, they’re putting more than skin in the game but also their neck on the line. For us at Mortar, we’ve personally invested over $9 million in deals alongside our investors. In addition, our offerings do not charge investors a fee on any equity invested in the offering other than the fees we charge via operations and the success of the project as detailed in our investor terms and presentation.
————————————————