Red Flags for Passive Real Estate Investing
This month we’ll explore some of the common warning signs that can help any investor quickly evaluate an offering or investment. More specifically, what to be on the lookout for when evaluating a sponsor – or what potential ‘red flags’ would look like. When analyzing any new sponsor or manager – whether it’s a syndication, real estate fund or any other investment, there will be some level of due diligence an investor must do. Whether an investor is choosing between a large institutional fund or a smaller local deal – proper due diligence is key.
Red Flag #1 – Sponsor market presence
To us – real estate is a local business, and a sponsor should be an expert in the local market. Deal metrics and investment variables vary greatly from city to city – or state to state. This doesn’t mean a sponsor should only invest in one city, but it does mean that the team must have local knowledge.
A sponsor with no local knowledge or relying on Google data searches should not satisfy an investor. A sponsor should understand local dynamics – geography, gentrification, and pricing history, as well as understand local building codes, and also have access to local consultants or contractors.
Red Flag #2 – No Track Record
One of the most important things to look for when evaluating a potential sponsor is whether or not they have experience and track record. A sponsor should be able to share a track record and their experience on any investment they have completed. One should also ask how the sponsor performed in various parts of the market cycle – in times like the crash of 2008 or during Covid. It’s much more likely that an experienced sponsor will be successful or better protect capital when the market is volatile or is in a downturn.
Red Flag #3 – Part-time Sponsor
A sponsor offering an investment should be in the business you’re investing in full time. They should have an office you can visit, a website with an investor portal, and a team dedicated to managing investments. Part-time sponsors we come across are usually someone just starting out (as all sponsors were at one point) – but those investments should be funded individually or by friends and family – until that sponsor establishes a track record and makes investments their full-time business.
Red Flag #4 – No Preferred Return
Most deals you see with established sponsors have a preferred return or interest distribution. The preferred return is usually a set amount or interest paid to the investors / limited partners before any splits or profit is shared with the manager. Ideally this keeps everyone’s interest aligned. It makes investors feel more comfortable, and it incentivizes a sponsor to outperform so they can share in the backend gain.
Red Flag #5 – No Skin in the Game
This is an important question, and one of the first that comes up often with potential investors. The sponsor should be investing a significant amount of his or her own capital along with the investors or should be providing some sort of guarantee on the senior debt. A partner having ‘skin in the game” ensures that all parties are aligned to have the same successful outcome on a project.
Simply put – A sponsor will fight harder to ensure an investment’s success if they have something to lose.
Red Flag #6 – Unresponsive Investor Communications
Communication is often overlooked, but it is essential to a successful sponsor / investor relationship. Managers should provide timely and accurate communication or 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 of recent deals and make sure they are delivered quarterly.
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.
Every sponsor will have different answers to some of these red flags, but here is a sample of how Mortar Group would address these questions.
Red Flag #1 – Sponsors market presence
- We are New York based, and that is where we work. We have in-depth local neighborhood knowledge, and focused opportunities that utilize our intimate knowledge of New York’s prime niche neighborhoods.
Red Flag #2 – No Track Record
- With over $320M in gross sales since 2001, we have been involved in over 30 offerings in New York. We have an established track record, and we have a team well versed in New York real estate.
Red Flag #3 – Part-time Sponsor
- We have a full-time staff managing all active investments and a team dedicated to investor relations. With over 400 active investors, we also have two offices (one in New York, and one in New Jersey), and a website and investor portal where investors can view how their investments are doing 24/7.
Red Flag #4 – No Preferred Return
- Every offering we launch has a preferred return dedicated to the limited partner and passive investors.
Red Flag #5 – No Skin in the Game
- Interests are aligned in our offerings. Mortar targets a 10% equity investment in each offering.
Red Flag #6 – Unresponsive Investor Communications
- We have a team dedicated to investor relations. We often meet with investors locally, we offer tours for visiting investors, and any email or phone inquiry will be responded to within 24 hours. Separately, we have a secure investor portal where investors can view quarterly reports, offering financials or obtain their tax information at any time.
At the end of the day – investors should understand where their savings or investment is going. The money being invested is hard earned, so you need to be comfortable with whom you work with, and that the sponsor will do what they say they will do.
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As a reminder, if you’re interested in learning more about Preferred Equity and other types of investments, feel free to schedule a call to learn more visit here: Schedule a Call
Also feel free to view a few of our most recent resources.
- Using your IRA for Real Estate Investments (Recent Article)
- Modern Guide to Real Estate Investing (Free Guide)
- Choosing Between Syndications and Real Estate Funds (Blog Post)
Mortar believes in experience and smarter real estate investing. Our fully integrated in-house design, development, and asset management expertise has resulted in dozens of successful privately syndicated deals.
This, combined with skin-in-the-game co-investments and in-depth local neighborhood knowledge, helps us mitigate risk and maximize investor returns. Focused opportunities combined with an intimate knowledge of New York’s prime niche neighborhoods allows investors to diversify and deploy capital conservatively in projects and divest risk throughout the real estate lifecycle.