What Questions Should I Ask Before Passively Investing In A Real Estate Syndication Now (After Coronavirus)?
When investing in a real estate syndication you are truly investing in the deal sponsors, the team that is going to be managing the deal and provide you with your means to earn passive income. Your investment is an act of trust in the integrity and competency of the deal sponsor to be able to execute their business plan as described in the offering materials of the investment opportunity. Given the highly critical and central role deal sponsors play, passive investors need to make sure they have clarity when investing, especially during uncertain times.
We have come up with some of the most important questions a passive investor should ask a deal sponsor before continuing to invest with them or investing with them for the first time. As you may note there are some questions on here that you should have been asking even before the Coronavirus pandemic, but they are even more important to know now. Keep reading to find out more.
1. How has your investment criteria changed since the onset of COVID-19?
The deal sponsor’s investment criteria should not have changed. They selected their investment criteria for a reason. As a passive investor you want to be comfortable that the deal sponsor is not going to be taking on inferior deals just for the sake of doing a deal or earning their acquisition fees at the risk of the passive investors seeing poor returns. Instead of changing their investment criteria a sponsor should be working harder to increase deal flow and find conforming investment opportunities.
If the investment thesis of the sponsor has changed you should get an understanding of why the sponsor has made this change and if the deal sponsor will be a good fit with your investment goals going forward.
2. How has your portfolio performed during Coronavirus?
Great leaders and businesses are built during times of adversity. Admittedly things like a global pandemic are out of anyone’s control and are highly unpredictable. This question is not meant to create a negative mark against those sponsors who had portfolios that did not perform well or to provide undue praise to those sponsors who had portfolios that out performed.
While good performance during the pandemic speaks well of potential future investment prospects as a passive investor you must always remember past performance does not guarantee future results. The goal of this question is to not only understand how the portfolio performed but why. Was the performance poor or strong based on the sponsors actions or was it due to luck and factors outside of his/her control? The response to this question will be a key consideration for how future deals will be run by this sponsor.
3. What was your communication cadence and substance during Coronavirus?
Over-communication and leaning in are important in times of crisis, even if things are going well. As a passive investor in real estate you know that real estate does not act like the stock market where you can log into a brokerage account and see the minute by minute changes in value of the assets you own.
Things move a lot slower and stable in real estate. Even considering that, the level of uncertainty and rapidly developing medical, regulatory and other macro-factors warrant some anxiety from a passive investor and you’ll naturally want to know what is going on. It is the sponsors job to provide the answers that help put you at ease. If the sponsor was radio silent during the pandemic, or only business as usual you may want to reconsider dealing with this sponsor.
4. What was your investor relations response to COVID-19?
Similar to the previous question but you want to key in specifically on the sponsor’s response to their investors. As a stakeholder, part owner of the investment property, you will want to know what is going on with your investment. Did the sponsor make themselves more available? Did they increase communications? Did they add additional video, pictures, written commentary? This will speak a lot of what to expect as an investor if things go bad on a deal in the future.
5. Have you continued to make distributions or decided to stop? What was the reasoning behind your decision?
There is nothing wrong with not receiving distributions, this may not be an indicator of the strength in performance of the asset as much as it is a display of risk management by the sponsor. Some may say it is even reckless for a sponsor to continue to make distributions in a time of crisis.
The key here is that you, a passive investor, understand the reasoning why the sponsor has chosen to stop or continue distributions. What is the source of the funds used for the distributions? Are they paying you out of equity raised or cash flow from the property? The source of payments and reasoning for distributions are key to understand the sponsors risk management and care of investor funds.
6. What was your asset management response to COVID-19?
Similar to understanding the response for investors you need to know – what did the sponsor do with the investment property? If they only continued business as usual when the whole world was shutting down, you may question the competency and risk management acumen of the sponsors.
If they have taken no means to help maintain (if not increase) the operating efficiency of the property during the virus outbreak, then they are likely even more lackadaisical during good times. This shows that the sponsor is not prioritizing the performance of the investment and ultimately the return on investment they are providing to their investors.
7. What things did you do that helped you to be prepared for potential market shocks like Coronavirus?
Prevention is better than cure. Experienced sponsors have learned through multiple market cycles the strategies and backstops needed to help sustain an investment during a downturn. Was this deal sponsor prudent in their preparation or were they entering in highly risky deals which were exposed as fragile once the pandemic started? If they made mistakes in their preparation, have they made plans to course correct on their portfolio now and for future acquisitions?
Capital preservation is one of the most important things a sponsor should prioritize prior to providing a return to investors. If the deal sponsor does not operate this way it may be a red flag for you to end that relationship.
8. How did the markets you are investing in fare during the virus outbreak?
This is out of the deal sponsors control, but it does provide insight into updates about the current market, perhaps they have additional information that you may not be able to easily access yourself. Knowing the importance of investing in a good market you will be able to evaluate why the deal sponsor is continuing to invest in the market given the current and future prospects for the market.
9. What is your break-even occupancy?
This is an old question, but Coronavirus has helped to highlight the importance. The break-even occupancy refers to how much of an economic occupancy do you need to have at the property to cover the basic monthly expenses and break even.
As mentioned before capital preservation should be a key consideration for the deal sponsor; if the deal sponsor does not even know at what point the property is break even how can they protect your investment?
10. On a deal – are there any tenant concentrations on this property?
A tenant concentration refers to when there is a significant percentage of the population of the apartment tenant population that is one demographic, job industry, or share some other common relationship. The COVID-19 pandemic has left a lot of health and economic destruction in its wake. All industries have been hit but certain industries have taken the brunt of the toll. Without jobs, these tenants can not pay rent and the property suffers.
You will want to understand what the chances are of this happening again in future properties. The deal sponsor should be able to answer this question and let you know how they plan to manage potential risk connected to having a concentration of a specific tenant population.