In Part I of our Comprehensive Guide to Real Estate Syndications, we covered the basics of real estate syndications – including the definition, the key players and their roles, and the legal structure. In addition, we discussed the various types of properties as well as the benefits and drawbacks of investing in real estate syndications. If you haven’t read Part I yet, we suggest starting there for a solid foundation.

In this part, we’ll dive deeper into the process of evaluating syndication opportunities, focusing on the importance of a good sponsor and the details of the deal itself. Also, we will provide more details on how to vet a sponsor and the different types of compensation and fees. With this, you can make informed decisions and maximize your investment potential.

The Importance of a Good Sponsor

When evaluating real estate syndication deals, two major components need your attention: the sponsor and the deal. Many syndication deals might look similar on paper, with promising numbers and projections. However, the success of syndication largely depends on the sponsor. An 8-10% return on your investment with the potential to double your money in 5 to 7 years sounds incredible, but not every sponsor will be able to deliver on these promises.

Furthermore, sponsors can vary widely in terms of their reliability and expertise. A good sponsor can improve any deal, while a bad one can turn even a promising deal into a disaster. Therefore, it’s crucial to scrutinize the sponsor thoroughly. If you trust the sponsor’s expertise, decision-making, and management skills, the specific property becomes less of a concern. Let’s take a closer look at what a sponsor does and how to vet them.

What Does the Sponsor Do?

The sponsor, also known as the operator, GP (general partner), or managing member, is responsible for many aspects of a real estate deal. Some of the duties, roles, and responsibilities of a sponsor in real estate syndications include:

  • Finding and sourcing deals: The sponsor will find local potential investment properties.
  • Negotiating contracts: The sponsor will put the deal under contract.
  • Due diligence: The sponsor will evaluate the property to ensure it’s a sound investment.
  • Securing capital and financing: The sponsor will find potential investors and gather the necessary funds and loans.
  • Developing and executing a business plan: The sponsor will outline how they will manage and improve the property.
  • Communicating with investors: The sponsor will provide up-to-date information and keep investors informed about the progress.
  • Managing the property: The sponsor will oversee the day-to-day operations, maintenance, and management of the property.
  • Providing updates and financial reports: The sponsor will share regular updates on the investment’s performance.
  • Deciding on the sale: The sponsor will determine the right time to sell the property.
  • Ensuring investor payouts: The sponsor will make sure that all investors get their returns.

In short, the sponsor does everything needed to ensure the deal’s success and profitability. As an investor, your role is mostly passive—once you’ve invested, you rely on the sponsor to manage the property and generate returns.

How to Vet a Sponsor

To find a good sponsor, look for the following characteristics: honesty, professionalism, experience, attention to detail, and diligence. Personal experience with a sponsor is ideal, but it’s not always possible. Here are some ways to vet a sponsor:

Reputation: Consider how you found the sponsor. Only choose a sponsor that is recommended by a reputable source. Also, ensure that they have positive reviews on crowdfunding websites.

Professionalism: Check their marketing materials, paperwork, and documentation. Due to the nature of the investment, any sponsor you decide to work with must be professional and well-organized.

Experience: Look at the team’s history in real estate investing. Evaluate how long they have been active in the industry, the number of assets they have managed, and their experience navigating economic downturns like the 2008 recession. Familiarity with the investment location is also crucial.

Track Record: Assess their past performance by comparing projected returns with actual results. Request detailed information about their previous deals, including both successes and failures. This will give you a clear picture of their reliability and effectiveness.

Leadership Team: Research the key members of the team to understand their roles and what tasks they outsource. Conduct background checks to ensure there are no criminal or financial issues. A strong, trustworthy leadership team is essential for the success of the real estate syndication.

Co-Investment: Determine how much of their own money the sponsor is investing in the deal. Typically, sponsors invest 5-10% of the total capital, which indicates they have a personal stake in the project’s success. This alignment of interests between the sponsor and investors is a positive sign.

Sponsor Compensation and Fees

One crucial way to vet a sponsor is by examining the fees involved in their deals. Sponsors typically require compensation in two ways:

  • Fixed Compensation: This is payment regardless of performance, which may encourage sponsors to do more deals without necessarily prioritizing quality.
  • Performance-Based Compensation: Also known as “promote” or carried interest, this aligns the sponsor’s success with the investors’ returns but might encourage higher risk-taking.

However, each compensation method has its pros and cons. The goal is to ensure the sponsor’s and investors’ interests are aligned as much as possible. Fees can vary significantly across deals, with more experienced sponsors sometimes charging higher fees for their proven expertise. 

Common Types of Fees

Furthermore, knowing the various fees helps in assessing the sponsor’s approach. Here’s a breakdown of common fees you might encounter:

Acquisition or Organizational Fee: Typically 1-2% of the property’s purchase price, earned upon closing the property. It compensates sponsors for their time and resources spent on evaluating the deal and analyzing risks.

Equity or Equity Placement Fees: Usually 2-3%, paid to those raising the necessary funds.

Financing or Loan Fees: Ranges from 0.5-1% and covers efforts related to securing financing.

Asset Management Fee: Generally 1-3%, reimburses the sponsor for overseeing the property’s management.

Expense Reimbursements: Covers pre-paid expenses like legal fees and due diligence reports.

Construction Fee: Around 3-5% of hard construction costs for significant renovations or developments.

Promote or Hurdles: Performance bonuses, often 20% over an 8% IRR hurdle and 35% over a 16% IRR hurdle, to serve as an incentive upon hitting certain performance targets.

Disposition Fee: About 1% for the effort involved in selling the property.

Fees are a crucial factor but not the only one. Net returns are what matter most. If the returns are satisfactory, fees are just the cost of doing business.

Conservative Underwriting

Another key aspect to look for in a sponsor is conservative underwriting. This means realistic and careful financial projections. It’s important to understand metrics like Internal Rate of Return (IRR) and Equity Multiples. Sponsors who under-promise and over-deliver are preferable to those who make lofty promises. 

Moreover, sensitivity analysis is crucial to evaluate how changes in variables like vacancy rates, rent, interest rates, and cap rates affect returns. Also, great management becomes extremely vital when dealing with less favorable markets or deals. Consistent conservative underwriting indicates a sponsor’s ability to navigate various market conditions effectively.

Final Thoughts

Vetting and choosing the right sponsors in real estate syndication involves more than just attractive numbers. A lot goes into making a sound investment decision, especially regarding the sponsor. By following the insightful information provided in this guide, the process of vetting and choosing sponsors will be a bit easier for you. In addition, always take the time to thoroughly vet the sponsor before diving into a deal. Remember, the lowest fees do not always equate to the best sponsor.

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