Real estate crowdfunding regulation has brought the world of private real estate online and opened it up to everyone. While this fragmented investment space is slowly becoming more transparent, it’s still challenging for non-real estate professionals to make informed investment decisions.
In an earlier post I shared my real estate crowdfunding investor checklist, highlighting the important aspects of a deal investors should be aware of such as return sensitivities, terms of deal, economic structure, tax implications etc.
While the intricacies, structure, and term of the investment are important, what’s more important is the quality of the sponsor. Real estate is an operational business. Investing in real estate is, in a lot of ways, like investing in start-ups; ideas are a dime a dozen and success is dictated by the team’s ability to execute. In real estate, best-in-class sponsors will outperform average sponsors. The purchase price (basis) is not the main determinant of success, it’s the sponsor’s ability to put the right debt in place, devise a quality business plan, connect all the dots, and execute.
With that in mind, crowdfunding investors should spend more time underwriting the sponsor as opposed to the deal itself.
Here’s 10 Questions Crowdfunding Investors Should Ask Sponsors Before Investing in a Deal:
- What is the sponsor’s experience with the product type, the market, and executing that business plan? Ask for a case study that shows purchase price, renovation scope (how much was spent and what work was completed), return-on-cost generated, and exit price. It’s important that these deals have gone full cycle through a refinance or an exit.
- If it’s a newer firm, did the principals specialize in that asset class, market, and investment strategy in their prior jobs?
- Keep in mind that many new firms (formed in the last 5 years) haven’t experienced a full cycle.
- What’s the background of the sponsors?
- How much direct real estate experience do they have? Did they work for best-in-class firms? More important than the firm they worked for is the day-to-day work they were doing.
- What’s their competitive advantage? Why did the deal come to them and how are they uniquely positioned to execute?
- Are they disclosing all the risks clearly up front? The investor memo shouldn’t be overly rosy, rather it should clearly state the risks and show why the deal is downside protected. If a deal looks too good to be true, it usually is.
- Request the sponsor/crowdfunding portal keep a running FAQ section so you can benefit from the collective questions of all investors.
- Ask the sponsor for investor referrals. When chatting with investors, ask about the quality of reporting, responsiveness, timeliness of K1’s, and past deal performance.
- Ask for an in-person meeting or at least a phone call (or video chat). During this meeting you’re trying to gauge what type of person the sponsor is. Are they trustworthy professionals who will act in good faith?
- Request that the sponsor/crowdfunding portal record a webinar to walk through the sponsor background, expertise, and the deal specifics.
- Research the sponsor online. If they don’t have a quality web presence; website, active social media accounts, and old news articles, you should be skeptical.
- How much money is the sponsor contributing to the investment? 5%-10% of the equity contribution is typical. You always want a partner with significant “skin in the game”.
- Where is this money coming from? Transparency in the partnership is key.
- Ask to see sample quarterly reporting. How thorough is it? Does the quarterly report show their expertise?
- And because I wanted to get to an even 10, ask why the sponsor opted to crowdfund the equity/debt for this deal? Any sponsor with access to quality deals, can raise equity from a variety of sources, so why go through the hassle of crowdfunding?
Private real estate deals can be a great investment, but when investing in real estate through crowdfunding, don’t just invest in deals that look great on paper. Invest in high quality deals with great sponsors who have a history of executing their investment strategy.
When you’re underwriting a sponsor, what would you look for?