In a previous blog post, I outlined the top five questions to ask a commercial real estate syndicator or operator before passively investing. When you are passively investing in commercial real estate, you are placing a lot of trust in the active operator. To ensure your capital is in good hands, here are the top five questions to ask before investing:
In addition to these five questions, here are five more questions you should ask a commercial real estate operator before investing in one of their deals.
As a passive investor, you have no control over the implementation of the business plan. However, one thing you can do (and want to do) is to monitor the performance of the investment. Therefore, you need to understand what type of information the operator discloses to investors, as well as how often they communicate.
In addition to asking them what information they provide to investors and how often this information is provided, ask for their last three investor communications. This will give you a much better understanding of their communication style. The most important thing you want to verify is that you can compare the actual performance of the property to the projections. This means the investor communications should at least include financial documents, like a profit and loss statement, occupancy rates, and rental premiums.
One of the best ways to gauge future success is past success. Therefore, you want to determine the performance of their current holdings. Ideally, information on their portfolio is readily available in their marketing material, like a case studies section in their company presentation or in their investment summaries for new deals.
Focus less on the absolute performance of each deal and more on how the deal performed compared to projections because that will give you context. For example, a deal that resulted in a 10% CoC return but was projected to achieve a 15% CoC return was less successful than a deal that resulted in an 8% CoC return but was projected to achieve a 6% CoC return.
Although this isn’t technically a question, make sure you speak with other passive investors who invest with the operator. You can ask the operator for a reference, but finding a reference on your own is more valuable because no one ever gives bad references.
Also, perform a background check on the operator. Utilize websites like the Better Business Bureau, Google Reviews, and the 506 Investor Group to find reviews on the company. Visit the company website to confirm that their values align with yours, too.
If something bad happens to the operator’s business or to one of their deals, like a lawsuit or extensive damage to the property, you want to make sure they have insurance to cover those expenses. Otherwise, you may lose a portion or all your capital investment.
This starts with property insurance, which is a requirement if the operator is securing financing. However, not all insurance carriers are alike. Ideally, they are working with an A-rated insurance carrier.
From a compliance perspective, ask if they have errors and omissions (E&O) insurance through their securities attorney to cover potential SEC-related lawsuits.
Since the operators have complete control over the business plan, they also have complete control over when to exit an investment. When they initially underwrite an opportunity, they assume a hold period. However, this doesn’t mean they are obligated to stick to that assumption. They may sell early, or they may elect to hold longer than projected.
As a passive investor, assuming you participate in the upside, the sale is usually when you make the most money. Whether you participate in the upside or not, the sale is usually when you get your money back. Therefore, understanding the operator’s decision-making process surrounding the exit is important.
Understand what would make them sell early. Hopefully, it is because the return is higher. But it is also possible that they will exit early for the opposite reason – because the returns are dropping and will continue to drop unless they exit now. To verify their response, see if they have exited an investment early in the past and how the actual returns compared to the projected returns.
How do they communicate the performance of the investment with the passive investors?
What is the performance of deals they have sold in the past, as well as the deals they currently hold?
(Not really a question, but) find passive investors who invest with the operator and ask about their experience with the operator. Also, perform a background investigation on the operator and their company.
What type of insurance do they have to cover large expenses if something goes wrong?
What would make them sell the deal early?
Disclaimer: The views and opinions expressed in this blog post are provided for informational purposes only, and should not be construed as an offer to buy or sell any securities or to make or consider any investment or course of action.