- Buying and managing institutional-quality commercial real estate investments requires a significant amount of experience, expertise, and capital.
- For individual investors looking to allocate capital to these types of properties, the best bet is to work with a transaction sponsor.
- All transaction sponsors are different and it is important for investors to work with one whose investment strategy and objectives match their own.
- To determine if this is the case, it is always a best practice to perform a significant amount of due diligence on each transaction sponsor. The easiest way to do this is by asking questions.
The purchase and management of institutional-quality commercial real estate assets is a complex business. The transactions can involve a significant amount of money, and the details of the financing structure can be incredibly complicated. Making such a purchase directly isn’t for everyone.
However, there is a strong argument to be made that commercial real estate as an asset class belongs in a broadly diversified portfolio of risk assets. As such, this presents an interesting dilemma. If this asset class can benefit all investors—but shouldn’t be transacted by just anyone—how should an individual go about investing in it?
For most investors, the answer to this question is a relatively simple one: it is to place their money with a professional real estate transaction sponsor who will undertake all of the complex activities on the investor’s behalf. This way, individual investors get all of the benefits of commercial real estate ownership without the hassle, expertise, time commitment, or experience needed to purchase it directly.
Because there is no shortage of real estate transaction sponsors, individual investors must perform their due diligence before selecting one (or more) with whom to invest their capital. To make the due diligence process easier, here are nine questions every investor should ask of a commercial real estate transaction sponsor.
Question 1: What is your level of experience?
The first indication of a good transaction sponsor is one who has a significant amount of commercial real estate investment experience. Ask how many years they have been in business. If they are a startup, they may not be the best choice. Years or even decades of experience is the preference here. To further qualify the transaction sponsor’s experience, ask follow up questions about how many successful transactions they have overseen, or how many successful property sales they have made.
Question #2: Who is on your investment team?
Commercial real estate investment is a team sport, and a good transaction sponsor will have an entire team dedicated to finding the best opportunities and managing the properties in a way that maximizes cash flow. At a minimum, they should have a lead underwriter/financial modeler, a deal team responsible for finding new opportunities, an asset manager to monitor the property’s performance, and a transaction manager to oversee logistics. These roles should also be supported by a qualified real estate attorney and a CPA to ensure that all real estate and tax laws are followed.
Question 3: What is your investment strategy / what are your investment objectives?
Every real estate investment is slightly different and individual investors should seek to work with sponsors whose strategy and objectives align with their own. For example, one sponsor may prefer to invest in value-added multifamily assets, while another may be an expert in high-rise office properties. Some sponsors may like to hold an asset for 10 years, while others like to hold them one for five. Some purchase assets as a “yield” play, meaning that they offer stable cash flow with little chance for growth, while others may pursue a growth objective, which means more risk. The answers to these questions should be reviewed carefully with the sponsor to ensure they are consistent with the individual investor’s personal strategy and objectives.
Question 4: Do you offer investments in funds or deals?
Typically, sponsor led commercial real estate investments come in one of two forms—a deal or a fund.
In a deal, an investor has an opportunity to know exactly what property he or she is investing in. The investor knows who the tenants are, where it is located, what the monthly rents are, and how the property is constructed. Some investors prefer to know exactly what they are investing in, while others are just as happy to invest in a fund.
In a fund, an investor provides a certain amount of capital to the sponsor, who invests it as they see fit. This means that the individual has little to no say over which properties are purchased, where they are located, who the tenants are, or how much is paid. The investor outsources all of these decisions to the sponsor and trusts that they will make the best choices.
Again, this is a matter of preference, and the sponsor’s offering should align with the individual investor’s desires.
Question 5: What if I need my money during the investment period?
Commercial real estate investments are not short-term and they are not known for their liquidity. These are assets that need to be held for long periods of time so that the sponsor has time to implement their management strategy and to maximize value. Often, the required holding period is between 5 and 10 years, during which time the investor does not have access to his or her funds.
Thus, it is important for investors to ask the sponsor what options are available to them if something happens during the required holding period, should they need to pull their money out of the property ahead of schedule. In some cases, it may not be possible; in others, they may have an opportunity to liquidate their holdings at a reduced price or at a high fee. Either way, it is important to understand what exit options are available if an emergency should arise.
NOTE: As a general best practice, individual investors should only invest funds that they know won’t be needed for the duration of the investment period.
Question 6: What metrics are used to measure investment success?
In order to understand how successful an investment is or is not, it is important to measure the property’s return. In most cases, the sponsor is likely to use the property’s Internal Rate of Return or the Equity Multiple, sometimes both. If this is the answer, it is important to understand exactly how these metrics are calculated and what investment decisions drive them. This knowledge will allow the individual to better understand the risk profile of the transaction.
Question 7: What fees do you charge?
A transaction sponsor does not work for free. In addition to taking a percentage of the property’s cash flow, they often charge sponsor fees that can reduce the investment’s overall return. Fees to look for include things like: management fees, asset management fees, debt placement fees, sale fees, and processing fees.
All fees should be clearly stated in the investment’s prospectus so that there are no surprises.
Question 8: How is the cash flow split?
This part can be a bit complicated, but most sponsored commercial real estate investment syndications involve a split of the property’s cash flows between the parties to the transaction. In most cases, the sponsor acts as the “General Partner” and is responsible for finding the property, arranging the financing, and managing it once purchased. The individual investors are known as “Limited Partners” and their role is strictly passive.
At the beginning of the investment, each party contributes a set amount of capital and property cash flows are split pro rata. As the return goes higher, the cash flow split tends to change in favor of the general partner as a reward for their strong performance. This is known as a “waterfall distribution” and each individual should understand how it works prior to making a capital allocation to the sponsor.
Question 9: What are the individual investor requirements?
In the United States, most sponsored commercial real estate transactions involve the sale of shares in the property’s ownership entity. In order for a private entity to sell these shares, they rely on a securities and exchange commission (SEC) exemption that allows them to do so as long as the share purchasers meet minimum income and net worth requirements. Individuals should ask what these requirements are, and may have to provide some documentation to prove they meet them.
NOTE: If the investment is offered through a financial advisor, broker-dealer, brokerage, ETF, or mutual fund, the requirements may differ slightly, which highlights the importance of asking the sponsor what they are.
Summary and Conclusion
Individual investors looking for additional portfolio diversification through exposure to commercial real estate assets are well served to work with a qualified transaction sponsor. In order to ensure the sponsor is indeed qualified, it is important that individual investors do their homework, and work with a sponsor whose investment strategy, objectives, and philosophy match their own.
Interested In Learning More?
First National Realty Partners is one of the real estate industry’s leading private equity commercial real estate investment firms. We leverage our decades of expertise and our available liquidity to find world-class, multi-tenanted assets below intrinsic value. In doing so, we seek to create superior long-term, risk-adjusted returns for our investors while creating strong economic assets for the communities in which we invest.
If you are an Accredited Investor and would like to learn more about our investment opportunities, contact us at (800) 605-4966 or email@example.com for more information.
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