S.A.M.S — The Fourth Commandment

Beyond the Brochure: Why Your Real Estate Sponsor and Their Team are Everything

Continuing on the 10 Commandments of Commercial Real Estate, #4 is a long one. It references the SAMS acronym. Standing for Sponsor, Asset Market and Structure. In this post we will look at the Sponsor or the first S in SAMS.

You’ve found a promising real estate deal, the numbers look good, and the location seems perfect. But hold on! Before you commit your hard-earned capital, there’s one crucial factor that often gets overlooked, yet is arguably the most important aspect of any real estate investment: the sponsor and their team.

So, what should you be looking for when vetting a real estate sponsor and their team? Chapter 3 of “Flight Plan For Investment Success” breaks it down:

1. Understanding the Organizational & Ownership Structure

Don’t just rely on fancy titles on a website. Dig deep to identify the central decision-maker – the person or people with both responsibility and authority for investment decisions. Ask for an organizational chart that clearly ranks individuals by their importance in decision-making, along with their professional biographies.

Also, understand the firm’s ownership structure. Owners and decision-makers aren’t always the same. Inquire about any changes in ownership over the last five years and anticipated changes in the next five, especially retirements, as these can significantly impact the firm’s future performance.

2. Peeking into Legal & Financial History

A glossy exterior can hide a checkered past. It’s crucial to investigate the firm’s and its principals’ legal and financial history.

• Legal History: Ask about any criminal or civil litigation or investigations. While civil disputes are common, consistent litigation or any criminal history should raise major red flags. Seth Wilson advises: felonies are a “nonstarter.”
• Financial History: Inquire if the firm or its officers have ever failed to make debt payments, including during events like the pandemic, or filed for bankruptcy. While bankruptcy can be a tactical maneuver, understanding the circumstances is vital.

3. Gauging Dedication and “Skin in the Game”

You want a sponsor who is 100% dedicated to your investment.

• Time Commitment: Find out if the firm’s officers engage in other businesses or non-business activities that take up significant time. For larger firms, officers should dedicate over 85% of their time to the company.
• Personal Investment: A major red flag for many investors is when a sponsor doesn’t invest their own funds in the opportunity they’re presenting. This “skin in the game” demonstrates high conviction and alignment of interests. While a lack of personal investment isn’t always a deal-breaker, especially if the sponsor is capital constrained but highly capable, it requires careful consideration and cross-referencing their financial capacity.

4. Evaluating Service Providers and Conflicts of Interest

Quality sponsors work with quality service providers. Request names and contact information for their accounting, legal, and property management teams, and ask how long they’ve worked together. Longevity often indicates a well-tuned team. These service providers can also serve as valuable references.

Be aware of conflicts of interest, especially if the sponsor owns related service companies (like property management). While common, these conflicts must be transparently managed, with fees aligned to industry rates, not inflated due to a “no-bid” situation.

5. Understanding Company Culture

Observe the company culture. Do their stated values align with your own? Are they professional and disciplined, or messy and disorganized? These observations, combined with questions about hiring plans and competitive advantages, paint a complete picture of the firm you’re considering partnering with.

The bottom line? Don’t just trust your gut when it comes to investing in commercial real estate. Take a disciplined, systematic approach to vetting the sponsor and their team. Their character and capabilities are your best defense against potential pitfalls and your greatest asset for long-term investment success.

 

Beyond the Pretty Picture: Diving Deep into Real Estate Deal Due Diligence

Next, we will address the A and M of SAMS. Asset and Market due diligence.

You’ve found a great sponsor, you’ve aligned on vision, and now a specific property opportunity lands on your desk. This is where the rubber meets the road: asset-level due diligence. Don’t be swayed by a slick marketing package alone! In the book “Flight Plan for Investment Success,” a disciplined approach to vetting the property itself is paramount for safeguarding your investment and securing long-term success.

So, how do you really know if a deal is solid? Let’s break down what to look for and what makes a strong property.

The Three Pillars of a Solid Deal

Every truly good deal, no matter how enticing the “story,” must stand firmly on three fundamental points, like a stable, three-legged stool:

1. The Team: While this is about the asset, the sponsor and their team are so critical they’re considered the most important pillar. Their character, capability, and alignment are the bedrock.
2. The Basis: This is the purchase price or total project cost. It must be low – cheap! Buying cheap provides a crucial cushion against market downturns and maximizes profit potential.

3. The Location: Proximity to growth, desirable demographics, access to transportation, and a favorable regulatory environment are key. Look for data-backed realities, not just “hot market” rumors.

Mastering Market Due Diligence before you even touch the property’s financials, understand its market. Smart sponsors will have this data, but you should too:

• Vacancy Rates & Rental Prices: Are they trending up or down?
• Job Creation & Diversity: Real estate follows jobs. A diverse job market is more resilient.

• Net Migration: Are people moving in or out? (Hint: U-Haul truck rentals can tell a story!)

• Median Household Income: Does the local income support the projected rents?

• Access to Transportation: Is it easy to get around?

• Supply and Demand: What’s the absorption rate?

• Government & Regulations: Are there rent controls or landlord-friendly policies?

• Climate & Environment: Consider long-term risks like water supply or natural disasters.

• Path of Progress: Is development moving towards your target property?

• Retail & Grocery: Are essential amenities nearby? Markets also have different “personalities”:

• Cyclical: (e.g., San Francisco, Miami) Boom and bust, attract global capital.
• Linear: (e.g., Kansas City, much of the Midwest) More stable, predictable, with higher cap rates and cash-on-cash returns.

• In-between: (e.g., cities in the Carolinas, Austin) Growing, but not as volatile as cyclical markets.The 6-Point Asset Due Diligence ChecklistOnce you understand the market, dive into the property’s specifics:

1. Basis (Purchase Price/Project Cost): As mentioned, buy cheap! This protects against downsides and amplifies returns.
2. Current Net Operating Income (NOI): This is the property’s gross income minus operating expenses (excluding debt or capital improvements). Understand typical expense ratios: newer buildings (40-45%), modern (45-50%), older (closer to 60%).

3. Pro Forma NOI: This is the projected NOI after improvements. Be skeptical of sponsors who promise to double NOI on a 90% occupied property without a clear, logical plan.

4. Debt (Leverage): Debt boosts returns but also risk. Aim for no less than 20% equity (up to 80% loan-to-value/cost). Be wary of non-bank lenders who are “loan-to-own” – they might be looking to take advantage of desperate sponsors.

5. Sources and Uses: This financial statement shows where money is coming from and where it’s going. It must balance! Any imbalance is a massive red flag for incompetence or fraud.

6. Exit Strategy: How will the property ultimately generate returns – through sale or refinance? Be wary of sponsors who project artificially low “reversion cap rates” to inflate projected valuations. A safer assumption is an exit cap rate at or above the acquisition cap rate. Navigating Fees on a Live Deal. Fees are part of the game, but transparency is key. Demand a clear, written breakdown of all fees: category, percentage (and what it’s a percentage of), and dollar amount. Understand how these fees impact your return. Be highly suspicious of deals where the sponsor makes substantial upfront fees without investing their own capital – this creates a severe misalignment of interests.

Ultimately, successful real estate investing in specific assets requires a blend of meticulous analysis, a healthy dose of skepticism, and an unwavering commitment to understanding the numbers and the people behind them. Don’t just trust the story; demand the data and the discipline.

Unpacking the Deal: Understanding Commercial Real Estate Partnership Structures

Finally, we will take a look at the final S of SAMS, which can be a make or break for any investment; Structure of the partnership.

So, you’re ready to invest in commercial real estate, but how exactly does your money fit into the bigger picture? Beyond the property itself, understanding the deal structure is critical. In the book “Flight Plan for Investment Success” it illuminates the primary ways ultra-high-net-worth individuals, family offices and wealth advisors can invest in private real estate deals, offering clarity on what to expect, what to watch out for, and the unique advantages of each.

Let’s break down the main partnership structures in direct commercial real estate investment.

Your Options as a limited partner: Syndication vs. Joint Venture (JV)

When investing directly in commercial real estate, you’ll primarily encounter two structures:

1. Syndication (or “Club Deal”):
   • The Structure: This is a time-honored method where a Sponsor (also known as a General Partner or GP) raises capital from multiple Limited Partners (LPs). The sponsor takes the lead, finding the property, managing the due diligence (financial, physical, environmental, legal, etc.), securing debt, and executing the business plan from acquisition through disposition.

• What to Look Out For: Sponsors typically charge LPs an upfront fee and receive a “carried interest” or “promote” – a disproportionate amount of property ownership relative to their capital contribution. While this is normal, ensure the fees are fair and transparent, and that the sponsor still has “skin in the game” (their own investment) to ensure aligned interests. Avoid deals where sponsors are “getting rich off fees” without genuine capital risk.
• The Positives:

• Accessibility: LPs don’t need to commit as much capital as in a JV deal.
• Direct Investment: You still get to choose which specific properties you invest in.

• Network Effect: Deals often come through trusted networks.

• Single Purpose Entity (SPE/SPV): Investments are usually held in an SPE/SPV, limiting risk to that specific asset.

2. Joint Venture (JV):

• The Structure: Similar to a syndication, but the JV investor brings a significant majority of the equity (often 90-95%), with the sponsor contributing the remaining 5-10%. In this scenario, the JV investor, as the major capital provider, can largely set the terms of the deal.

• What to Look Out For: Maintaining a good alignment of interest is paramount. The sponsor is the “labor” and effectively works for the JV investor. Avoid mistreating the sponsor or seeking to take unfair advantage, as this can sour the partnership. Also, be prepared for banks to potentially require the JV investor to act as a loan guarantor, which increases your liability beyond just your equity.

• The Positives:

• Control: As the primary capital provider, you have greater control over the deal’s terms and direction.
• Simplified Partnership: Fewer parties involved means a simpler transaction and partnership management.

• Bespoke Deals: Terms can be highly customized to your specific needs and goals.A Note on Crowdfunding: Proceed with CautionWhile gaining popularity, crowdfunding for real estate deals is generally advised against for sophisticated family investors. It often involves sponsors without strong networks for larger equity, a lack of meaningful relationships with investors, minimal transparency, and potentially high, non-negotiable fees. The risk of misalignment and being treated as a “cash machine” is significant.Beyond the Structure: Essential Due Diligence Points

Regardless of the structure, always ask about:

• Regulatory Compliance: Is the sponsor SEC-registered (if required), and are they in good standing?
• Fellow Investors: What types of investors does the sponsor work with? Are they similar to you, ensuring shared goals and expectations?
• Minimum Investment Size & Exceptions: Understand the requirements and if exceptions are made (and why).

• Reporting & Information Access: Ensure all investors receive the same, timely, and transparent information and have the right to inspect books and records.

• Capital Calls: Understand how the sponsor has handled these in the past and how they’ll manage them if unexpected events occur.Choosing the right deal structure, and the right sponsor to execute it, is as crucial as picking the right property. By understanding these nuances, you can ensure your investment aligns perfectly with your “flight plan” for success.