Chad is a Managing Partner and co-Founder of 37th Parallel Properties, a commercial multifamily acquisitions and asset management firm.
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Evaluating a direct real estate investment is different than investing in stocks, bonds and mutual funds. When you invest in direct commercial real estate, you own a fractional percentage of the actual property. You get access to the property’s performance without having to worry about the market’s volatility and lack of predictability. Many investors find that difference alone compelling because they can focus on business evaluation rather than trying to time the market.
However, finding the right business partner is necessary to make direct commercial real estate investing successful. Because you will be allocating capital with a sponsor (syndicator), selecting the right one is vitally important.
Fortunately, there are numerous approaches to how sponsors attract capital, acquire properties and manage those investments. That variety means that almost any investor can find a good match for their investment goals.
But filtering through the masses to find the right sponsor can be difficult.
In working with thousands of investors throughout the U.S. and internationally and evaluating countless commercial real estate investments every year, I believe there are a handful of key elements to finding the right sponsor.
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Keep in mind that textbooks are written about commercial real estate, so a deep dive into the entire subject is beyond the scope of this article. Instead, I’d like to give you a strong sponsor evaluation framework to help you learn more about this industry and empower you on your journey to match your investment goals with the right syndicator.
I call this framework the MAC Profile: market, approach and capability. It’s basically three primary areas of research. Where do they work? What are they doing now? How have they done in the past?
Within this framework, it’s important to keep in mind that the answers you gather aren’t necessarily right and wrong. Instead, this is a matching process where you’re looking for congruence between your investment goals and risk tolerance and what the syndicator is doing now compared to what they’ve done before.
Market
When it comes to direct real estate investing, new investors tend to focus on properties first. And clearly, properties are important. However, the best property in the worst market isn’t something I want to put my money into, and you shouldn’t either.
Supply and demand fundamentals vary from market to market and factor into rent growth, occupancy, cap rates and many other metrics. In fact, many lenders tier markets based on their fundamentals. Top-tier markets have healthy population growth, job growth and diversity of job centers, among other things.
Investments in these higher-quality markets qualify for better interest rates, lower debt-service coverage ratios, and overall better lending terms from the most successful lenders (i.e., debt investors) in the country.
Investing in lower-tier markets has additional risk. Investors willing to take on extra risk should have the potential for higher returns to compensate. Without the potential for a premium, it makes no sense to take on extra risk.
When it comes to evaluating syndicators, it’s important to know what markets they invest in and why. Do those markets comport with your risk tolerance, and does that syndicator have an approach that will work in that market?
Approach
Some sponsors offer a buffet of unrelated investments. They have their hands in retail, office, multifamily, industrial and hospitality, utilizing a mix of strategies in various markets. That might be worth considering if the sponsor is large with deep specialization in each of these asset classes. But, you have to consider how a multi-asset-class approach will impact their results.
Specialization in an already stable asset class has its benefits. Regardless of the direction you take, it’s very important to understand their approach.
Is their primary business new construction, or do they buy existing properties? Are they long-term holders, or do they focus on short-term renovation and disposition? Do they purchase A-grade properties with the expectation of cap rate compression (i.e., future bet), or do they prefer balanced income and equity growth approaches? Do they avoid or embrace things like qualified opportunity zones or tax credits, and why?
Their approach has to be congruent with what you believe is best for you and your portfolio for there to be a good match.
Capability
Occasionally sponsors will pursue opportunities outside of their capability. Be cautious of this because you don’t want to be caught paying for their “educational tax.” Never forget that past performance doesn’t guarantee future profits. However, success leaves clues. And repeated success over a long period of time is more than a trend.
You want to invest with successful syndicators that have proven themselves time and time again. The two must go hand in hand. Avoid inexperienced sponsors, those with subpar performances and those with a shotgun approach.
Some of the questions to ask in this category include how many years they’ve been in business? How many investments have gone full cycle? What have their gross and or net returns been? How much equity have they deployed and/or profitably returned over what period of time?
It’s important to understand their performance through every phase of the investment – from acquisitions to operations to disposition.
Along the way, how transparent are they? Do they share property manager report data, or do they just collate that information into a one-liner that leaves the investor mostly in the dark?
MAC Profile
Passive investing with an experienced syndicator that is aligned with your investment goals and risk tolerance can be quite lucrative. Conversely, investing with a sponsor that is not compatible can be painful. And because of the lack of liquidity, you can be connected with an investment and a sponsor for a long time. Think of these relationships as marriages, and choose wisely.
These factors are why it’s so important to evaluate the syndicator long before you ever invest. The MAC profile framework can be a powerful lens to help find the best real estate sponsor for you.
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