5 Questions You Should Ask Every Sponsor

Investors invest in people more than they invest in the deal. Having the right team in place is not only important but very beneficial for any passive investor to help protect them against the downside risk. Take the current scenario where the world as we knew it turned on its axis. Nobody thought it would’ve taken a sudden turn because of COVID-19, things have certainly changed since. Businesses changed and continue to change day by day.

Passive investors are looking for unique perspectives, fresh ideas and energy as an alternative to the volatile stock market. Making it evermore important with choosing the right sponsors. Passive investors seek out sponsors who provide these investment opportunities because they value their time and rely on the professional to efficiently manage the asset and participate in the returns. Once a passive investors has their criteria nailed down, they invest with a sponsor team that shares those same requirements. Below are some questions you must ask every sponsor.

1. How much liquidity do you keep per deal?

There are different ways equity can show up in a deal. Equity in the asset or loan to value (LTV), cash flow from operations and funds in the operating account. The lower the LTV, the higher the debt service coverage ratio (DSCR) and the larger the cash reserves all equates to a low risk investment. The more cash reserves the better chance you have of riding out economic downturns or one-off instances like COVID-19.

2. What is the worst-case scenario and how are you preparing to combat it?

No investment is guarenteed. The operator should be totally transparent and upfront with passive investors that there could be loses. There could be follow up capital calls if the asset’s value dips below the loan value or better yet, cash flow goes negative.

The operator should have a capital preservation plan as the first line of defense as part of their business plan. Though there is risk, the operator should be upfront with passive investors during those conversations.

3. How often are you communicating with passive investors?

Communication is important for establishing and building trusted relationships with passive investors. Essentially, passive investors receive a report int eh form of a newsletter every month on each investment. Each question should have a turn-around time of no longer than 24 hours.

4. How are you adding value or hedge inflation against possible rent reductions?

The sudden change due to COVID-19 has incurred many losses all over the world that effected several businesses. So, you need to make sure the sponsor is prepared and equip for economic impacts as well as one-off events. Sponsors should be prepared to talk through the process of mitigating risk and how to handle economic cycles.

5. What does the process look like for your financial reviews?

third party reviews can be ideal but not necessary. Having a few sets of eyes to review the numbers with many check points is a fiduciary responsibility of a company.

Asking these questions give you the clarity of things to expect to protect your downside as an investor. It helps provide clarity of the operator’s character. Finding the sponsor is easy, but choosing the right sponsor needs a little bit of effort. Hope this was very helpful to you the next time you interview the next sponsor you choose to invest with.

It’s always great to be in a place where you understand the value of investing. One of those reasons for most investors is battling inflation. Having certainty in the real estate multifamily market also helps passive investors feel confident in their investment.

For more information about passive investing in multifamily syndications visit our blog archive. We created the Passive Investors Journal just for working professionals to provide ideas, context and helpful strategies for their hands off investments in real estate.

There are more frequently asked questions that are answered in audio form.