When selling or buying a home, you often interview multiple real estate agents before you decide on the right one. A real estate agent who focuses on rural areas may not be the best fit for someone who is looking for a nice neighborhood and a house with a pool.
You need to do your due diligence as a buyer or seller to vet the real estate agent. Some ways to make sure the real estate agent is the right fit for you is by looking at their website, selling data, and other key information. Your real estate agent will be your right-hand person for at least a couple of months, and it is important they are the right fit for you.
When you decide to start the investment process and pursue a real estate syndication, you want to do your due diligence and research as well. You will want to research locations, the age of the investment property, the type of commercial property and trends related to that industry, and many other details.
Beyond property and market details, you’ll need to review the real estate operator carefully. A real estate operator is a person or company who rents, leases, and manages residential and commercial properties. They are involved in the development of properties, connected to broker and seller agents, and heavily involved in the appraisal and property management processes throughout your investment hold period.
Here you’ll learn how you can perform extensive due diligence when vetting a real estate operator and discover some red flags you should be aware of before diving into the first real estate syndication investment opportunity that comes across your desk.
Taking the time to gather and implement solid advice upfront will help you feel more confident throughout the investment process and will more likely lead you to the projected returns and the investor experience you were hoping for!
How To Vet a Real Estate Operator
Investors are always very excited to hear about the returns. When looking at different investment opportunities, you want to know what the cash flow will be like and how much money you will make.
But before you get too excited about the projected returns, you must realize that the deal operator is in charge of executing the business plan. It’s the proper execution of the plan, properly timed decisions, and the operator’s choice in other property management partners that create those returns.
So, before choosing a particular investment, you need to make sure your views and goals align with the operator and that you like the property market they are in. Then you can start talking about returns.
Due Diligence Process: Choosing the Operator
There are five questions investors should ask an operator when looking at different real estate syndications. These questions will help you ensure you get all the information you need to have a successful transaction and a great real estate partnership.
Questions To Ask The Operator
1. What is your investment philosophy?
You want your investment philosophy and your operator’s philosophy to be aligned. Aligned philosophies mean you have the same expectations regarding a real estate deal, investments, properties, financial matters, etc. All parties involved should have the same goals, and you want the operator’s philosophy to align with what you need in your portfolio.
An investor looking for double-digit returns who doesn’t need cash flow and wants to do hotel deals in California probably won’t align with 23rd Street Investors’ philosophy. But an investor looking for stabilized cash flow, reasonable chance of appreciation, growth markets, and who likes the idea of value ad markets where we can force the appreciation would want to invest with us here at 23rd Street Investors!
2. What does the company invest in?
This is when you ask about property information. If you are looking to invest in multi-family, but that operator does self-storage, you will not be a good fit. You also want to look at what the operator actually invests in. Do they invest in direct assets (single asset entity), funds, or REITs?
There are many different investment opportunities, and you want to ensure you understand what that real estate business group invests in and how they invest. Check to see if the operator offers multiple vehicles for investment. You may be able to meet various investing goals under one roof.
3. Is the OPERATOR competent?
Do they know what they are doing? Do they have a track record of successful real estate syndications? Have they done deals before, and if so, have they been through the full cycle and exit? Have they ever exited a deal early, and if so, how were investors treated throughout the process?
When completing your due diligence investigation, you need to look at the real estate syndications the operator has been a part of and see how many have gone full cycle. You want to be with operators who have experience and have learned from multiple deals—looking at the return profile as well.
4. Does the company work with sophisticated and/or accredited investors?
If you are in the middle of the due diligence process and are looking at the company website, see if they work with 506(c) deals. 506(c) deals mean they only work with accredited investors.
To become an accredited investor, you must make $200,000 annually for the last two years or $300,000 jointly with your partner or have one million dollars in assets outside your primary residence.
If the operator does 506(b) deals, they can take up to 35 sophisticated investors per deal. There are a couple of different groups raising for the deal, and they can take up to 35 sophisticated investors in each group.
Once you have found a deal, you’ve vetted the operator by conversing with them, looking at their markets, and getting a good idea of how the deal will work. You want to move on to number five.
5. Listen. How does the company respond to you?
Is the company happy to hear from you, and how do they respond to questions? When doing your due diligence, you must listen to your gut and feelings. How do you feel when you speak with them via phone or email. What type of vibe do you get from their social media? You will have a business relationship with them for a minimum of 5-7 years, and this relationship is an important part of real estate syndications.
You can probably find many of the answers to these questions on the operator’s website. If you can’t find answers to your questions there, call. It is important to be thorough. Investments are risks, and you want the best team to handle your investments.
Due Diligence Process: Operator Red Flags
When you are vetting a real estate operator, you should be aware of any possible red flags. These red flags may not completely rule out an operator. But if you notice a red flag during your due diligence investigation, you will need to dig a little further into your research. If a real estate investment opportunity seems too good to be true, it probably is!
Red Flags For Operators
1. No Business Background
There are a lot of new syndicators out there, which is excellent. But, what if they don’t come from a business background. Ask or figure out who does have this background on their team? It doesn’t have to be the person starting the company.
People start businesses all the time and build a dedicated team around them. Make sure someone on that team has the knowledge needed to successfully navigate through a market downturn, rate hike, occupancy slump, and more.
2. Part-Time Operator
You are transferring your time and energy. You want your investment to be taken care of by someone doing this full-time, and you want them to put excess care, time, and energy into the investment.
In exchange for your faith and financial capital, you want a full-time, dedicated operator who will make the proper management of this asset and the people involved a priority.
3. One Managing Partner
If there is only one managing partner within the company handling the deal, what happens if something happens to this one partner. What happens to the deal? How does the deal continue? Who takes on the financials and the exit plan? Looking for an operator with multiple managing partners is a good idea. Teams always bring great things to the table.
4. No Succession Plan
You want to understand who the partners are within the company. A business with multiple partners allows for a good succession plan. They need to have a plan in place to make sure their team is ready to continue with the deals and investments they have in place.
5. No Preferred Return
Preferred return is when the operator is so confident the property will make an excellent return that they are willing to give away the first X percent of the deal to the limited partners.
If there are no preferred returns, this doesn’t mean it is not a good deal, but do your due diligence and dig a little deeper into the real estate syndication waterfall model and see what is going on and why a preferred return is not being offered.
For a “heavy lift” project (a project with major renovations) the renovations could take years and the money earned will be put back into the project, which is a major reason why preferred returns might not be offered. But these type of projects usually have much higher returns at the back end.
6. Distributions are Return of Capital
You’ll want to determine if the distributions are a return of capital or return on capital. Either one can be okay when it comes to a real estate syndication.
You need to research and understand exactly how returns are calculated and whether you’re to expect your initial investment money back or not. You’re investing your own capital and need to know how returns will be handled.
For example, if you invest in ATM machines (a very common investment) the returns look phenomenal! – 18 to 22%! But when you look closer you realize that at the end of the term, usually 5 years, you don’t get any money. The asset you are invested in has a limited life and is worthless at the end of the term. So the money you receive on an annual basis is BOTH a return on capital and a return of capital.
7. Skin in the Game
Do the operators have skin in the game? Is it their general practice to invest alongside the limited partners?
There are some reasons a general partner would also want to invest in the property. The major one is to represent and prove their belief in the properties, and secondly, so they can reap the tax benefits too! This may be a red flag if they do not have plans to invest alongside you.
However, this does not mean that every general partner needs to invest in the project. Some of the general partners may have limited funds to invest and can’t invest in every deal they are involved with. Make sure that the major GPs are investing.
8. Encountered no Challenges
If you’re talking to an operator and every deal they have ever conducted has been a success, that means they have no experience navigating a bump in the road. This type of practice seems pretty unrealistic and may mean they’ve only been in business a short time or during a hot market.
We know all investments have risks, and if deciding between two operators, it may be best to go with the one who has had to deal with some bumps in the road because it shows they know how to conduct themselves in different situations, make tough decisions, and still produce successful opportunities for their investors.
9. Dodges Questions
Poor communication is a huge issue. If you are asking multiple questions or the same question in different ways and the operator continues to dodge the question and not answer it or does not seem interested in answering any of your questions; this is a huge red flag. You want to make sure your operator knows the answers or can quickly gain access to the answers.
There you have it!
Nine red flags you can look for when doing your due diligence as you research and vet operators.
Try not have unrealistic expectations about what you may find. Remember, operators are not perfect. Remember to refer to what we often call the “gut test.” It’s always in your best interest to follow your gut feeling. If your gut is telling you this operator does not align with your best investment or personal interests, it’s time to walk away.
The Perfect Operator For Your Investments
In any endeavor, you want to make sure you have the best team built around you. Real estate syndications involve risks, and it is always in your best interest to make sure each person on your team is the best fit.
Whether it’s an experienced sponsor, an operator, or other members, you want to do your due diligence to vet anyone who will be a part of the real estate transaction. Use the valuable advice throughout this article to help you perform thorough due diligence and avoid the major headaches one might experience if they wound up working with the wrong operator.
