Rules to help create good deals and avoid bad ones – Part I.
Rules to help create good deals and avoid bad ones – Part I.
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Investing in commercial real estate is a highly competitive field. If you are not yourself highly skilled and experienced in making this type of investment you may want to work with someone that offers you the chance to invest in one of their “deals”. Here are some things to look for when selecting someone to invest with.
Look carefully at the “sponsor”. Sponsor is a real estate term for the owner of a commercial property and/or the person or firm that is offering a real estate participation. The sponsor is the borrow or guarantor in a commercial property loan. Here are some important criteria for a good sponsor. The sponsor has sufficient net worth to be able to deal with the ups and downs that are always part of commercial real estate cycles. In construction there are always cost overruns. In operating an income property (like apartments and office buildings) a higher than anticipated vacancy rate may occur. Does this sponsor have access to enough capital to weather any kind of storm?
Does the sponsor manage a firm that has high quality experienced employees? The day-to-day management of properties makes the difference between higher income properties and properties that struggle. The sponsor’s firm oversees leasing and obviously that is a critical function that must be done well.
If this is an investment partnership opportunity take a careful look at how much money the sponsor is putting in the deal. Investment partnerships where the sponsor doesn’t have much skin in the game are high risk. If there is a loss in this investment, is the sponsor going to share in it or do they put all or most off the risk off on their investors. If the sponsor has a lot of capital in the deal it is a sign that they believe in it. If not, then buyer beware. How much of an investment by the sponsor is a good sign? 15% co-investment is a minimum. 20% or more is enough to show their limited partners that they see this as a good investment – not only for their passive investors but also for themselves.
See Part II of this blog series.