For accredited investors, private real estate can offer superior risk-adjusted returns and serve as a non-correlated asset class in a diversified portfolio.
Real estate has a low correlation to public market performance and substantially less volatility. It is a unique wealth-building vehicle that can offer dividend distribution, capital appreciation, substantial tax benefits, and a hedge against inflation.
To fully realize these unique benefits, you must participate in the private markets. For the majority of investors who lack the time, experience, or capital to purchase assets directly, this requires investing through a sponsor. With all of the noise and conflicting messages in the market, many potential investors find that selecting a trustworthy sponsor proves to be a challenge. These five criteria can guide your due diligence and help build confidence in your decision.
1. Track record
The first thing you’ll want to consider when investing with any potential sponsor is their track record of success in similar past deals. Ask to see evidence of consistent returns over time. Improvements in operational cash flow over time will illustrate whether the sponsor created value or simply got lucky with a well-timed exit. Be cautious of investing with any sponsor attempting a deal at a scale, or in a market, product type, or business plan with which they do not have previous experience and success.
Check to see if your sponsor has developed expertise in a particular niche. Do they have deep operational expertise in a particular sector or market? An operator who’s had previous success in retail properties, for example, may not be able to succeed with an industrial property deal. Likewise, even sponsors familiar with a sector or geographic market can struggle in implementing a strategy that is new to them. For example, extensive redevelopment or value-add strategies require a different skill set than managing a stabilized property.
3. Management experience
Look for an operator with a management team with years, and preferably decades, of industry experience. Ideally, the team will have had success operating across multiple market cycles. This experience will provide better context and effective underwriting of new investments.
4. Investor reporting
No one likes to be left in the dark, particularly when entering into a long-term partnership in a relatively illiquid investment. Ask about the sponsor’s reporting procedures and technology. You should have confidence that you’ll receive regular, transparent, and understandable reporting on the performance of your investment. Ask to see copies of previous quarterly or annual reports and ask for references from existing investors to hear firsthand about their investment experience.
5. Sponsor co-investment/alignment
Lastly, and perhaps most importantly, be extremely cautious about any sponsor who is not investing significant personal capital alongside you. As a passive investor, you’ll want your partner to have “skin in the game” to ensure that your interests are aligned: They should profit when you do from the performance of the property – not through a complex or hidden-fee structure.
Your due diligence on a potential sponsor is likely more important than any individual investment transaction you might make. Though past performance is never a guarantee of future success, choosing a sponsor who can deliver on the five criteria listed above will help you have confidence in your partner.