What Differentiates A Good Sponsor from A Bad Sponsor?

What Differentiates A Good Sponsor from A Bad Sponsor?

There is an element of risk in everything, especially when it comes to finances.

For example, keeping one’s savings in a bank account, with the knowledge of exponential inflation, could be riskier than making a smart investment.

But making that investment — choosing to act and commit to a strategy — can feel risky, too.

You did your due diligence and feel confident in the choice to invest in multi-family real estate. And you know your sponsor can make or break the experience. How do you know who to partner with?

First, refer to the criteria identified in The 7 Keys to Passive Investing in Multi-Family Real Estate: Trust, Track Record, Team, Transparency, Type, Thesis, and Terms.
The first four — Trust, Track Record, Team, and Transparency — are specific to the sponsor vetting process:

  • Trust. The first and most crucial key when vetting a sponsor. It is the foundation everything else builds on.
  • Track Record. Evaluate the data the sponsor presents. Objectively, how is their portfolio’s historic performance?
  • Team. Investments are not made by an individual. You need an understanding of who the decision-makers are and everyone who will touch the deal. Find out who is responsible for what, and who is accountable should things go south.
  • Transparency. Evaluate the level of communication being offered to you – reporting, team accessibility, online portals, and support processes. You need to have visibility into every aspect of your investment.

These keys take you through a chronologically prioritized funnel of evaluation criteria for how investors vet sponsors and improve investor-sponsor relationships. Start with Trust and do not move down to the next stage of the funnel unless the prospective sponsor passes with flying colors.

That seems simple enough in theory, but murkier in practice. How can you tell who to trust? How flawless of a track record is acceptable? And so on.

When differentiating a good sponsor from the ones you want to avoid, does it just come down to instinct? No.

You never know what answer you need until you know the question you’re asking. There are some telltale answers to look for when you begin the vetting process, and you can uncover them by asking these three initial questions:

  • Can you tell me about your worst deal? Better yet, your worst few deals. Go deep into those stories. Ask what went wrong, if it could have been avoided, and when they knew things were going badly. The response to this question will let you know how the sponsor treats their investors when things do not go according to plan.
  • What lessons did you learn from those bad deals? Nobody wins all the time. How they react to those less-than-ideal circumstances, and the learnings they take into their future decisions, is what counts.
  • Historically, where have you forecasted returns relative to where you ended up? This might be a calculation that is somewhat hard to produce on a deal-by-deal basis. That would be the ideal information, but even knowing a portfolio-wide average delta can tell you a lot about a sponsor.

You know the questions. Now, what answers are you looking for? That, we cannot tell you. Because the differentiation between a good and a bad sponsor does not always come down to numbers.

Every businessperson has made some deals that did not pan out the way they hoped. Every business has been off on its projections. The point is not to look for a sponsor with a perfect track record. The point is to listen to how they speak about these instances. Call them failures or call them learning opportunities. Is the sponsor transparent in sharing the details of what went wrong? Or do they hide information or avoid the question and try to get you to focus only on the good? Of course, the facts a potential sponsor presents are important. The integrity they show is invaluable.

Risk is relative. But passively investing in multi-family real estate with a good sponsor (and that is an important qualifier) is unequivocally the best risk-adjusted investment option in existence. Do not take chances on a good sponsor and you will not take chances on your investment.

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