Anyone who is interested in commercial real estate investing should have at least a rudimentary understanding of how the real estate sponsorship process works. Before you invest in a development project, it’s vital that you properly vet the sponsor to make sure they have the necessary experience to lead a successful commercial real estate project.
Fortunately for the rookie real estate investor, we’ve put together a crash course on getting started with real estate sponsorships. While we can’t make you an expert with one article, we can explain the basics and give you some valuable tips on how to decide if a sponsorship opportunity is a good investment.
In commercial real estate jargon, the term “sponsor” refers to the person or business that essentially runs the show on a commercial real estate project.
A sponsor manages every aspect of the transaction from conception through completion, which usually includes taking on the following responsibilities:
The sponsor is often referred to as the syndicator or the General Partner (GP), while the other equity investors are called Limited Partners or LPs. LPs usually have a more hands-off role in the management of the real estate project, so you might also hear an LP referred to as a “passive” or “silent” partner.
Because of their limited involvement, silent partners also have limited liability. This means that if the project goes belly up, LPs can’t lose more than the amount they’ve invested.
Check out our article, How Real Estate Syndicators Protect Assets & Avoid Taxes.
As a novice real estate investor, you might think you have to take whatever sponsorship you can get. However, nothing could be further from the truth. Savvy investors know they can’t afford to throw away their hard-earned money on failed projects, and getting a return on your investments is particularly crucial if you’re just getting started in the commercial real estate game. Since some sponsors have much stronger qualifications than others, you need to find a sponsor you can trust.
Here are a few things you should consider when evaluating a real estate sponsor for a potential investment:
You should evaluate the sponsor’s prior success— not just with real estate developments in general, but in the particular location and asset class of the potential investment. For example, you probably don’t want to partner with a sponsor who has only worked on apartment buildings on a retail property development project. Instead, look for a sponsor with experience working with the type of asset involved in the investment project.
The sponsor’s track record when it comes to failures is just as important— if not more important— than their successes. While most experienced sponsors will have a few black marks on their record, it’s essential that you understand what went wrong and how the sponsor handled it. It’s a major red flag if a sponsor has a history of keeping silent partners in the dark when things get tricky.
Obviously, getting paid is the reason you’re looking for a sponsorship in the first place. With that in mind, make sure you review the payout structure and understand how you and the sponsor will make money from the investment. Be wary of structures that are overly favorable to the sponsor, and make sure the proposed payout aligns with everyone’s interests.
Make sure to thoroughly evaluate the systems and processes the sponsor uses to make sure the project is appropriately managed. Look for a sponsor that has a coherent and consistent plan in place. The sponsor should also be able to confidently articulate a clear investment strategy for the project and explain how it will make income.
Just because you’re a new real estate investor doesn’t mean you have to settle for a sub-par sponsor. Investing in a commercial real estate development project with a sponsor you can’t trust to manage it well will not only cost you a lot of headaches, but more likely than not, it will also cost you cold hard cash.
Whether you’re a brand new investor or you’ve been doing this for years, you should never forget that you always have the power to walk away from a bad sponsor. If you can exercise the patience and wisdom to wait for the right deal, you’ll end up with a much better investment opportunity.
Scott Royal Smith is an asset protection attorney and long-time real estate investor. He's on a mission to help fellow investors free their time, protect their assets, and create lasting wealth.
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