Sponsors are essential in making sure that a passive real estate investment deal works for all parties. But what does a sponsor actually do to earn their money? I’ll give you a clue: it’s not just signing a check.
What is a Sponsor?
In real estate investment syndications, a sponsor is the person or people in charge of the deal, and they’re also known as the “general partner” or “manager of the entity.”
You can think of a deal sponsor as the CEO of a company. A talented CEO can lead a company to greatness, while a poor leader can cause the business to tank.
Even an otherwise good deal is likely to fail if the sponsor can’t run it well — their role is that important.
As I’ve said before it’s essential for investors to understand the market, the deal and the sponsor, and the sponsor is the most important part of that trinity.
It’s rare for there to be a single sponsor doing everything, as this puts a lot of responsibility and risk on one person so, there are often multiple people – or a company – acting as the sponsor. That company will typically assign different people to the project.
A sponsor could be a jack of all trades or a small team of sponsors, and that team may be divided by their areas of expertise. For example, I might do an acquisition and then bring the deal to another individual or a small group of sponsors with other skills that complement mine. Sponsors do a myriad of things and take on a lot of responsibility for the success of a deal, which is why they get paid. Let’s look at the two main phases of their work: acquisition and asset management.
Acquisition
Acquisition is the upfront work to find and analyze a deal that makes up the real estate investment.
Finding these deals might sound easy but there’s a lot of work involved.
For starters, sponsors need to establish relationships with brokers, and get to know areas/locations.
They also create and maintain personal contacts with other owners, all the while looking for new opportunities for acquisitions.
All of this relationship building can take years.
Sponsors spend significant time analyzing the deals and the local market.
They need to keep an eye on where their deals are going and on the state of development in their target areas. That means understanding the demographics and trends of the many submarkets within the main market of interest. I cover more about this in my book — Backstage Guide to Real Estate — but suffice to say this is ongoing work that requires thought and experience.
Sponsors make deals happen, which is everything from making a hypothesis, doing the underwriting, crafting an offer, all the way through to getting the deal under contract.
Once a sponsor has a deal under contract, they usually need to put down a deposit, which might be partly or fully non-refundable. This is upfront “at risk” capital.
Then they go through steps to acquire the property, including negotiating a mortgage. Their name goes on the loan agreement so they’re ultimately responsible if the deal doesn’t work.
They also conduct due diligence during the acquisition process, inspections, loan applications and all the banks’, lawyers’ and inspection costs. All of this is lost if the deal doesn’t go through, so again it’s a risk to the sponsors.
If I’m a sponsor on a deal, my due diligence includes trying to physically see every single unit that I’m buying if it’s humanly possible. And that’s no small task: I want to check boilers, AC units, interiors, the general property conditions, and more to ensure that I’m not investing in a dud that has some secret renovation bill that no one told me about.
Only when a sponsor has been through all of this upfront work should they close on the property.
With the deal secured, the sponsor has to keep in mind the economy and market conditions. For example, it might be better to sell early to avoid the risk of a market downturn.
But before anyone can think of selling and making a return, there’s the not-so-small matter of running the property through the lifetime of the deal. Those operations are totally different from acquisitions, but they’re also the responsibility of the sponsor. This is the domain of asset management, so let’s look at that next.
Asset Management
The second main role of the sponsor is asset management — the successful running of a property for the lifetime of the deal so that it can return a profit upon sale or refinancing.
This is a lot of work and a lot of the time, small sponsorship groups will divvy up the responsibilities and hire a third-party property management company.
Some large sponsorship groups might be “vertically integrated” and have their own in-house property management company.
Either way, the sponsors’ responsibility is to ensure that the property is run well.
Whether the sponsors do everything themselves or not, the important point here is that they’re responsible for the success of the deal and so it’s vital that you deal with people who know how to manage and run a business.
Their experience doesn’t even have to have been in real estate but they do need to at least have the basics of managing and running a business (which is more than just being able to read a profit and loss statement.)
These deals usually run over 5+ years and need to be profitable and run well throughout that time. So, you need people who are demonstrably competent in running a project of that length. In my experience, previous entrepreneurs and project managers can do this well.
What Asset Managers Do
The asset managers are responsible for managing people, budgets and timelines — everything from which staff carry out which roles, how much to pay for renovations and upgrades, to when it all happens. It’s a big project management job, especially for property investments that span hundreds of individual units.
A good asset manager will sometimes show up as a surprise and see whether the property is being managed properly. Conduct weekly or monthly check-ins to see that the property is being managed well. These check-ins will involve looking at different KPIs, including occupancy, delinquency, collections, and market surveys.
Choose the Right Sponsor
When looking at the sponsorship team, find out what sort of track record they have. What other deals have they done? How did those deals perform? If you can get references from a few other people that have invested with them, that’s great, but obtaining those references can be difficult and sponsors are reluctant to give out the names of their investors, who are usually very busy professionals.
My favorite way to meet a sponsor is to be introduced by another investor that I trust. That way, I know they can vouch for the sponsor. I find that’s the best way to have confidence in someone you haven’t worked with before.
If a friend of mine tells me they worked with a sponsor and that sponsor was great, very communicative, and kept them informed through the whole process (and by the way, made a handsome profit) then that is someone I want to meet!
Keep in mind though, that the right sponsor for you might not be the same as the right one for someone else on another deal. You really want someone who matches your communication style, has similar goals, the same approach to project management, and common values.
If you’re doing serious business, you need to choose people you can trust and get along with. Without this, the best-looking deal in the world might turn into a major headache.
Questions to Ask
Here are some questions to ask of sponsors to reduce the risk of your deal containing any unexpected and unwelcomed surprises:
• How is everything going to be run?
• How clear will their communication be?
• Are they going to send out monthly or quarterly updates?
• Are you only going to get an update when there’s good news?
• Will they devote the time to actually get on the phone with you if you have questions?
• If you have concerns, will they discuss things with you?
The key words here are transparency and accessibility.
Assess Your Sponsor
We’re just scratching the surface with the questions I have mentioned. There are actually a lot more questions to ask when assessing a potential sponsor to work with.
Again, I can’t stress how important it is to choose the right sponsor for you. Without the right captain of the ship, you risk sailing off course (and waving goodbye to your profits.)
Are they easy to deal with? Watch those early interactions. How do they act when you’re talking with them? There’s a lot to be said for surrounding yourself only with people you like and can communicate well with. Passive real estate investment shouldn’t be a stressful activity of butting heads with sponsors. If you don’t feel as though you’re in safe, supportive hands, don’t dive in.
Are they able to explain their role? Will your sponsor get on the phone and talk you through the deal from start to finish? How well do they know what they’re talking about? If they can’t answer your questions, think about how experienced they are. Don’t be satisfied if you get answers that don’t make sense or feel incomplete. Someone who knows what they’re doing should be able to explain their involvement and put your mind at ease. Also, beware of anyone who tries to claim that you’re guaranteed great returns and that there’s no risk. All investments involve some sort of risk! A responsible sponsor would never hide that from you.
When you ask questions or challenge assumptions, how do they react? If they’re not open to feedback and it’s their way or the highway, what happens if you disagree with something that happens relating to the deal? Also, if they aren’t available and transparent before you invest, how are they going to behave once you’ve already given them your money?
Do they follow SEC rules? This one could be a big red flag. If a sponsor doesn’t show due respect to the SEC rules, what other rules might they bend or break?
Are they solely raising capital? If a sponsor just raises capital to become a general partner in the deal, then they’re breaking SEC rules. A sponsor’s compensation cannot be based on the amount of capital they raise.
Do they show positive professional signals in their marketing? This may not be the most important factor but you should check out the sponsor and see how they show up online. Do they have a good website? Are they running everything through a free email address? Do you even have a reliable postal address for them?
As you can see, there are a lot of considerations when deciding whether you want to get into a deal with a sponsor, and there’s also lots of work for that sponsor to do when making and running a deal.
Join me backstage, at Picheny Investors Club where I help people become successful Sponsors in real estate syndications and separately, I help passive investors get into great deals so that they can make an income from investing in real estate.