Vetting the Sponsor - Focus on Capital Preservation

5 Replies

While capital preservation may not be very exciting, it certainly is one of the most critical building blocks of a solid deal. Every decision and initiative by the sponsor team should be rooted in preserving investor capital.

The five capital preservation pillars used in real estate syndication deals include:

  • Raise money to cover capital expenditures upfront
  • Purchase cash-flowing properties
  • Stress test every investment
  • Have multiple exit strategies in place
  • Put together an experienced team that values capital preservation

When browsing for your next real estate syndication investment, go ahead and soak in the pretty pictures, daydream about the projected returns, and imagine how smoothly that business plan might go.

Then, take a second pass, read between the lines, and look back through the deck with an investigative eye. Look for hints that capital preservation is as important to the sponsor team as it is to you.

What else should you ask the Sponsor to see if a passive investment is a good deal?

@Justin G. the multiple exit strategies is a big one I look at.  usually looking at the area and what industries will allow me to pivot the exit if needed.  What are some ways you have seen as successful strategies for "stress testing" an investment.  I'd be interested in your thoughts.  

"Rule No. 1: Never lose money. Rule No. 2: Never forget rule No. 1." - Warren Buffett
I agree that capital preservation is of utmost importance in any type of investing especially when you are handing money over to a syndicator. Some of the things I look at when determining if the underwriting is conservative in a multifamily deal (after vetting the sponsor) include the following:
1) Exit cap rate at least 0.5% higher than the entry cap in the pro forma
2) Breakeven occupancy is less than 80% (personally I like to see it below 70%)
3) DSCR of greater than 1.25
4) Conservative stabilized rent growth
5) IRR partition ratio of at least 25/75 meaning 25% of your IRR is coming from cash flow from rental income and 75% from sale proceeds and return of capital. I like to see the ratio at or closer to 30/70. The closer these numbers get, the faster your money is returned to you during ownership of the asset (preservation of capital).

If one is really looking at lower risk, capital preservation, then one might want to look lower on the capital stack. Equity will always be more risk than debt. Funds backed by first lien debt on cash flowing commercial Real Estate at lower LTVs fits that. There are a number of high yield debt funds that would work. Verivest.com is a good place to filter down on those.