What are some SOPs or best practices on due diligence before investing into a fund?

Question

Hey team,

My name is Chris Hoffmann, I am a small business owner based in Dallas, TX. Just finished up the winter Rookie Bootcamp where my wife and I have decided to leverage a HELOC from our primary residence to invest into a fund managed by people way more experienced than us as we learn.

That being said, we don't want to be taken advantage of. What are some best practices, checklists, etc that you follow in due diligence regarding a fund?

Keep in mind- the investment group we are looking into provides a deal platform that breaks down the deal and also provides a LIVE webinar to ask all of your questions. I know the co-partner from an event I attended and he would give me more 1:1 if I needed it.

Any advice, feedback, or resource would help. Thanks in advance!

Chris Seveney · Answer

We posted two blog posts on this. We agree with the other poster that you want to review multiple offerings. I agree with the other poster as well that taking money from e HELOC if your rate is 7-8% at the end of the day is not going to net you significant dollars compared to the risk you may be taking on.

The most important of what we wrote is about a companies financials and sponsor experience. If they cannot provide you the last quarter financial statement that deal is dead to me.

Nicholas L. · Answer

@Chris Hoffmann

i haven't invested in funds... but i don't think it makes any sense to invest borrowed money

good luck

Bruce Lynn · Answer

#1....don't just look at one group.....there are 100s or 1000s of groups.   One thing I see is that people go to one presentation and kind of hone in on that 1 group, when there are lots of options out there and often much better returns.

#2....Personally I don't like funds....I'd look at single asset deals.  Funds are often better for the sponsor than the investor in my opinion.  Gives them less risk of raising funds, especially in this environment when it is much more difficult for most sponsors to raise money.

#3 Investing in funds often means you don't really know where the assets are going to be.  I did see one fund recently where the assets had already been identified, but I want to know where those assets are and also the performance of the asset.  Investing in a fund, you're really going in blind in most cases.   Remember also that the sponsor has an incentive to spend that money...they're normally getting a fee for the purchase like 1% maybe.  So instead of selling you on the performance of a specific property and you deciding if that is the right deal for you, once they have your money, they could be motivated to spend it, even if the asset as not as good as you expected.

#4 In a fund you also don't really know what financing will be used on the property.  Single asset you do.  One fund I saw recently said something like, well we usually have this kind of capital stack, but it's been tough raising money...so we may use pref equity if we don't raise the goal.   That will cut your returns.   Probably no one using bridge debt today, but if they can or will do it, that could also cut your returns.

Personally I do not like that you're trying to pull money from HELOC to invest.  If you're looking at multifamily then in today's world I think most people would be looking at somewhere around 15% IRR target, and 8.5 on the HELOC.   For that spread and risk, you might be better off putting it in index funds or maybe even in just high yield savings...probably can get 4.5% in high yield savings with almost zero risk.   Fund or single asset, these can be super risky investments.  Thats why your PPM says several times throughout the document that you can loose your ENTIRE investment....so invest what you can afford to loose.  Personally I would not do that with your home equity.   I think most financial advisors would tell you the same.  I'm sure Dave Ramsey would tell you not to do that.

There are people who have already been 100% wiped out this year and there will be plenty more that get wiped out during the rest of the year and all of 2024.  That means not only no return, but also their investment is 100% gone.   So be super careful who you hand over your money to.  The next 2-3 years will also likely be a place where they prove true that saying....past performance is not indicative of future success, or whatever that phrase is.

Leo R. · Answer

@Chris Hoffmann investing borrowed money (like HELOC funds) is often extremely risky...very smart, very experienced people have gone bankrupt trying to invest borrowed money.

Of course, it also depends on how large the HELOC debt is compared to your overall financial picture. Warren Buffet can afford to use $100k of HELOC funds on an investment because that borrowed money is just a tiny fraction of his net worth--even if he lost it all, he could easily pay off the debt with other funds and move on with his life. Most people are not Warren Buffet.

As others have mentioned--even if you ignore the significant risks of investing borrowed money--the difference between the HELOC debt service and the investment return would likely be very minimal.

Good luck out there!

Bruce Lynn · Answer

If you are in startup mode I would suggest getting signed up with several different deal sponsors and start looking at their deal flow.   Watch the webinars.   Study the PPMs.  Maybe get some of the public company financial report and study those.   Look at different sponsors and what they charge for acquisitions fees, management fees, capital event fees, disposition fees, waterfall fees and such.  Look at their history.  Go to their meetups or zoom calls.  Listen to the podcasts.  All operators are very different.   There is opportunity....but often the pitches are better than the results.   I have not read the book but many recommend the book storing up profits.

David M. · Answer

@Chris Hoffmann

Borrowing money to invest is pretty risky in my opinion.  That's what banks do, and try to make money on the net interest margin...  I don't do it because I'm more conservative and I don't consider myself in the banking business..

Honestly, with the way the public markets are doing, you might as well invest in a publicly traded fund.  There are plenty of opportunities for income producing or growth, even just in REITs if you are laser focused on real estate.

I think the questions to ask are "tough" as in they aren't really questions.  How do you know if these managers are any good?  How do you know if their operating plan is any good, much less able to execute well?  Or, can they execute well in spite of a poor plan?  I'm always afraid that they will take my money and "run."

Congrats on the baby.  Good luck.

Chris Hoffmann · Answer

@Bruce Lynn thanks for the honest feedback and my apologies for the delayed response, my wife and I are on the final stretch of baby number 2 arriving. To your points1) This is a good point- as with little time to spend to speed up my learning curve on real estate investing- I think I have put a lot of my marbles into one bucket- due to meeting someone in person who has a lot of social proof. Will look into more here in Texas. 2) I can see that. 3) The asset in this case is either land or the development of a self-storage unit. They are promising a 6-month return at about 20% of your investment (with land). Once the 6 months is done they buy the land then the development company buys out the investors (ME) to build the self-storage unit. *Good point on not knowing the financing as I can see how that is important and also the timing of the market. We were thinking of getting more serious next year- right now it's a lot of data collection and strategy planning.

What are some SOPs or best practices on due diligence before investing into a fund?

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