What I Want to Know BEFORE Performing Due Diligence

Question

What I Want to Know BEFORE Investing in a Passive Investment

Before I invest in SOMEONE ELSE’S deal, I want to know five things even BEFORE I analyze the financial data of the investment itself

• 1. Is the investment offering compliant with SEC Reg D Offerings? If it isn’t, I’d only invest if I have personal experience with the sponsor, or if I’m offered active participation.
• 2. Does the sponsor/manager/GP have a VERIFIABLE track record of success, both in real estate investments in general, and in the subject investment type in particular?
• 3. Does the sponsor have a significant amount of their own capital invested in the deal?
• 4. Are there environmental, legal, ethical, or regulatory concerns with the subject property?
• 5. What is the “backstory” on the subject property, ownership, etc?

1. Is the investment offering compliant with SEC Reg D Offerings? If it isn’t, I’d only invest if I have personal experience with the sponsor, or if I’m offered active participation.

2. Does the sponsor/manager/GP have a VERIFIABLE track record of success, both in real estate investments in general, and in the subject investment type in particular?

3. Does the sponsor have a significant amount of their own capital invested in the deal?

4. Are there environmental, legal, ethical, or regulatory concerns with the subject property?

5. What is the “backstory” on the subject property, ownership, etc?

Back when I first started investing in limited partnerships, I’d spend three days gathering and analyzing historical financials, projections, marketing material, reading appraisals and feasibility studies and visiting the subject property. Only after the property passed all this analysis did I found out (about 75% of the time) that the sponsor had little experience or there were title issues, or that environmental was considered high risk, or that the offering was in some way “deficient”. I then realized I was operating “backwards”.

For those who do invest in passive investments, how do you qualify your interest in the deal?

Chris Seveney · Answer

Not a self-promotion but we provide investors a very detailed due diligence checklist. We had one investor use it on us, put it in ChatGPT, have the information filled out about our fund, and come up with some really good questions. The five things you point to are critical, as many skip them over or did not go through all of them.

For example in the past, people would just look at the deal and not the sponsor, which is what created a lot of the havoc we are seeing today. When you have sponsors promoting videos about working 4 hours per week and, on the same token, raising money for a fund, a real estate deal that ends up wiping out the investors

Kasing Ng · Answer

First of all, I am a financial analyst and tax modeler rather than a passive LP investor, but filtering the sponsor and legal structure before analyzing financial data is the correct sequence.

Checking SEC compliance, track record, and sponsor co investment first prevents wasted time on unproven operators. Track record and financial alignment are especially critical because they dictate whether the operating assumptions in the model are realistic.

Once those checks pass, the final review before deep underwriting involves verifying the tax structure, particularly how exit liabilities like depreciation recapture are handled. Vetting the sponsor first is necessary because reliable numbers require a reliable operator.

Evan Polaski · Answer

All great questions and good starting points. While I don't terribly like the saying that used to go around: "bet on the jockey, not the horse" or something along those lines, these are good starting points, because a bad jockey will lose with the best horse, BUT the best jockey can't turn a terrible horse into a winner. (although good jockeys, presumably, will know a bad horse when they see it and simply pass).

The one piece I would add above even these questions is self and market due diligence. No point vetting sponsors for RV parks, if I don't think RV parks are a prudent investment opportunity. And even before that: no point even thinking about private offerings, if I don't have the wherewithal (financially or mentally) to lose my investment, which we have seen from many is a very real possibility, even when the sponsor is compliant with the SEC has a track record of success that is verified, etc.

Divin Kanyama · Answer

Great approach, @Don Konipol. Too many investors start with the projected returns before asking whether they trust the people and structure behind the deal.

Beyond track record and compliance, one of the biggest questions is how the sponsor performs when things don't go according to plan. Most deals look good on paper. The real test is how they handle cost overruns, delays, or a weaker market.

At the end of the day, a great sponsor can sometimes salvage an average deal, but a poor sponsor can ruin a great one. That's why sponsor quality is often the first filter, not the last.

Don Konipol · Answer

Thank you for your input. That’s a VALUABLE piece of advice about verifying tax structure. Especially when expensing capital investment can be used to create large losses for investors - which will be totally wasted to an investor investing thru retirement programs.

Ronald Rohde · Answer

Property replacement market rent. Operator balance sheet and are they committed to working hard to save the deal if it goes sideways?

Don Konipol · Answer

Ronald, do you invest in or legally represent either GPs or LPs? You seem to have a lot more “syndication savvy than the average attorney!

What I Want to Know BEFORE Performing Due Diligence

What I Want to Know BEFORE Performing Due Diligence

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