Do you want to invest in real estate?
Then it’s important to understand that there are several players involved in bringing your project to fruition.
Here’s the thing…
A single deal involves several parties such as the General Partner (GP), Limited Partners (LP), lenders, contractors, attorneys, appraisers, and more.
However, the most critical player in real estate investment is the Sponsor.
Who is a real estate sponsor?
In commercial real estate, the Sponsor refers to an individual or company that effectively quarterbacks the project from conception to completion. A sponsor is responsible for all aspects of the transaction and operations.
A sponsor also aggregates capital and signs their name on all related loan documents. The Sponsor is responsible for finding, acquiring, evaluating, managing, and disposing of the real estate property on behalf of the partnership.
Sponsors also solicit investors for the partnership.
Therefore, before you invest in a deal, you’ll want to ensure the Sponsor’s experience is appropriate and proper track record to justify investing your money into it.
This article will address the importance of a sponsor in real estate investment and demonstrate how a sponsor is even more important than the property.
What’s the role of a sponsor?
The Sponsor champions all aspects of a commercial real estate project on behalf of equity investors.
The Sponsor is mostly referred to as the General Partner (GP), while the rest of the investors are the Limited Partners (LPs). LP’s role is mostly passive, therefore called the silent/passive partners.
As a result, LP investors have a limited liability- which means their potential loss is lower and limited to the amount of their investment.
The LPs trust the Sponsor, and the Sponsor has significant roles and responsibilities throughout the project lifecycle.
Here are the roles of a sponsor.
- Locates and negotiates the purchase of the property. The Sponsor’s role starts many months before investors even know the potential deal exists. The Sponsor finds a deal on the market or off-market and negotiates the terms of the purchase and sale agreement.
- Deposits significant sums of at risk earnest money, loan application fee, legal fees, etc.
- Performs due diligence on the property reviewing the physical aspects such as the plumbing, HVAC, roofs, along with all contracts
- Communicates with other investors; The Sponsor prepares investor marketing materials and assembles the equity capital and debt financing needed to acquire the property.
- Performs initial legal and tax diligence. The Sponsor oversees all pre-acquisition activities such as due diligence which includes engaging specialists to review existing financial information and provide third party reports on other important aspects.
- Arranges for management of the property and makes day-to-day operating decisions; After the acquisition, the Sponsor oversees project operations and management. Operations may include planned renovations, leasing, and maintenance.
Investment management also depends on the size of the project. The Sponsor may hire a property manager to handle the day to day management of the property. But the Sponsor will oversee the entire process to ensure they meet all the project objectives.
Eventually, the Sponsor is solely responsible for all aspects of the project.
- Manages the partnership; The Sponsor is responsible for all the financial reporting- usually shared with investors in quarterly reports. Financial reports cover drawdown requests to the lender, payment to investors following the operating agreement. They also engage accountants to prepare and handle tax matters.
- Obtains bank financing and negotiates the final disposition of the property.; The Sponsor arranges for the refinance or disposition of property at the end of the investment period.
In most deals, the Sponsor provides limited financial investment but brings valuable expertise to the deal. Investors provide most capital but do not involve themselves in the daily operations of the investment.
Most sponsors take acquisition fees because of all the work they put into the project, such as evaluation, underwriting, and preparing the deal for acquisition. The acquisition fees cover all the costs the Sponsor incurs at this stage.
How do you evaluate the importance of the Sponsor?
Given their importance in real estate investment, the Sponsor must be highly qualified.
The Sponsor should bring specific expertise to the project, whether about the local market, asset class, or both.
Therefore, as an investor, you should feel confident that a sponsor has a solid reputation, strong track record, right debt and equity relationships, and all other requisite skills and expertise needed to manage the investment cycle.
However, not all sponsors are equal. Some are more qualified than others, therefore more important.
Here’s a checklist of how to evaluate your sponsor;
- Sophistication of the property manager your sponsor is recommending. The manager should be able to screen tenants for employment, income, credit, criminal record and tenant performance.
- The sponsor should be able to put together an introduction of themselves to answer personal questions investors may ask
- Get their bio and resume – Their nbio should demonstrate business savvy, financial leadership, and managerial experience. Ability to hire lead people is also a plus.
- Do they have a deal history? Can they provide past books and allow you to visit properties etc.
- Look at their references, people they have worked with in the past. Did the sponsor hit projected returns?
- Obtain credit summary and investor questionnaire to [prove their sophistication and accreditation.
- Do they currently have their own properties or businesses? If they do, then review the associated P&Ls.
- Who is their mentor and is the mentor involved? Can they make money in up and down markets?
- Evaluate their team; legal counsel, property management, who secured loans, and who oversees the rehabilitation.
- Experience in the local market and that asset class. A sponsor who works primarily works with office or retail properties may not be qualified to sponsor the acquisition of apartments of 100+ units.
The Sponsor is more likely to have insight into or resources in markets with offices, investments, or employees. Choose a sponsor whose experience is aligned with your interests and goals.
- Level of failure and success of previous projects. First, a failed project is not always a red flag. But ask the Sponsor to elaborate and help you understand what happened and how they course-correct. The Sponsor also brings invaluable lessons learned from failures and successes.
- Sponsor’s capability in evaluating risks. Every project carries a degree of risk. The Sponsor can evaluate and explain the risks involved and how to mitigate them during the project cycle.
- Ability to identify other equity investors and arrange debt. A sponsor has several ways to line up equity investment. It could be through a fund, personal relationships, crowdfunding, among others.
When it comes to debt, the Sponsor could use a debt broker or develop strong relationships with individual banks.
A sponsor with a healthy relationship can quickly help you navigate through a recession. They can also get cheaper debt for the investment by leveraging existing bank relationships.
- Systems the Sponsor has in place to ensure proper management of the investment. Your investment will benefit from the Sponsor’s robust systems and processes, from financing to renovations through leasing and stabilization.
In short, a sponsor is the most important factor in commercial real estate investment success. Therefore, ensure to select one that is highly qualified and a proven track record.
As a passive LP investor, your decision making authority is limited after deciding to invest. Therefore, ensure you understand who you are working with, their responsibility, and how they plan to execute the project plan.
Working with a credible real estate investment sponsor
While investors contribute capital, the success of your investment relies heavily on the Sponsor.
The Sponsor serves as a fiduciary to other investors, providing reliable stewardship of the capital invested and creating long-term relationships for future sponsored commercial real estate investment opportunities.
Therefore, choose a sponsor whose projects are aligned with your interests and goals.