Due Diligence: Essential Questions for Evaluating a Deal

When considering a real estate syndication investment, conducting due diligence on a specific deal is crucial. Here's a guide to the key questions you should ask the sponsor:

Understanding the Seller’s Motivation

Question: Why is the owner selling?

Insight: Reasons can vary from retirement, upgrading, property underperformance, or flipping. The reason may not be critical, but understanding it can offer context to the deal.

Property Valuation

Question: Is the property being acquired for less than comparable buildings in the area?

Insight: The total cost, including purchase and capital expenditures, should be lower than area comps. Otherwise, it might indicate an overpayment.

Cap Rate Analysis

Question: What are the going-in and stabilized cap rates compared to the market?

Insight: In value-add deals, a higher stabilized cap rate indicates more equity being created. However, initial lower NOI and cap rate are less concerning.

Risk Identification

Question: What are the major risks associated with this project?

Insight: A reliable syndicator should recognize potential risks and have mitigation plans in place.

Inspection of Major Systems

Question: Have you inspected the major systems of the property?

Insight: Confirmation that the GP has personally inspected critical systems is vital for accurate capital expenditure budgeting.

Investment Duration

Question: How long will my money be tied up in the deal?

Insight: Understand the projected timeline, hold period, and exit strategy, which could be a refinance or sale.

Minimum Investment Requirement

Question: What is the minimum investment?

Insight: This helps determine if the deal aligns with your capital availability.

GP’s Personal Investment

Question: How much are you investing in the deal?

Insight: The GP’s personal investment can indicate confidence and alignment of interests.

Operator’s Liquidity and Capital Commitment

Question: How important is your own capital investment in the deal?

Insight: Understand the balance between the GP's capital commitment and the need for liquidity to manage the operation effectively.

Offering Type

Question: Is this a 506(b) or 506(c) offering?

Insight: This affects who can invest and the verification process for accredited investors.

Capital Expenditures Budget

Question: How did you determine the CapEx budget?

Insight: Look for budgets based on contractor bids rather than approximations.

Tax Assumptions

Question: Are tax assumptions based on the current owner's payment or the purchase price?

Insight: Tax calculations should be based on the purchase price for accuracy.

Debt Structure

Question: What is the debt structure on this deal?

Insight: Details about the financing, such as the term, interest rate, and whether it's locked-in or variable, are crucial.

Exit Strategy Assumptions

Question: How are you calculating the sales proceeds and exit cap rate?

Insight: A conservative approach assumes a higher exit cap rate than the current market rate, anticipating market downturns.

Conclusion

Understanding the motivations behind a property's sale, its valuation compared to the market, and the associated risks and financial strategies through these key questions can offer investors crucial insights, leading to more informed and strategic investment decision.