Are you and the general partnership team personally investing in this project?
As an investor, you want to see the sponsor(s) investing alongside the other limited partners. This ensures that all parties interests are aligned and suggests the management team believes in the property and projected returns.
Who are the primary management team members and what is their track record?
Ideally the sponsorship team has significant experience in the asset class, market, and business plan type (value-add) in which they are raising money for. In the example a lead sponsor is new to the market, have they aligned themselves with an established property manager, contractor, and team?
What happens if you cannot make the projected returns?
Generally speaking, preferred returns will accrue and have a catch-up provision clause. This means that if a project has not hit the preferred hurdle rate that the shortfall will be added to a running balance. The GP team will not receive any portion of equity until this balance has been paid thru future cash flows or sales proceeds. Check your PPM (private placement memorandum) for full details.
What is the projected timeline for this project?
Most multifamily syndicators are looking to execute a business plan in a 3-7 year time frame. Some are shorter, heavy value-add assets while other properties may be a longer buy and hold strategy.
What are the biggest risk(s) of investing in this asset?
You should never hear from the sponsor that there is no risk, as every investment carries some level of risk. For multifamily, the risks generally fall under the market, deal/financing, or the team. Understand what the uncertainties are and whether you feel comfortable with the offsetting upside.
What are the first three things to be done after closing?
By asking this question, you should understand the initial priorities of the management team in addition to confirming the business plan is well thought out.
How does the first year’s financial projections compare to the trailing twelve months?
As a limited partner, you will want to understand the business plan and economic pro forma projections. Value-add investments will aim to increase rental revenues while also potentially decreasing and optimizing expenses. Asking the sponsor for a comparison will allow you to analyze the plan and determine if the projections appear too aggressive.
What is the going in cap rate and projected exit cap rate?
As a reminder cap rate is net operating income / purchase price. It is common practice to add approximately 10 basis points (bps) to the entry cap rate for every year the property is held. This introduces some conservatism into the underwriting as future market rates are unknown.
Do you plan to refinance the property, and if so will limited partners stay invested in the deal?
Inquire whether the projected returns include a refinance and determine whether the strategy makes sense (eg a capex plan with value-add play). If the property will be refinanced confirm that investors will continue to maintain their equity shares. This is beneficial for LPs whose return of capital is accelerated but also continue to earn the equity split.
What type of reporting do investors receive?
Each investor will have a personal preference on the cadence of communication they are seeking. Sponsors vary in that some may provide monthly updates, others quarterly, and some annual. Make sure if you want to receive monthly updates that you are not investing with a team that will only reach out once a year.
Part of the Multifamily Scrum Series – Written by Brian Pownall