When you invest in a syndication, you are really betting that the asset management team can operate smoothly and deliver the results they are projecting. This means that you need to do your due diligence on the people making up the asset management team. Below are questions that, from our experience, you should ask every deal sponsor before you invest:
- What happens when you die?
- What is your capitalization policy?
- Will you be performing a cost segregation study?
- How do you plan to mitigate the business interest limitations?
- When can I expect my K-1 (so you know when to file your own tax returns)?
- How do you plan to manage cash flow?
- Who is the property manager?
- Who is your bookkeeper, controller, and CFO?
- What CPA firm are you working with?
- What law firm are you working with?
- When can I expect my distributions and financial reports?
- What will you do to communicate issues, such as performance below expectations or delays in distributions and report issuance?
Do NOT let the deal sponsor off the hook here. If they evade your question or provide half baked answers, dig deeper. Every single deal sponsor that knows what they are doing should be able to answer these questions with ease. A good but not great response would be “here’s my CPA/attorney’s contact information, ask them xyz” but that’s still better than a bad or no answer.
These questions are telling because it will tell you how well the deal sponsor put their team together. You can get a feel for how proactive their advisors are.
For example, if a sponsor doesn’t know what the capitalization policy is, that means they haven’t engaged in controller or CFO services which leaves a gaping hole in their financial office. We most often see deal sponsors try to avoid accounting costs by focusing only on bookkeeping services or offloading all of the accounting to the property manager. Our question: who is validating the data inputted by the bookkeeper or property manager? Asking about the capitalization policy can give you tons of insight here.
Another reason to ask about the capitalization policy is that sponsors can use it to inflate returns. For example, consider a syndicate with a $500 capitalization policy. They incur an $800 expense, but because they have a $500 capitalization policy, they don’t record the $800 as an expense but instead record it as a capital improvement and report it on the balance sheet. The problem here is that the income statement investors receive will be $800 higher than it otherwise could be this inflating returns. Such a sponsor could make the performance look much better than it actually is (to avoid this, you can ask for a Statement if Cashflows as that will show you cash in and cash out).
If a sponsor has a CPA team but can’t answer questions about cost segregation or business interest limitations, it means their CPA team is a glorified tax preparer. Be very careful of these syndicates. If they haven’t thought through their tax strategy prior to soliciting investor funds, what else haven’t they thought through?
Asking these questions will allow you to avoid investing with bad sponsors. You don’t want to get 12 months in only to realize the sponsor isn’t operating well because the team they put together stinks. These questions will give you insight into the sponsor’s team before it’s too late.
