Episode 3: Conducting Due Diligence on Sponsors

Welcome to Building Passive Income, the podcast for professionals, entrepreneurs and investors who want to build wealth, diversify beyond Wall street, and create true financial freedom through passive commercial real estate investing. I'm Wayne Courageous III, founding and managing principal of Crei Partners, a leading commercial real estate company, I created CreiColin, an AI powered resource to serve as your investor education guide. Built on the insights and experience we've developed at Crei Partners, CreiCollen is here to educate you through passive invest tax strategy topics to help your journey in passive investing. Just a quick disclaimer. This podcast and CRA Colin is for educational purposes only and is not legal tax or investment advice. Always consult with your attorney, CPA and financial advisor before making any investment decisions. I've spent nearly two decades helping investors understand the power of commercial real estate from multifamily to storage to retail. Each episode is under 15 minutes, simple to follow and and packed with insights to help you grow your income and protect your capital without becoming a landlord. If you're ready to learn quickly and invest smarter, you're in the right place. Welcome to Building Passive Income. Let's build wealth together. Here's creicollen.

Hey there, I'm Crei Colin and welcome back to Building Passive Income. In our last episode, we talked about how to define your investment criteria so you can filter deals and make confident decisions. Today, we're diving into one of the most important steps in the passive investing Conducting Due Diligence on sponsors. Here's the the sponsor is more important than the deal. You can have the best market, the best property, and the best projections. But if the sponsor can't execute, the deal will fail. Today we're going to walk through exactly how to evaluate a sponsor before you invest a single dollar. We'll cover what questions to ask, what red flags to watch for, and how to separate the pros from the pretenders. By the end of this episode, you'll have a clear step by step framework for conducting sponsor due diligence. Let me tell you about Michael. Michael is a successful entrepreneur who decided to invest in real estate syndications. He reviewed a deal that looked great on Strong Market Phoenix, Arizona Value Add Multifamily Projected 16% IRR. All the numbers looked good. So Michael invested $100,000. He didn't dig deep into the sponsor's track record. He didn't ask tough questions. He didn't call references. Big mistake. Eighteen months into the deal, the sponsor went silent. No updates, no distributions, no communication. Michael later found out the sponsor had over leveraged the property mismanaged the renovations and burned through the investor's capital. The property went into foreclosure. Michael lost his entire investment. What went wrong? Michael didn't conduct proper due diligence on the sponsor. He trusted the deal deck and the projections, but he didn't vet the people behind the deal. Here's the can't outsource trust. You have to do the work. Today I'm going to show you how to do that work. The five Pillars of Sponsor Due Diligence when evaluating a sponsor, you need to assess five critical areas. Pillar Number one Track Record and experience Pillar number two Team and Operations Pillar number three Deal Structure and alignment of interests Pillar number four Communication and Transparency Pillar number five Reputation and References. Let's dive into each one. Track Record and Experience the first thing you need to know is does this sponsor have a proven track record? Here are the questions you need to Question one How many deals have you completed? You want a sponsor who has completed at least five full cycle deals, meaning they bought, managed and sold the property. If they've only completed one or two deals or if all their deals are still active, proceed with caution. They haven't been tested through a full cycle yet. Question 2 How many deals have you exited? This is critical. Anyone can buy a property. The real test is can they execute the business plan and sell the property for a profit? Look for sponsors who have successfully exited multiple deals and returned capital to investors. Question 3 what were the actual returns on your past deals? Don't just ask for projected returns and ask for actual realized returns on completed deals. Compare the projected IRR at the time of investment to the actual IRR at exit. Did they meet, exceed or fall short of projections? A good sponsor will be transparent about this red flag. If they can't or won't share actual performance data, walk away. Have you been through a down market? This is huge. Anyone can make money in a bull market. The real test is how did they perform during the 2008 financial crisis or the 2020 pandemic or other downturns? Did they lose properties? Did they stop communicating? Or did they navigate the storm and protect investor capital? Look for sponsors with at least 10 years of experience who have been through at least one full market cycle. Question 5 Do you have experience in this specific asset class and market? A sponsor with a great track record in Dallas multifamily might not be the right choice for a Phoenix Self Storage deal. Make sure the sponsor has specific experience in the asset class and market they're presenting. Team and operations. Real estate is a team sport. You need to does this sponsor have the team and infrastructure to execute? Here are the questions to Question one who is on your team? A professional sponsor should have an acquisitions team to find and underwrite deals. An asset management team to oversee property operations A property management company either in house or third party A finance and accounting team to manage financials and investor reporting. An investor relations team to communicate with investors. If it's a one person show, that's a red flag. Real estate syndication is too complex for one person to handle. Question 2 Is this your full time business or a side hustle? You want sponsors who are full time dedicated professionals. If they're doing this on the side while working another job, they won't have the bandwidth to manage your investment properly. How many deals are you managing at once? Be cautious of sponsors who are over leveraged managing too many deals at once. If they have 20 active deals and a small team, they're stretched too thin. Quality over Quantity Question 4 who is your property management company? Property management is critical. Ask is it in house or third party? What's their track record? How long have you worked with them? How do you hold them accountable? A strong sponsor has strong property management partners. Question 5 what are your relationships with lenders and brokers? Experienced sponsors have strong relationships with lenders for favorable financing terms. Brokers for deal flow and off market opportunities. Contractors for cost effective renovations. These relationships are a competitive advantage. Deal structure and alignment of interests. You need to know is this sponsor's financial interest aligned with yours? Here are the key Question one How much of your own capital are you investing in this deal? This is critical. You want sponsors who have significant skin in the game. Industry Standard at least 5% of the total equity. If the sponsor isn't willing to invest their own money, why should you invest yours? Red flag sponsors who invest $0 of their own capital are not aligned with you. What is the fee structure? Understand all the fees the sponsor is charging. Acquisition fee typically 1 to 3% of purchase price asset management fee typically 1 to 3% of revenue or equity annually disposition fee typically 1 to 2% of sale price. Make sure the fees are reasonable and in line with industry standards. Red flag Excessive fees or fees that aren't clearly disclosed. What is the profit split and preferred return? Typical investors receive a preferred return 6 to 8% annually paid before the sponsor receives any profit. After the preferred return is met, profits are split typically 70 to 30 or 80 to 20 in favor of investors. Make sure the structure is fair and aligns the sponsor's incentives with yours, no preferred return or a profit split that heavily favors the sponsor. Question 4 How do you get paid if the deal underperforms? This is a tough but important question. If the deal doesn't hit projections, does the sponsor still collect fees? Make sure the sponsor's compensation is tied to performance, not just to managing the deal. Communication and transparency you need to know Will this sponsor keep you informed or will they go dark here? Here are the Questions to question 1 How often do you communicate with investors? Look for sponsors who provide monthly or quarterly investor updates detailed financial reports, including occupancy, income, expenses and distributions Updates on progress toward the business plan Annual tax documents delivered on time Red flag sponsors who only communicate once or twice a year or two, or who don't provide detailed financials. Question 2 what happens if things go wrong? Ask the sponsor directly if the deal underperforms or if there's an unexpected problem. How will you communicate that to investors? What's your track record of transparency when things don't go as planned? A good sponsor will be honest and proactive, even when delivering bad news. Question 3 How accessible are you to investors? Can investors email or call with questions? How quickly do you respond? Do you host investor calls or webinars? You want a sponsor who is accessible and responsive, not someone who hides behind their investor relations team. Question 4 Can I see examples of past investor updates? Ask the sponsor to share sample investor updates from previous deals. This will give you a sense of their communication, style and level of detail. Pillar number 5 Reputation and references you need to know what do other investors say about this sponsor? Here's how to find Step one Ask for investor references Ask the sponsor for contact information for at least three to five investors who have invested with them before. Then actually call those investors. Don't skip this step. Ask the right questions when you call references, ask how long have you been investing with this sponsor? How many deals have you invested in with them? Have they met their projections? How is their communication? Have there been any problems? If so, how did the sponsor handle them? Would you invest with them again? Listen carefully to their answers. Pay attention to hesitations or red flags. Do your own research. Google the sponsor's name and company. Look reviews or testimonials on their website or social media. Any news articles, lawsuits or complaints. Their presence in the investor community. Are they active? Are they respected? Check the Better Business Bureau, SEC filings and state records for any red flags. Trust your gut. If something feels off, it probably is. Don't ignore your instincts. Red flags to watch for. Here are the Biggest red flags that should make you walk away Red Flag 1 no track record or limited experience if they've completed fewer than five deals, or if they haven't exited any deals, Pass Lack of transparency if they won't share actual performance data, won't provide references, or are evasive when answering questions, walk away. Red flag number three over promising if they're projecting 25% plus IRR with little risk, they're either lying or inexperienced. Be skeptical of deals that sound too good to be true. Red flag number four no skin in the game if the sponsor isn't investing their own capital, they're not aligned with you. Red flag number five Poor communication if they're slow to respond, don't provide detailed updates or go silent when things go wrong, they that's a major red flag. Red flag number six Too many deals too fast if they're raising capital for five deals at once, or if they've gone from zero deals to 10 deals in two years, they're moving too fast. Red flag number seven high pressure sales tactics if they're pressuring you to invest quickly, or if they're saying this deal is closing tomorrow, you need to decide now. Run Good sponsors don't need to pressure investors. Red flag 8 excessive fees or unfair deal structure if the fees are significantly higher than industry standards or if the profit split heavily favors the sponsor, that's a red flag. How to organize your due Diligence Here's a simple system to organize your sponsor due diligence. Step 1 Create a due Diligence checklist Use this checklist for every sponsor you track Record number of deals and exits Actual returns Years in business Experience in asset class and market size Roles Full time or part time Skin in the game Sponsor Co Investment Percentage Fee structure Acquisition Asset management Disposition Fees Deal structure Preferred Return Profit split Communication Frequency Detail Transparency at least 3 investor References Contacted Online Research no red flags Create a sponsor scorecard Rate each sponsor on a scale of 1 to 5 for each category. Add up the scores. Only invest with sponsors who score at least 35 out of 45. Keep a sponsor database Track every sponsor you evaluate in a simple spreadsheet. Sponsor name Asset class and markets Track record Summary your rating notes Would you invest with them? This will help you build relationships with quality sponsors over time. The bottom line Conducting thorough due diligence on sponsors is the single most important thing you can do as a passive investor. Don't skip this step. Don't rush it. Don't assume everything is fine just because the deal looks good on paper. Remember you're not investing in a deal, you're investing in a sponsor. Take the time to vet them properly. Here's what I want you to do this week. Step 1 Create your sponsor due diligence checklist using the template I shared. Step 2 if you're currently evaluating a deal, use the checklist to assess the sponsor. Step 3 Call at least three investor references. Don't skip this. Step 4 Do your own online research on the sponsor. That's it. Do the work. Protect your capital. If you want help evaluating sponsors and conducting due diligence, join our free Passive Investor coaching program@ passiveinvestorcoaching.com we'll walk you through the process and help you avoid bad sponsors. You can also visit creipartners.com or email us@investreipartners.com Remember, trust is earned, not assumed. Do your due diligence and invest with confidence. Let's build wealth together.

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