How to Invest Wisely: Navigating LP Due Diligence & Fund Decisions

12/07/23 • 17 min

Commercial Real Estate Investing From A-Z

How to approach due diligence on a new operator as a limited partner? How should investors decide if they should invest in a fund or not? How should you fundraise for deals that have not been determined what they are yet? When to say no to a potential investor? Dr. Joseph Ryan Smolarz, founder of STOR, shares his insights.

Read the entire interview here: http://tinyurl.com/yph2892p

What are some of the main topics that you want to pass to passive investors and how should they do due diligence?

The basis of the whole interaction is trust, you're trying to build rapport with your investors from a sponsor's point of view. From an investor's point of view, you want to make sure that you're a good fit. You have ways of thinking about things and your risk tolerance needs to fit into the asset class and the investment strategy that you're trying to do because if you're in a very aggressive fund, and you have a low-risk tolerance, regardless of what happens, you're not going to be happy. Those are the questions that I would start with.

When you're starting the due diligence as a sponsor, the number one goal is to make sure you're not in a Ponzi scheme or some sort of fraudulent group. There's a lot of good questions to ask to sort of drill down on that and if you're not comfortable at the beginning, you're probably not going to be comfortable at the middle or the end, as well.

During an up market, how would you recommend doctors doing their best to find out if a sponsor is not legitimate?

Having made several pretty bad mistakes as a limited partner, this is a topic that's near and dear to my heart. When I approach a deal as a limited partner, what I'm trying to do is understand that sponsor in such a way that we can build a 30, 40-year relationship. It's not about the first deal in its entirety, because I'm willing to put in the time, effort, and cost to get to a comfortable place knowing that when these guys or girls have a deal, and they send it to me, that I'm never going to have to go through this first step of due diligence again. I'm comfortable that they're not trying to push one past me, or whatever the case may be. And that's a gigantic step. I would personally say, and I know this is going to be shocking to your audience, but a lot of times, what I'll do is, I will hire a PI to go through and make sure that some of their previous deals have not been fraudulent.

If I had a fund, and I knew that the economy was about to take a turn, for example, in 2024, we all know that it'll be even better for finding deals. However, there is a lot of fear that normal human beings think that that specific time will never end and it'll be doom and gloom for a very long time so they end up not putting the money. From a fund perspective, I would personally prefer to have that cash available right now in case people get cold feet, how would one go about that, in your experience?

There are lots of sponsors out there that will do that, they'll get the capital, and hold on to it. It does add liability to to the fund. If you're going to do that, you would probably want to know how much E&O insurance they have, errors and omissions, and all the things to safeguard. Is there the ability for one person to be able to extract all of the cash and run, or is there a safety mechanism where it takes two people to sign off on it? There are lots of checks and balances, and systems out there that can be put in place for a reasonable cost if the sponsor hasn't thought about that, and what happens in those scenarios, and they very well should. But it's just personal preference.

Dr. Joseph Ryan Smolarz

www.storpartners.com

The Medicine & Money Show

Read the entire interview here: http://tinyurl.com/yph2892p

What are some of the main topics that you want to pass to passive investors and how should they do due diligence?

During an up market, how would you recommend doctors doing their best to find out if a sponsor is not legitimate?

Dr. Joseph Ryan Smolarz

www.storpartners.com

The Medicine & Money Show

Previous Episode

Top Lessons Learned From 6 Decades of Investing

What are the top lessons learned over a very successful six decades of real estate investing? Tom Wilson, principal at Wilson Investment Properties, a seasoned investor in several asset classes including retail, office, multi-family, industrial and others, shares his wealth of knowledge.

Read the entire interview here: https://tinyurl.com/38phajz2

Major Lessons Learned

My first tip of the day is to go to Fannie Mae's website and look for Doug Duncan's predictions around what's going on in the marketplace, and he has accurately called every single rate change in the last 20 years.

Secondly, operations is indeed a critical element, Ken McElroy prides himself in having come into the real estate world from the operations standpoint, and he often emphasizes how important that is. The best underwriting, the best market, and product are only as good as you can execute it. You really need all the legs of the stool to be able to have something come off successful.

We always want high cap rates, low risk, and high appreciation but it's very hard to find all three, so you have to decide what is the most important to you. California has been able to generate great appreciations in recent years, but not so good on cap rates, and Texas, Florida, and other places have other things that are strong so you need to realize it's very hard to get everything you want, you have to choose which is important.

One of the most important things I've learned is how different sub-markets are and how different products are. It's incredible how different they are. You look at the curves of these markets and products. The general information will give you a general concept but you can always find products, you can always find portions of the market where it can be quite contrarian to what the general information is.

Don't fall in love with a deal and try to make it happen. Saying no can be more valuable than saying yes. Almost every property I've bought, I've gone to see it myself, I don't do the level of detail I used to but when you scale, you have to delegate to others. Go look at the other stores around the area, retail, grocery, etc. Who is it that actually comes in there? Market studies from the listing agents show you the one-mile, three-mile, and five-mile, what the demographics are, that's not necessarily who's in your property. As you can tell by going at nighttime, park the car, and see what comes in and out. When you make a mistake, it's tough to grieve, and lick your wounds for a while but don't run from it forever. Go back with your team and analyze what is it that went wrong or what is it we can do better next time. Sometimes we learn more from the things that don't work, than the things that do.

Change your model periodically. Switch from market to market to asset class to another, whatever it goes with the time so the market. One of the things I've done that has contributed to my success is to change the model. One of the things I haven't done so well is probably not change it as fast as I could have. It's hard to leave something that was working.

What's the most valuable asset that you have?

I think it's the 2,000 names that I have on my phone, because with those relationships you can start over if you have to rebuild. Relationships are critical, and character is more important than competence. It's nice to have both but character is number one.

And, above all, enjoy the journey. It's so easy to get caught up on every day operations and finding more success. But along the way, give back and smell the roses.

Tom Wilson

www.wilsoninvest.com

Next Episode

How to Find the Next Hot Market & How to Convince Investors

How to find the next market? How to convince investors to invest in something that is new to them? Neal Bawa, CEO of MultifamilyU, shares his knowledge.

Read the entire interview here: http://tinyurl.com/4vj3wyhr

You sold a deal today and you returned a huge amount to the investors. Let's go over the entire process from why were you analyzing that deal and what made you want to buy it.

The name of the deal is Equinox at Night, which is a name that we gave it, it was called Weatherly Walk when we bought it. The property was sold today, which ended December 2023, and was purchased right about this time four years ago. We wanted to buy it in time and close in time for the depreciation benefits in 2019. The journey was one day short of four years.

I wasn't looking for a property in this particular marketplace but back in 2019, I had started feeling that properties were getting too expensive inside city limits and I felt like it was a terrific market to be putting a lot of money into. As I was talking about Atlanta, I started seeing good things and then as the years went on 2017-2018, I found that I was seeing more negative things about Atlanta than positive things because inside of the city, I was starting to see pricing that was just unreasonable for the income levels. What was happening was that the incomes of the people living in Atlanta, were going up 4% a year, and the property prices were going up 20% a year when property prices go up that much, the new owner needs to raise rents, so they're forcing rents higher because everyone's buying at these new prices. And for a while that works but then what happens is that either you start seeing occupancy fall, or even worse, you start seeing delinquency increase, as you start forcing people into 40% of their income, 45% of their income going to rent and almost 50% go into rent, then you're going to see a lot of delinquency, the first time their car breaks down, they can't pay rent.

How do you convince the investors that may have been used to keep investing in MSA itself?

In many of our projects, you just send out an email, and all the shares are taken. We knew that we were buying a better property and were going to make a lot of money on it but first, we had to convince investors (you're not going to make any money if you can't close the property). We did a two-step approach: first, before we put the property in the contract, we were making offers and we had identified three cities not two, that were around. We started holding webinars about the true opportunity in Atlanta, and then another webinar about the true opportunity in Phoenix. "First, I'll tell you about the true opportunity webinars and then I'll tell you about how that transition into getting the property funded", this is something that every syndicator should do instead of telling everybody, "Fayetteville is the greatest city in the Atlanta metro" which never works, what we do is we started to rank some of these outside cities. We started comparing these cities and started talking about these different cities and why we felt that they were better than Atlanta itself, both for single-family and multifamily. We always tell our database, that if you want to buy single-family homes, go do it. You'll be back talking to us in one or two years once you realize you've turned into a landlord, you just wanted to be an investor. We always tell people that the single-family experience is worth it, you learn a lot, and you don't want to do it again.

Neal Bawa

www.multifamilyu.com