Due Diligence Matters
Private real estate firms can provide you, the high-net-worth investor, with access to institutional quality deals. This is an exciting new trend, which has opened up new opportunities to millions of accredited investors.
However, as a non-real estate professional, how can you properly navigate this specialized and opaque industry? There’s no easy answer, but fortunately, there are some guidelines you can follow to protect yourself.
Because these are private deals, you cannot assume you’ll have the information you need to properly evaluate the risks and merits of a deal. As a firm committed to transparency, we believe that an educated investor is the best partner.
Your money is at risk, so as with any investment, you need to do your own due diligence. We wrote this investor guide to help you in that process.
Suggested Investor Checklist
1. Transparency. Transparency. When investing in public markets, it’s easy to get used to the transparency available from annual 10K reports and other regulated requirements. In the private real estate market, you don’t have the same transparency. As a result, you may not have the information you need, or the quality of information you want, to make sound investment decisions. That’s why we recommend that you only consider firms that are seriously committed to transparency.
a. Audited financials. As a first step in transparency, does the firm provide compliant, audited financial statements? If not, you may not be able to rely on what is reported to you.
b. Third-party administration. Another way to gain transparency is to work with firms that utilize a third-party administrator. Third-party administrators can give you a higher level of confidence because they manage the financial and operational side of the venture. This frees up management to focus on their main business of real estate. You’ll also get an important check and balance system. Companies that are serious about transparency should not have issues using a third-party administrator. Look for this feature as you evaluate your options.
2. Fee structure. Fees always matter, so be sure to check the fee structure out thoroughly. Investors should receive priority distributions before managers. Ideally, you as the investor should receive a baseline return, then share profits above that with the management.
3. Skin in the game. How much is the manager contributing to each deal? You want the manager to have enough “skin in the game” so they are extremely motivated to make every deal a success.
4. Specialization. All real estate is not the same. It’s best to look for a firm with some competitive edge – something that’s often found through specialization. For example, Rastegar specializes in recession-resilient asset classes, such as self-storage and multi-family housing. A niche can give you an edge, especially when the management team has skills in exploiting undervalued or overlooked properties.
5. Experience. As we all know in our respective professions, experience counts. When your money is on the line, you don’t want to be part of anyone’s learning curve, so it’s vital to evaluate the experience of the team. What’s their reputation? Who are their investors?
6. Economic terms of each deal. If you are not an experienced real estate investor, there are terms of the deal you’ll need to understand. It helps to have a tax advisor review the terms with you, so you can understand the structure and how it impacts your investment. Things to pay attention to include:
a. Will leverage be used and if so what are the conditions?
b. What is required of the investor in the case of a capital call?
c. How is the deal structured between “preferred” units and common (the company’s interest)? These conditions can provide you with protections.
d. How often will distributions be made?
e. What is the tax treatment of distributions?
If you’re busy, find a professional who can review deals for you, so you are not surprised after you’ve already invested.
General things to note before investing:
1. Liquidity. When you invest in private real estate, you will not have a liquid investment. Find out the anticipated term of the investment. Are you prepared to keep your money invested for that entire time period?
2. Risk of Loss. Understand what happens to your investment in a worst-case scenario. While it may not be probable, it’s certainly possible that the investment may not go as planned. Find out what happens if the project fails.
Final Advice: Avoid Promises of High Returns
As a high-net-worth individual, you know there’s no free lunch in life. Higher returns always require more risk. If a firm tells you they can always generate higher returns, that is a red flag.
As an investor, you want to work with people who understand and respect risk and do their best to protect your money and theirs, while making a fair return. Promises of high returns without equally high risks of loss may indicate an inexperienced firm.
While none of this is rocket science, it’s easy to get burned if you don’t consistently do your due diligence. Please use this guide either yourself or along with your tax advisor or attorney. Our resource will help you make sure you are comfortable with an investment before signing on.