10 Red Flags You Need To Know When Vetting A Real Estate Operator
Investors are always very excited to hear about the returns of any investment. When looking at different opportunities, you want to know what the cash flow will be like and how much money you will make.
But before you get too excited about the projected returns, you must realize that the deal operator is in charge of executing the business plan. It's the proper execution of the plan, properly timed decisions, and the operator's choice in other property management partners that create those returns.
So, before choosing a particular investment, you need to make sure your views and goals align with the operator and that you like the property market they are in. Then you can start talking about returns.
Due Diligence Process: Operator Red Flags
When you are vetting a real estate operator, you should be aware of any possible red flags. These red flags may not completely rule out an operator. But if you notice a red flag during your due diligence investigation, you will need to dig a little further into your research. If a real estate investment opportunity seems too good to be true, it probably is!
1. No Business Background
There are a lot of new syndicators out there, which is excellent. But, they don't come from a business background if they have worked with syndications or real estate. Ask or figure out who does have this background on their team? It doesn't have to be the person starting the company.
People start businesses all the time and build a dedicated team around them. Make sure someone on that team has the knowledge needed to successfully navigate through a market downturn, rate hike, occupancy slump, and more.
2. Part-Time Operator
You are transferring your time and energy. You want your investment to be taken care of by someone doing this full-time, and you want them to put excess care, time, and energy into the investment. In exchange for your faith and financial capital, you want a full-time, dedicated operator who will make the proper management of this asset and the people involved a priority.
3. One Managing Partner
If there is only one managing partner within the company handling the deal, what happens if something happens to this one partner. What happens to the deal? How does the deal continue? Who takes on the financials and the exit plan? Looking for an operator with multiple managing partners is a good idea. Teams always bring great things to the table.
4. No Succession Plan
You want to understand who the partners are within the company. A business with multiple partners allows for a good succession plan. They need to have a plan in place to make sure their team is ready to continue with the deals and investments they have in place.
5. No Preferred Return
Preferred return is when the operator is so confident the property will make an excellent return that they are willing to give away the first X percent of the deal to the limited partners.
If there are no preferred returns, this doesn't mean it is not a good deal, but do your due diligence and dig a little deeper into the real estate syndication waterfall model and see what is going on and why a preferred return is not being offered.
6. Include Refinances In Projections
Is it a part of the company's practices to put refinances into their underwriting projections? This practice is more of a deal breaker than an operator breaker. But, you will get a sense of the operational level if this is their common practice.
It is best when an operator does not put refinance projections into their underwriting because no one knows what the economic/financial environment will be like in X number of years when the project is ready to refinance or has a supplemental loan attached. You do not want the project's success beholden to the refi.
7. Distributions are Return of Capital
You'll want to determine if the distributions are returning capital or return on capital. Either one can be okay when it comes to a real estate syndication.
You need to research and understand exactly how returns are calculated and whether you’re to expect your initial investment money back or not. You're investing your own capital and need to know how returns will be handled.
8. Skin in the Game
Do the operators have skin in the game? Is it their general practice to invest alongside the limited partners? There are some reasons a general partner would also want to invest in the property. The major one is to represent and prove their belief in the properties, and secondly, so they can reap the tax benefits too! This may be a red flag if they do not have plans to invest alongside you.
9. Encountered no Challenges
If you're talking to an operator and every deal they have ever conducted has been a success, that means they have no experience navigating a bump in the road. This type of practice seems pretty unrealistic and may mean they've only been in business a short time or during a hot market.
We know all investments have risks, and if deciding between two operators, it may be best to go with the one who has had to deal with some bumps in the road because it shows they know how to conduct themselves in different situations, make tough decisions, and still produce successful opportunities for their investors.
10. Dodges Questions
Poor communication is a huge issue. If you are asking multiple questions or the same question in different ways and the operator continues to dodge the question and not answer it or does not seem interested in answering any of your questions; this is a huge red flag. You want to make sure your operator knows the answers or can quickly gain access to the answers.
There you have it!
Ten red flags you can look out for when performing your due diligence process as you research and vet operators. Try not to have unrealistic expectations about what you may find. Remember, operators are not perfect. Remember to refer to what we often call the "gut test." It's always in your best interest to follow your gut feeling. If your gut is telling you this operator does not align with your best investment or personal interests, it's time to walk away.
The Perfect Operator For Your Investments
In any endeavor, you want to make sure you have the best team built around you. Real estate syndications involve risks, and it is always in your best interest to make sure each person on your team is the best fit.
Whether it's an experienced sponsor, an operator, or other members, you want to do your due diligence to vet anyone who will be a part of the real estate transaction. Use the valuable advice throughout this article to help you perform thorough due diligence and avoid the major headaches one might experience if they wound up working with the wrong operator.
When determining which is the right path for you, be sure to factor in your unique situation, goals, and interests. Join our DOCTORS INVESTMENT CLUB today if you're interested in learning more about passive real estate investing opportunities.