Beyond Track Records: Researching Real Estate Investment Managers

Barry Shurwinter was ready to enter the big-boy world of real estate investing. Or so he hoped. Some friends had recommended various managers with good track records, but when pressed for more information, it had become clear that his buddies didn’t really know much about these people. It had also become clear that some managers had performed well in some deals but faltered with others. Barry was puzzled. Shouldn’t he be doing more research about the quality and trustworthiness of these real estate syndicates?

How could he improve his chances of solid returns while minimizing the risks?

Syndication Managers Aren’t Created Equal

Many are attracted to the potential solid returns and tax favorability of real estate but don’t have enough time, skills, or capital to invest by themselves. They turn to real estate syndicate managers, many of whom do an excellent job finding good opportunities, gathering funds, and managing properties. But some managers aren’t especially competent or selective and cut corners to close as many deals as possible. Limited partners in large deals can find themselves pretty helpless if things don’t go as planned.

Track Record Limitations

Of course, even the best investment manager can get hit with a bad market or unforeseen hitches, but investors may improve their odds of success by being selective about whom they entrust their funds to. Choosing a manager solely based on a “good track record” is a simplistic approach to manager due diligence. Reputed track records are often too short to be meaningful or may simply be offering cherry-picked information. Short-term success stories that are not backed by solid data don’t mean much to savvy investors.

Streaks of Mazal

While every excellent investment manager by definition has strong historical performance, not everyone who provided investors with high returns is an excellent manager. “A rising tide lifts all boats,” the saying goes, and performance that managers may tout as proof of talent is often solely the credit of a strong market wave. Market cycles take time to unfold, and those who coasted while paying little attention to deal quality, management execution, and financing stability were really just throwing the dice. They are most likely to have deals blowing up, all the while blaming it on the horrible market environment.

Anecdotes Don’t Count

Again, even the most talented and careful investor can hit a rough spot and even have deals get wiped out. But investors are much less likely to get hurt under a careful and attentive manager versus one who’s just grabbing deals to build their own empire while giving little consideration to learning the business, finding solid deals, and working hard to protect their investors’ interests, in good economic times and bad. Therefore, basic hishtadlus requires looking beyond shallow anecdotal track records. Professional investors look under the hood to evaluate the quality of their general manager’s character, capabilities, and incentives before wiring funds.

People Perspectives

While mazal plays a role, we should always look to do business with those who are ehrlich, straightforward, and talented. An investor should inquire as to the personal reputation of the key players handling their hard-earned dollars. Someone who’s left a trail of dinei Torah and litigation behind them is probably not going to be a good partner in the long run. Does the team responsible for finding, underwriting, and managing the deals consist of smart, experienced, and motivated people? Some think a chevrahman partner will make them money in creative ways. Perhaps. But often, the sly partner will use subterfuge against their partners, not for them.

Process Questions

Even ehrlich and savvy managers don’t always have a consistent process to find and execute on pipelines of solid opportunities. Good deals don’t grow on trees, and it’s common for even established players to pivot into new regions and property types. Do they have the capacity for that change? Are excellent local management teams in place to execute? How much risk does a manager prepare for in their deal structures? What’s the stability of their usual capital stack? Are projected returns driven by shaky mortgage structures? Will limited partners (LPs) have money for cash calls in case that becomes necessary? All good questions to ask.

Focus on Fees

Fees charged by investment managers obviously matter because every dollar going into their pocket is a dollar not going into the limited partners’ pockets. General Partner (GP) investment managers can and generally will negotiate the best fee structure that they can get investors to accept, but the Limited Partner (LP) silent investors should try to ensure that the payments are commensurate with the attractiveness of the deal’s potential. Excessive fees can make the risk of a deal not worthwhile from the LP’s perspective. Net (after-fee) returns is what matters to those putting money in the deal, not the gross.

Alignment of Interest

But much more than the amounts, it’s the structure of how fees are paid that requires scrutiny. People follow incentives, and allowing managers to structure “heads, we win; tails, I win, you lose” terms is a recipe for financial disaster. In well-designed compensation structures, interests between investors and managers are kept as tight as possible. Requiring significant skin in the game, priority on returns of capital, hurdle rates, and the like is so important to ensure true partnership between capital and those running the deals. Unfortunately, many deal terms incentivize quantity over quality, to the little guy’s detriment.

Not for Everyone

As you can see, this kind of due diligence is not easy or quick. In a practical sense, it’s often not possible for smaller investors who are determined to get access to real estate syndications (and hedge fund-type managers too). Should a $50,000 or even $500,000 investor attempt to grill an established manager the way I’m describing, there’s a good chance they will simply hang up the phone. Not that I’m blaming the GPs. I probably would be impatient too if I were in a similar circumstance. They often can find investors easily, without jumping through additional hoops and negotiations.

Still, most larger investors do thorough manager due diligence and/or have unbiased professionals vet their deals for them. Smaller investors in pooled deals who skip managerial research should at least recognize that they’re likely taking a shortcut that may come back to bite them. Some are therefore better off sticking to simpler modes of investment like mutual funds and single-family home rentals they can control.

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