Most private real estate due diligence goes wrong in the same way: the investor studies the deal and skips the operator. But the deal is a set of assumptions, and the operator is the only thing that determines whether those assumptions survive contact with reality.
These are the twelve questions we would ask any sponsor, including us. We have added what a good answer sounds like, because knowing the question is only half of it.
On track record
1. How many full-cycle deals have you taken from acquisition to sale?
Anyone can show unrealised paper returns. A completed cycle proves capital actually came back. If the answer is none, that is not disqualifying — but it should change your position size.
2. What was your worst deal, and what happened?
The most informative question on the list. A sponsor who has never had a deal go sideways either has not operated long enough or is not telling you. Listen for specifics and for accountability rather than blame directed at the market.
3. Show me an underwritten-versus-actual comparison on a realised deal.
Line by line: rent premium, renovation cost, expense ratio, hold period, multiple. A sponsor with a process has this and will show it, including the lines that missed.
On the deal
4. What rent growth are you assuming, and what supports it?
The answer should point at comparable units already leasing at that rent nearby, today. If the support is a market forecast, the assumption is a hope.
5. What happens at a cap rate 100 basis points worse than entry?
A serious operator has already run this and can tell you the resulting return without opening a file. If exit cap equals entry cap in the model, the model is optimistic by construction.
6. What are the debt terms, and when does the loan mature relative to the business plan?
Fixed or capped, and maturing well after the plan completes. Short floating-rate debt maturing mid-plan is how a large number of 2021-vintage deals ran into trouble.
7. How much of the raise is reserves, and when can they be spent?
Reserves capitalised at closing are real. Reserves “funded from cash flow” are a promise competing directly with your distribution.
On alignment
8. How much of your own money is in this deal, and on what terms?
A meaningful amount, on the same terms as investors. “Sweat equity” is not co-investment.
9. Walk me through every fee, including any paid to affiliates.
Acquisition, asset management, disposition, refinance, construction management, and any property management paid to a related entity. All of it should be in the memorandum. Hesitation here is itself the answer.
10. What is the split, and is the preferred return cumulative?
Cumulative means a missed year accrues and is made up before the sponsor participates. Non-cumulative means a missed year is simply gone.
On what happens after the wire
11. What exactly will I receive each quarter, and when?
Ask to see a real, redacted quarterly report from a live asset. Compare its candour to the marketing material. If a sponsor reports as well as they sell, that is a good sign.
12. Who tells me when something goes wrong, and how fast?
The correct answer is the sponsor, in the quarter it happens, before you notice it in the numbers. Anything else means you will find out last.
A sponsor who welcomes these questions is telling you something about how the next five years will go. So is one who deflects them.
One more, for yourself
Can you commit this capital for the full hold period without needing it back? If the honest answer is no, no sponsor's answers to the twelve questions above matter. Illiquidity is the first condition of this asset class, not a footnote in the risk section.
This article is general information, not investment, tax, or legal advice. Preferred Capital Partners is not a registered investment adviser. Consult your own advisors before making any investment decision.
