(Usual disclaimer: I’m just an investor expressing my own personal opinion and not a financial advisor. Consult your own financial advisor before making any investment decisions).

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This is the second of a two-part interview with Paul Kaseburg.

(Paul's the author of an eBook on passive real estate investing that I wish I'd read when I started and think should be required reading for every beginner and pro.

Paul’s sat on both sides of the table on over $1.7 billion of real estate deals. And his book covers everything a newbie needs to understand: from asset selection, to evaluating sponsors, to capital structures. For pros, he challenges conventional wisdom and explodes sacred cows by exposing hidden conflicts of interests and mis-alignments that many in the industry won’t admit to. The book is called "Investing in Real Estate Private Equity: An Insider’s Guide to Real Estate Partnerships, Funds, Joint Ventures & Crowdfunding" (written under his pseudonym of Sean Cook).
 

In the previous part one of the interview, Paul talked about sponsor performance-based compensation misalignment, stress tests and the advantages of capital calls. In this, part two of the interview, Paul talks about how to analyze a sponsor.

 

Part 2

 

4. “TRECFR: Several times you’ve mentioned the importance of picking the right sponsor. What are the top couple of things an investor should be looking at to weed out the best ones from the rest?”

 

Investing in real estate intuitively seems like it should be about picking real estate deals.  I think most investors are better served by spending their limited time researching and picking the best sponsors, and leaving the transaction picking, more or less, to them. 

This isn’t because most investors couldn’t evaluate deals, it’s because to evaluate deals well requires a time investment in the industry and market that isn’t efficient for passive investors, particularly if they are trying to diversify across products and geographies.  It’s a division of labor argument; like how investors pick hedge funds and rely on those managers to pick individual trades. 

So… this is what I would look for when evaluating sponsors:
 

• Track Record: Both the actual net returns to investors and the depth and longevity of the track record are important to consider. 
  
  Higher returns, all else being equal, are good to see.  But it’s also helpful to look at the consistency of returns as an indicator of the risk profile that the sponsor uses when picking deals and capitalizing them. 
  
  Also, a longer track record with deals done throughout market cycles is helpful.  Nearly everyone doing deals in the past five years has done well, so deal history in a limited vintage isn’t particularly useful.
  
  See the top 3 most experienced crowdfunding fund manager all-stars here.
   

• Platform and History: Having a fully-integrated platform can naturally make underwriting more conservative and helps sponsors keep a close eye on their investments throughout the ownership process.  Having maintained a stable platform through market cycles is also an indicator that a company is being managed with a long-term mentality, which is beneficial for investors. 
   

[Editor’s note: when Paul talks about “platform”, he’s talking about something different than some crowdfunding investors mean by it.Investors usually use the word “platform” to describe a real estate crowdfunding website that features potential investments for sale.

When Paul says “platform”, he’s describing the staffing, management and expertise that the sponsor of the deal/fund has set up to perform all the major management tasks of the investment. That includes things like property acquisition, property management, property disposition, etc..Some sponsors will outsource these things, so they’re not considered to have their own platform.

Also, running such a platform successfully through cycles is not only a sign of additional expertise, but can also be an additional source of stability. It's an additional revenue stream that might increase the chances that the sponsor can "keep the lights on" over challenging portions of the real estate cycle.]

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• Executive Team: Look for a team that is experienced specifically with the product type and strategy being proposed.  Also, teams with a track record of working together are a good indicator of platform stability.
   

• Activity: Sponsors who are actively buyers and sellers have an advantage over those who don’t.  Having recent transaction experience with brokers and other owners is very helpful as a potential buyer and leads to better pricing and terms on new acquisitions. 

 

4b) TRECFR: These are very useful methods to judge sponsors. At the same time, there would be a difficulty for the average crowdfunding investor to put many of them into practice.

 

Most don't have deal flow from anything other than the crowdfunding platforms where 99% of the sponsors have never been through a complete market cycle (let alone multiple cycles).  So the vast majority of the investors can't truly analyze sponsors based on the stability of their returns at different stages of the cycle, or evaluate a long track record, or look for one that's maintained a stable platform through multiple cycles etc.

 

Some have argued the reason for this is that the sponsors who have gone even just full cycle (and done well) will have already built up a significant, enthusiastic investor base over more than a decade or more. With all the dry powder chasing yield out there, they don't have a need to go to a crowdfunding site to drum up interest when they can do it easier and cheaper themselves. Whatever the reason: the average investor is currently only seeing newer/less experienced sponsors.
 

In this situation, I've seen a lot of newer investors taking the advice to "evaluate the sponsor first" and doing really strange and scary things with it. Many are essentially looking to see whether the sponsor is someone they like (personally) or not. Others are looking to feel compelled by their story, or the story of the deal (which is essentially just evaluating how good of a marketer the sponsor is) .
 

So this may be a tricky question to answer, but what would you recommend for these types of investors? (Maybe they need to find better deal flow outside of the sites, and if so how do they do that?) Also, are there any experienced, multiple cycle sponsors that you like, that investors could research?

I don’t disagree with your assessment that most crowdfunding investors don’t have access to many of the most experienced sponsors.  It seems like the crowdfunding sites, for the moment and for whatever reason, haven’t attracted the most experienced sponsors.  That’s probably for the reason you mentioned – most of the most experienced sponsors with the best track records have more equity than deals right now. 

Also, crowdfunding sites are limited in terms of how much money they can raise, which makes them less efficient for the larger sponsors.  Hopefully that will change over time if crowdfunding gets more traction and can raise more money for each deal.  While many experienced sponsors don’t go out of their way right now to attract new investors, most of them also don’t turn accredited investors away either. 

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I think the best way to find good sponsors is to start from the ground up rather than by evaluating deals as they come in.  So, the process would be:
 

1. Decide target allocation to real estate
    

2. Build a strategy: REIT vs. private, fund vs. syndicate, debt vs. equity
    

3. Figure out target deal types, geography, and size
    

4. Find sponsors (Look through industry publications/press and call a few brokers to get lists of the groups that have been most active lately in that space.  Then reach out to those groups to see which accept private investors, talk about their strategy and evaluate their track record.)
    

5. Evaluate deals

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[Editor’s note: See the site’s investment education section to learn how to decide your real estate target allocation, build a strategy, target deal types, and evaluate deals.]

For those interested in learning more from Paul’s considerable experience, you can download his e-book from Amazon.