What’s unique about investing in a private placement is the access you have to top tier management who are typically pretty good about keeping an open line of communication to answer any of your questions or address any concerns.
This transparency and access provide potential investors with the opportunity to perform thorough due diligence in order to make an informed investment decision.
Before making an investment decision, it’s important to ask the right questions in order to ensure the management’s goals, objectives and strategies align with those of your own.
Here are the seven more relevant questions to ask before investing in a private placement:
What is management’s track record? Have you invested in this type of asset class and subsegment before? Have you been involved in prior private placements? If so, what is your track record of success? Do you have financial statements or investor reports you can share from prior deals?
Be leery of management with a lack of a track record in the particular asset class in which they’re attempting to raise capital to invest in. Lack of experience in launching and managing a private offering is less concerning than a lack of investment experience.
What is management’s background? What is your educational and professional background? What is the specialty of each team member? Does someone specialize in the analysis of deals? Legal? Financial? Property management?
Make sure management has core competence from their educational and professional backgrounds. Make sure the various aspects of property management are covered by a team member or in the case of outsourcing, by competent third parties.
What is the Objective and Strategy? Are you focused on cash flow, appreciation, asset preservation, or a combination of one or more of those factors? What type of asset segment will you be targeting? Class A, B, C, D? What about investment strategy? Core, Core-Plus, Value-Add, Opportunistic? What geographic locations, demographics, etc. will you be targeting?
Make sure management has a clear, defined strategy in a targeted asset segment. Does management clearly communicate this strategy? Is it focused? Investors should avoid broad, vague, unfocused, and speculative strategies. A scatter-shot approach with no defined asset class or geographic area or delving into asset classes management has no familiarity or experience with should be avoided.
A clear and proven strategy will contain specific details such as clear-cut:
- Asset Class.
- Geographic Focus.
- Company and Market Data.
- Development or Renovation Plan.
- Financial Projections.
- Exit Strategy.
What are the principal financial projections and terms surrounding the venture? Do you have proformas? What’s the acquisition cost? Total costs with cap-ex? Will it be leveraged? What’s the cap rate at acquisition? What’s the projected cap rate at the time of disposition? What’s the projected first-year cash-on-cash return? The average annual return? The IRR? How often can we expect distributions?
Make sure management knows their numbers and make sure the numbers pass the smell test. Avoid pie-in-the-sky financial promises. Ensure that the payout and distribution structure of the opportunity aligns with your own investment goals and objectives. Are you more interested in a long-term return and payoff from appreciation or are you more interested in cash flow with a consistent return? Or are you interested in a mix of both? Make sure the fund’s business strategy aligns with your financial goals.
Diversification. Diversification hedges risk and can be accomplished in a variety of ways including compiling a portfolio of single-tenant properties in various geographical markets or investing in a multi-tenant property or across multiple property types in one geographical market. Investors should pay attention to a QOF’s diversification strategy. Any QOF with all eggs in one basket approach should be avoided.
How will management be compensated? Will you or any affiliated companies receive any type of periodic or per-transaction fees? What is your profit split of cash flow from operations? What is your profit split of cash flow from dispositions?
In an ideal world, management should be only compensated if they’re successful. In other words, they should only get paid if you get paid. That’s not to say that upfront or management fees are inherently bad. Just make sure they’re reasonable.
What is the exit strategy? How long should I expect my investment capital to be locked up? How should I expect a return of my capital? From a refinance? Sale?
Avoid open-ended exit strategies. Expect a defined exit strategy but with a little management, flexibility to allow for disposition at the optimal time.
What are the business, market, and financial risks of this opportunity? Beware of the risk-free pitch. There’s no such thing. Make sure management recognizes the risks and has a plan for mitigating that risk.
Private placements offer investors a tremendous opportunity to benefit financially from alternative investments offering above-market risk-adjusted returns uncorrelated to Wall Street.
However, to take full advantage of these investment opportunities, it’s important not to get suckered into just any deal. Asking the right questions will go a long way towards aligning your financial goals and objectives, as well as minimizing risk.
Recognizing red flags will help you avoid bad managers and investments and allow you to truly maximize the benefits of investing in the private markets.