The Three Pillars of Real Estate Investment Success

Savvy investors know that no real estate investment is perfect.

And experienced developers know this about their projects too.

The truth is, all deals involve risk, sometimes substantial risk.

And that’s OK, because that's where the reward comes from.

But if you think you’re getting a safe return with a stabilised property investment that’s offering you an annual 15% return, you’re probably missing something.

So keep looking!

There are three pillars of real estate investment success:

• Execution. Track record and counterparty risk.
• Alignment of Interests. Co-investment, waterfall, and fees.
• Property. Valuation and business plan

Whilst each of these three pillars (Execution, Alignment, and Property) are critical to an investment’s performance, they can (and should) be analysed independently.

Missing any one of them will almost always be detrimental.

More than one, and the patient normally dies.

Here are three examples to demonstrate what I mean:

Strong Execution: A Sponsor, Promoter, or Manager could have great execution skills, but missed a major risk on a property and thereby lost investor’s money.

Strong Alignment: A Sponsor, Promoter, or Manager has a favourable fee and waterfall structure, and perhaps even bought a great property at the right price with a realistic business plan.

However, the investment failed due to lack of experience.

Strong Property: The Sponsor, Promoter, or Manager is buying a phenomenal property, at a great price, and the business plan is realistic.

However, the business plan didn’t work and as a result of a weak alignment of incentives (or lack of experience), the investment failed.

These examples are provided to illustrate a critical point:

• Investment is an inherently risky and complex undertaking.?
• No investment will rank 10/10 on each of the three pillars.?
• And if it does, you need to dig more, because something has been missed.

The best investments will have risks that you have identified, priced accordingly, and are comfortable with due to the mitigants that are already in place, or that are planned to be deployed, within the cost constraints allocated to them.

So with that introduction behind us, let’s dig into the first of the three pillars:

Execution - Track Record and Counterparty Risk

The reason why Execution is the first of the three pillars is because as an intending investor in a Sponsor, Promoter, or Manager’s scheme, you’re about to get into a relationship.

Maybe for a long time.

Relationships are inherently trust based.

And as a general rule, a passive investor in an unlisted Syndication, Trust, or Fund will have little to no say about what happens with their investment from the day they vest the funds.

This is important to consider, since once you invest and part with your capital, you won’t have an opportunity to change your mind or influence the Sponsor, Promoter, or Manager’s decision making, no matter how much you might disagree with them.

You only have leverage before you invest.

So do your diligence well.

Track Record

Trackr records are a bit like statistics.

They can say whatever you like.

So the best approach when presented with track record, is "Trust, but verify".

Or if a mystical aphorism is more to your taste; “Trust the universe, but tether your camel.”

This is a test of how long a Sponsor, Promoter, or Manager has been in business.

And how well they did during that period.

All else being equal, a longer track record, provided it’s a record of success and spans at least one economic cycle (not COVID), is better than a shorter one.?

And of course, higher returns that are consistent through cycles are better than lower returns too.

And although a strong track record isn’t everything, it is arguably one of the most important variables in understanding a deal and assessing risk to capital.

Still, it’s important to remember that everyone has to start somewhere.

Every successful Sponsor, Promoter, or Manager did their first deal at some point.

They didn’t have a 30 year track record to point to at the start of their careers.

And you should be comfortable backing a new Sponsor, Promoter, or Manager.

But just know that when you do, all else being equal, the risk is higher with a newer Sponsor, Promoter, or Manager than one with a longer and successful track record.

However some might say, not without merit, that the “eagerness” to succeed as a newer Sponsor, Promoter, or Manager is hard to beat.

Hungry goes harder!

And, as a result, these newer players outperform those with a long track record.

But in my opinion, if you took this experiment out to a sizeable sample size, the opposite would be true.

Of course there are counterexamples and phenomenal newer Sponsors, Promoters, and Managers doing great work. There are some super smart, diligent, and organised operators coming through that are truly very impressive.

But even so, if a Sponsor, Promoter, or Manager is new/newer, you should not take the same terms as you would from a Sponsor, Promoter, or Manager that has been around for a long time successfully delivering stellar deals.

Bottom line?

You need to be compensated for the additional execution risk you are assuming with a new or newer Sponsor, Promoter, or Manager.

Most Sponsors, Promoters, or Managers will have a track record slide when they are pitching an opportunity to you.

And it’s one of the most important slides for you to examine carefully.

There are a few key things to look for when reviewing track record info:

• If the slide is vague or not specific as to their experience (vs the experience of their corporate employer, for example), this is something you should notice immediately and ask about.
• The contents of the slide should specify properties that have been bought and sold (or developed) by the Sponsor, Promoter, or Manager (full cycle transactions), their entry and exit prices, returns, as well as entry/exit dates.
• Dates are particularly important, since not all exits are created equal.?

For example, if a property was acquired in 2007 and sold in 2009 (right after the crash) and made a 2x multiple on equity, that’s a lot more impressive than buying in 2019 and selling in 2021 when cap rates compressed due to the availability of almost free money (cheap and abundant debt).

While we’re on this topic, I just want to mention that it’s important to separate skill from luck.?

Of course both are at play for any Sponsor, Promoter, or Manager.

But entry/exit dates are one of the best ways to decipher this when you consider what was happening in the broader economy at the relevant time.

Don’t just trust the track record either; verify, and make sure it’s complete.

I’ve seen cases where the track record slide neglected to mention failed investments or the returns weren’t honestly presented.

It doesn’t happen often.

There are checks and balances in the system.

But it happens often enough to flag it here.

Counterparty Risk

First impressions matter.

Since investing into a Sponsor, Promoter, or Manager’s scheme, syndication, or fund is a trust-based relationship, you need to ensure that the Sponsor, Promoter, or Manager (and any relevant entities) aren’t involved in material lawsuits.

Lawsuits happen.

They are part of doing business.?

So whilst we are always interested in whether there are any lawsuits on foot or about to commence, it’s the nature of the lawsuit that’s more important than having a lawsuit to grapple with in and of itself.

In fact, sometimes an outstanding lawsuit might mean that the Sponsor, Promoter, or Manager is savvy and proactively doing the right thing for Scheme investors.

Although you can’t (and shouldn’t) purely base an investment decision on past lawsuits and disputes, it’s certainly something you should consider strongly as part of a larger investment decision because litigation is always costly and usually a massive distraction and disruption to a business.

Unfortunately, there are Sponsors, Promoters, and Managers with stellar records that may still do something immoral, sometimes even borderline illegal.

But thankfully, it’s a rarity these days.

Yet it still happens every cycle.

And inexperienced investors always get burned, every single cycle.

Remember this; the chances of someone doing something ethically immoral or borderline illegal, after a history of behaving that way, is likely to be higher than if they were committed to conducting ethical business.

And if the Sponsor, Promoter, and Manager team seems a bit erratic, then it’s probably because they are actually all over the shop.

Look, I don’t have statistical proof for this.

But I’ve seen numerous cases of deals falling apart where the Sponsor, Promoter, and Managers’ entity comprises a thrown-together compilation of people who all work at different firms.

That’s a problem because there needs to be a cohesive team driving an investment or project.

And there always has to be a clear decision maker with responsibility for an investment’s performance and a project outcome.

There can’t be any ducking and weaving or dicking around with this.

And that responsible person needs to have direct experience executing the type of business plan that applies to the subject investment.?

You don’t want them learning on your time and putting your capital at even more risk, unless you have been adequately compensated for assuming that burden.

So check the Sponsor, Promoter, and Managers’ website and LinkedIn profile to carefully examine the backgrounds of the Executive team that will be responsible for the investment or project.

Do they seem fit for their titles based on their experiences?

Note that key person risk is important to consider and price here as well.?

What happens if something happens to the Sponsor, Promoter, and Manager and they’re no longer able to be a part of the business?

Are there competent people in the firm to fill in and be good (or at least “good enough”) stewards of your capital until exit?

There are many things to ponder before you slide your capital across the table.

And in the next article in this series, we’ll address Alignment.

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