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We publish this because we would rather be asked. Every question below is one we answer about our own deals, and two of them are the ones that most reliably separate a sponsor who has operated through a difficult cycle from one who has not.
The nine, before the reasoning
These are the questions we would ask a sponsor before wiring, in the order we would ask them. Each one has a right answer and a revealing wrong answer, and none of them requires you to be a real estate professional to evaluate.
| # | Question | What it tests |
|---|---|---|
| 1 | How many deals have gone full cycle, and may I see all of them? | Whether the track record is selected |
| 2 | Are those returns gross or net? | Whether the number is one an investor received |
| 3 | How much have you invested here, in dollars, and from where? | Whether alignment is capital or accounting |
| 4 | What is every fee, at every stage, including affiliates? | What the sponsor is paid for |
| 5 | Fixed or floating, when does it mature, when does the cap expire? | The thing that actually breaks deals |
| 6 | Is the preferred return cumulative, and does it compound? | Who absorbs a bad year |
| 7 | What happens if I decline a capital call? | Your maximum exposure |
| 8 | Which assumption are you least confident about? | Whether they have stress-tested their own work |
| 9 | May I speak to an investor in your worst deal? | How they behave when it goes wrong |
The rest of this page is why each one matters and what a good answer sounds like.
Questions one and two: the record, and whether it is the whole record
An unrealized return is a projection wearing the clothes of a result. Until a property is sold, its return is the sponsor's own estimate of what it would fetch. So the first question is how many deals have been bought and sold, and those are the track record.
The second half is harder to ask and more revealing. Request every offering they have ever made, including underperformers, deals still held past their original horizon, and any where investors received less than their capital back. Then check that list against the sponsor's own Form D filings, which are filed within 15 days after the first sale of an offering1 and are public and searchable on EDGAR.2
A gap between the list you were given and the filings you found is the single most informative thing available in this entire process. It costs five minutes.
On gross versus net: a gross return is what the asset produced, a net return is what reached an investor after fees, promote and expenses. In a leveraged deal with a full fee stack the two are far apart, and a gross figure quoted to a limited partner is a number nobody could have received. Ask explicitly, and ask again if the answer is imprecise.
Questions three and four: where their money is, and how they get paid
Every sponsor says they invest alongside you. The claim means little without two figures: how much, in dollars, and where it came from.
A deferred fee credited as equity appears in a capital account exactly like cash does. Only one of them was money the sponsor could have kept. Ask for the dollar amount and the source, and ask whether the co-investment sits on the same terms as yours or on preferential ones.
On fees, ask for all of them at once rather than line by line: acquisition, asset management, construction management, guarantee or loan fee, refinancing, disposition, plus anything paid to an affiliate for property management, insurance, construction or leasing. Then ask the question that summarizes it: what proportion of your total expected compensation, in the base case, comes from fees rather than promote?
A sponsor whose economics are mostly fees is paid for transacting and holding. One whose economics are mostly promote is paid for outcomes. Neither is wrong and the ratio tells you what the structure rewards. Affiliate transactions are not improper either, and they are a transfer from the partnership to the sponsor at a price nobody negotiated, so they should be disclosed, benchmarked against a third-party quote and visible in reporting.
Question five: the one that actually breaks deals
Most multifamily deals that failed recently did not fail on operations. They failed on the capital structure, and unlike the operating assumptions the debt terms are facts at the moment you invest rather than forecasts.
Establish all of it: fixed or floating; if floating, the index and the spread; the term and the exact maturity date; any interest-only period and its length; the amortization after it; the rate cap strike, its expiry and what replacement costs at today's pricing; the debt service coverage and loan-to-value covenants; and whether a cash management or lockbox trigger exists and at what level it springs.
Then ask the question that ties them together: what combination of circumstances breaches a covenant or requires new equity, and how far is that from the base case? A sponsor who has run that analysis answers in numbers.
Ask who signs the loan, too. Lenders assess guarantors on a global basis, and the federal banking agencies' policy statement refers to global debt service coverage as "inclusive of the cash flows generated by both the borrower(s) and guarantor(s), as well as the combined financial obligations (including contingent obligations) of the borrower(s) and guarantor(s)."3 A guarantor stretched across other stressed loans weakens your deal even if your property performs.
Questions six and seven: the two clauses that decide your downside
Whether the preferred return is cumulative decides who absorbs the cost of a bad year. Cumulative means an unpaid amount accrues and must be satisfied before any promote. Non-cumulative means it is extinguished and the sponsor can earn a promote again the following year without ever making you whole. On a five-year hold with two soft years the difference runs to double figures as a percentage of invested capital, and the arithmetic is worked through at cumulative versus non-cumulative preferred returns.
Then ask what happens if you decline a capital call, quoted from the agreement rather than paraphrased. This is the clause that determines your maximum exposure, and there are three broad answers: mandatory with a legal remedy, in which case your downside is not capped at what you wired; optional with dilution, which caps it; or optional with a new preferred instrument for contributing partners, which can be more punitive than dilution while not being called a penalty.
Ask whether any penalty factor applies to dilution and at what multiple. Two-to-one and three-to-one exist. The mechanics are at capital calls.
Questions eight and nine: how they behave when it is not working
Asking which assumption they are least confident about does two things at once. It surfaces the real risk in the model, and it tests whether they have stress-tested their own work. Every model has a weakest assumption. A sponsor who claims otherwise has either not looked or is not saying.
Follow it with the sensitivities: the return with the exit cap rate expanded by fifty and by a hundred basis points, rent premiums achieved at half the assumed level, renovation twenty percent over and six months late. These already exist in any properly built model, so the request is not a burden. If fifty basis points of cap rate expansion removes most of the projected profit, the deal is a bet on the market wearing the clothes of a business plan.
The ninth question is the one sponsors least expect. Ask to speak to an investor in the deal that performed worst. A curated reference list tells you nothing; everyone knows that. What tells you something is whether they will connect you to someone who lost money, and what that person says about how they were treated.
Ask for the last four quarterly reports from an existing deal, unredacted, while you are there. Reporting quality under stress is the closest available proxy for how you will be treated when something goes wrong, and it cannot be manufactured after the fact.
The twenty minutes of checking you can do without asking anyone
Four public databases cover different ground, and checking one and stopping is the common error.
FINRA BrokerCheck is the official record for brokers and brokerage firms.4 Investment Adviser Public Disclosure covers adviser firms and their representatives and is the route to a firm's Form ADV.5 The SEC Action Lookup searches individuals named in federal court actions and administrative proceedings.6 And your state securities regulator brings actions the SEC does not.7
Read a clean result carefully, because it is not the same as a clean record. The SEC states that its individual lookup results "will not include individuals whose cases are currently pending at the trial court or those against whom no judgment or order has been issued," and advises against relying on the tool alone.6 A sponsor currently being litigated returns nothing. One who was never registered returns nothing from BrokerCheck.
Rule 506 also carries a disqualification regime at paragraph (d), reaching directors, executive officers, general partners, promoters and twenty percent beneficial owners.8 Ask directly whether any covered person has a disqualifying event or has obtained a waiver. A sponsor who has done this properly holds the answer in writing already.
What none of this protects you from
Worth stating plainly so the list is not oversold. None of these questions makes a private real estate investment safe.
The offering is exempt from registration, which means nobody reviewed the property, the projections, the fees or the sponsor, and a Form D is a notice rather than an approval.9 The interest you buy is a restricted security with a holding period before any resale would even be lawful, and the partnership agreement restricts transfer on top of that, so there is no practical exit before the sponsor sells.10 Any loss allocated to you is likely to be passive and suspended rather than usable against your salary.11
Distributions can be suspended, hold periods extend, capital can be called, and you can lose the entire amount. Nine good answers reduce the chance of avoidable loss. They do not convert a speculative illiquid investment into a safe one.
The most common serious mistake is not choosing a poor deal. It is choosing a good one at the wrong size.
We expect to be asked these
We publish this list knowing it will be used against us, which is the only reason it is worth publishing. A diligence list a sponsor would not want you to run is not a diligence list, it is marketing.
We will answer all nine in writing, connect you with existing investors including from our least successful deal, and tell you which assumption in the model we are least sure about.
What we will not tell you is that any of it is safe, that a projection is a forecast, or that a record predicts the future. The longer method is at how to vet a sponsor.
The nine, in order
- Is the preferred return cumulative or non-cumulative, and does it compound?
- What happens to an investor who declines a capital call?
- Where would rescue capital sit relative to my position?
- What is the total fee load across the whole hold, in dollars?
- Who is the lender and when does the loan mature?
- What does replacing the rate cap cost, and who pays for it?
- Have you ever issued a capital call, and what happened to those who declined?
- Can I speak to an investor from a deal that did not go to plan?
- What will you not do?
What this is built on
- U.S. Securities and Exchange Commission, Form D, notice of exempt offering of securities
- U.S. Securities and Exchange Commission, EDGAR full text filing search
- Board of Governors of the Federal Reserve System, Policy Statement on Prudent Commercial Real Estate Loan Accommodations and Workouts
- Financial Industry Regulatory Authority, BrokerCheck
- U.S. Securities and Exchange Commission, Investment Adviser Public Disclosure
- U.S. Securities and Exchange Commission, SEC Action Lookup for Individuals
- North American Securities Administrators Association, Contact your state securities regulator
- Legal Information Institute, Cornell Law School, 17 CFR 230.506, including the paragraph (d) disqualification provisions
- Investor.gov, Private placements under Rule 506(b) and 506(c)
- U.S. Securities and Exchange Commission, Rule 144, selling restricted and control securities
- Internal Revenue Service, Publication 925, Passive Activity and At-Risk Rules
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No question matches that. Try another word, or ask the one that is not on this list.
Ricardo Sanabria · Grey Oaks Multifamily
Answering
Follow-up questions people ask after reading this.
Which two do sponsors struggle with most?
The capital call history and the request to speak to an investor from a deal that went badly. Both require a track record through a difficult period rather than a marketing document, and both are easy to deflect if you let them be deflected.
Ricardo Sanabria, Grey Oaks Multifamily
Is it unreasonable to ask for a reference from a bad deal?
No, and the reaction tells you as much as the answer. A sponsor who has operated for any length of time has had a deal disappoint. One who claims otherwise is either new or is not being straight with you.
Ricardo Sanabria, Grey Oaks Multifamily
What if a sponsor will not answer in writing?
Treat that as the answer. Every one of these nine is answerable from the operating agreement, the loan documents or the sponsor own records, so a refusal to put it in writing is a choice rather than a limitation.
Ricardo Sanabria, Grey Oaks Multifamily
Do you expect investors to ask you these?
Yes. We published them for that purpose, and we would rather field them before a subscription than after a distribution is missed. Our disclosures are at disclosures.
Ricardo Sanabria, Grey Oaks Multifamily
4 questions
