For many single-family and multifamily offices, there is a desire to invest directly into real estate opportunities rather than a fund or a managed account. The ability to do the proper due diligence for each family office varies based upon the internal resources and experience that the office has available. With the constant requests from real estate companies wanting a family office to invest with them, it is essential for the family office to be able to screen any opportunities efficiently before spending additional time.
Although there may be a few other items you’ll want to add to your list, the following are the initial points to check off when determining if it makes sense to continue the due diligence process. These are the same five items that real estate investment banking firms and institutions look at before investing or taking on any mandates from clients.
1. Sponsor Experience
The first area that needs to be considered is the joint venture partner’s experience. Does the sponsor have experience in similar types of deals, property types and geographic markets of the asset that the JV partner is asking for the family office to consider?
As the family office will be looking to its JV partner for expertise on the day-to-day operations of the real estate opportunity, members must have complete confidence in the JV partner. This includes confidence in their ability to not only manage the project during the good times but also understand what to do when things don’t turn out as projected or the market changes direction.
2. JV Partner’s Strength
Does the JV partner have a strong business balance sheet and does the principal have a strong personal balance sheet to complete the suggested project and to weather any storms? How many projects does the JV partner have in the works? Is the JV partner spreading themselves too thin or do they have the capacity to see each of the projects that the family office is involved in to fruition? The last thing the family office wants is to have its plan fail because the JV partner took on too many opportunities because “the market was hot.”
3. JV Partner’s Track Record
When evaluating a JV with a partner, the following questions must be asked: What does their history show? Have their returns been consistent? How long is their track record — one year? Five years? Ten, 20 or 30 years? If the JV partner’s track record is since 2010, is their success because they bought when the market was down, or did they withstand multiple cycles and how did they perform?
The track record says a lot as it can give you some insight into the future of your joint venture. Don’t take the JV partner’s word for it — be sure to confirm.
4. Economic Viability Of The Investment
One of the key tasks with projects, especially during times of real estate being a go-to investment, is to identify whether the proposed investment is feasible and the projections are realistic. Some questions you should evaluate are:
• Are the finances such that the project’s lifetime operating costs are covered and the project still provides an acceptable return on investment for the family office?
• Are the models on the project proposed to the family office by the JV partner aggressive, conservative or somewhere in the middle? Too often, all that is presented to the family office are the best case scenarios.
• Was the project stress tested by running different downside scenarios so that the family office has an understanding of what really could happen and how that would affect the potential returns?
5. Alignment Of Interest
Although there is no one way a Joint Venture is structured, the typical structure consists of 90% of the equity provided by the family office investors (LPs) and 10% by the operating partner (GP). After a return of capital back to the investors, capital will then receive an agreed upon-preferred return pari-passu, after which time there is a split of profits above the preferred return of 80% to the LPs and 20% to the GP. This 20% is considered a “promote” to the GP, which is essentially the financial incentive for the GP to carry out a successful project. Any other fees that the GP may charge such as development or property management fees would be able to be earned at market-rate prices.
Some family offices prefer a simple structure of 50/50 with minimal expenses going to pay the standard costs. Sometimes JV partners will want to charge everything from an acquisition fee, sales fee, debt origination fee, fee for raising equity from you the family office and asset management fees. Fees are fine to be charged by the JV partner, but be sure to have a good understanding of what these are.
A joint venture with a sponsor is a great way for family offices to minimize some of the due diligence that is required to invest into a real estate opportunity, as well as to have a predetermined structure for future deals. The best thing the family offices can remember is the underwriting of the sponsor is the priority, and the deal is secondary. If you can’t get past the sponsor, the deal doesn’t matter.