If you’re looking into real estate syndication, doing the right due diligence can make all the difference. Today, I’ll walk you through our process for doing due diligence, using an example from one of our deals, Overlook Apartments.
This step-by-step guide can help you decide if a deal is solid or if it has too many hidden risks.
Due diligence is more than items on a checklist, it’s your way to make sure the property, location, finances, and team running the deal all lineup. This is important to know even if you’re a passive investor! By going deep into these areas, you’re not only protecting your investment but setting yourself up for success.
Here’s how we do it:
Why Due Diligence Matters for Real Estate Syndications
Due diligence is crucial for avoiding hidden issues in your multifamily investment. Without proper due diligence, you might invest in something with unrealistic financial projections, an unproven operator, or a location with low tenant demand. As an investor, you don’t want to risk your money without understanding the full picture.
And for active investors, having strong due diligence builds trust with investors, helping you build a solid reputation. Whether you’re a passive investor or an operator, let’s dive into what to look for in a syndication.
Key Parts of Due Diligence
When we evaluate a real estate syndication, we focus on three main areas:
- Asset class
- Operator
- The deal itself
Asset Class
First, decide if the asset type is the right choice for the current market. We focus on multifamily properties because there’s always a need for affordable housing. Multifamily units tend to hold up well during recessions since people still need a place to live, even when times are tough.
Plus, multifamily properties have a track record of stable performance, making them a safer choice.
Operator
The operator’s experience and track record are essential.
You want to invest with a team that knows the market, has a strong history of success, and is focused on property management.
For example, our team has been working together since 2017, and we’ve handled over 20 deals, buying, selling, and managing properties. We have an in-house team, including asset managers and construction managers, who make sure every project runs smoothly.
This experience helps us make informed decisions on each deal – and is something you should look for in your operators also.
The Deal Itself
Finally, look at the specifics of the property and the business plan.
A good business plan explains how the operator plans to improve the property and increase rents or value.
I’m going to use our Overlook Apartments as an example: we saw that rents were below market, giving us room to increase income by making simple upgrades. We looked at the current tenant base, property condition, and nearby amenities to make sure our plan would work.
Steps for Evaluating a Deal
Let’s break down some clear steps based on our experience with Overlook Apartments:
- Check the Location
Start by assessing the area. Is it growing? Is there demand for rentals? For Overlook Apartments, we saw that it was in a desirable county with limited affordable housing options.
We liked that there were few choices for affordable rentals, and we saw that new, high-end apartments were being built. This showed us there was demand in the area for people looking for quality homes at affordable prices.
- Analyze the Financial Projections
Dig into the deal’s financial projections. Are rent increases and vacancy assumptions realistic? In the Overlook deal, we assumed a high vacancy rate at first to give ourselves a buffer. For example, if we couldn’t fill the units immediately after renovations, this cushion meant we’d still be on track financially.
We also checked that other projected expenses like property taxes, insurance, and payroll were set at realistic levels. In today’s market, some costs, like insurance, have been going up fast, so we made sure to account for that.
- Understand the Loan Terms
A deal’s debt structure can have a huge impact on returns. For Overlook Apartments, we chose a low-risk fixed-rate loan with 65% loan-to-value (LTV), meaning we borrowed 65% of the property’s purchase price and raised the rest in cash.
This structure made the deal less risky since it kept our debt payments stable even if market rates changed. Fixed-rate loans can be critical in a volatile market, especially compared to variable-rate loans that may increase costs as interest rates rise.
- Look for Reserves
Reserves are funds set aside to cover unexpected costs, like higher-than-expected construction expenses or repairs. For Overlook Apartments, we set aside 15% of our construction budget as reserves, giving us a cushion if anything went over budget. If there’s a big surprise cost, reserves let us cover it without impacting returns to investors.
- Check the Business Plan and Risks
Evaluate the business plan carefully. In our deal, we planned to add value by upgrading units, which would let us charge higher rents.
This “value-add” strategy is common in syndications, where properties are often underperforming but have potential.
A key part of our plan was understanding local competition, so we visited similar properties in person to compare rents and amenities. This step showed us that our rent goals were achievable based on other properties in the area.
- Assess the Exit Cap Rate
The exit cap rate is what the operator thinks the property will be worth when it’s sold. It’s a multiplier used to estimate value, and it directly affects the deal’s returns.
Look for deals with a conservative cap rate that reflects current market conditions – and try not to be overly optimistic. Even a small change in the cap rate can have a big impact on returns, so it’s essential to keep this realistic.
Wrap-Up and Final Thoughts
Due diligence is more than just checking numbers; it’s about making sure each part of the deal’s story makes sense.
Ask yourself questions about the asset class, operator, financials, and exit strategy to make sure you understand the full picture. This process is crucial for both passive investors and operators.
For passive investors, due diligence ensures you’re putting your money into a well-researched deal.
For operators, addressing these questions upfront builds trust with investors and shows that you’ve done your homework.
So, if you’re serious about real estate investing, take the time to dig into the details of each syndication deal. Investing in well-researched, high-quality syndications can be a powerful way to build wealth.
If you want to learn more about investing with us, check out Nighthawk Equity and schedule a call.
