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Questions You Should Be Prepared To Answer As A Sponsor

September 14, 2022

chrisseveney

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CWS 217 | Sponsor Questions

 

Before any business relationship begins, trust needs to be established. Doing your due diligence by answering and asking questions saves you from possible disaster. As a sponsor, you need to come equipped when investors start taking a step towards a possible partnership. In this episode, Lauren Wells and Chris Seveney help by sharing the questions you should be prepared to answer. From the state of the current economy to the pricing and risks involved, they break down the top inquiries among investors and how you can position yourself to best answer them. So tune in to this great conversation to not miss out on some valuable nuggets. After all, what you’re investing in the asset class is just as important as who you’re investing with.

Watch the episode here

 

Listen to the podcast here


 

Questions You Should Be Prepared To Answer As A Sponsor

In this episode, we want to talk about questions that you should be prepared to answer as a sponsor. We’ve talked about questions you should ask when interviewing a sponsor. Let’s talk about these questions that I’m getting, that Chris is getting, the other sponsors I’m sure are getting, people talk with them about who is interested in investing, want to get on a call? What questions am I fielding? It might also be different from the questions Chris is fielding. Chris, what is probably the top question that you are getting when you speak with people? It’s probably different than what I’m getting.

This topic also came up to add a little color as well to it. I was on a call with some other investors. They are interested in starting a fund. I went through a lot of the lessons learned that I had over the five-plus funds that we’ve done on things that work and things to make sure you understand. We were also talking about things like what to be prepared for. Lauren and I have been having multiple conversations, making sure we are all on the same page in regards to the questions that come up with the investors.

The first big question we’ve received is about the economy, “What’s going on with the economy? What’s going on with interest rates? What’s going on with housing and with it being a fund focused on real estate and ours on the finance side of real estate?” The inflation question and overall real estate in the economy come up, probably I would say number one, would you agree?

Yeah, there are the top three questions I get asked. That’s probably in the top three. “How does the economic environment affect this investment?” Anything with the economy, inflation, the stock market, everything. “How does that affect what I’m investing in with you?”

For everyone reading, these questions aren’t just pertaining to real estate or anything. This could be any type of money raise you are doing, whether you are raising VC money or money for a business or a real estate fund. It doesn’t matter.

The economic environment affects them all in some way. If you look at the VCs now, they are holding tight to their cash. That’s a huge factor for them. We can answer these in relation to broad but also give an example specifically to our specific investment and what we invest in. Obviously, this one will be more specific because we can’t answer how the economic environment is affecting all different assets or all different investment types because we’re not experts in all investment types. Specifically, to note investing, when someone asks how is the market affecting this specific asset class and investment, what would you say?

First, our fund is diverse, where we are going to have hundreds of thousands of assets in our fund versus one asset, which could be a multifamily building. The most comparative analysis that we hear from people is that they are multifamily investors. By having a diverse, broad portfolio, also as the lender on a loan and us, not leveraging it either like if it’s a $100,000 house and there’s a $100,000 loan, we are going to buy that at a discount. We have that built-in equity, plus the leverage is the investor’s cash. It’s not as if we have a $100,000 investment, bank money, and our money, which limits what we can do. Having the investors as the leverage gives us many options and exit strategies to allow us to be flexible.

With us, if we do take a property back, we can rent, rehab, resell, and sell or finance it. If you have a rental with a mortgage on it and the price drops, you can rent it but you can’t sell it. You are tied to what you can do. We watched the markets. We watch real estate. We are making sure that we are not buying all of our notes in Phoenix, which is an area where many people are concerned with all the eye buyers.

Having a diverse, broad portfolio really gives us so many options and exit strategies to allow us to be very flexible. Click To Tweet

Also, one last thing, information, and education. We follow a lot of different information pieces to get our own analysis of what’s going on. The media is challenging because some of the stories that are put out might be a little biased. It’s important to get a lot of information and analyze that data, which to me, as an engineer, that’s a dream.

Let’s tie that back. More specifically, people will say, “What about the housing market? If prices and values were to fall, how would that impact what you guys are doing?” They’ve risen aggressively in the last few years.

First, we are assuming. We’ve adjusted our models for when we go to acquire based on asset value. We are discounting asset values in the models that we run. It’s because we’ve had such a big run-up over the years, most properties now have that built-in equity. If a borrower owes us $250,000 on their loan and the house went from $300,000 to $400,000, say we bought it for $200,000. $250,000 is how much they owe us, and we bought it for $50,000 less, and the house is worth $400,000. How far does that house have to drop before our cost is “underwater?”

With that $400,000, half to drop below $200,000.

It has to have a 50% drop. Even if it does that, you can still work out a new plan with the borrower or if you take it back, you could rent it until it starts to increase. We are the bank, and they are not paying, so we are in control. The biggest thing to remember is that we are the ones in control. We are the bank, unlike other types of syndications. For us, what I like to think of is that we have a lot of built-in cushions compared to if all the other real estate investors that are out there lost 50% on the value of their property. Unless they bought it several years ago, they would be in a lot of pain. For us, I view it as not painful.

When I answer this question, another thing I talk about with investors is the price of acquisition for us. Housing prices have skyrocketed in the past few years. Our acquisition price, because of that, has also gone up.

The pricing has gone up. That has compressed returns slightly. It’s compressed them compared to what they are going to pass.

CWS 217 | Sponsor Questions

Sponsor Q:uestions: The only thing that’s pretty much guaranteed is death and taxes.

 

That mirrors the market. As prices come down, we are not going to be paying the same price as we have been for assets. As prices go up, acquisition prices go up. However, as prices come down, our prices go down. It’s not like prices come down, we are still paying these crazy fees, and our equity is less. That’s something that is important for investors to know.

When we run our sensitivity analysis, again, this all comes into play. One of the other things I like to talk to people about with being the bank is that you own a house. If your house drops by 20%, your house drops by 20%, you are working. You are getting paid. You will most likely continue to pay your mortgage. Jobs are a bigger factor that we watch for than the housing market. Housing is important.

To that point, when it comes to the media, yes, a lot of companies are laying off. I saw a post that someone got laid off from their job. They were worried because all they had been seeing was all these layoffs that had been happening. That’s what they said. They are like, “I got a job super quickly that was double my salary.” I didn’t expect that because all I have been reading was how there all these tech companies are laying off but there are many people still hiring. Again, what we hear is going on and what we see happening are two different things. Being aware of that as well, digging below the headlines.

I could talk for hours on this topic, which we don’t have but that does play into the next question that I will pose to you. What is my risk in this investment? What is the risk?

In comparison to what is always my question. In comparison to your money sitting in a savings account at a bank that is FDIC insured. We are not a bank. We act as the bank when we are acquiring these assets but we are not a bank in the sense that money is not FDIC insured. It’s always in comparison to what. That’s a personal question on the investor needing to know what their risk threshold is. I get this question a lot but it depends. I get it from people who have a lower risk tolerance than someone who’s invested in a ton of different syndications or funds and diversified their portfolio. I don’t typically get that.

They know what their risk specialty is. They are probably not getting on the phone with me if this is outside of their tolerance. I would say, in comparison to what? If the bank is a risk level of one being super safe and the stock market is a ten, you don’t know what you are going to get. It’s probably not great. Any given day, it’s up and down now but mostly down. I would say we fall somewhere, maybe a 4 or 5 at this point, conservative.

I would say probably less. Always ask them, like, “In comparison to what? What are you benchmarking this against? What have you invested in before?” and then tie it back to your question of risk. Usually, they are asking that one because this is something they’re not familiar with. It’s more familiarizing them with notes in comparison to the economics now.

As your risk goes up, you should have a higher potential for return. Click To Tweet

I have a feeling me asking that question threw you a curve ball because you were going to go somewhere else.

I was going to ask you that question but I get asked this a lot, so it’s fine.

A few things, one, as a sponsor, be honest about what the risk is involved in any investment. We will talk about providing the G word later. One of the things that I see a lot when people ask about risk is that for any type of investment, there’s basically the seesaw. There’s the risk and the return or it’s not to seesaw. As your risk goes up, you should have a higher potential for return.

I saw a sponsor promoting syndication that is a 110% return over two years. I see that. To me, I would jump in my spaceship and fly far away. How many people or companies out there that are smart give their investors 110% over two years? I know Apple and Microsoft don’t. Those are pretty big companies. Warren Buffett’s historic return is somewhere in the ‘20s. This person was predicting that they can top Warren Buffett 5X over a two-year period, essentially. Think about that.

I’m going to answer this as a sponsor when you set things up. Be realistic but if you do think you have this type of grand slam deal that’s in there, put the numbers and then put a high-risk factor in. Say it’s a new construction development, and you are building condos. It’s going to take 2 years to build and 2 years absorption to sell the units. At that point in time, it’s a grand slam. What does it look like if it’s 3 years to build and 4 years absorption?

If at that point, it’s still providing good returns that investors would be interested in, that’s what you can start underwriting in your performer, so you understand the sense in that risk. If somebody is throwing out their returns that don’t make sense, especially to accredited investors, many of them are going to see right through that.

That was what I was going to talk about. It comes back to the individual investor. I’m not having the risk conversation with people who are accredited, see the 8% or 10% if they qualify for bonus shares, and come to me. It’s more about getting to know you and me and doing research on us and making sure we are credible. Where I see this question coming up a lot is whether this is the first fund they’ve invested in, they were not familiar with notes or they haven’t done a ton of diversification. They are heavily in the stock market. It’s interesting because people who aren’t as familiar saw 8% and were like, “That’s great. Is that real?” They see that as 110%.

CWS 217 | Sponsor Questions

Sponsor Q:uestions: If you’re somebody trying to build a brand, you have to have some type of presence. Online lets people know who you are. If you are invisible online, you may set off some red flags.

 

They are used to getting 2%, 3%, or 1% in the bank, bonds or CDs. You look at other investors who have invested in real estate and who have invested in different portfolios, and they see 8%. That’s super safe for them. They were like, “Eight percent all? That’s a no-brainer.” They are used to getting 10% plus doing hard money lending or something else. It is also interesting. This question ties in and gives me a sense of what type of investor they are from a sponsor/investor relations perspective. It also leads to the next question that I get.

Before you jump back, I want to jump right in on this point. Our fund starts at 8%. Some folks see that and say, “No way you could ever hit that.” I have investors who’ve invested with me in the past. I shared this with them, and they were like, “I can’t touch 8%. I won’t invest in anything less than 20%.” I’m like, “I can’t give you 20% on this type of venture,” but it’s different based on the two perspectives. As a sponsor, you need to understand when you are going to market this, what you are offering, and what is your target audience. If you are offering a nice preferred return, is that people were looking for the risk or people who want their money to basically be hair-on-fire, light it up, and see what can happen?

Unfortunately, what’s going to happen is that over the last few years, many people have been easy to make money in real estate and make good returns. I don’t think that’s going to be as easy anymore. A lot of these deals that were being underwritten with low-interest rates or exit strategies, if it was a 5, 7-year exit, it’s going to end up being a 10, 11-year exit because they can’t exit, unfortunately.

That comes to the lockup. That’s a different question. Leading into my next question, the big question, I get a ton. It leads to the type of investor I’m speaking with. I get this via email. This is the top question that I get. I don’t know if you get this as your number one. This by far takes the lead, “Is this guaranteed? What’s the guarantee?” This is different from what’s the risk but they go hand in hand. Chris, what would be your answer to this?

First, if you are a sponsor and you tell somebody something is guaranteed, then you get yourself in a lot of trouble.

Disclaimer, nowhere on anything do we use the word guaranteed. We are not even allowed to use the word guaranteed.

Nobody should use the word guaranteed. What’s funny is that we use the word aim because you can’t say, “We are giving you this.”

If you're a sponsor and you tell somebody something is guaranteed, then you just got yourself in a lot of trouble. Click To Tweet

That’s seen as guaranteed.

“This is what we are aiming for, where we have some confidence that we can provide that but we are not guaranteeing anything.” You have some haters that pick on that. The only thing that’s pretty much guaranteed, as the saying goes, is death and taxes. That’s it. Nobody should be guaranteeing. No one should be saying, “You are going to get this.” We are targeting. We are aiming. We are projecting based on, “This is what we may anticipate but who knows what’s going to happen?”

That’s where it comes into doing your homework on who the sponsors are, what their track record is, and the market specifically that they are investing in. It comes down to knowing the asset class in comparison to the economics of the current time, your risk threshold, and who are the people you are investing with. I don’t get enough, “Who is Chris? Who are you? Who’s your team?” That’s always the last question.

It’s like, “By the way, can you tell me a little bit about yourself? Can you tell me a little bit more about Chris and the team behind this?” If I get a reference, that person automatically has more trust in my book. The asset class is just as important as who you are investing with. Do they have a good online reputation? Can you google them? What comes up when you google them? Hopefully, it’s not bad stuff but if it is, I would ask them straight up about that.

If you do have skeletons in the closet, you want to come out with those, whether you’ve had personal bankruptcies in the past or lawsuits and stuff like that, which most indications you probably wouldn’t want to be sponsoring anyways. To that point too as a sponsor, depending on where you are at in your career, you need to have some type of social media or online presence, especially as you are getting started, to let people know who you are. You are a real human person. I like to do a lot of Zoom calls. I joke with people because I will be on the call. My son will come down, run down, and ask for a cookie or candy and show. I’m a father. I’m a person. I’m a real human being.

I’m not somebody hanging in a bunker in a foreign country that is basically trying to take somebody’s money. If you get to a point of somebody in our space who a lot of people look up to like Dave Van Horn, who’s raised $250 million plus, and has been doing it for many years, he’s got that street credit. Everybody already knows who he is. He doesn’t need to be active in that role. If you are somebody trying to build a brand, you have to have some type of presence online to let people know who you are. If you are invisible online, to me as a sponsor, you may set off some red flags for people.

It’s funny because we are talking about going back to our questions that we think you should ask sponsors. It’s all about them and their history, their track record, their business model, all of that. Whereas the questions we always get are more of like, “What’s the risk? Is this guaranteed? How’s this impacted by the market now?” It’s super interesting.

CWS 217 | Sponsor Questions

Sponsor Q:uestions: Let them know where you’re at in the race or why you’re at that number.

 

It’s one of the last questions I always get. “I feel like I already know you because I’ve read the blogs.” One time, I met with someone, a husband and wife. The wife was asking a little bit about me. The husband was like, “I basically already know you. I read the blogs.” I feel like that’s a compliment. It is a good way to get to know people. This is part of why we do it.

It’s interesting too because it popped into my head. As a sponsor, we put out questions to ask investors ask the sponsors. Sponsors should go read that because it’s a lot of things that you should get asked and understand. As a sponsor, you better be able to answer, “How do you financial report? How often do you financially report? How do you report to your investors? What type of platforms and systems are you using?” There’s the overall basis of that. “How many investors are going to be involved?”

“Why this fund over other funds? How do you make money? How do investors get paid?” Those are other common questions I get. “How do you make money?” We can start with that.

It’s always with the assets that you need to acquire. That’s a question that rolls into something that popped into my head. “What if you don’t raise enough money? What if you basically can’t find assets?” There are all those types of risks as well that are questions that people ask. You are looking to raise X amount of dollars. “What is the minimum you need to raise to make this thing work?” That’s a question we get asked a lot as well.

They should have that answer. For us, for example, we run several. I have said that to one of your investors. I was like, “You know Chris. We’ve literally modeled this off of every possible scenario and every different race threshold.” They should have answers to, “What happens if you only raise this amount? Have you thought about that? Have you budgeted for that?”

One question that gets asked too that you have to be truly and upfront with people and don’t blow smoke nowhere is if somebody asks, “How much have you raised?” You have to be honest with those people. If you raised $3 million, don’t tell them, “We are $5 million.” Be honest with them. Let them know where you are at in the race too or why you are at that number.

“How long have you been raising money? Where are you at?” Also for us, every twice a year, we have to provide audited financials. Twice a year, we provide audited financials. People could go look at that. If you are saying one thing and your books a few months later say something completely different, it would not look great. Be honest with people.

What you're investing in the asset class is just as important as who you're investing with. Click To Tweet

For every syndication, they have to file taxes. In your taxes, if it’s a typical LLC syndication, you are going to be a member that you have X amount of percentage. If you are in a $10 million fund and you gave somebody $100,000 and thinking, “I got 1%,” and all of a sudden, it comes back, and you have 3%. It’s like, “Something is not adding up here.”

How do you make money sometimes? There’s the broad of how do we make money as a business in mortgage notes but then it’s from other investors or from investors who have invested before. They were like, “How does the company make money?” If you are giving us 8%, are there management fees? Are there expenses? Are we getting paid before and after those? That’s another question that comes up. I’ve lumped a few questions together. “Are there management fees?” is one. For us, for example, we have one expense. It’s payroll, then investors get paid, and then any excess profit goes to the company. Sometimes that’s what people are looking forward too when they are like, “How do you make money?”

We have more than just payroll and expenses but they are true expenses. We don’t have fees. We don’t have an acquisition fee, a disposition fee or a management fee. I see a lot of the other types of deals. It’s interesting. “How do you make money?” For me, because I’ve run 1 or 2 spreadsheets on things. We analyze things like our bifurcated returns, which are how much we are making when we are holding the asset and performing versus how much we make on the sale. Are we making 10% maybe on the asset while we are holding it? On the sale, it’s 30% or 20%.

Combined, that return is maybe 18%. Understanding where your returns come from is part of a question that we get asked from sophisticated investors that I’ve also seen in multifamily deals. It’s like, “You are holding this. Are you making any money while you are holding it or are you only making money when you refinance or exit it?” to understand the returns because that is important for you as a sponsor.

The reason they are asking that question is that it ties back to what the risk is. As an investor, they are thinking in their head, “If all my profit is tied to the exit of this thing five years from now, that’s a long time, and a lot can happen. If only a percent of it is tied to that in three the years, we are still making something, then the risk tolerance, risk perspective or sensitivity is significantly less.”

All of these questions come back to risk and what you are looking for as an investor. Are you looking for passive income? We can answer all these questions. At the end of the day, it’s like, “What are you looking for? How soon do investors get paid?” That’s the question I get. We’ve talked about this for us specifically but it’s important for people to know. If you are investing in a fund and you are not getting paid until they are making profits or until the end of year one, that’s different.

That could be fine for some investors. That’s exactly what they are looking for. Some people are looking for their money to be put to work right away. That’s different. They don’t want to wait a whole year. For us, it’s monthly. If you were to invest by the end of the month, your interest starts accruing the following month. You get paid the first of the following month. That is also a question I get a lot. “When do I get paid? How often do I get paid?” More of the details questions.

CWS 217 | Sponsor Questions

Sponsor Q:uestions: Be careful of the Fear Of Missing Out. Just stick to your guns and understand your investments and the risks involved.

 

One question popped in my head, which is like the softball of questions that we forgot even to put on our matrix and everything, which is, “As a fund, whether you are a sponsor or an investor, is it a blind fund or is there an asset already targeted?”

Is that your softball question?

The question is, “You are going to go raise $50 million? I’m investing in X but is it a deal you already have under agreement doing due diligence on or are you getting this money to go find a deal?”

I have not once been asked that question, and I’m not going to lie.

We are in notes. People know, within notes, typically, it’s a question I should be asked.

It is a softball but it’s not a question. I literally have not been asked that but there you go. There’s the question you should be asking.

That’s what I’m getting at. It’s a question you should be asking that you are probably not asking. As a sponsor, it’s something that you should do. I hope if you started to put all of this together and you are raising money, you know what you are going to do with it. It’s a softball for the sponsor to answer that question.

As a sponsor, it's not only a real estate deal, but you're managing a portfolio and a business. Click To Tweet

Any other common questions? I feel like we covered most of them. The big ones are, “Is this guaranteed? What is the risk? How does the economic environment now affect this investment class?”

My last final thought for anybody who’s looking to go sponsor something is, remember, it’s not only a real estate deal but you are managing a portfolio and a business. It’s different from owning a few single-family rentals in your own portfolio that you have mortgages on. You have to balance cashflow, how much money you are keeping in reserves, and how much you’ve got going out the door. It’s like running a business full-time. Cash management is extremely important.

My final thoughts, and I feel like I’ve said this in past episodes before because it’s true. If you are a newer investor, haven’t invested in any syndications or funds, or are starting to diversify your portfolio, know what you are looking for and be realistic about your goals. There is a lot of, “We will make you millionaires overnight,” guarantees out there. Being realistic about what your goals are, getting started, knowing what your risk tolerance is, and then knowing who you are investing with Those three.

There was a lot of FOMO, Fear Of Missing Out, that people wanted to get in, and people now or the last few years, they’ve run up on the short-term rentals because people were bragging about how much of their money they were making on that. I will use Bitcoin. There’s the big run-up on Bitcoin where it’s going to go to $100,000. People are running it up at $40,000, $50,000, $60,000 or wherever it got to. I have no clue where it’s at but it’s probably not at $60,000.

Be careful of stuff like the fear of missing out on things and stick to your guns. Understand your investments and what risk is involved because of the worst thing you can do. I see this happen to a lot of people, it is a rush to fear of missing out. They get in an investment, and then it goes terribly bad. It sets them back for 5 to 10 years. If you have a $100,000 investment and lose 50% of it, now you have $50,000. Think of how long it will take you to get back to that at even a 10% annual return to get back to that number. It’s going to take you seven years.

I’m thinking about all the investors I speak with or potential investors or current investors, and the range of types of an investor or where they are in their investment journey. I’m thinking of the one guy, for example, who’s committed, $700,000. He started somewhere like everyone. I’m a little bit younger than you, Chris. People my age are used to chasing. It has been a great market for the past several years. By starting with something that you are investing in that can grow, that you can get your feet wet, that’s consistent, that’s monthly, quarterly or whatever it might be is a good place to start.

You are not expecting to get rich overnight. That’s not what this is. The people who are at the point of investing $500,000 plus get that. The people that are coming to us, that this is a no-brainer to them, get that. It comes back to being realistic about what you are looking for, having the right expectations, and being able to play the long game, which, as we all know, us, Millennials, are not great at.

This was fun.

Thank you, guys, so much for joining us on this episode of Creating Wealth Simplified. If you enjoyed the show, share it with a friend, subscribe or leave a survey view. Until next time. Thank you.

Thank you.

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