Asset types

Assessing GP Vetting Process

For your investment decision it is crucial to understand a sponsoring team’s process of vetting deals and how they come up with the numbers they present. We discuss the importance of the vetting process of the general partner in this article.

If you choose to invest via an online real estate investment platform, they already have their formula for vetting deals and don’t just accept whatever was presented by a potential sponsor.

When you start to evaluate these deals, you should look for certain criteria from each of them. You would encounter some of the clues which would guarantee that a sponsoring team has done a good job of vetting investment opportunities in their underwriting process before presenting the deals to investors.

Some of the questions you would want to ask while assessing the vetting process are as follows:

*What is the sponsor’s process for underwriting deals? The underwriting process dictates which opportunities qualify for review of their internal investment committee and become later available to investors. In order to get through the underwriting process a sponsor must check:

* Operating Financial Statements should include a balance sheet, detailed profit and loss statement, YTD general ledger, current year operating budget and audited statements that the documents are correct.

* Occupancy History. Understanding occupancy history should give a sponsor an idea about how easy or difficult it is to acquire tenants for a property and the retention rate in order to estimate vacancy risk.

* Leasing Reports should include all in-place lease terms and expiration schedules and be reconciled with lease agreements.

* Bookkeeping Reports. A sponsor must confirm the accounting was done right for a property so far to make sure the numbers on the P&L and balance sheet are valid.

* Repairs and Maintenance Report in order to check how much was spent for property repairs in recent years and estimate potential future maintenance costs.

* Operating Expenses Reports and Reconciliations to their respective accounts

* Financing and Legal documents to ensure that the debt service calculations supplied by the seller are correct as well as confirm there are no issues with the title.

* Environmental Studies to ensure there are no possible chemical or oil spills for example as this would increase both holding and disposition costs.

* Check all the agreements with vendors and service providers in order to confirm the amounts of expenses stated in the expense reports and financial statements and make sure there will not be any changes in the price and quality, or quantity of services provided.

* After performing detailed analysis of the supplied documentation from the seller a sponsor must create appropriate cash flow projections for the deal and approve or reject the project based on its return potential.

* Are the deal’s forecasted expenses in line with historical expenses? If not, does the business plan offer a sound explanation?

* Are the forecasted rental rate assumptions supported by market research and how much do they deviate from historical figures? If the difference between the in-place and projected rental rates is significant, how is that explained by the business plan and occupancy strategy?

* Are the property’s assumed stabilized vacancy rate assumptions supported by market research?

* Are the assumptions for all of the above supported by market research from trusted third-party data providers? Be cautious if a sponsor uses data, they collected themselves.

* Does the assumed exit cap rate logically fit in between the going-in and market cap rates for a deal?

* If the deal is leveraged, what are the loan-to-cost (LTC, in the event of developments) and loan-to-value (LTV) rates? Are these in line with present market rates?

* Do you notice any red flags in the deal’s assumptions that might suggest its projected value has been overestimated on purpose due to presenting you with overly optimistic numbers? 

* If there is a reason to suppose a potential overestimation, how this will impact the projected returns?

Evaluating the vetting process of a Sponsor helps to ensure the trustworthiness of the numbers presented by a Sponsor. The trustworthiness of the numbers does not guarantee the success of investment but at least creates certainty that a Sponsor understands the business.