Easiest Predictor Of Losing Money In A Fund

[Chris Seveney]

As someone who has worn both hats as a GP and a LP - here is a statistic which to date has had 100% accuracy in determining if the investment will not end up successful.

What is it?

Having Audited financials completed on time.

So how would you know? Several ways,

1. Many sponsors are going the regulation a+ offering route which requires them to be submitted 120 days after year end. Now some firms will miss that date, but if they do it should be within another 30-60 days. Thus they should be in by July 1. There are a significant number of entities who have yet to still file their 2022 audited financials (with 2023 due in about 80 days….)

If things are going well, it won’t take a year to submit audited financials…

2. Let’s say it’s a 506c, or 506b, I recommend only investing in those that have audited financials and again they should have those available by summer time of following year.

But if they do not, they also should be able to send unaudited financials by that time.

Ok share what is something as part of DD you feel is also a great predictor?

[Evan Polaski]

@Chris Seveney, as I am continuing to learn, I would not totally rely on audited financials, UNLESS, the audit goes all the way down to the property entities themselves and are auditing the cash flows from tenant payment through to full investment level, including owner contributions and distributions.  And the audit is from a large, well-known firm.  As a reminder, Madoff "had annual audits".

Part of my DD, while I do ask if a company has audits and shares them with LPs, I also ask for FULL financials: Income Statement, Balance Sheet and Statement of Cash Flows for properties through partnership level items.  I ask for current deals and past deals, and compare to underwriting/initial packages.  

I also look for full proformas of the offering. Many packages show down to NOI and then LP projected distributions. But I want to see NOI, debt service, asset management fees, if there are priorities in share classes, i.e. Class A, Class B, Class C, where A gets paid first, then I want to see where the cashflow for those distributions is coming from day 1, and whether the lower tier distributions are really coming from the property or are financially engineered by raising additional reserves just to pay early distributions.

And very important, if in an equity position: is there positive leverage being used, meaning going in cap rate is HIGHER than interest? Is there strong going in DSCR? Is their floating rate debt? And if fixed I/O, what happens to cash flow if/when loan goes to amortizing? If in a fund, are all the debt maturities hitting at same time?

So basically, a lot of items. :)