Posting an update here in case anyone is following or is curious on how this plays out.
I received an investor update from the sponsor a day or two after initiating this thread. According to the update, they've been busy negotiating the sale of both of the properties I invested in. They're under contract on one with closing tentatively scheduled for February. They're also expecting an official offer on the second property soon.
If everything goes smoothly I'm obviously glad that my money isn't gone, but I don't think that excuses the lack of communication and inability to respond to LPs. The full voicemail inbox suggests to me that I'm not the only LP in these deals that feels that way.
Below are notes on my post-mortem for this investment in case others are curious.
What I Didn't Do Well:
1. Should have done more digging up front on everyone involved in the deal, not just the managing GP. There were half a dozen GPs on this deal and I should have asked more questions about their roles and real estate experience. For many of them, their brief bios don't even mention real estate experience.
2. Should have asked about focus. None of the GPs are full time real estate investors. If I'm being honest with myself, I probably should have walked away from these based on that alone, especially coupled with #3 below.
3. The GPs had only made this type of investment once before. In fairness to them, the deal had gone full cycle, but I definitely should have asked more questions about that deal. I should have asked what their operating plan was and how they were able to execute against it. I should have asked for pro formas vs. actuals. I should have asked what didn't go according to plan and how they handled it, and what the ultimate outcome was since the brief summary of that deal just says they sold at a profit.
4. The sponsor was required to contribute 10% of the equity which I felt was pretty good, but I didn't account for the fact that the 10% might have been split among five or six GPs. I should have asked about that and determined whether each of them contributing 1-2% of the deal was enough to properly incentivize them if that 10% equity was split among all GPs. Even more so after considering a 2% acquisition fee which theoretically could pay for a portion of their 10% equity.
5. I should have taken the time to research market waterfall agreements at the time. This deal had an 8% pref. with an 80-20% split until investors got back 200% of their investment. I think a 200%+ return was unlikely the whole time, but if the deals did exceed that hurdle it was a 60-40% split on any addition gain. I'd be interested to hear more experienced investors' opinions on this structure. For a team that had only done one successful deal to date, the 60-40 portion of the waterfall doesn't feel appropriate to me. On the other hand, a 200%+ return is fantastic and if they had been able to achieve that, perhaps rewarding the GPs for it is appropriate.
6. The Forms C for these deals discuss the impact of the COVID pandemic, both positives and negatives. In the positives, they describe a local news source as saying it’s a “buying frenzy” in the area. This probably should have minimally been a yellow flag and an indicator that the group may not have been buying at attractive cap rates.
7. Also in Form C, it's stated that the source of funds for purposes of making distributions is immaterial. I should have gotten more clarity on this since I'm reading it to mean that distributions could have been paid from raising more money than they needed. That said, the sources and uses did not indicate they were over-raising.
8. In terms of fees, they generally felt fine to me. One exception might have been a 3% construction mgmt fee. Both of these deals required significant renovations. Under normal circumstances a fee to manage the contractors and construction process seems appropriate, but one of the GPs owns the construction company that was used for the renos. To me, that puts this fee in question. It seems like his day job is managing construction projects (for which LP's contributed money to pay his company to do), so why do they need an extra fee for this? I'd be interested to hear others' thoughts on this as well.
9. Documentation provided by the crowdfunding platform provided background checks on the managing GP and the LLC that was set up to hold the properties (separate LLCs for each), but not on any of the co-GPs. I don't think it would have been worth the money to do my own background checks on them given my investment amount, but I also don't remember doing basic Google searches on any of them. Maybe I did and I don't remember, but if I did, I should have taken some notes on my findings.
What I Think I Did Well:
1. I did re-create the provided pro formas and did some stress testing of their assumptions. I stress-tested a five year hold vs. the stated ten year hold, as well as assumptions on nightly rates and occupancy. I also adjusted some operating expenses to what I felt were more reasonable and based on my own research (property taxes). I also modeled out what the investment might look like if the exit cap rate increased compared to the purchase cap rate.
2. I asked about the terms of the seller financing agreement. The initial plan was to refi the agreement after five years so I wanted to make sure they had a backup plan in case they couldn't refi at attractive terms. Even though they planned to refi after five years, the seller financing did not require it, it was a 30 year term.
Overall I think I did a decent job of evaluating the property (still some room for improvement there), but not the people. Pretty typical rookie mistake from what I've learned since then. I have some feelings about the timing of the sale of the property, but that's the control you give up as an LP. The upside is that I can say I learned a lot from this experience.
