26 questions to ask your GP

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26 questions to ask your GP

A few weeks ago, we talked about the 5 principles of an investor’s mindset. The 5th was “a willingness to ask questions and walk away.”

Today, I would like to dive deeper into this topic and provide you with a list of questions you should ask before investing in a syndication. Some of these questions might be answered for you through the investment deck and legal documents that you were provided. Having said that, a healthy dose of skepticism is important and you should make sure that the answers to these questions are true answers rather than your interpretation of what the answers should be.

If you’re forced to choose between a GP getting annoyed with your question and not being able to invest, you should choose the latter nearly every single time.

As a general rule, you should always shy away from asking questions that can be answered with a simple number or a yes/no. The questions should always require detail that allow you to verify that your original assumptions were correct. A good rule to keep in mind, especially when you’re just starting to get to know the other party: verify, then trust.

Verify, then trust.

Example:

• Bad LP Question: “what is the entry cap rate on this transaction”

• GPs Answer: “6%, and we think this is great”

• Better Question: “it appears that you are buying this property based on $600,000 in year one NOI, translating to a 6% cap rate. Could you verify whether that's correct and provide comp support to help me understand how this 6% number compares to recent trades in the marketplace?”

• Notice that this question is better, both because it is rooted in numbers inside of the deck while also asking for broader context

• Best Question: “it appears that you are buying this property based on $600,000 in year one NOI, translating to a 6% cap rate. Could you verify whether that's correct and provide comp support to help me understand how this 6% number compares to recent trades in the marketplace? On a related point, how did you get comfortable with the exit cap rate assumption of 5%?”

• This now pulls another related question into the same thread - the exit cap rate

Notice that if you ask the first question and stop there, you would have missed a lot of context and potentially would have made an investment decision without understanding the risks involved - all based on the GP’s comment around the 6% being fair.

I always say that I have no issue with LPs entering risky transactions - all investments carry risk. What I do have an issue with is when an LP gets into a transaction without understanding the risks involved.

Take all the risks you want with your own money, but just make sure that you understand them to the best of your ability before wiring that capital.

A quick preface:

It is impossible for me to write out a comprehensive list of questions for all deals, since every deal is different. Having said that I hope this list not only helps, but also encourages you to ask more than you would have otherwise.

There's a balance here, because the GP cannot reasonably take hundreds of questions from every single LP. However, it is typically the case that either (i) the GP has a team dedicated to investor relations or (ii) the GP is newer and doesn’t have an IR team.

In either case (in particular for your first deal as you’re getting to know the counterparty) my humble opinion is that you should err on the side of asking, as opposed to being worried about bothering them too much. If you’re talking to a larger company and speaking to an IR member, you should also not be afraid to ask to speak to an executive. Such an ask should come once you’re closer to a “yes” decision, rather than at the outset, though.

Err on the side of asking

If you haven’t read top 15 syndication mistakes in full, I’d recommend reading that first since these topics are related.

Lastly, I know this list is long, but keep in mind that some of these questions you will (hopefully) be able to answer confidently without having to ask them. There are also many other questions, but I tried to keep this as succinct as possible (highest impact questions, as opposed to listing anything you could ever ask).

As always, I will continue to update this list as I get new ideas, so check back anytime!

Question list:

• What are all the fees that you’ll be charging throughout the cycle of the transaction?

• You can see a list of different fees here and see how they impact you (hint: more than most realize!) here

• What preferred return are you offering, and what is the waterfall split on both cash flow and capital events (refinance, disposition).

• You should understand the waterfall structure early on and ensure that the return of capital provision is in place

• One simple way to ask this is: let’s assume there’s no pref, no cash flow during the project and no transaction fees (for simpler math). Multiply the purchase price by 20% (I’ll assume a purchase price of $100MM for the sake of simplicity) and then ask:

• How are the profits split between GP/LP if this deal sells in a year for $120MM? Now repeat for $200MM (really great outcome) and $90MM (bad outcome!)

• More generally, you should always ask yourself whether (i.e. to what magnitude) the person you're speaking to is going to make money while you lose money

• How many real estate transactions have you bought and sold on your own as a sole GP?

• A related direct question is whether the GP has owned property during a recessionary period (COVID presented some challenges, but I’d say it doesn’t count as far as this question is concerned)

• As I always say, there's absolutely nothing wrong with the GP that is new but there is something wrong with a GP who is new acting like they're not; a corollary is that there’s nothing wrong with investing in a GP who’s new as long as you knew that up front and were fine with it

• A reminder:

• • Brokerage experience isn't the same thing as investing experience

• Investing experience isn't the same thing as operating experience

• Operating experience isn't the same thing as construction experience

• All experience helps, but you should always understand how much before you invest

• Are you the ultimate decision maker on this transaction and its operations or, instead, somehow related to them?

• e.g. there could be two co-GPs in a deal and the one that you are speaking to doesn't have true rights over the transaction

• Generally speaking, the more cooks in the kitchen, the more confusing things get

• If someone is raising money from you on behalf of a GP: what is your relationship with the GP and how are you compensated

• The compensation matters both from your LP investment as well as any agreements between the fundraiser and the GP

• As an example, there are intermediary firms that will charge a fee to place your capital with a syndicator, while also participating in the upside as part of the GPs promote. There are circumstances where this makes sense (it’s costly to you and the fundamental question is how much due diligence did the intermediary really do - i.e. is the extra cost worth it), but it's important to recognize that the downside of this intermediary is “only” their reputation. That's not to say that a reputation shouldn't be taken seriously, but rather that (unlike you) the intermediary does not have any capital at risk and will benefit from the placement fee even if their promote ends up being worthless. This is a classic case of a misalignment of interests.

• When do you expect cash distributions to begin

• This is basic, but you would be surprised to know how many times the GP and the LP were not on the same page - preferred return does not mean you’ll be getting paid immediately (it should accrue if it isn’t paid)

• This applies to tax planning as well - if part of your investment thesis is getting tax benefits, make sure you ask the right questions beforehand

• As a very simple example, if you are investing in a ground up development you should not expect to get distributions for some time

• What percentage of equity are you putting up as the GP, and is that money coming from you personally?

• More on this in the alignment of interest article, but I’ll state up front that you should keep the acquisition fee as well as the GPs net worth (i.e. is the coinvest meaningful to them) in mind

• What do you think is the probability of not making any money on this investment?

• In other words, 5 years later, the LP gets their original investment back, or less, with no return in the interim

• If the answer from the GP is anything less than 10% you’re (in my opinion) not talking to a realistic person … in many cases this number is significantly higher. Remember that the only instrument that has 0% risk are treasuries so by default anything in excess of the risk free rate has to have a probability of no returns or even losing capital

• More on comparing real estate to treasuries and developing a probabilistic mindset here

• Have you ever lost any initial LP equity principal and/or made capital call on a deal; can you walk me through such a case?

• A few notes here - first, mistakes happen and perfect investors don’t exist (certainly not over a long enough investment horizon). Having said that, a capital call (that’s not expected) is negative and you should watch for how the GP talks about this deal, and ask for some reporting before the capital call hit to ensure there was enough transparency going into it on the LP side

• An important PSA on capital calls, while we’re on the topic: A GP not doing a capital call doesn't mean that the LP equity is worth something. In other words, a GP might publicly tell you that they don’t do capital calls (or never have) while they're in middle of raising pref equity at 15% interest … meanwhile the LP equity is impaired. Notice how this is extremely subtle - this is where a healthy dose of skepticism comes in.

• If the answer to #9 is no, try the following: what was the most difficult challenge you’ve faced in a transaction and what did you do to overcome it? Try to get down to real examples, a deck, a model… something tangible. Also ask them how they’ve evolved as a company as a result of those mistakes (i.e. what changed in their process, and the answer should be very concrete)

• Everyone has these stories, and don’t let the answer be about a time they forgot to call the landscaper on time for a property. :)

• Who will be making management decisions for this property?

• If internally managed: how much experience have you had internally managing the property and why (economically speaking) do you think that’s better from the perspective of an LP (when compared to external management).

• Generally speaking, the smaller the GP, the less it makes sense to internally manage both due to skill and capital

• Always ask for the model behind any information in the deck, and play around it to ensure it works and doesn’t have errors

• You’d be surprised to know how many times the diligence stops there - some mistakes shouldn’t be made, while others deserve a second chance/clarifications

• I’ve also heard of some GPs refusing to give models - in my humble opinion your diligence should stop there and you should move on (in the vast majority of cases)

• The model can also help you understand whether the returns you’re looking at are deal level or LP level - something that’s critical to clarify up front

• Project level returns can be much higher than expected LP returns. They typically don't account for fees the LP would be charged (e.g. disposition fee). Perhaps more importantly, they don't account for the fact that a lot of the return will be given to the GP (via promote and/or catch up). An LP might see a 17% IRR and get excited, but in reality that same deal will only return 10% to the LP, net of promote and fees

• Don’t forget to Google

• Google the name of the principal +"lawsuit"; reiterate for firm name and any other principals. ~25% of the time your due diligence process will end there

• I hope it's obvious that lawsuits aren't created equal ... if it's irrelevant to the deal at hand (or the GPs character, etc) then don't just pass based on simply seeing the world lawsuit

• If something strange pops up, ask about it..

• How did you find this opportunity and what puts you in a unique position to execute on the business plan?

• Don’t forget to have a healthy dose of skepticism when you’re listening to the answer

• More generally, if an investment depends on a few key variables (they always do - see #2 here), ensure that you have ample support to get you comfortable with those variables. Once you have a thesis developed yourself on what the downside catalysts are (important first step) ask the GP what the major risks are in the deal and how they’re mitigated

• Another way to ask this is “what assumptions in your model would have the highest impact on me losing all of my money on this deal”

• If the answer is vague or “you’re crazy, there’s no way you’ll lose money” please pass immediately

• If the answers are loose or don’t address the actual risks, present them with that you think the risks are.. if you’re not satisfied with the logic of their response, you might have your investment decision made at this point

• What 506 designation is this raise considered?

• Sometimes GPs raise money against securities laws, and that’s probably (in my opinion) enough of a reason to pause diligence. There are laws here regarding how they can market the transaction and what pool of LPs are eligible.

• Who is your CPA (more on why it matters and questions to ask here)? Is there a fund administrator? What other third party firms do you use and for what?

• On a related note, you can ask whether they get audited annually - most smaller syndicators don’t, but if you’re talking to a larger firm they likely have to

• While we’re on the topic of the CPA: “when did you send our your K1s last year?” - generalities aren’t good, hopefully these are on time

• How often do you report on your existing investments (monthly, quarterly, annually) to LPs and what does the package include?

• Could you give me an example of a reporting package from property x. A few tips:

• Generally a good idea to pick the most recent quarter or reporting period as opposed to looking at something old

• Give the GP some time obviously, I’d say 3-4 months is good because sometimes these reports take time

• I like the idea of choosing a property - perhaps it’s in a similar market to the subject property, perhaps you have a hunch it’s not doing well and that might help with your investment decision, etc.. regardless, after 3-4 months of a reporting period, the report should be off the shelf and ready to send while you’re on the phone (i.e. it shouldn’t take days!)

• If the track record isn’t obvious (and thorough) from the deck, ask for a full table of all the properties they’ve been involved in and their returns. Every GP keeps this file, and there’s no reason why they shouldn’t show it off…

• On a related note - how long has the management team been working together… and are all the deals on the list from them working together (vs individually or while being employed at other companies)

• Is the track record related to the subject acquisition or it’s different (e.g. buying properties isn’t the same as lending to them; similarly a track record in multifamily for an industrial investment is less relevant)

• What % of your overall existing AUM is this deal?

• This should be fairly easy to answer yourself.. larger percentages typically get more attention from a GP since they (usually) have larger promote potential

• Are you personally guaranteeing the loan for the property?

• If someone else is (i.e. not the GP him/herself): what is their economic relationship with this transaction and the GP? Are they also investing money or participating in the promote?

• Presumably if someone else is PGing the loan and they’re not involved, they’re doing it for some benefit

• Have you been able to achieve the projected margin (NOI/Revenue as an example) at your existing properties?

• You’d be surprised how many times GPs model to assumptions that they have never hit themselves

• Did you exceed the cap ex budget on any prior deals, and what makes you confident about this particular budget and renovation schedule?

• Again, try to talk numbers with examples and avoid generalities

• Can I speak to another investor in this deal?

• This sometimes helps, but sometimes it doesn’t. You need to be mindful that the person on the end will likely be a huge fan of the GP (since they were hand selected), but speaking to an investor in this particular deal (as opposed to an investor in a past deal) is incrementally useful since you might be able to ask them about how they perceive risk in this transaction and what got them comfortable

• Also recommend seeing Social Proof Tactics (#2) here

• If something happens to you (i.e. disability, death, bankruptcy due to other ventures outside of this investment) what happens to the management & oversight of the property per the legal agreement? On a related note, if the investment isn’t performing in a few years, what rights do LPs have to replace the GP?

• Tell me more about the make up of your LP pool - (1) family vs people you don’t know and (2) full time investors vs working individuals who are investing on the side? Average number of deals per investor? Average check size?

• What are the Sources and Uses of the transaction?

• This should include a breakout of equity (GP vs LP equity), any debt, fees, etc

• You should know exactly how and when your money is being used…

**I’m going to remind you again: don’t be afraid to ask questions! **Of course you should ask questions in a candid and not assuming manner. Most GPs are dealing with many of these questions and they're simply trying to make a living - so remember that there are two sides and a relationship. Also, check out this awesome thread for more ideas on this topic.

Thank you for reading! I genuinely hope you found this helpful - the best way to say thank you is to spread the word.

I have dozens of topics on my list for 2024 and I’m very excited. If you have a topic you’d like me to cover or have any questions on this article, please leave a comment.

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