Top lessons from an allocator & GP

Welcome back and happy Sunday, I have special one for you today.

A friend of mine has seen both the GP (buying properties and seeking LPs) and the allocator (deploying capital on behalf of a $1b+ firm as an LP) world.

Given his unique perspective, I asked him to distill these experiences into 7 lessons for LPs and 5 lessons for GPs - enjoy and let me know if you’d like more articles like this!

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Lessons for the LP:

• Don’t assume anyone else is smarter than you. If you ask simple questions and don’t get answers that hold water or make sense to you, you are likely not being told the full picture.

• I wrote on this in Top 15 Syndication Mistakes as well: “This touches on a broader subject of trust. If anything - and I mean anything - is done during the sales process that makes you question the integrity of the other side, be mindful.”

• Balance Sheets matter. Don’t just look at Income Statements. Looking at the IS without looking at the BS is like trying to judge your financial health by looking at your credit card bills without checking your bank statements. If you don’t have a clear picture of the capital stack on an upcoming investment, you should stop and ask for more information. If you don’t get a BS from your GP on an existing deal as part of your reporting packages, ask for one! This point deserves its own article but here are just a few examples where you need a BS to see the full story:

• Income looks great but why does the BS show a low cash balance and dividends aren’t being paid out?

• Expenses seem low, but lo and behold (pardon the pun) there are huge unpaid bills (also known as aging accounts payable) on the BS?

• The GP tells you the deal is doing well, and even sends you another one to invest into, but why did the debt principal balance just increase by a few million on the Balance Sheet? On a similar note, why is there a new debt instrument (e.g. loan from the GP or even an external loan / pref equity piece) that’s in the balance sheet when the reporting packages didn’t mention it?

What do you guys think? This one took me some time :P

• Anything is negotiable. Don’t assume all LPs pay the same fees and promote. I’ve seen LPs say they weren’t going to pay the Acq. fee and the GP stripped it out for that investor. The more the GP needs your cash, the more negotiating power you have. Side letters are common once check sizes get to a material portion of the equity raise.

• Numbers do lie. Honest GPs use Excel/pro-forma/underwriting to check their gut and walk away if the math shows it's a poor investment. However, many GPs are biased and if their gut likes a deal, they will influence the numbers either consciously or subconsciously to corroborate their gut. This is why understanding assumptions of the GP is so important as an LP.

• **Proformas are fantasy. **Many GPs (and definitely brokers!) present overly rosy (aka “aggressive”) return projections in their decks. You should view their projections as best-case scenarios, but challenge a few simple assumptions such as exit cap-rate, rent growth, or the vacancy factor and you will discover a more realistic (aka “conservative”) projection.

• Read more in why most LP Investments won’t 2x your money and see there for examples of datatables (which you should ask for to understand how returns change based on a set of 2 assumptions)

• Even wealthy people make stupid investments. Don’t assume it’s a good investment just because a wealthy/successful person is involved (or a friend / member of your church/synagogue). He could be wrong or have a misalignment of interests that you don’t know about. Hey, maybe that’s how he got rich in the first place 😉

• Fraud happens. “Fraud” sounds like a strong word reserved for felons, however disorganization and poor business practices can lead even the best-intentioned GPs to commingle and unintentionally misappropriate your funds. This may sound harmless or theoretical, but it's unfortunately too common and puts your capital at risk - make sure you’re keeping up with your reporting updates.

Lessons for the GP:

• See above. Read the section above, you’ll likely learn something.

• Be realistic. I bet you are underwriting raising rents and cutting costs, but why do you think you can do better than the previous owner? How realistic are your assumptions? Do you own similar properties in the same area? Did you stress-test how “off” you can be before the investment becomes a major challenge? If you do have good answers, then present it to your LPs and you’ll win their trust - there’s nothing LPs love more than GP who consistently underpromise (by underwriting conservatively) and overdeliver.

• **Be honest. **If the investment is not doing well, just say so … and don’t wait. As an LP, getting emails from GPs saying how swell everything is going and then discovering a different reality from the financials or when the <bleep> hits the fan is frustrating and will destroy your credibility. It may seem like an easier route now to avoid questions, but ultimately will result in worse questioning, fewer repeat LPs, and is simply just dishonest. Your next best LP is usually your existing investor, so try your best to play the long game.

• **Be timely. **You’d be amazed how much LPs just want consistent and timely communication and distributions. Doing so will earn you a much easier time on your next capital raise. I’ve heard LPs say that even though their investment isn’t doing as well as projected, they’d still invest again with the GP “because he emails and distributes like clockwork each quarter.” A lot of this investment management game is about setting expectations and meeting them - the details and the work are complicated, but the end result (your communication with LPs) isn’t.

• **Asset Management is hair-ripping tough. **Make sure you have the time to dedicate to each property.

• If you currently self-manage, you know exactly what I’m talking about. You should have the appropriate resources to properly manage each asset

• Using third party management might make sense while you’re growing, but make sure to be extremely on top of what you’re seeing … the less in touch you are, the less attention your property is likely getting.

As always, I hope this is helpful and I look forward to your feedback!

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