Why are elite investors drawn to private investments? 

HIGHER RETURNS. Private market investments offer the potential to earn significantly higher returns than public equities.

Why are mainstream investors turned off by private investments?  

RISK. Private investments can pose a higher risk than public counterparts.

Why are elite investors undeterred by risk?  

Because risk can be mitigated in the hands of competent management.

Savvy investors are undeterred by risk in the private markets because if you know how to evaluate management and weed out the pretenders, you greatly improve your chances at success. And the unique feature of investing in private opportunities through a private placement is the accessibility of management.

The top executives of private placements are typically their own brokers. They are the ones soliciting investors and are motivated to gain investor trust through availability and transparency.

Investors who ask the right questions will be able to identify those private placements that give them the least likelihood of losing money and the best chance at making the types of gains the ultra-rich have been relying on for decades to create, grow and preserve generational wealth.

These are the five most important questions to ask management before investing in a private placement.

Question #1 – What Is Your Background And Track Record?

Most real estate investors didn’t start in real estate, but it helps to know their background to see any complementary or transferable skills ideal for real estate investing. A background in which the manager exercised the ability to negotiate, analyze and execute transactions – no matter what field – are valuable skills in commercial real estate investing.

Once management background has been established, move on to their track record – both with investing and managing a fund:

• How long have they been investing in commercial real estate?
• What about this specific segment for which they’re raising capital?
• If raising money for senior housing, have they invested in a senior property before? If so, describe the property, location, performance.
• Have they raised capital through a private placement before? If so, describe the offering. How much did they raise?
• Describe the property invested in and the performance of the venture.
• If they have never raised capital through a private placement, ask them if they have ever invested in one.

Management that lacks the background or track record you would consider necessary should be avoided. Pay close attention when interacting with management. Are they detailed, or do they speak mostly in vagaries? Attention to detail is a good sign.

Lack of experience in a particular segment is more concerning than the lack of experience in launching and managing a private offering. Running a fund is just a matter of scale. The dollar amounts and properties will be larger, but the right managers should have no problems scaling with the right background and track record.

Question #2 – What Is The Fund’s Exit Strategy?

You might be wondering why this question is high on the list, but the answer to this question will tell you a lot about management’s focus and competency. A manager with a defined exit strategy will have everything laid out in clear and defined detail.

You want to hear something along the lines of:

“We have the property under contract. We have X amount committed from XYZ bank based on a down payment of Y. We expect to reach our capital goal by such and such a date and close on the property by this other date. We will make capital and operational improvements and be fully stabilized by this date and cash-flowing by the end of the Z quarter. We plan to be operational for 5 years with a total term of 6 years. At the end of the 6th year, we plan on selling and returning investor capital along with their share of profits from appreciation.”

Question #3 – What Is The Fund’s Investment Strategy? What Are The Major Risks?

Why is management zeroed in on this particular property, this particular condition, location, and strategy? What type of opportunity is this – Core, Core-Plus, Value-Add, Opportunistic? If value-add or opportunistic, why did they decide to go this route? And what are the major risks of this property, location, and strategy?

Management should have clear and concise answers to these questions. Responses like the following should be encouraging: “We like this value-add opportunity because of our track record and infrastructure to be able to improve ROI by X percent. Abstract answers to these questions should be red flags.

Question #4 – What Are The Main Financial Terms Of This Venture?

What is the expected average annual cash-on-cash return? What is the expected IRR? Do you have proformas to back up these numbers? What is the distribution schedule for cash flow from operations? What about cash flow from a refinance or sale?

Here are the financial metrics you should probe:

• Acquisition Cost.
• Total costs with Cap-Ex.
• Leverage.
• Cap Rate at Acquisition.
• Cap Rate at Disposition.
• First Year Cash-on-Cash Return.
• Average Annual Return.
• IRR.

Details. Details. Details. Make sure management has the data to back up their numbers. Scrutinize the spreadsheets.

Question #5 – Do You Have Skin In The Game And How Will You Be Compensated?

Is management contributing any of their own capital to the venture? The more skin they have in the game, the better and the more incentive to achieve a return of investor capital and their own capital.

Be leery of front-loaded management compensation through excessive fees. The majority of management compensation should come from performance in the form of a share of profits. That’s not to say management fees shouldn’t be expected. They should be reasonable in light of all circumstances.

The #1 Key To The Success Of Every Private Investment Is The Management!

Asking the right questions will weed the pretenders out from the pool of candidates. These five particular questions should go a long way towards identifying the opportunities that give you the best odds of success.