By Gerald Tay (guest contributor)
Five years ago, I was invited to co-invest in the joint-development of a hotel in Singapore. Investors would fund the development costs and share profits after selling the hotel to a potential buyer when it was completed. The equity share was 51% for the principal deal finder (finds the deal and raises the money), and 49% for the remaining joint investors.
The returns promised were as high as 15% per annum. I rejected the deal outright.
Why did I reject the deal?
1. Having an only 49% equity shareholding for the joint investors mean they would have no say in the operations, finances and other major decisions involved in the investment. From the investment contract: “Management reserves the right for every say and decisions made without having to consult with co-investors.”
2. The deal finder appeared more interested in my money than answering the many questions and doubts I had.
3. The deal finder avoided any personal and conference calls with investors. There was only one scheduled investor meeting. Email questions were not answered or answered vaguely. I perceived the deal finder’s mindset as follows: “If you want to invest and make money, put your money in and don’t ask too many bothersome questions. You’re not the only investor I can raise money from as there are many other keen investors who don’t ask as many questions as you.”
4. The 49% equity shareholding was split among too many investors. There’s a saying:“Too many cooks spoil the broth.”
5. The deal was structured to benefit the deal finder far more than was reasonable.
6. The deal felt and smelt wrong.
7. There were too many unsophisticated investors with a low entry investment quantum in the deal (as little as $10,000 to participate).
It’s not about whether a deal can make money or how much can be made
One must look beyond promised investment returns. Examples of things investors should pay attention to are issues like the complexity of managing the project or property, available key experienced people to manage the project, having a strong support network, in-depth knowledge of industry trends, markets and the economy.
The crucial question you need to ask before entering into investment deals with anyone is: “Will the deal or investment remain sustainable even if projections don’t go well as expected?”
If the joint-investment hotel deal goes well, investors will happily walk away with profits by a stroke of good luck. But if the deal goes awry due to unforeseen events, unsophisticated investors will be filing law-suits. This is not the kind of investment you want to be involved in no matter what exciting returns are promised to you initially.
It’s fine if you like to remain a passive investor in a deal, but do understand the difference between “taking advantage of” and “being taken advantage of.”
10 Questions You Need to Ask Your Deal Finders
Over the last five years, my USA partners and I have structured and jointly invested in large-scale USA Commercial Real Estate (RE) deals with our investors. These properties are priced between US$2 million to US$5 million apiece. A typical American Single Family Home costs US$150,000.
In your interview with your deal finders, ask them these ten questions. These are great questions I always encourage my investors to ask or I’ll personally ask them when considering any co-investment deals myself.
1. Who exactly are they?
- What’s their investment experience?
- What previous deals have they done in the market of deal origin?
- How successful were they?
- Who were their investors?
- Any proven track records?
- What’s their real estate investment background?
- Any expertise in the market of deal origin?
2. Do they have any equity stake in the same deal with you?
- If not, why?
3. Any Finder’s fee or Management fee?
- One-time or yearly?
- How much if yearly?
- Fair compensation value?
4. What legal documents are you required to sign?
- There should be a minimum of two legal documents for signing by all investors/shareholders/managers – The Management and Partnership Agreement.
- What are their terms and underwriting criteria?
5. What is the structure of deal?
- Roles and responsibilities of management, and voting rights by co-investors
- Who decides on major decisions?
- How are decisions settled among all shareholders?
- Who is involved in the management and who is passive?
- What is the shareholder’s profit sharing arrangement?
6. Who decides on the investment exit?
- Time-frame and penalties if any
7. What is the minimum investment equity and number of investors?
- Smaller investment quantum deals will attract more unsophisticated and immature investors
- Higher investment quantum deals will attract more mature and sophisticated investors
- Investment success or failure will depend greatly on who your investment partners are, their attitude and thinking, investment sophistication and maturity
- The more the number of small quantum-size investors, the more risky and problematic the deal will become. “Too many amateur cooks spoil the broth”
- Only consider investment deals that have a higher entry barrier with no more than 10 investors per deal including yourself. Know who your co-investors are
8. What is the holding structure for the property?
- Is the property held under a corporate entity or individual liability?
- Is the loan non-recourse, or does it have to be personally guaranteed and by whom?
- What extra profit sharing percentage is allowed for the investor who shoulders more risk with a personal guarantee?
9.What kinds of returns are promised to you?
- If guaranteed or high returns are promised, you should question the risk of the deal
- Never invest in promises
- Instead, always think sustainability and stability of the investment’s future
- Remember – the credibility and expertise of the people managing the property is more important than the property itself
10.Is there any strong support network available/accessible for maintaining operations and management of the project?
- These include relationships with known local vendors, property managers, lawyers and others to ensure smooth operations.
Never invest in deals that benefit the other guy (deal finder/seller/developer) far more than is reasonable.Before you put your money into any deal under contract, you should clearly understand your investment terms, underwriting criteria and investment objectives.
Imagine this: You put money into a deal under contract. You later find that the guaranteed return promised by the seller has not been fulfilled. Or that the deal finder had inflated the price and you end up with a lemon. Or that the deal finder/platform makes plenty of money from you from the start leaving you with scraps at the end. Or worse, your overseas property gets into trouble with a neighboring property and there’s no one to assist you with the legal issues.
While ignorance is sometimes bliss, in this case these kinds of surprises could cost you plenty of your hard-earned money. And when you’re doing a deal, you don’t want surprises like these.
The lesson learned is this: clearly understand the terms of the deal and how the deal finder/seller will “underwrite” the deal.
You want to benefit fairly, and not be taken for a sucker.
By guest contributor Gerald Tay, who is the founder and coach at CREI Academy Group Pte Ltd, an organization dedicated to empowering retail property investors with smarter investing philosophy and strategies. He is a full-time investor with over 13 years of solid experience in building his wealth through Property Investment and is financially wealthy today.