IR Insights: Doing Your Due Diligence

November 5, 2021
By Hans Matta
Welcome to our latest series, IR Insights. In this series, EquityMultiple’s Investor Relations Team will discuss everything from how to open an account to the latest asset class trends. This article provides a detailed overview of how investors can navigate the offering memorandum and investor packet. Continue reading to learn more.

EquityMultiple brings investors high-quality CRE offerings by diligently vetting and screening each investment offering that we launch on our platform. We take extensive measures to verify the quality and track record of each sponsor, as well as past performance of individual properties. At the sponsor level, this includes analyzing documents such as:

  • Sponsor track record (and that of its principals, where applicable)
  • Sponsor criminal background check and credit check
  • 2-year sponsor personal tax returns
  • Current sponsor banking relationships and contact info
  • Management Agreement
  • And more…

At the property level, we undertake an extensive review of imperative property-level documents including:

  • Excel pro forma and financial model
  • Senior and/or mezzanine loan documents
  • Operating agreement
  • Operating financials
  • Rent rolls
  • Purchase & sale agreement
  • And more…

This information allows EquityMultiple to underwrite each deal that we launch, independent of the sponsor, giving investors multiple layers of due diligence and allowing them to view target deal performance spanning a broader range of scenarios.

While this multi-tiered underwriting process serves as reassurance for investors as they participate in complex CRE deals, it is just as important for individual investors to identify offerings that are most aligned with their individual goals. Commercial real estate investment materials can be dense and opaque, but EquityMultiple’s offering memorandums present key information in a streamlined, digestible, and educational manner to benefit new and seasoned real estate investors alike.

We typically offer two key sources of information for each of our CRE offerings: the offering memorandum and the investor packet. The offering memorandum covers all aspects of the investment in great depth, and the investor packet specifically dives more deeply into key quantitative information regarding the property, including return targets and the support for these targets.

Offering Memorandum

The goal of the offering memorandum, or “OM,” is to provide qualitative information about all key aspects of the deal.

The Offering Memorandum begins with key terms of the deal.

Here, you will see the sponsor, asset type, projected term, and target return metrics including the target IRR, equity multiple, and average cash yield. Further details regarding returns and distributions are included in the “Financials & Structure” section as well as the investor packet. Also highlighted is the “Quick-Jump” menu which allows you to jump directly to a chosen section of the offering memorandum.

Other sections include the sponsor, the business plan, financials with regard to the property as well as distributions, and broader market highlights. In preparing an OM, EquityMultiple’s goal is to give investors a comprehensive picture of several key factors we use in our analysis and return projection process.

The “Overview” section is perhaps the most comprehensive section of the offering memorandum and provides a thesis for the investment. A detailed explanation of the business plan, the sponsor’s experience, and key metrics such as the cost basis, market growth projections, and target rent growth rates help form the quantitative basis of the investment thesis. Using information in the overview, investors can quickly understand the merits of a particular offering and select investments that align with their investment philosophy.

For a more concise view, investors are able to jump to the highlights next. This section clearly outlines the most compelling points of a particular investment. Investors may jump to the highlights section to quickly gain a grasp of the story and key points of a given investment offering, such as the potential for consistent income or capital appreciation based on market growth, in-place cash flow, attractive bases, or sponsor’s prior projects.

A real estate investment opportunity is only as good as the sponsor, or GP party, of the project. The GP is typically the operator of an investment, in charge of sourcing the property, developing the capital structure, and ultimately executing the business plan. Thus, as a major part of EM’s due diligence process, we offer a detailed overview of the GP member(s) of the offering. Here, we give a background on the key principals that make up the sponsor’s firm, as well as a track record or overview of their experience where possible. EquityMultiple looks to continue to build relationships with reliable, high-quality sponsors and form partnerships that span multiple projects. Where appropriate, EquityMultiple may provide a webinar interview of the sponsor regarding specifics of the investment, the sponsor’s track record, and the firm’s operating philosophies.

Financials & Structure

The Financials & Structure section provides full transparency regarding the investment’s capital stack, fee structure, and key financial metrics.

For example, investors can understand the amount of GP equity involved in the transaction, or “skin in the game,” as well as what percentage of the equity is provided by EquityMultiple, which can influence the level of control that EM has in making key decisions that may influence the trajectory of a particular investment.

Another crucial piece of information shown to investors is the distribution schedule. Here, investors understand whether distributions are expected to be quarterly or monthly, and when they are expected to begin. Investors may learn whether the investment in question issues a K-1 or 1099 tax document, which correlates with the part of the capital stack the investment is in. Finally, it is revealed whether the sponsor uses the cost segregation accounting method to pass along depreciation benefits to investors, a key benefit of CRE investing.

Also included in this section are the fees to investors, transaction fees which are assessed to sponsors, and the waterfall structure which highlights the payment priority for equity investors at the property. Specifically, this outlines the share of proceeds from the property distributed between EquityMultiple’s entity (which includes all EM investors) and the sponsor.

Property Details, Market Summary, & Comparables

Finally, a key part of EM’s diligence process is evaluating the market that a property is located in. This includes a deep dive into the demographics that make up a market, recent trends in the local economy, and future expectations for the region. Local submarket dynamics are critical. By identifying comparable properties in the same submarket, we are able to analyze prevailing asset prices, rent growth trends, and cap rate movement in order to gauge the viability of a project and further inform our projections for a given investment.

Documents – Investor Packet

The Documents section includes relevant supporting materials for the investment, including pro forma model projections, updated results and, most commonly, the aforementioned investor packet. While this document is a comprehensive legal document which includes the general risk factors, EquityMultiple LLC Agreement, and the subscription agreement for the offering, specific offering performance targets are available as well, along with the supporting assumptions contained in the pro forma model.

In the first table, we see a summary of the key terms and target return metrics for the investor, including the IRR, Target Yield, and equity multiple. Additionally, in the next table, we see the investment summary from the perspective of the EM entity. Key items include the capital structure and the distribution waterfall between EquityMultiple & the sponsor.

If any terms, metrics, or concepts in the Investor Packet are unclear, please know that you may always reach out to our Investor Relations Team at ir@equitymultiple.com for clarification.

Exhibit A – Pro Forma Model

Finally, in Exhibit A of the investor packet, we find the pro forma model, which paints a picture of the year-by-year performance targets of a given investment. This is especially helpful for investments with unevenly distributed cash flows and serves as a foundation for the return targets that are shown on the offering memorandum and the investor packet. As no return metrics are guaranteed and simply serve as targets, each pro forma has a set of assumptions that are used to support these targets. Such assumptions include market growth, upgraded rents, and financing obligations given the current loan structure.

As these are simply assumptions and are subject to change, EquityMultiple is committed to underwriting each project internally, displaying to investors the sponsor base case as well as a more conservative scenario that includes potentially less favorable market conditions. By underwriting each deal, displaying the pro forma as well as the inputs that help develop the pro forma, EquityMultiple offers investors a granular view of the property and future expectations.

We hope that this wealth of detail helps you to confidently make investments that align with your risk tolerance and strategy.

Doing Your Due Diligence

EquityMultiple provides highly vetted CRE investments to our investors. Still, however, we encourage investors to reflect on their unique investment goals and carefully consider the pros and cons of each investment in the context of their personal investment portfolios. EquityMultiple seeks to make this decision-making process as simple and informative as possible. If you have any questions as you browse the OM & investor packet, or would like to speak about a particular offering, please reach out to ir@equitymultiple.com or call our IR team at 646-844-9918.

This document is for informational purposes only and is not an offer or solicitation to purchase or sell securities. Investing involves risks, including the potential for principal loss. There is no guarantee that the strategies and services will be successful or outperform other strategies and services. Certain assumptions may have been made in connection with the analysis presented herein, and changes to the assumptions may have a material impact on the analysis or results.

Past performance is no guarantee of future results. The investments discussed herein may be unsuitable for investors depending on their specific investment objectives and financial position. Investors should independently evaluate each investment discussed in the context of their own objectives, risk profile and circumstances.

All opinions expressed herein constitute  judgement as of the date of this article and are subject to change without notice. Statements made are not facts, including statements regarding trends, market conditions and the experience or expertise of EquityMultiple, are based on current expectations, estimates, opinions and/or beliefs of EquityMultiple. Such statements are not facts and involve known and unknown risks, uncertainties and other factors. Past events and trends do not predict or guarantee or indicate future events or results.

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