The Role of a Sponsor: 2024 Insights for CRE Investors

What is a Real Estate Sponsor?

A real estate sponsor, often referred to as the General Partner (GP), is the individual or company responsible for managing a real estate project from inception to completion. The sponsor is involved in every aspect of the transaction, including sourcing the deal, arranging financing, overseeing operations, and ultimately selling or refinancing the property. In essence, the sponsor is the quarterback of the real estate transaction, ensuring that all parts move cohesively to achieve the project’s goals.

The Importance of a Sponsor in Real Estate Investing

The sponsor plays a critical role in the success of any real estate project. Here are some of the key sponsor responsibilities:

1. Sourcing & Negotiating Deals
   • The sponsor often has the market knowledge and relationships necessary to source on- and off-market deals. In 2024, with interest rates remaining high and market volatility affecting property values, sponsors with strong relationships and negotiation skills are better positioned to source compelling transactions and secure favorable terms for their investors.
   • In 2024, real estate acquisition transaction volume has seen a significant decline. Through the first quarter of 2024, U.S. commercial real estate (CRE) transaction volumes were down 28% compared to the same period in 2023. This marked the lowest level of transaction activity since 2013, driven primarily by the ongoing high-interest-rate environment and reduced capital availability. During such times of abnormally low transaction volumes, sponsors will typically reallocate more resources to asset management. However, this may actually be a favorable time to acquire new assets at attractive prices, and a sponsor better situated to find off-market deals is more likely to transact under these circumstances.
2. Raising Capital
   • Sponsors are responsible for aggregating capital from Limited Partners (LPs), who typically take on a more passive role. As of mid-2024, the rising interest rate environment has made financing more expensive, putting pressure on sponsors to effectively raise equity and secure favorable debt terms. Experienced sponsors are likely to have stronger relationships with lenders, which is increasingly critical as financing conditions tighten.
3. Overseeing Due Diligence & Closing
   • Before any investment is finalized, sponsors conduct thorough due diligence to assess the property’s viability. This includes evaluating the property’s condition, market conditions, and financial performance. Given the economic uncertainties of 2024, such as inflation and fluctuating demand in various real estate sectors, thorough due diligence is more important than ever. In addition, the sponsor will be responsible for managing all of the legal and administrative work that goes into closing an acquisition.
4. Managing Operations and Enhancing Value
   • After acquisition, sponsors manage the day-to-day operations of the property, which may involve hiring third-party property managers or directly overseeing maintenance, leasing, and tenant relations. They are also responsible for executing value-add strategies, such as renovations or re-tenanting, which can enhance the property’s value. In 2024, with a potential slowdown in rent growth imminent for some markets, effective property management and operational efficiency (particularly expense management) are key to maintaining profitability.
   • Managing operations is especially important for senior housing transactions that are more operationally intensive given the larger number of employees needed to serve resident needs. For example, operating profit margins for assisted living facilities may range from 20% to 30% – meaning a good operator can outperform a poor operator by 50% or more.
5. Financial Reporting and Compliance
   • Sponsors provide investors with regular financial updates, typically on a quarterly basis. They also ensure compliance with local regulations and tax laws, a task that has become more complex with recent changes in tax policy and regulatory requirements.
6. Exit Strategy Execution
   • Finally, sponsors are responsible for devising and executing an exit strategy, whether through refinancing, selling the property, or another method. Given the economic environment in 2024, sponsors must carefully time these exits to maximize returns while managing risks associated with market volatility.

How Sponsors Make Money

Sponsors typically earn income through several channels:

• Acquisition Fees: Sponsors may charge a fee for sourcing and closing the deal, typically a percentage of the purchase price. In general, the larger the deal size the smaller the percentage.
• Equity Investment: Sponsors often invest their own capital into the deal, aligning their interests with those of LP investors. In 2024, with capital markets tightening, sponsors’ willingness to commit significant equity can be an important sign of confidence in the project.
• Asset Management Fees: Sponsors may charge an ongoing fee for managing the property and overseeing its operations. AM fees can range from 0.75% to 1.5% of gross revenues. The sponsor may also receive construction management fees, which are typically 5% to 6% of the cost of the renovations.
• Performance-Based Promote: A performance fee, known as a “promote,” may be earned if the project exceeds a certain return threshold, known as the preferred return. Typically, the limited partners will be entitled to a full return of their investment plus a preferred return (6% to 8% is “market”). Above the preferred return, profits are split between the sponsor and the LPs (usually in favor of the LPs ranging from 65/35 to 80/20). This structure ensures that sponsors are incentivized to maximize the project’s success.

Evaluating a Sponsor in 2024

Given the sponsor’s critical role, it is essential to conduct thorough due diligence before partnering with one. Here are key considerations:

• Track Record and Experience: Evaluate the sponsor’s experience with similar assets and markets. In 2024, sponsors with a proven track record in navigating challenging economic conditions, such as those seen during the COVID-19 pandemic, may be better equipped to manage current market uncertainties.
• Risk Management: Understanding how a sponsor manages risk is crucial. Ask about their approach to mitigating risks such as economic downturns, rising interest rates, and construction delays. With economic conditions fluctuating in 2024, sponsors with robust risk management strategies are more likely to succeed.
• Investor Relations: Transparency and communication are key. A good sponsor provides regular updates and is upfront about potential challenges. Given the complexity of the current market, clear communication is more important than ever to keep investors informed and confident.

Conclusion

In commercial real estate, the sponsor is the linchpin that holds a project together. Their expertise, experience, and ability to navigate complex market conditions are critical to the success of any real estate investment. As the economic landscape continues to evolve in 2024, partnering with a qualified, experienced sponsor is more important than ever for achieving strong, risk-adjusted returns.