Knowing When To Walk Away - Importance of Due Diligence
Updated: Oct 31, 2019
Evaluating investments is what we do. We've done well selecting our investments with a top down approach as we want to have long term partners that we know, trust and understand their investment criteria. We review the markets they invest in and gain familiarity with how they look at opportunities. Having a solid team, trusted partner and operator working in a strong growth market that we understand reduces risk.
We can evaluate individual investment deals much faster and get into deals without the concern that everything is new and up in the air until proven. That's why we are careful in our selection of partners and opportunities. Our first response is typically to say “no” to new partners, markets and deals. That said, we didn’t get to where we are by saying no all the time, or we would have no partners or deals. So, we entertain partners first at a high level. We don’t look to do a deal or invest with them unless we do our due diligence on them, their background and experiences.
That said, even with careful selection of a partner things can come up that are often not disclosed. This is where the importance of due dilience becomes apparent. We had a recent opportunity that we spent a lot of time evaluating, invested money in legal fees to get our sponsorship setup, talked with investors and received soft commits of $10m + and were very close to sending out a PPM with funding instructions. As we were in the later stages of this process, we uncovered a potential low probability but high stakes financial impact to our fund and investors. There is a healthy risk section in all private placement offerings and most are manageable excluding certain black swan events. But this one was different because it was a current risk that could be great. It was not called out to us but we uncovered it and it was hard to really evaluate the odds of its impact.
More importantly, we felt that the current operator would be very distracted dealing with this issue for an indefinite period, as these investments take a lot of attention. The last thing we would want is a protracted issue that consumes our managers time and could lead to financial harm to our investors. As a new partner operator with us, we were less tolerant of the unknown and decided to walk away after careful consideration.
We realize that the short-term loss of an opportunity in time, effort, and cost is a small price to pay if we had invested in a long-term opportunity that we had less assurances of a positive outcome for our investors. The message for us and our investors is that we are in this for the long haul. We invest alongside them in every deal. We would love to get every investment decision right, but we know over time that we may have investments that don’t meet expectations. No one is going to be perfect. We expect to under promise and over deliver most of the time.
What we are trying to avoid for sure are potential “high risk” investments that without continual due diligence we may have gone into with no turning back.
Investments in commercial real estate are not liquid. It’s not like a stock where if you receive bad news you can liquidate your position and try to cut your losses. Real estate is not liquid and as a result once the decision is made one needs to stick with it through inevitable ups and downs. Extra care and diligence before getting in is well worth it.
Learn to say “no” and be careful picking partners, evaluating markets and specific deals. You are always doing due diligence along the way and don’t be afraid to "walk away" no matter where you are in the process before you close on the property. Lost time, money and opportunity is a small price to pay for making a bad investment you may have to live with for some time.