For shortfalls and unexpected challenges, all syndicates should have a contingency or operating fund. If renovations are planned, we like to use a 10% - 20% of the renovation budget to be our benchmark for the operating fund. When fielding sponsors, ask them how much upfront money they’ve budgeted to cover potential shortfalls. The unexpected happens when you’re not expecting it – such as maintenance issues, low occupancy, insurance payments, etc. We abide by 1% to 3% of the purchase price. You may also ask them how much money they budget each year to a reserves account. We reserve $250 to $300 per unit per year. For example, a 100-unit apartment community should save $25,000 to $30,000 as reserves. Beware if the operating fund doesn’t account for shortfalls, as the sponsor may reach out to his limited partners for additional capital if an issue does arise.

Whether the sponsor works with one property management company or more than one, depends on several factors. First, the pros of working with one company: the sponsor can maintain a long-term working relationship and streamline processes. When more than one point-of-contact is used, lines can get crossed and confusion may abound. Using one property management company can help with accessing residents as well. If there is a vacancy, the property management company may refer a tenant from another property. However, if it can be managed well there are advantages for a sponsor to work with more than one property management company. For example, if a sponsor wishes to segue into another market, they may need a second management company who specializes in that market. As well, if the sponsor has two management companies in the same market and one company experiences challenges, then the sponsor can fall back on the second company whom they already have a relationship with.

The condition of the major systems – such as the plumbing, roofs, siding, windows, and HVAC – are absolutely crucial to assess as they figure into the capital expenditures budget. If the major systems need work, then you better make sure that the contingency fund is robust enough to fix those systems if need be. We recommend that you ensure your sponsor assesses the major systems rather than taking the owner or real estate broker’s word for it as to their condition.

Also called a CapEx budget, the capital expenditures budget should detail how much money is budgeted for each project. Understand how the CapEx budget is calculated. Are the costs estimated by the sponsor or are based on actual bids from contractors who inspected the property? Accuracy is king in CapEx budgets, so we opt for contractor bids, that way we have a clear idea of what we and our passive investors are getting into. Another important key here is knowing what portion of the CapEx budget is earmarked for the contingency fund. We aim for 10-20% of the total CapEx costs.