The First Questions to Ask When You Review a Deal

Below are a handful of questions an accredited investor should ask themselves when first reviewing a deal. These aren't all the questions you should consider, but they are some of the most important — and they can help you filter through deals efficiently.

1. How Much of the Profit Is the Sponsor Keeping?

Every deal has two sets of returns: what the project generates and what the investor actually receives. The gap between them is the cost of the sponsor's fees and promote. This spread tells you how much you're being diluted by the sponsor, and it can be a useful gut check.

The fastest gut check is the spread between the project-level IRR and the investor-level IRR. For example, a 300 basis point spread (a 20% project IRR against a 17% investor IRR) could indicate the sponsor is being aggressive with their proposed fee and waterfall structure, depending on the deal type. The spread on a more stable deal should typically be smaller than the spread on a higher-risk, more operationally intensive one.

What to watch for

• The spread between project-level and investor-level IRR. The target spread will depend on the deal's risk profile and sponsor quality.

2. How Much Is the Sponsor Investing?

A sponsor with meaningful capital at risk behaves differently from one without. When their money is invested alongside yours, incentives are aligned, leading to better outcomes for investors. When it isn't, they collect fees on the way in and walk away relatively unscathed if the deal underperforms.

What to watch for

• The actual dollar amount the sponsor is contributing.
• That contribution as a percentage of total equity. Around 5–10% is typical and creates meaningful alignment, depending on the total dollar amount.
• Whether the co-investment is actual cash in the deal or a non-cash contribution (a stepped-up land basis, deferred fees, and the like).

3. Is the Business Plan and Its Timeline Realistic?

Many bad deals can be prevented simply by understanding the business plan and then asking: does this make sense? If a business plan is overly complicated or convoluted and doesn't pass a commonsense sniff test, there's a good chance it's just not a good deal.

Understanding the implied timeline and asking whether it's reasonable is another area where many deals fail the commonsense test. Development is where this matters most. If a sponsor expects to finish construction within 12 months, you should understand exactly what it will take to make that happen — entitlements, permitting, general contractor bidding, mobilization, and the actual construction. What's the timeline for each component, and does it seem realistic?

Entitlement alone can take longer than a year. Permitting can often take several months. Finalizing the contract with the GC and then mobilizing them can take several more. A timeline that slips erodes returns, because time is the enemy of IRR — the longer your capital sits before it's returned, the lower your annualized return.

What to watch for

• Whether entitlement is already in hand or still pending — it can take over a year on its own.
• How much more design work needs to happen.
• Whether the construction schedule leaves room for permitting delays, contractor pushback, and supply issues.
• Whether the lease-up and renovation pace is supported by how fast comparable properties are actually leasing.

4. What Is the Leverage?

Leverage magnifies outcomes both ways. Ask whether the projected equity returns come from the real estate performing or simply from piling on debt. A deal at 80% loan-to-cost shows stronger returns than the same deal at 60%, but the additional leverage doesn't actually make the deal itself better. Leverage is a tradeoff: by adding it, you're layering more risk onto the deal while attempting to enhance the equity returns.

Investors should look at the all-cash, or unlevered, project IRR and compare it to the levered IRR. The larger the gap between the two, the more the equity returns are being driven by financial engineering and the layering on of additional risk.

What to watch for

• The loan-to-cost or loan-to-value ratio. The higher it is, the smaller the miss it takes to impair your equity.
• Floating-rate debt and short loan terms with maturities arriving before the business plan is finished.

5. Is the Underwriting Supported by Market Data?

A financial model produces whatever answer you feed it. Garbage in, garbage out. One way to check whether the model is being fed garbage is to verify that the major assumptions are supported by facts.

The two assumptions typically most impactful to financial models are the exit cap rate and forecasted rents. Does the exit cap tie out to recent sale comparables? Are the forecasted rents supported by genuine comparables, or by one or two outliers at the top of the market?

What to watch for

• The exit cap rate versus recent sale comparables — not a tighter cap assumed years out.
• Forecasted rents versus genuine rent comparables, not outliers at the top of the market.
• Post-renovation rent assumptions that imply a premium the submarket hasn't shown it will pay.

6. How Much Contingency Is the Sponsor Carrying?

Optimistic deals tend to share one trait: no margin for error. Good sponsors build contingency into several areas of their pro formas — most notably the construction numbers, the project schedule, and the exit cap rate.

A hard-cost contingency (often in the 5–10% range, more for ground-up or complex work and depending on the design stage) absorbs cost overruns. Without it, any overrun comes straight out of returns or triggers a capital call. Good sponsors also build contingency into the project timeline, because they know something will go wrong and be delayed at some point. And on the exit cap rate, most good sponsors underwrite future exit rates 25–50 bps higher than the current market cap rate. Unless the property goes through a major transformation, using an exit cap rate lower than the current market cap rate can be a red flag.

What to watch for

• A hard-cost construction contingency, sized to the complexity of the work and the design stage of the project.
• Schedule slack in the timeline, so the plan still works if permitting, construction, or lease-up runs long.
• An exit cap rate at or above the going-in cap, rather than assumed cap compression doing the heavy lifting.

7. When Is the Capital Being Called — and Will the Deal Be Fully Capitalized?

When does the sponsor plan to call your equity, and will the rest of the capital stack be in place at that point? You don't want to be the first money into a deal that isn't fully capitalized. If your equity is called before the senior loan is committed and the remaining equity is secured, you're funding the deal on the hope the rest comes together — and if it doesn't, your capital can end up stranded. Confirm the loan is in place and the full stack is secured before your money goes in.

What to watch for

• When your equity is called relative to when the senior loan and other parts of the capital stack fund.
• Whether the full capital stack is committed — debt and remaining equity — before your money goes in.
• How the closing is sequenced, so no single source of capital is exposed before the others.

The Takeaway

Knowing the questions to ask is the first step in being able to filter out the bad deals. When you follow up with the sponsor and ask them, how they react is also a good way to identify a good or bad sponsor.

A good sponsor will have clear, direct answers supported by facts. A sponsor who gets evasive, or who just wants to feed you a fancy-sounding narrative without data, is probably one to avoid.