Hi {{first_name | there}},
Each Tuesday, I send a short note on commercial real estate to help you be a better investor. Topics may include deal stories, how I'm thinking about risk, lessons I'm learning, and market observations as we oversee our $500MM+ CRE portfolio and serve our 1,100+ investors.
One of our investors replied to a recent note with a good question.
Paraphrasing: some of your investments haven't gone according to plan. What changed in how you evaluate deals and operators because of that?
Three parts of our investment process have changed materially. One judgment call has changed even more.
1. Where We Sit in the Deal
Through 2022, we were largely investing common equity as limited partners ("LPs"). Our check sizes sometimes earned us better economics or a seat on an LP advisory committee, but we generally did not have contractual control over major decisions.
A few weeks ago I wrote about a self-storage investment that returned our capital and nothing more. We invested as an LP in that deal. When execution started slipping, we had opinions and phone calls and the ability to hassle the operator. We did not have major decision control rights.
Starting in 2023, we shifted almost entirely to investing preferred equity and JV Hybrid Equity.
I covered how those structures work last week. Both are generally structured with capital seniority, common equity absorbing losses before us, and negotiated control rights over major decisions.
That isn't just a better due diligence checklist item...it's a completely different way of investing.
2. We Try to Verify Everything We Can Independently
One of the biggest changes in our diligence process is that we try to rely as little as possible on a single source of information, especially when that source is the group asking us to invest.
If an operator gives us a track record or schedule of real estate owned ("SREO"), we don't simply accept it. We use Trepp, a data platform that costs us more than $30,000 per year, along with public records and other sources, to independently verify ownership, debt, and, where possible, historical operating information.
We also aim to talk to brokers active in the market who aren't involved in the transaction. They often know the property, the operator, recent sales, and what is actually happening in the submarket. Importantly, they don't have a commission riding on whether our particular deal closes.
In certain situations, we've gone further and hired outside intelligence firms to conduct public-record research and speak with former colleagues or other industry sources about the people behind an operator.
The same philosophy applies to the property financials. Beginning in 2023, we started paying an outside firm roughly $10,000 per deal to independently verify in-place NOI. They reconcile reported financials against bank statements, rent rolls, tenant ledgers, invoices, payroll, and other source documents.
The principle is simple: whenever possible, don't verify a claim with another document provided by the person making the claim. Find an independent source.
3. We Can See the Accounts After We Invest
Independent verification shouldn't stop when the wire goes out. Since roughly mid-2025, we have required view-only access to the property's bank accounts and property management software as a standard term in our agreements.
That means we don't depend on what an operator chooses to include in the monthly reporting package. Our asset management team regularly reconciles the reporting we receive against actual deposits and withdrawals.
The Change That Matters Most
When we were investing LP equity, operator quality was paramount. When we moved into preferred equity, operator quality still mattered a lot. But in hindsight, we sometimes gave strong deal structure too much weight as a compensating factor for operator risk.
Preferred equity can look very protective on paper. You're ahead of common equity, there's often a substantial capital cushion in the first-loss position, and you have negotiated control rights.
The danger is that strong structural protection can create a false sense of security about the one thing documents cannot fix: operator execution.
On a few of our preferred equity investments, we learned that the hard way. The structure helped. It didn't fully compensate for operator problems.
Today, operator quality has to clear the bar on its own before we give any credit to how protective the structure looks.
The Takeaway
If you're evaluating a private real estate investment, I'd want answers to four questions:
What position am I actually in, and what rights come with it?
What claims about the operator, property, and financials were independently verified rather than simply accepted?
After I invest, can the person managing my capital independently verify what's actually happening at the property?
Would I still want to invest with this operator if I didn't have structural protection?
If you have feedback or there's a topic you'd like me to cover in a future newsletter, reply to this email. I read every response!
All the best,
Ben Kahle
Managing Partner | Wellings Capital