Most LP due diligence happens in the wrong order. You read the executive summary, the pro forma looks compelling, and you start asking questions from a position of interest rather than skepticism. By the time you identify a red flag, you have already anchored to the deal.
This issue is a pre-screening checklist. Run it before you spend time on the financial model. Each flag below is specific enough to be actionable. These are not opinions about risk tolerance. They are observable patterns in sponsor materials that correlate with worse outcomes.
Red Flag 01
Aggregate Track Record Without Deal-Level Data
The deck states "we have delivered 18 percent average IRR across 23 deals." No deal-level breakdown is provided. This format allows sponsors to weight returns by raising a large amount on a good deal while obscuring a series of smaller losses or underperformances. Legitimate track records show every realized deal: vintage year, asset type, equity multiple, and net LP IRR. The aggregate number is only meaningful once you understand the distribution underneath it.
What to Ask
"Can you provide a deal-level schedule of all realized investments including those that underperformed, with net LP IRR and equity multiple for each?"
Red Flag 02
No Mention of How 2020 to 2022 Deals Are Performing
Any sponsor who raised capital between 2020 and mid-2022 acquired assets at peak-cycle pricing using low-rate assumptions. Those deals are now facing refinancing into a 6.5 to 7.5 percent debt environment. A sponsor who does not address this proactively in their materials is either managing assets with problems they are not disclosing, or they did not do deals in that period and their track record is shorter than it appears. Either case requires follow-up.
What to Ask
"For any deals raised in 2020, 2021, or 2022: what is the current debt maturity schedule, and have any assets required restructuring or capital calls?"
Red Flag 03
Sponsor Co-Invest Listed as a Percentage Without Form
The deck says the sponsor has "5 percent co-invest." What it does not say: whether the sponsor paid cash or contributed the deal itself as their equity (a promote-funded co-invest), whether the co-invest is in the same tranche as LP capital or in a junior position, and whether it was committed upfront or deferred. A 5 percent cash co-invest with the sponsor in the same position as LPs is meaningful alignment. A 5 percent co-invest through a GP entity that owns promoted interests is not equivalent. Ask for the structure, not the percentage.
What to Ask
"What form does your co-invest take? Is it cash contributed at close, in the same tranche as LP capital, and did you pay acquisition fees on your own co-invest?"
Red Flag 04
Vacancy Assumptions Below Current Submarket Data
A sponsor projects 3 percent economic vacancy in a market where actual submarket vacancy is running at 7 to 9 percent and new supply is still delivering. This is not a rounding error. It is a revenue assumption difference of 4 to 6 percent that flows directly to NOI and, compounded over a 5-year hold, becomes a material IRR discrepancy. The data to check this is publicly available: CoStar, Yardi, and local brokerage reports for any major market. If you cannot access these, ask the sponsor what their source is for the vacancy assumption.
What to Ask
"What is the current 90-day trailing economic vacancy in this submarket, and what is the projected supply delivery over the hold period?"
Red Flag 05
Exit Cap Rate Assumptions Below Going-In Cap Rate
The deal acquires at a 5.5 percent cap rate and projects a 4.75 percent exit cap rate in five years. This is not intrinsically wrong but it requires a specific thesis: either meaningful rate cuts, significant NOI growth that compresses the cap relative to higher value, or a market dynamic that increases institutional demand for the asset class. If no explicit thesis is offered for cap rate compression, the model is projecting market tailwinds without acknowledging them as a risk variable. Ask what the IRR looks like at a flat or 50 basis point wider exit cap.
What to Ask
"Can you run the return scenario at exit cap rates 50 and 100 basis points higher than your base case assumption?"
Red Flag 06
Acquisition Fee Plus Asset Management Fee Plus Disposition Fee Totaling Above 4 Percent of Equity
Sponsor fees are a drag on LP returns. An acquisition fee of 2 percent of purchase price on a $20M deal is $400,000 out of LP capital before a single dollar of rent is collected. Add an annual asset management fee of 1.5 percent of equity plus a 1 percent disposition fee and you have a material headwind that must be overcome by operational performance before LPs approach their preferred return. None of these fees are inherently wrong but their total load should be transparent, added up in your model, and compared to what fee-light structures offer.
What to Ask
"What is the total fee load to LPs expressed as a percentage of total equity raised, including all acquisition, management, and disposition fees?"
Red Flag 07
No Key-Man Clause in the Operating Agreement
You are investing in a specific team as much as in an asset. If the principal responsible for asset management or capital relationships leaves or becomes incapacitated, and the operating agreement contains no key-man provision that triggers LP rights, you have no contractual mechanism to respond. This does not mean the deal fails. It means your rights depend entirely on the goodwill of whoever takes over. Key-man provisions giving LPs the right to vote on continuance are standard in institutional structures. Their absence is negotiable before close, not after.
What to Ask
"Does the operating agreement contain a key-man clause, and if so, what are the defined triggers and LP rights upon activation?"
Red Flag 08
Bridge Loan With No Identified Refinance Path
The deal uses a 2-year bridge loan at SOFR plus 350. The sponsor's plan is to stabilize the asset and refinance into permanent agency debt at maturity. This is a common structure. The flag is when the sponsor has not modeled what happens if the refinance conditions are not met: if occupancy is 88 percent instead of the 93 percent required for agency eligibility, or if interest rates rise another 100 basis points and the debt service does not work at the original basis. Ask for the refinance scenario analysis. A sponsor who has not run it is managing cash flow month to month rather than planning the capital event.
What to Ask
"What are the minimum occupancy and DSCR requirements for your target permanent financing, and what is the plan if the asset does not meet those thresholds at maturity?"
Red Flag 09
Preferred Return Calculated on Committed Rather Than Drawn Capital
LP commits $500,000 in March. Capital is called in three tranches over 18 months. If the preferred return is calculated on the full $500,000 from day one, the LP accumulates preferred return on capital not yet deployed. That benefits LPs in one sense, but it also means the sponsor is promising returns on money they have not received, which creates a liability they may not be able to honor if the deal underperforms. More importantly, if the preferred is calculated on committed capital but contributions are delayed, ask whether the pref accrues or compounds and how it interacts with the waterfall at a partial exit.
What to Ask
"Does the preferred return accrue from the date of commitment or the date each capital call is drawn, and does it compound or accrue simply?"
Red Flag 10
References Available Only From Completed Deals, Not Active Investors
The sponsor offers references, all of whom are LPs from fully exited deals completed in 2019 to 2021. No current investors are available as references. This is not necessarily dishonest. But investors in exited deals can only speak to what already happened, often favorably, whereas current investors can tell you whether distributions are on schedule, whether the sponsor communicates proactively, and whether they would re-invest. Ask specifically for references from active investors in current portfolio deals, not only past investors.
What to Ask
"Can you provide two references from LPs who are currently invested in active deals and who have experienced at least one distribution cycle?"
None of these flags are automatic deal-killers. A strong sponsor may have a legitimate explanation for any one of them. The point is to surface them before you are committed emotionally or financially. Ask the questions early. If a sponsor becomes defensive when you raise structured diligence questions, that is itself a data point worth weighing.