After some critical thinking and planning, you have decided to ramp up your real estate investing. Now is the perfect time to increase your portfolio, acquire assets, get involved in development projects, and even create a real estate syndication. But, what goes into putting together such a venture? And, what are the requisite legal pieces to the puzzle that must be put in place first?
Well, first and foremost, if you decide that real estate is the right option for you, and you want to raise private capital as a way of accessing it, you’ll need to create a private placement memorandum or PPM that directly relates to the property or fund that you’d like other people to back on your behalf.
Just as private placement memorandums exist for startup equity, and other opportunities, there are PPMs for specific purposes such as real estate ventures as well. These solutions allow investors to back the particular assets in question. They also give you the opportunity to raise the funds that you need for your real estate venture.
So how does it all work?
What Is Real Estate Syndication?
Real estate syndication, at its core, seems relatively simple: a group of investors pools their money together to invest in real estate. But it’s not as easy as it sounds.
You have to properly structure your organization, determine compensation structures, and assess your legal and tax obligations. State and federal laws consider real estate syndication a form of security, and you must comply with a myriad of securities regulations.
There are two primary roles in a real estate syndication:
- Syndicator or Sponsor: Typically, this individual is responsible for identifying and acquiring real estate and managing the project’s day-to-day operations. In addition to sweat equity, the syndicator typically also makes a financial investment
- Investors: In exchange for financial equity, they receive passive income from the venture. Investors don’t necessarily need significant real estate experience and typically aren’t involved in the business’ daily operations.
Your PPM should clearly outline how investors and the syndicator receive compensation, defining structures for fees, preferred returns, and the distribution of rental income and appreciation.
In the pre-digital age, real estate syndication was even more complex. Identifying investors and building relationships with them was sometimes difficult. Thankfully, in the era of digital crowdfunding, real estate syndicators have a new array of tools available.
Purchasing a commercial real estate property without real estate syndication can be financially daunting. If you’re ready to ramp up your real estate portfolio, syndication (a form of crowdfunding or investment) can offer numerous benefits.
Choosing the Right Business Model
One of the first steps in your real estate syndication is forming a business organization. Depending on your goals, you might choose to create a corporation, limited liability company (LLC), or limited partnership (LP). Each of these organizations offers advantages and disadvantages. A PPM lawyer can help you fully assess the tax, liability, and other implications of an LLC, corporation, or limited partnership in your venture. For example:
- Corporation: in most circumstances, a corporation isn’t the best option for real estate syndication. With a C corporation, you’ll have to deal with double taxation and other issues. And with an S corp, you’ll have limits on the number of passive investors involved in your real estate syndication.
- LLC: LLCs are commonly used in real estate syndications. These hybrid organizations offer the limited liability of a corporation without the hassle of corporate compliance or double-taxation.
- LP: limited partnerships are appealing to investors since they can receive passive income without the risk of liability. However, if a limited partner becomes involved in the day-to-day operations of the syndication, he or she might convert into a general partner (and face increased liability during a lawsuit or dispute).
A PPM lawyer can help you fully assess the tax, liability, and other implications of an LLC, corporation, or limited partnership in your venture.
Drafting Documents That Protect the Syndicator and Investors
A PPM lawyer can also help you craft the necessary operating documents that define each party’s rights and responsibilities. You’ll want to delineate exactly what fees the sponsor will receive, how preferred returns will be issued, and how profits are distributed. In addition to compensation, you should address business governance, voting rights, and other important issues. A well-defined operating agreement or partnership agreement can help you avoid disputes and confusion in the long run.
What Is a Real Estate PPM?
A private placement memorandum, or PPM, is a form of documentation that discloses everything an investor should know when making a decision on whether to provide funding. Separate and distinct from the conventional business plan, a PPM will detail the various aspects of the investment option, disclaiming legal liabilities, and providing the underlying risk factors that may be associated with the venture.
Real estate PPMs may include data about:
- the offering structure;
- expected location of the real estate assets;
- the type of real estate, such as residential or commercial;
- the criteria used to identify the real estate assets;
- the bios of the people involved;
- and other information about the intended real estate asset mix.
The PPM should also include the following:
- subscription agreement,
- investor questionnaire, and,
- in the event you intend to issue debt rather than equity, the form of debt or note the investors will purchase.
Private placement memorandums are crucial because they offer the vital information an investor needs to make a crucial decision about their involvement with the future of a real estate enterprise. What’s more, because they are “stand alone” documents, individuals only need to have a professionally drafted PPM as the self-contained instrument to help the investor make an informed decision.
Benefits of a Real Estate PPM
Having a PPM in place can be a huge benefit for people looking to take part in a real estate venture. Perhaps the biggest advantage of dealing with a private placement memorandum is that it helps to limit liability for the companies or entrepreneurs operating the real estate venture by assisting investors in understanding clearly the risks involved. What’s more, depending on the set of REG D rules a sponsor chooses, a real estate PPM can raise up to $1 million with a small number of investors, or tens or even hundreds of millions of dollars with many investors.
Because investing is a stressful situation for every party involved, PPMs can help to facilitate trust between real estate venture and investor by demonstrating thorough disclosure with a professional presentation. This can allow for peace of mind, and be the beginning of a very valuable relationship.
Be Prepared With a Strategic Plan
Real estate syndication is a relationship business. You’ll need to build trust with your investors, whether they are crowdsourced or not. This requires identifying the marketable properties, crafting compelling pitch decks, and articulating the potential ROI of your venture.
Before you start pitching, make sure you have a strategic plan. Sometimes, a sponsor can do this on their own, but that’s a relatively rare occurrence. You should always recognize your unique strengths and weaknesses — and work alongside a PPM lawyer who can provide guidance and information when you need it.
While some syndicators simply seek investments from friends and family, you should carefully consider the parties involved. Crowdsourcing has certainly helped make real estate syndication easier. Nonetheless, do your due diligence. Depending on your Regulation D exemptions, you’ll need to ensure that your investors are accredited.
Ensuring Compliance With Securities Regulations
Unlike some business and investment opportunities, a real estate syndication must comply with state and federal securities laws. The vast majority of real estate syndications fall under one of Regulation D’s exemptions, which let you avoid certain reporting and disclosure requirements.
However, picking the wrong exemption — or failing to comply with it — can have catastrophic ramifications. Before you choose a Rule 506 or 504 exemption, you should seriously consider working with a skilled PPM for help with these issues.
Without a PPM Lawyer, You Might Make Costly Mistakes
It’s easy to make mistakes when you’re creating and operating a real estate syndicate on your own. Common errors include the following:
- Choosing the wrong exemptions
- Failing to follow your exemption’s rules about solicitation and standards
- Failing to file all the necessary documents with the SEC and state securities agencies
- Registering your entity in the wrong jurisdiction
- Choosing the wrong type of business organization for your venture
- Poorly structured offers that miss compensation opportunities
- Compliance issues that put you at risk for civil and criminal liability
It’s always in your best interest to work with an experienced PPM lawyer throughout the real estate syndication process. At Weingold Law, our team focuses on real estate, crowdfunding, and securities issues. To learn more about our approach to real estate syndication, contact us directly.
Schedule an Appointment With a Real Estate Syndication Lawyer
Weingold Law guides entrepreneurs and investors through the complicated process of real estate syndication. Located in New York City, we are a detail-oriented team with extensive experience in crowdfunding, securities regulation, and contract and real estate law. For a complimentary initial consultation, contact Weingold Law.