The Basics Of Real Estate Syndication Deals

Real estate investment deals are trending. You’ve found a multifamily complex or a hotel or some other commercial property with a great upside return, but you need to raise investment capital to buy it. In other words, you need to create a syndicated real estate fund. Welcome to the big(ger) leagues of real estate investments where you now get to manage a real estate investment fund. Have you drafted all the necessary legal paperwork for your investors? Have you considered all your tax implications? Have you taken the right measures to be compliant with the SEC and state securities laws?

The raise of investment dollars for a private fund is called a “private placement” in that it is a private offering of equity in exchange for private investment capital. If you’re getting into this space, not only should you be familiar with the documents, but also the general process and the various securities compliance items that you will encounter. This article, as a primer of the basics, should get you asking the right questions. Each deal is different, of course, so be sure to consult your attorneys (if you need one, our attorneys are available 24/7 and really enjoy coffee – we’d love to buy you a cup).

So how does this work? Generally, you, the sponsor/organizer of the fund act as the “general partner” in putting the deal together and managing it all the way through to its inevitable and profitable exit. It’s that simple (just kidding). Your investors (your “limited partners”) provide investment capital in exchange for a percentage stake in the fund (in the deal). They’ll be silent investors and you’ll do all the work, but in exchange you’ll get paid management and other fees as the fund’s manager which can be very rewarding.

To get started you’ll need to determine the structure of the fund and the payouts. Will it be organized as a limited partnership or as a limited liability company? Both have their advantages and disadvantages. While your attorney will help you navigate the legal pros/cons, ultimately this may come down to tax implications, so it’s time to loop in your CPA (if you need one, we’ve got some good recommendations and they like coffee, too). Then it’s time to show the investors the money: what is their projected return and how/when will it be paid out? How about your fees as the fund’s manager? Will all of this be paid out annually, quarterly, or just upon the sale of the asset? Your attorney should advise you on best practices here.

Next, you’ll need to be sure your legal documents are up to scratch. These typically include the fund’s Company Agreement (or Partnership Agreement, depending on the legal structure of the fund), the Subscription Agreement, the Investor Suitability Questionnaire, and the mythical Private Placement Memorandum (or PPM for short). Because each deal is different, these documents will vary significantly and so you should avoid using “canned” document templates. Like a bespoke suit, the fit should be just right.

Specifically, and probably the most famous of these is the PPM (it gets its own paragraph). The PPM is a tombstone summary document; its lengthy, legal, and can be a tedious read. Its purpose is to summarize the deal and disclose all material and relevant information about the fund, the sponsor, the deal, the property, the market, the financials, the legal, and everything else a-z  that an investor may find “material and relevant” in deciding to invest (hence the length). This document needs to be as specific as possible and should disclose and disclaim everything about the deal. Your attorney will spend a great deal of time on this one to get it right for each deal.

But probably the most important piece of the puzzle (and the piece people get wrong most often) is navigating your securities compliance measures. In private placement deals, such as syndicated real estate deals, the fund may only sell its equity pursuant to what is known as a “safe harbor exemption from securities registration.” In other words, the fund needs to let the SEC know that its raising of capital is a private raise (and meets all the criteria to qualify as such) and therefore doesn’t have to register with the SEC. It’s a little counter-intuitive – you need to “register” so that you don’t have to “register” but more on that later. The trick is in determining which “safe harbor” exemption your fund qualifies for, because each one is significantly different and has different criteria to qualify for and different rules about what you can and cannot do.

Regulation D has three primary safe harbors: R.504, R.506(b), and R.506(c). Determining which safe harbor your capital raise will fall under includes evaluating a number of factors, including the total amount of your raise, the time period in which you seek to raise it, the types of investors you seek to solicit, and whether you will be permitted to “generally advertise”. It is absolutely critical to have an experienced securities lawyer assist you and your fund in this process – a failure to properly comply with the securities regulations in this area can be disastrous and subject you, the fund organizer, to a lot of liability.

Once you determine the appropriate safe harbor with the help of your attorney, all your offering documents must fit. You must then file an exemption form with the SEC (for the appropriate safe harbor) and also file similar exemption forms with all states in which your investors are located (the “Bluesky filings”). Lot of work to do? Indeed, but your attorney’s job will be to guide you through it all.

In sum, the content of this article should at least get you thinking in the right direction and asking the right questions. What should the structure of my fund be? What securities regulations will I be subject to? Which exemption safe harbor do I fit into? What are the limits on my capital raise? All of these questions and more need to be satisfactorily answered prior to conducting any private placement offerings, and in almost all cases – seek the advice and counsel of an attorney who knows the field.

Mr. Merchant is a partner at M&W Law, PLLC, a Dallas-based business law firm. He focuses on corporate structuring and corporate finance, specifically private placement deals.

Disclaimer: this article is should not be taken as legal advice, as each situation can be unique. Please consult your attorney prior to taking any steps. If you do not have an attorney, please feel free to give us a call to set up a consultation.