Syndication vs Private Fund LLC

[Mitch Conrad]

My wife and I own and operate 23 senior living communities (assisted living, memory care, and independent living) across Colorado and we are now expanding into Arizona.  I've often had people ask if they can invest to help with our expansion, but for the amount of capital needed, this would require pooling funds as a syndication.  I don't want to syndicate because of the time, expense, and compliance issues; and typically, when I discuss syndication with investors, they expect a split of the operations in addition to ownership of the property.  I understand this is the way syndication works with multifamily properties because the operations are generally only a few people, however, in senior living, the operations are much larger and more litigious because we are providing 24-hour care, medication management, meals, transportation, activities, etc.  The entity structure is typically different than multifamily as well.  In a senior living business, the operations are usually a separate entity and the operation entity rents from the property entities to keep operations completely separate from the property. 

I currently work with an investment fund group that purchases the properties we want and then offers us a lease with an option to purchase the property after three years. We basically execute a form of the BRRRR strategy by targeting communities that require significant renovations or improved management to bring them back to profitability and then we are able to use the increased equity when we exercise the option. This system has worked well and has allowed us to expand much faster than we could on our own, while at the same time, keeping the business operations separate from the property entities. The biggest downside in the system is that our rents are significantly higher than mortgage payments would be if we were able to purchase at the beginning.

Recently, I met an apartment investor who uses private investors for his purchases. He stated that he was able to avoid the classification of a security by treating the investors like a bank rather than as a syndication. The private investors form an LLC and get standard loan terms in a promissory note without equity or profit sharing. Basically, he is able to avoid all the bank requirements and cut out the middle-man syndication. He is paying a rate higher than a bank but lower than hard money and he can refinance after his equity has increased. I've discussed this with my real estate attorney who isn't a syndication attorney, and he seems to think that this could work, but to be safe, should be a small group without any association with my company. I'd like to discuss this with a syndication attorney but I thought I'd ask this forum first as I'm not sure how many syndication attorneys would honestly say we don't need their services and give steps needed to avoid being classified as a security.

[Don Konipol]

Quote from @Mitch Conrad:

My wife and I own and operate 23 senior living communities (assisted living, memory care, and independent living) across Colorado and we are now expanding into Arizona.  I've often had people ask if they can invest to help with our expansion, but for the amount of capital needed, this would require pooling funds as a syndication.  I don't want to syndicate because of the time, expense, and compliance issues; and typically, when I discuss syndication with investors, they expect a split of the operations in addition to ownership of the property.  I understand this is the way syndication works with multifamily properties because the operations are generally only a few people, however, in senior living, the operations are much larger and more litigious because we are providing 24-hour care, medication management, meals, transportation, activities, etc.  The entity structure is typically different than multifamily as well.  In a senior living business, the operations are usually a separate entity and the operation entity rents from the property entities to keep operations completely separate from the property. 

I currently work with an investment fund group that purchases the properties we want and then offers us a lease with an option to purchase the property after three years. We basically execute a form of the BRRRR strategy by targeting communities that require significant renovations or improved management to bring them back to profitability and then we are able to use the increased equity when we exercise the option. This system has worked well and has allowed us to expand much faster than we could on our own, while at the same time, keeping the business operations separate from the property entities. The biggest downside in the system is that our rents are significantly higher than mortgage payments would be if we were able to purchase at the beginning.

Recently, I met an apartment investor who uses private investors for his purchases. He stated that he was able to avoid the classification of a security by treating the investors like a bank rather than as a syndication. The private investors form an LLC and get standard loan terms in a promissory note without equity or profit sharing. Basically, he is able to avoid all the bank requirements and cut out the middle-man syndication. He is paying a rate higher than a bank but lower than hard money and he can refinance after his equity has increased. I've discussed this with my real estate attorney who isn't a syndication attorney, and he seems to think that this could work, but to be safe, should be a small group without any association with my company. I'd like to discuss this with a syndication attorney but I thought I'd ask this forum first as I'm not sure how many syndication attorneys would honestly say we don't need their services and give steps needed to avoid being classified as a security.

My take on this is you’ve gotten advice 10 years old.  Since 2014 debt is considered no different from equity in determining if an investment is a security.  Whoever creates and sponsors the syndicate needs to comply with the SEC regulations for securities offerings UNLESS the offering qualifies for an EXEMPTION from registration.  The most common exemption is the exemption for private offerings.  This doesn’t mean the offering isn’t a security, it just means it doesn’t have to be registered with the SEC.
One could have an offering relying on the GENERAL exemption for private offerings.  However, this type of offering while least costly and fastest has some big disadvantages, mainly (1) provides the sponsor with almost no protection from being sued by disgruntled investors and (2) investors with any savvy will only invest in offerings where the offering is compliant with Reg D.
Reg D is a “safe harbor” requiring the offering to be FILED, not REGISTERED with the SEC.  Cost is mostly legal, with about $10K - $15K being average. Depending on the amount being raised, there is Reg D 504, 505, 506B, and 506c.  
investors holding a note secured by a assisted living facility will require an interest rate of 9 - 14% depending on desirability of property and strength of operator/borrower.  Returns demanded by investors are much higher for assisted living than for apartments as the loss from default is much higher.