Posted over 3 years ago

Vetting Syndications: The Deal Structure (5 minute read)

In the previous two articles I took a close look at vetting the Business Plan and the Deal Sponsor. In this article I’m going to introduce you to the elements that pertain to the Deal Structure. The Deal Structure is really a subset of the overall business plan but is very worthy of further analysis. There are multiple ways to structure a syndicated apartment investment deal. I’m not going to go into all of the variations but rather show you what to look for then provide you with a checklist to help you ask the right questions before making your decision to invest.

Private Placement Memorandum

First and foremost the main area where the deal structure is laid out is in what is called the private placement memorandum or PPM. A PPM can be thought of as the contract that you sign with the syndication group. It is legal required by the SEC for the types of fund raising events where the investments are not registered under state or federal law (such as stocks). It will contain all the disclosures about the agreement including things like:

-The offering summary
-Entity structure (LLC or Limited Partnership)
-Distribution structure (preferred return information)
-Risks factors
-Management structure
-Management compensation fees
-Business plan summary
-Investor questionnaire (are you accredited or not and supporting information)

These are not short documents. The most recent PPM I signed was 125 pages long. They are very detailed and should be read and fully understood before you sign anything. I could go in to a ton of detail about PPMs here but the best way for you to get an understanding would be to see a PPM and review it. Here is a link to a sample PPM from the PPMfast.com website https://ppmfast.com/real-estate-syndicate-ppm/. This template is very similar to the PPMs that I’ve signed for all of my investments. I highly recommend you take the time to review it.

Accredited VS Sophisticated Investors

The next very important piece you need to know about if you are going to invest in a syndication is the understanding of being an accredited or sophisticated investor. Syndications are regulated by the Securities and Exchange Commission (SEC) and there are very specific rules to raising capital for these syndications. There are two types of capital raising structures used by syndicators; Rule 506b and Rule 506c. At a very high level 506b offerings are not open to the public and there can be no advertising or marketing efforts to solicit from the general public. 506c offerings can solicits funds and advertise to the general public. The reason for this is that in the world of investing there is a concept of what is called an accredited investor. Accredited investors have a high net worth, and the rational is that a high net worth investor is assuming less risk or can more easily take a financial hit if the investment goes bad than a non-high net worth individual. Essentially the SEC is trying to protect normal wage earners from investing their life savings in to a deal that could potentially leave them bankrupt.

For more information on 506b and 506c rules follow these links:

So what exactly is the definition of an accredited investor? The below image is a great visual to help explain the most common definition. Most people qualify as an accredited investor by having a net worth exceeding $1,000,000 excluding your primary residence OR their income exceeds $200,000 for the last two years as an individual or $300,000 for the last two years if filing joint with a spouse.

Normal 1622209512 Who Is An Accredited Investor

Many individuals just getting started in apartment investing don’t qualify as an accredited investor. That’s where a 506b offering comes in. The SEC has carved out an exception to being an accredited investors in 506b offerings. The SEC says you can still invest in these deals if you are “sophisticated” and have a pre-existing relationship with the deal sponsor. The best way to quickly become sophisticated and establish a pre-existing relationship is to join a group that’s actively doing syndications. Not only will this fast track you to becoming educated and meeting successful syndicators it also fast tracks you to financial freedom!

Far and away most of the apartment investment opportunities that I see are 506b offerings and only come from people I know. I do on occasion get sent a solicitation from someone I’ve never met or I’ll even see the offerings pop up on Facebook. This is completely legal so long as the investment group properly vets their investors to ensure they truly are accredited.

Keeping Track of Everything

I know this is a lot of information to digest in just a blog post. Take your time to follow the links I’ve provided and start to let this information sink in. You’ll be happy you did when you make that leap into passive apartment investing. To help you sift through all of the deal structure information on your next investment here is a checklist for you to use:

-What is the holding period – does it align with your timeline?
-Have you read and understand the business plan- It is not a liquid investment. (You cannot cash out whenever you want.)
-Do you understand the management plan?
---Who will be managing the property?
---Do they have experience with this type of asset?
---What is their track record on this type of deal?
-What entity being used to structure the business?
---LLC or Limited partnership (LP)?
-----Look for provisions that allow for the removal of the entity manager
-Do they have a PPM and have you read and understand all of it?
---If you have questions consult with the sponsorship team
-Are they only accepting accredited or sophisticated Investors (506b or 506c offering)?
-Do they have an investor questionnaire?
---Can they validate that they know if you are not accredited?
---Can they validate you sophisticated?
---What is your pre-existing relationship?
-Do you know what financial reporting will be available?
---Can the sponsorship team provide examples from previous deals?
---What financial reports should you be receiving and how frequently?
-----Year to date profit and loss statements
-----Rent roll
-----Delinquency report
-----General ledger
-Do you fully understand the sponsor and passive investor compensation model?
---Sponsor compensation should be proportional to their experience & track record
---Ownership Interest
-----Subordinate interest – Proceeds to sponsor is only after investors have been made whole
-----Non-subordinate interest – Always getting profits regardless of investor reimbursement
-----What are the acquisition fees? – The acquisition fees should be based on factors of the deal and sponsor experience
-----What are the asset management fees? – Covers all the time the sponsor is putting into managing the operations

Conclusion

Passive investing in apartments can be a very lucrative way to invest but it does take some dedication to also invest in your education. In this blog series I’ve presented information regarding the Deal Sponsor, the Business Plan and the Deal Structure. Hopefully by now you feel much more comfortable with what all goes into a syndication and how to position yourself as a passive investor to not only get into a deal but get into a good deal.

As always, please let me know if you have any questions or have suggestions for a new topic. I'm happy to help you any way I can!

Stephen Lee-Thomas

#multifamily #syndication #passive #investing