All Forum Posts by: Mitch Conrad

Hey Joseph.

Jasper had some great points and I agree with almost everything he posted. My wife and I have 24 locations in Colorado and Arizona. 21 locations are larger residential properties (up to 16 residents) and 3 are commercial communities. Both smaller RALs and larger commercial communities rely on word of mouth and local reputation to fill rooms, but we haven't had much luck with local health care providers. Most health care providers say that they don't give referrals because they don't want any liability from making the referral. Usually, they will refer to a placement agency who will tour the resident and family through at least three locations they think are the best fit for their client. Placement agencies also advertise quite loudly that their service is free for their clients, which means that they receive anywhere from 75-100% of one month's care revenue from the senior care provider. Placement agency costs are one the highest expenses we have and it takes a while to recoup those costs. Consequently, we do our best to bring in organic leads through our web and social media efforts. Our goal is 50% of our residents coming from our organic leads but we have yet to reach that goal.

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There are tons of REITs in the commercial sector of senior living. I have acquired two senior living communities from REITs that wanted to exit. One was because of poor management and the other because the property needed major renovations to be competitive in the area.

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Quote from @Jerel Ehlert:

TL;DR version: You could have the people who want to lend you money for the real estate form an entity to loan out of but you should not be overly involved in setting it up for them. An attorney in the state where you are buying should advise them. They should keep the number of participants low.

Longer version:

The Howie test is one of many precedence to consider. To determine if something is a security, look at Reves v Ernest & Young (494 US 56 (1990). Every court starts with a rebuttable presumption that everything is a security unless it's not. Here, a Co-Op marketed an "Investment Program" of notes paid at variable interest rates on demand after a lock-out period. Co-Op went bankrupt, buyers sued. An instrument is not a security if it resembles a family of non-securities (the "family resemblance" test).

In 2020, Kirschner v. JPMorgan out of NY - a trustee sued financial institutions claiming that broadly syndicated loans were securities. The district court applied the Reves test and ruled that these kinds of loans were not securities. The 2nd Court of Appeals affirmed in 2023. US Supreme Court declined certiori (decided not to hear the case). This means the 2nd CoA ruling is good law in those states, but because SCOTUS didn't rule on it means it is not good law across the country. Other district courts may take that case into consideration, but are not bound by it.

Links:

Kirschner v. JPMorgan

2nd Circuit case

SCOTUS case

Now, keep in mind that "broadly syndicated loans" are a very different creature than a small, private debt fund. These are usually used to fund mergers, acquisitions, etc. in the $10-100s+ million in value, with 100-1000s of SOPHISTICATED or institutional investors buying fractionalized interests. Would your loans qualify? probably not on its own.

There are a few good books that cover raising capital and complying with SEC rules. They are dense reading by necessity. Securities law was one of my most demanding courses in law school for a reason.

Thanks for the detailed response! I have a lot to research...

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Perhaps I should consider offering an equity position in the property (not the assisted living business) as the down payment instead of debt. Then have a buy-out or refinance option after a certain amount of time. We could negotiate the rent the property would generate from the business which would set the return for the investors. What are pros and cons of that structure? Is that something that would be attractive to investors? This structure seems like it most certainly be classified as a security.

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Quote from @Shafi Noss:

Hi Mitch, it would be helpful to know how much you are thinking of raising and between how many people.

If your objection is time, expense and compliance issues, it's not clear to me this alternative is less expensive or time consuming, and likely is even dicier on compliance. If it walks like a duck and all that.

I'm also not sure what you mean by 'avoid bank requirements' and 'middle-man syndication'. Is your bank putting requirements on how you source your downpayment? If you are offering a secured promissory note, a bank would probably like that less than syndicated equity. Or are you trying to syndicate the entire capital stack? Knowing those details would help us evaluate more precisely.

Hi Shafi. I haven't taken the next steps with the banks yet so I'm not sure how happy they would be with the down payment coming from a debt LLC. But I have a few local and regional banks I've worked with that might be open to it. If no bank is willing to allow debt as a down payment, I would need to raise the capital stack which would usually be around $10MM. So my challenges will be either to find a lender willing to accept debt for the down payment or raising the entire capital stack but I'm not sure I would have enough 'friends' to raise that much and the more members in the LLC, the more it acts like a security.

When I stated 'avoiding the bank requirements,' I was referring to the process of going through committee approval, extra documentation, negotiating any covenants, etc. For the middle-man syndication I was referring to the extra costs I incur in using capital from the syndication fund we've been using who give us a lease-option on the properties after they purchase. It seemed that having my investors for their own LLC and loan me the down payment or the entire capital stack would be less expensive than the rent I pay. In that scenario, I would also get depreciation benefits as the title holder.

Using the syndication fund as been pretty smooth and easy, however, I'm not sure they have been raising enough capital to keep up with our growth pace so I'm looking for another alternative. I think my best bet is to find a flexible bank and bring in the down payment as debt.

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Quote from @Chris Seveney:

@Mitch Conrad

The other option is for them to do a participation agreement between each other.

Can you give me more details of what you mean by a participation agreement? Thanks for your time and comments!

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Quote from @Greg Dickerson:

This is an easy one @Mauricio Rauld can help you.

I agree. Mauricio would probably be my first call but I wanted to get feedback from this forum before taking that step. This seems like such a grey area of the law. Even discussing with my real estate attorney, his first response was that a note is a security (unless you're a bank). But the more I questioned things and asked, "How can I", the more he came up with similar requirements similar to Chris's comments.

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Quote from @Don Konipol:

Quote from @Mitch Conrad:

Quote from @Don Konipol:

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.

Thanks for the reply! Do you have any documentation showing there is no
difference between debt and equity in determining if an investment is a
security?

My research so far shows that debt and equity investments are treated differently when determining if they qualify as securities under U.S. law. The primary test used to determine whether an instrument is a security is the Howey Test, which originated from the Supreme Court case SEC v. W.J. Howey Co. The Howey Test defines an investment contract (a type of security) as a transaction where a person invests money in a common enterprise and is led to expect profits solely from the efforts of others. While debt holders expect repayment of principal and interest rather than profits, the interest received can be seen as a form of profit derived from the issuer's efforts.

SEC regulates the offering of securities. A security is "[a]n instrument that evidences the holder's ownership rights in a firm (e.g., a stock), the holder's creditor relationship with a firm or government (e.g., a bond), or the holder's other rights (e.g., an option)." Black's Law Dictionary, 10th ed.

Since 2014 the SEC has clarified that it regards loans as securities. Further, most loan participations are in the form of LLC units, which in itself is an equity security with the company in question holding a debt instrument.

The Howey test is still somewhat applicable for determining if the sale of a business interest is a security or a business opportunity . It does not apply to debt offerings.

Thanks for the feedback again! Do you have any feedback regarding Chris's comments concerning notes?
The members of the debt LLC would raise money specifically for a property purchase; members would not be investing in a business for profits, they would receive monthly payments according to the terms of the note; and the LLC would receive collateral in the purchased property. Number 2 seems pretty vague as to the number of members that would be acceptable.

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Quote from @Don Konipol:

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Thanks for the reply! Do you have any documentation showing there is no difference between debt and equity in determining if an investment is a security?

My research so far shows that debt and equity investments are treated differently when determining if they qualify as securities under U.S. law. The primary test used to determine whether an instrument is a security is the Howey Test, which originated from the Supreme Court case SEC v. W.J. Howey Co. The Howey Test defines an investment contract (a type of security) as a transaction where a person invests money in a common enterprise and is led to expect profits solely from the efforts of others. While debt holders expect repayment of principal and interest rather than profits, the interest received can be seen as a form of profit derived from the issuer's efforts.

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All Forum Posts by: Mitch Conrad

Mitch Conrad has started 2 posts and replied 29 times.

Post: Assisted Senior Living /Adult foster Home

Post: Senior Living REIT

Post: Syndication vs Private Fund LLC

Post: Syndication vs Private Fund LLC

Post: Syndication vs Private Fund LLC

Post: Syndication vs Private Fund LLC

Post: Syndication vs Private Fund LLC

Post: Syndication vs Private Fund LLC

Post: Syndication vs Private Fund LLC

Post: Syndication vs Private Fund LLC