The Wealth Elevator Syndication eCourse

Regulations and Investor Qualifications

SDIRA Account Holders

For an entity such as an Individual Retirement Account (IRA) or Self Employed Person (SEP) Retirement Account, all of the beneficial owners must meet the investor qualifications requirements for either the Regulation D 506(b) (sophisticated investor) or 506(c) deals (must meet accredited investor qualifications). The beneficial owners may be either natural persons or a corporate entity. 

1031 Exchanges

Be sure to vet syndicators who promise to do 1031 exchanges upon sale. 

If you were to do a 1031 upon the sale of a property or entity,  you would have to declare a new property (typically within 45 days) to invest in. Upon the sale, the capital gains would be deferred to the next property. However, it should be noted that this is an unlikely scenario. 

1031s are very rare and, in most cases, do not make sense. If you are trying to 1031 into a deal from a previous property, please review this.

What Type of Investors are Not Allowed in Syndications?

It’s the General Partner’s (GP) job to know every individual investor in the investment opportunity and make sure that they are in compliance with all regulations and investor qualifications

Acts such as criminal convictions, citations, cease and desist, or other final orders issued by a court, state, or federal regulatory agency related to financial matters, securities violations, fraud, or misrepresentation should be flagged by the General Partner. GPs also take reasonable measures to make sure money entering the deal is not being laundered by unscrupulous investors.

PPM Risks & Rewards: How You Get Paid

Now that we’ve established the regulatory side of private investment opportunities and perhaps freaked everyone out, we can jump into why we are investing in alternative investments in the first place.

We’ll discuss how both you and the syndicator get paid, as well as the associated risks:

• Risk Factors
• Sources and Uses of Proceeds
• Distributions to Limited Partners
• Fees and Compensation
• Conflicts of Interest
• Duties of the investment company GP to LP

Risk Factors

There are many risks involved with investing in private investment opportunities. These are the most common you will find in real estate syndications:

GPs Ability

• The success of the deal depends largely on the Syndicator’s ability to properly execute the acquisition, management, operation, finance, and disposition of the private offering.

Lack of Control

• If you’re a Class A LP, then you don’t have control of the day-to-day operations, and your voting power is limited. You are not a Managing Member, but this can be a good thing for liability reasons and investor protection.

Liquidity

• As mentioned before, you are locked in for the hold period of the investment. But as an equity owner, there should be provisions to sell your shares (likely at a big discount) to another qualified investor. Note: If you are looking to sell your shares, please contact your sponsor if they are able to move your shares, but depending on whether the deal is going well or not you should be looking at taking at least a 10% cut to defer the administrative headache of assigning your shares to another potential investor. It may take time to find another sophisticated investor since selling syndication shares is in a private market, and there are limited means of general solicitation.

Lack of Capital

• Unexpected expenses could be detrimental to the business plan and delay financial targets. There are a lot of parts of the PPM that discuss interest rates of new capital brought in, which could be a stopgap between an LP capital call by bringing in a private lender to bridge the asset over to better times.

Not Receiving Distributable Cash

• If there is not enough cash flow, you may not receive any distributions. This can be an outcome of the management not being able to collect rents from all tenants. All investors should understand that in any investment, there is risk.

Inaccurate Financial Projections

• Projections aren’t guaranteed; this is where you vet a conservative syndicator rather than an optimistic one. There is a large variance in returns, too. Sometimes you can be pleasantly surprised (2x in 2.5 years). Conditions change the day after the deal closes, so thinking you are still going to get exactly 6.87% cashflow in year 2 is not realistic.

Sources and Uses of Proceeds

The projected use of funds and financial statements should be clearly outlined in a spreadsheet or table.

Included with most PPMs are pro forma financial statements showing the fund’s projected income for at least 3-5 years and sometimes longer. The failure by a fund to provide financial statements or coherent ones should be a red flag.

If there’s a leap in projected net income from one year to another, are these projections based on sound economic principles, or are they based on speculative factors? Beware of overpromising by the manager.

When I was an LP and things were not going well, or at the start of a deal. I would verify who the sponsor was using as their syndication attorney and CPA. I was lucky enough to have a personal relationship with the attorney and CPA firm, so that was one check I was able to do to just make sure the sponsor was using good third-party vendors (if any). This is like the medical industry with HIPAA laws, so use your relationships and ask around.

Insider Tip
from Lane

Raising Capital – Minimum and Maximum Dollar Amount

For every syndication model, there is a minimum and maximum dollar amount to be raised in order to acquire the property, with corresponding expenses. The amount of capital raised can play a role in distributions and reserves. Most investors freak out when the sponsors say they are raising 9M for a deal and the PPM states the max capital raise is $11M. It is pretty standard for the PPM to be written with some flexibility to avoid having to create a brand new ($10-20k cost) PPM and/or write an Addendum. So chill out… no one is lying to you, these are just one of those things to understand with these types of documents.

Minimum Dollar Amount

The GP can lower this amount at their discretion, but this will tell you the low threshold of the capital raise, in order for the GP to use investor funds. Some things that can happen when the minimum is raised are the GP deferring fees, advancing funds, or getting a loan from a third party.

Maximum Dollar Amount

The GP will not raise any more money than this and can terminate the offer at any point before the maximum is raised.

Closing Costs

This section will explain how the proceeds of the offering will be used to pay the GP back for costs they may have incurred in the acquisition.

There is usually a table or appendix that shows the estimated closing costs of the deal. 

You may also find a provision that states the GP will advance funds to close (if only the minimum dollar amount is raised) and how much interest they will charge until repaid.

Working Capital and Reserves

If there is excess cash raised above what is needed to acquire the property, then the excess may be held in a bank account as working capital/reserves.

If the minimum amount is raised, the cash flow from the property may be used instead. 

Deferral Of Fees / Reimbursements

If only the minimum amount is raised, this section talks about how the GP’s fees will be handled.

I use the “Command + F” feature on my keyboard to search for terms like “fees” or “voting/vote” to spot check those important items (in a sea of legalese)

Insider Tip
from Lane

Distributions to Limited Partners

This is probably the most interesting part of the PPM, where the LP can find out how much and when they will be paid. You can review distributions back in Module 4.

Capital Transactions

There will also be a payout structure for when the property is sold or refinanced. It’s important to note how the returns are affected by your initial capital contribution. 

Dissolution And Termination

This will outline the next steps after the final settlement is made on the property.

Fees and Compensation

The fees will typically be outlined in a table. Pay attention to the rate of the property management services and whether they will be hiring a local company or if the GP has an in-house property management division. 

Conflicts of Interest

Sometimes, there will be conflicts of interest listed, which sounds worse than it is. Some examples are: 

GP Involved in Similar Investments

This is just telling you that the GP is involved in other deals. Which can be a good thing, so you, as the LP, can check out their other deals to see how they are doing. On the other hand, if the GP is spread too thin, this can be a negative.

Perhaps the syndicator is buying the property at an inflated price from itself?

GP Raising Capital for Others

If the GP has a larger network of investors, it’s common that they may have helped someone raise money on a deal. Be very careful with this, as if there are a lot of people doing this in a deal, it multiplies the chance for some rogue LP to sue the whole partnership. This is why we (Hui Deal Pipeline Club) have stayed away from these deals where they get multiple internet/Podcast/Guru celebrities together to raise money from unsophisticated/litigious investors who have not been properly educated.

GP to LP Duties 

The GP is legally obligated to act in your interest.

The GP can not be held liable for damages from the regular course of business events or unforeseen events; however, they will be held liable if they engage in willful misconduct, bad faith, or fraud.