Frequently Asked Questions
Do you have a question about syndication of a general nature that the Syndication Attorneys, PLLC team can answer for you and other readers on this page? Click here to submit your questions.
How Can You Set Yourself Up for Success In Syndication?
You do this by developing a marketing program that includes live networking to meet and create a list of potential investors, following up after the event to get to know them, and then periodically keeping in touch with them to let them know what you are doing. The follow-up can be in person, on the phone, or via an email drip system.
You can establish credibility by having a company, a business card, a compelling company name and title, a professionally designed corporate brochure and website.
Once you decide to be a syndicator, you are no longer just a real estate investor; you are also in the marketing business.
Where Do You Meet Syndicators Who Do 506(b) Offerings that Allow Sophisticated Investors in Their Deals?
Is There a General Format or Template for Soliciting Investors?
- Document the Relationship.The SEC says you need to have a pre-existing relationship with an investor prior to making an offer (not a sale).
- The relationship is three-part and depends more on qualitythan timing. Think of this like dating; it’s more about the quality of the contact, and not how many times you have seen or talked to someone that determines whether that individual is a long-term prospect.
- a) Pre-Qualification.The relationship begins after you have met someone and know the person well enough to determine whether he or she is accredited or sophisticated, as required for a Rule 506(b) offering. You can use the pre-qualification questionnaire that the person fills out, your notes from an interview with him or her [you fill out the pre-qual questionnaire], the individual’s financials, or other information that makes him or her obviously qualified (e.g., the potential investor is the president of Ford Motor Company, runs an investment club, has owned self-storage or other investment real estate [aside from a personal home] etc.).
- b) Determine Suitability.The initial meeting must be followed by contact (preferably a phone call or face-to-face meeting) from you to determine the person’s suitability to invest in the type of things you may have to offer in the future (this is not a place to pitch what you have available today). This conversation should be 70% about the potential investor and 30% about your company and what it does in general (see example dialogue below). It is possible to combine steps a and b.
- c) Passage of Time.Finally, there must also be a passage of time between when you first met and when you make the investment offer during which the relationship ripens. It would be ridiculous to meet someone in a bar, have a follow-up phone call three days later, wait 30 days and ask that person to get married, right? Something else has to happen in between to further the relationship. So put that person’s contact information in your investor database after the suitability call, send out a newsletter or “welcome email,” get the investor on a drip system so he or she gets information about the self-storage industry (as an example), invite him or her to a webinar or self-storage educational event, or wait a week or two and invite the person to the password-protected area of your website, etc. The idea is to do something to nurture the relationship that furthers the other person’s knowledge about who you are and why he or she might want to invest with you, before you start making offers.
- Make Offers.Your Investment Summary is an investment offer. Only after some passage of time during which the relationship ripens can you make offers (1 to 3 weeks or more would be ideal with several documented contacts). CAVEAT: DO NOT SEND OFFERS VIA EMAIL BLASTS, EVEN IF YOU HAVE ESTABLISHED RELATIONSHIPS WITH ALL RECIPIENTS. THE SEC CONSIDERS EMAIL BLASTS TO BE GENERAL SOLICITATION.
- Technically, for a Rule 506(b) Offering, you should not make offers to people you met after your offering was contemplated or active. Your offering is active when you have documents in hand and are actively raising money. This rule can be relaxed if you take time to go through the steps in Number 2 above and document every contact for every investor. Ideally, you should develop a written policy on how you will do this that everyone raising money in your group follows. Additionally, you should consider a Customer Relations Management (CRM) software system such as Insightly (cheapest), Constant Contact, Salesforce, Filemaker Pro, etc., to keep track of investor contact information and contacts with your company.
Here are some example questions/dialogue for your Suitability Conference (No. 2 above): About Them:
- Have you invested in real estate before?
- Have you invested in a small group before?
- Do you know anything about the self-storage industry?
- What is your investment experience?
- What kind of returns are you getting on your investments now?
- How long would you be comfortable having your funds invested?
- Have you ever had a bad experience with an investment? What went wrong?
- Do you have a self-directed IRA?
- How much are you looking to invest?
- How soon would you be interested in making an investment?
About You: “We are a small investment company that pools funds from private investors to buy real estate [INSERT TYPE]. We buy properties at a discount through our network of nationwide brokers and industry contacts and then turn them around with capital improvements and a professional (or affiliated) property management team. Once we get the properties stabilized, we refinance them to cash out our investors, usually within three to five years. We typically offer annualized returns of 12% to 15%, depending on the amount invested. Our minimum investment requirement is $25,000. Does this sound interesting to you?” If yes, then, “Great, with your permission I will put you in our investor database so we can let you know when we have an opportunity that meets your criteria.” (You get the gist – you probably need to memorize and practice something like this). When you are ready to make the offer, you would send an individual email that would say something like: “Dear Investor, you may recall our conversation about investing in self-storage facilities. We currently have an opportunity for an investor in our private placement offering that meets your criteria. Please see the Investment Highlights below. If you would like more information, please click on the link to see the entire offering package.” You could attach your Investment Summary, or provide a link to the entire offering package. Call the investor to follow up and talk to him or her about the opportunity. Live contact is always the most effective. Remember, people invest in you, not in your offering.
Can I Just Borrow Money From My Family And Friends Without Having To Comply With Securities Laws?
What is the Difference Between Rules 506(b) and 506(c)?
What Should be Included on a Business Card You Use for a Real Estate Investment Company?
Also, you should consider using a title that invites conversation, such as “Acquisition Manager” or “Acquisition Director” – or “Investment Manager” or “Investor Relations Director.”
Don’t use “Managing Partner” as your title. There are technically no partners in an LLC; there are only Managers, Members or Managing Members, none of which invites conversation.
Additionally, you should consider saying something on your card that describes what you do, such as “Commercial Property Acquisitions and Investments.”
What are the Rules Regarding 506(b) Solicitation and Mass Communication?
“I am a member of a group of several hundred people who are interested in investing in commercial real estate. Many of them are not Accredited so I want to do a Regulation D, Rule 506(b) Offering. Can I email my deal to the group or invite them to attend a webinar where we discuss the deal as a means of finding potential investors?”
If you want to use mass communications for your offerings, you need to do rule 506(c) Offerings that allow advertising and general solicitation, but then you will be restricted to only having verified, Accredited investors. The Rule 506(c) exemption was designed for internet communications. Rule 506(b) — the original Rule 506 — has been around since before the internet existed. The Rule 506(b) exemption is reserved for one-on-one, word-of-mouth offerings to people the issuer already knows and not for mass communication to people they don’t know.
Here are the rules for soliciting for a Regulation D, Rule 506(b) Offering, as I see them:
1) You must have a substantive, pre-existing relationship before you make offers.
2) The pre-existing relationship is defined as already knowing an investor’s financial qualifications before making an offer.
3) You can’t create new relationships and invite them to invest in a current or contemplated offering.
4) A Letter of Intent would not be current or contemplated, and a purchase agreement might still not be. But the offering is surely current or contemplated at the time you hire securities counsel to draft your offering documents and have completed substantive due diligence.
5) You shouldn’t email-blast offering documents or details to groups of investors if you have a Rule 506(b) exemption. The SEC has stated that email blasts to several hundred people, even if you have a pre-existing relationship, is a general solicitation.
6) The safest (and most effective) way to solicit investors is to communicate individually with each potential investor, starting with a phone call to the prospect who meets the requirements of steps 1 and 2 above, followed by an email with the offering documents, and then a subsequent followup by phone to see if they have questions.
Can I Include in My Syndication an Investor Who Wants to do a 1031 Exchange?
The 1031 investor would have to take direct title to his or her proportionate share of the real estate. Your syndicate could own the rest. Unfortunately for syndicators, profits get split amongst the TIC owners at the property level, so you can’t earn any distributions from the portion of the property owned by the other party, except perhaps an asset management fee. Additionally, you would have higher legal fees, as this structure would require all of the usual syndication documents plus a tenant-in-common agreement and an asset management agreement.
Unless the 1031 investor is bringing a substantial amount of money (e.g., 50%) that you don’t think you can raise from other passive investors, it’s not really worth it for you to coordinate the exchange, as you could be giving up a substantial portion of your earnings.
How Do I Structure a Small Multifamily Deal With Investors?
To ensure that everyone stays active, they need more than just a voting right. You can either give them a title and a job, or simply don’t take control of their money (i.e., you could ask them to contribute money when you need it and they write a check).
The downside is that if you want to do bigger deals that you will syndicate down the road, the JV structure will hold you back and it won’t necessarily count toward your syndication track record, which will become important for subsequent deals. If you plan to stay with small deals with just a few high-net-worth investors in each deal, it can work for you.
A loan from a private lender is fine unless you have an institutional loan in first position that won’t allow subordinate debt. But notes are securities, too. If you do an isolated transaction with an accredited investor, you may not need to do anything else, but if you are pooling funds from non-accredited investors, or your business starts to depend on repeated borrowing from private investors, you are in the business of selling notes as securities and you still need to comply with securities laws.
If your concern is regarding the costs of syndication, you can keep them low by only using a small number of accredited investors, as a PPM won’t be required (although it is still advised) if everyone is accredited.
Using private money for real estate is a business where it is easier to go big than it is to stay small, as the securities compliance requirements may be the same for a small or big deal. But in a bigger deal, the costs are not as disproportionate.
As always, it is best to talk to a securities attorney when dealing with private money so you understand all of the options available to you, and some may vary on a state-by-state basis.
How Can I Write a Personal Biography for my Investment Company that Inspires Confidence in my Investors?
Here are some other tips and guidelines:
- Use a professional photo or headshot (it shouldn’t be more than two years old)
- List your name and title for this company. The title should be compelling enough to invite conversation, so don’t use President or CEO (boring!!!)
- Describe your role in the company you’re promoting (all the different hats you wear, etc.)
- Describe related experience, training or education
- Describe unrelated, professional experience and training. (Note: Leave the personal stuff for your singles ad!)
Can I Still Invest in a Securities Offering if I am Not Accredited?
Some ways to do this are to:
1) Ask securities attorneys to introduce you to some of their clients who do 506(b) offerings;
2) Reach out to some of the syndicators on Bigger Pockets or other forums and get to know them offline; or
3) Reach out to some of the crowdfunding platforms (like Crowdstreet.com) that can introduce you to some of their clients who do 506(b) offerings.
What Might Happen if I Lie About My Financial Qualifications to Get Into a Deal?
The financial qualifications for investors will be spelled out in the “suitability” section of the Private Placement Memorandum (required if unaccredited investors are allowed), so prospective investors should always read this section of the offering documents carefully to make sure they are qualified before investing.
Accredited Investors should beware of “fudging” their qualifications. It’s surprising how many people say they’re accredited to get into a deal (when they are not) and then complain later that they weren’t qualified and shouldn’t have been allowed to invest when the deal fails. Syndication offering documents often require the investor to indemnify the Syndicator if they lie about their qualifications and it causes liability for the Syndicator later, so there could be repercussions against investors in those cases. I know of legal actions involving syndicators where this very thing was one of the issues.
Bottom line, investors need to be as truthful about their qualifications as they expect the syndicator to be about the deal, and don’t invest if you can’t afford to lose the money.
How Do I Structure a Deal with Investors?
A typical syndicate uses a limited liability company (LLC). Although some may use limited partnerships, LLCs are more common. The syndicator “carves out” a portion of the ownership interests for himself/herself (20%-40%, depending on how good the overall returns look in your projections) and sell the rest to investors in exchange for their “capital contributions.” Ideally, you want to find a deal that yields a 12% cash on cash return during operations from the beginning or within a couple of years, and you can do something to add value or decrease expenses so that the property can increase in value in 3-7 years, giving you equity to share with investors on resale.
The sweet spot for multifamily investors in today’s market seems to be 8% annualized cumulative preferred return from cash flow (calculated quarterly) before the syndicator takes his/her cut. Additionally, for multifamily deals, investors typically get a share of excess cash flow or equity on resale based on their “percentage interests.”
Investors like to see projected overall returns in the high teens to low 20% range, after applying the amount of equity they realize on sale, spreading it out over the years the property has been held and adding it to the cash they received from operations.
As for who signs on the loan, if you don’t have strong enough financials to do it yourself, you will probably need a “sponsor” (or experienced syndicator) who can help you qualify, even for non-recourse loans. In exchange, you might offer a piece of the syndicator’s carve-out. It is not typical for every investor to be underwritten, unless you have a very small number of investors.
In any case, if you are selling passive interests (where profits are not derived from the investor’s own efforts) you are selling Securities and will need to comply with Securities laws, so be sure to seek advice from a syndication attorney prior to offering interests to investors.
Also, see our article entitled “How to Structure a Real Estate Syndicate.”
How Does Cash Flow in a Syndicate?
- Investor funds are collected in the Investor LLC Operating Account.
- When it is time to close on the Property, the manager of the Investor LLC (Manager) – Note: this is not the Property Manager; it’s the Syndicate Manager) – wires only the funds needed for closing. There should be excess cash remaining the Investor LLC bank account that will be used to pay the Manager LLC for its Acquisition Fees and to reimburse the Manager (or its members) for any out-of-pocket expenses.
- The Property earns money.
- Either the Property Manager or the manager of the Investor LLC (Manager) writes checks for Property Operating Expenses and Debt Service.
- Excess cash is swept to the Investor LLC Operating Account.
- The Manager writes checks from this account to itself for any Fees that are due at that time. Manager’s Fees are described in Article 5 of your Operating Agreement.*
- The Manager decides how much to retain in the Investor LLC operating account as Working Capital and Reserves and how much, if any, is Distributable Cash.
- If there is to be a Distribution, the Manager follows the Waterfall in Article 4 of the Investor LLC Operating Agreement, depending on the phase of the Company (operations or a capital transaction [re-fi or sale]).
- The Manager uses Appendix A, Tables 1 (for Class A Interests) and Table 2 (for Class B Interests) from the Investor LLC Operating Agreement to determine who will receive checks, and how much each Member is entitled to receive from the Distribution. The checks are written from the Investor LLC to the Class A & Class B Members listed in those tables – using the exact Member names listed in those tables (which should match their Subscription Agreements).
*The Manager LLC distributes its earnings to its members as described in the Manager LLC’s Operating Agreement.
Also, see our article entitled “How to Structure a Real Estate Syndicate.”
How Long Does it Take to Set up a Real Estate Syndication?
For a specified Offering, you should plan on 3-4 weeks from the time you engage us to the time you receive your completed documents.
For a blind pool Offering, you should plan on 3-4 weeks from the time you provide a draft Business Plan/Investment Summary outlining your investment program. If you plan to draft this yourself, you should do it prior to engaging us (you can refer to our article, “How to Write a Blind Pool Investment Summary,” for instructions on how to do this). If you are having us draft it, you should plan on 2-3 weeks from engagement to completed Investment Summary. Thus, your total time for a Blind Pool could be as long as 6-8 weeks.
For a specified offering, you should hire us when you have a purchase agreement on a property, someone from your team has been to the site, and you have reviewed the last 2-3 years of financial statements.
Unfortunately, many clients wait too long to hire us and incur 20% Rush Fees, as well as needless stress for themselves and for their Investors (not to mention their Attorneys).
If you want to be a successful syndicator, it pays to plan ahead.
Are Rule 506 Offerings Exempt from Blue Sky Laws?
Rule 506 offerings are exempt from further regulation at the state level, except that issuers must:
- Be able to demonstrate to state regulators how they followed the applicable 506 rules,
- Not pay any fees to unlicensed brokers (most states have this requirement that basically eliminates finders fees), and
- File state securities notices (giving the state jurisdiction over the issuer) and pay the required notice filing fees, usually within 15 days of when an investor’s funds become “irrevocably contractually committed.”
Rule 506 offerings (b or c) are exempt from following additional state requirements, such as limiting the amount of an investment to a portion of the investor’s net worth, etc., as long as they comply with the above rules.
Should I Become an 'Accredited' Investor?
The fact of the matter is that “Accredited” is not something one “becomes;” you either meet the definition or you don’t.
You meet the definition of an accredited investor if you have:
- Over $1 million net worth, excluding any equity in your primary residence, or
- Make over $200,000 per year if you are single*, or
- Make over $300,000 a year if you are a married couple*.
*The income classification requires that you have met the qualifications for the past 2 years with an expectation that it will continue indefinitely into the future. There are other definitions for legal entities, but generally, the entity must have >$5M in equity or all of their members/beneficiaries/shareholders must meet the accredited definition above. Sponsors/managers of their own securities offerings also fall within the definition of an Accredited Investor.
The confusion seems to stem around whether one should get “verified” as an Accredited Investor, which entails getting a certification letter from your own CPA, Attorney, or Registered Investment Advisor, or from a third-party verification company, which reviews the investor’s financial information and then “verifies” whether the investor meets the definition above.
An investor’s Accredited status must be verified to invest in a securities offering that has chosen the Regulation D, Rule 506(c) exemption (which allows the issuer to advertise or crowdfund the investment opportunity). The burden is on the issuer of a Rule 506(c) securities offering to have a reasonable assurance that all investors are accredited, prior to accepting their funds. However, the SEC requires that the verification is dated within 90 days of the investment. So it won’t help you to get “verified” now unless you will be making an investment in a Rule 506(c) offering within the next 90 days.
Note: The Regulation D, Rule 506(b) securities exemption does not have the same verification requirement. In a Rule 506(b) exempt securities offering, the investors can self-certify that they meet the requirements. But investors must have a pre-existing relationship with the sponsor of the offering before being allowed to invest, so if you don’t want to go through the third-party verification process, you should develop pre-existing relationships with sponsors of Rule 506(b) offerings, who will let you personally know if they have an opportunity. They are still required to ask if you meet the qualifications and you do have an obligation to be truthful, but you may not need to cough up financial or income statements to be allowed to invest, and you won’t have to get re-certified within 90 days of making the investment.
How Should I Structure a Small Multifamily Deal With Investors?
Your legal compliance requirements will largely depend on whether your investors are:
- active (easiest legal documents) or passive (more complex legal documents)
- accredited (easiest legal documents – No PPM required) or non-accredited (PPM/disclosure document required)
- everything is in one state – you, investors and the property (may be an easy intrastate offering exemption you could follow), or crossing state lines (usually means you have to follow the federal exemption rules, which can be costly)
- people with whom you have a pre-existing relationship (easiest way to raise money) or want to advertise (harder to raise money, probably need a track record with similar properties and investors)
Some of the questions relate to legal compliance, but others are more logistical, such as “Who do know who might invest with you?”
A consultation with an experienced syndication attorney can usually place you on the right track and help you figure out what will work for your deal, while containing costs to the extent possible.
You should also consider getting some formal training in multifamily investing, as it’s easy to make $100,000 mistakes when you are first starting out. Better to learn from others’ mistakes versus your own.
How Can I Establish a Relationship With Investors to Invest in my Deals?
Generally, you can say you are planning to form some group investments for future multifamily acquisitions and would like to get to know others who might be interested in learning more about group real estate investing.
Then, you need an established plan of how you will follow up (and start the “dating process”) with people who express interest.
First date should be to get to know them (their goals; their financial qualifications, etc.) and general information about what you are doing. It should NOT be a sales pitch.
Subsequent contacts should be to provide educational information (not offers to invest) about the type of investments you are planning to do.
After a period of time has elapsed, you can contact investors one by one and talk to them about specific deals.
You must keep records of each contact and what was discussed or provided.
Here is the order in which to do things:
- Meet and get contact info.
- Interview and prequalify.
- Follow up/educate.
- Then. make offers.
This all has to happen over a minimum period of time (30-45 days) during which no direct offers are made, and should NOT happen after you have a current or contemplated offering.
What to do if You Want to Invest in a Rule 506(c) Offering?
The SEC, in its final rule regarding requirements for compliance with Rule 506(c), offered some non-exclusive methods that issuers could use to verify Accredited status for natural persons, which include such things as:
- Verifying income from the past two years’ tax returns and written assertions that the income is expected to continue;
- Verification of assets by reviewing statement balances from brokerage houses or banks, reviewing tax assessments/third-party appraisals of real estate holdings and verification of liabilities through an investor’s credit report; or
- Obtaining a written confirmation from a securities broker-dealer, registered investment adviser, licensed attorney or CPA, who attests to have taken reasonable steps to verify the investor’s Accredited status within the past 90 days and that the person is, in fact, Accredited; and
- There is an exemption for investors who previously invested with an issuer as an Accredited investor.
Bottom line, this isn’t simply the issuer trying to dig into your private affairs; they are required to receive this information or refuse your investment.
Simply stated: If you want to invest, you have to pass the test.
How Can I Develop A Relationship With a Syndicator So That I Can Invest With Them As An Unaccredited Investor?
Where Can I Meet Syndicators Who Allow Unaccredited Investors?
Also, even though someone has a 506(c) offering currently, they may do a 506(b) offering later on if they get contacted by enough people who are unaccredited to make it worth their while. Many current 506(c) Syndicators have simply exhausted their current database of unaccredited investors in previous deals and now have to do 506(c) offerings in order to fill their current deals. Bottom line, reach out to 506(c) syndicators and ask if they ever do 506(b) deals and if so, get to know them.
Are All Group Investments Syndicates That Require Compliance With Securities Laws?
If you are selling securities, you either need to register your offering (i.e., go public — a long and expensive process) or find an exemption from registration, such as Regulation D, Rule 506, or another applicable exemption that will allow passive investors to legally invest with you without registration. There are several choices and there are securities exemptions that will allow unaccredited investors to invest with you.
So, in answer to your question, both scenarios could be group investments, but both are not securities. A securities attorney can help you determine the appropriate structure (JV or Syndicate) based on your facts and circumstances and then draft the appropriate legal documents.