How to Avoid Fraud When Investing in Real Estate, with Kent Ritter

In this interview with Kent Ritter on his podcast, Ritter on Real Estate, guest Kim Lisa Taylor discusses how to identify fraudulent real estate deals and bad sponsors before it’s too late

Among the points covered:

• The reason people commit fraud
• The three types of fraud:

1. 1. Illegally raising money (not following securities laws)
   2. Embezzlement – Partner Fraud
   3. Ponzi Schemes

• Practical tips on what to look out for before and during your investment
• What questions you should be asking your sponsors to validate their behavior
• What to do if you find yourself in a position where you think fraud is happening in your deal

Scroll to read the transcript.

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Kent Ritter:

Hello, fellow investors. Welcome to Ritter on Real Estate, where we focus on how to passively invest like a pro. Today, we’ve got a very special guest. We have Kim Lisa Taylor. She’s a nationally recognized corporate securities attorney, speaker and the author of the number one Amazon bestselling book, How to Legally Raise Private Money. She’s the founder of Syndication Attorneys, PLLC and investormarketingmaterials.com, whose purpose is to provide quality legal advice, offering documents and professionally designed marketing materials for clients nationwide.

Kim has been the responsible attorney for hundreds of securities offerings, and she routinely teaches subjects related to legally raising private money in front of groups ranging from 50 to 1,000 plus attendees. Wow, I’m so excited to have you here today, Kim. That is an amazing resume, and I think such an important topic, just focusing on something that from a private investor standpoint I doubt we spend enough time really thinking about is you try to think at least the idea that people are well-intentioned and that people are going into these things with the best of intent. And that’s not always the case. So I’m so glad you’re here to talk to us today about how we avoid fraud and how do we find the right sponsors and what should we be looking out for. So, again, thank you for being here.

Kim Lisa Taylor:

Oh, you’re so welcome. And thank you so much for inviting me. This is just a hugely important topic. And I think right now, in the midst of the coronavirus, we have probably a higher potential for fraud than maybe ever before because there are people who are in desperate need and they’re thinking creatively about how to dumbest other people of their money, unfortunately. And then there’s also some other reasons that people might do this that aren’t as intentional, so we can talk a little bit more about that.

Kent Ritter:

Yeah, that’s an interesting take. Especially right now, you’re right. There’s distress out there. And that can cause people to act in unfortunate ways, so I think very timely topics. But before we get into how to identify this, before you get into a deal, can you tell us a little bit about why it’s so important?

Kim Lisa Taylor:

Well, if somebody is accumulating funds from private investors and then they engage in some kind of fraud that makes the investment not viable, what happens is if they get in trouble, okay, if somebody complains to regulator or somebody hires an attorney, tries to get their money back, or something like that, then all of a sudden this person they’re faced with these huge legal bills. And so what do they do? Well, they have control of your money, so they suspend all distributions, they start hoarding all the cash and using it to pay their own legal bills. So all of a sudden, your investment is being used to pay somebody else’s defense after they stole your money leading to further that. So it’s just a vicious cycle. You just have to be cautious because it’s going to impact your investment. Even if you do end up getting the money back, chances are you’re not going to get all of it back. You might get part of it back if you’re lucky, you might get none of it back. Either way, your investment is going to be lost.

Kent Ritter:

And what typically happens to the property that you’re invested in if somebody does get in trouble with the SEC, for example?

Kim Lisa Taylor:

I guess it just depends. They could be forced into bankruptcy, the property could go to a receiver. More likely, they’re going to stop paying the bills and then it’s going to go into foreclosure and the lender is going to foreclose and recover their losses, but there probably isn’t going to be enough money to pay anybody else back.

Kent Ritter:

Got you. And as an investor, what’s your recourse against the sponsor as an investor? Is there anything that you can really do at that point once you’ve already gotten into the deal?

Kim Lisa Taylor:

And the only things you really can do, certainly you can call the person and complain and tell him you want your money back, likely that’s not going to happen. Maybe if you catch it early enough, they might just get rid of you because you’re the squeaky wheel. But the people that don’t complain are going to go down with this ship. But you might have an opportunity. You can always only complain to your own state securities regulators. You can complain to the SEC too, if you want to. My experience with the SEC is that they typically don’t investigate things where somebody’s stolen like $15 million. They don’t necessarily get involved with the small stuff just because they’ve got bigger fish to fry and they have limited resources.

But your state securities agencies are very interested in the small stuff and they’ve got the time and the resources to pursue it. So your audience might not know that if you’ve invested in a syndication, say you live in Arizona, your Arizona securities agency… Every state has its own securities agency. So you can complain to your Arizona State Securities Agency because every offering, even if it’s a federal offering under federal law still has to comply with state filing requirements and still has to give jurisdiction to the state over that person in order to raise money within the states. So just a convoluted rule is that you have to at least notify the states and then they have jurisdiction over you if you commit fraud within their state.

So if you live in Arizona, your correct person to complain to would be the Arizona Securities Agency. Attorneys can’t help you do that, by the way. Attorneys are not allowed to help people to try to threaten criminal prosecution to gain an advantage in civil litigation, most people don’t realize that. So you’re always free as a citizen to go on your own and complain to your regulatory agencies, but that’s not something that an attorney can necessarily help you do. But the flip side of that is you could hire an attorney and civilly sue that person and sue them for violations of securities laws. So there are ways to do it, but of course, that one’s going to be the more expensive way to do it because you’re going to have to put the legal bills in order to get any kind of recovery. And who knows if you’re actually going to get recovery.

Kent Ritter:

Yeah, no, that’s great information. I didn’t realize a lot of that, especially about the state. So it sounds like really once you’re in it, you’re stuck. There’s not a great way out of it. Either way, most likely you’re going to lose your money, or you’re going to spend a lot of money trying to go after the person to try to recover some money from person that realistically probably doesn’t have a lot of money because now there’s a reason that they’re doing all this. So I think the important thing is, it sounds like let’s make sure we don’t end up in this situation in the first place.

Kim Lisa Taylor:

That’s right.

Kent Ritter:

So let’s talk about how we avoid ending up in that bad situation.

Kim Lisa Taylor:

Well, so you need to realize first what the types of ways are that people can commit fraud in a syndication. And I think there’s really three different ways. There’s people that are illegally raising private money. So they’re not following securities laws when they’re doing the raise, which is putting the entire investment at risk because any violation of securities laws could cause the whole thing to completely derail if any investor ever complaints and the regulators come around and start unraveling the deal.

There’s embezzlement, so partner fraud, where you’ve got maybe three or four people within the management team, and one of them is stealing money, and the other three aren’t really paying attention, or they’re not preventing it, or maybe that person has control of the money and they can’t do anything about it. So I think that’s probably one of the more common ones. And then there’s Ponzi schemes, where people have already had an offering in place, they’ve either lost the money or used the money maybe for an improper purpose like their lifestyle or that kind of thing. And now, in order to make the earlier investors whole, they have to bring in money from new investors. So those I think are the three common types. And certainly, there’s other creative types out there I’m sure.

Kent Ritter:

Well, yeah. I think that’s a lot to unpack. There’s a lot of things to watch out for. So why don’t you take us through the three types and how do we identify for each of those? Are there early warning signs, red flags, things that we can be watching out for as we enter investments?

Kim Lisa Taylor:

Yeah. So I think let’s start with the illegally raising private money and how can you spot that. So the first thing is you have to have an understanding of the securities laws that are allowing this person to even raise money from you if you’re the passive investor. So the quick one-on-one primer of the securities laws that might be applicable to what you’re doing is if someone is selling securities, so that means they’re either selling the promissory notes or they’re selling something called investment contracts. Investment contracts would include investing in a company, where you’re buying a portion of the ownership interest in that company. And it doesn’t matter what kind of company it is. It could be a limited partnership, could be an LLC, something like that, but you’re giving somebody your money in exchange for ownership interest in that thing, then that’s an investment contract.

As anytime you are passively investing and relying on someone else to generate a profit for you, that’s really the classic definition of an investment contract. So first, okay, if you’re investing in securities, one of those things, then that person in order to be able to offer that to you either has to register the offering in advance. And that means going public like Google did, like Facebook did and getting preapproved by regulatory agencies before they even offer those investment opportunities. And for real estate, that’s not going to happen because you don’t have time to go public, it’s too expensive, it takes too long. You can’t do it on an individual deal basis, which is how most people are raising money. So you have to qualify for an exemption from registration.

So the exemptions that are most common are Regulation D Rule 506, the Regulation D Rule 506, and then there’s intrastate exemptions, if somebody was raising money all within one state and all of the assets were in that state and they were in one state. So you can do a Texas intrastate offering if everything was in Texas. But the most common are the Reg D Rule 506. And there’s two options under that. There’s Rule 506(b), B like boy, that allows the investor or the syndicator to raise an unlimited amount of money from an unlimited number of accredited investors and up to 35 non-accredited investors, but they can’t do it through any means of general advertising or solicitation. So that point there about no advertising is key because if you are investing with someone and who claims they have a Reg D Rule 506(b) exemption and you learned about this deal through some kind of an email blast and you don’t know this person, they’ve already violated the law.

Kent Ritter:

Not fair.

Kim Lisa Taylor:

Okay, and that’s very, very common way that people violate the law. The other side of that is Regulation D Rule 506(c), C like cat. Okay, the 506(c) exemption allows them to raise an unlimited amount of money from an unlimited number of verified accredited investors. So usually I have to go through some verification process or provide some evidence that you actually are accredited, and that has to have been done within 90 days of making the investment. But if they’re offering the securities under Regulation D Rule 506(c), then they are allowed to freely advertise. So what would be your cues as to whether someone was doing this legally or not, if they’re doing a 506(b) offering and you got the information about the offering through an ad and you don’t have a preexisting substantive relationship with the person who’s offering those securities to you, then that’s your first red flag that they’re probably doing it illegally.

If it’s a 506(c) and they’re saying it’s open to accredited investors, and they could even do that with a 0506(b), they could restrict it to accredited investors only. Well, I’ve actually had an instance where somebody approached me and said, “Hey, I invested in this deal with this guy and I want to get my money back. They haven’t made the investment. They’ve had my money for like six months.” And he said, “Well, it was an all accredited offering, but I’m not accredited. I only have about $900,000 worth of net worth.” And so I was able to look at the documents and wrote a letter to that person and said, “Hey, this person wasn’t even accredited. You should never have even allowed them in your deal in the first place and they want their money back.” So they were able to get their money back luckily. And they were one of the few in that deal that did get their money back.

So you’ve got to look at to make sure that you meet the qualifications for that investment, because if you don’t and they’re letting you in, then they’re already violating securities laws and now you’re at risk and the whole thing starts to unravel down the road. You also have to understand from a security standpoint, what is the appropriate documentation you should be looking for? So if you’re investing in a Rule 506(b) offering, then you need to look for a private placement memorandum. So that’s the disclosure document required by the SEC that explains the risks of the investment and also explains how things are set up, who are the people that are in charge, how much money they’re raising, where they’re getting it from and what the money is going to be used for. All those things are required to be in a private placement memorandum.

And the SEC has very specific rules on what those private placement memorandums look like. If you’re a non-accredited investor and you’re being allowed in a deal, and the sec would even dictate what’s on the cover page, what’s on page two, what follows the cover page, what other information has to be contained within that document. So look for a private placement memorandum, get familiar with what that entails and make sure that yours is sufficient. And make sure that it describes which exemption these people are relying on. So they should be naming in that private placement memorandum, whether they’re doing a 506(b), 506(c), or some other exemption. And then you want to look up the rules for that exemption. You can do that at the SEC’s website and figure out whether or not you meet those requirements.

And if you don’t meet it, don’t try to invest, even if they say it’s okay, because it’s not. And if they’re allowing you, they’re allowing other people, they’re violating law, just stay clear. And then you can also look up if it is a Reg D Rule 506(b) or a 506(c) offering, there’s a form that gets filed with the SEC called the form D. And you can look up that company and the person that’s offering those securities with the SEC on what’s called their EDGAR database, E-D-G-A-R database. So if you look up SEC EDGAR database, you’ll find the right link to it. And you can go there and you can punch in their name and see if you can find them. And they should be individually listed because the SEC always wants to know who the individuals are behind the rays. They’re going to be asking questions about that.

So here’s another red flag is if somebody is introducing you to someone who has a deal and they say, “Well, I know a guy who’s raising money,” then ask the person that’s introducing you if they’re being compensated for bringing you to that deal, because the only people that can earn commissions on referring investors to a deal have to have the appropriate securities licenses. If they don’t, then they cannot earn a commission. So if somebody says to you, “Oh, well, I get a commission of 3% on whatever money you invest in the deal,” then you need to know that. And they also it’s mandatory that they disclose that to you, that either they disclose it to you or that the syndicator discloses that to you. So you want to know about that and make sure that you understand whether or not that’s legal. And if you’re not sure, then you may want to check with someone like me to ask them if what’s being done is legal before you make that decision.

Kent Ritter:

Got you. That is great. That’s so much good information. So it sounds like you’ve got to be aware of the type of deal. Well, I guess, one, the type of security offering that they’re doing and making sure that you understand the rules of each, which I think you actually explained and then the documentation related to each of those offerings. So it sounds like the documentation from a 506(b) is different than what would be expected in a 506(c), is that right?

Kim Lisa Taylor:

The description of the business is going to be largely the same. But the investor qualification section, which is called the suitability section, that’s usually going to be section one of the private placement memorandum, that’s going to be different depending on which exemption they selected.

Kent Ritter:

Okay. And how as an investor do we get verified that we are accredited? How do you make sure you’re following the rules?

Kim Lisa Taylor:

If you’re investing in a Reg D Rule 506(b) offering, then you don’t have to go through a verification process. The documents that the syndicator provides to you, they should have the explanation of what is accredited in there. And you get to read that and decide whether or not you meet those qualifications and you can self-certify. So just to verify, it’s just to go through what those qualifications are. So an accredited investor is somebody who has over $1 million of net worth, excluding any equity in their private primary residence. So just other investments that you own, other rental properties, income properties that you own, that’s all part of your net worth, but you just can’t include any equity in your personal residence. So that’s one qualification.

The other alternative is an income qualification, which is if you’re a single person and you make over $200,000 a year, or if you’re a married person, you make over $300,000 a year as a married couple, and that has to have been for the last two years with an expectation that we’re continuing to the current year. So think of it as a one, two, three year, either $1 million net worth, or $200,000 income and single, $300,000 and married.

Kent Ritter:

Got you. And then on a 506(c) where they have to validate that you’re accredited, how does that process usually work?

Kim Lisa Taylor:

So the syndicator may have the capabilities of doing that in-house by reviewing your income statements, or your net worth, or they may send you to a third party that has to usually come from somebody who has a license and it’s CPA and attorney registered investment advisor, could be your own person. And you can use your own CPA to verify. And then the rule for the syndicator is they have to have reasonable assurance that you’re accredited before they allow you to invest with them. So you’re going to provide a letter from somebody that you’ve either paid to do it, or somebody that already knows your qualifications and can review them for you.

Kent Ritter:

Got you. Okay, thanks. So that’s the first step, making sure you’re avoiding people that are raising illegally. And then you talked about the next type of fraud could be partner-related fraud.

Kim Lisa Taylor:

That’s right. Yeah. So this is a scary time for partner fraud, otherwise known as embezzlement. So there’s something called the triangle of fraud, and you can look it up on the internet and read about it more yourself. But it always consists of these three things. First, there has to be opportunity and access to the funds. Second, there has to be some unshareable need, something you can’t go to your partners and say, “Oh my gosh, I’m going to lose my house if I don’t make my mortgage payment, could I borrow 2,000 bucks?” Something like that. So they’ll have some unshareable need. And it could be a valid need, it could be their own greed, or their own vanity, it could be, “Gosh, I really need this BMW. I should be living a different lifestyle than I am, unfortunately. I deserve a yacht,” something like that.

And I don’t mean to make light of this, but it does happen. So opportunity, unshareable need, and then the third part is justification. So what happens, the opportunity, they’ve got to have access to the bank account, maybe access to the investor funds. So when we’re dealing with syndicator and just… We bandied that word about maybe if just in case somebody doesn’t know what that means. That’s just somebody who puts a group of investors together for a common purpose. So this syndicator has access to all of these investor funds. Maybe there’s some delays in getting the property acquired and so they’ve accumulated funds.

I actually was involved in a case once where there was a syndicator who had raised $1 million to buy a property. And then there were some title defects on the property, they were trying to cure the property defects. And in the meantime, this person started deciding that all the things they thought they were going to be able to buy after the property closed, once they get their acquisition fees, they needed them now. So they went out and they bought a brand new BMW, they bought a new house, they did all these things. And pretty soon, there’s only half the money left in the bank.

And when some of the other members of the management team came to us and said, “We need help. We don’t have access to the funds, but we know this is happening. We’re really concerned. The investors are calling us, what can we do?” And we were able to rest the money, to get it away from that person before they exhausted all of it. But unfortunately, half of it was already gone. Property was never acquired. Those investors got their money back, the amount that remained, so about half their money back. Unfortunately, this person was a confidence man. We’ve all heard the term con man and the con men are very charming and persuasive. And they were able to persuade some of those people to put their money into the next deal where they would be made whole. I have no idea what happened with that. But once bitten, twice shy might be the rule here.

So they had access. They had this unshareable need while you can’t tell anybody while I really needed BMW because they’re not going to agree with that. And so they just started helping themselves to the money. And what was interesting is when they justified it… So they created this justification and so they would write checks to themselves out of the bank account. And in the memo line on the check, it would say, “Repurchase of shares.” So they were selling their shares, which were nonexistent because the company had never began operation. They were selling them back to the company and taking the money. So unfortunately, that didn’t turn out as well as it could have, but it certainly didn’t turn out as badly as it could have either.

So that’s your unshareable need. Now the justification, so unshareable need right now in the midst of the coronavirus, “I don’t have any income, I need to pay my bills, I need to keep this business afloat, I need to keep my other business afloat, I need help my kids, there’s all kinds of unshareable needs that people could be experiencing right now. So this is the time if there ever was one to really pay close attention to what’s going on in your syndication bank accounts and to ask if you’re an investor in one of those syndications to ask for an accounting and ask for it regularly, whether or not you’re going to be able to get it is another question, but certainly time to be questioning that. And if you are a member of a management team within a syndicate, pay very close attention to your bank accounts and to the other members right now, just to make sure that nobody is illegally taking some money out of the bank account that they shouldn’t be.

The justification is always, “Oh, I’m doing it. I’m just selling back my shares, or I worked really hard and I spent all this time on this and I haven’t been compensated at all. So I really deserve it, or gee, I’m the one that put this whole entire deal together and I’ve worked harder than anybody else. So I really deserve it now.” So there’s a lot of that. And usually, it doesn’t even start with the justification. It usually starts with, “I’m just going to borrow the money. If I just use part of the money now, and then when this happens, I’ll be able to pay it back and then this never happens, or this gets kicked too far down the road, and then they have to justify why they don’t need to pay it back anyway.” So that’s the triangle of fraud.

So you’ve just got to really watch your partners, your bank accounts closely, always set up a syndicate so that at least two people are watching the bank accounts. And for any withdrawals or checks of a certain dollar amount, there should be a requirement for approval from two people and it should be written approval. But just keep that in mind. Watch for things like ATM withdrawals. Now, somebody will just very frequently start going to the ATM and withdrawing $300 to $500 at a time and then not justifying that, not providing the proper documentation of what that was for. Watch for people taking advances on their pay, people who are just saying, “Oh, well, I’m just going to take an advance on my paycheck for this and this and this,” and then they never reconcile it. So the pay [inaudible 00:28:05]. So just be careful of those things. Watch for people who are paying their own personal credit cards with company cards.

Kent Ritter:

So this one seems a little bit more difficult as a limited partner, as an investor to figure out right. Seems like you have to be asking some really good questions. So you said ask for an accounting, for example. But specifically, what should we as investors be asking the sponsors or expecting the deal sponsors to provide back to make sure this isn’t happening?

Kim Lisa Taylor:

Well, before you invest, might be a good time to ask, “What kind of documentation are you going to be providing to investors on a regular basis?” So somebody who is very responsible or if it’s a public company, they’re going to be required to provide you with some quarterly statements that have very specific information now. So ideally, you’d love to invest with somebody who’s going to provide you with quarterly reconciliation of the bank accounts and all of the income and expense statements for the property for the prior quarter, so that you can look at those and make sure that the checks that have gone out and the withdrawals that have been made coincide with the expenses incurred by the property during that period of time. And anything that’s being paid to the management, you want to just check and make sure that that’s done in accordance with what the offering documents said. So back to the private placement memorandum or the operating agreement if a broad interest in a company it’s going to say what the manager is entitled to take.

They’re entitled to certain fees at certain times and a share of profits maybe after you’ve received your share, or maybe it’s just a straight split, but they shouldn’t be taking their shares of profits at times that are not specified in those offering documents. So those are the things you really got to pay attention to. Knowing in advance that they’re going to provide that stuff is going to give you some comfort and then if they don’t provide it, then all of a sudden you’re going to know that, “Well, they said they were going to do one thing, they did something else. That’s always a red flag.”

Kent Ritter:

Mm-hmm (affirmative). Yeah, I think those are great tips. So the third thing you described what was the Ponzi scheme, which is made famous again with Bernie Madoff and all that happened back then, which has been 10 years ago now. So talk to us a little bit about what that is. Let’s remind folks what a Ponzi scheme is and how do we watch out for that?

Kim Lisa Taylor:

So a Ponzi scheme is really just where somebody has already used the investor funds for whether it’s legal or an illegal purpose, but they’ve used the investor funds and now they have to keep the business going. And they’ve got investors that are saying, “Hey, where’s our returns that you promised,” and so they don’t have the money anymore. So they have to go out and raise money from new people and pay the previous people. And so it just becomes a downward spiral where they’re never going to be able to get out of it. The money’s gone, it’s not coming back, it was never a viable investment to begin with, or something went wrong with it that they didn’t share with investors, and we’re not able to fix, or didn’t take the steps necessary to fix it, and the whole thing starts to go down.

One place where this might happen in, say, a real estate syndicate is it’s very common for people to be able to raise enough money to close on the property, but not all the money they need to do all the things they want to do to the property. But they can raise enough to close on the property and acquire it and then they don’t ever raise the rest of the money. So it’s just a mistake for syndicators to take their foot off the gas after the property is acquired and that often happens. So if you haven’t raised enough money or the person you’ve invested with hasn’t raised enough money to do all the improvements and everything else, they need to meet their projections, then you’ll just have the same property that the last person sold to you.

So it’s still going to be under performing, you’re not going to be able to get those additional units rented, you’re not going to be able to raise the rent, all the things that they said they were going to do are not going to happen because they didn’t raise enough money in the first place. And so it’s not a Ponzi scheme for them to continue raising money as long as they’re offering documents that they can, where it becomes a Ponzi scheme is if maybe they underestimated the amount that they needed to raise and they’re not being honest with their investors about what’s really needed, and so they go out and start getting hard money loans or personal loans or something like that in order to make up any kind of a shortfall. And so they’re not following the documents. So as long as they’re following what the documents allow them to do, then that’s not a red flag. But it’s when they start deviating from what the documents allow them to do in order to make up those shortfalls that the other investors need to be concerned.

Kent Ritter:

Got you. So what you are describing, Kim, is or what investors can look out for is the capital expenses budget. Making sure that when you’re evaluating a deal and the sponsors talking about the improvements that they’re going to make and how they’re going to raise rent, you have to make sure that there’s capital allocated to do that. So you want to see an itemized cap X budget that lays out specifically what they’re going to do, both externally and then internally, how much they’re going to put into each unit to realize that additional revenue. Because as Kim said, if that’s not there, then you’re just going to have the same property that the person had before. You’ve got to have the budget to do that.

So I think that is a key mistakes. I think asking for that budget, making sure it’s itemized so that there’s a clear relationship between what’s going to be done and the improvements is really important. That’s one way to look out for it. So that’s going into the deal. What if you’re in the deal and you just have a sense that things for whatever reason that they don’t feel right, how can you identify once you’re already in the Ponzi scheme?

Kim Lisa Taylor:

Well, you’re going to start hearing from other investors and your calls perhaps to the syndicator are going to go unanswered. That’s a common thing is that somebody gets into financial trouble, what do they do? They tend to stick their head in the sand and just try not to answer anybody’s calls or disappear. We actually write it to the operating agreements that we have that a manager can be disassociated for not answering phone calls, or going for some period of time without responding to anybody, unless you knew they were going on vacation somewhere, but all of a sudden they just become unresponsive that the members then can get together and can try to get rid of that manager.

So how can you tell if somebody is engaging in a Ponzi scheme? Usually, a very classic Ponzi scheme is they’re trying to fix this investment, buy a new investment. So this was the situation with that guy that I was saying had taken half the money and tried to get the investors to reinvest the money with him in a new deal where he was going to make them whole. That would have been more along the lines of the Ponzi scheme. So how can you tell if somebody engages in Ponzi scheme in certain… Always do a Google search on the names of the people that are involved in management. So usually, when we’re creating a real estate syndicate, we’re going to create a management LLC that’s going to have multiple members. So you want to know who those members are, and you want to search their names. You want to know who’s in control of the deal. And the lender’s doing that, you should be doing that too.

So search for their name on the SEC’s… or on just Google. Also, search to see if they filed their form D with the SEC. The timing of the filing is usually they have to do the filing within 15 days of when your funds become irrevocably, contractually committed. So depending on what their documents say, that could happen as when you send in the documents, or it could happen when they close on the property. But that’s going to be that trigger for when they have to do that form D filing. For our clients, we file those form D’s as soon as we give them their final offering docs so that anybody investor could look them up at any time and see that they’re legitimately filed with the SEC. Read the documents carefully and make sure you understand what you’re getting into. If you don’t understand the waterfall and the fees that they’re getting, if the structure is too complex, shy away, don’t invest in what you don’t understand. It should be simple and straightforward enough that you can understand it without having to hire a lawyer to interpret it for you.

Ask questions of the people that are promoting the deal and listen carefully to their answers and make sure that the answers make sense to you and that they’re consistent with what you’ve read in the document. If you’re investing in a syndicate, you’re going to get somewhere between 120 and 140 pages of legal documents. Understand what those documents are and what they mean that will help you be able to assimilate all that information that you can hire someone like us to look at the documents and just to make sure that they comply with securities laws, make sure you understand what it says and what it means. But honestly, you should be able to do that yourself.

We make sure that we always write our documents in plain English so that our investors and our clients who are the syndicators always know and can easily follow and understand those documents. If you get a set of documents that you have to have an attorney interpret for you, then maybe this isn’t the right kind of investment for you. Ask the members of the management team if they have a problem with you doing background checks on them. They may or may not like that, they may or may not want to do it, but you can always ask them and just listen to their reaction and decide whether you’re comfortable with it.

Kent Ritter:

Mm-hmm (affirmative). Yeah, asking… One thing, I’m a huge proponent of I always try to tell people is ask a lot of questions up front and make sure that you’re getting answers that you’re satisfied with. You should never be made to feel stupid, or you don’t know what you’re talking about, or because you’re asking questions. And if people are trying to avoid those, there’s probably something behind that. And it just goes to show the type of manager they’re going to be as you get into the deal and how communication is probably going to be throughout the deal as well. So I think don’t be afraid to ask those questions up front. There are no stupid questions when it comes to investing your own money. And so I think that’s fantastic advice.

And hopefully, the documents are in plain English. I’ve seen plenty that are not, I guess they didn’t hire you. So what I would say is it’s definitely worth the money to have an attorney review them on the front end. You may spend a few hundred dollars to have that happen, but it’s going to be well worth it avoiding a bad deal. So invest that on the front end if you don’t feel comfortable, it would be my advice.

Kim Lisa Taylor:

That’s right.

Kent Ritter:

Yeah, Kim, this has been so much great information. I hope that today we’re going to help some people avoid some bad deals. I hope that we get people thinking that they need to be conscious of this. And I think as you said, in times of financial distress, you have to be even more vigilant. So I really appreciate you coming on. Before I let you leave, I’d love to get your thoughts, I’ve got a section I do at the end of the show called Keys to Success, just some short answers that I’d love to hear your responses to. The first one is what’s one question that every passive investor should ask the deal sponsor? So if you only had one, what would that be?

Kim Lisa Taylor:

What have you done before that’s like this? And their answer either needs to be, “Well, I’ve done this many of these.” So if you’re investing in multifamily, you want to invest with somebody who’s already invested in multifamily. If the person that you’re talking to hasn’t invested in multifamily, it’s okay, they may have teamed with somebody else who has that experience. So just understand the members of the management team and what experience they have doing what you are planning on investing with them. And find out if they have advisors and coaches and just get a feel for their knowledge and whether or not they’re competent to do it.

Kent Ritter:

Great. And what are you most proud of in your career?

Kim Lisa Taylor:

I’m very proud of the fact that we… One of the things our firm does is help people who have never raised money before learn how to do it successfully and correctly so that they can go on and create a career, helping their investors and also making a decent living for themselves. So I like the fact that we’re able to not just help our clients, but we’re indirectly helping all of their investors and we’re trying to teach people how to do it correctly and right so that they don’t get into these situations of fraud and they’re very transparent with their investors and their investors and they all understand what they’re getting into.

Kent Ritter:

And what books should everyone read?

Kim Lisa Taylor:

Oh, they should read my book.

Kent Ritter:

That’s easy, right?

Kim Lisa Taylor:

Well, there actually is a section in there on passive investors and what to look for in a syndicator, or what to look for before you invest in a real estate syndicate. And the reason I wrote the book, it’s 164 pages, it’s not that long of a read. I’ve written in plain English. So it’s just lays out the whole process. So if you’re thinking about investing in real estate syndication, if you need to understand all the things that we’ve talked about today and how they’re structured, then you’ll have the right questions to ask, and you’ll be able to know whether the people you’re investing in are setting it up the right way and what to look for and what things to ask them for.

One of the most important things to ask people is who drafted their offering documents. If they drafted them themselves, you might be a little suspect of that. And the industry standard is to hire a competent securities attorney to draft those for you. We have securities liability insurance, your syndicator who’s drafting their documents themselves does not. And just because they think, “All I have to do is take this boiler plate and fill in some blanks,” it’s not necessarily true, there’s quite a bit that goes into putting these documents together and making sure that the right tax provisions are in the documents. We’ve rescued people that have had the wrong tax revisions before that would have been harmful to their investors, just making sure that the things are set up correctly.

Kent Ritter:

Yeah. I think that would be a huge red flag for me if somebody said that they did it themselves.

Kim Lisa Taylor:

Yeah. And it should be because they’re saving money at your expense. And in a syndicate, the legal fees are an upfront cost for the syndicator, but they’re part of the setup costs of that company, which are expenses that can be reimbursed from the raise. So the syndicators should be raising enough money to acquire the property, so for the down payment, the closing costs, any pre-closing expenses they incur, including all legal fees, hiring property inspectors, things like that. So they should be able to get reimbursed for all of those expenses. So you want them to hire competent counsel and you should be happy to pay for those fees as part of the cost of doing the business because then you know that it’s done right and that they sought appropriate counsel. They’re probably not breaking the law the way they’re raising the money because we’ve counseled them about that, the documents are going to be written in a way that’s customary in the industry.

Kent Ritter:

Yeah. It seems like hiring a competent securities attorney and validate that what they’ve done is a way to validate that, that at least on that first one of raising illegally, that they’re not doing that because they have that person that’s guiding them to do the process correctly. Is that right?

Kim Lisa Taylor:

That’s right. Yeah. And if you’re interested in what’s on our website, we have a lot of, lot of educational material for free that’s available on our website at syndicationattorneys.com. We have an entire library full of articles and frequently asked questions, previously recorded teleseminars. We do free monthly teleseminars every single month and we post them all on the website on all different topics related to syndication. So it’s just a really great way to get educated.

Kent Ritter:

Yeah. That’s a great resource. I’ll make sure that we get that in the show notes for folks. And then what’s your number one key to success?

Kim Lisa Taylor:

Consistency, is just being out there all the time, being in front of people, letting people know what you do. And I guess from the perspective of a syndicator, or somebody who’s raising money, it’s just important for you to be engaging in the promotion of your business as we do for our law firm. If you’re somebody who is looking to invest in deals, you need to network and you need to network at events where experienced real estate investors go. So that would be any of the real estate trainers that are out there that hold these nationwide networking events. I know they’re all on pause right now. But when they do resume, that’s a great place to go and to meet people face-to-face and learn about what they do.

You can go to your local real estate investment association meetings and to local real estate meetups and meet people that are doing this. So it’s best if you can get to know the people you invest in more than just a single meeting and make sure that they understand your investing goals, as well as you understand who they are and their background and just really get familiar with them. You’re going to be in a relationship for the next three to seven years and you want it to be a successful relationship. So spend some time developing that relationship and making sure that you’re comfortable before you move it forward.

Kent Ritter:

Yeah, that’s fantastic advice. So you told us about the website, but what’s the name of the book?

Kim Lisa Taylor:

How to Legally Raise Private Money. And you can get a free copy of it at our website at syndicationattorneys.com. There’s a tab there that says get the book, or you can buy it on Amazon.

Kent Ritter:

Oh, fantastic. It sounds like it’s well worth it, well worth it. I think what we’ve proven today, once again, is that passive investing is anything but passive. If you want to do it the right way, it takes work, it takes commitment. I agree with you, you need to be out networking to find deal sponsors and get to know them before you invest. And you need to do your due diligence going into it, not just on the deal underwriting, but on the legal structure, how they’ve set it up and make sure that they’re following the right steps and the right processes to make sure that the deal doesn’t become a risk at some point. So we’ve got to be educating ourselves as passive investors and making sure that we’re putting the hard work in too. Thank you, Kim, so much for your time. Really appreciate all the value you brought here. It’s been just jam packed with info. So thank you so much again.

Kim Lisa Taylor:

Oh, thank you so much, Kent. It’s been a pleasure.

Kent Ritter:

Yeah. And everybody listening, I want you to take two minutes and go subscribe to the podcast right in the app right now, because if you do that in may and you send me an email at info@ritteronrealestate.com, you’re going to receive some powerful content. In support of the show, Joe Fairless, Gino Barbaro of Jake & Gino, Dan Handford of passiveinvesting.com, Hunter Thompson of Asym Capital, and John Kasman of Kasman Capital and actually Kim Lisa Taylor here has offered as well to provide some fantastic content to share with you. So they’re each providing a piece of content in support of the show. All you have to do to receive this package is go and subscribe to the podcast in may, and again, send an email to info@ritteronrealestate.com. So don’t miss out. With that, thank you, Kim, so much. And I hope to talk again soon. Bye.

Kim Lisa Taylor:

Okay, bye.

Kent Ritter:

Thanks for listening to another great episode of Ritter on Real Estate. Hit the “Subscribe” button to make sure you don’t miss out on the content that will make you a better investor. Also, visit kentritter.com for articles, videos, and tools curated just for passive investors. Until next time, this is Kent Ritter with Ritter on Real Estate. Now, go out and invest like a pro.