Suppose you’ve found a smoking-hot real estate investment opportunity but you don’t have the necessary funds outright? Don’t procrastinate; syndicate! But by all means, make sure you use professional help – because do-it-yourself (DIY) syndication can be more dangerous than you could imagine. In this article, we’ll look at 13 dangers of DIY real estate syndication.
Real estate syndication—pooling your money with other investors for the purpose of acquiring, operating and disposing of real estate for profit—is not difficult, but it does require the help of experts, as you are now in the realm of securities. Any misstep could be very costly—both to you and those who choose to invest in your syndication deal.
It’s best to turn for help to an attorney who specializes in this area and who can ensure that you adhere to the many laws and regulations that come into play.
13 Dangers of DIY Real Estate Syndication
- Improperly Structuring (thereby Losing) Syndicator Compensation: A competent securities attorney will help you structure your offering with respect to how you and your investors get paid. You may overlook opportunities for syndicator compensation via acceptable fees and/or distributions if you don’t have competent securities advice.
- Failing to Make the Required Filings: The offering documents aren’t the only thing required of a securities offering. Notice of your offering must be filed with federal and/or state agencies within specific time frames (usually 14 days from an offer or sale of a security to an investor) or any exemptions that would otherwise be applicable could be lost, and you could be accused of selling unregistered securities by either the SEC, the state securities agencies, or both. Yikes!
- Selecting the Wrong Exemption: There are a variety of federal and state securities exemptions that may be applicable to your offering. And without advice of counsel you may be selecting an exemption that is inappropriate, too restrictive or overly burdensome.
- Not Following the Rules Specific to Each Exemption (Which Could Result in Civil & Criminal Prosecution): In addition to the offering documents and notice filings, there are specific rules that must be followed for any exemption to be applicable, particularly with respect to solicitation of the opportunity and suitability standards for your investors, etc. Failure to follow the specific rules of the exemption you are claiming may allow the investors an extended right of rescission, which they or a regulatory agency could invoke at any time. In this event, you might have only have 30 days to give everyone their money back! Failure to comply could result in civil fines or possibly criminal penalties.
- Selecting the Wrong Entity/Jurisdiction: Selection of jurisdiction for an offering is an important consideration, and doing this incorrectly could require revising your filing documents and/or registering your offering in multiple states with potentially burdensome legal compliance and tax consequences.
- Running Afoul of Tax Requirements: There may be huge tax implications for you and your investors if you use the wrong entity or legal structure; i.e., member-managed vs. manager-managed LLC; or using a corporation versus an LLC. The value of any ownership interest a syndicator takes in exchange for managing the syndication may be wholly taxable in the first year if you don’t set it up right!
- Practicing Law Without a License: The unauthorized practice of law is defined as drafting legal documents that define the rights and duties of people other than yourself. Just as you can sell your own house without a real estate license, you can draft your own will or represent yourself in court. But if others will be signing legal documents that you prepare, you are practicing law without a license and could be prosecuted. In many jurisdictions, the unauthorized practice of law is a criminal offense. Attorneys are prohibited from assisting non-attorneys with the unauthorized practice of law.
- Misleading or Conflicting Documents: You may inadvertently make statements about your offering or the property that are misleading. And that could subject you to personal and perhaps criminal liability if such representations turn out to be false. An attorney should help you guard against making such statements.
- Improper or Incomplete Disclosure: You may inadvertently fail to advise potential investors of risks associated with your offering. Doing so could subject you to continuing liability for the duration of your offering. An attorney will help you identify all of the direct and indirect risks of your offering, including some that you might overlook on your own.
- Legal Fees are Reimbursable: Legal fees for the formation of a syndication are reimbursable to the investor once the minimum offering amount has been raised. Consider your investment in competent securities counsel to be an insurance policy that will protect YOU and will be reimbursed by your investors.
- Hiring the Wrong Attorney Can Cost You More Than Hiring the Right One: Make sure the attorney you’ve hired is experienced in real estate syndication. Ask how many offerings the firm has done in the recent past and whether it has the correct insurance to cover securities offerings, which is one of the highest premiums an attorney can pay. There’s a reason for that.
- Litigation Costs Far Exceed Costs of Proper Syndication: Undoing or fixing an incorrectly structured or noncompliant offering will cost you many times more in legal fees than it would have cost you to hire a competent securities attorney to help you do it right in the first place.
- You Can’t Be Indemnified for Securities Violations: No limited liability entity can protect you from violations of the law. And as a matter of public policy, a syndicator cannot be indemnified by the syndication for securities violations.
Drafting your own syndication documents without an attorney is bound to cost more in the long run than hiring one to assist you with the proper structure and appropriate exemption in the first place. Failure to do so may place your personal assets at risk.
Would YOU pack your own parachute without the assistance of a qualified professional?
NOTE: This information is of a general, educational nature and may not be construed as legal advice pertaining to your specific offering, exemption or situation. Any such advice must be sought from your own attorney pursuant to an attorney-client relationship, after consideration of your specific facts or questions. At Syndication Attorneys, PLLC, we will be happy to discuss your investing goals with you. You can schedule a free, 30-minute consultation by clicking this link.