How to Keep Yourself Out of Jail: Legal Compliance in Syndications
10/17/23 • 23 min
What are some of the biggest items that syndicators need to keep in mind? How to raise a fund yourself under your company name? Mauricio Rauld , real estate syndication attorney of Premier Law Group and host of real estate syndicator live, shares his knowledge.
Read this episode here: https://tinyurl.com/yvk4k4e3
What are some of the biggest items that syndicators need to keep in mind that are easily forgotten?
Understand that you are in the business of selling securities, because a lot of times, especially new real estate syndicators, they don't quite understand that. I'm just buying real estate, why do I have to worry about the Securities and Exchange Commission or the SEC? I'm just getting a couple of my friends and we're going to go buy a single family home, or buy this building, why do we have to worry about all this stuff? People think of SEC as the stock market, stocks, bonds, mutual funds, etc but it is much broadly than that. TIC agreements, joint ventures, profit sharing agreements and promissory notes are potentially securities, I always joke that high fives and handshakes are securities but the structure itself doesn't matter. People try and get creative such as I'm going to structure it this way or that way, or it's just a loan, it's just my dad, but the reality is the SEC doesn't care about any of that, all they care about is whether you are raising money, where the returns are generated by your efforts. If you're raising money, and you're doing all the work, or you and your co-sponsors are doing all the work, and you have passive investors who are writing you a check, it doesn't matter how you structure it, and how creative you get structuring it, it's going to be a security and that's something that newbies forget.
What would be a way to go around that, would it be to raise a fund yourself under your company name, and then invest in that deal if you don't want to participate fully on the operations side or other things?
In order for somebody to come into the syndication group as a legitimate co-sponsor and bringing in some capital, there are three things they need to fit into because there's an exemption. The general rule is you need a broker dealer license, but we can find an exemption to registration and that would be what we call the issuer exemption which requires three things and most of these deals don't follow. Number one is no transaction-based compensation. This happens a lot, you have to be willing to say, I'm going to give you 10% of the GP even if you don't bring a single dime. I know you promised that you thought you were going bring a half a million dollars from your investors and it turns out, you aren't able to bring any, you still have to get that 5% or 10% because you're giving that person that percentage, not for raising money, but for other things they should be doing like any other syndicator: due diligence, underwriting, asset management and all these little ton of things otherwise it's transaction-based compensation. Your primary role needs to be those substantial duties, it can't be raising capital and you have to show that you're doing more than that. If you're a real syndicator, you have two or three partners, you're part of the team, and you're all working hard to make this deal work, then you're going to fit into that exemption.
Do funds pay an interest until they allocate all of the funds, is that optional?
That's the beauty of syndications in general and certainly with funds, you can be as creative as you want to be. I would usually recommend not making it super complicated, because then you start losing investors. Some people decide to give a flat fee, almost like a coupon rate.
What are some of the biggest items that syndicators need to keep in mind? How to raise a fund yourself under your company name? Mauricio Rauld , real estate syndication attorney of Premier Law Group and host of real estate syndicator live, shares his knowledge.
Read this episode here: https://tinyurl.com/yvk4k4e3
What are some of the biggest items that syndicators need to keep in mind that are easily forgotten?
Understand that you are in the business of selling securities, because a lot of times, especially new real estate syndicators, they don't quite understand that. I'm just buying real estate, why do I have to worry about the Securities and Exchange Commission or the SEC? I'm just getting a couple of my friends and we're going to go buy a single family home, or buy this building, why do we have to worry about all this stuff? People think of SEC as the stock market, stocks, bonds, mutual funds, etc but it is much broadly than that. TIC agreements, joint ventures, profit sharing agreements and promissory notes are potentially securities, I always joke that high fives and handshakes are securities but the structure itself doesn't matter. People try and get creative such as I'm going to structure it this way or that way, or it's just a loan, it's just my dad, but the reality is the SEC doesn't care about any of that, all they care about is whether you are raising money, where the returns are generated by your efforts. If you're raising money, and you're doing all the work, or you and your co-sponsors are doing all the work, and you have passive investors who are writing you a check, it doesn't matter how you structure it, and how creative you get structuring it, it's going to be a security and that's something that newbies forget.
What would be a way to go around that, would it be to raise a fund yourself under your company name, and then invest in that deal if you don't want to participate fully on the operations side or other things?
In order for somebody to come into the syndication group as a legitimate co-sponsor and bringing in some capital, there are three things they need to fit into because there's an exemption. The general rule is you need a broker dealer license, but we can find an exemption to registration and that would be what we call the issuer exemption which requires three things and most of these deals don't follow. Number one is no transaction-based compensation. This happens a lot, you have to be willing to say, I'm going to give you 10% of the GP even if you don't bring a single dime. I know you promised that you thought you were going bring a half a million dollars from your investors and it turns out, you aren't able to bring any, you still have to get that 5% or 10% because you're giving that person that percentage, not for raising money, but for other things they should be doing like any other syndicator: due diligence, underwriting, asset management and all these little ton of things otherwise it's transaction-based compensation. Your primary role needs to be those substantial duties, it can't be raising capital and you have to show that you're doing more than that. If you're a real syndicator, you have two or three partners, you're part of the team, and you're all working hard to make this deal work, then you're going to fit into that exemption.
Do funds pay an interest until they allocate all of the funds, is that optional?
That's the beauty of syndications in general and certainly with funds, you can be as creative as you want to be. I would usually recommend not making it super complicated, because then you start losing investors. Some people decide to give a flat fee, almost like a coupon rate.
Previous Episode
Family Offices: What Do They Look For in an Investment?
What do family offices look for in a deal? How do they manage their investments, are they risk takers or not? How are they evaluating deals in today's market? Irwin Boris is responsible for Acquisitions & Asset Management at Peykar Capital, he has 25+ years of hands-on FP&A, due diligence, and operations experience.
Read this entire interview here: https://tinyurl.com/4ycychye
How were you evaluating deals when the market was hot and extremely competitive? How has that changed today?
We stopped doing multifamily early, about four or five years ago, and we sold a bunch, we only hold one multifamily project that I'm involved with right now. People call to buy it every day of the week. I say, I got six years left on my mortgage, we only have renovated half the units, I really don't care, if make me a stupid offer, and we'll consider selling it because I have no place to put the money. We don't really care about it. I've been doing industrial for many years, it's a cap rate play. What's the spread between your going in, your current cash flow, and your cost to finance? If I could buy on a 9.5 cap, I could finance on a 7.5% and then get 65% leverage with some interest only, I could probably get 8.5 or 9% current out of the deal, after closing costs. That's really what I look at, if you can't do it on a cocktail napkin, don't do the deal.
What are some of your hardest deals and lessons learned?
There are always deals that die in due diligence. Hopefully, they die earlier than later because you have out-of-pocket costs. We have one deal that we really liked that was upstate New York, in the vicinity of Ithaca College, it sat on a lot of excess land that was zoned for industrial or multifamily, whatever I wanted to build there. Basically, the land was free, it was a covered land play with a lot of excess land where the current ownership had already gone through the PUD approval with the municipality. I just needed a site plan.
In the middle of due diligence, the seller told me that their major tenant called them and said that they don't need all the space, they want to renegotiate the lease and give back 20% of the space. I said I don't want to deal with this now. And then the lender's appraiser found that was a sublet listing on Costar for the space. Unfortunately for the sellers, who were all in their late 70s and early 80s, they've owned this for quite some time, they asked me, what do we do? I said, you really don't have a choice but to renegotiate their lease now and ask them for another five or seven years before their options because three years from now, when they are up for renewals, they got you, and they'll tell you what they're going to pay. Here, you still have a little bit of strength. They ended up taking my advice, and they took back the idea, they brought down the rent a little bit, and they have seven years left before five-year options. But unfortunately, based on the revised income, I couldn't stand behind the price anymore.
There's always going to be deals in due diligence that die in due diligence. And there's no way to flush those out in advance. One thing I do with commercial buildings is I like to get the 10 largest tenants on the telephone and interview them. How's business? How many people? What are you doing? Are you back in the office? Are you still remote? How's the square footage working out for you? You flush a lot of these things out when you have those interviews. Don't just rely on an engineering report, an appraisal, and the financials because the tenants are going to tell what you the future of the building will be after the close.
Join our investing club here: https://montecarlorei.com/investors
Next Episode
How Should You Do a Capital Call to Your Investors?
How to approach doing a capital call to your investors? And on the other hand, how should investors decide to give more money for a deal that is in trouble? Mauricio Rauld, securities attorney of Premier Law Group and host of Real Estate Syndicator Live, shares his knowledge.
Read this entire interview here: https://tinyurl.com/3mz7t22h
A lot of people are in trouble, interest rates have doubled, insurance has doubled in many states, and some people have to do capital calls, how would you approach doing a capital call? And from an investor's perspective, how would you choose to participate in it or not?
The first thing we typically advise clients is from my buddy, Ken McElroy, when things aren't going well and things are starting to not go according to plan because lack of cash flows don't happen from one day to the next because those things are going to slowly start happening, the key is to make sure that you double down on your communication with your investors. A lot of syndicators, especially new ones, tend to sort of stick their heads in the sand a little bit when things aren't going well, the investor is going to be upset at us, and we should not tell them, if you're communicating once a quarter and things aren't going well, start communicating once a month or once a week or every day, depending on how severe things are. That way, when it's time to do the cash call, it's not a complete shocker, you've slowly been showing what's going on, it's been a tough environment, we need to refinance, and we can't because the interest rates have gone up and the whatever the situation is. Letting them know earlier will be appreciated by the investors and you’re going to be in a much better situation.
Try to avoid a cash call at the beginning. Usually, if there's the inclining of issues that happen, let's say, rents or revenues down because of whatever reason, then, the first line will be the syndicator. They'll make a loan to the company, they'll make a capital contribution to the project: 1) to show faith that they're confident in the project, 2) the cash call is the last thing you want to do.
For both syndicators and for investors, as you want to look at the operating agreement. If you need $500k, you probably want to ask for $750k. There are a lot of funds out there that are really targeting they might come in and say, look, I know you need 500, I'm going to give you the 500 or I'll give you a million, but then they insert themselves way ahead of everybody else. Obviously, the bank is going to be number one always, but then they're going to be second and they're going to have their money out before any of the LP money comes out.
If you like this episode you’ll love
Episode Comments
Generate a badge
Get a badge for your website that links back to this episode
<a href="https://goodpods.com/podcasts/commercial-real-estate-investing-from-a-z-16676/how-to-keep-yourself-out-of-jail-legal-compliance-in-syndications-35035453"> <img src="https://storage.googleapis.com/goodpods-images-bucket/badges/generic-badge-1.svg" alt="listen to how to keep yourself out of jail: legal compliance in syndications on goodpods" style="width: 225px" /> </a>
Copy