The Private Placement Memorandum in Real Estate Syndication

The private placement memorandum is a crucial aspect of due diligence for passive investors who are considering a real estate syndication. However, it can often be overlooked due to fatigue or a lack of understanding of its importance. Despite investors having already examined the investment’s track record, financial statements, and submarket, the PPM can still be overwhelming, with its lengthy legal jargon. Many real estate investors view the PPM as similar to the fine print in stock purchases or a prescription’s potential side effects. What exactly does the PPM entail, and what risks or side effects are associated with it?

This article will delve into the definition and significance of a PPM, as well as its crucial role in the investment process. Additionally, we will outline the key components and information that are typically included in this crucial document.

What is a private placement memorandum?

While an investment summary may feature attractive visuals of various aspects of a property, such as its design, pools, and amenities, the Private Placement Memorandum (PPM) is a factual and comprehensive document that addresses all pertinent aspects of an investment opportunity. It delves into the specific details of the offering and provides a full description of the property. It also outlines the various fees involved, such as the acquisition fee and the property management fee, along with any commissions. Additionally, it clarifies the structure of the deal between the general and limited partners and assesses the risk factors of the investment opportunity. Essentially, the PPM provides all the necessary information for potential investors to make a well-informed decision.

Why is there a private placement memorandum?

A Private Placement Memorandum (PPM) is utilized by businesses that sell securities in private real estate offerings. This includes entities like REITs, real estate investment funds, syndications, and crowdfunding platforms. Although some offerings under Rule 506C of Regulation D may not require a PPM or disclosures to private investors, it is not considered best practice to omit such information. Real estate investors require detailed information to make informed decisions, and a PPM provides a comprehensive description of the investment opportunity, including details about fees, commissions, and the structure of the deal between the general and limited partners.

While it may be legally permissible to forego providing a PPM, businesses that seek to sell securities, especially real estate syndicators, are advised to offer one to their investors. Providing a PPM builds trust with potential investors and reduces the risk of any miscommunications that could lead to legal disputes. Ultimately, offering a PPM demonstrates a commitment to transparency and provides investors with the information they need to make informed investment decisions.

Contents of the Private Placement Memorandum

The structure and format of PPMs are typically consistent, so the information provided here can help prepare you for what to expect.

Introduction

The introduction section of a PPM provides a summary of the team involved and a brief overview of the private placement that investors will be investing their money in.

Investment summary

The investment summary included in a PPM serves a similar purpose as a marketing prospectus, with the exception of the absence of visual aids. It outlines the key aspects of the business plan and property details, and can be considered as an executive summary of the investment opportunity.

Risk Factors

These are the potential risks associated with real estate investments, which are akin to the “side effects” disclosed in prescription medication. Both securities attorneys and general partners are obligated to remind real estate investors of these risks, despite the fact that syndications often focus on recession-resistant assets. While these investments can be rewarding, there is always a chance of financial loss due to factors such as natural disasters, economic downturns, operational incompetence, management issues, increased competition, tenant issues, and tax challenges.

Description of the Company and the Management

The background information section of the PPM provides details about the company, highlighting its extensive experience and expertise in property management. This includes information about team members, their biographies, special skills, and performance history.

Use of Proceeds

At the end of the year, when I pay a significant amount of income tax, I often wonder about the allocation of those funds. Similarly, in a disclosure document, it is essential to provide complete transparency regarding the intended uses of investor funds. These may include capital expenditures, such as a renovation budget, a downpayment for the loan, and fees associated with the offering.

Offering Terms

The offering terms section of the PPM, which is also included in the subscription agreement, provides comprehensive details on the investment opportunity’s structure. It covers the membership interests purchased, projected returns, and the hold period for the investment. This section also includes information about the equity split and delivery of distributions.

Investor Suitability

Depending on the regulations set by the Securities Exchange Commission (SEC), an investment offering may only be accessible to Accredited Investors. However, there are exceptions to this rule. For instance, if it is a 506B offering, “Sophisticated Investors” who possess sufficient knowledge and funds may also participate. Conversely, if it is a 506C offering, only Accredited Investors will be allowed to invest, and their status will need to be verified through a third party, such as a tax professional. In contrast, a 506B offering permits accredited investors to self-accredit by providing their word.

Fees

As previously mentioned, there are costs involved with private placement investments, which may include sponsor fees such as acquisition, asset management, and disposition fees. Apart from that, loan fees and closing costs may also apply.

Description of Securities

In the section on securities, the disclosure document outlines the features of the securities being offered, including their associated rights and limitations such as voting rights, transferability, and liquidity of shares. Additionally, it will provide information on accounting practices and how the company can change its capitalization structure, including capital calls, issuance of additional loans from investors, various classes of shares, distribution of funds, and the conditions for termination.

Subscription Procedures

After reviewing the PPM, you will need to determine the steps to take in investing in the offering. This will involve indicating the amount of shares you intend to purchase and providing funding instructions once you accept the terms of the document.

Timing and Location of Funds

It’s important to know where your large sums of money went after investing $50,000 or $100,000 in a private placement, as it can be a nerve-wracking experience. Therefore, it’s essential to have full disclosure about the location of funds, the duration of time they’ll be held, and the potential consequences if the offering is not fully funded.

Conflicts of Interests

It’s crucial to disclose any potential conflicts of interest that might arise within a partnership. For example, the third-party property management company that you’ve hired to manage the property could have a building of its own down the street, which could potentially compete with your property for tenants. Additionally, one of the general partners may also be a broker who is set to earn a commission on the closing of the property, which could lead to a conflict of interest.

Taxes

The tax section of the PPM provides information on important tax documents, particularly the K1, which investors receive annually.

Other Documents

The exhibits section typically includes the operating agreement, which outlines how the team will manage the investment. It is important to note that investors are required to sign a subscription agreement, which legally binds them to the issuer and acknowledges that they have read the PPM.

Finally, Take the Time to Carefully Review the PPM

In situations like reviewing escrow documents, we are often unfairly rushed to sign contracts without fully understanding the terms. Similarly, when reviewing Private Placement Memorandums (PPMs), investors may feel fatigued after completing their due diligence, which could lead to skimming important documents. However, giving oneself ample time to review the PPM and starting the due diligence process early could help combat fatigue.

Investors should start the due diligence process early to get a jump on the competition because these offerings are limited and fill quickly. Once they conclude that the investment opportunity is promising, investors can place their soft commitment, give themselves a little break, and then dive into the details of the PPM with a fresh and rested mind.

While entering into a private placement may help an investor’s financial situation, they may encounter scary language like “you may lose all your money!” However, investors should not be too frightened. Nobody wants to be liable, so they include such language in bold print to ensure that investors understand the risks involved. It is better to read such language upfront than to miss important details when buying stocks or real estate.

Consider joining the Onbridge Capital to explore upcoming opportunities and enjoy the benefits of real estate without the complexities and difficulties of being a landlord.