For the last two-plus decades, investing in stocks and ETFs has been very straightforward.
Gone are the days where you’d pick up the phone, call your stock broker, and have them place a buy or sell order for you. Discount / self-service brokerages, like Fidelity and Schwab, brought the broker to your keyboard, allowing you to buy or sell stocks with a couple mouse clicks.
I’d wager that most reading this have bought or sold a stock, mutual fund, or ETFs using a discount broker. The process is simple, easy, fast. Most importantly, it’s known. You know how to do it. There’s no fear of the unknown.
But if you’ve never invested in a syndication or other private placement, the same can’t be said.
It’s something new, filled with long legal documents, terms you’ve never heard before, and minimum investment amounts larger than you’re used to. Like anything new, it’s initially outside of your comfort zone.
Recently I’ve talked with several investors who are new to syndications that expressed hesitation at investing because of the increased complexity as compared to buying a stock or an ETF.
So today, I want to shine a quick light on the process and the documents involved, and remove any “fear of the unknown” for new investors.
What You’re Really Investing In
When you invest in a real estate syndication, you purchase an ownership interest in an entity (usually an LLC) that will directly own real estate or will own other entities that directly own real estate. Your name will not appear on the deed of the property. The entity owns the property, and you are a part owner of the entity, along with the other passive investors/LPs and the sponsors/GPs.
The Process and Documents
Quick note: this is a high-level overview. The exact process will vary from sponsor to sponsor.
1. Raise Your Hand (Soft Commit)
You need to let the sponsor know you’re interested in investing so that they can plan for your investment and provide you with all the necessary legal documents. The sponsor will explain how to do this (use their online portal, send an email, call them, etc.) in the investment’s promotional material.
2. Review & Sign the Investment’s Legal Docs
The sponsor will provide you with several documents to review and sign. At a minimum, they should include:
A) Private Placement Memorandum (PPM)
The PPM is one of the most important documents in a real estate syndication. In addition to an overview of the investment opportunity, it includes the investment’s risk factors, the painfully detailed information about the potential risks involved in the investment. This section is crucial as it helps you understand what could go wrong and how those risks are potentially mitigated.
The PPM can look scary since it describes a myriad of ways you could lose your money, but don’t be put off by it. All investing involves risk, and the PPM is designed to ensure you are aware of the investment-specific risks before investing.
The PPM is primarily a disclosure document and doesn’t require a signature, though some sponsors may ask you to sign or initial as acknowledgement that you read it.
B) LLC Operating Agreement (OA)
The investment entity’s Operating Agreement outlines the roles, responsibilities, and legal rights of all parties involved, including both the investors and sponsors. Key components of the Operating Agreement include:
Management Structure: Details about who will manage the investment and how decisions will be made.
Distribution of Profits: Information on how cash flow will be distributed among investors and sponsors.
Member’s Rights: The legal rights, including voting rights, of all members (investors and sponsors). The management rights of the investors are usually very limited (hence, limited partners), as the sponsors are expected to fully manage the investment.
The OA ensures that everyone understands their duties and what to expect throughout the investment period. You will be required to sign the OA to become a member (LLC parlance for “owner”) of the entity.
C) Subscription Agreement (SA)
The Subscription Agreement is the document you will sign to officially commit to the investment. It includes:
Investor Information: Your personal details and accreditation status (i.e., whether you meet the SEC’s requirements of an “accredited investor”).
Investment Amount: The amount of money you are investing in the syndication.
Acknowledgement of Risks: A section where you acknowledge that you understand the risks involved in the investment.
By signing the Subscription Agreement, you formally agree to the terms outlined in the PPM and OA. It’s common for the docs to be set up such that your signature on the Subscription Agreement constitutes your signature on the Operating Agreement.
3. Fund Your Investment
Typically, the sponsor will let you know when they’ve reviewed your signed documents and whether or not you have been officially admitted as an LP to the investment.
Once your subscription has been accepted, the final step is to transfer your investment funds to the sponsor. The sponsor will provide you with detailed instructions, but this is usually done via wire transfer or ACH.
That’s It!
Not so crazy, huh? Sure, it’s more involved than buying shares of GameStop in your Robinhood account, but it’s definitely not something to be afraid of.
And most sponsors today are using web-based portals to facilitate the entire process, so it’s truly easier than it’s ever been. No more printing, signing, and Fedex’ing physical documents across the country.