What To Look For in a Private Placement Memorandum
You’ve vetted the sponsor, market and property, pored over financial statements and investment summary, and attended the webinar. After spending hours doing your research, you’ve decided on the real estate opportunity you want to invest in. You’re ready to pull the trigger.
And then you’re handed the private placement memorandum (PPM).
Your head starts spinning from the 100+ pages of dense legal jargon. Memories of first-year of medical school start creeping in, when you felt like you were drinking out of a firehose learning all the new medical talk.
Now you start second-guessing yourself as to whether you should proceed with the investment.
Fear not. If you’ve gotten all the way to reviewing the PPM, you likely know alot about the investment already. In this article, we’ll discuss what to look for when reviewing a PPM and what each section of the document means for you as a passive investor.
What is a Private Placement Memorandum?
The private placement memorandum (PPM) is a detailed legal document describing the terms and condition of the investment offering. The document provides full disclosure on every topic you need to know before investing capital into a deal.
The PPM is like the paper insert that comes with medications listing all the potential side effects (which, to be honest, I hardly ever read). Or think of the PPM like the informed consent we give to patients to read and sign before they proceed with a procedure.
The information provided inside the PPM allows investors to conduct due diligence on the sponsor team, management team, the asset, the market, and to learn about the potential risks of the deal. To put it succinctly, the PPM should include all the information you need to make an investment decision.
What is in a Private Placement Memorandum
The specific contents of the PPM vary by transaction, but they typically include the following sections:
-Disclaimers
-Investment/Executive Summary
-Investor Suitability
-Overview of the Company
-Offering Terms
-Fees
-Sponsor, Property Manager and Key Personnel
-Risk Factors
-Use of Proceeds
-Distributions To Members
-Tax Matters
-Conflicts of Interest
-Subscription Procedures
-Exhibits
Now let’s look at what’s inside each section of the PPM and what you should look for as a passive investor.
Disclaimers
In this section, you’ll find the disclaimers and disclosures. The purpose of this section is to inform you that the investment involves risk, and that you can lose some or all of your invested capital.
Some key disclaimers you might come across are:
-An investor suitability statement which states something like: “This investment is only suitable for investors with the appropriate risk tolerance and time horizon.”
-The document contains forward-looking statements that should not be relied upon as an indicator of investment performance, and that actual performance can vary from the proforma.
-The securities are not registered with regulators and are offered under an exemption.
-No legal, tax, or business advice is being offered.
Investment/Executive Summary
This section provides details regarding the property and highlights other critical details about the offering.
Investor Suitability
In this section, you’ll know if the investment allows sophisticated or only accredited investors.
Regulation D 506 exemptions control who can invest in the project.
With Rule 506c, the investment is only open to accredited investors
Under Rule 506b, the project is open to accredited investors and up to 35 sophisticated investors. Sophisticated investors must have a pre-existing relationship with the sponsor.
Overview of the Company
The section contains the company’s background information, listing its experience, team members’ biographies, skills and performance history. You can glean how much market knowledge and experience your sponsor may have in private real estate deals similar to the one you’re considering.
Offering Terms
The term sheet outlines essential information such as the number of shares being offered, the price for each share and the required minimum investment. This section will also describe expected returns, anticipated length of the investment term, how equity will be divided and how dividends will be distributed.
Fees
This section outlines the fees associated with the offering. Sponsors do not work for free and they often charge fees to support their efforts in finding, underwriting, financing and managing the real estate investment.
Common fees associated with a real estate syndication are the acquisition fee, asset management fee, construction management fee, loan fee, refinance fee, and disposition fee. You should carefully review the fee structure as part of your due diligence process and compare it to other opportunities.
Sponsor, Property Manager and Key Personnel
This section outlines the sponsor, management company and other key personnel who will be in charge of day-to-day operations, and notes their experience and qualifications. You want to make sure the team has solid real estate experience in the particular asset class and in the particular market.
Risk Factors
The purpose of this section is to disclose all of the potential risks associated with investing in the deal. Examples risks include tenant concerns, local market, economic conditions, the asset type, regulatory changes, competition and financing.
The following are some examples of potential risks:
-Market risk: rental rates and/or cap rates can change, impacting the property’s value.
-Credit risk: tenants could stop making rent payments.
-Financing risk: sponsor may not be able to obtain the necessary financing at acquisition or during refinancing.
-Liquidity risk: the property may not sell at all or may not sell for the desired price.
Use of Proceeds
The use of proceeds section explains exactly how the raised capital will be used. Examples include capital expenditures (renovations), downpayment for the loan, and fees.
Distributions To Members
This section will tell the investor whether there are any sort of redemption options and if the securities can be transferred at any point. There will be information about the hold period, any refinance expectations, and when/how you can expect to receive distributions and sale profits.
Taxes
The tax section explains the documents you can anticipate to receive on a yearly basis, most notably the K1 tax document. Other tax issues addressed include depreciation, rates and deadlines.
Conflicts of Interest
Any potential conflicts of interest with the investors are disclosed. For example, one of the general partners is a broker who receives a commission when the property closes.
Subscription Procedures
This section describes how to invest in the offering. Once you agree to the terms of the PPM, you sign the agreement and indicate the number of shares you want to purchase. You will then wire funds.
Exhibits
The exhibits section contains any supplemental information and documents that are helpful in understanding the deal. The exhibits could include proformas, copies of investment contracts, copies of leases, business plans, and organizational charts of the company.
Conclusion
The PPM is a required document that must accompany every private real estate offering. So it’s important for you to understand what it is, why it’s important, and how to understand the information in it. Understanding the different sections of a PPM and how to read them will set you up for success in investing in real estate syndications.
If you have any questions regarding the fundamentals of real estate syndication investments or about the private placement memoranda, please contact us.
