Real estate speculation is a risky business. Mitigating that risk through a comprehensive understanding of pricing, market conditions and trends, zoning and land use issues, city process, and construction costs is essential. For the real estate syndication cycle to end with profitable results, acquiring the asset for the right price is not nearly as important as understanding how to run a proper cost analysis and pro forma.
There are many ways to structure syndicated or crowdfunded real estate deals and partnerships. There’s donation based, debt, equity participations, and crowdfunding opportunities. Sponsors can make their money in a variety of ways and choose to offer a variety of different returns. To avoid mistakes, make sure the deal structure is well thought-out, competitive, framed, and marketed in an appealing way that your target investors will understand.
As we said, real estate speculation is risky, but that’s largely from an investment standpoint. Syndication is even riskier because it adds an additional layer of liability risk – from investors and government authorities. Both investor rights attorneys and government regulators have the ability to cripple an investment syndicate and cause sponsors to incur personal liability, in some cases.
With any group investment where there are both active and passive investors, sponsors should be thinking about Regulation A, D and A+ filings and other variations. There are also state Blue Sky laws and, in California, Section 25102(f) notices and exemptions. If self-directed IRAs are being used, sponsors must think about and address ERISA issues in their offerings and private placements. This can be a really dangerous game to play if you don’t know what you’re doing. For that reason, having solid legal counsel with experience in these areas can help you avoid some of the major pitfalls associated with syndication and structure your ask and raise correctly.
Each round of financing requires thought and the foresight to anticipate investor questions and concerns. If you are raising too much money, you probably aren’t saving enough equity for later rounds, which might cause negative dilution and a reduced profit margin for investors. If you raise too little, you have to make a capital call or open another round, which can upset investors and throw off your pro forma. Still, it is far better to have too much than to go back to your investors to ask for more cash at a later point. There can be a lot of additional costs involved in syndicating real estate deals. Especially if you don’t have a solid business plan. These costs can range from legal work, research, and marketing to staffing, servicing investor clients, payment processing fees, accounting, property renovations, city fees, and more. The last thing you want after you’ve done all the work and raised the money is to realize those costs mean that you can’t deliver on your promise to your investors.
Without the right legal documents, such as partnership agreements, operating agreements, PPMs, subscription agreements, internal policies and procedures, etc., and without ongoing general counsel, you miss the opportunity to address, in advance, problems created by external forces, including management problems, sponsor bankruptcies, investor lawsuits, and marital dissolutions. The urge may be to present to investors a more attractive pro forma by significantly reducing your budget for legal services, but that is a mistake. Mature projections always include sufficient legal budgets that account not only for initial organization, but ongoing counsel in an effort to mitigate the damage caused by such external forces.