One of the most lucrative ways to obtain easy passive income is to pool funds with other investors to buy income-producing real estate. This simple and effective strategy is called real estate syndication.
The limited partners take most of the risk investing cash, but the syndicators run the entire operation. The job of a syndicator comprises many duties, including finding research, acquisition, management, refinancing, and filing.
The person who makes this entire process easier is a real estate syndication attorney. Property syndication doesn’t have to involve a qualified legal advisor, but as we’ll see, there are many reasons why that might be the right move.
What is a Real Estate Syndication Attorney?
Doing your legal due diligence is crucial when you’re using other people’s money to buy property. A real estate syndication attorney is there to help the syndicator with everything involving the law along the way.
They can provide appropriate guidance for syndication structure and advise which type of entities (LLCs or Corporations) would be ideal in a specific syndication. They can also assist with putting the deal together for the investors.
But most importantly, real estate syndication attorneys can help the syndicator comply with all the relevant securities laws. Keep in mind that securities lawyers operate under federal laws and should be licensed to work in any state.
When you’re researching a potential candidate, make sure to ask about their licenses. You should also make sure to hire an attorney who does this type of work regularly and knows all the crucial details.
Furthermore, your real estate syndication attorney should give you practical and reliable legal advice on approaching potential investors and dividing the profits among them. But there are other vital services they can provide.
They Can Help With Tax Negotiations
One of the reasons real estate syndications are so necessary to investors is all the potential tax benefits. The investors have the advantage of an accelerated rate of claiming depreciation because they’ll own the property for between 5 and 10 years before selling.
There’s also the lower capital gains tax rate, obtain the best mortgage interest deduction rate, and help you compensate for the lack of self-employment tax. Your real estate syndication lawyer should know about these and other tax implications and offer their expertise to provide you with the best-case scenario.
Also, since the more property the syndication invests in, the more taxes they’ll have to pay each year. A real estate syndication attorney should make sure you don’t pay a dime more than you should.
They Can Help Minimize Risk and Maximize Profits
Your real estate syndication attorney can help you set goals for a specific real estate project. Depending on their level of involvement, they can assist the syndicator in buying or selling real estate at the best possible price and develop the best strategy for profit return.
They can also make sure you’re taking the lowest possible financial risk and obtaining the highest return in the long run from a legal perspective.
They Can Guide You Through Tenant Rights
Many real estate syndications buy residential or commercial property intended for leasing. These arrangements can be highly lucrative, and if they are managed properly, they can be a resilient investment, even during a global economic downturn.
By providing their expertise on tenant rights, the real estate syndication attorney can inform you of all the relevant implications of this agreement. They can review all leasing terms and suggest valuable strategies the syndication should consider.
Finally, they can use their experience and knowledge to minimize potential disputes between tenants and landlords and mitigate fair housing complaints.
They Can Prepare You for Unforeseen Circumstances
Every savvy syndicator knows that real estate syndications are not without risk. Sometimes syndicators get in trouble with debt. Or an environmental accident can jeopardize the property.
There is a lot that can go wrong, which can result in lawsuits. An experienced real estate syndication attorney is there to give you legal advice and defend your capital and property.
When to Hire a Real Estate Syndication Attorney
Ideally, you should hire a real estate syndication lawyer as soon as you receive a letter of intent. This document outlines the main terms of the commitment between the general and limited partners in syndication.
Your attorney can take it from there. They can start drafting the required offering documents and work on a strategy for the deal. However, you can hire a property syndication lawyer at any point in the process if you feel like you’re dealing with matters that require professional legal advice.
Choose a Regulation D Exemption – 506(b) or 506(c)
The Securities Act of 1933 is a groundbreaking piece of legislation that regulates the stock market. Up until that point, syndicators or sponsors (then called promotors) were allowed to promise outrageous returns on investment, which sometimes never materialized.
It’s partly the reason the country went into the Great Depression, which brought long-lasting consequences. The Securities Act made it necessary for anyone selling securities, including real estate, to disclose all the risks involved, allowing the investor to make an informed decision.
Every security must be registered with the Securities and Exchange Commission (SEC), which acts as a regulatory body.
However, under Regulation D of the Securities Act, there are certain exemptions that allow syndicators to sell securities without going through SEC registration.
These rules – 506(b) and 506(c,) – have plenty of features in common. They’re both designed to make raising capital for investors easier by avoiding stringent requirements.
After all, going public with Initial Public Offering (IPO) is an impossible task for most companies, as they typically need to be valued at over $1 billion.
But the rules are also different in a few relevant ways. In structuring a real estate syndication deal, investors and syndicators much decide whether to choose 506(b) or 506(c) Regulation D exemption.
More About Rule 506(b)
Exemption 506(b) was created first and was developed simultaneously with Regulation D. It allowed investors to gather funds via a private offering for the first time. This rule alone has made it possible for many business owners to participate in the real estate industry.
The most critical element of this exemption is that it allows investors to raise an unlimited amount of money. However, while the number of accredited investors is unlimited, only 35 non-accredited investors can participate in the fundraising.
Again, none of the collected capital needs to be registered with the SEC, nor is there an approval timeline. However, one of the significant downsides of rule 506(b) is that it prohibits solicitation. Essentially, that means anyone who wants to sell real estate securities under this rule can do so with people they already know and have with whom they have an established connection.
The security issuers can’t advertise to people they don’t know and who aren’t familiar with this private offering. Also, the syndicator needs to prove that the 35 non-accredited participants are familiar with the process. That means they must have knowledge of real estate investing and preferably have experience in similar endeavors.
Also, disclosures don’t have to be given to accredited investors, but if they are, the same must be delivered to the non-accredited investors.
Finally, under rule 506(b), the syndicator must file Form D with the SEC within 15 business days of the first securities sale. When all the capital has been raised and the private offering is completed, the real estate syndication doesn’t have to file anything with the SEC.
More About Rule 506(c)
As mentioned, exemption 506(c) has numerous similarities to exemption 506(b.) But that is because rule 506(c) is essentially an extension designed by 2012, the Jumpstart Our Business Startups Act (JOBS Act.)
This regulatory alteration has fundamentally transformed real estate equity crowdfunding and syndication and has made it even easier for real estate investors to raise capital. The main difference in rule 506(c) is that businesses were not allowed to solicit investors and advertise their projects to anyone.
However, this exemption prevents the participation of non-accredited investors completely. Securities issuers are still permitted to raise unlimited amounts of capital, but only through accredited investors.
Another important change is that the issuers are in charge of verifying the status of accredited investors under this rule (under 506(b,) the investors had to self-verify). Form D also needs to be submitted within 15 business days of the first securities being sold.
Which Regulation D Exemption Should You Choose?
For many real estate syndicators, this might be a tricky decision to make. Usually, the determining factor is whether there are enough people in their network and whether they have permission for general solicitation.
Often, people choose to go with the exemption 506(b) for the first round of the first deal and later switch to 506(c) for the second round of raising capital.
But more importantly, this is a question your real estate syndication attorney should answer. They should be able to present all the facts about both Regulation D exemptions, consider your situation, and help you reach the best possible decision.
Strategize Accredited Investors vs. Non-Accredited Investors
We have already touched on the concepts of accredited and non-accredited investors in the context of Regulation D exemptions.
However, in the process of structuring your private offering, it’s vital to review and strategize on what type of investors are the right choice for you. Your real estate syndication attorney should go through all the criteria for both types of investors with you and see which type works best.
Accredited Investor Defined
Since an accredited investor is the only type allowed under both Regulation D exemptions, let’s take a closer look at them.
There are two main criteria, and an accredited investor must meet at least one. They need to have at least $1 million in net worth – without counting the primary residence – or they must have a $200,000 in income in the last two years. For married couples, that amount comes out to $300,000.
Remember that an accredited investor doesn’t have to meet both criteria. Depending on the type of investment pursued, the accredited investor will either need to verify their status by themselves or submit the appropriate paperwork.
Non-Accredited Investors Defined
As the name implies, the non-accredited doesn’t meet either of the above-mentioned criteria for accreditation.
The fact that accredited investors are primarily people and companies with more capital puts them at an advantage compared to others who want to invest but don’t have the same earnings.
However, under rule 506(b,) there’s room for 35 non-accredited investors for each private offering. So, if you have a net worth under $1 million and earn less than $200,000 annually, you can still participate in the process.
It’s important to point out that non-accredited investors make up the majority of real estate investors, given that real estate investing is vast and diverse.
However, there is an important reason why the SEC limits the number of non-accredited investors to 35. This decision is designed to protect these investors from potential losses that can hurt them financially.
As mentioned, it’s implied that the non-accredited investors are sophisticated participants and understand the risks involved with the investment they’re making. Your real estate syndications attorney can help you vet potential non-accredited investors to ensure the best possible outcome.
Prepare a Private Placement Memorandum
One of the most important elements of Regulation D 506(c) exemption is the Private Placement Memorandum (PPM). This is a document the syndicator must distribute to potential limited investors.
In some ways, the PPM is like a business plan but doesn’t include the marketing element. The best way to explain a PPM is it is an entirely factual document containing all the relevant information for the investors that will help them make an informed decision.
Sometimes the PPM is called an offering memorandum as it contains all the terms of the private offering. Since this is one of the most important documents of the real estate syndication efforts, it’s imperative to get it right.
A syndicator with extensive experience could draft the PPM to satisfy potential investors. However, it would be advisable for the real estate syndication attorney to review it and provide professional advice even in that case.
Ideally, though, the attorney would participate in the creation of the PPM and make sure it has all the necessary elements.
What is in the Private Placement Memorandum?
The first few pages of the PPM contain short descriptions of the company and all the relevant “legends” (restrictions) mandated by the state and federal laws including the restrictions on resale.
The next section should contain a full summary of offering terms. The language and structure of the summary should allow potential investors to quickly and efficiently assess whether they’ll participate in the venture.
The current capitalization of the company and risk factors are the most important parts of this section. A list of all required documentation should be included too.
The next PPM section should reflect an overview of the company’s purpose. The document should contain a clear outline of the company’s structure and what the goal is under the syndicator’s leadership.
The PPM should also outline the intended use of proceeds. Naturally, every investor wants to know how their money is going to be used for a specific real estate project. This section of the document can put their minds at ease. If possible, itemize the list for further clarity and make sure to include transaction expenses and all legal and accounting fees.
The final crucial part of the PPM is legal and taxation matters. If any pending lawsuits are coming, the document should reflect this.
The taxation portion of the section can vary in comprehensiveness, but for a real estate syndication, it should probably contain every single relevant detail.
Your real estate syndication attorney will add all the other PPM sections that might seem less relevant but could make a significant impact. Also, remember that proper formatting, fonts, and color schemes are essential when it comes to presentation.
Prepare Operating and Subscription Agreements
When you are structuring your private funding round of securities, you will need to draft a Subscription Agreement (also known as a Share Agreement) designed for your investors to complete.
But you must also draft a more detailed Operating Agreement that outlines how the real estate syndication will be managed.
Your attorney should help you create these documents and ensure no relevant details are missing. Here’s what both agreements should contain.
If you have structured your real estate syndication as a limited liability company (LLC), this document should outline how it will be managed.
This agreement legally binds all the syndication members and describes the governing principles. The Operating Agreement names the managers and notes how their voting rights are distributed. It also lists all the capital distributions and subsequent distributions.
The Operating Agreement protects all participants from personal liability and notes any changes in the company’s structure.
Essentially, the Subscription Agreement is designed to attract qualified investors and encourage them to back the real estate project you have in mind.
Without adequate legal advice, Subscription Agreements can sometimes contain a plethora of legal errors that could create numerous problems in the future.
Your Subscription Agreement needs to contain all the terms and conditions regarding key transactions and provisions, payout terms, indemnities and warranties, a confidentiality clause, and minute books.
The more comprehensive the Subscription Agreement is, the more likely investors will view it as a low-risk endeavor.
File Form D
You are not required to register your offering with the SEC, but you still must notify them about it and the exemption status under which it’s being filed.
This process is completed using Form D, a relatively straightforward document that puts you within the legal parameters and in compliance with the SEC.
It’s not possible to simply start selling securities without the proper documentation, even under Regulation D. When you begin selling securities, you have 15 business days before you’re obligated to complete the filing.
Keep in mind that all the information contained in Form D is searchable on the SEC official website. If a company wants to ensure their investors stay confidential, they register with the SEC instead of using Regulation D exemptions. Form D is filed online and only after your Form ID is notarized and submitted to the SEC.
But what happens if you make a mistake and file a document with inaccurate information? Don’t worry, it’s not the end of the world. All you need to do is call your real estate syndication attorney and file an amendment to Form D.
To avoid this type of stress, it’s best to consult your attorney before filing to ensure all the information is accurate.
Experience As a Real Estate Syndicator is Critical
Real estate syndication limited investors have passive roles in the organization because they bring all the capital. However, the success of a real estate syndication largely depends on the experience of the general partner – syndicator.
The syndicator must be the jack of all trades in some regards. A competent syndicator should have the necessary market knowledge or know-how to research it properly. They should be familiar with pertinent tax implications and know how to pitch a great investment opportunity.
These skills are gained only through experience, as that’s the main asset of a savvy syndicator. You can’t simply wake up one day and become a syndicator; you learn how to become one by making decisions and consulting with the right people.
On that note, even with extensive familiarity with real estate laws and regulations, an experienced syndicator knows that the real estate syndication attorney is an important ally in their ventures. Together, they can build impressive real estate investment portfolios that impress any potential investors.
Building a Strong Real Estate Syndication With Moschetti Law Group
Going into any business investment without the proper legal advice is risky, and that’s putting it mildly. A smart and experienced syndicator is the driving force behind every successful real estate syndication.
But with a top-of-the-line syndication law firm, they can achieve great deals. Your real estate syndication attorney can be there with you every step of the way and create opportunities while minimizing the multitude of risks.
A skilled attorney will talk to you about tax implications and makes sure Form D is filed on time.
Reach out to Moschetti Law Group and schedule a free consultation today. The process is simple – all you need to do is complete the contact form and choose a convenient time and date.
Tilden Moschetti, Esq., is a highly sought-after syndication attorney with nearly two decades of experience. His clientele ranges from real estate developers and startups to established businesses and private equity funds. Tilden’s expertise in syndication law comes not only from his knowledge of syndication and securities law but from real, hands-on experience as an active syndicator himself in every real estate product type and nearly all markets in the US. His knowledge and experience set him apart and established him as the Reg D legal services leader.