Updated: Jan 9, 2021
You found the perfect multifamily property. It’s in the right location, with a stable area around the building. The price is in the range you were looking for, and the property fits perfectly with your value-add strategy. Now you’re ready to present it to your passive investors, and you’ve prepared your PPM (private placement memorandum). The only problem: your potential investors are raising objections to your proposal, threatening to prevent the deal from going forward.
Actually, objections are presented all the time with real estate deals. If you’re the syndicator, you must have the facts, figures and answers ready so you can quickly respond to those objections and keep the deal going. As has been said a countless number of times in everything from the Boy Scouts to medical procedures - be prepared. If you’re prepared in advance before the objections or questions are raised, there’s a good chance you’ll satisfy the objector.
If you’ve been a syndicator for any length of time, you’ll find that the same objections are raised over and over again. There may be some variance, but overall, they’re considered “universal objections.” That makes it easier for you to prepare yourself with the answers needed to respond to those objections. Let’s look at some of those objections and the answers that can satisfy the investors.
“What if I have to sell my shares?”
As a sponsor, you have a business plan that is designed to make money on every real estate deal you’re involved in. That business plan will include a proposed holding period, the time it takes before the deal will realize the proposed gains you anticipate and be ready to be refinanced or sold. Many new passive investors wonder what will happen if they need access to their investment during the hold period, so they raise the objection about “liquidity.”
Another similar objection raised is if they must gain access to their investment, can they sell it to one of the other investors or to someone else? That would depend on your original agreement, where you would spell out the answers to these questions/objections. Most multifamily properties are purchased as an LLC, or limited liability corporation. You purchase shares in the LLC when you invest in the property. The LLC’s agreement will determine whether or not an investor can sell their shares to another party. Knowing the arrangement regarding selling the shares in the PPM is important, so you can be prepared ahead of time and inform passive investors accordingly when asked about it.
In some cases, the sponsor will vet the new investor the same way they had vetted the original investor. If they meet the criteria established by the sponsor, then the sponsor may allow the shares to be sold to that new investor. In other cases, the sale of shares is prohibited. An investor should know in advance what is possible and whether or not he or she can tolerate the risk.
But there’s a bigger issue to consider, and that has to do with the SEC (Securities and Exchange Commission). If the SEC considers your real estate deal a security, it can regulate what happens. How can you determine if it is a security? It has to meet 4 specific criteria:
• It has to involve raising capital
• There has to be an expectation of profit
• There has to be a “common enterprise,” in that the investor and the lead investor or sponsor are on the same side of the deal
• The investor is 100% passive - he or she has no involvement in the working of the deal
As an syndicator as well as an investor, you should be aware of the SEC’s Regulation D, which also includes three SEC rules: Rules 504, 505 and 506. The rules all place specific limitations and requirements on the issuers, who they can sell shares to and whether or not the security, or investment, can be exempt from being registered.
The potential passive investor should know how the shares are valued; so that they can have a good sense of what they are worth if a sale has to take place. As with any investment, it pays to do extensive due diligence before investing to make sure that they have a good comfort level with the proposed investment.
“What if I Lose My Money?”
While it’s a question that may be expected from a new investor, It’s a fair question and one that requires an honest answer. The fact is, there is risk inherent in any investment, whether it’s shares in a real estate LLC or it’s money put in the stock market. The risk is that the money could be lost if the investment goes bad. However, if you are a conservative syndicator and buy properties that have positive cash flow from day 1, this risk is mitigated, and it’s important to explain that to your investors.
That’s why every honest sponsor insists that new passive investors do their due diligence before putting down one penny in a real estate investment. The passive investor must determine their own level of risk that they’re willing to take, and must take responsibility if their money is lost. There are some things a prospective investor can do to help protect their investment. When considering an investment, there are some specific components every deal should include, and the investor should examine these as part of their due diligence.
To start with, remind the passive investors that they should only invest with an experienced sponsor that has a track record of successful deals. Syndicators who are just starting out may offer reduced frees or reduced commissions in order to get a deal going, but investors should consider those concessions red flags. Discuss that there is a huge amount of work involved in putting a real estate deal together, and the sponsor should be compensated fairly for their time, knowledge and effort. If you have no prior experience, I highly recommend you partner with an experience syndicator and rely on their experience when speaking with investors. Your partner’s experience can help you make investors more comfortable about the risk of losing their money.
Another way to help passive investors who are concerned about losing their money is to only invest in a preferred return investment. That way, they’ll be paid before others who are not preferred investors. Preferred return investors are the first ones to receive profits on a real estate deal. They’re the ones who get the returns from the real estate income - which is usually the rent. You should always explain to your investors if the returns are compounded or non-compounded, as well as whether the returns are cumulative or non-cumulative. These questions relate to how the returns are calculated, and will impact an investor’s overall return.
Here’s something else to do: remind the investors that when the syndicator is putting his or her own money into the deal it shows confidence in the proposed property. Generally, the passive investors is getting the lion’s share of the deal, whether it’s a 80%-20% split, or 70%-30% split. As part of your answer to this particular objection, let the investors know that you are sharing in the overall risk by placing your money in the deal, and you are subject to the same risk of loss as the investors. For that reason, I always put my own money into every deal I propose. Keep in mind that there are times when negative returns can be quite helpful to the investor in terms of taxation and can help offset losses from other sources of income.
I’m a conservative investor, and I encourage my passive investors to approach investing in real estate the same way. If someone came to me with a deal that promised a high return in a short amount of time, I’d run the other way, and I would urge any other investor to do the same. It simply doesn’t work that way in legitimate real estate deals. There are exceptions, of course, but overall, it’s a major red flag if someone is offering big returns over a short amount of time.
I would much rather project a return of 8% - 10% over the investment period than promote a 15% return to potential investors. I would also gladly share my previous results with people considering participating in one of my deals.
If a deal does go bad, look into the reasons why it failed. The reasons could be due to a bad real estate market, fraud or just poor judgment on the part of the syndicator. Whatever the reasons, learn from the experience.
“You don’t have much experience”
One of the bigger concerns that passive investors have is whether the syndicator has a good track record and experience with real estate syndication. After all, if the passive investor is new to multifamily real estate investments, they’re going to need someone who has the experience and successful track record, which you can demonstrate to potential investors in order to handle this objection.
If you are just starting out and have little or no prior experience, you can partner with another syndicator with a significant track record. This way, if investors are pointing out your lack of experience, you can point out your partner’s experience and talk about their past successes. This is a great way for you to get in the game and handle this objection.
Passive investors are going to voice some objections, and being prepared to answer those objections is the best way to handle things in a professional manner. This article discussed the main objections you can encounter, especially as a young syndicator, but there are obviously more objections and you will face them all as you work on more deals. The main piece of advice I can give you is to make sure you have an answer to all the potential objection you might hear. Come prepared to any investor conversation and it will make it easier and will help you manage the conversation in more confidence.
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