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If you’ve been involved in any real estate deals or have worked with a syndicator, you’re probably familiar with the term, PPM. If you’re new to real estate investing, here’s some background information on this critical component of any real estate investment.
A PPM is a Private Placement Memorandum.
It’s a legal document given to all prospective investors in a real estate investment, whether they invest as an LLC or individuals. It’s designed to provide potential investors with full disclosure based on the requirements of the federal securities law. Some investors confuse a PPM with a business plan.
The PPM is not a business plan, but rather a document that outlines the entire investment including what’s required from investors, the fees and commissions earned by the Sponsor and a complete description of the property.
Every PPM has four key parts that you, as a passive investor, should be aware of.
1. PPM Introduction
The introduction provides a short summary of the actual offer, a description of the property, when the offering period will terminate, the minimum investment that is required, a statement of any risks involved, a suitability standards statement, plus a disclosure of fees and commission payable to the Sponsor.
2. Disclosures
As a legal document, the PPM is required to provide key information that would help potential investors determine the capabilities of the Sponsor. It must include full disclosure of the key items that are associated with the deal’s Sponsor.
Another portion of the PPM will provide key info that includes the property’s description along with estimated project costs. It should also show the use of proceeds and gross sales revenues. It can also include a Preforma and any projected returns, which is usually included as a separate exhibit attached to the PPM.
There should also be a section relating to the risks that are associated with the particular investment opportunity that’s being offered. These risks may include tenant issues, market problems, legal or tax issues. In some cases there may be a unique risk, like where the property is located or if there is a specific tenant concern.
3. Legal Agreement
The third part of the PPM is the operating agreement that will show how the LLC, limited partnership or other Special Purpose Vehicle (SPV) will be managed (this will be the entity that owns the property, while investors own shares of that entity).
These are governing rules of the investors and Sponsor, and may include key information like accounting rules, management plan, rights of the group members, the ability assign or transfer ownership, termination plan and other potential issues.
4. Subscription Agreement
Here’s where you agree to the terms of the PPM, because you’re expected to sign the agreement regarding how many shares you’re willing to purchase with the offering.
All of the investors will be required to submit funds at this point in order to seal the offer.
What to Consider Before Signing a PPM
It’s exciting to participate in a syndication deal. Investors are lined up, you did your due diligence on the property and the Sponsor, and now it’s time to sign the PPM and hand over a check.
Before you do, there are several key issues to consider before signing the PPM and writing a check. These issues can help protect you in case something goes south, so let’s take a look at them.
#1: Liquidation
Unfortunately, many people ask about their ability to sell their shares after they sign the deal and hand over their money. As a passive investor, you really don’t own the property; you own the shares of an entity (usually LLC) that owns the property. That means you can’t decide to sell your shares on your own - if you need to get out of a deal after you’ve signed it, you need permission from the Sponsor to sell those shares.
Not every Sponsor is willing to let you sell your shares, or if selling is permitted, it usually comes with limitations. After all, the Sponsor is getting a new partner and they want to be sure that it’s someone who they don’t mind spending time with, or one who has a style that’s compatible with their own style. They also want to be sure the person who is willing to buy the shares is financially solvent.
Some sponsors put the information about selling shares in the PPM, others don’t and review the request on a case-by-case basis if it comes up. If you have concerns, ask questions prior to signing the PPM.
There are some legal limitation to the minimum hold period before passive investors can sell their shares, so even if the Sponsor allows it, shares might not be available for sell right away.
#2: Fees and Equity Split
Sponsors of a syndication deal earn money in two ways they earn fees and they earn income from an equity split. Sponsors bring a lot of knowledge and expertise to the table, and they’re working hard to find a property that is worthy of consideration by passive investors. Even after the deal is completed there is still a lot of work to be done, including finding the proper financing and managing the property until it is sold.
The equity split is between the Sponsor (General Partner) and the investors, who are known as the Limited Partners. There are two common splits in the industry: 30%-70%, and 20%-80%, where the Limited Partners receive the higher amount of equity.
The Sponsor also receives an equity split when the property sells and proceeds are available. Normal splits are often 30%-70% of the income, along with 50% of the sale proceeds. Some Sponsors choose to have a “waterfall” equity split, where they receive a higher percentage of the equity if they’re able to provide a predetermined return to investors. One example would be a 30% equity if the investment yields 15% IRR to investors, and 40% if the investment yields 16% IRR. It’s an incentive for the Sponsor to maximize the returns for investors.
There are a variety of fees that a Sponsor can earn, depending on the type of property and the structure of the deal. These fees are on top of the equity split that is pre-determined before the deal begins.
A transaction fee, which ranges from 1% to 2% of the transaction’s value is designed to compensate the Sponsor for their hard work, which can last anywhere from 3- to 6-months or longer. Plus, Sponsors have overhead and operating costs that are related to finding and acquiring the property, including travel, hotels, salary to employees and other overhead.
An asset management fee, which is usually 1% to 2% of the effective income, is paid to the Sponsor to find and oversee the property management company that manages the asset.
There is far too much work to do in a multifamily property for the Sponsor to manage the property on their own, so they hire and manage a property management company.
Investors appreciate this function; as the work involved includes having an extensive knowledge of the market, so they understand vacancy rates, rent structures and where to find quality tenants. They also have the resources to manage the day-to-day operations of the property including repairs, rent collection and minimizing tenant turnover. The last thing an investor wants is an empty unit.
Most experienced Sponsors meet with the property management company on a regular basis to ensure that the property is being managed properly. If there is renovation or repositioning involved, the Sponsor will oversee construction and manage costs, while keeping the projects on schedule.
There is also a lot of work involved keeping investors informed, continually updating the property’s performance. The asset management fee is designed to cover this work as well.
A disposition fee, which is generally 1% to 2% of the actual sale price is used to cover the sale process. The Sponsor will conduct a market analysis and work with a broker to sell the property.
One thing to watch for is that the fees are defined in the PPM, and that they don’t fluctuate from what the PPM states.
#3: Indemnification
The final item to watch for in the PPM is the indemnification of the Sponsor. You want to be sure that the Sponsor is not eligible to be indemnified for all causes, as it would leave the investors liable. When reviewing the PPM, be sure to check that this is not included.
Summary
Reviewing a PPM can be daunting at first, but it is critical to do the necessary due diligence before signing in order to protect your investment! If questions arise, ask the Sponsor, or check with your own attorney or tax advisor to see how a specific issue might impact your unique situation.
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About Ellie Perlman
Ellie Perlman is the founder of Blue Lake Capital, a commercial real estate investment firm specializing in multifamily investing throughout the United States. At Blue Lake Capital, Ellie partners with both institutional and individual investors to grow their wealth by achieving double-digit returns by investing alongside her in exclusive multifamily deals they usually don't have access to.
A defining factor of Blue Lake Capital’s strategy is founded in utilizing machine learning/artificial intelligence throughout the course of all acquisitions and asset management. This advanced technology enables the company to produce accurate and data-driven forecasting for all assets on a market, property, and even tenant basis. In doing so, Blue Lake is able to lead commercial investments with the full capabilities of today’s technology.
Ellie is the host of REady2Scale, a podcast that highlights the assets, processes, and strategies for the multiple approaches to successful real estate investing.
She started her career as a commercial real estate lawyer, leading real estate transactions for one of Israel’s leading development companies. Later, as a property manager for Israel’s largest energy company, she oversaw properties worth over $100MM. Additionally, Ellie is an experienced entrepreneur who helped build and scale companies by improving their business operations.
Ellie holds a Masters in Law from Bar-Ilan University in Israel and an MBA from MIT Sloan School of Managemen
You can read more about Blue Lake Capital and Ellie Perlman at www.bluelake-capital.com.