Six Easy Steps to Reviewing a Real Estate Private Placement Memorandum

By David Sheets | Jun 13, 2018 Blog
Tuller Ridge

Today, more and more investors are considering adding alternative real estate programs to their investment portfolios. Before investing your hard-earned dollars into a venture, you will first receive a private placement memorandum (PPM) that explains the objectives, terms, risks, and potential benefits of the investment. The PPM will often be accompanied by several additional documents, including an investment summary, a limited liability company operating agreement, subscription agreement and other offering materials.

Many of the documents associated with a private placement offering are lengthy and complex, with some reaching more than 100 pages. In this blog post, we provide six steps to help you navigate a private placement real estate offering.

1.  Review terms of the deal
Before reading the more detailed legal documents, a sponsor will typically provide an investment summary or term sheet for your review.

First, determine if the asset and investment class match your client’s investment strategy. Then review the terms of the deal, including the projected hold period, minimum investment, financial proforma, sponsor compensation structure and investment type. Each of these should be compared to other offerings to determine if these terms compare favorably to the market and fit within your client’s investment criteria.

The fee structure is also an important factor of the deal. Do the fees seem reasonable? Are they similar to fees that other private placement sponsors are offering, or do they seem too low to be realistic or too high?

The investment strategy for the offering should be a key part of your initial due diligence. Does the sponsor detail how it plans to be successful with the acquisition, management and disposition of the property? Does the sponsor provide third-party information that backs up its claims? If you think the strategy is sound and the investment fits with your client’s investment objectives, then it is time to move to the next step.

2.  Sponsor due diligence
Even the best sounding deal can turn into a bad investment if the sponsor is inexperienced, untrustworthy, or has a poor track record.

Company principals are a good indicator of the experience of the company. A good sponsor has principals with extensive experience in real estate acquisitions, financing, investor relations, asset management and disposition, as well as a successful track record of property transactions.

The sponsor’s track record is also an important factor. While past performance is not an indicator of future success, it is an important point to consider when evaluation an investment. If a sponsor has not consistently met or exceeded original projections, not delivered anticipated yield or return, and has consistently low occupancy in its properties, investing with this sponsor may be risky.(1)

A sponsor should also have several professional references who can attest to the track record, portfolio and operations. These references may include banking, legal, lending, a FINRA broker-dealer, or a CPA who is currently or has previously worked with the sponsor.

3.  Review the Private Placement Memorandum
The PPM can be an intimidating legal document, but it is necessary that you and your client read it in its entirety in order to gain a complete understanding of the project, strategy, risk, terms, and all other aspects of the deal.

A thorough, detailed PPM is often between 50-100 pages. A PPM that is short and not detailed could indicate that the sponsor is inexperienced, lacks sufficient legal representation and/or does not want to divulge certain aspects of the deal. While the entire PPM is crucial, the following sections include the most important details of the offering.

Project Description
This section often includes the exact location, improvements needed, environmental conditions, easements, zoning, appraised value and other property-related items. The information in this section should provide you with an overview of the condition of the property.

Risk Factors
One of the primary purposes of a PPM is to provide a comprehensive list and explanation of the various risk factors involved in the transaction. Investing in real estate has inherent risks and your client should thoroughly understand the risks prior to investing. In addition, the PPM should give you and your clients instructions on how to submit questions to the sponsor in order to better understand the risks.

Financing Terms
The financing terms should be clearly detailed and include loan-to-value ratio, interest rate, terms, lender, reserves, events of default, potential years of interest only, and more. If these details are unclear or seem inconsistent with the offering, ask the sponsor to clarify.

Market Overview
Each PPM should have a section that covers the overall market in which the property is located as well as the submarket in relation to the asset class. Evaluate the data in order to determine if the sponsor’s strategy and assumptions are accurate. Market details such as population and employment growth, market vacancy rates, access/location, and presence of major industries are all important details to look for. The data in this section, including the appraisal, should come from third-party resources.

Business Plan
The company’s business plan outlines the primary objectives and opportunities to achieve the desired returns. It should cover all aspects of the project, including acquisition, asset management, and projected holding period. The plan should be commensurate with the market and competition. For example, if local market rent is higher than the average rent at the project, part of the business plan should be to increase rents to market rate upon tenant rollover.

Distribution Plan
The distribution plan explains how and when operating profits or losses are to be distributed to investors throughout the duration of the project and upon sale of the property.

Potential Tax Consequences
The tax consequence section details the potential effects that a federal tax law change or the sale of the property can have on investor return. It is important to read this section carefully in order to understand how the investment could affect your client’s taxes, and how tax changes can potentially affect your client’s return. If your clients have questions about how an investment could affect their tax situation, we suggest you advise them to consult their accountant or CPA.

Prior Performance and Compensation of the Manager
This section covers who the manager is and how it is involved in the offering. The section on prior performance of the sponsor includes the amount of equity raised to date by the company, the number of investors who have participated in previous deals and the total number of acquisitions the company has made to date. This section can be a good tool for helping you determine whether the sponsor/manager has experience in the offering type and whether the company is forthright in how it will manage.

Potential Conflicts of Interest
Potential conflicts of interest include sponsor obligations to other entities, interests in other activities, acquisition of other properties, and more. This section is intended to make your client aware of other obligations that the company has and may have in the future that could potentially affect investor return.

4.  Review the LLC or LP Operating Agreement
Fees, Distributions and Profit Sharing
While the PPM will give an in-depth overview of the transaction, the operating agreement will expressly set forth the legal and financial terms of the investment. Carefully review the fees, process for distributions from operations, and profit sharing arrangement (sometimes referred to as the “waterfall”) with sponsor prior to investing. Are they the same as what was in the investment summary and the PPM? Are they comparable to other offerings in the marketplace? Do the fees and waterfall break points benefit the investors and the sponsor so their goals are aligned? If not, ask the sponsor about the differences.

Manager Responsibilities and Compensation
This section details who the manager is, its authority, how it is held accountable under different scenarios and how it is compensated. The agreement should detail the manager’s responsibility in numerous scenarios, including how it is to handle distributions from operations and sale, and what type of asset and property management fees are to be paid and to whom.

Rights, authority and voting
Your client’s rights and liabilities as an investor should be clearly described in this section. What decisions is your client entitled to vote on, and which will be left to the discretion of the manager? What type of liability do investors have if things in the investment don’t go as projected? Learning what level of authority and responsibility a client holds as an investor can help you determine if the investment is the right fit for a particular client.

5.  Ask for a copy of the appraisal
Verify the information in the PPM
Private placement sponsors are not required to obtain third-party verification of the claims made in the Investment Summary. However, sponsors must obtain a third-party appraisal of the property to qualify for obtaining a loan or when conducting an offering through a FINRA broker-dealer. Therefore, it is wise to ask for a copy of this appraisal. In addition to allowing you to verify property details, an appraisal contains a great deal of useful information about the property, market conditions, tenant profiles and rental rates. Moreover, it allows you to compare information to the investment summary and the PPM, and then determine if the sponsor’s claims are accurate and if the sponsor’s financial projections, lease-up opportunities, and potential sale prices and cap rates are supported by a professional third-party source.

6.  Determine who produced the offering documents and who is clearing the deal
In your due diligence, it is important to understand who wrote the offering documents. Because these documents detail the legalities of the deal, you should understand the experience and reputation of the parties producing the documents. Having a top law firm provide the offering documents should create a greater level of comfort than having the sponsor produce the documents themselves.

Most importantly, ask the sponsor all your questions. Whether you feel that the offering documents were unclear or you still do not understand aspects of the deal, give the sponsor the opportunity to provide an answer to you. A sponsor who is unwilling or unable to answer your questions should raise red flags. A sponsor who can give a clear, concise explanation and help you feel comfortable with the offering may be an indication of a quality investment.
Private placement real estate can be a great addition to your client’s portfolio. Doing detailed due diligence can help you avoid an investment that could damage the investor’s portfolio and financial health.

If you’d like to receive information on Avistone’s current multi-tenant flex industrial real estate offerings, visit the current offerings page on our website. If you’d like to speak to an Avistone representative, contact us directly at 949.682.7216 or visit our contact page, fill out the form and we will get back to you.

1. Past performance may not be indicative of future results; there is no assurance that objectives will be met.
2. Security transactions administered by Wealthforge Securities, LLC, member FINRA/SIPC. WealthForge Securities, LLC and Avistone are not affiliated.
3. Private security transactions involve a high degree of risk and are not suitable for all investors. They are illiquid, may have a long holding period, and may result in the loss of invested principal.
4. Commercial real estate is subject to risks inherent to the acquisition, management and ownership of real property, including environmental concerns, changes in economic conditions, changes in the investment climate for real estate investments, new competition, changes in the demand from competing properties, changes in local market conditions, changes in lease-up periods, changes in real estate tax rates and other operating expenses.
5. Property images used are of properties owned by Avistone.

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