[RWS #609] Real Estate Syndication Tips & Definitions for Investors

picure of people with fists together for Real Wealth Show Episode #609

Real Estate Syndication Podcast Transcript

Kathy: Real estate syndications are large-scale group investments. If you find a great real estate deal, but don’t have enough money to acquire it yourself, you might reach out to other investors for the capital. In this case, you would be the sponsor of a syndication. And on the flip side, if you have money that you’d like to invest passively – rather than be an active manager, you might like to invest in someone else’s deal that they manage for you. Again, this would be a syndication. Anytime you invest other people’s money, you fall under SEC regulations. And the Securities Exchange Commission is strict.

One of the syndication attorneys that we use at Real Wealth Network for our syndications, to make sure that they’re structuring the deal properly with the right paperwork and the right filing with the SEC, is Gene Trowbridge, of Trowbridge Sidoti LLP. He’s also a real estate broker, a senior CCIM instructor, author and former syndicator. So he’s got a lot of great tips to share with us. Whether you’re on the side of the sponsor or the investor. So Gene, welcome to the Real Wealth Show.

Gene: Well thanks Kathy.

Kathy: And you’re just a legend in the business. So how did you get started?

Gene: Well after enough years, you do become a legend. I think that must be. Maybe it’s just the age Kathy, I’m not sure. But I got started in commercial real estate right out of college. I was in the Midwest. And did that for about 10 years, and moved to California. And became a syndicator. I spent 15 years as a syndicator putting together regulation D offerings, primarily in the area of new construction.

I think most of my offerings were in the area of building storage facilities down here in Southern California. And was lucky enough to have been involved in the broker dealer community, where securities people sold the interest in my offerings. Then I decided, and one of my favorite lines is, “The care and maintenance of partners can become overwhelming.” And at a certain time, I know I sent out 16,087 K1’s one year.

Kathy: Oh my goodness.

Gene: I said, Kathy – I said, “This is just about enough of this.” So I did a mid-life crisis deal and I went to law school when I was 45.

Kathy: Oh my goodness, wow.

Gene: And 2 kids at home. My wife was working, I was still working. Went to law school here in Southern California, and unbelievably passed the bar the first time. The California bar, and set off to be an attorney. So I’ve been doing this now for over 20 years, running my law firm with my partner Jillian, Jillian Sidoti – for the last 4 years. And we’re lucky to do quite a bit of business. I, I hope that some of the people are listening to you, are already my clients. And I say hi to them.

Kathy: Well it’s so funny. It’s kind of like you did it in reverse. We have a lot of people who become attorneys and say, “Wow, this isn’t what I thought it would be, I want to be in real estate.” And they try to create passive income through real estate. But you sort of did it all backwards. You did real estate first, and then attorney second. Or maybe you’re still doing the real estate and the attorney work.

Gene: That’s funny. The attorneys who I hired to do my offerings all said, “You’re crazy going to law school. We want to do what you’re doing.” I said, “Well go ahead, I’m leaving a big opening, go right in.”

Kathy: Oh that’s amazing. So how did you make the switch? Were you a broker when you were doing commercial real estate in the Midwest?

Gene: Yes, I was a broker. I got my CCIM designation when I was very young, 28 years old. And followed the CCIM commercial real estate trail. And in fact, I’m still teaching courses for the CCIM Institute. And been involved with commercial real estate all the way along.

Kathy: Wow, and so how did you go from being a broker to doing your first syndication?

Gene: A couple of my friends, who I’d gone to college with – we got together one night and we were talking. And I had been buying real estate on my own. And they said, “Well why don’t we all go together and buy something?” So many syndicators – Kathy, get to a point where they don’t have enough money to buy all the real estate they want themselves. So they look for other people to invest with them.

And so our first deal was with 3 guys I went to college with and myself. And what I found is when I had other people’s money that I was in charge of, I spent more time and I was more concerned about taking care of their money than my own. So after about 2 years of that – Kathy, I decided I wouldn’t invest myself anymore in real estate. I would just invest with other people. And that lasted about 15 years.

Kathy: Amazing. Okay so in the time that you syndicated deals personally and now help others – from a legal perspective, making sure they’re compliant. What are some of the mistakes you see people making these days who find – maybe find a great real estate deal, bring in other people’s money, and just aren’t quite doing it right. What are some of the mistakes you’ve seen?

Gene: Kathy, do you want me to identify which ones I’ve made, or should we just identify the ones that I see – that I saw during my career as a syndicator, and now as a lawyer? I think I’ll just do it that way. The number 1 mistake that I see – and Kathy, in preparing for this call – I tried to come up with some stakes that investors should be interested in, and syndicators should be interested in. Not just syndicators.

So I’m speaking to investors and syndicators. Then number one mistake is if the offering doesn’t have a plan for continuity. If I brought an offering to you, Kathy, and you said, “Gee it would be – I’d love to invest in this. I’ve got the $50,000 Gene, but I’m just concerned, what happens – what happens if something happens to you?” That I run into all the time. And I think investors–

I get people who call me and say, “Will you look at the offering documents?” And I generally don’t do that if they’re drafted by someone else. But I always do ask the question, “Is there an individual managing member?” And if there is, I usually suggest to the people that they talk to that managing member, and see what the plan for continuity is. And if they don’t have an answer, find another investment to go into.

Kathy: Because if anything happened to that one person, there would be no one to manage it.

Gene: Right. And for the manager, that’s devastating. How can you protect your investors if you’re in there just on your own? And then for the managers or the sponsors, wrapping yourself in an LLC with another – at least one other member does give you some asset protection. So having to plan for continuity helps the investors, and I think it’s very important for the syndicator. Does that make sense to you?

Kathy: Yeah, yeah. So what do you like to see then for continuity? What’s an ideal situation?

Gene: I like to see an LLC. I actually used an S corporation, but times have changed. So an LLC is fine. The problem with a single member LLC in many states, Kathy is if – if that member died. And that’s not the only thing that can happen to a manager, believe me. But if that manager dies, that member of that LLC dies – the LLC is dissolved automatically by an act of law. Now what do you do?

Kathy: Right.

Gene: So that’s probably the biggest thing I always think about upfront. Do we have continuity?

Kathy: So if you don’t recommend a single member LLC, then in any syndication would you want to see 2 people?

Gene: I’d like at least 2. I have been replacement managers or general partners for 5 deals in my career. And only 1 deal needed a replacement person because of a death. I’ve replaced managers who have gone skiing and hit their head on a rock and had become a quadriplegic. I’ve seen managers who have gotten involved in crazy divorces, bankruptcies and other health issues. And for the protection of the members, the partners – we just had to vote them out. We had to put someone new in there. And they didn’t – they did not have a plan for continuity. So we had to make a major change.

Kathy: Yeah, interesting. I mean we have a deal in Reno that actually you guys put together the PPM for. And the manager is an experienced developer, a 40 year veteran. Which is how I like it. I like people with lots of years of experience, so that they know how to maneuver through what always happens – which is, surprises, right? Any real estate deal doesn’t always go as planned.

And so someone with more experience usually knows how to work around it. And he is up in years, so to speak. So that’s a question that always comes up. Is – what if anything ever happened to this developer? And fortunately, he has his son in the business, who’s building out the community. And I’m a partner in it. And there’s another partner. So we do have that plan. But it’s interesting that you said that. Because – that question, of course comes up a lot as it should.

Gene: Yes and I, I actually think from the sponsor standpoint – if you can’t answer that question, it’s going to be a negative in your, in your fundraising.

Kathy: Sure, absolutely.

Gene: I haven’t even talked about cap rates and NOI or anything yet. And we’re talking about mistakes. Isn’t that interesting?

Kathy: Well let’s talk cap rates then and NOI.

Gene: No let’s not, no. No, let’s not do that. Let’s go to another one. Another one that’s important for the investors and the sponsors is having to plan for capital call. Many investors would like not to have a provision for a capital call. And if there is a provision for a capital call, they’d like to make sure that it isn’t – is not mandatory. If they can’t contribute to a capital call, their interest isn’t diluted. Well that’s wonderful. So we’re looking for charity, right?

I have 3 syndicators who have apartment projects in Houston. All 3 projects were damaged by the hurricane. Now what if there’s no ability for the company to raise money? We always write the offerings, that the company can – can always go out and borrow more money from an institution. But not if the property’s damaged. The company can actually go to the members and say, “We’d like to borrow some money from you, ’cause we need to raise some capital.” Well that may or may not work. Well if you can’t do those 2 things, how are you going to fix your building?

So I don’t believe in mandatory capital calls, ’cause I don’t think that’s effective. I don’t think you can really force people. But I do believe in capital calls that are voted on, and with a maybe a 50% vote from the people that this is going to be the capital call. And if in fact you can’t put your money in, you’re not going to be diluted. It’s just that with the capital call, we now have a new level of capital contribution across the company. And we just simply change everyone’s percentage – based on how much do you have in, compared to the new one.

There are many ways to do that. But I do think in protecting your investors, you cannot write an agreement that doesn’t give the manager the ability to draft and create some sort of an agreeable capital call. And to think that the members who don’t want to contribute and don’t want any dilution – to think that the other members are just going to – out of charity, come up with the money to fix their problem, I think that’s a little foolish.

Kathy: You raise a great point. I’m always so nervous to see that in our documents – the possibility of a capital call, because you hope you never need to do that. But how often do you see that happen from your perspective – where projects don’t go as planned, and a capital call is needed?

Gene: We’ve had a great 10 or 15 years, haven’t we – in real estate? So we haven’t seen it very often. But that is the situation where you need that. You just need it, and everyone knows. Or they walk away. People have the right to say, “No, we’re not going to put any money.” What’s the saying? “We’re not going to put good money after bad money?” They all had – vote no on a capital call. Then we’re all grown-ups, property goes away – whatever. It’s not the fault of the sponsor. Most of this stuff isn’t the fault – when a deal goes bad over my career, it’s not really the fault of the sponsor.

So there we go – I think having a capital call is important for the sponsor, so he can protect all of his investors. And the investor should read their documents and see what it says. And I always write, “The manager can’t have a mandatory capital call. Here’s a plan.” And I put it in there. “If you guys like this plan, let’s vote. 50% of the people vote, we’ll do this plan. If another plan is better – make it up and let’s see if we get 75% to vote, and then we’ll move forward.”

Kathy: Very good. Alright, what else? I know you’ve got more.

Gene: I have 2 more.

Kathy: Alright.

Gene: I think today, Kathy – and I think you’re going to agree with me here. That if you’re offering as a sponsor, or an investor who’s looking at an offering – doesn’t have the potential for a current cash distribution. Unless it’s a development deal, and we all understand it’s going to be 2 or 3 years before the project is finished. But just a specific offering. If there isn’t a possibility for a cash distribution in the first – let’s say 6 months, I think that’s a marketing mistake for the sponsor. And I think investors should know that there are plenty of offerings out there that can start producing distributable cash within the first 6 months of the takeover of the property by the new company.

Kathy: Okay.

Gene: I think the days of – and the days that I’m talking about, were 2002 to 2009. When you could just tell everyone, “Hey, we’re just going to buy something. There’s no cash flow, but whatever we buy is going to go up in value so fast – we’ll just sell it, and we’ll make a profit.” Those days are over. Maybe you don’t need to have all of the positive cash flow for distribution that you think the project is going to create? But I think within the first 6 months, we’d better send those investors a check.

Kathy: Sure, unless it’s a non-cash flow deal, right? Like a development deal.

Gene: Oh sure. And then Kathy, you know that investors who invest in those deals don’t care about the cash flow. They’re investing for capital appreciation. They’re investing for net worth. And one of things I always say is that as a sponsor, you need to inventory what type of investors you have.

Kathy: Yeah.

Gene: Projected market that meets what they’re looking for. And as an investor, if you know you’re a retired lawyer and you need passive, current cash flow – don’t be investing in a marina on spec in Havasu. Just don’t do that.

Kathy: Pretty simple, just don’t do that.

Gene: Isn’t that great? And that’s my last– I have one more, then I’m going to get back to the other one that is for both investors and sponsors is – for the sponsors, don’t try to draft your own documents. And for the investors – be sure you read the documents that someone gives you. Don’t invest just because you like Gene Trowbridge. Read the document, and you will know quickly if they’ve drafted their own document. If you have any investment acumen, you’ve seen documents.

The best one I ever saw was – they were going to put together an LLC, and they were going to sell shares. And the LLC was going to be president. And that was all in the first paragraph. I said, “Okay, where did that come from?” So drafting your own documents and not reading your documents when you’re ready to invest. I think those are mistakes that both sides make.

Kathy: So for our newer investors, I just want to explain that. That a corporation, a C corp or an S corp has shares, correct? But a LLC has member units.

Gene: Yes, units and is run by a manager and not a President. And it’s crazy, it’s crazy. So you took the words right out of my mouth. The last mistake have – comes right around the words, “Don’t do this.” Not everyone can be a sponsor. Not everyone can take the responsibility of handling people’s money. It’s one thing to be a commercial real estate broker and sell someone a property. And when the deal closes, you get paid and the buyer gets the keys and you become friends.

But it’s a totally different thing when you’re going to be in charge of 15, 20, 30 people’s money for the next 6 or 7 years. Not everyone can do that. So if that isn’t your make up, don’t do it. And I can tell you on the other side, I’ve had investors who should never invest in a deal. Where all they’re expected to do is be passive. ‘Cause many, many investors want to jump in. They want to run the deal. And buy your own real estate then. Don’t invest in one of these offerings. And don’t do it.

My all-time favorite movie is, “It’s a wonderful life.” And it has so much to talk about. The scene where everyone runs up to the building and loan office and have their passbooks. And they say to Jimmy Stewart, “I need my money, I need my money.” And he says, “The money isn’t in the bank, the money’s in this gentleman’s bar or it’s in this ladies house.”

We don’t have the money. That’s exactly what a syndicator is. It’s a person who manages money. They don’t have the money. They manage the money for people. They put it in projects. They put it in cement trucks. They put it in whatever they do. But the investors still think you have their money. And if you can’t deal with that – sponsors, don’t do this.

Kathy: Yeah it involves having systems and communication – regular communication, which can be challenging when you have lots and lots of different investors involved.

Gene: That’s another reason to have some continuity. And you have someone else with you in the deal. Some people are great at those details. I can just imagine a – an LLC that’s a managing member, made up of a seasoned property manager who knows how to write reports, how to run the bank accounts, how to do the project management perfect. And someone who’s out there in the field looking for good deals. ‘Cause the person who’s out there looking for good deals, doesn’t know how to write reports. And the person who sits and writes reports and managed the property may not always know what a good deal is. So what a great team that would be.

Kathy: Right. Wonderful. Alright, well you have an event coming up for people who want to become syndicators, or maybe want to invest in syndication’s. Tell us a little bit about that.

Gene: Yes, we’re having our second annual crowd converge event. It’s in Las Vegas. It’s at Mandalay Bay. It’s February 1st and 2nd, and it’s a 2 day event. Where great people like you, Kathy are going to come and talk to our audience about your successes. And how you can either get in this business, or be better than you were yesterday in this business.

And we have 2 full days of speakers, panel discussions, a lot of networking possibilities. And as I said, it’s February 1st and 2nd. Kind of short notice. But the best way to learn about it, and see who the speakers and the sponsors are – would be to go to the website. It’s kind of a long word – Crowd Converge Con. It ends with a C-O-N, dot com. For Crowd Converge Convention, crowdconvergecon.com. And if you go there, you will see all the information.

We have a room block at the Delano Hotel, which is right alongside of – connected to Mandalay, where we have discounted rooms. And we’d love to see some of your people there.

Kathy: And what kinds of topics will there be?

Gene: Well half of the presentations are going to be on how do you raise money? How to make your money raising easier. Education based marketing using LinkedIn. How do people do regulation A offerings, where they can advertise? And then the other half is really the service providers. The accountants, the back office people who help you run your operations. We’re having someone talk about EB5’s. We’re having someone talk about Delaware statutory trusts. And we’re having someone talk about Bitcoins.

Kathy: Wow, alright.

Gene: It’s a very eclectic group of people. You were there last year. Did you like it last year, Kathy?

Kathy: I loved it, and I’m excited to be back there. So if any of our listeners want to go, I will be there. I think I might have a little stage time with Jillian, doing a little Q & A on our syndications.

Gene: Oh absolutely. Looking forward to hearing that.

Kathy: Yeah, and I look forward to hopefully meeting some of our listeners. And that’s in Las Vegas on February 1st and 2nd. So wonderful, with Gene Trowbridge – always a pleasure speaking with you. And thank you so much for coming here on The Real Wealth Show.

Gene: Well thanks for having me Kathy.

Kathy: And thank you for joining me here on The Real Wealth Show.

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