Summary: In this article, you’ll learn about real estate Private Placement Memorandums, what exactly they are and how to read one. Topics also include types of PPMs, when a PPM should be used, the difference between a business plan vs PPM vs prospectus and more.
Real Estate syndicates commonly use Private Placement Memorandums as a way for investors to analyze a potential investment opportunity. Why should you be interested in real estate syndications? There are plenty of reasons!
The biggest benefit is that syndication projects allow “small-time” investors to participate in larger scale real estate investments. These include commercial buildings, apartment buildings, land/developments, etc.
Investing with a syndicate also comes with the added benefits of utilizing the syndicate’s experience, expertise connections and relationships in the real estate industry.
Finally, investing in multiple syndications can add diversification to your portfolio. To illustrate this, consider the following two scenarios: 1) You invest $50,000 in five asset classes, all located in different markets. Or 2) you invest in one apartment building for $250,000. The safer investment would obviously be smaller investments in many projects.
What is a Private Placement Memorandum (PPM)?
A Private Placement Memorandum is an offering document that is used by privately held companies to get investors to buy into a project. PPMs are a vital tool in raising capital to fund a larger multi-family property or commercial building, for instance. It basically outlines and describes the terms of an investment opportunity and includes the project details, who can invest, timeline, anticipated return on investment, legal disclosures, potential risks and more.
The fund managers are responsible for putting together the PPM for a project and presenting the offering documents to those that qualify.
Types of Private Placement Memorandums
While there are several different types of PPMs, the two main types are Equity PPM and Debt PPM. The type of offering or purpose of offering determines the type of PPM.
- Equity Private Placement – when a company allows investors to buy shares, that’s called an equity offering. With an LLC (limited liability company) or a LP (limited partnership), the offering may be to invest in rental units or limited partnership interest of a company.
- Debt Private Placement – a debt offering is when a company sells a bond or note to investors. The company will explain the terms of the security being offered, such as interest rate and maturity date of the loan.
What is in a Private Placement Memorandum?
Investors are only responsible for reading and understanding the PPM to ultimately decide whether to move forward with the investment or not. While there are no finite PPM requirements, they generally should include the following sections with project information and specifics:
Summary of the Offering
A Private Placement Memorandum, as a whole, is meant to paint a picture of the investment. In the Offering Summary, found at the beginning of the PPM, is an overview of the project, highlighting the most important details. After reading the offering summary, the investor should have a good idea of what the overall investment entails.
Legal Disclosures & Investor Suitability Standards
Legal disclosures would include Regulation D disclaimers in accordance with SEC guidelines. Regulation D 506 exemptions control who can invest in the project or what type of investor the project is open to. The reason the SEC sets these standards is to protect investors that may not know what they’re doing.
Investor Suitability Standards are as follows:
The investment is only open to Accredited Investors and project details can be discussed with non-members (of RealWealth™ or no prior relationship required).
Under this rule, the project is open to Accredited Investors and 35 Sophisticated Investors. Sophisticated investors must have a pre existing relationship with the syndicator, where they can essentially “vouch” for your financial status and investing know-how.
Company Information, Fund Manager and Objectives
The company making the investment offering should provide their information and detailed objectives explaining the purpose and expectations of the project. The fund manager’s information and responsibilities should also be included in this section.
Property / Project Description and Note Agreement (if applicable)
What type of property is the offering for, where is it located, and what are the terms of the Note agreement (if the investment is being financed)? All of these details should be included in the PPM, along with the maturity date of the loan (if applicable).
The offering terms and conditions will list the minimum investment amount and the expected return to investors. These terms will also define who is eligible to participate in the investment opportunity.
Investor qualification or suitability standards will outline who can invest in the project and who can’t. For example, a project may be open to accredited investors only. While other projects may accept both accredited investors and up to 35 sophisticated investors. The subscription booklet (more on that below) should come with an Investor Suitability Questionnaire, that helps determine if you qualify as an accredited or sophisticated investor.
Location of Funds & Timing of the Offering
This section will explain where the funds will be kept during the investment period. The PPM should be completely transparent about the funds, where they will be held and the timing of the offering.
Use of Proceeds
The use of proceeds basically outlines what the proceeds or money will be used for. The proceeds could be used to buy an apartment building, a commercial property or single-family rentals.
Allocation of Distributions, Profits and Losses
This section will outline how distributable cash will be allocated, i.e. to investors and the fund manager. The interest percentage investors will receive should also be outlined in this section of the PPM. It should also include expectations of when cash should start to be distributed to investors. Also, any profit sharing restrictions should be stated here.
An investment is only as good as its return. Investors should pay attention to how the expected ROI is presented and the details therein. For example, the PPM may show a 15% expected return, but take a look at the fine print to make sure what the actual cut for investors is verus the manager. There should be a clear distinction regarding the allocation of distributions.
The manager’s compensation section should clearly state how the manager will be compensated throughout the investment period. All reimbursements and profits to the manager should be described in detail.
Risk Factors and Conflicts of Interest
Every type of investment usually comes with some level of risk. This section should include a list of potential risk factors associated with the investment. Any conflicts of interest regarding the project, manager, and investors should be disclosed in this section.
Liquidity and Transferability
The liquidity and transferability section should set an expectation about how liquid the investment opportunity will be. For instance, buying rental units is a relatively illiquid investment, at least in the short-term. So those interested in investing should know that their money will be tied up for the length of the investment term. There may be an option to transfer or sell the units after a certain period of time. All of these terms and conditions should be laid out in this section.
Duration of the Investment
Investors should know how long the investment is expected to last. If a Note is being used to finance the project, the length of the loan should be disclosed here. Also, any prepayment options and/or penalties should be explained in the duration of the investment section.
How to Invest
Investors interested in joining the project will then follow the steps for how to invest. Typically, potential investors will be asked to fill out an offering package, subscription agreement and perform their own due diligence. We’ll go into more detail about these documents and how to read them below.
Tax Filing Information
If you decide to invest in a syndication or group project, a Schedule K1 tax document will be sent to you annually. This will lay out any profits, losses, deductions and credits and will help file your taxes and investment properly .
How to Read a Private Placement Memorandum (PPM)?
To help investors understand what they’re reading and potentially signing up for, fund manager’s will sometimes include a page explaining, “how to review this offering,” as part of the Private Placement Memorandum.
If you’re a member of RealWealth®, you’ll get a great one-sheet reference for any questions you might have while they’re reviewing the PPM. There are also a number of resources available online, including private placement memorandum templates and samples.
The Offering Package
The Offering Package is all the documents the fund manager deems relevant for investors to know before investing.
The Private Placement Memorandum
As we learned earlier in this article, the memorandum includes important legal disclosures, company structure, distributions, risks, etc.
The Company Agreement
This agreement details how the company will be run. It describes the duties, responsibilities and rights of investors and the manager. The Company Agreement includes in detail how the company will operate, how meetings and votes will be held, how cash distributions will be made and when, where to access project books and records, and more. It’s a legal document where all parties must agree and adhere to in order to participate in the investment.
The Subscription Booklet
In order to buy into a project, investors must fill out a Subscription Agreement and Booklet. This document also has legal implications and asks for investors representations and warranties in order to qualify. In other words, the Subscription Booklet determines if a person meets the suitability standards to invest in the offering. Investors will also include how much they want to invest in the project.
Investors Must Conduct Their Own Due Diligence
No matter how much experience you have investing, your financial advisor, CPA and lawyer should always review an offering before moving forward. Consulting with a financial expert who specializes in real estate will be your best resource as you navigate the waters of investing.
Investor Tip: It’s important for an investor to understand both the PPM and Operating Agreement (also called the Company Agreement .
Business Plan vs PPM vs Prospectus
A business plan is more of a marketing tool to promote your company and future plans. A PPM isn’t meant to persuade or promote, rather it is descriptive, discloses information and focuses on the value of the investment.
A Prospectus is similar to a Private Placement Memorandum, but is used in the publicly-traded sector. For example, when a publicly traded company lists on the stock exchange, a potential investor would find all relevant information in the Prospectus.
Understanding a Private Placement Memorandum, what it is and how to read one will add another key tool to your real estate investing toolbox. While combing through the details of a PPM is one of the less glamorous parts of real estate investing, it’s one of the most important. If you know how to read and interpret a Private Placement Memorandum, it will help you decipher a good investment from a bad one.