Syndication and Small Multifamily Homes
Justin WoodworthPro Member
Madison WI · Member since 2019 · 71 posts · 45 votesHello fellow BP'ers. Recently I have bought a duplex in Madison WI as my first investment and am looking to keep the train rolling. I work a lot of hours at my job and I have eliminated most expenses in my life. I have come to realize though that even if I save up money for years it will take me a long time to save up 20%-25% for an actual investment property. After listening to 30+ hours of podcasts and hearing about syndication I have become very interested.
Questions: Has anyone syndicated a duplex/triplex/quadplex etc and what was your experience? What is the most efficient way to set up your funding? More importantly, what is legal and what is illegal? (I don't want to experience prison)
I hope this has been clear! Thank you ahead of time for any responses and time taken to read this post!
So... any time you take money from investors where the returns are generated by YOUR efforts, you are issuing a security and must comply with Federal and State securities laws. With a security, you must a) register it with the SEC, b) find an exemption or c) its illegal. Most find an exemption to registration and almost everyone relies on one of the Reg D exemtptions (506b or 506C). These generally require you to provide full blown disclosure documents (PPM) to your investors. (technically if accredited you get to chose what disclosure you get but best practice is a ppm). Undortunately there is a compliance costs of around $10k-$15k which makes doing small deals (ie: $100K, $200K) not worth it. If only 1 investor there are creative ways to structure in order to avoid being considered a security but you must still tread lightly. In essence if your investor(s) are passive and your are active, you are dealing with a security.
Hope this helps and clarifies.
It is hard to make syndication work financially on small deals. To do a syndication legally will cost a minimum of about $10K in legal and filing fees for a PPM. The annual LLC maintenance and K1 filings will eat into your cash flow.
Consider partnering instead. Or find ways to improve returns on your existing properties. Another solution would be to go bigger but I'd recommend you get more formal education on how to properly run a syndication before starting. Good education isn't cheap.
I appreciate the info Greg. I found an excellent post on partnerships and trusts. It seems to be saying the same thing. Thanks!
BRRRR is still the gold standard for folks in your situation. Otherwise, instead of formally syndicating, find a high-net-worth partner who will put up the majority of the money and give you an increased share of the profits for doing a good job in managing the property. Once you get some experience, you'll be able to grow your investor pool and move on to syndicating larger properties.
Hi Justin,
Small-scale syndications under $5m are very easy. I disagree with Greg in that the legal fees will be $10k and the LLC maintenance will kill cash flow.
Here is what you can do:
1. Set up an LLC in Delaware (annual tax of $300) and list all the members, their contributions, and their equity % on the Operating Agreement. You can do this on LegalZoom, Rocketlawyer, etc. I recommend doing it yourself and then paying an attorney $300-$500 to review it for any issues. Get all the investors to sign the Operating Agreement.
2. Take your Articles of Incorporation to the bank and set up a corporate bank account.
3. Find a deal and place it under contract. Pay your attorney another $300-$500 to review the Purchase and Sale Agreement if you don’t trust your real estate agent.
4. Present the deal to your investors in a nice PowerPoint. Make sure to include a Legal Disclaimer slide that outlines all of the possible risks as well as a boiler plate statement that you can find online if you google “Private Placement Memorandum Legal Disclaimer”. Ask the potential investors to let you know if they are committed within a few days.
4. Send your investors a “Capital Contribution Notice”. This is a one page document that tells your investors exactly how much money they need to transfer into the corporate bank account, when they need to transfer it, and the bank account details.
5. Close on the deal.
For small deals like this, there is no need to spend $10k in legal fees and jump through hoops to ensure you’re in compliance with SEC regulation. Once you get into larger deals ($5+ million), you will need to worry about SEC rule 506.
Good luck to you and let me know if you have any questions!
*Please note that I am not an attorney and you should not rely solely on my advice to make decisions regarding the management of money. Please conduct your own diligence and ask a licensed attorney for any clarification on all legal matters.*
I think @Greg Scott gave you a pretty good picture of whether to take a syndication route with a residential multi. I suggest you take it a step further and consult with attorney. You can talk to a regular RE attorney and a securities attorney to hear both sides.
@Elijah Brown Can you please provide evidence that supports this comment of yours? (below)
I listened to an early BP podcast where a guest did this and I cringed listening to it. I also contacted that person to let them know of the risks they were taking.
@Justin Woodworth @Elijah Brown Please listen to this podcast with an SEC attorney. http://www.lifestylesunlimited.com/october-28-2014...
I've heard several podcasts with different SEC attorneys and they all basically say the same thing. Elijah's plan breaks SEC laws. People that successfully do what Elijah is proposing just haven't gotten caught. Of course, if the deal does really well, odds are none of your investors will complain, which is how the SEC becomes aware of most issues. Still, that is just gambling with the law. Do you want to take the chance of hefty fines or jail for the chance to buy a duplex?
I've also heard several stories of SEC busting people on small deals, so beware there is no threshold of size.
@Elijah Brown please talk with a securities attorney before taking your own advice. What you just described poses a great deal of risk from a legal standpoint. You are taking investors money and need to take it seriously.
@Justin Woodworth, you can syndicate duplexes, but it doesn't make sense to do it one at a time. I have a friend that raised $5mm in a fund to buy houses and duplexes. They did the raise and then bought a bunch of properties.
Raising funds for a single duplex though makes no sense. In my opinion, you need to raise at least $500k for it to make sense. If you want to accelerate your time and focus on duplexes, then focus on buying distressed duplexes, renovate them, raise rents, and refinance to pull capital back out. You can do this process over and over. The other way is to find partners and buy duplexes or form syndications to buy larger commercial/multifamily.
@Todd Dexheimer Thank you I appreciate your insight
@Greg Scott I did a few more hours of research on this subject last night and agree with you. What Elijah is saying is dangerous if a investor complains. Thank you for the link! I plan on knocking both of them down.
Do either of you have any podcast link to partnerships?
You guys rock!
@Todd Dexheimer @Greg Scott He’s pooling money for a duplex, not a $5m commercial apartment complex.
He should be able to claim an exemption from registration under rule 506 of Regulation D. He won’t even have to provide a Private Placement Memorandum although it’s highly encouraged for added protection. He can also take non-accredited investors if he wants!
To be safe, he should give all his investors a job to do in the Operating Agreement so the offering isn’t considered a “security” (because it is not solely through the efforts of another).
I would understand spending $10k on legal fees if you’re raising millions, but for a 20% down payment on a duplex, I don’t see how it’s necessary or feasible.
As long as he discloses to his investors all the risks involved and avoids any sort of fraudulent activity, the SEC likely won’t question his ability to serve as a good fiduciary.
However, as you both mentioned, it is highly recommended to consult a RE attorney before proceeding. I usually spend around $300-500 on this....again not $10k for these small deals.
A JV is better. The costs of the syndication will likely make any good deal a bad deal.
I AM an SEC lawyer and you are 1000% wrong! About to hop on a call but will respond re this shortly. Even if you raise $1 from 1 investor it COULD be a security and thus you would need to comply with securities laws. And yes, will cost you $10k-$15K
@Todd Dexheimer @Greg Scott He’s pooling money for a duplex, not a $5m commercial apartment complex.
He should be able to claim an exemption from registration under rule 506 of Regulation D. He won’t even have to provide a Private Placement Memorandum although it’s highly encouraged for added protection. He can also take non-accredited investors if he wants!
To be safe, he should give all his investors a job to do in the Operating Agreement so the offering isn’t considered a “security” (because it is not solely through the efforts of another).
I would understand spending $10k on legal fees if you’re raising millions, but for a 20% down payment on a duplex, I don’t see how it’s necessary or feasible.
As long as he discloses to his investors all the risks involved and avoids any sort of fraudulent activity, the SEC likely won’t question his ability to serve as a good fiduciary.
However, as you both mentioned, it is highly recommended to consult a RE attorney before proceeding. I usually spend around $300-500 on this....again not $10k for these small deals.
you forgot to add your disclaimer to this post
which to this non-lawyer seems to be just as incorrect as your last post, maybe more, because you say, "give all his investors a job to do"
So... any time you take money from investors where the returns are generated by YOUR efforts, you are issuing a security and must comply with Federal and State securities laws. With a security, you must a) register it with the SEC, b) find an exemption or c) its illegal. Most find an exemption to registration and almost everyone relies on one of the Reg D exemtptions (506b or 506C). These generally require you to provide full blown disclosure documents (PPM) to your investors. (technically if accredited you get to chose what disclosure you get but best practice is a ppm). Undortunately there is a compliance costs of around $10k-$15k which makes doing small deals (ie: $100K, $200K) not worth it. If only 1 investor there are creative ways to structure in order to avoid being considered a security but you must still tread lightly. In essence if your investor(s) are passive and your are active, you are dealing with a security.
Hope this helps and clarifies.
Also, many people try and get around the securities laws by calling it a JV Agreement or TIC Agreement or Profit sharing agreement or a handshake or a high five! Structure DOES NOT matter. You can have a JV agreement and could still be a security. Same rules apply above. You dont get to chose. It is either a security or it is not and the laws will dictate what you have on your hands.
Think of it this way.
You and I agree to do something illegal. We maybe I am selling something you want to use. We sign a contract as two adults. It is all spelled out in the contract.
Does the agreement, the contract, change the law? If it was illegal and we have a contract, do you think the judge will care?
Similar to speeding on the highway. You and I and any number of people go wizzing by above the speed limit. None of us receive a ticket.
Does the lack of a ticket change the law?
So, if you want to play with fire and get burned, do the time as an adult. If you do not want to serve time, do not mess with the SEC.
One guy, IL based, served time for putting multiple people together for a loan. Something he had done for years without complaint. Until he had a deal go bad and an investor decided to ring the SEC. The problem with the deal had nothing to do with the set up. An accident happened and it tipped the deal over.
You have all been very helpful and insightful. Thank you guys!
@Mauricio Rauld what if the returns aren’t generated solely through my efforts? What if my other partners/investors have clearly defined roles in the operating agreement? Would it still be a security?
@Justin Woodworth can you share that post? Thanks!
@Elijah Brown Couple of things. First, under your 506 mention, a PPM is REQUIRED if any of your investors are non-accredited. Second, yes, you are correct. If there are a few of you and everyone is actively involved in the business, then you essentially started a business since everyone is involved. You would then want a really well crafted Operating Agreement so ensure all the members understand their roles and responsibilities (Def would cost you WAY more than $500 since you do not want a templated OA). HOWEVER, HOWEVER, HOWEVER.... first, it will be YOUR burden to prove too the SEC that all of the business owners are proportionately doing work in the new business venture you started and second, you can only do this with about 4 or 5 business partners because the SEC has said that anything above that, it is impossible for all 6 people to be doing all the work. Inevitably there is one that does not do very much. So if you are truing to get 10-15 people this way, you have No chance of convincing the SEC that you started a business.
The fact that you even called these people investors would be enough to show your intent that this is a security as opposed to recruiting business partners.
@Mauricio Rauld thanks for posting your responses. I was cringing going through this thread. I've interviewed numerous SEC attorneys and there are a lot of investors who make incorrect assumptions on the risks invovled. As one of the attorneys told me, you can do whatever you want but that doesn't mean it will hold up in front of a judge. And just because others were doing it is not a sufficient argument.
@Justin Woodworth I would recommend finding an ACCREDITED investor and asking them to be private lender. Otherwise, find 1-2 partners who are looking to be active and do a JV. Make sure they have a clear role and access to the finances/bank account statements.
@Elijah Brown He will need a PPM. He will still need to file Form D with the SEC on EDGAR. He can only accept non-accredited investors if uses 506(B) as his exemption.
You cant just give people a job. They actually have to do work. In most syndications the GP or Sponsors will usually top out at 5-6.
Never underestimate what the SEC will go after or wont. Doesn't matter the size monetarily. $500,000 or 500 million. The SEC is also just the feds. States have Blue Sky laws and if you don't file under Reg D you have to file in each state you are raising money in.
DISCLAIMER: I AM NOT AN ATTORNEY NOR GIVING LEGAL ADVICE. MY EXPERIENCE IS THAT OF SOMEONE WHO HAS WRITTEN OR PARTICIPATED IN ASSITING ATTORNEYS, FUND MANAGERS ETC WITH THEIR INVESTOR PRESENTATIONS, PORTALS AND OTHER SERVICES. WHILE I KNOW A LOT OF SECURITIES LAWS, EXEMPTIONS AND RULES I CONSULT WITH LAWYERS ON BEHALF OF MF MY CLIENTS OR REFER THEM OUTRIGHT.
Mauricio is the man. He answered many of my questions.
@Todd Dexheimer @Greg Scott He’s pooling money for a duplex, not a $5m commercial apartment complex.
He should be able to claim an exemption from registration under rule 506 of Regulation D. He won’t even have to provide a Private Placement Memorandum although it’s highly encouraged for added protection. He can also take non-accredited investors if he wants!
To be safe, he should give all his investors a job to do in the Operating Agreement so the offering isn’t considered a “security” (because it is not solely through the efforts of another).
I would understand spending $10k on legal fees if you’re raising millions, but for a 20% down payment on a duplex, I don’t see how it’s necessary or feasible.
As long as he discloses to his investors all the risks involved and avoids any sort of fraudulent activity, the SEC likely won’t question his ability to serve as a good fiduciary.
However, as you both mentioned, it is highly recommended to consult a RE attorney before proceeding. I usually spend around $300-500 on this....again not $10k for these small deals.
It doesn't matter how big the deal is. If you raise money, you are subject to SEC regulations. A duplex is no different from a $5mm commercial building. I am not an attorney, but the counseling I have received from securities attorney's lead me to this conclusion.
@Mauricio Rauld what if the returns aren’t generated solely through my efforts? What if my other partners/investors have clearly defined roles in the operating agreement? Would it still be a security?
What if the other partner falls out with you and claims they did not have the skills or knowledge to run things. That you would not listen.
An operating agreement is a piece of paper. That does not mean that is what happened. If you end up in court, the judge will look at who did what.
And the question of what is a security has been addressed.