How to set up "non-investment" private syndication betw friends

12 Replies

A few like-minded friends and I are considering pooling our resources and purchasing a piece of raw land in a desirable area (Malibu) and are wondering if a syndication with a LLC shell might be the best entity for this. I use the term "non-investment" because the land would be for future development and use by the investors and would not be principally a vehicle for making money. Of course, there is always the possibility of liquidating the property at some undetermined future date and splitting the proposed profits on appreciation, but this is not the stated goal.

The goal is to develop some living quarters and communal space which friends and family can use for their enjoyment with the probability that any number of the partners may retire there at some point. I know, it maybe sounds like some hippy commune real estate nightmare scenario, but we want to try to realistically work out a solid, grounded scenario that we envision. 

I read a BP forum post from a few years back that provided some general guidelines into setting up a syndication (thank you @Lew Payne): https://www.biggerpockets.com/forums/311/topics/18...

"You set up such syndication entities by clearly establishing their purpose and goals, the benefits to investors, the exit strategy, the management strategy, and the processes for handling disputes, change in membership due to estate or bankruptcy of a member, the process for winding-down a series, and the overall exit strategy. Once you've done that, you confer with an attorney experienced in real estate syndication, and retain him."

I'm wondering if anyone else has any thoughts or insights to share.

Thank you

Paul O'Bryan

It may be best to not use the word syndication in this case. That will just confuse things. This does not meet the SEC’s definition of a security. I believe all you would need is a simple LLC and operating agreement. You do not need to seek a securities attorney who specializes in real estate syndication.
Having an attorney who is well-versed in real estate operating agreements would be very helpful. They can help you think of scenarios to ensure you’re getting everything on paper before purchasing the property.
It wouldn’t hurt to consult a real estate attorney and CPA regarding the pros and cons of setting this up as a trust of some sort.

Originally posted by @Paul OBryan :

A few like-minded friends and I are considering pooling our resources and purchasing a piece of raw land in a desirable area (Malibu) and are wondering if a syndication with a LLC shell might be the best entity for this. I use the term "non-investment" because the land would be for future development and use by the investors and would not be principally a vehicle for making money. Of course, there is always the possibility of liquidating the property at some undetermined future date and splitting the proposed profits on appreciation, but this is not the stated goal.

The goal is to develop some living quarters and communal space which friends and family can use for their enjoyment with the probability that any number of the partners may retire there at some point. I know, it maybe sounds like some hippy commune real estate nightmare scenario, but we want to try to realistically work out a solid, grounded scenario that we envision. 

I read a BP forum post from a few years back that provided some general guidelines into setting up a syndication (thank you @Lew Payne): https://www.biggerpockets.com/forums/311/topics/18...

"You set up such syndication entities by clearly establishing their purpose and goals, the benefits to investors, the exit strategy, the management strategy, and the processes for handling disputes, change in membership due to estate or bankruptcy of a member, the process for winding-down a series, and the overall exit strategy. Once you've done that, you confer with an attorney experienced in real estate syndication, and retain him."

I'm wondering if anyone else has any thoughts or insights to share.

Thank you

Paul O'Bryan

Paul, 

I suggest documenting your intent to hold the land as an investment property rather than a development related property.

If you do any development on this land in future , documenting your intent as investment peppery now will give you ability to use capital gain rate on your land appreciation.

If not, if you ever do development and sell houses, you will pay ordinary tax rate on entire gain related to development and land appreciation. 

However, if you document you intent to hold the land for now , and before developing the house, sell the land to a  new s corps doing the development, the gain on the land will be capital gain rate.  You will save significant amount of tax. 

Also, you can use LLc to hold land and for development use a S Corp to save Selfemployment Tax on the development. 

Hope that makes sense. 

Thank you @Steeve Breton and @Ashish Acharya .

Steeve, that makes perfect sense... if it's not an investment property, but if we document it as an investment property per Ashish's tax savings suggestion, would we still go the LLC and operating agreement route and avoid the word "syndication"? I guess, setting up a "trust" might be the answer?

Either way, talking to an RE attorney seems like a smart strategy.

Here's another question, which I should have asked as part of my first query (and maybe should post it as a new forum entry): 

Can we get conventional financing with this "investment trust" and put down 20-25%? Asked another way: What kind of partnership entity would be the best to get conventional financing?

And if we cannot get conventional financing, could we get some other kind of financing? 

Thank you

Just do a JV.

@Lane Kawaoka What do you mean by joint venture? How the partnership is set up?

@Paul OBryan

To start, I second @Steeve Breton 's advice: forget the word "syndication" - it's not applicable to what you're planning.

You need a legal structure for multiple people pulling their resources for a project. It's either a partnership or a JV. They're similar, but they have distinctions that should be explained by a lawyer, and I'm not one.

Which one of them is easier for financing is a question for - you guessed it - a lender, and I'm not one, either.

For tax purposes, partnerships and JVs are the same: a partnership.

A partnership may choose a different form of taxation, such as an S-corporation, for some specific tax benefits down the road, as @Ashish Acharya referred to. I feel that it is too early to consider that. Once you cross that bridge - i.e. ready to start development - then you should discuss creating a separate entity for that and maybe, as Ashish suggested, make it an S-corporation.

For now, it should be either a partnership or a JV - depending on an attorney's recommendation and partially on a lender's input. An attorney may add an extra layer of a trust in your setup if they feel it is warranted.

A very important warning, based on my 20 years of seeing these types of arrangements: investors tend to take shortcuts in setting up these deals. After all, we're friends, and if something happens - we will figure it out. But when stuff hits the fan, it is too late. I know many people who ended up regretting not thinking through various "what-if" scenarios upfront and documenting them. Think prenuptial agreements - basically the same concept. Leave it to chance only when you do not mind losing everything if things go wrong.

@Michael Plaks  

Michael, thank you for your reply. Talk to an attorney and lender, and don't cut corners--excellent advice. Much appreciated.

@Paul OBryan You've received good recommendations from @Steeve Breton and @Ashish Acharya

You don't need anything fancy. You can create a partnership outlining the duties and responsibilities of each partner. I would follow Ashish's advice for tax efficiency. 

You are opening yourself to unnecessary scrutiny anytime you get into complex structures.

Securing financing on raw land is always hard - with or without any structure. The 20-25% down thig doesn't work because it is not throwing off any income (till you develop). 

Your best bet would to be either use private money or start working with specialized lenders. Raw land investment is very risky and most lenders shy away from it.

I second that. From what I understand, financing on raw land at 20-25% equity is almost impossible.

@Paul OBryan To make it easier for you and your friends, you may want to look into "tenancy in common" ownership. This type of ownership allows each owner to leave his share of ownership to his beneficiaries upon death. All investment is  owned equally by the group. One of more of co-tenants may buy out another tenant if they'd like to dissolve tenancy in common at some point later. 

Regardless, which type of ownership you and your friends chose, I think you should always run it by real estate attorney for the best advice.

Best!

@Paul OBryan Seek a real estate attorney to help you and your friends determine the best structure based on your plans. They'll ask a lot of questions that have not yet been asked here. They can explain the differences between going with a JV vs. LLC vs. TIC and pros/cons of each.

I like the LLC b/c TICs can be an issue when one of you wants out, gets divorced, or files bankruptcy. It can put the TIC in jeopardy. Also, financing is often difficult under a TIC with several members (b/c banks know about my first point on TICs).

LLCs also provide liability protection that a JV or TIC will not. If someone gets hurt on the property and sues, I believe you're all jointly liable and they can come after all of your assets. With the LLC your liability is capped at your interest in the LLC.

The downside to the LLC is that you have to file the annual fees/tax, which in some states is only $100 or $200, but in California it's $800!

As you can see, there are so many options.  Please consult with professionals on this.  It will be money well spent.  .... I am not an attorney or CPA and in this case you should probably seek the advice of both.

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