At long last, the real estate investment market is beginning to show signs of life. Commercial and industrial property transactions are increasingly common, and multifamily properties of all sizes are being snapped up by investors. Historically low interest rates, high occupancy rates, increasing rental rates, and rising property values are contributing factors.
Early transactions have often been cash deals, where the investor paid cash for the property rather than seek financing. This can be a great opportunity to achieve high yields for investors flush with cash, but what about everyone else? What about potential investors who have limited cash on hand?
Unlike the easy-credit days preceding the Great Recession, real estate investment financing is more difficult to obtain and requires a significantly higher equity contribution by investors. Common loan to value ratios are 60% to 65%, which means that for each $1,000,000 the investor needs, the investor can likely borrow only $600,000 to $650,000. Consequently, the investor must come up with between $350,000 and $400,000 in equity for each $1,000,000 of purchase price. For many investors, this may not be an easy task.
Solution? Go back to the way we did things in the old days – before the days of easy, near 100% financing: pool funds with other like-minded investors.
1. Private Placement Memorandum (PPM)
When raising capital from investors, keep in mind that you are engaged in a securities offering governed by state, and perhaps federal, securities laws. This is true even if the money is being invested by friends and family. A PPM is advisable to protect against claims by investors that the investment turned out to be other than what it was portrayed to be. This is particularly important if the investment goes bad – as investments sometimes do.
2. Compliance and Disclosure
PPM’s for real estate investments need not be particularly complicated, but they need to comply with applicable securities laws and include the disclosures and information necessary to protect the promoter from liability. The promoter must be particularly cautious if funds are being obtained from investors other than “accredited investors” as that term is defined by Rule 501 of Regulation D. Helping promoters comply with the law while raising capital is a key function for lawyers.
3. Consult an Expert
In September 2013, as required by the Jumpstart Our Business Startups Act (JOBS Act), new rules were established by the U.S. Securities and Exchange Commission to permit general solicitation or general advertising for certain securities offerings limited to accredited investors only. While this may prove helpful to promoters’ efforts to find investors and raise funds, the importance of a carefully crafted PPM has not diminished. Thoughtful promoters and lawyers will recognize that a well-crafted PPM may now be more important than ever.
Raising capital through a private offering of securities is a viable strategy for real estate investment, but it must be done with skill and great care. Failure to fully comply with the law can be financially catastrophic. Take care to do it right.
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