Real Estate PPM: Mitigating Risk and Maximizing Return on Investment

If you’ve been reading this blog or watching some of my YouTube videos, you know that real estate syndications are one of my favorite investments.

In 2017, my first investment was an apartment syndication in Dallas. It was nerve racking to go through the process the first time as a passive investor.

From reading the offering memorandum and private placement memorandum (real estate PPM) to wiring the money, this can be downright frightening. Many times, investors back out of a deal because they are afraid of the “unknown.”

But once I went through it and began receiving the quarterly cash distributions and tax breaks, it didn’t take long to jump into another deal five months later.

Before wiring the money, you’re faced with having to look over the private placement memorandum (PPM), which is a long document full of legal and financial terms. It’s given by the sponsor and describes the offering, including the business plan for how the money will be used and how the limited partners will make money.

In order for you to fully understand the significant amount of money that’s required to invest in syndications, it’s important to understand the basics of what’s included in the PPM.

Think of it like this: the PPM is to a real estate syndication as a prospectus is to a mutual fund.

It breaks down things such as:

• fees
• risks
• potential returns

In this article, we’ll discuss what to look for when reviewing a private placement memorandum, the purpose of the PPM, when it’s used and what each section of this document means for prospective investors.

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What is a Private Placement Memorandum (PPM)?

A Private Placement Memorandum (PPM) is a document used by an issuer (company) in private investment offerings of securities to provide information to potential investors. 

This legal document contains:

• a thorough description of the property
• terms and conditions of the investment
• a risk factor section
• financial statements

Occasionally investors think a PPM and business plan are the same thing.

They’re not.

A business plan is a tool used to sell a new business idea to investors.

What is a Real Estate PPM?

A sponsor will locate a property and put it under contract in a typical private equity commercial real estate investment deal. Next, a limited liability corporation (LLC) is set up to facilitate the transaction and it’s used to buy the property.

In order to raise money for the deal, shares in the LLC are sold to investors.

A PPM is a requirement for any real estate deals since it helps potential investors make an educated decision. And it’s for this reasons that they’re typically lengthy.

As a side note, before a deal is released to our Passive Investors Circle members, I’ll record a webinar with the sponsor going over the real estate PPM of the specific deal.

When is a PPM Used?

When securities are not registered under applicable state or federal law, a PPM is used in private transactions. This means that the securities are being sold without being registered.

Regarding a real estate offering, when a sponsor is selling securities for a private placement offering then a PPM is used.

They’re essential in real estate investments in order to thoroughly explain the opportunity to potential investors. This disclosure document also provides comprehensive information regarding the risks associated with the investment.

Examples of private offerings are:

• Syndication
• Private equity fund
• Private Real Estate Investment Trust (REITs)
• Crowdfunding
• Real estate fund

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What Information Is Contained in a PPM?

Each document from a private placement I’ve seen from a syndication I’ve invested in has had a similar look due to the specific information that’s required.

Here’s a break down of the key sections and what’s included for individual investors:

Introduction

Gives a brief description of the company and a summary of the private placement that the firm is looking for. This informs potential investors about the company and the investment they are making.

Investment summary

This section provides more details and highlights regarding the property to invest in.

Risk factors

This part of the PPM talks about the possible risks that could come with investing in the deal. Often, it takes up the most space in the entire document.

Risk examples include:

• credit risk – tenants might not pay their rent on time
• liability risks – for accidents that could happen on the premises
• local market – there ‘s a chance that rental rates and/or cap rates will change, which could affect the property’s value
• vacancy risk – tenants may decide not to renew their lease, which could lead to long periods of being vacant.
• financing risks – the sponsor might not be capable of obtaining the funds they need to buy or refinance the business.

Other risks include: tenant issues, existing debts and cybersecurity issues

Company information and management

Here, you can find out more about the company in which you are investing, such as:

• management biographies about each general partner and team member
• company’s financial status
• track record 

Who Can Invest

This lists the different kinds of investors who can take part in the project (mainly accredited investors).

Related video:

Executive Summary of offering

In this part of the document, the sponsors make clear what they want. It’s a summary of the offer’s terms, such as:

• purchase price
• minimum investment
• expected rate of return
• number of shares being sold
• how distributions will be handled
• expected length of investment term

Conflicts of interest

This section talks about any conflicts of interests with the investors. For example, one of the company’s manager could also be a real estate broker that earns a commission after the property closes.

Use of proceeds

This part explains how the investors’ money will be used. 

Examples include:

• closing costs
• down payment
• renovations to the property
• any salaries or bonuses paid

Financial Information

As an investor, you should read this section carefully as it could be one of the most important. You have the right to know how the company you might invest with is doing financially.

This includes:

• historical financials
• expenses
• pro forma financials 
• timeline to achieve profitability
• specific financial risks 

Tax matters

This section informs investors the specific tax documents they can expect annually. All of the syndications I’ve invested in normally provides a K1 tax document.

It also provides other tax matters such as the depreciation expected.

Fees

If you want to know what fees the sponsor charges, this section will tell you about things like:

• acquisition fee
• loan fees
• transaction fees
• asset management fee
• disposition fees

Liquidity and transferability

Investors may need to get their money out of their investments before the property is sold. Most syndications are long-term investments, and this section of the private placement memorandum will tell you if there are any ways to get your money back and if the securities can be transferred at any point.

Timing and location of funds

Most of the time, money is collected and put into an account while the offering is still open.

This section will explain where the funds will be kept, when the offering will take place, and what will happen if the offering doesn’t raise enough money.

How to invest

Usually, the section on how to fund the offering is at the end of the PPM. It tells investors how to send money, such as with a certified check, a wire transfer, etc.

Exhibits

The PPM’s section on exhibits can be thought of as a sort of appendix. It has all the extra information that is needed to support the main the investment decision.

For example, the exhibits could include:

• copies of investment contracts
• detailed proformas
• business plans
• financial statements
• organizational charts of the investment company
• required licenses

Other Documents To Include With a PPM

 A few other possible documents are:

Subscription Agreement

A subscription agreement is a document that spells out the terms of an investment in a private securities offering. Rule 506(b) and 506(c) of Regulation D from the Securities and Exchange Commission (SEC) lays out the general rules and the details of each agreement can be different, depending on how much money was put in.

Operating Agreement

Since the asset is held by a limited liability company, the Operating Agreement tells how the company will be run.

Most of the time, it states:

• who has the power to make decisions
• what happens when members disagree
• how the corporation will end when the property is sold

Offering Memorandum

The “OM” is a marketing document that talks about each of the property’s features. Usually, it has details about the local market, the location, tenants, operating costs, possible cash flow, and a potential investment strategy.

It will also have pictures of the property and maps which indicate where things are located. It is meant to help investors get a feel for the property, which is especially helpful if it is out of market.

Who Creates a PPM?

Most of the time, the PPM is created by the real estate developer or investment company that is presenting the investment opportunity. They might work with lawyers, accountants, and financial experts to put together the document. This assures that the paper follows federal rules about securities and gives potential investors all the information they need.

How Are Prospective Investors Given Access To a PPM?

PPMs are often made available to potential investors in a number of ways. It could be given in person at a meeting with the real estate developer or investment company. Email and online websites can be used for digital distribution.

It may be distributed by some real estate developers and investment companies in collaboration with brokers.

Reviewing The PPM

Deloitte did a study that found that 91% of people agree to legal terms and services without reading them.

Most of the time, before we sign long, important documents like the PPM and insurance forms, we only skim through them. Don’t forget that when you sign the document, you agree to all of the terms of the contract.

So it’s best to take your time and read through the whole thing carefully. If you don’t understand the contract’s terms and conditions, you can consult with a real estate professional or a law firm.

How Do SEC Regulations Apply To Real Estate PPMs?

Regulation D, which exempts real estate PPMs from SEC registration requirements, permits private investment offerings to accredited investors. Real estate developers and investment firms are still required to abide by the SEC’s anti-fraud and anti-manipulation standards.

Bottom Line

A PPM is a legal document offered to potential investors in a private placement offering of real estate. Depending on the transaction, the PPM’s specific contents may vary, but generally speaking, it will have the following sections:

• introduction
• disclosures
• risks
• company description
• offering terms
• fees
• exhibits

The PPM is just one of several documents provided to investors. The operating agreement, subscription agreement, and offering memorandum are additional legal documents.

PPMs are written in complex legal language. The best course of action is always to get advice from a tax advisoe (CPA) or real estate attorney if you aren’t comfortable reading them.

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