If you want to buy a publicly-traded stock, you can review its prospectus, the SEC-mandated report outlining the details of that offering. But, the SEC doesn’t require these reports for privately-offered real estate syndications. Instead, syndications include a report known as a private placement memorandum, or PPM, that outlines the key elements of a deal. As such, investors considering a real estate syndication must understand how to read a PPM, which we’ll discuss in this article.
Specifically, we’ll cover the following topics:
- Real Estate Syndications and PPMs
- How to Read a Syndication PPM
- Final Thoughts
Real Estate Syndications and PPMs
Syndication Overview
With commercial real estate, developers and investors often find great deals but lack the capital to execute. Conversely, many passive investors want a return on their investment but lack the time or expertise to find and lead a real estate deal.
Real estate syndication solves both problems. With the syndication model, a deal syndicator (also known as a sponsor), finds, underwrites, and executes a commercial real estate deal. As part of that underwriting process, the syndicator identifies the cash gap, that is, the difference between the cash required and the cash he plans on personally contributing.
With this cash gap and the deal’s projected returns identified, the sponsor pitches the deal to potential investors. In a commonly-used syndication model, the investors receive a minimum required return – paid out prior to the syndicator receiving a return on his equity investment. If the deal’s performance exceeds this minimum return, the syndicator receives a disproportionate amount of that upside through his catch-up return and promoted interest distributions. This set-up A) protects the investors, and B) incentivizes the syndicator.
The Role of the PPM
Sponsors create a legal document known as a private placement memorandum, or PPM, that outlines the details of the syndication. As the name suggests, PPMs are used in privately-offered deals, that is, deals that, due to one of several exemptions, do not need to be registered with the SEC.
Unlike a deal “pitch deck,” PPMs do not serve primarily as marketing tools. Rather, they function as a disclosure, explaining the overview, investment terms, risk factors, and supporting analysis of a given real estate syndication. Armed with this PPM information, a potential investor should be able to make an informed decision about whether or not to join a given deal.
How to Read a Syndication PPM
Due to the private nature of these real estate syndications, no SEC-mandated template exists for putting together a PPM. But, most of these disclosures follow a similar pattern. In this section, we outline the major parts you can expect to see in a PPM. While the naming convention and sequencing may vary, the general content will remain consistent.
Part 1: Introduction
The first section of the PPM introduces the company or individual sponsor behind the syndication, a high-level deal description, projected returns, and any potential state- and/or federal-government required disclaimers.
The introduction also generally includes a table of contents outlining the remainder of the document. For investors who haven’t studied a PPM before, this table provides a solid overview of the “shape” of the document.
Part 2: Syndication Deal Overview
This section includes a term sheet outlining the specifics of the syndication offering. Details will include the equity structure before and after the offering. Often, the deal sponsor will hold 100% of the equity prior to soliciting outside investors. Once the deal has been fully capitalized, sponsor equity generally decreases to 5% to 10%, with investors members holding the remaining equity. A description of this post-investment equity structure will likely also include the deal’s cash waterfall, or instructions on how cash distributions will be made.
The term sheet will likely also highlight the provisions that protect investors. For instance, most syndications provide investors a minimum required return that must be reached before the sponsor earns a return.
Part 3: Risk Factors
This section highlights the risks faced by the syndication and its members. These risks include both general risks common to commercial real estate investing and risks specific to the particular deal. For example, interest rate risk (i.e. rates increasing and derailing a deal’s profitability) are common to the industry as a whole. On the other hand, risks of a local zoning board not approving a syndication’s development plans would be a deal-specific risk.
These risks are often described in dense “legalese,” having been drawn up by a real estate attorney. Unfortunately, this writing style leads many investors to quickly scan the risk section without truly understanding it. Don’t do this! This section highlights the items that could cause the deal to fail, and it provides key insight into the deal sponsor’s views on risk.
Part 4: Sponsor and Syndication Team Description
When you invest in a syndication, you invest in the people behind that deal – the sponsor and other syndication team members. Depending on the deal, in addition to the sponsor, these other team members likely include a design team, general contractor, property manager, lender, real estate attorney, and asset management accountant, at a minimum.
This section will provide background information on the above individuals. Similar to the risk section, you’ll want to closely review the experience of this team. Has the sponsor led successful syndications in the past? Has he worked with this particular syndication team? Experience drives success in commercial real estate, so you’ll want to confirm that the syndication team has an established track record.
Part 5: Sources and Uses
The PPM sources and uses section, as the name suggests, outlines A) all funding sources, both debt and equity, and B) how that funding will be used (e.g. acquisition, construction period, sponsor fees, etc.). The clear breakdown of sources and uses confirms to investors that their contributed funds will be used as advertised.
Part 6: Investor Instructions
This section provides the technical details on how to invest in the syndication. Instructions generally include information about contact details, how to make a cash contribution, and the legal steps to join the deal.
Part 7: Supporting Exhibits
The supporting exhibits can be likened to a PPM’s “back-up slides.” That is, they include all the detailed information and supporting documentation that went into building the deal and its PPM. Common exhibits include:
- Deal pro forma and other underwriting documents
- Rent comps
- Design plans and G/C contracts
- Engineering studies
- Environmental survey results
- Zoning approval or other correspondence with planning and zoning departments
Closely reviewing this information helps investors identify the assumptions a sponsor has made and whether or not those assumptions are valid. For example, the introduction section may project a 12% total deal return. But, you’ll need to look into the exhibits to confirm whether that return is based on projected rents that actually align with market realities (i.e. local comps).
Final Thoughts
Even with the information in this article, new investors may feel overwhelmed the first few times they review a syndication’s PPM. At High Peaks Capital, we can help! Our team has extensive experience analyzing and investing in real estate syndications. We use this experience to help you navigate the ins and outs of different deals and their associated PPMs.
If you’d like to discuss different real estate investing options for your unique situation, we’d love to chat! Drop us a note, and we’ll set up a meeting to talk about available passive real estate investment opportunities – and how to analyze them.