Investors should take the time to fully understand the investments they're making, especially when it comes to the significant amount of money usually required for private real estate offerings. Understanding what a private placement memorandum is, what it includes, and what to look for is a major step in understanding those investments.
What is a private placement memorandum?
A private placement memorandum (PPM) is an offering document provided by a private company that lays out the details and disclosures of a private real estate offering. A private placement memorandum is often referred to as an offering memorandum or a disclosure document. This document is similar to the prospectus public companies provide when issuing a public offering.
When you're reviewing an investment opportunity, the PPM should include all the information you'll need to make an investment decision. These documents can be extremely lengthy, but they contain important information throughout that will be important to know as an investor.
When is a private placement memorandum used?
When it comes to real estate, a PPM is used when a business is selling securities for any type of private real estate offering. These private offerings may include:
Private placement memorandums aren't always required in a private securities offering. For instance, crowdfunding deals being sold using Rule 506(c) of Regulation D under the Securities Act aren't required by the Securities and Exchange Commission (SEC) to provide a PPM, or any disclosures, to prospective investors.
As a real estate investor, you should be very cautious about purchasing any securities where the issuer doesn't provide you with an offering memorandum. While they may not always be required, any information the issuer provides is required to be accurate. There are a lot of things to consider when reviewing a potential investment, and not having all the details of the offering will make it very difficult to make an informed decision.
As somebody selling securities, it's important to provide a prospective investor with a PPM. For one, you won't likely find very many investors willing to trust you with their money if you don't provide one. Providing one can also help you avoid any misunderstandings that could result in a potential lawsuit later. You want to disclose all of the potential risks, costs, and details on how the investor will be paid back. Unpleasant surprises for them can result in unpleasant surprises for you.
What's included in a PPM?
A private placement memorandum will typically have multiple sections that will cover different aspects of the deal. They should be well organized and easy to reference. Let's take a look at the common sections of a PPM and what they include.
The introduction is a very brief overview of the company and the investment. It's like a one-page flyer. This gives the private investor an idea of what the investment is and who they're investing with.
The investment summary will get into more details about the investment. This will provide property details and highlights of the investment offering.
This section will lay out the risks involved in the investment. This will normally include the general risks present with any real estate investment as well as any risks specific to this particular deal. They may have to do with potential issues with the property, the local market, or tenant issues.
Company and management
This section of the PPM will detail for the investor who they're investing with. This will explain the company's track record, its financial condition, and the people involved as well as their personal experience and track record.
Use of proceeds
This will describe exactly how the proceeds that are collected from the investors will be used. Common uses include the down payment on the property, renovations, and closing costs.
This is the term sheet that explains details such as the minimum investment, the expected rate of return, and the expected length of the investment term. This will also explain how the equity will be split between the issuer and investors and how distributions will be handled.
There are often a handful of fees that go along with a private placement offering. These may include acquisition fees, loan fees, asset management fees, disposition fees, and so forth.
Liquidity and transferability
Most private real estate deals are long-term investments. This section will tell the investor whether there are any sort of redemption options and if the securities can be transferred at any point.
Description of the securities
There are different types of securities companies can offer. This section will describe which type of securities investors will be buying and exactly what it all means.
Timing and location of funds
The investor funds will have to be held somewhere while the offering is open. Some private offerings will require a certain amount of securities to be sold before the offering closes. This section will describe where the funds will be held, the timing of the offering, and what will happen if the offering isn't fully funded.
Conflicts of interest
There may be conflicts of interest with either the company itself or the management team. For instance, one of the managers may be an investor in a property that would be competing for tenants, or one of the managers may be a real estate broker earning a commission when the offering closes. This section will explain any of these conflicts with investors.
This part of the PPM will describe what tax documents will be sent to you each year. This document is normally a K1.
This section may explain whether only accredited investors are allowed to participate and may have a questionnaire to determine whether the potential investor is an accredited investor.
How to invest
This will explain how to invest in the private offering. It should include such information as what subscription documents will be required and how to provide funds.
What other documents go along with a private placement memorandum?
The PPM should be accompanied by other documents related to the deal. This may include supplemental information like a purchase agreement for the real estate, appraisals, closing documents, escrow agent agreements, contracts for renovations, the company's financial statements, or anything else an investor should be able to review. These would normally be attached as exhibits.
The private placement memorandum document should also come with a subscription agreement. This is a legal document between the investor and the issuer. This is where all of the terms of the deal will be agreed to and where the investor will acknowledge that they read the PPM and disclosures.
There may also be an operating agreement if the investor is buying either shares as a limited partner in alimited partnership or membership interest in a limited liability company (LLC). This document lays out how the company is organized, how decisions are made, and who has voting rights.
Reviewing the private placement memorandum
It's a common habit for people to just skim through long documents before signing. This happens all the time at the closing table when someone is signing mortgage documents, buying insurance, or filling out forms at a doctor's office.
When it comes to the PPM for a real estate deal you're considering investing in, it's important to actually take the time to carefully review the documents. Each section may have important disclosures, costs that you may not have been aware of, and details on how profits on the deal will be split. You don't want to be in a situation where you're expecting to get paid out a certain amount of equity at the end only to find out that your return has been eaten up by fees.
Hiring a law firm to review all of the documents may be an expense you don't want to take on, but it may cost you a lot less than getting into an investment you don't fully understand. You'll have a hard time arguing that you weren't aware of something when you signed the document saying you were.
The bottom line
The private placement memorandum is a key document when you're doing your due diligence on a private real estate offering. Your investment is likely to be tied up for at least a few years, so you want to have a clear understanding of what it will be tied up in. Understanding what to look for in the private placement memorandum and taking the time to carefully review it will go a long way in making smart investment decisions.