Apartment Syndication: How-To Guide
All the steps needed to set-up a private real estate offering
A regular feature I do is called “Deal or No Deal”, where I find a random property on the internet and go through my underwriting process to determine if it is worth buying.
In previous articles, I outlined how-to:
If you have investors, this article will focus on the final step of the acquisition process: Setting up an apartment syndication (private offering).
Disclaimer: I am not a business or securities lawyer (yuck). This is not legal advice. You will need professional legal advice to do this properly. No way around it. But I’m assuming you know how to read and fill out forms, so some of this you can do yourself.
What’s An Apartment Syndication?
This article is specific to setting up a basic apartment syndication. If you don’t know what that is, go spend some time on Google reading about it before diving in. It’s just a fancy way of saying a coordinated effort to pool investor money to buy a property.
So, You Want To Take On Investors
You’ve bought a few investment properties on your own the last few years and you’ve absolutely killed it. Pat yourself on the back. It’s all you, champ.
You now want to start taking advantage of all that sweet, sweet investor capital you keep reading about on Twitter. You dream at night of those beautiful 3% acquisition fees and 50% promotes that all the Twitter famous GPs like to talk about.
So how do you go about legally having investors back the Brinks truck up to your door and dump piles of cash for you to invest?
Selling A Security
When you take $0.01 from someone to invest in your real estate deal, you have just sold a security. In order to legally do this, there are a bunch of steps required. While private offerings like apartment syndications do not have to be registered with the SEC like a public offering (expensive and time consuming), the process for a private real estate deal still requires “registering” your apartment syndication with the SEC to stay out of Federal prison.
The SEC offers a bunch of exemptions for capital raising for private placement offerings (more on this below), so it isn’t super hard to register. It’s one of the few things the gubmint has done right.
A private offering is a much simpler process than a public offering and doesn’t take much time or expense to do, so there really isn’t a reason not to do it. Can’t have those SEC goons breaking down your door at 2 am just to save a few hours of your time and a few bucks.
Pro Tip: If a General Partner is not planning to register their offering with the SEC because it’s just “friends and family”, run away very fast.
Step-By-Step Guide For Simpletons
Here’s all the steps in the order that I generally do them. It’s not necessary to be in this order, but might save you some time in the long run. In addition to the SEC filing mentioned previously, there are various legal docs that also need to be created along the way.
1. Choose An LLC Name
Keep it simple. Trying to be witty or creative is a waste of time and you’ll probably regret it later when you are on syndication 273. And remember this is the name that resident’s will likely send rent payments to. “My Road To Riches Off The Backs Of The Working Class LLC”, while completely true, probably isn’t a great choice for a name.
One purpose of an LLC is to provide anonymity to ownership, so it’s not a great idea to put your name, initials or anything that can be personally tied back to you in the name. My methodology for naming is to use a number and just iterate: 471 Properties LLC, 472 Properties LLC, etc.
2. Search Databases
There are a couple databases you want to search to make sure your LLC name is not already taken.
State Database: Whatever state you will be incorporating, go to the secretary of state’s website and find the searchable corporate database. Do a search for your exact name and also pieces of the name. Your LLC may get rejected if it is similar to an existing LLC.
SEC Database: Prior to filing with the SEC, you need to set-up an account on the Electronic Data Gathering, Analysis, and Retrieval system (EDGAR). There’s a database you can search here (website appears to have been created in 1997 lol) to make sure there isn’t an existing entity with the same name. Duplicate names are allowed with a notation on the EDGAR account set-up, but it’s just easier to avoid any duplication.
3. File LLC Application
This is the legal entity that will own the property.
The difficulty and expense will depend on the state you are filing in. The state I typically file in is ridiculously easy and can be done in 15 minutes without a lawyer. The only thing I need is a registered agent that lives in the state since I’m not a resident. My real estate attorney is my registered agent. This also allows anonymity as my personal name is not shown in the public database.
4. Get An Employer Identification Number (EIN)
You will need this to open up bank accounts, files taxes, etc. as the LLC.
Go to the IRS EIN website and fill out an application. With any luck, the automated system doesn’t have an issue with your LLC name, and it just spits out the EIN number. This is one reason I do the step 2 search first. I have filed LLCs with the state with no name issues on state database, but was rejected for the automated online EIN number because it was too close of a match to an existing entity. The step 2 search may not be a total mitigation of a name issue, but it helps.
Resolving an EIN LLC name issue is painful:
Call the IRS and sit on hold for about 90 minutes.
Answer 713 questions before they finally tell you your LLC name is too close to another one and that’s why the automated system rejected it.
Smash your head against the desk after they tell you to go download form SS-4 and then TO FAX IT TO THEM AT 855-641-6935 AND THEY MIGHT GET IT PROCESSED IN 20 BUSINESS DAYS. Yes, this has happened to me twice in the last three years. Brutal.
5. Create LLC Operating Agreement
This is the property level agreement that spells out all the terms between the general partner (deal sponsor) and limited partners (investors).
This will be full of legal mumbo jumbo, 50% of which you won’t understand. This needs to be written by a lawyer. Cost will depend on how anal your lawyer is. But plan on in the thousands.
6. Create Private Placement Memorandum (PPM)
This is a “plain English” document that outlines the terms of the offering.
It is required by the SEC to be distributed to investors. It contains the important sections of the operating agreement in language a 5th grader can understand, along with providing a list of every risk possible up to and including nuclear war (lol). It’s like a mutual fund prospectus - nobody will read it, but you have to provide it. The PPM also includes the property business plan, which many times is just the existing investor pitch deck inserted into the document.
At this point, you will need to decide the type of offering you will be doing as that is included in the PPM. The SEC has a nice table here with all the exempt offering types.
Most syndications are either Rule 506(b) or 506(c). There are actually a bunch of different offering types beyond this, but I believe the reason most are 506(b) or (c) is because all states recognize these SEC offerings (more on the SEC and state filings later), so there aren’t a bunch of extra hoops to jump through at the state level to register.
The two main differences between rule 506(b) and rule 506(c) are:
(b) allows accredited investors and up to 35 “sophisticated investors”. (c) only allows accredited investors. A sophisticated investor “must have sufficient knowledge and experience in financial and business matters to make them capable of evaluating the merits and risks of the prospective investment” per the SEC.
(c) allows for general solicitation, i.e., Tweeting non-stop begging people for money is OK. (b) does not allow any public statements about your offering.
The PPM is another document that needs to be written by a lawyer, specifically a lawyer well versed in real estate securities. Cost is probably about $10,000, even though the lawyer is just recycling a template they wrote 15 years ago. C’est la vie.
7. Create Subscription Agreement
This is a legally binding document provided to investors where they make a formal commitment to fund your investment.
This document also may contain the “accredited investor form” where your investors state they meet the SEC requirements of an accredited investor. There’s a bunch of these online you can download for free or make your own.
If you are registering as a 506(c), you must take “reasonable steps” to verify all investors are accredited. A 506(b) does not require “reasonable steps”, just a signed form. The SEC has defined what these reasonable steps are here, all of which require some level of financial review of each investor. The easiest way to verify accredited status is to use a third party service like verifyinvestor.com.
The subscription agreement is another lawyer document, cost again depends on how anal your lawyer is. Or YOLO and download a template online.
8. Create Other Miscellaneous Docs As Needed
Depending on the state your LLC exists in, you may have additional documents to provide to investors or receive signatures on.
For example, a state I am familiar with requires an affidavit signed by every out-of-state investor saying they will pay taxes to the LLC state. Of course, the form requires social security numbers, so now I have the responsibility of properly encrypting and storing these documents. Thanks, gubmint!
9. Bundle Docs And Send To Investors
You want to get all your docs prepped ahead of time and send to investors one time for their signature. Nothing says “I’m completely unorganized and don’t know what I’m doing” when you send investors docs several times for signatures.
Docusign or HelloSign are good apps to use for keeping track of signatures and you can create templates, so it’s a fairly automated process.
10. File With The SEC
This step is where you formally “register” your private offering with the SEC. There is no cost to do this. You must do this within 15 days of selling the security - that means receiving a signed subscription agreement, not taking actual money.
There are several steps to this, but not too onerous if you follow the process exactly.
Create an account for your LLC on EDGAR following these directions. Requires a notarized form (ugh) to submit.
Once you receive EDGAR access, submit Form D following these directions.
11. File With States
This step is where you formally register your private offering WITH EVERY STATE YOU HAVE AN INVESTOR RESIDING IN. The time-frame this must be done is state dependent, but the states I’m familiar with follow the 15 day SEC timing.
This website is helpful to find the securities regulator website for each state: nasaa.org/contact-your-regulator/
Registering with states is a total money grab and seems to add zero value/protection to the investor. States cannot supersede the SEC, so you are literally just mailing in SEC Form D and a check for whatever amount the state government wants to take from you. New York state is an example of getting greedy and creating an onerous process that overreaches past the SEC rules, so many don’t bother registering in New York because their requirements are unenforceable. Galaxy brains.
State registrations are where things can get time consuming and a bit expensive if you have investors from a ton of different states. But if you’re that big, you have a staff doing all this grunt work, so who cares. I’m a small-time chump and only have a handful of investors from a few states, so it isn’t too difficult for me.
A couple states I am familiar with are Massachusetts and Florida. Florida is awesome - they require no registration. The security law is basically written as “we trust you until we don’t, so just follow the rules and we won’t need Moose and Rocco to pay you a visit”.
Massachusetts is typical I think of many states. Mail in the Form D, a check (amount depending how big your offering is), and a consent to service of process form (agreeing to be served court documents for when you are inevitably sued - lol).
12. Document Everything
Assuming you want to scale your syndication business, takes notes on this process along the way for future reference. I was able to write this article fairly quickly because I had written down all the steps to register with the SEC and states several years ago, including specific links to the various laws, regulations, etc.
And That’s All Folks
You have just learned in 10 minutes what took me many hours to figure out several years ago. Now go get them fees!
This is great info. Thanks for putting it together.
SEC registration sounds like a big detractor, especially for smaller deals, to do syndications. I know there's several items that make a difference in the aggregate cost of setting this up (number of state registrations, number of investors, etc), but do you have a benchmark in terms of size of deal when this starts to make sense? For example, I know this won't make sense for a 500k, but for a 2M purchase? 5M? etc.
Also, is this something that can be done by a one man show + tools such as verify investor and external resources such as lawyers? I'm guessing it requires a team or the admin work will kill you.
Lastly, do you use any tools/systems/services for reporting?