What Do Partners Want?
Hello everyone,
I have located several properties, completed due diligence and am now ready to seek out a partner(s) to finance the deals. I am creating a professional-looking package for potential partners--documenting the financials and other particulars of each individual property; composing bio info on myself and the contractor I will use; and obtaining pics of the properties. Next on to-do list: place classified ads in local newspapers.
Some of the properties make more sense as rehabs and quick turn sales. Others with less equity make more sense to hold onto for a while as short term LOs or LCs.
My question is: Would partners be looking for a high interest return on their investment or a split on the spread when the property sells? Or should the choices be a part of the conversation with potential investors?
Amelia :-?
Thanks. For the deals I'm proposing, I was looking in the neighborhood of 24% ROI. Will keep digging for info. Thanks again.
Amelia
Three things:
1) do NOT promise investors 24% ROI (or any other rate of return). To do so is a violation of securities laws.
2) if you thougt the project was going to make that kind of money here's what i would do: A LLC or LP with a profit split that goes like this, the investor gets 100% of any profits up until they have a 10% ROI annualized. Above that number you split 50/50.
3) my own opinion is that an ad in the newspaper for investors is a violation of the private placement rules of the SEC act. I know its done all the time but I'd be really nervous.
[ Edited by commercialking on Date 06/20/2004 ]
Commercialking,
Whew! I had no idea promising a certain dollar amount or percentage for ROI was illegal. I thought it would be similar to a bank asking for a certain amount of interest on a loan, then amortizing the payments so you know exactly how much you're paying.
I certainly don't want to break the law, whether or not I get "caught." I am not incorporated, so am I still bound by SEC law?
Amelia
Real estate securties are exempt from certain parts of federal law. The key here for you is to check your local state law.
"Real estate securties are exempt from certain parts of federal law. The key here for you is to check your local state law."
Not true, and even the little bit of truth is true only in a very misleading way.
Real estate transactions are not securities and are, therefore, exempt from the provisions of the SEC act. However real estate securities are regulated by the SEC act. Unfortunately it is pretty easy to move across the line from one to the other. Accepting partners is one way to make the move.
If the justice department decides that what you are doing is dealing in securities then you are not exempt even if those securities were backed by real estate.
Now then, there are certain kinds of securities transactions which are exempt from certain parts of the SEC act. Specifically, as it most often applies to Real Estate, Private Placements. Private placements may not have more than 35 unqualified investors and those investors may not be located as a result of "generally soliciting the public." Short of a TV ad I cannot think of a more efficient way of "generally soliciting the public" than taking out an ad in the newspaper.
However, even if you qualify for a Private Placement exemption you are exempt only from the registration requirements of the SEC act. The fraud provisions remain in force. It is clear that promising a rate of return falls under the definition of fraud in the act unless you have somebody (usually an insurance company with deep pockets or the FDIC) willing to guarantee that rate of return. This is why every ad for a mutual fund (a securities vehicle requireing registration) contains the language: "past performance is no guarantee of future returns".
In short, if you sell the property to an investor you are probably exempt from the SEC act. If however you accept an investor as a partner as Amelia appears to be considering doing then you are not exempt from the SEC act.
To show you how easy it is to move from a real estate transaction to a securities transaction: A good friend has just finished 42 months as a guest in the Federal Prison Camp because he accepted partners in certain mortgage notes. A mortgage is an exempt transaction because it is a real estate transaction. However, when he sold partial interests in the mortgages those interests were not real estate transaction but were a security. By virtue of that small difference he did more time that Martha Stewart or Ken Lay will.
As I have pointed out many times on these boards this is a highly regulated portion of the business and the penalties are severe. Enter at your own risk and get good legal counsel, which this post does not pretend to be, before you you go.
Well, it does look like it's time for me to talk to an RE atty. But I think I see the fine line between a mortgage and a security. If an investor offers me a loan on a property and charges a certain amount of interest (that's not so high it constitutes usury), that is a mortgage. However, if I solicit investors with an implication (not a promise) of profit, that is a security.
Am I getting this?
Amelia
And I should add that by soliciting investors, I'm not talking about an infomercial. I'm talking about something that would be considered private placement--finding people through word-of-mouth, friends, relatives, etc.
. I've seen on other sites information that encourages newbies to run out, place ads and get people to raid their IRAs. I had the feeling something was amiss, but after reading your posts, that seems a little, um, irresponsible.
The fact that your friend, Commercialking, spent time "camping," gives me pause (and the willies<g>
Amelia
If an investor takes an equity stake in the property (there name is on the deed) you don't have any problem.
If you are soliticing an investor to give you cash to purchase the property you will have violated the law but I have never heard of anyone being prosecuted for this type of transaction. To solicit for investors you should file a Reg D offering but realistically nobody (in situations like this) ever do. Just go down to your local REIA meeting and you'll see guys breaking this law the entire meeting. Almost every website on the Internet that deals with REI solicits for private investors and nobody walks away in shackles.
Talk to a lawyer and ask them about the practical and realistic applications of the law.
Well, to work my way back up this post.
In essence the Securities Act of 1933 requires the registration of all securities not exempt from registration. The most basic sort of registration is carried forth under the rules set forth in Regulation D of the Securities Exchange commission rules and is therefore called a Reg D filing. A reg D filing is required for all securities sold to the general public unless those securities are covered under some other regulation which is even more rigorous. Although the definition of general solicitation is unclear your local REI group probably does not qualify as the general public. Therefore you are not required to file a reg D to talk about your three-flat partnership. The purpose of this exemption was to make it possible for start-ups and family companies to avoid expensive registration requirements before you could talk to your brother-in-law about kicking in $5,000 for that butcher shop you always wanted to operate.
So Jfruend is wrong that such a filing is necessary and that the SEC or the Department of Justice is simply not enforcing the act. As long as you do not generally solicit the public you are not required to register the security.
By the way the act also requires persons collecting a commission for selling securities to have a license. However it also exempts principles or others who get paid primarily for other duties in the company and who sell securities only incidentaly to their other activites.
Now then, turning to jFreud's claim that these provisions are unenforced there is some truth to this, in the same way that speeding laws are frequently unenforced. If you ask why you didn't get a speeding ticket when you drove 90 mph on the way to work this morning the answer would be, "because no policeman was there with a radar gun." I.e. you didn't get caught. That is not quite the same as saying the law is unenforced. If, as a result of going 90 you run off the road and plow through farmer Jones' chicken coop and kill all the chickens the police are going to come out and, in all probablilty, give you a speeding ticket (along with reckless operation) so that Farmer Jones can try to collect for all those dead chickens and broken eggs.
The enforcement of the provisions of the SE act is similar. No one will care if you violate this act as long as none of your investors loose any money. But let a deal go south and someone is likely to be upset and upset people tend to look around for people to complain to. If they happen to come across the justice department or the SEC then you can count on federal officers with guns and badges asking you about how you went about finding these investors in the first place. If one or more of your investors were little old ladies who are not related to you and who lost their pin money you can expect to spend a great deal of money on lawyers who practice in the federal courthouse.
Now then, the SE act also makes it a criminal and civil tort to make untrue statements in the sale of any security, even one exempt from registration. The law even specifies that omiting some piece of information necessary to prevent some otherwise true statement from being misleading is fraud. The SEC has made it clear that they consider any statement implying a rate of return to be misleading unless it includes a statement that the return is a projection and is not guaranteed.
Just because jFreud doesn't know anybody who's been hauled off for this doesn't count for much. I know several (though only one who actually did time), but maybe he hangs out with a better class of people than I do.
Finally (at least for this round):
"Well, it does look like it's time for me to talk to an RE atty."
Yes, but make sure he knows something about securities law as well. Even many real estate attnys are not very well versed in these matters.
"But I think I see the fine line between a mortgage and a security. If an investor offers me a loan on a property and charges a certain amount of interest (that's not so high it constitutes usury), that is a mortgage. However, if I solicit investors with an implication (not a promise) of profit, that is a security.
No, not quite. Even the interest-rate vehicle could be a security if the investor does not usually make such deals (i.e. if he's unqualified), if you found him through a newspaper ad and if he looses his money. The justice/SEC guys are more likely to be willing to go this route if they think your investor is unsophisticated.
And your second scenerio might not be a security. If that investor's name were on the title to the property then this is more likely to be interepreted as a real estate transaction and therefore not a security.
The point is that securities law is extreemly complicated in part because it has a very broad and general purpose-- to prevent the general public from being taken advantage of by unscrupulous promoters of investment schemes. Every rule in the book is subject to exception if the officials come to believe that you were taking advantage of "little old ladies". Likewise, they are likely to overlook even pretty large violations if the only people who loose their money were smart guys who should have known better-- another reason your local REI club is probably safe.
This is what I learned in school since yesterday:
1. Don't solicit $$ from the general public. Newspaper ads soliciting investors put me at risk for receiving a "go directly to jail" card.
2. Don't be careless. I intend to do RE transactions, not sell securities. Make sure I know the differences. Ignorance is no excuse.
3. Ask for help. I need to keep talking with seasoned investors and a knowledgeable attorney. I'd rather look like a neophyte in NE Ohio than a criminal in Leavenworth, KS.
Thanks for all your responses. I'll keep you posted on my progress. BTW, Commercialking, I know a lot more about writing than I do about REI, so if you ever decide to write a book....<g>
Amelia
Well thank you Amelia, what a nice offer.
Yes, I think you did quite well at summarizing the lessons of the day.