Just how does a real estate syndicator or a fund sponsor?
Think about the exit? How are we going to exit out of this
property? What is the mechanisms that we can do that this video
is going to go through the five different ways of exiting out
getting your investors back their money?
My name is Tilden Moschetti. I'm a syndication attorney with the
Moschetti syndication Law Group. Let's go through those five
different ways in order to get out of a property to exit and
then get investors money have that capital event occur. So the
first way is very clear cut, it's probably what you think of
first, well, don't we just sell the asset? Yeah, that's exactly
what you do. You sell the asset. Now, whenever that happens, the
asset gets sold. The money's sitting there. And now what do
you do with it, you just follow through what you told them, Look
at the operating agreement, look at the PPM look at everything
you've told them, and use that like a recipe. For example, if
you've got a waterfall structure with a preferred return and
says, Well, first you give investors the money back, then
you give a preferred return of 8%, just making numbers up here.
And then we've got a 7030 split. So 70% goes to the investors and
30% goes to you the sponsor, you just follow that like a clear
cut example. And then you give everybody and accounting you're
done at the end of the day, that's the most common way that
happens in I mean, that's certainly the way that you're
going to plan will has the possibility of happening because
certainly, it happens probably in 90% of deals. Probably the
second most common way is called a refinance exit. So if the
property value is here, right, but you've also got, the loan
amount is already down here. And so it's got pre existing debt,
or maybe it doesn't have debt at all, what the sponsor can do is
say, Okay, I'm gonna go put debt on it, I'm going to put it up
here. And so now I can give investors that money. So we set
the fair market value, let's say the shareholders own 70% of the
asset. And I'm able to get because it's such a great asset,
I'm able to get a loan to value of 75%, you go to the bank, you
say, give me 75% on the value of the property, and then you go
back to your investors and say, Look, fair market value of this
is, is here, we have this pool of money from refinancing,
here's the money. What it essentially is doing is making
it that you are the sponsor, you the sponsor are buying the
property at fair market value. Now, this has some clear
advantages, it lowers the risk of the deal going sour, and
lowers the risk of not the risk of it sitting around, it lowers
the risk of it not trading for exactly what fair market value
is. The reason the The caveat is you really want to make sure
that you're doing it at fair market. As soon as you come to
the investors with this idea with this proposition of what
you're going to be doing. Shareholders are immediately
going to be a little taken aback. They're going to be
asking themselves, how do I know that I'm really getting fair
market value and not getting taken advantage of that they're
not getting that property for pennies on the dollar, they know
it better than I do. So you need to make sure that the mechanisms
are in place. So your syndication attorney should have
baked in that possibility if it's there to make sure that,
okay, we've got this mechanism will determine fair market value
based on an appraisal by a third party. And then that appraisal
will go to the investor so that they can understand it. They can
ask questions, they can question it. Sometimes if you if we think
we perceive that the trust level might be a little bit less, we
might say and if there's a question on fair market value,
the shareholders themselves can ask for an appraisal, another
appraisal. And if it's off by more than 5%, then we take the
then we can do a third appraisal and we take the average or
whatever that is. So there are mechanisms in order to take care
of that answer. That's a fairly common thing to bake into a real
estate syndication, so that those sponsors are able to
basically keep that property for themselves. The third way that
happens is called a recapitalisation. So through
recapitalisation what, this isn't actually a pure sale. This
is changing the way that whole capital stack happens. So
perhaps let's say that the property was bought for $5
million, it's worth $5 million, and you've decided you want to
recapitalize it, so if it was Buy all cash, right? So that $5
million worth of value and you go to the bank, and they were
willing to give you a loan to value of 50%. So now that's two
and a half million dollars in cash, you can then go to your
investors and say, great news, based on the equity, you know,
you guys own 75% of the equity, we're now going to dole out 75%
of this loan out to you in order to make sure that everybody has
that money. So that's a money that's being paid out. It
reduces it's a return of capital, so reduces their bases,
and basically gets them their money sooner. Why would you do
this? Well, to get their money sooner, it's going to drive up
your IRR like sky high, because now you've gotten them a bulk of
money up front, right, so they've gotten a huge amount of
value, you just want to make sure ultimately, at the end of
the day is that the fees that you're going to pay are worth
it, right, because there's still loan fees and appraisal fees and
all those things that go into recapitalisation. And you want
to make sure that your investors are benefiting out of it at the
end of the day. The fourth way as a way that I oftentimes get
asked, and it sometimes works, but it sometimes doesn't. And
that way is through what's called a 1031 exchange. Now, if
you're in real estate, you probably know what a 1031
exchange is, it's where you take an existing property and you
exchange it for a light kind property, replace the dead
replace the money, things like that. And then you don't have to
pay any gains. So the gains tax never happens, it doesn't
trigger that. Now, the reason I say it sometimes works in
sometimes doesn't is because as an entity as its investment
entity, it can act just like you as a person, it can do this
thing, where it's going into into another property. But where
we sometimes run into problems is if there are people who want
to leave the fund or the syndication, and you want to pay
them out, sometimes we have a problem there. And you really
want to talk to a good qualified tax attorney who specializes in
1031 exchanges will definitely know about this issue, and be
able to help make sure that either it's going to work or
it's not going to work and make sure that it's all done in the
right manner. The last way is through what's called merger or
acquisition. So this is where you take that investment, that
all that equity that's in the investment entity itself, and
you turn it into something that might be through an upgrade into
another REIT. And it might be into a merger into another fund
that another fund buys it out. And gives the investors the
opportunity to either stay in, or in an opportunity in order to
exit. This works sort of like a like a 1031 exchange, or
actually works sort of like an upgrade, but not exactly because
their tax cut, the taxes are a little bit different. But it's
an opportunity for your investors to either stay in if
they really want to, if they're attached to that, that asset or
as a as an ownership or to move out in general. That's not as
common, maybe because the the kind of portfolios that exist is
they're not being absorbed in that way, all the time. It
definitely happens on a larger portfolio, where a REIT might be
interested in buying out the entire portfolio and willing to
go through the legal hurdles of doing an upgrade. Or if it's a
private equity fund or a larger syndicator that is once to
incorporate that into its fun. They can happen. It can also
happen with the sponsor, like hat, who also has a separate
fun, who wants to absorb that as an opportunity can be set up
ahead of time, but they got to know it ahead of time your
investors have to know it because again, it looks like
maybe something fishy is going on here. And I'm getting either
getting this new thing that I never bargained for in the
beginning. So you're want to make sure that your syndication
attorney has baked in that possibility into the PPM into
the operating agreement. So it's there. So at the end of the day,
if there's any question and your investors start asking you why
why you're doing it and what basis you can do it. You can
point to them and say this is why and this is why it's a good
thing. My name is Tilden Moschetti. I am a real estate
syndication attorney with the Moschetti syndication Law Group.
We specialize in Regulation D rule 506 B, and rule 506 C
offerings for real estate syndicators, real estate
investment funds, businesses, really anyone who's trying to
raise money, they want to take investor money and be able to
use it in order to make them More money and make the sponsor
you as more money as well. That's where we help. Give us a
call if you'd like to meet and discuss your project and see if
there's a good fit between what you're looking to do and what we
offer.