What is a Private Placement Memorandum in Commercial Real Estate?
When an individual commits capital to a private real estate investment, the transaction sponsor is required to provide them with a series of legal documents that outline the terms and conditions of the investment. One of those documents is known as a “Private Placement Memorandum” or PPM for short.
In this article, we will define what a PPM is, why it is important, and what information it typically contains. By the end, readers should be able to use this knowledge to analyze the PPMs for their own real estate investment opportunities.
At First National Realty Partners, we create unique PPMs for all of our commercial real estate investment opportunities. To learn more about our current offerings, click here.
Private Placement Memorandums Explained
In a typical private equity commercial real estate investment transaction, a sponsor will find a property and place it under contract. To facilitate the transaction, a limited liability company – LLC – is formed and the property is purchased using it. To raise equity for the purchase, shares in the LLC are sold to investors.
With this structure in mind, a Private Placement Memorandum is a legal document provided to prospective investors who are interested in purchasing shares of the LLC NOTE: PPMs are not unique to CRE). As the name suggests, PPMs are used in “private” transactions where the securities being sold are not registered with state and/or federal investment regulatory authorities.
The purpose of the PPM is to describe the terms and conditions of the investment offering and is meant as a disclosure for investors so that they are aware of the specifics of the deal.
NOTE: Private investment offerings (as opposed to a public offering) are only available to accredited investors who meet certain income and/or net worth hurdles.
What to Look For in a Private Placement Memorandum
The specific contents of a PPM vary depending on the deal and sponsor. However, they typically follow a similar outline that includes the following sections.
The introduction section of the PPM includes an overview of the deal, the basic terms, a brief statement about the company, the investment objectives, and all legends required by state and federal securities laws.
At its core, a PPM is a legal document. As such, it typically includes a series of disclaimers about the investment being offered. Often, the disclaimers can cover several pages, but typically contain the following key points:
- Investor suitability statement which says something like “this investment is only suitable for investors with the appropriate risk tolerance and time horizon.”
- A discussion of the fact that the document contains forward looking statements that should not be relied upon as an indicator of investment performance. Actual performance can vary from the initial proforma.
- The securities are not registered with regulators. Instead, they are offered under an exemption.
- Any restrictions on the sale or transferability of the securities being sold.
- No legal, tax, or business advice is being offered.
- Right of the issuer to modify or withdraw the investment offering.
- Any potential conflicts of interest for the sponsor.
The important point is that legal disclaimers are the fine print in the transaction and they should be read carefully. Although they can be lengthy and presented in legalese, they present a very clear disclosure to investors that the investment involves a high degree of risk and that they could lose some or all of their investment capital.
A private commercial real estate investment is inherently risky and the risk factor section is dedicated to summarizing the risks in the investment. Typically, they include, but aren’t limited to:
- Market risk that rental rates and/or cap rates may change, impacting the value of the property.
- Credit risk that property tenants could default on their required lease payments.
- Vacancy risk that tenants may decide not to renew their lease, leading to periods of extended vacancy
- Liability associated with accidents that could happen on the premises of the property.
- Financing risk that the sponsor may not be able to obtain the necessary financing both at acquisition and if they choose to refinance.
- Liquidity risk that the property may not sell quickly or for the desired price.
The important point is that one of the major goals of the PPM is to provide potential real estate investors with awareness of the potential risks associated with the deal. They are outlined in this section.
Company & Management Description
In this section, the transaction sponsor, the management team, their track record, and their management strategy is described. This is meant to provide investors with comfort that the real estate sponsor is capable of leading the transaction.
Use of Proceeds
As described above, private securities are typically sold to raise the equity needed to close a commercial real estate deal. The use of proceeds section describes exactly how the funds will be used including which portion goes directly towards purchasing the property versus how much goes to pay for fees and administrative overhead.
This section describes the specific terms of the investment offering. Typically it includes the number of shares being offered, the price for each, and the required minimum investment. This section may also describe any lockup periods during which time the securities are illiquid and cannot be sold. In commercial real estate, these periods could stretch up to ten years.
Transaction sponsors do not work for free and they often charge fees to support the administrative overhead involved with the effort required to find, underwrite, finance, and manage the real estate offering. Common fees include:
- Acquisition fees to support the effort of finding the property
- Asset management fees to support the effort to manage the asset on a day to day basis
- Sales fees associated with the marketing effort required to sell the property
- Syndication fees to support the effort required to create the LLC and market the securities offering
In short, real estate investors need to carefully review the investment’s fee structure as part of their due diligence process and compare it to other opportunities to see how it stacks up.
This section provides additional color on the rights, restrictions, and classes of securities being sold. It may also describe whether or not the issuer has the ability to change the capitalization of the company by doing things such as issuing more shares or issuing different classes of shares.
The procedures section is relatively straightforward and it describes the steps that the investor needs to take to purchase a membership interest in the deal. Often this includes filling out a series of forms, signing several documents, and wiring funds to the appropriate place.
The exhibits section can be thought of as an appendix of sorts. It contains all of the necessary supplemental information necessary to support the investment decision. For example, the exhibits could include things like: copies of investment contracts, detailed proformas, financial statements, business plans, organizational charts of the investment company, and required licenses.
Other Documents to Include With a Private Placement Memorandum
As the introduction to the article suggests, the PPM is just one of several legal documents provided to prospective investors. Other potential documents include:
- Subscription Agreement: A subscription agreement is a document that defines the terms for an investment in a private securities offering. Rules for subscription agreements are generally defined in Securities and Exchange Commission (SEC) Rule 506(b) and 506(c) of Regulation D. The content of each subscription agreement can vary depending on the investment.
- Operating Agreement: Since the property is held in a limited liability company, the Operating Agreement outlines how the company will be run. Typically, it outlines who has decision making power, what happens when there is a disagreement between members, and how the corporation will be dissolved when the property is sold.
- Offering Memorandum: The “OM” is a marketing document of sorts that describes every aspect of the property. Usually, it includes information about the local market conditions, location, tenants, operating expenses, potential cash flow, and potential investment strategy. It will also include pictures of the property and relevant maps. It is meant to help investors get a feel for the property, which is especially helpful if it is located out of market.
Other documents may be included as needed, based on the specifics of the deal.
Summary of Private Placement Memorandums
In real estate investing, a private placement memorandum – PPM for short – is a legal document provided to prospective investors in a private placement offering.
The specific contents of the PPM may vary by transaction, but they typically include the following sections: introduction, disclosures, risk factors, company description, offering terms, fees, and exhibits.
The PPM is just one of several documents provided to investors. Other legal documents include the subscription agreement, operating agreement, and offering memorandum.
PPMs are filled with dense, legal language. For individuals not familiar with reading them, it is always a best practice to consult a qualified real estate attorney and/or CPA
Interested In Learning More?
First National Realty Partners is one of the country’s leading private equity commercial real estate investment firms. With an intentional focus on finding world-class, multi-tenanted assets well below intrinsic value, we seek to create superior long-term, risk-adjusted returns for our investors while creating strong economic assets for the communities we invest in.
If you are an Accredited Real Estate Investor and would like to learn more about our investment opportunities, contact us at (800) 605-4966 or email@example.com for more information.