BPI Episode #14: How to Read an Offering Memorandum (OM)

Welcome to Building Passive Income, the podcast for professionals, entrepreneurs and investors who want to build wealth, diversify beyond Wall street, and create financial freedom through passive commercial real estate investing. Your host is Wayne Courageous iii, a seasoned investor and founder of CREI Partners, a leading commercial real estate investment company. He spent nearly two decades navigating and educating others on the commercial real estate, from multifamily to storage to retail. Each episode is under 15 minutes, intentionally short, easy to understand, and packed with insights that help you grow your income and protect your capital without becoming a landlord or sacrificing your time. If you're ready to learn fast and invest smarter, you're in the right place. Let's get started.

Welcome back to Building Passive Income podcast. We are on episode 14 and super excited to keep the momentum going and hopefully you're finding some great insights. If you have not listened to the prior podcast, definitely check those out because I'm just trying to provide as much bite sized information as possible in hopes that it helps you on your journey. So today we're going to be talking through how to read an offering memorandum. Now this is an important aspect of real estate investing. We've talked about looking at sponsors, looking at red flags, looking at deals, et cetera, and we're going to dive more into those over the future. But when you get to a point where you feel like, okay, I've got the capital to invest, I'm feeling good about the sponsor, I'm liking the overall deal. Now, all those presentations and everything you've looked at to this point needs to sort of be the back of your mind at this point. Now it's time to go into the four corners of the document that really matters. Nothing can be held up down the road with a PowerPoint presentation, et cetera. But that four corner document, which is the private placement memorandum, is where you will really want to dig in and understand the document. Now there's a lot of legal jargon and so you know, there are some investors who open it up and sign it and trust the process. I do not recommend that. I think you should definitely, especially if it's your first time with the sponsor, go through page by page, like look through those documents, understand really what the business plan and we talked about that previously about the business plan. But look at the risk, look how the, the structure of the waterfall and structure, is it in line with how the presentation that you are understanding about the, the preferred returns and the splits, does that show similarly in the private placement memorandum? So there's typically three documents in a private Placement memorandum. The first is an overview of the property, gives you the sites of, like, what the returns are going to be, what's the address of the property, who's the key members of the general partner team. You know, it'll go into other, you know, the business plan, it'll go into the risk. It really is just a good overview of what the property is and really it's there to scare you away in a little bit as far as, like, of all the risks that are in real estate investing. Well, there's a lot of risk in stocks investing and anywhere else. But it does, you know, don't be surprised where it does. When you read it, you're like, oh my goodness, what am I getting myself into? It's very normal and it's there to really protect the sponsor, but it's also to protect yourself too, because you got to make sure that you're comfortable with, with investing in real estate and the risks that do come with it. There's a lot of rewards, a lot of people have made great money, great cash flow. And as I mentioned on a prior podcast, like real estate investing is the original investment. You know, back into the caveman days, like real estate was there. And we're always going to have real estate as an investment. So when you read that, don't get too concerned on the risk other than are you comfortable with putting capital into that type of investment, Whether you're doing cryptocurrency or the stock market or you're doing your own investment, there's always going to be risk. The other document, typically it could be a separate document or it could be all part of one package, is the subscription agreement. That subscription agreement really is, is the paper, one of the paperworks that you will sign. The other document, the PPM you don't sign that, you sign the subscription agreement. That subscription agreement is more to tell you like, okay, every share is worth $5,000. I've invested $50,000. So with each share being 5,000, I have 10 shares in ABC Limited Partnership entity, which has deed on the property. Right. So that subscription agreement is really identifying how much you're putting in and how much that investment gives you in the terms of shares. It will also determine if there's multiple investor classes, whether it's class A, B or C. And different ones may have different waterfalls based on what the sponsor says that class A shares are worth or class B shares. But it's going to identify which share of investor you are. So if you're a $50,000 investment amount gets you into a class C share at say a 7% preferred return and a 75, 25 equity split that will be in that subscription agreement as the box that you check on that as well. The other document aside from subscription agreement is the company agreement. Now when you invest in a syndication, you are an actual owner in that deal. And so the owner of the deal is solidified by you signing the company agreement as a member. So you are a member in that LLC that owns the land that is on the title for that, for that property. And so you will want to read that and just make sure you're comfortable with it. Definitely feel free to get an attorney involved or maybe your tax person involved because there are depreciation, there are tax benefits. So just getting your cpa, maybe your tax advisor, your attorney. If a sponsor is trying to rush you, like, hey, we got to rush, rush, we got to do this now. Like, no, there's plenty of time, plenty of other opportunities. The biggest thing is you have the opportunity to go through the documents, understand what you're reading, understanding what the terms state. And then when you sign, the last step would be to wire. So there's not a whole lot more room to sort of figure out like, hey, is this the investment for you without taking the time and reading that ppm? So those are the three documents. You got private placement memorandum, you got the subscription agreement and then you have your company agreement. I want to go through the offering memorandum or the PPM portion of it and sort of share a little bit more detail of what you should expect in that document. Now this is separate from the subscription and the company agreement. So we're just going to talk about the PPM portion. So typically you'll see an executive summary. And again, that's going to be sharing the type of property, is it a 1985 built 150 unit multifamily in North San Antonio. What the story is, maybe the seller is in distress or maybe they bought it 15 years ago, but it'll share on like why this deal is intriguing to the sponsor. And then typically from the executive summary, you'll get into the market overview. Population growth, job growth, employer base, median income. You know, those are good drivers to sort of share more exposure of, of why this real estate is a good investment. Now we all know real estate is location, location, location. So really look into that market overview. In some cases, that market overview is also on the webinar or the other information that the sponsor has given. But again, you just want to make sure you understand the market overview and what they're planning on doing, then you want to look at the business plan. So the business plan should be part of this offering memorandum. And so that business plan should talk about the number of units they're renovating, what they're planning on getting on an increase of those rents, how many are remaining. They look at like capital improvements to the exterior. Does the pool need to be refinished or resurfaced, the roofs need to be repaired or replaced. So those business plan not only on the exterior, but on the interior. And ultimately how are they planning on making money? Because you can spend a lot of money on properties, but if it doesn't do anything to equate with driving revenue or reducing expenses, then where really is the value add? And that's really where you want to understand is what is really the business plan? And as I mentioned on a prior podcast, don't overcomplicate real estate. It is a business and it's very simple. Like income minus expenses is profit. So what's the business plan on the revenue, what's on the expenses and if there's any capital improvements, what are those going to be and how does that directly impact revenue or expenses? So looking at that business plan, financial projections, this is typically year over year, they'll break down. And you want to see it at a detailed level, not necessarily as a summary, but what is the base rent, what is other income? What are the utility billing reimbursements? What are they seeing as vacancy? What do they see as bad debt? You know, those are things you just want to look at. And some of the stuff you may not know what like bad debt is. And that's okay. And that's why we're doing this podcast. We're going to dive in. Bad debt is, you know, tenants who have not paid their rent. And so there's those write offs. So most people understand what write offs are. And so you're just learning different terminology and nomenclature. And so as you go through this podcast and other education, you just learn through it. But you want to understand all the different line items on the rental, like what all line up to that net rental income and then go down on the expenses side. And what are all the expenses from trash management fees, rna, which is repairs and maintenance, landscaping, et cetera. So understanding the financial projections and the assumptions that are taken in place into those projections lastly, not lastly, but one of the other things, we only have a few more here is the capital stack. What's the debt structure like? Is it a fixed rate debt? Is it A variable rate? Is it a five year loan, 10 year loan, three year loan? What happens if it comes to year five and you're not able to sell because the market doesn't support a good sell right now? Do you have flexibility in the loan to extend? Those are all things you want to look at from a equity stack and understanding what the debt, excuse me, the capital stack, you understanding what the debt structure looks like. And then looking at the equity splits likely, there was a webinar and it showed you like, hey, if I invest in this asset class, I might get this type of preferred return and this equity split, that's great. Now you just want to make sure it's in the paperwork. Also looking at exit strategy, are they looking to sell after five years? Are they looking to refinance in two years, get some of your capital back and hold onto the asset finance for many more years? Is it a short term hold? Is it a long term hold? What's your comfort level? Are you okay with having all your capital held up in seven years or are you more happy with three to five years? So looking at what the projection is on the exit will help you understand like, hey, is this a good deal for me to invest in or not? Because if not, that's okay. There's other investments, other real estate opportunities that may be more in line. The last thing I would want to put on this in reading the offering memorandum or the PPM is the risk section. And we've talked about this a lot. But understanding what the market risk, what property specific issues are there, understanding, you know, what happens if, you know, the market starts declining and there's negative rental growth instead of positive rental growth. One of the big risks recently in certain markets is there's been a lot of new supply. So there was this push of demand for many years. And so developers started, you know, doing what they do because they're cyclical. They started putting out apartments out there so, you know, the demand could be met through supply. And then when things get oversupplied, then you have this glut in the market and it does absorb. Over the next, you know, two, three years they will absorb. And so if you're buying a property that has say 1,000 units being put online over the next year, that's going to drive the, the demand and you know, on your property, right? And so just thinking of it like how what are the units like that are coming online and how's that going to impact our property? So just asking questions, thinking of supply and demand, looking at the revenue and expenses. And just going through the offering memorandum, it's going to be very similar to what has already been presented to you. And that's a good thing because if it's not, then you're like, well, why are they showcasing this and this is the actual document and it's not lining up, then that's a red flag. Please run. But other than that, a lot of it's going to align. But anyway, just want to go through what an offering memorandum is. And we also touched briefly on the subscription agreement and also the company agreement. So hey, if you want to continue learning more and at a faster pace, check out passiveinvestorcoaching.com again, that's passive investor coaching.com it's free. It's, you know, I go through a bunch of videos about 5 hours in length of shorter videos, but it definitely helps accelerate how to look at a deal, how to analyze a sponsor, a market, et cetera. So definitely check that out and we'll keep these podcasts going. Please like and subscribe and help, you know, share it with others. These are short 15 minute or less podcasts and I'm excited just to keep these going and hopefully help you on your journey in real estate investing.

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