Legal Must Knows for Passive Multi-Family Investors

Hey, welcome everybody. This is Wayne Courageous. And thank you all for joining our meetup. We just had a great breakout session for the past 20 minutes or so and excited to jump right in. So a few slides here, but a little bit about our meetup. So we meet on the fourth Monday of each month, 7pm Central Time. We don't meet in December, but typically January through November. We are meeting typically in the very beginning. We'll do our breakout sessions. Just always feel like it's really important to have relationships. One it lowers everybody's guard a little bit and opening up to a great meeting. But also relationships are the most important in investing. So we can read books and all. But the end of the day, how deals get done is by knowing people. So we do that in the beginning and then we get into our guest presentation and then go into Q and A. I typically bring in a lot of experienced syndicators, but also a lot of partners. And when I say partners like people like Zeeshan today who, you know, do work on our transactions. So I've had an SEC attorney, I've had tax people, I've had insurance.

Real.

Estate attorneys and, and others. So, you know, each month my hope is that it's informative and, and something that everybody can to learn from and then, you know, keep building the relationship and hopefully we can both invest and, you know, build partnerships together. So a little bit about myself. I was born and raised in Austin, Texas. I went into the Marine Corps right out of high school, served in the Marine Corps for four years, ended up in Washington D.C. which is really where my commercial real estate experience started. I bought my first single family property in Twentynine Palms, California while I was in the Marine Corps. So that was my intro to real estate. But from a standpoint of commercial real estate, it started off in Washington D.C. where I spent about five years there, and then relocated to Houston, where I spent another five years, and then Austin, my hometown, since 2017. So since that time I've invested in real estate deals. We've had our own transactions. Most recently we closed on 101 units and the Galleria Submarket of Houston. So we're super excited about that opportunity. And then earlier this year we did. We're doing a build to rent development in Lafayette, Louisiana. And so a lot of fun things. But like, real estate is my. I could talk real estate all day, all night. I just love it. It's my hobby. And so again, you know, I just enjoy these meetups so we can all learn and grow together. So a few things if we haven't connected before, you know, check out craipartners.com on craipartners.com there's a lot of, I mean we do blogs every other week. We've got podcasts, there's a lot of resource information for those that are trying to learn about multifamily syndications and just sort of the know first steps. But you know, the podcast is, is there as well and then we have a Facebook page, Texas Multifamily Investors Group on Facebook. So you know, join us there. So with all that said, you know, let's turn to Zeeshan. Zeeshan and I grew up, I mean we like grade school, like we go way back. But Zeeshan is somebody that I trust in all of our real estate transaction deals from a legal perspective. He is a transactional real estate attorney and focused on practical solution oriented accounts to his, to his clients. He's got a lot of experience in all different asset classes focusing on negotiations of debt, equity financing, vertical development, leasing. He's been trained at a large international law firm with a very diverse client base and went to the University of Texas be in government with JD at the University of Houston Law. So with that I'm going to stop sharing. I'm going to turn it over to Zeeshan and I really appreciate his time with us this evening.

Well, thank you Wayne. I appreciate that. Great, great to connect with everybody. In the breakout session I was in, I want to note that one of the individuals asked, asked a question about the most important thing to think about in real estate in this changing market and somebody and maybe a couple of people chimed in and mentioned that relationships and the operators that were involved, the boots on the ground with respect to whatever project, that that was the most important thing and I liked hearing that. Even though I'm here to talk to you guys about legal issues, legal risks, legal hurdles and items you guys should think about when, when structuring your deals and where you fit in as a passive or active investor. Certainly the most important thing is the people you know and the operators that you're trusting with your funds and you're trusting that are going to do the right things when the chips are down. It was just nice to hear that. So I say that to say what I'm telling you is less important than the relationships that you have. But by way of introduction, my name is Zeeshan. I'm an Austinite born and raised and just like Wayne mentioned, he and I have a long history together. It's good to be able to connect in the professional space with people you grew up with and knew at a young age. I'm a transactional attorney. All I do is real estate. I'm in the real estate space specifically and in the legal space secondarily. Right. I, I thoroughly enjoy getting to be involved on real estate transactions and helping people set up incredible deals that help them to build the built environment and help them contribute to the spaces that we all live in that we all call our homes. And secondarily to that allow people to do well when things are do well financially, when projects are executed in the right way. So a couple of things I want to. Want to hit on first. This is an open conversation. Anything you guys have, please chime in at any time. Happy to field any questions on the fly. Happy to take anything afterwards. In thinking about connecting with everyone here, I thought one of the things I could try to add value to this group. I know there's a lot of people involved and a lot of people with a lot more experience than myself and there's a lot for me to learn here. But I can tell you from the structuring and organizational standpoint, I've seen thousands of deals. I've seen how some of the most sophisticated developers in the Southwest U.S. structure their deals in order to take on debt and equity in order to bring on limited partner investors or passive member investors. And thinking about it from structuring from a tax standpoint, from a liability standpoint, from an operational efficiency standpoint, and from a strategic standpoint as well. So with that, I was hoping to run through a couple of different structures what we think of as the most common structures in real estate development. Right. We think of folks that are investing as passive investors, first as members in a limited liability company and second as limited partners in a limited partnership investment. So, Wayne, if you don't mind, I have two slides that I was going to throw up on the screen for everybody to. To everybody to take a look at the biggest. The biggest difference between a limited liability company and a limited partnership in Texas at least, is. Or one of the larger differences is the tax efficiencies that are involved. So there used to be, there's this thing in Texas called the franchise tax. Recently was somebody saying something. There's a thing in Texas called the franchise tax, and by statute, it's written into Texas law. If you are a Texas limited partnership, you will pay 3/4 of 1% additional tax, franchise tax on the gain and the year in which you're on the gain in the year in which your property is Sold. That used to be a large number. It used to be something like 4% by statute. It was cut down to 3%, 2%. I think one and a half percent. It's now at three quarters of 1%. So $7,500 of additional tax on every million dollars a gain. I'm not going to tell you that's not real money. It is real money, especially if the, if the asset is going to be appreciating significantly. But that's one of the largest reasons why a lot of developers in Texas use the limited partnership as the vehicle through which they're going to purchase their real estate and the vehicle through which they're going to bring on their limited, their passive investors. Now, what Wayne is showing up on the screen right now is a Texas limited liability company example. You see the property owner LLC up at the top that's going to own fee simple title to the deal, to the dirt and dirt and the dirt in the deal. On the left side you have your managing members, the deal champions. I call them Deal Champ one, Deal Champ two, Deal Champ three. Those are your syndicators, for lack of a better word. Those are your folks that have sourced the deal, finding the debt, putting the entire deal together, and typically going out and guaranteeing the deal as well. And on the right side are your passive investor members. And that's where most folks that are passively involved in real estate sit. Those individuals can come in either as individuals or they can come in through a trust, or they can come in through a limited liability company. They can come in through whatever entity they want. One of the items I want to highlight is the limited liability protection. The limited liability protection in a limited partnership, and in this case a limited liability company comes in at the entity level. So the fact that the entity that's owning the dirt up there at the top is a limited liability company. That's what provides the limited liability protection for everybody underneath it. And so if you're coming in on the right side as a passive member investor right here, member in this deal you had, even if you come in individually in your own name, the name through which you own your, your home, the most you can lose in this deal is the amount of money that you have put into the deal. So let's say you invest $100 into this example. Even if you own a home that's worth $200, if the worst case scenario happens and there's a catastrophic lawsuit that affects the property, the most you can lose as a passive Investor is the $100 that you put in this deal absent some type of piercing the corporate veil lawsuit, which is a very, very, very limited set of circumstances and is very, very limited in Texas and is something I wouldn't, I wouldn't expand upon at this time. But it's nice to think when you come in, it doesn't matter if you are coming in as a passive investor as a limited liability company, or as a trust, or as a limited partnership, or as an individual, your limited liability protection is given to you by virtue of the fact that the deal is owned by a limited liability company. And Wayne, if you can go to the next slide, I'll contrast this example with the example of a Texas limited partnership. And this Texas limited partnership might be more of what everybody is thinking about when they think about a typical deal. Because in a Texas limited partnership scenario, you have the dirt owned by an entity and then you have a general partner that runs the deal. That's where your deal champions are living. And then you have limited partner investors. Looks like, Wayne, you're trying to share the screen. We'll wait until this slide comes up. But to compare a Texas limited partnership to a Texas limited liability company, in the limited liability company example, you had your managing members, your deal champions, in this case, in a limited partnership example, those individuals are up in your general partner entity. And that's where your deal champions live. And the passive limited partner investors that sit underneath the property owner, that's where the passive investors sit. Again, you're given that limited liability protection by virtue of the fact that it's a limited partnership. Again, it doesn't matter if you come in through a trust as an individual through a limited liability company, your limited liabilities is provided to you by virtue of the fact that you are a limited partner in a Texas limited partnership. Now that answer as to what vehicle you personally invest through is more complicated by tax liabilities. So something I suggest you plan with your CPA and estate planning folks to make sure that you're doing things in the most tax efficient manner possible. But so what Wade has pulled up is that is that limited limited partnership example. And again, one of the largest reasons why developers roll with this, this format, the structure, is because of those tax efficiencies. Again, Texas limited partnerships do not pay the franchise tax, while a limited liability company does pay the franchise tax. So it's just just one, one, one more efficiency. You can see when looking at deals, as I know most of you all know, I'm going to go with a very basic level. There are a couple of Main doc. There are a couple of documents that you typically see with every deal. The first is your private placement memorandum. So the PPM is the introduction of whatever deal to the prospective investors. It gives a snapshot as to the deal. It talks about the deal champions their experience. It talks about the returns, it talks about the risks and just provides information about the deal. The way I structure these PPMs is I have the ppm and I'll use exhibits to the ppm. The first exhibit will be your subscription agreement, which is, in short, where all of the SEC terms live. You're talking about your risks, you're talking about risk factors, you're talking about SEC regulations, you're talking about who you are as an investor, whether you're accredited or unaccredited. And you're checking certain boxes to give certainties to the limited partnership that's taking on the steel or the limited liability company that's taking on this deal. And then the next exhibit should be the operating agreement for the entity that's taking down the dirt. So in the two cases I provided, one would be a company agreement of a limited liability company, and the second would be a partnership agreement of the limited partnership. In those two operating agreements, although they're structured slightly differently, one, the limited liability company doesn't have a gp, but it has, it has managers or managing members, and the limited partnership has a general partner that controls the deal. There are certain things you guys want to pay attention to. I'll tell you that every word in the document is important, but there are some that are more important than others when it comes to thinking about your return. First, I always pay attention to additional capital calls. I think about, and this is what I would think about, not from the legal side, but just from the passive investor side. I would think when, under what circumstances and how much money can the deal champions ask from me? If they ask for additional money, what happens if I don't contribute? If I don't contribute, can they redeem my membership interest or redeem my limited liability or my limited partnership interest? Can they dilute the interest, my limited liability interest or my partnership interests? Can they treat those, that additional capital that comes from somebody else as a loan? There's a variety of ways to use it, to deal with it, and I see different ways all the time. And that just totally depends on the asset, the class, the investors, the amount of the raise and who they're, who they're taking the deal out to, whether they're taking it out to the general public through, through an informal syndication with everybody or if they're just taking it out to friends and family. So in additional, so additional capital contributions, that's what I think about. The next thing I think about is the waterfall of distributions. And that's the, that's, that's, that's the thing that everybody on this call, I know hones in on right away. That's it, that's, that's up front and cent the ppm. That's what everybody talks about when they talk about their returns, how much return they get until the deal champions get their return, their promoted interest, and then how much flows to those limited partner investors thereafter. And another thing I look at is, and this is something that maybe people don't think about all of the time, but I think about exit opportunities. And this is something that can get complex but can be important. I think about an individual or an investor's ability to sell their interests in whatever deal they're a part of. Everybody has different financial considerations. Everybody's financial considerations change all of the time. One day you might be okay, and the next day you might say, well wait a minute, I need to take my cash out of that deal in order to do whatever I need to do. And so the exit opportunities are important to pay attention to. And in this case it would be selling your limited liability company membership interests or selling your limited partner membership, your limited partner interest in whatever deal you're in. Sometimes sales are just completely barred. Sometimes the sales are opened up to the remaining passive investors in the deal. Sometimes you're allowed to take your interest and sell them to third parties. Sometimes you have to take them and sell them to third parties, but share your profits with the deal champions. Sometimes the deal champions have the right of first refusal. Just a variety of ways to handle that. And every syndicator will handle it differently. Again, just like additional capital contributions and just like the waterfall, they'll handle it differently depending on the asset class, market types, market timing of the market, and who they're taking the deal out to. But again, so it's thinking about the ppm, learning about the deal, thinking about the subscription agreement, making sure you're paying attention to the subscription agreement. And then the third thing is making sure you're paying attention to the operating agreement that you're entering into and the three big provisions in the operating agreement, among others, additional capital, your waterfall distributions, and your exit opportunities. There are a number of things to drill down into in the real estate space. And thinking about diligence on a deal and executing on a purchase and sale agreement. And moving that deal along through the life cycle. But as a passive investor, a lot of times you're taking the opportunity to invest in people as opposed to saying, I'm going to invest in a multifamily apartment complex on this highway in San Antonio, Texas, because I think it has a good location, it's in a good sub market, it has the opportunity to be repositioned in the right way. You're really investing in the people, the boots on the ground. Just like in my first breakout group there, you're investing in the deal champions and you're hoping that those are the folks that are going to be able to execute on the deal. So even though the legal stuff is really important, when I personally look to invest on behalf of my family, yes, the legal stuff is important and yes, I love getting in and reading the documents and understanding them and knowing my rights and responsibilities and how things are going to shake out. But all of that is secondary to the deal team. It's secondary to who you're investing with, to the relationships you have and understanding whether or not you believe the people that are taking your money to invest in a deal are going to do things the right way at the right times for the right reasons. And so that just kind of brings it back to say there's not much value I can add to this group. That first breakout group, everybody knew that relationships were the important thing. With that I'll open it up. Any questions that you guys have, any comments, anything to further the conversation, please let me know.

And if anybody wants to put a question in the chat box, I can read it if people are more comfortable. But Zeeshan, thank you for, for your time and, and you know, honestly, this is a great opportunity to ask some legal questions, you know, questions that you may be thinking about. No question is too silly. I mean, we all start somewhere. So we've got.

Also, no. Also sorry to cut you off, Wayne. Also know just from a, you know, the tasteful disclaimer here that, that what I'm providing is not legal advice. Know that I'm interested in hopping into this group to help out as I can and provide expertise, but want to make sure everybody knows it's not legal advice. But if there are any questions you guys have.

I have a general question. I'm pretty sure that you usually have a lot of PPMs that you're reviewing. How often do you see people try to sneak in things or sneak in terms that are new, not necessarily good for the passive investors and what is the best way to actually try and make sure that we don't get caught up in those unfavorable terms.

No, absolutely. I'm going to give you three answers. One, I've never seen that. Two, trust. You got to understand the people that you're doing business with and, and, and if somebody's trying to sneak something in that is not market or is not favorable and they're not willing to call that out, those aren't folks that I would do business with. And the third thing is the overall protection you have is to make sure you read every word multiple times in, in, in the PPM and in all of the, in all of the documents. And if you need contract out with, with, with a specialist, whether that be an attorney, whether that, be it a, be a tax expert, whether that be some type of consultant, but contract out with somebody that's seen thousands of these PPMs and knows where to look and knows what terms are not market. I haven't seen that because I'm in a, I'm in a luxury, I'm in a favorable position and, and we'll see if market conditions stay this way. But look, Austin, Texas and Central Texas has been an incredible place to be an attorney. It's been an incredible place to do business. The last 10 years have provided a lot of opportunities and so I only take on work with people that I know and I trust and I respect and those are not folks that are, that are, that are willing to do, to do what you're mentioning. But yeah, make sure you arm yourself with the benefit of reading documents. Make sure you know who you're doing business with and don't let folks like that, don't let folks like that raise capital. Folks like that, folks like that need to, need to know that they can't syndicate deals from, from the general public. Great question though. I appreciate that.

I'll add to that. So if anybody here needs some recommendations on who can look at ppm documents, etc. You know, feel free to email me. But the separate thing, it's a small world network. I mean you can ask Trevor who's like the networker genius in this room here, but I mean all jokes aside, you know, people talk and so you know, as you're joining these meetups, you're building relationships, it's a small world and reputations matter. And so I think that's why Zeeshan doesn't see a lot of this is because we realize that what really makes, makes this work, you know, are good people with high integrity doing the right things when other people are not looking. With that said, I always recommend having an attorney review, but hopefully, you know, that helps a little bit. Thanks, D. Sean, for answering it.

Yeah, I think you're. I think you're right. I think you're right, Wayne. You got to find the right people that are willing to do the right things for the right reasons, and, and great things can happen from there. Can you provide your contact info, CIA, if we want to reach out to you, please. Yeah, in the two slides, and I'm sure Wayne will share that with you guys, but in two slides, my contact information is there, but if you look up my name as an Austin, Texas attorney, I can promise you there's only one. That's the value of having a unique name. Value having a unique name. But yeah, my, My. My contact information is at the. As it is in the header of. Header of both of those. Both of those slides. The limited liability company and limited partnership slide.

The work I do, I'm gonna put on the slide.

Yeah. Feel free. Feel free. You know, I, I enjoy getting to work with folks in, in my hometown. You know, it's, it's. It's a, it's a fun business to be a part of because you get to connect with individuals, folks that are pursuing different types of deals, folks, folks like Wayne that are. That are finding good deals and sourcing good deals. And it's, it's exciting to be a part of it, so.

Hi, Zeeshan. I had a question in terms of being a passive investor. So my husband and I invest together. We're married. We file our taxes as married. And there's always the option of investing, like, as an individual or investing as married with joint survivorship. And just wanted to understand, like, what the benefits were of doing the joint survivorship in the state of Texas. That's where we live. And if there were any, you know, pros or cons to doing it that way versus just doing it as individuals.

Yeah. Great question. I'm going to start with a heavy disclaimer. I'm not a family law attorney nor an estate planner. But, but I've seen that question before in the state of Texas, when you invest or when you purchase assets as a married couple, your partner, your, your, Your spouse, your legal spouse has a right to 50% of what you've purchased, right? Assuming it's been purchased with community assets, so long as you can't take the. Take that money and, and trace it back to some type of individual source. And so with that, you have. If you go out and spend $100 on a deal with Wayne, technically, your husband owns half of the profits or half of that interest. Right. Half of that belongs to your husband or your partner or your spouse. The rights of survivorship issue is a technical legal item that I would highly recommend you seek out estate planning folks for. There are, there are marital property reasons, there are tax reasons, and there are just family law planning matters that come into consideration with that. But from a liability standpoint, from a return standpoint, from a real estate standpoint, it doesn't, it doesn't matter. It. Those proceeds will come back to you. How, however they would have if you were going to get a 10% return. You'll get your 10% return assuming the deal hits so heavy disclaimer on that. But it's different for everybody, right? Somebody investing in one tax bracket might have a different outcome than somebody investing in another based on the entity through which they invest, whether they come in through an individual, a trust, a limited liability company, a limited partnership, or some type of IRA account.

Thank you.

Yeah, and that's not a very specific answer. I know. I apologize.

Zeeshan, we had a question. What are the most two to three common questions you get for beginners versus veterans?

Wow, that's a great question. That's a great question. And I'm assuming we're talking on the passive investor side. And so with that, with folks that are just getting involved, the typical questions I get are, when do I have to deposit money? What happens if the deal falls through? How much can I lose? That's the second question. And the third is when do I get paid? So all of those, interestingly, have to do with the waterfall of distributions. So most people ask about the waterfall of distributions because they're most concerned about money in and money out. That's what novice folks. That's what, when I was first getting involved, that's what I was interested in. Just the money more advanced folks, I think, look beyond that and they say, well, do I have rights by virtue of this document, this operating agreement to invest in future deals? Do I have rights to invest in, let's say a syndicator is just taking down a piece of dirt as phase one one and phase two is they're going to take out, they're going to raise another fund, they're going to contribute the land into another entity that's going to build vertically. Does the investor in the land deal have the ability to contribute in the vertical partnership, in the vertical development deal? That's spelled out in the operating agreements. That again, is just deal specific. And it's just whether or not you know what's happening with the life cycle of the deal. Because as everybody can imagine, land deals make so much and vertical developments with good operators that are doing the right things in the right way have the ability to grow significantly more. Other folks ask about their ability to invest additional funds in a deal in the event that other passive investors are unable to make their quota if there's an additional capital call. So if everybody on this call, there's 10 of us, for example, if we all invest $10, if they call, they do an additional capital call and they need an additional $10. If somebody can't contribute their $1, if I do, I have the opportunity as a passive investor to take on that $1. And if I do, what's my additional consideration? What's my additional return for taking on that additional liability that my other passive investor could not do, couldn't handle their pro rata share on? There's an opportunity for passive investors that are sophisticated, that understand the documents that are well capitalized in a good deal to increase their share in the entity that owns the dirt proportionally or disproportionately. Right? You can have a return where you get a valuation of 2 to 1 or your interest is increased while you're the passive investor who didn't increase, who didn't invest, their membership is demoted. And so knowing what the rights and responsibilities are and what the additional capital call provisions provide, that's something that advance folks ask about. And then just like the third point I mentioned, knowing what your rights are to sell again, knowing how liquid or illiquid your asset is and knowing what belt, what hoops you got to jump through to sell, sell your membership interests or your limited partnership interests, what those are. So beginner folks only ask about money, but advanced folks ask about money. Certainly they ask about the ability to invest more and they ask about the ability to cash out and the time for them to cash out. Great question.

Thank you Zeeshan for the value appreciating it. This might be a beginner question, but for the ownership structure, is that an LLC per property, I'm assuming, or is.

That, would you ever have multiple properties under one llc? No. Great, great question. Most deals that I work on are they use what's called an spe, a special purpose entity. And that's for two reasons. One is for liability. I'll say it's for three reasons. One, it's reliability, two, it's for raising money, and three, it's a lender requirement. So when I say A special purpose entity. I mean, in your case, you're talking about one limited liability company buying 123 Main street that limited liability would not then go out and buy 123 Congress Ave. As well. The reason is one for liability. If you have one LLC that owns two assets, if there's a slip and fall accident at 123 Main St. And it's catastrophic and it's worth tens of millions or hundreds of millions of dollars, the plaintiff in that case could reach into the pocket of 123 Main St. And into 123 Congress Ave. At the same time. And so the investors and the deal at 1:23 Congress is affected by something that happened at a completely different property not associated with 123congress. And so that liability, that insulation having one, one limited liability company or one limited partnership per asset helps to insulate liability. You contain everything with respect to one property in one entity. To just raising money. It's easier for us to go out and syndicate deals and say, okay guys, you're going to produce a PPM and say, hey, you're going to invest in this deal and I'm going to tell you the history of the deal and I'm going to tell you the amount of doors that are at this deal and I'm going to tell you how we're going to reposition this asset as opposed to saying, here's how we're going to reposition these assets. Right? Because we have this asset at 123 Main Street. We have this asset at 123 Congress. We're going to be doing different things. And you think about the return on those assets. Right. Typically each asset has a different set of hurdles they have to get through and a different set of financials. And so they're going to return a slightly different amount. So you want for raising money and for returning money, it's easier to be separate. And then the third, probably the biggest thing, and this is the rule that we all know, the golden rule. Those with the money make the rules. In real estate, it's the lenders. And so the lenders say, you borrower have to be a special purpose entity and you cannot go out and own anything else. And if you do, you need to come to us. And even if you do own something else, that something else automatically becomes collateral under your loan. So to your point, for a variety of reasons, most deals you have a special purpose entity that just owns one asset. Excellent.

Thank you.

Yeah, yeah.

We may have time for one more question. Anybody have one question?

All right.

Well, Zeeshan and thank you for your time this evening. Thank you, everybody, for your time. A lot of great value. And I will send the recording out to everybody, but I'll also send Zeeshan's info as well and hopefully see you all for November's meetup. So it'll be Thanksgiving week, so I don't know how big the turnout will be, but that'll be our last meetup of the year. It's crazy to think December, it's just. I mean, it's going to be here. So, anyway, y' all stay well and thank you.

Thanks.