What kind of paperwork do you need to read through and sign in order to start passively investing? Your Castle Real Estate and Ironton Capital founder Lon Welsh is back to walk us through the process and explain what you need to understand about this paperwork before you sign off on it. While this may not be the most exciting topic, it’s very important for investors to fully comprehend before putting their money in someone else’s syndication or fund!
Remember: we’re giving you an educational overview, not legal advice. Always talk to your CPA or legal team before signing anything.
- Listen to the podcast “#403: Understanding the 3 Documents You Sign as a Passive Investor” Denver Real Estate Investing Podcast
- Watch the YouTube video (at the bottom).
- Read the blog post. Note, the blog is an executive summary. Get the in-depth breakdown from the podcast or video.
How Passive Investing Documents Differ from Real Estate Transactions
Passive investors probably have experience buying and selling property and are used to the common structure of the paperwork process. There are title documents, a contract, inspection reports, and then mortgage related documents signed at closing.
While passive investing documents are different, they all have the same overall structure and will begin to look familiar after doing it a couple of times. And unlike buying and selling real estate, these documents can usually be signed at home without the presence of a notary.
Private Placement Memorandum
The Private Placement Memorandum (PPM) is usually the longest document investors receive. It’s typically about 50 pages or more and essentially tells you all of the possible risks you’re taking on. These documents are written by attorneys to detail all the potential outcomes in an investment.
Lon says the best way to picture this document is to imagine you’re buying a kitchen carving knife. You receive a PPM telling you how you could cut yourself, your children could cut themselves, or a burglar could break into your house and cut you with it.
So, what should you look for in a PPM? Make sure the marketing presentation that convinced you to sign up matches what’s in the document. The payment structure should be the same as advertised. If you were told that you’d be charged 1% upfront to set it up, 2% to run it, and that limited partners (LPs) will receive a 6% preferred return, make sure the document spells out the same information. There shouldn’t be any surprise fees or splits that differ from what you were promised.
An Operating Agreement (OA) may be familiar to you if you already have an LLC for your investments. If you’re thinking about the possibility of having to cash out early, check this document to see if there’s a provision for it and how much it would cost. Typically, this would be a net asset value: if you invest $100K and have a $5K dividend, the net asset value is $95K. If you’re four years in and the property was refinanced with a recent appraisal, the calculated value may be more accurate.
Another thing to check for in the OA is what would happen if you and your spouse are investing as joint tenants and you pass away. Find out if your spouse inherits the investment and if they would have different rights than you did.
You can also find out in this document how the profit and fees are divided up.
Finally, you will receive the Subscription Agreement (SA). This is your attestation that you read the other documents and were able to ask the General Partner any and all questions that you have. It also says that you understand the risks and rewards that you’re signing up for.
If you need to be an accredited investor for the investment, this is the document where you verify it. There are a couple of different ways you could do this, but typically you check the box that fits your accreditation and a third part will verify its accuracy.
This document will also collect your demographic information, address, and the way you want to get your cash. Generally, this is a simple document for most people to fill out.
You may receive a document called a Joinder that’s just a few pages long. Usually if you have an OA with just a few people in the LLC, each person can sign the back page of the OA. However, if there are 200 people investing, it would be impractical to have that many people sign one document.
Instead, a Joinder is a legal document that you sign, which states that you agree that everyone else who signed their Joinder is collectively part of the LP pool.
A Word about Wire Fraud
Whether you’re an active or passive real estate investor, wire fraud is a big concern. There’s an astonishing level of sophistication from the fraudsters out there.
Best practices to avoid being a victim of wire fraud are to receive wire instructions from an investor platform or get verbal instructions on how to wire money.
When working with a bank, it’s typical to get an email notification that you have a secure message you can only access through the bank’s platform. In that message, you’ll find sensitive information you don’t want in your email. Wire instructions should be treated the same way—accessed through a secure platform with a PDF of instructions. To be extra safe, call and verify the information with someone in accounting.
Next Steps for Passive Investors
To learn more about the details of passive investing in Ironton Capital, check out this webinar.