08/04/2010
Real estate loans are tougher than ever to get, and lenders want to see more and more cash invested in a project before making a loan. Developers are used to getting credit for the appraised value of their land as their capital contribution, while financing most of the balance of project costs with traditional real estate loans. It may be a long time, if ever, before we see this type of real estate lending again.
An alternative that is becoming more popular is raising funds through private offerings or syndications. This is the practice of having investors make contributions in exchange for equity ownership. This was the standard practice during the 1980s, when leverage and tax incentives made investments in limited partnerships popular. The popularity of this method of fund raising markedly dropped off after the Tax Reform Act of 1986, when developers tired of securities law compliance. During the last decade, liberal lending practices made borrowing the method of choice for funding real estate development.
Now developers are looking for more creative ways of funding their projects. One is to use other people's money to replace or supplement borrowing. Some of the trade-offs are obvious. Using borrowed funds may be cheaper than having to pay an investor a rate of return. Managing and being accountable to investors may be tough for developers who are used to being accountable only to themselves and their lender. Securities law compliance and investor relations require more effort than providing an occasional financial statement to a lender. It is also rare for a project to be completely funded by fund raising. Usually there is a lending component as well, making a developer accountable to both the lender and the investors.
There are enough advantages to private offerings to give this method of fund raising serious consideration. Cash flow is the key to keeping a project alive. Investors expect a developer to receive significant fees, producing an income through commissions, and project development and management fees are rewarding, even if profits have to be split. Keeping a project moving is better than letting it die from lack of funding. Lenders are more likely to look positively at a loan if a good part of the project is supported by the cash of the developer, even if that cash is raised through investors.
Raising funds is not easy, and those who are successful usually have a stable of qualified prospects from prior deals. There is no better way to sell then from past success, so the novice fundraiser must be adept at marketing.
Fund raising is also limited by the myriad of federal and state securities laws and the limitations they impose. These laws place limitations on the manner and form of securities offerings (in order to be exempt from onerous registration requirements) and impose disclosure obligations. Failing to follow the rules can have a range of civil and even criminal sanctions. Still, there are a number of developers who, with the guidance of legal counsel, can follow the rules and raise money successfully. Because raising money via private offerings is difficult, not many developers attempt it, but those who do, and are successful at it, know that it is the inherent difficulty of this method that gives them an advantage, because many developers are afraid to make the effort.
Most developers limit their solicitation to a small group of "accredited investors," who by definition are wealthy (thus requiring a lower threshold of disclosure), and with whom they have a pre-existing relationship.
There are limited exemptions available to raise money from other classes of investors, but these exemptions require a level of disclosure that is generally higher and which ultimately increases the cost of the offering. In addition to federal requirements, offerings must also comply with state securities laws (except where they are preempted by federal law). Stinson's real estate attorneys work in concert with our securities attorneys to assist clients in making these offerings.
If you would like more information about making an investor offering, please contact Allen W. Blair at 816-691-2744 or ablair@stinson.com.