1. How are the investment opportunities structured?
Most opportunities are structured as a partnership “Limited Liability Company” or LLC. The person or team putting the project together is called a syndicator, sponsor, or operator. The syndicator/sponsor may also include general partners to manage the multiple aspects of the project. They will also invite individuals to join them in the project as investors and limited partners. As the name implies, the limited partners have very little to no actual involvement in the day-to-day operations of the project but still benefit from the cashflow and appreciation of the asset.
2. How much money do I need?
Most investments will state the minimum in the offering memorandum and/or project presentation. Typically, the minimum investment is $50,000 though some require $100,000. It is rare, but some may even allow you to join as a limited partner at something less than $50,000. Likewise, the offering documents may state the maximum that any one individual or entity can invest in that project.
3. Can I invest with Individual Retirement Account (IRA) funds?
Many opportunities do allow investment using IRA funds. This will require you to create what is known as a Self-Directed IRA (SDIRA) and complete any additional paperwork required by your SDIRA custodian. However, investing through a SDIRA will likely negate the tax benefits discussed below.
4. What are these tax benefits I have heard about?
Everyone’s tax situation is different, so you definitely need to discuss with your own tax professional. Generally, as previously stated, all of these opportunities are structured as a partnership LLC. Just like individuals, LLCs must prepare and file tax returns every year using an IRS Form 1065 or U.S. Return of Partnership Income. As part of that filing, the LLC must also prepare a Form K-1 for every partner of the LLC. Each partners pro-rata share of both profits and losses are reported on their respective K-1 that is then filed with your individual (or joint) tax return. Once the apartment complex is purchased by the LLC, the physical building and many contents of the building (appliances, flooring, etc…) are depreciated based on applicable IRS published depreciation schedules. Often, this depreciation process yields a paper loss on the K-1 for each partner even though the asset itself is generating real cashflow. These paper losses that exceed annual profits can be used to off-set other similar income thus creating a tax benefit. Under certain circumstances, these paper losses can even off-set taxable earned income of the investor or that of a spouse. To the extent that the paper losses exceed all income that it can off-set in any given tax year, the losses can accumulate for use in future years to then potentially off-set the capital gain from the sale of the asset at the end of the project’s life cycle. There will also be a depreciation recapture calculation at the end of the project’s life cycle which will impact your taxes. Again, consult your own tax professional to discuss how these investments might impact your specific tax situation.
5. What is the duration of my investment?
Investment timelines vary based on the project and market conditions. Most offering documents will provide a projected hold period in the information presented. However, you need to approach these opportunities with a long-term mindset. Most projects involve a 5-7 year hold period for the project. If market conditions favor a shorter duration, the operator may choose to exit earlier than originally projected. Likewise, some market conditions may necessitate a longer than projected hold period. In any case, other than distributions, your funds will generally not be easily accessible until conclusion of the hold period and sale of the asset. If this approach does not align with your investment style and goals, these opportunities likely aren’t for you.
6. How often are distributions paid?
Distributions are paid to the partners at the discretion of the operator based on the financial health of the project and are typically paid monthly or quarterly. However, in some cases, the operator may be forced to hold distributions until the financial situation of the project gets better. Depending on the project, distributions may not begin until several months or even a year or two after acquisition of the project. A deep value add project for example may take a couple of years to stabilize versus a project that is already doing well with high occupancy that may produce enough cash flow to provide distributions within the first 3-6 months. These projects are in no way guaranteed and investors need to understand that at the on-set.
7. What is this reference to 506(b) and 506(c)?
These are references to portions of Regulation D from the Securities and Exchange Commission (SEC) that provides for exemptions, under certain circumstances, from registering an investment with the SEC. Practically every offer of the type discussed here will fall within one of these two exemptions. Rather than providing a full explanation, here is a good blog post that explains it well: https://carta.com/blog/506b-vs-506c/
8. What is an accredited investor and a sophisticated investor?
The above mentioned sections of SEC Regulation D also discuss both accredited and sophisticated investors.
For individuals, an accredited investor is someone who 1) has a net worth of over $1 million, not including their primary residence, or 2) had an annual income over $200,000 (or $300,000 jointly) for the past 2 years.
A sophisticated investor is someone that “must have sufficient knowledge and experience in financial and business matters to make them capable of evaluating the merits and risks of the prospective investment.”
You can find additional information about Regulation D offerings, accredited investors, and sophisticated investors on the SEC website at: https://www.investor.gov/introduction-investing/investing-basics/glossary/rule-506-regulation-d