The Ask Mauricio Show Real Estate Syndication QA Edition (Episode 2)

Hey everyone, this is Mauricio Roldan. You’re watching episode two of the Ask Mauricio Show, your weekly real estate syndication Q&A show. And before we get started with this week’s episode, I really wanted to give a shout out to everyone who took the time to drop a comment and link about the title. Still not 100% sure how we’re going to do it, but I wanted to really thank you guys for taking the time. And I just wanted to get these videos going. So we’ll figure out what the title is going to end up being. But for now, let’s get right into your questions. J. Scott asks, when is the syndication entity an LLC versus an LP? J. Scott, that’s a great question. And most of the time we do use LLCs. And back in the day, back in the day, like 10, 20 years ago, there actually was a difference between LLCs and LPs. There were some tax things and some things you could do with distributions with an LP that you couldn’t do with an LLC. And that’s one of the reasons you’ll see a lot of the old timers, you know, that have been doing this for a while, maybe use LPs out of habit. But these days, probably 95, 99% of the time, we really do use LLCs. That’s kind of the most common entity that we use. But there are a few instances where we would use an LP. So I appreciate the question. Probably the most common is when we have international investors that don’t recognize LLCs. So Canada is a really typical example. So Canada does not recognize LLCs. And so if we have a Canadian investor invest in a US LLC, because the Canadian taxing authority doesn’t recognize that, they’ll actually default to a corporation and the Canadian investors will get double taxed. And so depending on how many investors you have, if it’s just one Canadian or two Canadians, Canadian investors, a lot of times we’ll make the Canadian investor create their own LP first, and then they can invest in the US LLC through their own LP. But sometimes I’ve had clients who have a really large amount of Canadian investors, you know, maybe 10, 15, or 20 or whatever, are large enough that it makes sense to actually change the structure entirely. And in those scenarios, we would create a GP in order, I’m sorry, an LP in order to accommodate the Canadian investors. It’s purely a tax issue. The second reason we would potentially do an LP is if you’re, if actually, if you’re doing deals in Texas and your exit price is going to be significantly high, then a lot of the CPAs lately have been telling us that it’s better from a franchise tax perspective to have the entity be held in a limited partnership versus an LLC. Again, we’re going to defer always to your CPA, but right now I would say it’s 50-50 or 75-25 that people, people, CPAs are starting to advise that. I don’t know if it’s a new thing that’s coming up because, you know, if you go back to, you know, pre-COVID days, that wasn’t something that came up, but I have noticed that trend lately. So let’s definitely check with your CPA. If you’ve got a property in Texas, whether it makes sense to do it as an LP, if it’s a large enough project, if it’s, you know, 10, 15, $20 million. And then the last reason I’ve been doing some LPs in the past is with some oil and gas deals. And I know most people watching this, and it is actually a real estate syndication Q&A, but I do have a client who does the oil and gas. And in order to get the oil and gas tax break, the investors need to have unlimited exposure. They have to have unlimited liability in order to be able to take advantage of the tax break. So it’s one of those, you know, do you want asset protection or do you want the tax benefit? But in that case, we have the investors come in as a GP, because as we all know, a GP has unlimited exposure versus a manager of an LLC, that’s going to be a limited liability issue. So I think those are probably the three most common Canadian investors or any international investor that doesn’t recognize LLCs. If you’ve got property in Texas that’s going to sell or projected to sell for really high valuation, check with your CPA. And then the last one would be if you’re doing oil and gas and you have a tax requirement that requires the investors to have an unlimited exposure. So great question, Jay. And Courtney, let’s go to the next one. Ryan asks, what is the difference between a syndication and a fund? Great question, Ryan. They’re actually technically the same thing. A syndication and a fund are both securities offerings. So we still need to comply with all the securities laws. In fact, I did a video on this on how to structure a fund, which we’ll probably put up somewhere here. But we go through those two different structures. But just keep in mind that all funds are… Think of it this way, all funds are syndications, but not all syndications aren’t necessarily funds. So when people say syndication, generally they’re talking about a project-specific syndication, meaning they’ve identified the property, they’ve gone into contract to the property, and now they’ve got a specific business plan on that particular property, and they have to go raise the capital to execute on that business plan. With a fund, it’s reversed because you actually raise the money first and then go out and look for the property. So when you’re raising the capital on a fund, you don’t actually have anything to show the investors. You essentially are giving them your fund criteria, your parameters of what you’re looking at. Hey, I’m going to go buy a 100-unit apartment building in this particular state, and this is what we’re looking for. But the investors don’t actually know exactly what you’re going to be putting the money in. So they’re completely relying on you as opposed to being able to underwrite and look at the project-specific. So I always say with a fund, they’re really betting on the jockey, right? Because they’re just handing over your money and trusting the fund manager that they know how to go use that. What makes it easier to raise for a syndication or a project-specific syndication is that an investor can actually look at your numbers and look at your assumptions and question them. And so it just tends to be a lot easier to raise capital for a syndication. But man, if you can do a fund, what we call a blind fund, it’s a great mechanism to have because now you’ve got the money in the bank. You don’t have to stress over having to raise the money and having a deadline. You’ve got the money in the bank, and you may even be able to use that as leverage in making offers because you can show the seller that you don’t have to go raise the money like everybody else. You’ve actually got the money in the bank already. And so that typically puts you in a much stronger position. But that’s the main difference. You’re still complying with all the same securities laws. It’s still register, find an exemption, or it’s illegal. Most funds are 506B or 506E. So that part of it doesn’t change. If you look at the video I did, the main difference is going to be in the business plan. Because as I mentioned, there’s not going to be pretty pictures of the property. It’s not going to be anything specific. It’s going to be these general parameters of what it is that I’m going to do with your money once you give it to me. And the investor has to basically trust that you know what you’re doing. Can I hold back profits from the deal and use for reserves or roll over into a next investment or short balance sheet? Another great question. The answer is always, almost always yes, as long as we’re disclosing everything. Again, the name of the game is disclose, disclose, disclose. So you can do pretty much anything you want with various limited limitations. But you can do pretty much anything as long as you’re disclosing it up front in the PPM, in the private place memorandum, and letting your investors know exactly what you’re doing. If you let them know what’s going on, they review that, they go into the deal with eyes wide open. You can do pretty much anything you want. Now in this particular example of putting it towards sort of reserves and just kind of having it to shore up the balance sheet or to sort of just have money set aside for a rainy day, which makes a ton of sense. One thing you always have to be cautious about is that from a tax perspective, the tax is due once that profit is made, whether it gets distributed or not. So you typically want to at least distribute enough profit to handle the individual investor’s tax burden. And we always in our operating agreements make an assumption, whether it’s true or not, but that there’s a 40% tax rate. So at a minimum, you want to distribute enough to the investors so they can pay their taxes, because otherwise they’re going to have what we call phantom gains, meaning on their K ones, it’s going to show as profit, whatever their percentage profit in the LLC, but they will not have received the distribution or the cash. So they’re going to have a tax hit, but they’re not going to have cash to pay it. So just keep that in mind. But in terms of can you do it legally, as long as you disclose it, you can absolutely do that. And if you want to then take those profits and buy another property, again, if that’s in the PPM and you’ve disclosed that to the investors and they knew that was a possibility, then you can absolutely do that. Great questions this week. And if you’ve got any questions, please drop them in the comments or just reach out to me because I’m really looking forward to answering your questions. And so the more questions I get, I think the better the show will be. So we’ll see you in episode three next week. Thanks.

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