Global Investors Podcast
GI32: Understanding the In’s and Out’s of Real Estate Syndication with Attorney Dugan Kelley
January 29, 2020
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Dugan P. Kelley co-founded Kelley Clarke, PC with the mission to deliver big firm expertise and experience to the local community. Kelley Clarke currently serves clients throughout the United States with its principal offices in Prosper, Texas and Santa Barbara, California. Mr. Kelley chairs the firm’s securities and real estate practice group, assisting clients in all phases of multi-family, commercial, and residential acquisitions or sales. Throughout Mr. Kelley’s career, he has assisted clients in structuring real estate transactions in excess of $2 Billion.  Currently, Mr. Kelley provides syndication and securities services for clients throughout the United States, assisting clients in all phases of their acquisition and sale of commercial and residential real-estate assets.

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Announcer
Welcome to the Global Investors Podcast, a show that focuses on helping foreign investors enter the lucrative US real estate market. Host, Charles Carillo, combined decades of real estate investing experience with a professional background in international banking to interview experts in all areas of US real estate investing. Now here’s your host, Charles Carillo.

Charles
Welcome to another episode of the Global Investors Podcast. I’m your host, Charles Carillo. Today, we have Dugan Kelley. He is the co-founder of Kelly Clarke PLLC, which currently serves clients throughout the US with offices in Texas and California. He’s assisting clients instruction, real estate transactions in excess of 2 billion and provide syndication and security services for clients throughout the United States, in addition to assisting clients with their acquisition, and sale of commercial and residential real estate assets. So thank you very much for being on the on the interview today.

Dugan
Thanks, Charles. Thanks for having me. Hello, everybody.

Charles
And I want to kind of before we get into SEC and all this real estate, so what was was your professional background prior to starting your current business- Kelly Clark.

Dugan
Yeah, so I am practicing law for a little over 20 years. And when I started, I thought I was going to be in the courtroom. So like many people that go to law school, if you see TV shows and movies and you think you’re going to be in the courtroom trying case after case after case. So I was a litigator for a long time before I realized that people that are often balton are not happy. So Whether you’re being sued or whether you’re suing, whether somebody is trying to put you in prison, all of those various cases, I have litigated, I’ve either defended or prosecuted those types of cases, both on the civil side and then on the criminal side. And so I just realized that people were more happy doing real estate transactions and starting businesses. And so that’s how I gradually over my career got involved in real estate and real estate transactions.

Charles
Awesome. And you’re located in Texas, correct? at the Texas office.

Dugan
Yeah, so we have offices in Southern California. We’re in a place called Santa Barbara, California, which is about 90 miles north of Los Angeles. And then we’re in the Dallas Fort Worth area. So we have, we have two offices, but most of our clients are hunting for acquisitions around the United States and in the hottest kind of multifamily markets.

Charles
Yeah, for sure. So some of our listeners have have never invested in a syndication before. Can you go over a typical syndication deal structure for let’s say, a multi family acquisition, which I imagine most of the listeners would be pondering investing in?

Dugan
Yeah, sure. So when we talk about syndication, what we’re really talking about is the pooling together of investors money sufficient so that we can actually get to that low so me I like I usually tell people, it’s like buying a home most of us our home owners we had to show up at the closing table, we had to pay our 10% or 20%, or whatever the bank said, here’s the amount of cash that you got to show up in order to get the keys to your home. Well, buying and selling apartment buildings is really no different. It just is a very much more money that the banks want you to show up at the closing table with. So when we are buying and selling large apartment buildings, the amount of equity that we need to show up with largely depend on the leverage that we can on the loan side. So if we can get 80% leverage on a loan, that means that we’re going to show up to the table with 20% equity. And many of us don’t have millions of dollars lying around. But we have friends and family people that love and know us and would like to own a piece of an apartment building. And so what we do is we syndicate it, we create a single entity, that will be the borrower. That’s the entity that will sell off is a potential investors and they will give us that money in order to reach that 20% or 30% number that we need to reach to satisfy the bank’s criteria about getting the keys to the apartment building so that’s really what syndication is. So anyone any one of your listeners Charles and thought to themselves, I’m a lawyer, or I’m even I own some small commercial real estate. How do I own a piece of an apartment building? How do this? Syndication is a perfect vehicle for them to be able to get into the space and to be able to own a piece of an apartment building?

Charles
Awesome. So what are traditional fees charged by a sponsorship team and the sponsorship team being the general partners or the ones that are actually putting together the the syndication?

Dugan
These can vary wildly from deal to deal but in general, if you’re a passive investor you’re looking at one of these deals, here’s the type of fees that you can expect to receive to be disclosed to you as being charged by the sponsors. There’s typically an acquisition fee, that’s usually one to three points 1-3 percent based on the purchase price of the apartment building or the asset that’s being acquired. That’s typically a one time closing that’s pay back closing that amount of fees. there’s typically a monthly asset management fee, that’s the a 1 to 3% percentage on the gross revenue that’s flowing through the apartment building. So the rents, the pet fees, the laundry, all of that is gross revenue. The sponsors are typically the managers or the asset managers for the passive investors, and they charge a fee for that. And that fee is typically one to 3% of the gross monthly revenue that’s flowing through the apartment building.And then there will often be an equity side. So the passive investors may own 80% of the apartment building and the sponsor syndicators may own 20%. And it’s not always an 80/20, it could be 7030 with an 8% preferred return, or something in between, we’re really onlylimited by our lack of creativity on the sponsorship side, and what your potential investor base will, will appeal to. So if you have a sponsors taking 80% and only selling 20%, to investors that may not appeal to many investors. So it’s fairly typical that the investors own the vast majority of the apartment building and they also get the vast majority of the compensation and the district issues that fall out.

Charles
Awesome. And in regards to distributions, how our passive investors compensated after investing.

Dugan
Yeah, so passive investors are largely compensated through a variety of distributions. So most deals not all deals. But most deals, readers get the passive investors receive quarterly distributions, or they’ll receive monthly distributions. If you’re on the sponsorship side, you want to make sure that those distributions are frequent enough that you’re giving enough love to your investors so that you seen something, if they’ve given you 50,000 or $100,000, and they’re getting no love back from you either on a monthly basis or a quarterly basis, the likelihood is they’re not going to invest in your next deal. And so, sponsors want to incentivize and inform their investors and frankly, get distributions out to them as soon as they possibly can, so that they can come into the next deal. So what you typically will see is quarterly distributions over and above expenses for the property meaning the debt service, we got to pound out the light bill. We got to pay the mortgage, we got to pay the pet fees, we got to pay the we got to pay the landscapers all of the various costs that go into operating the apartment, the lien our top line items of costs that come out. And then typically the investors will either receive or receive if there’s a preferred return offer on that particular or receive their preferred return after the preferred return is paid. If there’s any excess left, that is typically split between the sponsors and the investors depending on their ownership split. So in our hypothetical, if it’s a 70/30 split with an 8% preferred return cost to operate the apartment building come first, the 8% preferred return on the initial invested capital comes out second. Third, if we have any excess 70% will go to the investors on a pro rata basis based on their percentage of ownership and the entity and 30% will go to the sponsors.

Charles
Okay, awesome. So you work with a lot of different syndicators and how would a passive investor How would you suggest if a passive investor was a potential percent passive investor was interested in investing? How would they vet what would be the best ways methods of vetting a potential sponsors and the syndicator sponsor?

Dugan
Excellent question I get to ask this all the time, because, as you know, in commercial real estate, you’re often not investing. If you’re a passive investor, you’re often not knowing personally like face to face, the sponsors of the deal. And so how do you know that this is a legitimate deal? Well, you gotta do your due diligence. If you’re a passive investor, you’ve got to get references from the sponsor. You need to know what their track record is. Is this their first syndication? Is this their first deal? Or are they seasoned operators? Do they know people that, you know, it’s not unlike kind of putting on our little detective hat. And we’re going to do a little bit of investigation into whether this is an appropriate kind of suitable investment for you. So if anything red, any red flags come up in that process of you as the passive investor vetting the potential sponsor, whether you call the references and the references say, Well, I don’t know this person, or a sponsor says, I’ve done deals with so and so and you know, so and so and you call so and so and they say, I don’t know what you’re talking about. That’s a red flag. Don’t give them your money. But if you’re able to validate the information, you’re able to kind of work and see their historical track record. And then I’m a big believer and asking sponsors to help me a deal that went sideways is there if you do this long enough, there will be deals that go sideways. And I want to sponsor that’s humble enough to admit mistakes or deals that haven’t exactly worked out the best and that they’ve owned it and what they’ve learned from it. So I’m talking to somebody as a potential passive investor, and the sponsors just telling me roses, roses, roses, roses, and there’s no bumps in the road. That’s that’s a potential warning flag because the reality is that there are no guarantees in this business. Well, real estate backed securities are, in my opinion, some of the safest in the country. And they result in in many ways, better returns than where you’re going to get if you leave your money in the bank. There are no guarantees. So you want to know that no office associated with that. So I want honesty, I want humbleness, but I also want to know that the sponsors have a track record that I can help verify.

Charles
Yeah, of course at the sponsors been through a downturn or a pullback, they’ve probably seen that their deals haven’t reached the are their estimates their expectations, or they have lost money on them. So that’s very important to do that know about that. One of the things is when I initially years back my first passive investment, I got that private placement memorandum the PPM. And the thing was, the thing was huge. And it took me like a whole weekend I read the thing, it took me like a whole weekend to read this because I had no idea what I was getting myself into. And one investor gets that for the first time, what are like some of the key provisions that the investor should look at, because a lot of it is really just boilerplate and then there’s parts of it that are very that, you know they’re detailing the fees are the more important stuff. That’s per deal.

Dugan
Right. Yeah. So I tell all of my passive investors. So when I’m not the deal Council, I’m often vetting deals for potential investors, is it? You’re right, it can be intimidating. It can almost be overwhelming. And there can almost be kind of like paralysis by analysis, because you get a big stack of paperwork, hundred and 30, hundred and 60 depending on the size of the deal. It could be a couple hundred pages of stuff that for most people that don’t live in, well, in this strange world of syndication all the time. It’s foreign. It’s like a foreign language. You don’t understand it. You don’t know what’s important, what’s not important. So the reality is I tell all of my clients on the passive investor side, a few key things. One, I want to know what are the fees that the sponsor is receiving for structuring the deal, I tell all my passive investors is perfectly understandable and expected that the sponsors be paid. They have massive amounts of time, energy resources, their own money invested in these deals, they need to get paid. But I as the passive investor, not wanting to know what it is what it is that they’re going to be paid. Two, what am I going to receive? If I invest into this deal as a passive investor? Where is our waterfall or our plan of distribution that will? Am I getting it preferred return? If so, what’s that amount? When do the distributions begin? How often should I receive reporting? Right? I want to know, are they going to be reporting to me monthly, quarterly, something in between that annually? If I’m if I’m only getting distributions once a year and I’m only receiving reports once a year, that’s probably not going to fly with many of my investors, they want to be informed by their sponsors. And then most importantly, I want to know what’s the exit strategy, right? Because I’ve given you Charles, is the sponsor $100,000. You’ve taken that hundred thousand dollars, you cool that together with a bunch of other investors money. And now you own and control an apartment building of which I own a slice of how long is my hundred thousand dollars going to be tied up in this apartment building? passive investors want to see their money grow. And they want to see what’s the exit strategy. So is this a five year old? a six year old? Is it a three year old to the managers have the ability to sell the asset if market if the market starts to soften, or they get an offer? So I want I want to know those types of things. What’s the expectation of money in? What’s the expectation of money out? What are the rights that I have? And what’s the exit strategy? Those are coming hallmarks of the pinch points in the in, you’re going to want to see as a passive investor, and that will help you hopefully sort through that jumble of 200 pages of what you think is mostly nonsense. You know, stacks and stacks of just stuff.

Charles
So your firm will actually review it for a potential client, a client that came to you and that had a PPM that they’re not investing. Okay, awesome. Yeah, it’s great to know. The, for a portion of investors that are based outside the United States, how does this change the structure of the syndication? I imagine this is more of a question that a sponsor would be probably asking, but how does it change the structure of the syndication or what what does something that you have to do now if for changing that?

Dugan
Yeah, so So typically, we love and Uncle Sam, let’s just say this Uncle Sam loves foreign investors. So Uncle Sam loves money from people that don’t live in the United States. We love for you to invest in private offerings. I’m a big believer in in private offerings. I think that small business growth in the United States is largely driven by the fuel, the fuel being private equity. So without private equity, both both investors that live in the United States and investors from abroad, our our economy doesn’t home the same way. So in large part, we knew we need to help make it easy for foreign investors to invest in private placement, placements in the area of multifamily. I see all the time. Investors from Canada, the UK, Israel, China, other countries investing in these apartment deals. And the reality is, what it does is it shifts back to the sponsor, some extra obligation and foremost is we want to make sure that the country or the rest of the foreign investor that lives in the country, is okay with United States that we’re not at war with them that is not a prohibited type of transaction. Secondarily, we want to make sure that the foreign investor is going to actually pay their share of taxes to Uncle Sam. So remember, Uncle Sam loves people to invest in our deal also want you to pay your fair share of taxes. And the reality is when you’re when you’re a sponsor, cater, and you allow foreign investors to come and invest in your deal that shifts the burden back to you, if they’re a foreign investor, to make sure that they do pay their fair share of taxes and most operating agreements, which is the governing document that will exist after the investment. This so after the rays and the offering has closed. There’s one day document that exists between that governs how the apartment building will be run. That’s called the operating agreement. Most operating agreements will contain provisions that allow the sponsors or the managers to withhold from the foreign investors distributions amount, some amount of money to ensure that they actually pay their taxes. Otherwise, if we’re faced with God forbidden odd at some point by the IRS, we want to be able to demonstrate that all of our investors are foreign born investors have in fact, met their tax their tax obligations for the United States. But in large part, there’s absolutely no prohibition on foreign investors to invest and private offerings. And in fact, if they would qualify if it would be a suitable investment for them as if they live here in the United States, it would be a suitable investment for them, but we don’t advise, typically you will not find counsel that are based in the United States Do you also that are structuring these deals that will advise them on the securities laws of other nations? So to the extent that there are impacts with them in the UK or Israel or Canada, they’ll need to vet those considerations with their own lawyers when they’re looking at whether this is an appropriate investment.

Charles
Yeah, yeah. So the the IRS wants you to invest, but they don’t want to be chasing people offshore for taxes. So they leave that to the sponsor, which makes perfect sense. I mean, the sponsor and then as I understand it, then that specific investor then has to file return, they get their money back, if not all that was required for taxes. That’s where like, you work with a lot of syndicators, what is like common theme that you see in your successful syndicators that come back to you and keep on doing deals. What do you see that they’re doing that maybe novice investor or novice syndicator doesn’t do what what do you see there?

Dugan
I think the biggest rule of success that I see with most of my syndicators around the country that have wild success and being able to scale their investor base is one communication. So communication with their investors communication when things are going well, but maybe even more importantly, communication when things are not going well. So you made a reference like Charles, if you’re getting a pro forma or projection or an estimate in the ppm and a year down the road for whatever reason the property is not performing at the level that was projected when you initially made your investment. As a passive investor. I want to hear feedback from my sponsor as to why like what are the key key issues or factors in the disparity between what I thought I was going to get and from what I get now. So I see sponsors that have good, often frequent touch points with their investors, those sponsors are often more successful than the ones that don’t, and to, we want to make it easy for our investors to invest in things. So if our sponsors are not able to answer our questions, if they’re not able to return phone calls or emails, or there’s some sort of lag time, when we’re looking at a potential investment, that’s no brother, that our investors are not they don’t, they don’t like that they want. They want a well oiled machine, somebody that’s highly responsive, somebody that gets back to them with good clean communication, but most importantly, that they perform, right? So an investor and even if you sponsors a little prickly, even if their bedside manner is not awesome, but yet, I’m seeing those checks, hit my mailbox every month or quarter. I’m coming back for more. Yeah. So, you know, those are the two kind of big things that I would say that I see that differentiates between a great sponsor and and those that are just getting their feet wet and they’re trying to trying to figure out exactly what the secret sauces.

Charles
Yeah, that communication is a huge thing. I was at a conference last year. And somebody on stage was like, how many people have invested in the syndication? Maybe like 60-70% of people raised their hand. And then they said, how many people would like to hear more news, more communication with the sponsor? And the majority of them kept their hands up. So it’s definitely it’s it’s crazy how a short email or short newsletter can go so far and letting people know because then they’re they’re ready for that investment. They’re ready for that the return to be because of that email to expect what’s going to happen, so absolutely, but awesome. So how can listeners learn more about you and your firm?

Charles
Hey man, we would love to hear from your listener. We’re really it was our pleasure and honor to be on your on your podcast. There’s a couple ways in which you can reach out and touch base with us one you can go to our website, go to our website, learn more about us whether we might be a good fit for you. And in your area. Our website is kelleyclarkelaw.com or you can send me a private email message and hopefully I’ll be just I’ll be giving you back expect is especially what I advise my clients and that is a response, immediate response to your email to me, but it’s my first name dugan d u g a n @Kelley K e l l e y Clarke C l a r k e law l a w .com. Or you can always call us and talking to people on the phone, and our number is 972-253-4440.

Charles
Okay, awesome. Well, I will put all the links and the contact information in the podcast and also in the YouTube notes. So I want to thank you so much for being on the show today, and look forward to connecting me with near future.

Dugan
Thanks, Charles.

Charles
Thank you, brother. Have a good day.

Charles
Hi guys, this is Charles from the Global Investors Podcast. I hope you enjoyed the show. If you’re interested in investing in real estate and you don’t know where to begin, set up a free 15 minute strategy call with me at schedulecharles.com. That’s schedulecharles.com.

Announcer
Thank you for listening to the Global Investors Podcast. If you’d like to show, be sure to subscribe on iTunes or Google play to get new weekly episodes. For more resources and to receive our newsletter, please visit global investor podcast.com and don’t forget to join us next week for another episode.

Announcer
Nothing in this episode should be considered specific, personal or professional advice. Any investment opportunities mentioned on this podcast are limited to accredited investors. Any investments will only be made with proper disclosure, subscription documentation, and are subject to all applicable laws. Please consult an appropriate tax legal, real estate, financial or business professional for individualized advice. Opinions of guests are their own information is not guaranteed. All investment strategies have the potential for profit or loss. The host is operating on behalf of harborside partners incorporated exclusively.

Links and Contact Information Mentioned In The Episode:

About Dugan P. Kelley

Dugan P. Kelley co-founded Kelley Clarke, PC with the mission to deliver big firm expertise and experience to the local community. Kelley Clarke currently serves clients throughout the United States with its principal offices in Prosper, Texas and Santa Barbara, California. Mr. Kelley chairs the firm’s securities and real estate practice group, assisting clients in all phases of multi-family, commercial, and residential acquisitions or sales. Throughout Mr. Kelley’s career, he has assisted clients in structuring real estate transactions in excess of $2 Billion.  Currently, Mr. Kelley provides syndication and securities services for clients throughout the United States, assisting clients in all phases of their acquisition and sale of commercial and residential real-estate assets.

Mr. Kelley’s real estate expertise includes transactional services for his clients ranging from commercial loan closings, real estate private equity capital raises, joint venture agreements, commercial leasing, business acquisitions and general commercial real estate services for multi-family syndicators, investors, and developers.

Throughout Mr. Kelley’s 20 years of experience, he also has tried numerous cases in state and federal courts, administrative courts, and arbitration. With over $100 million in verdicts, settlements, workouts, and millions in settlements prior to trial, Mr. Kelley understands that there isn’t a one-solution fits all for every case. Mr. Kelley routinely advises real estate investors and other entrepreneurs about entity selection, corporate formation, risk assessment and other related transactional needs. Mr. Kelley also represents a number of companies and family businesses in providing advice and counsel in the capacity as outside general counsel.

Mr. Kelley was previously a partner with Cappello & Noel, one of the nation’s foremost complex commercial litigation firms, in Santa Barbara, California. While at Cappello, Mr. Kelley successfully prosecuted and defended major commercial litigation involving a variety of commercial matters including lender liability, contract and transactional disputes, and fraud. Prior to his tenure at Cappello, Mr. Kelley was a litigator at Bonne, Bridges, Mueller, O’Keefe & Nichols in Los Angeles where he successfully defended healthcare professionals and healthcare institutions involved in malpractice suits. Mr. Kelley’s practice also included defending employment claims against professionals and the County of Los Angeles. Prior to moving into the civil sector, Mr. Kelley successfully prosecuted criminal matters.

In addition, for several years, Mr. Kelley was an adjunct law professor teaching fundamental legal skills, legal research and writing, and moot court to law students in the Orange County area. From 2008 through 2016, Mr. Kelley has been selected as a “Super Lawyer Rising Star,” with only 2.5% of attorneys recognized as the best attorneys. Mr. Kelley routinely acts as a mediator for other attorneys or as settlement counsel for complex litigation matters that require a unique solution. Mr. Kelley is a best-selling author of Purpose, Passion & Profit and is frequent speaker and lecturer at events.  He also serves on a number of non-profit Boards, including Treasured Vessels Foundation, which has a purpose for ending human sex trafficking and providing shelter to those victims of human sex trafficking.

Mr. Kelley and his wife, Michelle have 3 boys. The entire Kelley family is actively involved in giving back to their local church and community.

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