In any real estate transaction, it’s important to be clear and concise about the key terms and conditions which relate to the deal in question, for the benefit of all parties involved, and an Offering Memorandum is a term often used.
Clarity in the terms of an offer is especially important when funds for a real estate investment are being sought from third parties or passive investors. Not only do the terms and conditions of the acquisition need to be clearly set out, but also key information about the property, investment returns, dividend payments, the sponsor and so on.
In Real Estate Private Equity or syndication situations, the presentation of such material is usually called an “Offering Memorandum”.
What exactly is an Offering Memorandum?
An Offering Memorandum (“OM”) is a detailed document provided to potential investors in a private placement deal, setting out, amongst other things, the key risks, financial expectations, and deal terms of such placement.
An OM may also be known as a Private Placement Memorandum (“PPM”), and can be considered as a business plan intended to allow investors to fully understand the investment opportunity being presented and attract investor interest. It generates interest by clearly setting out the risks, returns, operational details and capital structure of the real estate transaction.
A prospectus, whilst similar, is used for public not private markets. The OM may also be referred to as an “Offering Circular” if it requires registration with the stock exchange commission or other regulatory authority for any reason.
Who usually prepares an Offering Memorandum?
Offering memorandums are usually put together by project sponsor or GP in conjunction with its team of legal advisors, accountants, property appraisers etc, possibly using an Offering Memorandum standard template.
Typical contents of an Offering Memorandum
The contents of an OM may vary slightly case to case, but the key objectives are to present the necessary information in a detailed and comprehensive manner. This is in order to give potential investors enough information to make an informed decision whether to invest.
Simplicity and clarity of presentation are important aspects to consider when preparing an OM, so that readers have a positive first impression, and makes the investor want to learn more about the offering.
The basic contents of an OM in any syndication may include:
- basic information about the property.
- details about a value-add, enhancement or planned development.
- projected investment returns.
- equity requirement.
- structure of syndicate structure including promote, fees, sponsor’s equity contribution, debt of funding details.
- expected holding period.
- estimated transaction closing date.
- deadline date for investor’s indication of interest.
This will normally be a section describing the attractions of the investment and highlighting its investment potential; some key points which can be included:
- attractions of the property’s location.
- certain enhancements or add-value works which will improve capital value.
- information on substantial cash flow upside once aforementioned improvements completed.
- any improving macro-economic factors such as overall economic uptrend, population growth or infrastructural changes.
- details about the experienced sponsor, management team and a solid business plan.
Description of subject property
As a centrepiece of the transaction, the property needs to be fully described, including sections on the key facts and comments on grade and condition. The actual contents can vary slightly between OM, but the basics should include:
- address and location, with location map as appropriate.
- summary of construction of main structure.
- age of property.
- land area and permitted uses for site.
- asset type, ie multi-family, offices, retail, industrial etc.
- grade of asset both in terms of quality of build and physical condition.
- market grade of property.
- total built gross area and units number of units if multi-family and/or square feet or metres of usable space if offices, retail or industrial.
- building services such as HVAC (central air or window units); water, electricity sources.
- number and size of typical units, mix of 1-bed, 2-bed units if multi-family.
- facilities such as gym, swimming pool, in-unit washer/dryer; on-site convenience shopping or dry-cleaner etc.
- car parking on site or nearby.
This needs to contain an in-depth analysis of the market characteristics of the subject property’s sub-market include:
- overview of local and statewide economic factors.
- state initiatives and master planning strategies.
- supply and demand factors and drivers.
- capital and rental growth trends.
- occupancy and vacancy trends.
- population data and trend, major or minor demographic changes (average income, unemployment rate, etc).
- competitive projects now or forecast to be available in the future.
- surrounding and nearby facilities such as shopping, recreational and business centres.
Details about value-add strategy or Capital Investment Plan
Whilst all investments will have a business plan, not all investments will involve a value-add strategy or capital investment plan. If the property in question does present such an opportunity, the details need to be included in the Offering Memorandum.
The strategy for the property upgrade can be outlined and the plan include an estimate of costs, timeline, as well as details of the impact of any value-add or capital improvements.
The various elements of the capital improvement plan should be summarised in text but, often, figures in a table can demonstrate the situation better. They can show the incremental return on investment associated with the capital improvement plan, comparing at least two scenarios, one with and one without the implementation of the value-add strategy.
Pro-forma Valuation and expected Investor Returns
One of the most important sections… it’s the part an investor will probably spend most of their time reviewing!
A summary of the property’s pro-forma assumptions such as a risk and estimated returns, cash flow projections and most of the following metrics need to be included:
- Rental and operating expense growth.
- Occupancy and vacancy rate predictions.
- Going-in and exit cap rates.
- Cash on Cash Return (“Yield”).
- Internal Rate of Return (“IRR”).
- Total equity investment required.
- Total investment returns for both the total project and limited partners or sponsor should be demonstrated with examples;
- Debt assumptions such as interest rate (fixed or variable), amortisation rate, loan to value ratio.
- Debt service coverage ratio.
- Equity multiple.
- Reserves of cash.
- Sensitivity analysis to reflect different risks and variables such as:
- holding periods.
- capitalisation rates.
- rental and price market growth rates.
- construction budget and expected timeline.
- occupancy and vacancy rates.
- operating costs.
Investment transaction structure and timing
Under this section the relationship between the subject property, the general partner or sponsor, and limited partners can be explained, as well as the investment’s equity waterfall and promote structure.
The following topics can also be covered:
- distributions including the timing and determination of amount to distribute.
- Sponsor’s or syndicator’s compensation.
- promote fees.
- other fees such as for acquisition, asset management or disposal.
- type of waterfall arrangement between the parties.
- the project’s financial reporting schedule.
- target holding period and whether this is subject to any flexibility on investment duration.
The investment risks/considerations section should discuss downside scenarios that are out of the sponsor’s control and its mitigation plan.
For example, some risks might include:
- limited transferability or saleability.
- changes in capital markets, tightening of liquidity.
- rising capitalisation rates.
- weakening rental or sales market.
- overbuilding or increased supply.
- mitigation plan about why investment risks are minimal; factors such as:
- strong location of property.
- historically high occupancy/low vacancy.
- relatively low acquisition cost relative to other comparables or competitors in the market;
- improving market fundamentals such as tightening of supply, increased demand.
Background of sponsor
Although one of the most important sections, information about the GP or sponsor and its management team background section will typically be near the end of the OM.
This should include details of the firm’s experience and track record, as well as bios of the key participants, all necessary to build trust of potential investors.
If the sponsor has a track record of “full cycle” syndication deals, where projects have been successfully acquired, upgraded and sold, with funds distributed to investors along the way, such information should be included.
Call to Action
As with any other offers for sales of property or where funding is being sought, a CTA needs to be a strong message.
An OM, therefore, is a complete document which informs potential investors all they need to know about the sponsor, the terms of investment and the potential risks and returns. It almost always includes a subscription agreement, which constitutes a legal contract between the issuing company and the investor.
Some OMs will require the signing of a confidentiality agreement (“CA”) or a non-disclosure agreement (“NDA”) before investors can secure further information.
CPI Capital knows the importance of creating a well-presented, informative OM. Whilst almost all potential investors appreciate an Offering Memorandum which is clear and concise, most serious passive investors are primarily interested in the operating financials, cash flow, deal structure and, of course, the potential returns from the property.
We always make our OMs detailed enough so that our passive, as well as any active, investors have all the relevant information needed to make an informed investment decision.
We provide complete and easy to review financial information to give our potential a true feel as to how their capital will be deployed in the investment on offer.
CPI Capital believes that a well-prepared Offering Memorandum is important for not only raising money from passive investors but also an opportunity to demonstrate our knowledge skills, experience and track record in the multi-family sector!
CSO, COO, Co-Founder CPI Capital