How to Invest in Commercial Real Estate

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Episode #038 - How to LEGALLY Setup your Commercial Real Estate Investment Offering w/ Tom Hutchison

by Criterion, Braden Cheek, Brian Duck
August 16th 2021

Have you ever wondered how you can legally setup a company to raise money from investors and then use that money to invest in commercial real estate? Today our hosts Brian Duck, Braden Cheek & ... More

And if you're doing like you said, a deal with your brother in law, a friend of yours, which is the two of you and you're buying a house for rental property. Probably not a risk there, a lot of risk there. But if you're raising significant money from outside investors, particularly folks don't have a pre existing relationship with. You want to be concerned about the types of investors they are. And making sure you're either conducting a registered offering which usually you don't want to almost always you don't wanna do in a real estate deal or you're, you're doing so percent an exemption from registration with the sec because you don't wanna get trouble with the sec. Mhm. Yeah. Welcome back to how to invest in commercial real estate. My name is Brandon and today we have a special guest Tom Hutchinson with gable. Got wells. Thanks for coming man. Yeah, thanks for having me. So like said tom is an attorney, a partner with gable here in Tulsa. You have branches in and Tulsa and Oklahoma city that you can probably work a lot of places. Um, but anyway, tell us a little bit about yourself what you do for gable and then we'll hop into wine attorneys necessity and investing in commercial real estate. Sure, thanks a lot brian. Uh yeah. Born and raised here in Tulsa, graduated law school in 2007. Uh started a gable.

Have been there ever since you have a transactional practice and do a lot of work with commercial real estate developers, commercial estate lenders, um everything from helping form companies review loan, docs review purchase and sale agreements for real estate. Uh As you guys know, help with security, private placements and subscription documents for capital raises. So uh real estate, pretty much your focus. I know you do a lot of other stuff but is it is the bulk of your stuff on real estate? Uh No I do a little bit of uh anything in the transactional world. So I do some some lending work for banks, real estate and non real estate also do some M. And A. And securities transaction in the in the non real estate sector. So do a fair amount real estate work to do some other stuff as well. Yeah man well you just write it off a whole bunch of stuff that that sounds easy because it's in your world, but first of all it's it's impressive that you've been a gable uh that long I mean started they're still there so something's something's going right. Yeah it doesn't feel that long but I'm getting older I guess. Um Yeah I mean it's it's exciting to see people stay with one company.

I mean it makes it easy for sure doesn't happen as much anymore but yeah it's been a good time for me. Um Well you know for for criterion um we lean heavily on you guys obviously you rep us and everything we do and it really makes us be able to sleep at night because like you said, you know from from forming a company, you know, some people freak out like oh my gosh, I have to have to start a company, you know that five minutes, you know, maybe it's a couple a couple things you can get an attorney, you cannot an attorney. I'd like to hear it because from an attorney, what does it take to to start your own real estate company? Because yeah, that that is daunting to some people that are listening because they just haven't done it. So how easy is it tom just walk us through the steps so to actually form the entity being an LLC incorporation or or limited partnership, it's usually filing a document, the Secretary of State, it's a one page document uh usually get here in Oklahoma to get it back the same day usually or the next day and it costs 100 bucks um a little bit of attorney time in it, I use it, I'm in charge for performing the actual entity because the paperwork's so so simple.

So 100 dollars you pick a name, I guess you do a search and you file on the same day, you can have your company. That's right. And what's the document you get when you, when you format for an L. L. C. It's an article articles of organization here in Oklahoma. Sometimes it's called a certificate of formation in other states, it's a corporation to be a certificate of incorporation. Um Now there's also a governing document you need with those operating agreement in the case of an LLC or an LLC agreement. And those can be a little more complicated and a little more time consuming, depending on how many partners you have, what the entity is doing. Um you know, if it's a it's a sole sole proprietorship soul member, uh those are pretty easy to generate as well, but an experienced counsel can put that together for you fairly easily and and not too expensive. And in your experience, you mentioned an L. L. C. In a partnership, sole proprietorship, is that usually what a real estate company is, how it's filed? Typically an LLC, you see a lot of that there are, I mean, a big advantage of LLCS is the amount of flexibility you have in terms of setting up uh, equity distributions, waterfalls, setting up management rights, whether it be a board of managers or a single managing member.

Lots of flexibility there. So that's an advantage. There's also tax advantages they can be taxed as a pass through. Uh So you're not getting double taxation, you might with a corporation. Okay. What if somebody was setting up uh and going through that form that you mentioned and they click the wrong button and then they find out later they get an attorney and he says, oh no, you needed to be an LLC. Can you change it from what you originally you can now, depending on what you've done in the interim, there could be tax consequences to that. I mean, if you haven't, it's early on, may be sure if it's early on, doesn't have any assets, haven't done anything. You can change that very easily or it's fairly inexpensive. Just set up a new entity. If you've, you've got concerns on that. All right, now, that's good. I just want people to know how easy it is. Hey, I want to form a company that's going to buy real estate. It's a form, uh, it's $100. Uh, Secretary of State website, you get your arteries with organization, you can get the, the operating agreement can come later. That's right. That's right. So that guys, that's how easy it is. You can get that done quick and then get, I mean, you could probably get an operating agreement online sample, but we suggest using uh an attorney like tom that that's going to know what you need in there to protect you and have all of it laid out.

Yeah, I'd recommend that, but I have a vested interest in doing so so, but I definitely recommend having attorney do so. And so someone would come to you and said, okay, I need an operating agreement. You just sort of ask them certain questions about how they want to arrange it and based on how they answer those questions, then you come up with the operating. Absolutely, Absolutely. And for folks like you who have done multiple deals with usually come with an operator you're comfortable with. So if on deal 23 and four, if you're setting up a new entity makes it that much cheaper and easier to do. Okay. So you could come up with one originally and then if you form another entity for another real estate deal, then you can use, uh, the first one, generally sure every deal, every deal is different, but you gotta form, you're comfortable with and the next deal is going to be similar to the one prior that yeah, it's a lot, a lot easier put together. All right. Yeah. I think its relationship based too. So I mean just like you said, going through answering the questions saying the points of concern. I mean, I think we've done three or four operating grants just this year and it's literally to the point where it's, you know, an email with a few sentences that says, hey, here's, here's the waterfall hurdle.

Here's the pref, here's the splits after that. And then we use the same form that we've approved, you know, three times already this year. And okay, here are the different points, You know, and we don't even, you know, isn't necessarily review the entire document anymore. It's nice that you can just get the change, change the change pages only. Um, so I mean on my, my time, you know, I'm writing an operator operating agreement like five minutes because tom's writing it and we've written in three or four times in the year and we've done it before. So like I said, you know, finding an attorney where you can lean on them through throughout the same thing. If you're doing that, you know, if you're in real estate it becomes a lot easier. And I just to go back to his point on how flexible the operating agreement is with an LLC is any, any amount of ownership percentages and the, and the decision making and who gets the benefits and who gets the ball. That is just really easily structural able to structure in the operating agreement however you want it. Yeah. And again, a big benefit of the LLC, your point. Just a lot of flexibility.

So, you know, some deals are similar than others. Some are very different, but whatever you want to do, we usually can accommodate within certain reasons. So kind of talking about an operating agreement, um, a lot of people, you know, can, can go in on investments with their friends like, hey, let's go in, let's by a house, let's, let's fix it up. Me and you, we'll go and we'll paint it, we'll fix it, we'll flip it, you will do the thing me, you were painting together. That's probably okay, right. You both have a physical vested interest, you both, you know, maybe contributing money, you both have the expectation that you're gonna get a return on that money, hopefully, but you're both working hard for it. So it's probably okay that you just get an operating agreement fairly easier than the alternative, which is more in the securities world where you're raising money from, you know, potential strangers passively for, for the purpose of, you know, getting a return that's going to be different than an operating agreement. Right? Yeah. That's potentially a long answer to your question. But, uh, in short, you want to be careful whenever you're selling securities and if you're doing like you said, a deal with your brother in law, a friend of yours, which is the two of you and you're buying a house for rental property, probably not a risk there.

A lot of risk there. But if you're raising significant money from outside investors, particularly folks don't have a pre existing relationship with, you want to be concerned about the types of investors they are. And making sure you're either conducting a registered offering, which usually you don't want to, I mean, almost always, you don't want to be a real estate deal or you're, you're doing so percent. An exemption from registration with the sec because you don't wanna get trouble with the sec, uh, and most deals that folks are doing, uh, you know, comfortably fall within an exemption from registration. But again, you want to talk to a competent attorney and make sure that you're doing so. Yeah, So, I mean, that's, that's a massive point. You know, that's, that's a big one. You can't just go, you know, create a facebook ad and say, hey, we're gonna buy an apartment complex, get, you know, 10 people's money that you don't know and then just go, go, do it. You know, even if it works, it's illegal. So it's kind of a point, right? Yeah. And the reality is if that happens, probably if things go well, the investment pays off, it probably won't matter. I'm not advising anybody do that. But it becomes a problem if investment doesn't go well and then folks start asking for their money back and they've got all kinds of rights and remedies, including Recision or so new for fraud alleging fraud because something wasn't disclosed.

And even if you didn't commit fraud, uh, if you busted the exemption registration, you're gonna have problems on your hand. So let's, let's just walk through how easy it can be because it can sound intimidating. You know, there's a private placement memorandum that you legally have to put together. There's maybe a subscription agreement, which, you know, all of these things is just to bring caution, bring awareness to the potential investor, right? Just to disclose everything that's right. I mean, usually when a client comes to me and they're doing a capital raise for real estate investment? The question is, who are your investors? Is it a father in law and brother in law or close friend that you've known for a long time. How much money are we talking about? How many investors are they? Are they close friends or are you gonna solicit outside and based on the answers to those questions, you find out how you structure the offering and what exemption might be applicable there. And generally the larger the investment and the more folks are bringing in and folks that are maybe not people, you know directly, uh, you've got to be a little more cautious and a little more hoops you gotta drop through. And one of those is the private placement memorandum or sometimes called an offering memorandum. Uh, and that's a document takes a little time and effort to put together.

But it'll basically disclose everything about the real estate investment, about the company, how the waterfall works if there's a distribution waterfall, how management works, uh, the property, if there's a particular assets being bought just so everybody goes into this wide eyed. Yeah, I think the key is, is disclosure how you, uh, this for people listening, how do you keep yourself from? Uh, committing fraud is just disclosed honesty openness. Um, I'll give an example. I invested online through those online crowdfunding sites. I just saw the lawsuit today on one that I invested in that has been a disaster. But basically the guy was a hotel deal and the guy was gonna ground lease the hotel deal from the owner. Well, he got a childhood buddy, uh, that lived in another state and he formed the exact same entity name, but in Texas vs where the hotel was in Connecticut of the hotel owner. So they looked identical and, and so he agreed to pay the hotel owner 500,000 for the lease. Uh, but then he turned around and used the same company name in texas and used our money or the investors money and paid his buddy, which is him a million and a half dollars for that same least pocketed the million.

And he might have been able to do it if he would have told everyone this is exactly what I'm doing, but didn't tell anybody nobody knew. And he made it look like it was the same company and the million just went to his pocket and now we're all fighting for our money back. So it's all about disclosure when we're doing these things and, and the whole point of the PPM, the private placement and all this is to fully disclose everything. We know possibly that about the offer and what can go wrong with the offer. So everybody yeah, goes in full knowledge. Yeah, I think that's a great summary and I would not advise doing just, that's just what you describe. Yeah. Um Yeah. So I mean, I think our last PPM private, the private offering memorandum was 100 and three pages. You know, it's, it's a heck of a document. It includes the operating agreement includes articles of incorporation or articles of organization, it includes maybe a budget or bios about you where the funds are being used. Who's getting what monies that were taking from investors. Yeah. And and like tom mentioned earlier, it really matters if the deal goes south. But if the deal goes south, you're probably gonna get sued, somebody is going to read this document and I'm telling you if, if you co mingled the funds, if you didn't pay your taxes, if you paid yourself too many fees or didn't follow what you wrote, right because they get the opportunity to make changes, they get the opportunity, we get the opportunity to make changes.

And if you don't follow the rules of your own operating agreement, you're going to get in trouble. And like you said, I mean you can be dealing with large real estate transactions or large amounts of money and at the end of the day, you know, people think attorneys can be expensive and you know, from, from some perception fraternities or attorneys are expensive but compared to, You know, 20 years in prison or the fines from the sec, you can get or not being able to raise money or buy real estate deals again, or or thinking things are okay when they're actually super illegal because of your ignorance and your ability to not want to go get an attorney goodbye to you in the ass. Yeah, I'll reiterate all that again. And the other thing I'll add is is like the operate agreement if you're doing multiple deals, the PPM can be a lot more efficient and less expensive to prepare if it's a similar structure. Every time. I know that's something we've done. Obviously if the deal is wildly different, you've got to revise it a lot, but a little bit of effort on the first one can make things more efficient and less expensive down the road. Yeah, I got a little story about how expensive attorneys are. So you know, I, I wanted to have to try to save a buck every now and then we started with no money and so I used to not use attorneys to the extent I use them today.

And uh we had this property, it was an in Arkansas and we had put a bunch of non refundable or we put a bunch of refundable Ernest made down but we were about to pass are where the money goes. Nonrefundable, going back to the deadlines that tom mentioned probably the most important part. And so we knew we knew we were going on refundable. But what happened was the day that I went nonrefundable on $250,000. The main tenant. A story came out about them potentially filing bankruptcy, not even filing bank, just potentially filing bankruptcy. Well the lender pulled alone And now I was unable to close on the property by the date I had to close and so I ended up losing 250,000 dollars and you're probably still willing to buy it. I would have, I might have tried to buy. Yeah. Um, you couldn't because the lender Couldn't, because I lost alone because of the story. But the takeaway is this, that it could have so easily been uh, saved the $250,000.

If I would have had a competent attorney, Make sure I had a material adverse change clause in the contract, which I did not have. And so what that means is, Hey, as long as this deal is the same deal that I signed up to buy when I entered the contract to the time my clothes then that I'm good. But between those two days, the landlord or the owners got to take some risk in case one of these tenants files for bankruptcy and the deal changes and it's now not the same deal. Well, I didn't have that in there and I and my partner and I, we, we basically burned $250,000 in a day. And it was a really tough lesson. But I don't know if I've spent, You know, I may have spent $250,000 on attorneys from like day 1-2 year, you know, 19 and yet I lost all of that in a day. Right, trying to save a few dollars. So anyway, that's my story. That's another part of the documents is the contract between the buyer and the seller, I guess, right? Yeah. The purchase and sale agreement, that's an important one. That's gonna be important. Yeah. Just a little bit of time from an attorney reviewing those.

Can, can lead to avoiding some of the issues you just mentioned right there. Definitely. We were chatting little bit before we got started. And I think deadlines or something just being mindful of those creating a schedule. Those, that's one of the things that trips people up, particularly not using an attorney making sure they're making, they're meeting their due diligence deadlines or title review periods all those things because missing one can, can cause you to lose your escrow money or, or other adverse consequences. Do you ever find yourself actually corresponding with the attorney on the other side of the deal? Absolutely. Absolutely, particularly bigger deals a lot of times the attorneys and the most negotiation back and forth. But a lot of real estate investors are pretty savvy. And so sometimes it's more of a take a look at this and spot issues, uh, level review depends on the size of the deal. The client. All those things can be, can be customized as needed. Well, I know we're almost, uh, time to wrap it up, but I do want to make a point on how to pick an attorney because I have seen in my time, attorneys that can be very combative and they can spend a lot of time fighting increasing their fees all along the way. And, and so I think it's really important to find an attorney that you trust that you have some relationship with or they know someone, you know, so you know, they're, they're, they're in the deal for your best interest because I have at times gone with an attorney, I didn't know and I really felt like they were going to drag it out and they weren't, I wasn't their primary interest.

Their fee structure was so uh, we trust tom we've used tom but there are other good attorneys, but I would say that's a big recommendation for me is get one that, that you trust and that you have a relationship with that's going to be working to lower your attorney bill. Not increase it. Yeah, definitely big plug for tom you know, we, we use them on like I said, every, every single deal, every transaction, every operating agreement, every purchase and sale agreement, their team takes care of. They put schedules. You know, just like you were saying about the timelines I get a gorgeous Excel document I opened up and it's got timelines on it. Put those in the counter. I mean, it just literally allows us to be to do what we do best and allows you guys to do. You know what I'm amazed at the things that you and your staff find that I had no idea that that was, you know, a concern. And the other thing I like about your staff is you give us what the concern is and you tell us why that's a concern. And then a lot of times you said, well, you know, the final decision is up to you. But here is exactly what that means and here's possible consequences. You guys decide whether you want to do that or not.

It's really easy to work with. Thanks for the kind words guys appreciate it. Just to kind of reiterate what Joel said. All you guys are saying, I mean you want an attorney who's going to keep their eyes on the prize, which is getting the deal done. Uh, and its commercial and identifies the risks and ultimately your degree of risk tolerance and where you wanna go forward or not. But you don't want somebody who's just negotiating for the sake of negotiating. There's a reason we do this and it's so the deal gets done. Not so you can drive up. You've got really good with that. I'm glad you brought that up because that's how you seem to attack it as you want to get the deal done. Yeah. Well hopefully you learn something today. Um, if you didn't get an attorney, that's what you should learn. Thanks for joining us. Make sure to like and subscribe if you're interested in using tom or gable, um, hit us up, hit us up, Give it a google. We'll catch you next time on how to invest in commercial real estate. Thanks for having us guys. Yeah, yeah.

Episode #038 - How to LEGALLY Setup your Commercial Real Estate Investment Offering w/ Tom Hutchison
Episode #038 - How to LEGALLY Setup your Commercial Real Estate Investment Offering w/ Tom Hutchison
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