Josh Cantwell: So, Nic, hey, so excited to have you on the show today and talk a little bit about syndication and especially from your perspective as a practicing attorney in the syndication space. Thanks for joining me on the show today.

Nic McGrue: Yes, very happy to be here. Thanks for having me.

Josh Cantwell: So, Nic, let’s talk about what’s going on in the market today. Obviously, there’s been a tremendous amount of capital that’s been flowing into commercial real estate, multifamily, syndications. A lot of people talk about commercial real estate and multifamily being very recession– not recession proof, but very recession resistant, I would call it.

And so, just from your seat, where you sit as a lawyer, as an attorney, helping operators like me set up these entities and do syndications, how has the market changed for you over the last couple of years as you’ve been doing this? And what do you kind of see happening over the next maybe couple of years or months as the market shifts into this kind of recessionary inflationary market? Just what do you think about the market sitting where you sit as an advisor?

Nic McGrue: Yeah, so I think one of the big things that I’ve seen is some of the returns have gotten a little smaller. Part of that, from what I’m seeing, is that there’s lots of capital out there, so a lot more people are competing for deals, which makes the costs go higher. So, the investor returns have dropped a little bit. And I think with how the economy is going now, we might see a bit more of that. But like you said, I do think, I wouldn’t say nothing necessarily recession proof, but it’s one good place to be, if we are in a recession, commercial real estate, especially multifamily, people are going to need a place to live. And so, it’s one place that I think can fair pretty well even in tough economic times.

Josh Cantwell: Yep, I think so. And especially with inflation, it kind of works with us and against us. So, as an as an owner in an inflationary environment, rents are going up, especially when we have such a supply problem on single-family homes and we have such an affordability problem with single-family homes that works in our favor. Pushing rents higher where people can get in trouble is when they have short-term financing, and rates are going up.

And when rates go up, if they need to refinance, if they have a balloon payment, their notes gets called due at the wrong time, then some people can get in trouble. So, with that in mind, as you’re working with some of your clients, how do you help them navigate that? How are they operating to make sure they maybe get longer term debt or lower loan to value on their debt?

Nic McGrue: Yeah. So, one thing that this economy has done as well is that as it’s getting a little bit tighter, it’s going to make people have to be actually better at their job because before returns were just flowing and you could do a deal that maybe wasn’t the best, but it could be saved by the time it’s time for you to exit. So, now, one of the things that I’m looking at is I don’t underwrite myself, but I say, hey, make sure you’ve done sensitivity analysis, make sure you’re checking this through because there’s things that are changing, and we don’t really know what’s going on.

And then on the loan front, kind of same thing is that we want to make sure you’re working with a reputable lender. I’m having a good relationship with them so you can get those more favorable terms because before, you can say, oh, this rate’s not that great, but in three years, we’re going to sell it and we’re going to lead to the next. So, it’s not a big deal. Now, we don’t quite know that’s going to happen, so you’ve got to be a lot more conscious of that.

Josh Cantwell: Yeah, I definitely think that there are some operators who didn’t execute their business plan and got bailed out by a rising market. Well, that’s not going to be the case here in the next couple of years as people kind of prep for a possible recession and rising interest rates. So, Nic, let’s talk specifically about syndications. We’ve done 18 of them. I would like to think that we dotted every i, crossed every t. We’re really good at what we do. So, I think I’ve done it the right way by the book.

But if I was a new client of yours and we were engaging and you were going to help me go through this first syndication, or maybe my third or fourth or fifth syndication, let’s talk about syndication basics for a minute. What are the things when you engage with somebody that you want to look at when they’re doing a syndication, the structure of the syndication, how to kind of prepare to do the capital raise, but get all your kind of legal things, all your ducks in a row beforehand? So, if we were having a first conversation or first couple of conversations, what are some things that you would want to look out for? What are some questions you would ask to make sure that an operator is going to get set up for success?

Nic McGrue: Yeah. So, one of the big things that I’d ask initially is who do you think your investor pool is or what does it look like because that’s going to help us determine which exemptions might apply to you. Because when we’re talking about syndication, you’re selling us security. And so, if you’re selling us security, you either have to register that or have an exemption.

And so, syndications are typically doing with exemptions and opinion on what your investor pool looks like, such as if they’re accredited or sophisticated or even qualified, that’s going to determine which exemptions might work best for your deal. So, that’d be one of the first things and I say is, okay, who do you think is going to be investing?

And realistically, especially if you’re doing your first to third deal, it’s mostly going to be the people that are pretty close to you. And so, I’d say, okay, who are the people around you? Are they accredited, sophisticated, qualified? Because that’s probably going to be where the bulk of your investors are coming from.

Josh Cantwell: Got it. Just so our audience, in case this is maybe their first time listening to my podcast, even though we have hundreds of shows, they should listen to them all, just define for us accredited, sophisticated, qualified, in case somebody doesn’t know.

Nic McGrue: Yes. So, accredited, there are lots of different ways to qualify, but the most common way is if you’re an individual, you make $200 or more for the past two years and expect to make that much again this year, or if through your net worth is $1 million or more exclusively your primary residence. So, that’s accredited.

Sophisticated, is a little bit more gray, but essentially, we’re trying to see do you possess the resources either through yourself or through your purchaser representative to determine the risks and merits of this investment, so based upon past investments, your work, your education, that sort of stuff. Can you see? Does this make sense for me? So, that’s sophisticated. And then qualified investors typically are worth $5 million or more.

Josh Cantwell: Got it. Love it. Thanks for clarifying. So, one of the things I’ve noticed that when people go into a syndication, they don’t always know everything that’s involved. So, let’s just peel back the onion a little bit about some of the different documents, paperwork, and a great syndication attorney such as yourself is going to help us do. So, let’s first talk about the private placement memorandum, the PPM, the disclosure document. Just describe that for us and some of the major pieces that should be in that, then we can talk a little bit about the operating agreement. We can talk a little bit about subscription agreement, some of those types of documents that are key to putting this all together, but let’s start with the PPM. When you’re drafting that or you’re sitting with the client to draft it, what’s important? What are the major pieces of it? What are the things that are absolute must-haves?

Nic McGrue: Yeah. So, the first thing I’ll say is that it’s not necessarily meant to sell your deal. It’s going to look kind of scary. It’s going to say the world could end. You can get zero money back. I always tell clients that like when it says they might lose their money. I was like, yeah, that could happen. We hope we won’t. Because the big, at least from my perspective, the primary objective of PPM is to apprize the would-be investor of the risks of this because the operator knows the ins and outs, they know what they saw in due diligence, they know the things that are keeping them up at night about this deal, and the investor doesn’t necessarily know that.

So, in the PPM, we’re disclosing those sorts of things. So, it’s going to seem a little bit scary, but I would say you’d rather have them be scared away from the PPM when you don’t have their money versus for you to not disclose something, you have their money. And now, that scary thing actually happened. It’s going to be significantly worse for you.

Josh Cantwell: Good advice. I like that. So, full, fair, and adequate disclosure, right? So, when I did my first PPM and we’ve done, I don’t know, I think 30 of them, because we had a fund before and we were doing lending and we had a private equity fund and all this kind of stuff, my syndication attorney for that and my securities attorney, he said, “Josh, look, part of the thing we have to do here is we have to think about all the questions that an investor could ask, even if they don’t know to ask.” So, we have to kind of brainstorm, what are all the things that they might ask down the road that they don’t know to ask because we have to solve this kind of full, fair, and adequate disclosure?

So, we literally sat around a conference table and just asked each other crazy questions, like weird, whatever we could think of to think of what are the things that an investor could ask us. So, just describe that, like crafting a PPM, literally, it’s kind of this ham and egg process between the attorney and the client, the client being the syndicator, the operator, coming up with all of these risk scenarios. What could happen? What could not happen? What if this happened? What if that happens? What’s that like for you sitting in your seat?

Nic McGrue: As a transactional attorney, that’s kind of my job even if it’s not a syndication. I’m always trying to think of, okay, what could happen? What could go wrong here so that we can get ahead of it in our documents in advance? I think it’s funny that you mentioned that you kind of go around and say, what’s going on? One of the things that I actually ask clients is I say, hey, talk to your wife or talk to your husband or somebody close. It’s not in this field, and see what questions they have because we want somebody who has no idea and we want to be able to answer all of their questions as well.

Josh Cantwell: Yeah, absolutely. Because often people don’t know what to ask, that will ask the craziest question that you didn’t think of. They’re like, okay, now, I’ve got to put that in the PPM because it’s a question that somebody might ask down the road.

Next document that’s really critical is the subscription agreement. And this is critical because depending on what kind of exemption we’re using, 506(b), 506(c) are obviously very popular. That subscription agreement is where the investor, passive investor, limited partner is identifying. Are they accredited, qualified, sophisticated? Is there a relationship? So, just explain to our audience if they’re not familiar, what is a subscription agreement, what’s its purpose, and some key parts that need to be in there?

Nic McGrue: Yeah. So, a subscription agreement, there’s going to be some sort of entity. Usually, it’s an LLC or a partnership, but it can vary. And so, part of what the subscription agreement does is that it makes you, as the investor, say, yes, I’m agreeing to be a member or a shareholder or a partner in this entity because usually, the entities governing documents are signed mainly just by the managers. And it would be quite cumbersome to have every single investor resign every single time.

So, the subscription agreement says, I’ve read the PPM, I’ve read the operating agreements, I know I’ve read the risks. I’ve talked with my financial advisors, my tax planners, and with all of that, I’m deciding to move forward. And then as you mentioned as well, there are certain things that they have to do to qualify themselves for the investment. So, they’re saying, yes, I am accredited or I am sophisticated. And I had a preexisting relationship with you.

Josh Cantwell: Got it. Yep, the next document is that operating agreement. And this is really important to me because I have business partners. I have two other general partners that I invest with, my good friends, Glenn and Tyler, but I’m the CEO and the majority shareholder and I have the final vote.

And then there are limited partners who have a non-voting share. And so, I want to make sure in that operating agreement that certain things are spelled out. And your operating agreement is essentially your governing document for that LLC. Who can make decisions? How can they make decisions? Is it through a vote? What is each vote worth? What percentage? So, Nicholas, talk about the operating agreement, how critical it is, and maybe some mistakes that people might make, maybe things that they don’t include in an operating agreement that are critical that they should include.

Nic McGrue: Yeah. So, the operating agreement is kind of the guidelines for the entity. With that as well, we’re trying to predict, okay, what are some things that can happen? And let’s try to resolve these now before it happens because it’s much easier to resolve something when there’s clear heads and nothing really at stake versus if we haven’t discussed it and now it’s at issue, there’s hot tempers, it’s going to be a lot harder to resolve. So, that’s what we’re trying to accomplish in the operating agreement or whatever the governing documents are going to be.

I’d say one big thing that I see particularly, when I’m reviewing subscription agreements and PPM documents for a client that’s looking to invest is, as an operator, you want to make sure that your PPM and your operating agreement are mirroring each other or at least are congruent, and not incongruent because I’ve seen some, where the PPM says one thing and the operating agreement says another thing. And so, that’s a problem because ultimately, the operating agreement is the thing that prevails. And so, as an operator, you want to make sure that those are jiving together and you’re not telling people one thing with the PPM but really having the ability to do something else in the operating agreement.

Josh Cantwell: Yeah, the operating agreement is what’s going to govern how those decisions are made. Guys, just remember, our audience, the PPM is just disclosing that language, those bullets, that’s just disclosing that to possible investors. So, the PPM doesn’t govern the LLC. It’s just a disclosure document to disclose to the world how this entity is going to be managed and how it’s managed on paper. So, if there is a disagreement down the road, if there’s a death in the partnership, whatever, that it’s done that way.

Another thing, Nic, that a great attorney that handles this stuff can do is review other types of documents, construction agreements, for example, or property management agreements. We engage with third-party property management and they do the day-to-day property management for us because we really do a lot of construction and I own the construction company. So, talk a little bit about construction agreements. I like to use, if I’m hiring a third-party construction, like a cost plus fee construction agreement and then the property management agreement because a lot of times, your lender won’t fund the deal unless all these documents are agreed on and disclosed and signed as part of the loan commitment. So, talk to us about those agreements as well.

Nic McGrue: Yeah. So, for construction agreements, again, it’s one thing that you really want to make sure that you’re outlining everything. One of the big things I’d say you want, and that is to make sure that you’re stating who has the responsibility to handle what. I had a client just recently. I’m licensed in California and Washington. And so, this client was in Washington.

And so, there they call it laboring industries was basically doing a worksite check. And the client itself ended up being the one that was getting the fines. And that’s through between the client and L&I. L&I says, “I don’t care about what your agreement is with the contractor. You’re on the worksite, so it’s on you.” But thankfully, we had an agreement with the contractor that said, “No, they’re responsible for making sure that they’re doing the safety checks and all the things that are required.”

And so, while my client had to pay that, ultimately, they’re able to get it back from the contractor. And if we hadn’t outlined those things, then it essentially probably would have been my client’s responsibility to pay for all of that. So, you want to think about who’s going to have the responsibility. That’s one of the big things. Really, with any contract, it’s a negotiation of who’s got responsibilities, who has rights when certain scenarios arise.

Josh Cantwell: Yep. And that construction agreement, too, there are different types of– I like the cost plus fee model because I like the disclosure of the cost. I want to know what the cost is for the labor, the material at cost. I don’t mind paying the fee to the contractor for the work that they did, but I don’t like the gray– that’s just me personally, I don’t like the gray of hey, they’re just going to mark up materials X percent or mark up their labor X percent. And it’s kind of not disclosed to me. So, I prefer the cost plus fee model.

I just did a coaching call before this, Nic, with our group, and they were talking about hey, if there’s overruns, like if there’s a schedule, let’s say it’s a two-year schedule. There’s a certain number of draws that are supposed to happen with the contractor. And the contractor doesn’t execute on time, on the schedule, or on budget. So, this construction agreement would spell all that out because this is where, hey, if you got a $2 or $3 million budget to do a value-add improvement on a multifamily and they’re behind schedule, it’s costing real estate taxes, insurance, interest on your loan. Your loan could be called due. So, it’s really critical that that gets in there and there’s maybe some sort of penalty to the contractor if they’re not on time and on budget, right?

Nic McGrue: Yeah. And that’s something that you’d want to make sure that you put in the contract because typically with a contract, if somebody is late, you’re not going to be able to recoup the additional cost that that lateness incurs. And now, we call that special damages.

And so, in order to recover special damages, they have to be foreseeable. And typically, the way to make it very clearly foreseeable is to say, hey, if you are late, here’s the cost that I’m going to start incurring. And so, you’re going to be responsible for that.

Josh Cantwell: Yeah. I got it. Love it. The other thing Nic could do for you is most large property managers, whether regional or national. They have an initial property management agreement that spells out what they’re going to do, how they’re going to do it, what their fees are. We typically, because we use fairly large property managers, we use asset living, we manage 100,000 doors. We use Trinity Multifamily, they’ve already managed 20,000 doors. We use RHM, they manage 13,000 doors.

So, they kind of have their standard agreement, but it doesn’t mean that we have to just accept it carte blanche. We can look at the agreement, we can edit certain things, maybe certain fees, negotiate the management fee. Are we paying the salaries for their people? Are we paying for the federal taxes or the health care? All of this is stuff that when you get an agreement, give it to a lawyer like Nic that they would review and spell this out for you. So, that agreement is probably the one that doesn’t get as much kind of renegotiation as the others because it’s got a lot of it’s a template, but it’s still really important to have that reviewed and signed off.

Nic McGrue: Yeah. So, I always tell clients, that there’s no such thing as a boilerplate or standard contract. It’s your contract so make sure that you’re happy with it. I’m now with that. If they say this is the terms that we’re only willing to give, then you can decide to go with that or go find someone else.

Yeah, so there’s usually not a whole lot of negotiation or anything with that, but even with that, still, we’ll review it and we’ll explain it to you so that you understand what’s in this. What are my rights if something happens? Or who is paying those taxes? Because it’s not so much necessarily that there’s going to be bad things in there, but you just want to know what’s in there so that you can plan accordingly and take your actions in light of the contract.

Josh Cantwell: Yeah. Nic, the other thing I could think of that we have our attorney working on that is really important for you to work on with new clients is other contracts, like when you buy a 200- unit building, let’s say you pay 15 million bucks for 20 million or whatever the number is, you’re a lot of times inheriting these contracts that the former seller had. So, you could have a contract for landscaping, a contract for snow plowing, contract for the laundry.

Like laundry, that could be a contract that could have– some of these laundry contracts we’ve inherited are five, seven, ten-year contracts. So, all of that should be reviewed by a guy like Nic ahead of time so that when you’re going through due diligence, you engage Nic, you work with him, he gets copies of all that stuff and he can kind of hunt and peck through it and say, here’s your commission on your laundry contractor, here’s what you’re signing up for on your landscape contractor, here’s a pre-negotiated water and sewer contract. These are all things that can absolutely hit your P&L, your net operating income. And if you don’t know this upfront, when you’re going through due diligence, you just inherit the building, you could be in for a world of hurt afterwards. So, Nic, just talk about reviewing and even modifying those contracts before the purchase.

Nic McGrue: Yeah. That’s something that we definitely want to review in the LOI, PSA, or whenever the due diligence is taking place. And because, as you mentioned, a lot of these contracts are just inherited, if they’re on the property, then when the new owner comes in, a lot of times the PSA will say, “You’re inheriting these contracts or you have to delineate which ones are not really part of it.” And so, you want to know what those contracts are and how much they cost, what they look like because that can dramatically affect your underwriting. If you’re putting in assumptions for a certain cost thinking that, “Oh yeah. I know this company and they’re great and they’re who’s going to handle it,” not realizing that your property has a contract for that service for three or four more years, that could dramatically change your underwriting. And so, yeah, that’s something that we handle in the due diligence process and that’s important to understand because there’s been many times where we either say, “No, that contract has to be canceled or we’ll negotiate the price down because of how bad that contract is in the current market.”

Josh Cantwell: Yeah. And I think that leads us to the last and final that I can think of and might not be the final but it’s certainly really important, which is the purchase and sales agreement, the PSA, because PSA is for commercial real estate. There is no template, there is no boiler, they’re all custom. And you could put all kinds of modifications in there. You could have a 30-day due diligence period, 30 close, and a 30-day extension. A certain amount of earnest money down, earnest money after due diligence, earnest money to get an extension. That’s pretty vanilla. That’s how we do it, 30-30-30 earnest money, earnest money, earnest money if we need an extension so very vanilla. But, Nic, I mean, these things can be, I mean, you could be splitting up closing costs. You could be splitting up transfer taxes. You could be splitting up. There could be certain reparations, expense perforations, all kinds of stuff. And so, this we could probably have a whole nother call just on this, Nic. But if somebody is not crafting and reviewing the PSA and doing it in a timely way because when you have an agreed-upon LOI, the seller and a buyer want to get into a contract usually as fast as possible, right?

And this is where an attorney that can review it quickly, provide feedback quickly, and kind of partner with, you’re not partnering with them, but for lack of a better word, working with, collaborating with the seller’s attorney and the buyer’s attorney, working together in a really kind of, again, collaboration that can actually make the deal and set the deal off to be heading the right direction versus if you have a PSA and that negotiation gets ugly, it can be an ugly transaction starting right from the beginning, right?

Nic McGrue: Yeah. I’d say one of the big, I don’t know, this is a caution or whatever, I’d say everybody wants to get the best deal. But remember, there’s likely going to be an attorney or unit on the other side. So, a lot of times the clients will say, “Why don’t you have it this or why don’t you have it that?” I say because that’s not going to get through. Because if I was looking at that, I would say, “Absolutely not.” So, you want to kind of strike a balance between making sure you’re protected and making sure you get everything that you need in there, but also realizing the other side’s going to be looking at it. And if you have some stuff that’s kind of nonsense or just far overreaching, you’re going to now be in a negotiation back and forth, which is going to slow things down. It might sow some a little bit of bad will and make the transaction that much more difficult. So, keep in mind that, yes, we want to make sure that you’re getting what you need, that you’re protected but you also got to realize the other side has somebody looking for them as well. And if we go shoot for the moon, then it’s probably going to cause more problems than the benefit you get from it.

Josh Cantwell: Yeah, fantastic stuff. The last thing, last, last, which we don’t need to peel back the onion too much on but the last piece that also gets reviewed by Nic is your loan agreement. Your loan agreement, right? So, when you get loan for commercial real estate, that also is a custom document. The bank might have a template, but again, some of those things are negotiable, editable, etcetera, etcetera. So, when you get your loan docs, you’re going to make sure those get reviewed as well before closing. So, you see we’ve probably covered here at least eight or nine different documents that when you’re going into a commercial real estate transaction, that you’d need a good attorney, a good partner, a good advisor, and Nic McGrew and his firm is exactly that. So, guys, I know if you’ve got an immediate need, again, Nic is licensed in California and Washington. If you have a need outside of that, you still want to talk to Nic, reach out at PolymathLegal.com. If for some reason that Nic is not able to help you in your state, I’m sure he can refer you to somebody else that could. Again PolymathLegal.com. We’ll put that in the show notes.

And, guys, there’s so much other stuff. We look at our attorneys as absolute kind of partners in the transaction, collaborators, advisors, and an absolute must-have to have somebody who can get back to you quickly and really provide good advice quickly because these transactions don’t wait forever. So, Nic, listen, I know we’re short for time, but I wanted to thank you for jumping on the show today. Any other places that people should be able to reach out to you or is the PolymathLegal.com, is that the best one?

Nic McGrue: Yeah. PolymathLegal.com. And then all social media at Polymath Legal as well.

Josh Cantwell: Fantastic stuff. Nic, listen, thanks for joining me today. This is great.

Nic McGrue: Thank you for having me.