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Real Estate L.P.’s Gone Bad

Last August, I wrote a post titled “Are you a Sub-Prime Lender?” which you can revisit by clicking on the link here.

It took a while but one of the largest firms concentrating in this area has applied for bankruptcy protection on several of its deals. Hundreds and perhaps thousands of investors stand to lose millions of dollars on just this company alone and there are alot of companies in this space.

Why and how could it happen? The why should be easy to explain and understand. If a company buys a property for $100 million. A bank will usually lend 70% or $70 million on a first mortgage. The $30 million down payment is coming from individual investors that earn 11% – 18% depending on the deal that they invested in.

The firm raising the funds has to do alot of marketing to raise these funds. Radio, TV, Seminars, commission to sales people, etc. They also have to start paying interest on the funds they raised now even if it takes them six months to raise all the funds to close the deal.

The real estate investment has to go up 10% or more just to breakeven. As almost everyone knows, real estate especially in Calgary has dropped. If real estate has dropped by 20% and an investment of $100 million is now worth $80 million, the $30 million in equity raised through private investors is now worth $10 million. Add interest and marketing costs and the equity is marginally above zero. With the values going down and the time it took to turnaround and sell a deal getting longer, the real estate companies get squeezed.

Who was watching this? The real estate companies offer these units through an offering memorandum, which is different than a prospectus. An offering memorandum has very little disclosure relating to the viability of the project, the financial health of the promoting company or the history of the directors of the company. All of these things are disclosed in a prospectus offering which a brokerage firm looks at prior to recommending an investment to a client.

Often, the offering memorandum wasnt even filed with the Alberta Securities Commission which means that they dont know it exists until something goes wrong. Even if the memorandum is filed, the promoter will state that an investor is a friend, family member, or business associate of the promoter to allow an individual to get into the deal.

I believe that there will be some regulatory changes and private investments through offering memorandums will be greatly restricted going forward. Unfortunately, it will be too little too late for many.

Your thoughts and comments are always appreciated.


One Response

  1. Great article



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