The days of being a small fish in the ocean of real estate investing are in the past. Through real estate syndication, small fish are able to band together and keep up with the sharks. Similar to crowdfunding, real estate syndications are an opportunity for multiple investors to come together in raising capital to purchase properties that would otherwise be out of reach. With these opportunities come specific rules pertaining to how securities are sold.
Before looking into real estate syndication opportunities, you need to understand the differences between common exemptions and the laws that govern them.
How Does Regulation D Work for Syndication?
From the ashes of the Great Depression, the government had to impose strict laws in order to protect investors from fraud and to restore confidence. While these protections were necessary to ensure the financial safety of investors, they also made the process of selling securities a more cumbersome task.
When real estate syndications raise funds, they are governed by the Securities Act of 1933. This federal law states that the issuing of a security must be registered with the Security and Exchanges Commission (SEC). This process can be both time consuming and costly. Regulation D, under the Securities Act, provides exemptions to this registration requirement, so long as sponsors meet two requirements.
- They file a notice with the state after the security is sold.
- They file a notice on Form D with the SEC.
Two rules under Regulation D outline exemptions commonly used by real estate syndicates. Those are Rule 506(b) and Rule 506(c). The key difference between the two is the ability to advertise under 506(c) and the specifications as to who is able to invest in an offer.
Rule 506(b)
Offers that fall under this exemption must satisfy certain requirements. While sponsors are allowed to raise an unlimited amount of funds, they must adhere to the following:
- The sponsor may not advertise to the public about an offer.
- The sponsor may sell securities to 35 (or less) non-accredited investors.
- Non-accredited investors must be “sophisticated” – or have the financial savvy to be able to invest.
- The sponsor may have an unlimited number of accredited investors..
This exemption is enticing to sponsors because it provides flexibility as to the amount of investors they can bring on, while not bearing the responsibility of verifying if the investor is accredited. This is because investors are able to self-verify in writing.
With a 506(b) offering, potential investors must also have a substantive relationship with the sponsor (i.e. friends, family, or they have a previously established form of communication). A previously established form of communication may include things like online educational offerings and email lists.
Rule 506(c)
A key difference with 506(c) is that it allows sponsors to advertise an offer to the general public, however they must take actions to ensure all purchasers are accredited investors. This can be done through a verification system which may include:
- A written endorsement from the investor’s CPA or financial advisor.
- Third party representation with supporting documentation (i.e. bank and brokerage statements, and a statement of real estate owned).
Sponsors may be drawn to this exemption because it opens up the opportunity to advertise, despite the added process of ensuring that all investors are accredited.
Accredited Vs. Non-Accredited Investor
If you aren’t sure whether you fall under the accredited or non-accredited category, there are specific guidelines that indicate where you land.
First off, an investor can qualify as accredited through one of two ways.
- They pass the income test.
- They pass the net worth test.
In order to pass the income test as an individual, you need to have earned at least $200,000 for a minimum of the past two years. For married couples to qualify jointly, they need to have a combined income of at least $300,000.
If you pass the net worth test, it’s because you have a net worth of at least $1,000,000 (excluding your primary residence). This requirement remains the same for married couples.
Non-accredited simply means that you do not qualify under either category, but that does not mean you can’t invest in real estate syndications. There are many options for non-accredited investors to get in the real estate game.
Are you an accredited investor interested in 506(c) opportunities?
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Both accredited and non-accredited investors are welcome to join the discussion and learn about the multifamily investment marketplace!