One benefit of real estate investing is the opportunity to raise capital from investors to buy larger properties and reduce risk for all involved. Through money pooling, investors are able to own properties that they would not normally be able to purchase on their own. Investors who have the capital to purchase a property without investors, are still likely to invest with others to reduce their capital risk exposure and participate in multiple investment opportunities.
In order to participate in raising and pooling money, the deal sponsor must follow Security Exchange Commission rules under Regulation D to sell securities. Regulation D is part of the Securities Act of 1933 (the “Securities Act”), which was put in place to protect investors after the 1929 stock market crash.
One of the most common and original rules a sponsor may follow under Regulation D is called Rule 506(b). This rule is an exemption to register when offering and selling securities. The 506(b) rule, also known as the “safe harbor” rule, allows sponsors to offer securities to unlimited accredited investors and up to 35 sophisticated investors.
A common question we receive is; what defines a sophisticated and accredited investor? SEC defines a sophisticated investor as someone who has sufficient knowledge and experience in financial and business matters to evaluate the merits and risks of the prospective investment. There is not a minimum net worth requirement.
SEC defines an accredited investor with the following criteria:
- earned income that exceeds $200,000 (or $300,000 together with a spouse) in each of the prior two years, and reasonably expects the same for the current year, OR
- has a net worth over $1 million, either alone or together with a spouse (excluding the value of the person’s primary residence).
- holds in good standing a Series 7, 65, or 82 license.
There are other categories of accredited investors, including the following, which may be relevant to you:
- any trust, with total assets in excess of $5 million, not formed specifically to purchase the subject securities, whose purchase is directed by a sophisticated person, or
- any entity in which all of the equity owners are accredited investors.
In addition, there are other categories of accredited investors that recently were updated and provided great news for those who do not meet the criteria above. Click here for a separate blog on those changes.
In a 506(b) offering, the deal sponsor cannot post general advertisements promoting an investment. For example, if you are seeing an investment opportunity posted on Facebook this is not (or should not be) a 506(b) offering. The investments posted to the general public follows the 506(c) rule under Regulation D, which will be discussed on a future blog post.
Another important factor on a 506(b) offering is the deal sponsor must prove a substantive, pre-existing relationship with non-accredited investors. There is no time commitment to the relationship, but the sponsor is not able to offer an opportunity to invest without having a prior substantive relationship.
If an investor does not have a prior relationship with the deal sponsor, and wants to invest in the opportunity, the investor will self-certify that they meet the accredited requirements listed above.
The 506(b) rule is very common when raising capital to buy large multi-family apartments. This is due to the benefits of allowing investors to invest without a net worth requirement and having a pre-existing relationship that is built around trust.
If you would like to learn more about multi-family real estate investing or would like to start building our relationship to participate in future 506(b) offerings, please contact us today.