If you’ve ever invested in real estate, you know that there are two types of investors: accredited and non-accredited. It’s really important to know what makes an investor qualified as accredited, because it will impact whether or not the investor can participate in real estate syndications and other investments. In order to be considered an accredited investor, one has to meet certain requirements and regulations imposed by the Securities and Exchange Commission (SEC). It matters, because it impacts who can access certain investment opportunities and how a sponsor can approach both types of investors.
You might be wondering why the SEC is involved in real estate investing. The reason is simple: when you participate in a real estate syndication, you’re not really purchasing a share of a building; you’re buying shares in a Limited Liability Corporation (LLC) that was established in order to buy the asset. Because they are considered shares, the SEC treats them as securities, and that gives them the ability to regulate who can purchase them.
On the one hand, the SEC would like to promote investing in all types of ventures, because investments have potential to have a large payout in the future, and that includes multifamily properties. On the other hand, the SEC wants to protect those investors with limited knowledge or those who may not have the financial wherewithal to deal with a financial risk.
Basically, the SEC’s thinking is that an accredited investor is more adept at accepting the financial risks that are associated with investments in unregistered securities. A sponsor doesn’t have to register the securities as long as they offer them to accredited investors. However, they still are required to notify the SEC and obtain an exemption. This makes it much easier for an investor, because the process to register securities takes a long time and costs a lot of money.
The SEC has recently expanded the Accredited Investor definition to include more investors, but before we talk about the new accredited investors, let’s talk about who was considered accredited already:
What is an Accredited Investor?
So, what makes an investor “accredited?” Regulation D of the Securities Act of 1933 defines an accredited investor as someone who:
• Earned at least $200,000 in annual income over the past two years ($300,000 for a married couple);
• Have a net worth in excess of $1,000,000 excluding the value of their primary residence.
According to Rule 506c, sponsors are able to syndicate their real estate deals as long as they’re marketing to accredited investors. This gives passive investors who are accredited access to investment opportunities that non-accredited investors do not have access to. This is an advantage that many investors don’t enjoy.
What About Non-Accredited Investors?
If you look a little deeper at Regulation D, Rule 506b, you’ll find that non-accredited investors are still allowed to participate in a syndication deal if they’re considered “sophisticated.” So, what’s a sophisticated investor? It’s someone who has sufficient knowledge and experience in financial and business matters to evaluate the risks and advantages of a prospective real estate investment.
There is a surprising statistic, however. In the past year, more than $36 billion was raised in syndication, and approximately 85% of all Regulation D offerings were made by “sophisticated” investors. There are some limits, however, imposed by the SEC. Each deal is limited to a maximum of 35 sophisticated (and non-accredited) investors.
Additionally, sponsors are not allowed to advertise investments to non-accredited investors, so those passive investors who are sophisticated but non-accredited must network with sponsors in order to find out about pending syndications and investment opportunities. In addition, sponsors are legally required to have a pre-existing relationship with sophisticated investors in order to participate in an investment, which makes it even more important to have built a relationship with a sponsor.
New Definitions for Accredited Investors
In August of 2020, the SEC amended the definition of accredited investors, which is the foundation for having the ability to participate in private capital markets. While the income and net worth requirements still can be used to gain an accredited investor status, additional amendments have been added to the accredited investor definition.
All of the changes were made in order to allow more people to participate in private offerings. Now, a person can be considered to be accredited based on certain professional certifications, designations or credentials issued by an accredited educational institution. In addition, people who hold a license in good standing in Series 7, Series 65, and Series 82 are also qualified as accredited investors.
For those not familiar with those types of licenses, a Series 7 license applies to a general securities (GS) license and is given to someone who sells securities. A Series 65 license is awarded to financial planners and advisors who provide investment advice, including stockbrokers, registered representatives who deal with managed money accounts and others. A series 82 license is a certification given to financial professionals who offer private securities for their clients.
The SEC also clarified that LLC companies that are worth $5M in assets are also qualified as accredited investors, as are SEC and state-registered investment advisors. There is also a new category that includes Indian tribes, government bodies, funds and entities who are organized under the laws of foreign countries that own investments in excess of $5M. The only qualification for those organized under those laws did not form the entity for the purpose of investing in the securities that are being offered.
Another category that was added was for knowledgeable employees of a private fund to qualify as accredited investors for investment in the fund. This would include directors, trustees, general partners, advisory board members or other executive officers.
One other category that was added was “family offices,” who have at least $5M in assets under management under their “family clients.” These are privately held companies that handle investment management and wealth management tasks for a wealthy family. Another change was made to accredited investor definition was to add the term of “spousal equivalent,” so that they are now able to pool their finances for the purpose of qualifying as an accredited investor even if they’re not legally married.
The changes to the definition of an accredited investor were based on public comments and recommendations from a variety of financial experts and SEC commission members. This began in 2016 and the changes were adopted in 2020. The SEC plans to continue seeking public comments in order to ensure that there is opportunity to invest in private capital markets.
The SEC regulates how sponsors can work with passive investors, who fall into one of two categories: accredited and non-accredited investors. However, in August of 2020 the SEC amended the definition of an accredited investor in order to include more individuals. This was done to provide investment opportunities in private offerings to many investors who were previously excluded from the accredited investor status.
While income and net worth can still be used to gain an accredited investor status, the SEC has expanded requirements to include investors who have professional certifications, designations or credentials issued by an accredited educational institution. Individuals who hold Series 7, 65 or 82 licenses are now also considered accredited investors.
LLC companies with $5M in assets are also considered accredited, along with SEC and state registered investment advisors. A new category was added to include knowledgeable employees of a private fund, which would include directors, board members, general partners and others. “Family offices” was also added as a new category, and additionally the SEC added the term “spousal equivalent” to qualify someone as an accredited investor even if they’re not legally married.
The final new category added was one that includes Indian tribes, government bodies, funds and entities who are organized under the laws of foreign countries that own investments in excess of $5M. Each has specific qualifications
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About the Author
Ellie is the founder of Blue Lake Capital, a real estate company specialized in multifamily investing throughout the United States. At Blue Lake Capital, Ellie helps investors grow their wealth and achieve double-digit returns by investing alongside her in exclusive multifamily deals they usually don't have access to.
Ellie is the host of REady2Scale , a podcast that focuses on the "APS" of real estate: Asset, Process, and Strategy. Each episode discusses how investors can scale their real estate portfolio and/or businesses.
She started her career as a commercial real estate lawyer, leading real estate transactions for one of Israel’s leading development companies. Later, as a property manager for Israel’s largest energy company, she oversaw properties worth over $100MM. Additionally, Ellie is an experienced entrepreneur who helped build and scale companies by improving their business operations.
Ellie holds a Masters in Law from Bar-Ilan University in Israel and an MBA from MIT Sloan School of Management.