In the past, investing in commercial real estate seemed out of reach for many people because the capital required far exceeded what most people could invest individually. This made commercial real estate an investment vehicle available only to the wealthy and well-connected. However, the Securities and Exchange Commission (SEC) has established rules that make investing in commercial real estate more accessible to the general public.
There are two rules to be aware of if you are interested in a private listing of commercial real estate in the United States: Rule 506(b) and Rule 506(c). The rules are similar, but the differences are crucial for potential investors, whether you want to be an active or passive investor. We'll start with some background competition on SEC regulation, then get to the heart of the two rules by exploring a cross-comparison chart.
What is the purpose of section 506(b) and section 506(c)?
Each rule has a purpose, and 506(b) and 506(c) are no different. Therefore, to understand how they work and why they are written the way they are, it is important to understand the context of why these two rules exist.
It all starts with Section 5 of the Securities Act, which states that all offers and sales of securities must be registered with the Securities and Exchange Commission (SEC) unless an exemption from registration is available.
Exemption from registration may not seem like a big deal at first, but registering an offering for the sale of securities with the SEC requires a lot of money, paperwork, time, and legal advice. If every commercial real estate deal had to be listed with the SEC, it would entail a huge amount of work for the committee to review and approve, likely creating a huge backlog and long delays for investors to get approval . Given the speed at which real estate can move, requiring registration for every real estate company would become too prohibitively expensive for investment and for the industry as a whole.
There are two common places where registration exceptions apply:Section 4(a)(2) of the Securities Actwhich was redesignated by section 4(a)(2) of the JOBS Act and Regulation D. Here is a brief overview of each:
Section 4(a)(2) exempts offers and sales from issuers that do not involve a public offer or distribution (such as a listing on a stock exchange) from registration. These private offerings are generally considered to be private placements, and an issuer is generally considered to be any person that issues (or intends to issue) a security.
While section 4(a)(2) is helpful, it is fairly ambiguous about what qualifies as a public offering or distribution, and does not provide much clarity to an issuer as to whether or not its offering and sale of a security would qualify. as a private placement that is exempt from registration. Therefore, the SEC has passed Reg D to provide a safe harbor mechanism to assure issuers that their offerings and sales of securities are exempt from registration.
Regulation D provides two safe harbor exemptions from the Securities Act's Section 5 registration requirements (and state-level blue sky laws) for commercial real estate investments underRule 506(b)iRule 506(c).
There are important differences between the two lines that should be carefully considered before you start raising capital. So let's look at each rule individually and then look at a direct comparison between Rule 506(b) and 506(c) Regulation D.
What is a 506(b) offer?
Rule 506(b) allows a real estate association to raise an unlimited amount of money from an unlimited number of accredited investors and up to 35 non-accredited investors. The offering cannot be advertised publicly and the issuer can only present the offering if it already has a relationship with the investor, but authorized investors can "self-accredit" in 506b, meaning the syndication can take the investor's word for it. they are authorized.
Because general advertising is not permitted, the issuer may not post a social media message on social media platforms promoting a particular offering, place an advertisement in a newspaper, show an advertisement on television or use any other form of advertising.
What is a 506(c) offering?
A 506(c) offering allows a real estate association to raise an unlimited amount of money from an unlimited number of accredited investors (but not non-accredited investors). The offering may be publicly advertised without restrictions, but all investors must be verified authorized investors. A verification request can be made by a third party, such as verificationinvestor.com, or by a written statement from the investor's CPA or financial advisor with supporting documentation such as W-2s, tax returns, financial statements, credit reports, financial documents, bank statements, brokerage statements , etc.
The ban on blanket invitations has always been in effect under Regulation D, but the new Rule 506(c) was created in 2012 as part of Title II of the JOBS Act to help a general partner or union raise money using general invitations to support economic support. grow.
What is the difference between Section 506(b) and Section 506(c)?
The two main differences between 506(b) and 506(c) are that in a Rule 506(b) offering, a real estate syndicate can raise money from accredited and non-accredited investors and take the word of the investor that it is accredited. but the issuer cannot advertise the company at all without a previous relationship. In a 506(c) offering, a real estate association may raise funds from accredited investors, even if they have no prior relationship, and may publicly promote the offering, but the issuer must take reasonable steps to create a quality screening process to ensure that the verify investor accreditation. .
Comparison Chart of Section 506(b) and Section 506(c).
If you are raising money for commercial real estate investment opportunities, you must meet the following requirements of the SEC's securities laws. Here is a table of the main differences and similarities between the 506 b and 506 c offerings:
| Rule 506(b) | Rule 506(c) | |
| Authorized Investors | • Unlimited number of authorized investors • Up to 35 non-accredited investors who qualify as 'sophisticated investor'. | • Unlimited number of authorized investors |
| Authorized investor verification | An issuer may accept authorized investors who "accredit" themselves by providing a written statement that they meet the requirements. The issuer must conduct due diligence to arrive at a reasonable belief that the written statement is true. | The issuer must confirm that investors are authorized. Often a third party is used for the verification process to confirm the status of an authorized investor. |
| Financial constraints | • There is no limit on the amount collected • There is no limit to how much each investor can invest | • There is no limit on the amount collected • There is no limit to how much each investor can invest |
| Advertisement | • It is not allowed to advertise the offer • The offer can only be made by the issuer if the issuer already has a relationship with the investor | • Any form of advertising is allowed • No substantive prior relationship with the investor required (though still a good idea) |
| required data | If the offering involves one or more non-accredited investors, the law requires the issuer to provide information. If only authorized investors are involved in the offering, the information is not required by law. However, it is probably a good idea to include information to inform investors and avoid liability under Rule 10b-5. The issuer must be available to answer questions from potential investors. | There is no legal obligation to provide information. However, it is probably a good idea to include information to inform investors and avoid liability under Rule 10b-5. The issuer must be available to answer questions from potential investors. |
| SEC registration | And | And |
| State registration | And | And |
| Submissions after sales | • The issuer must file a Form D with the SEC • The issuer must file the appropriate forms for each state where the investor resides | • The issuer must file a Form D with the SEC • The issuer must file the appropriate forms for each state where the investor resides |
There are several terms we have discussed in relation to investor protection:real estate investorsand investment offers. Let's take a moment to clarify what some of them mean.
What is an Authorized Investor?
The SEC provides a simple definition of an accredited investor. To qualify as an accredited investor, the SEC requires that you:
- An individual whose gross annual income in each of the past two years has exceeded $200,000, or whose joint income with a spouse or partner has exceeded $300,000. In addition, the person or couple has a reasonable expectation that, based on a reasonable forecast, they will earn the same or higher income in the coming year.
- A person whose total net worth, excluding primary residence, individually or together with their spouse or partner exceeds $1,000,000.
As you can see, the SEC guidelines provide a clear definition of an accredited investor, without making it overly complicated. More information about the different types of investors can be found here.
What is an Advanced Investor?
An experienced investor is a high net worth investor who is considered to have extensive experience and knowledge of the market, making him eligible for certain benefits and opportunities. The SEC defines sophisticated investors as those who have "sufficient financial and business knowledge and experience to evaluate the benefits and risks of a prospective investment."
Here you can learn more about advanced investors.
What is a pre-existing material relationship?
The SEC defines a “pre-existing” relationship as one that “was formed prior to the commencement of the offering or established through a broker-dealer or investment advisor prior to that investment professional's participation in the offering.”
The SEC defines a “material” relationship as one that “occurs when the entity offering the securities (ie, the Company or its broker-dealer or investment advisor) has sufficient information to evaluate and judge. "
506(b) or 506(c): Which is Better for Me?
As with all real estate investment decisions, the only way to determine what's best for you is to thoroughly consider all factors within your situation and consult with local experts about your goals and challenges. That said, here are some general guidelines:
A 506(b) may be the best choice if you plan to raise money from people in your personal network who may or may not be accredited investors. Many novice real estate syndicators use Section 506(b) for their first deal because they rely on acquaintances first.
If you're looking for a wider reach of only accredited investors, a 506c affiliate may be the best choice because you can promote your offering to a wider network of investors than just those in your personal network.
Abstract
Rules 506(b) and 506(c) both serve as broad exemptions for private placements that are safe havens from the registration requirements of the securities laws. Both of these rules help you invest in more companies and open up your business to more potential investors. Each policy has its pros and cons, and this is not legal advice, so you should always do your due diligence and speak with your attorney before making a decision. These two rules are a win-win situation for real estate sponsors and passive investors.