Tapping Investment Capital

New federal rules could be a boon for commercial practitioners, but there’s a lot of fine print to absorb.

March 19, 2014

The federal Jobs Act of 2013 opened up new funding sources for real estate investment by allowing companies greater access to capital. But the new law poses hurdles for commercial practitioners, says attorney Dominic Lloyd, a Denver-based partner in the law firm of BakerHostetler LLP.

How has Regulation D, Rule 506(c) changed the way real estate practitioners can market securitized properties to potential investors?

Historically under Regulation D, unless you registered the offering with the Securities and Exchange Commission, you had to have an existing relationship with investors before you could market your securities to them. These private placement investments still exist, but the new rule gives you the option to make general solicitations to investors. There are no limits on the number or form of solicitations. You can use social media, your website, the radio, newspaper ads, or an encounter at a conference. You can also add solicitation respondents to your client database and then contact them later for future private placement deals.

This sounds like a great opportunity for commercial real estate developers. What are the downsides?

The biggest challenge is the new verification rules. Now you can market to the world at large, but you can sell investments only to accredited investors. The difference is that with private placements, which don’t allow for general solicitation, investors self-certify that they meet the income or net worth requirements. Under the new rule, the person making the offering has to take “reasonable steps” to verify that investors are accredited. This means you will have to obtain information that independently confirms an investor’s status as an accredited investor. Steps could include obtaining copies of financials such as tax returns and brokerage statements or getting a letter from a bank or attorney. (An accredited investor is an individual with a net worth of $1 million, excluding primary residence, or an income of $200,000 in the two most recent years and expected for the current year. It’s $300,000 for a couple.)

Are there other issues that should concern commercial practitioners?

Using general solicitations takes you out of the statutory exemption for private placements. Rule 506(c) offers a safe harbor under the statute if you comply with all requirements and don’t use a general solicitation. Another hurdle is the filing requirements. Under the regulations, you will have to file a notice of your offering with the SEC 15 days before the first offer of sale by general solicitation. It might be hard to determine exactly when the general solicitation begins to meet that 15-day deadline. The rules also require filing all the materials you use in the solicitation with the SEC. Finally, offerings are limited to U.S. residents, so you will have to require Internet prospects to self-certify as residents before they can view an offering.

According to the SEC, only about 7.2 percent of U.S. households qualified as accredited investors in 2010. Are there other changes that would enable real estate practitioners to raise capital from smaller investors?

The proposed crowdfunding rules would let you make general solicitations to nonaccredited investors through approved Internet portal sites. The proposed rules allow investors with incomes of less than $100,000 to invest $2,000 a year or 5 percent of their annual income or net worth, whichever is greater. Investors with higher incomes or net worth can invest 10 percent annually, to a maximum of $100,000. Another limitation is that a company can raise only $1 million a year in this way. If you have a separate LLC for each property, you will probably be able to raise that amount for each deal. On the positive side, you won’t have as much due diligence responsibility to qualify investors. The portals will handle that. The challenge will be the potential hundreds of small investors in each transaction that you will have to manage.

Mariwyn Evans

Mariwyn Evans is a former REALTOR® Magazine writer and editor, covering both residential brokerage and commercial real estate topics.