“Devotion to the truth is the hallmark of morality; there is no greater, nobler, more heroic form of devotion than the act of a man who assumes the responsibility of thinking.” Ayn Rand
Real estate syndicatiors, hedge funds, and start up companies received the long awaited blessing from the Securities Exchange Commission (SEC) to begin advertising for accredited investors on Wednesday, July 10th. The vote lifted an eighty year ban for general solicitation and some clear winners and losers are sure to emerge with the change.
This will affect accredited investors witch means the eight million or so Americans with a liquid net worth of $1,000,000. This is impressive crowd for the record. Some estimates suggest that 1.4 TRILLION will be raised under the new rules.
To fully grasp the magnitude of the change consider this crash course in securities law. A prospective investment is a security (The Howey Test) if it is:
- investment of money due to
- an expectation of profits arising from
- a common enterprise
- which depends solely on the efforts of a promoter or third party
Therefore, if a promoter is making the business decisions for the venture then its a security. Other structures that are not a security include a member managed LLC, a Tenet in Common ownership structure, and a debt obligation that is not fictionalized.
Registration of a securities is extraordinarily expense (Accounting, Lawyers). For a single asset purchase is not cost effective. However, the private placement rules permit a much less costly avenue for promoter under three provisions: regulation D rules 504, 505, and 506. Rule 506 is the most popular with sponsors because it has no dollar limit being raised and lower disclosures required because it is targeted at accredited investors.
The protection scheme of 506 is supported by the policy that accredited/sophisticated investors are wise enough to not need hand holding. Up till now however the process of meeting new investors was to say the least a lot like dating. You had to meet the investor and create a per-existing relationship before you could pitch your specific investment. (These rules still apply to 504 and 505).
The JOBS act has taken away the “courtship” aspect as to rule 506. Its on like Donkey Kong! Direct mail is fired up and ready to go all across the land. An interesting question is how much will actually change. The promoter will still need to gain the trust of the investor. Will someone invest on the basis of a postcard alone?
This change is not without some concern. Here are the winners and possible losers under this change:
- Real Estate Syndicates perhaps the biggest winners. It will permit a much more aggressive marketing model.
- Small fry hedge fund managers: This will permit the mom and pop hedge funds to aggressively seek a larger capital base
- Existing commercial real estate owners looking to sell. The flood of liquidity coming to the market price will bid up. Its going to be very intriguing to see what markets and asset classes will bear the brunt? Will multifamily overbuilding get pushed into overdrive?
- Accredited Investors: more choice is a good thing in almost every circumstance. This change will permit a greater exposure to opportunities
- Ponzi schemers: somewhat joking here. This will possibly permit a scheme to to run a lot longer before it crashes.
The need for taking responsibility of education: it will now be even more incumbent upon the investor to be critical of the offerings.
The overly trusting, keep up with the Jones, invest because my doctors neighbors said he was great guy investor is officially doomed and the clock is ticking.
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Tips for Protecting Yourself in the New Era if You Are an Accredited Investor:
- Gravity is real….investment returns of far greater than ten percent or returns that are consistent in spite of market fluctuations demand scrutiny
- Stay diversified. Don’t place too large a percentage with one promoter or opportunity.
- If you don’t understand how they are proposing to generate the returns…trust on the axiom a confused mind must say no!
- How much access will the permit to ongoing books and records? The truth is found in a paper trail….always
- Trust your gut: our flight instincts will protect us if we listen
- Watch American Greed on CNBC. The key theme I draw from the show occasionally demand your capital to be returned. Note single asset real estate deals generally will not permit this option.
- Read The Intelligent Investor by Benjamin Graham
- Read The Snowball: Warren Buffett and the Business of Life by Alice Schroeder
Overall, the changes in the securities rules will have a tremendous impact and I believe mostly positive in the real estate world. The dangers do exist for the unwary. That’s the truth.
Photo: Scrambled Squash