You may have already heard that the SEC is changing the rules on accreditation. So what does that mean for investors like you and me?
For many syndicated real estate investment opportunities, the SEC requires that all participating investors are accredited, but changes are coming. This might be great news for a lot of potential investors, or it might feel like uncertainty is creeping in.
(If you already know the basics about the SEC, feel free to skim ahead. And if you already know about accreditation, then smile. Already, you’re further than a lot of great people looking to diversify and get started investing in real estate.)
Why the SEC is Changing the Rules on Accreditation and How it Could Affect You
The Big Press Release by the SEC
On December 18, 2019, the SEC released a statement of intent to update the definition of an accredited investor, in order to increase access to investments.
According to the release, “The proposed amendments would allow more investors to participate in private offerings by adding new categories of natural persons that may qualify as accredited investors based on their professional knowledge, experience, or certifications. The proposal would also expand the list of entities that may qualify as accredited investors by, among other things, allowing any entity that meets an investment test to qualify.”
Okay, first things first.
1. What’s the SEC?
The U.S. Securities and Exchange Commission (SEC) is an independent agency of the U.S. federal government with one declared mission: to protect investors; maintain fair, orderly and efficient markets; and facilitate capital formation.
That’s kind of a mouthful.
In broad terms, it exists to protect investors by setting the ground rules for U.S. market exchanges, trading, corporate finance, and a wide range of securities and investments. To read more about the five divisions of the SEC and exactly what the agency does and does not regulate, here’s a short article that lays it out in simple terms.
When it comes to real estate syndications and passive streams of income, the SEC is involved in regulating who can invest, and how some of these investments are structured.
2. What is an Accredited Investor?
An accredited investor is someone who meets specific requirements regarding income and net worth based on regulations set by the Securities and Exchange Commission (SEC). This is part of the mission of the SEC — to make sure that investors have proper protection.
Not all investments require investors to be accredited. For example, buying a residential rental property, buying shares in a public company, investing in a mutual fund, or even buying a four-unit rental property — none of these investments require you to be an accredited investor.
To be an accredited investor you must meet at least one of the following requirements:
- An annual income of $200,000 ($300,000 for joint income) for the past two years, and a reasonable expectation that you’ll earn the same income (or higher) for the current year.
- A net worth exceeding $1 million (individually or joint), not including your primary residential home (as an asset or a liability).
Accredited investors have access to investment opportunities that might not be available to non-accredited investors. Some investment opportunities might include:
- private money lending
- debt syndication
- certain passive real estate investments
- venture capital funds
- private stock offerings
3. Why does the SEC set accreditation guidelines to limit who can invest?
In short, the SEC limits investment choices for non-accredited investors as a way to protect people from getting involved with investments that are most likely beyond their reach. Sure, you might be ready to take the risk, but the SEC steps in and says hey, by the looks of everything, we think you should wait. It’s nice to know we’ve got some regulations set in place to protect investors, but it could be frustrating, too.
While many of our real estate investments are only available to accredited investors, the SEC has proposed some changes that may open up opportunities for many potential investors.
Okay, now let’s get to the proposed changes
4. Why the SEC is proposing an amendment to redefine what it means to be an accredited investor
Remember that a big part of the SEC mission is to protect investors. Over the years, several amendments have been put into place to help better align the investment marketplace with the needs of investors. And redefining accreditation is a recent proposal.
In short, the current guidelines appear to define accredited investors based solely on their current wealth, while not recognizing education, expertise, or other factors that may highlight investor preparedness.
The proposed changes attempt to make room for potential investors who may be highly qualified and prepared, even though they don’t meet the previous benchmarks.
5. Proposed categories that will redefine what it means to be an accredited investor
Here are a few proposed categories in the updated definition of an accredited investor:
- Certain professional certifications and designations
- Certain credentials issued by accredited educational institutions
- Certain “knowledgeable employees” with respect to specific funds
- Certain LLCs, registered investment advisors, and RBICs
- Certain “family offices” with at least $5M in assets
- Adding the term “spousal equivalent” to the accredited investor definition
For an in-depth study of the proposed amendment, you can read the full proposal here.
6. Is this good news or bad news when it comes to investing in real estate and generating passive income?
Depending on your current financial situation and your financial outlook, this might be great news! You might be realizing for the first time that there are investment opportunities opening up for you that weren’t available before.
If you’re not an accredited investor (yet), the recent changes made by the SEC are making room for more opportunity!
If you’re already an accredited investor, you might have concerns about whether or not future investments will start to include investors that aren’t financially prepared. The great news is that an experienced sponsor will always vet every opportunity and every investor before putting together a successful deal. These changes by the SEC don’t require investors to include any participants, but rather it opens up opportunity to vet potential investors from a wider base.
7. When will these proposed changes by the SEC go into effect?
The general public has 60 days from the original date of publication to comment on whether or not the proposed amendments should be approved by the regulator.
To submit comments, anyone is welcome to engage by sending an email, submitting comments via the SEC comment form, or by mail. To view comment submission guidelines and addresses, visit their submission details. Comments should be received on or before March 16, 2020
The outcome is unclear, though the proposal indicates an intent to pass the new amendments.
The Big Takeaway
- The SEC sets the ground rules when it comes to most investment opportunities, and accredited investors have a lot more options when deciding to invest beyond standard stocks and securities.
- There are a LOT of options for accredited and non-accredited investors when it comes to investing in real estate. Take some time to think about your financial goals and choose the path that makes the best sense.
- With the recent changes proposed by the SEC, updating the definition of an accredited investor may open up a lot of passive real estate investment opportunities for people who are currently limited from participating.
So now’s the time to dig deeper with education, and keep your eyes and ears out for new opportunities so you can start your investment research.
When you’re ready to take the next step, start the conversation with someone you trust. Investing in commercial real estate syndications and building passive income streams could be the next step on your journey to financial freedom.