The SEC recently announced changes to its definition of accredited investor. We spoke with Ashwini Habbu, Juniper Square’s Senior Regulatory Compliance Counsel, to learn more about these changes and how they’ll impact the commercial real estate (CRE) industry.
The good news: sponsors stand to benefit from a new pool of potential investors.
A brief history
Habbu brought us all the way back to the Securities Act of 1933. Part of that act included a requirement that any offer to sell securities must be registered with the SEC or meet certain exemption requirements. As registration is a cumbersome and costly exercise, exemptions are a good way to bypass red tape.
Habbu stated, “There’s a general exemption that says if you’re not engaged in a public offering of securities, then you don’t have to register. But the SEC hasn’t been particularly explicit in what counts as public or not public, so people are kind of living in this in-between space where they don’t really know.
“So, the SEC passed what’s called a safe harbor, or Regulation D. That safe harbor gives people solace that, well, we may not know if this would be considered public and we don’t want to risk having the SEC say, ‘You should’ve registered this.’ Let’s hold ourselves to a higher standard and meet the requirements of the safe harbor.”
That brings us to the accredited investor standard.
How it works now
As Habbu explained, there are a few different flavors to the safe harbor (Regulation D) for different types of securities offerings, but the most common in the private equity space are:
- Rule 506(b): An investment vehicle (a “fund”) is eligible for the safe harbor if, among other things, it does not engage in “general solicitation” and generally accepts only “accredited investors.”
- Rule 506(c): A fund is eligible for the safe harbor even if it engages in “general solicitation”—including through advertising and other publicity—if, among other things, the investors accepted are not only accredited, but the fund also took additional “steps to verify” that they were, in fact, accredited.
“For the longest time if you wanted to raise capital from investors, usually you just had to do it privately, and only let accredited investors in,” said Habbu.
“There’s always the fallback position under the Securities Act that if you don’t engage in ‘public’ offerings, you are safe; that was probably enough for people raising from a small club or friends and family. But for other people, who may be doing a broader raise or moving up the investor market, the last thing you want is to risk registration—so you make sure you accept only accredited investors.”
The accredited investor definition itself has multiple categories, but generally exist along two main categories—one set for individuals and another for entities:
- Individuals: those who earn, on an annual basis, at least $200,000 alone or $300,000 with a spouse, have net worth of $1 million or more alone or with a spouse, or have $5 million or more in assets
- Entities: corporations, partnerships, and 501(c)(3) organizations with more than
$5 million in assets, or owned by individuals or people who themselves qualify as accredited investors
Although there have been a few incremental changes to these definitions over the last few years, this is the investing world we’ve been living in for a long time.
As financial markets have evolved, the definition of accredited investor needs to evolve with it. The new rules include expanding who falls into the accredited investor category:
- More people with industry expertise will be considered an accredited investor (“knowledgeable employees”).
- You can fit the definition if you have a shared income of at least $300,000 with a “spousal equivalent” (as opposed to a “spouse”).
- Family offices with at least $5 million in assets under management and their clients are now part of the definition.
- Limited liability companies with $5 million in assets can be accredited investors.
Habbu explained the reasoning behind the changes.
“Things have become more sophisticated. People are finding that the technical requirements of the accredited investor definition were scoping people out that should be scoped in. For example, folks who worked day-to-day for an investment manager would qualify for all of these other technical designations, but they wouldn’t meet the letter of the accredited investor definition. The recent changes are meant to bridge this gap.
“The definition as currently constituted says that in order to be considered an accredited investor and as an insider, you have to be an executive officer, a director, or in senior executive leadership. In many instances, there are people working in your shop with a lot of experience who don’t technically meet this requirement.
Now, the rules say that if you have the industry expertise—for instance, certain people who hold Series 7, Series 65 licenses—you’ll be scoped in as an accredited investor.
For those eager to invest but not necessarily working for investment firms, the rules are also providing a bit more flexibility.
“What they’ve said now is that you don’t have to be married to qualify for the definition at $300,000—you can have a ‘spousal equivalent’. So, if you’ve got a long-term partner you can include them as part of either your income, asset, or net worth test.”
When will the updated rules take effect? Once the new categories officially make their way into the Code of Federal Regulations, it’ll be another 60 days before they’re live and in use.
A boon for the commercial real estate industry
Allowing for more flexibility around who’s considered an accredited investor means greater opportunity for investment managers. It also moves us closer to leveling the playing field and democratizing access to capital markets.
“For family offices and family clients in particular,” stated Habbu, “As long as they’re led by someone with the right expertise and sophistication and have $5 million worth of assets, they’ll now be scoped into the accredited investor definition. These concepts were already lurking in certain types of trusts. This joins the two and explicitly acknowledges that a lot of people are investing through family offices. Now, they should be good to go.
“The same applies to LLCs. It used to be the case that you’d have to go through a bit of gymnastics to get to the point where a limited liability company was scoped in. Now, if you’re an LLC, the SEC will treat you like every other business entity and allow you to fit the accredited investor definition.”
Habbu also expects the new guidelines to positively impact CRE subscriptions.
“I think it’s going to make the subscription process a lot easier. The documents are going to be more straightforward, since they’re adding more categories—which will open up and increase the pool of investors.”
How big is the opportunity? Habbu referenced the $1.56 trillion raised under Rule 506(b) and 506(c) in 2019, which was a steady increase from 2018. It’ll only go up from there.
“I do think that it’s going to continue growing. There’s a willingness to accept smaller amounts of cash just to raise more funds and get more people in the door, as well as remove the barriers to entry.”
Greater access for more people
At Juniper Square, we believe that more people should be able to participate in commercial real estate investing. The accredited investor update is a step in that direction.
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We’re looking forward to further helping make this vision a reality.
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