What is a Syndicator?
Syndicators are a group of people that join together creating syndications network. They jointly purchase and have the liquidity and net worth to buy an asset. It is not limited to real estate. It can be done with many other things, i.e., Broadway or movie productions.
The Key Differences
The key differences are that they exclude certain parts of the population from investing in private placements, which do not have to be registered with the SEC but are governed by it. Generally, these are considered exemptions; therefore, there is a set of reasonable steps the SEC requires syndicators to take to protect the investors.
Any natural persons, a legal term for anyone a legal citizen or resident in the United States, could also be an entity such as an LLC owned by someone who lives abroad. The SEC generally wants to protect U.S. residents and citizens and is interested in defining their investor status.
What Defines a 506(b)
Rule 506b is a private offering that cannot be publicly advertised. It is only open to people with a substantive relationship with the syndicator and is, therefore, limited to the network of the deal sponsor.
A sophisticated investor must have such knowledge of bank statements, financial documents, and sales of securities that the general partner can verify that they are fit for the private securities offerings and a prior relationship with the general partner.
This is crucial verification requirement to meet SEC regulations, but it allows sophisticated investors who have the necessary understanding to make an investment.
This is generally established by checking particular facts about the investor’s background and making sure they understand the risks and downside of any given offering. It is usually limited to 35 sophisticated investors, and if more funding is required, it can only be met with accredited investors.
Also, if an entity with five owners invests, this entity does not count as one sophisticated investor but as five.
What Defines a 506(c)
A 506(c) is a public offering that can use general solicitation, which means it can be advertised in public, i.e., on social media. It is aimed at investors based on their net worth or other rules that might apply, such as license series 65, a new law that allows investors to act as accredited investors as defined under regulation d of the SEC.
Generally speaking, an accredited investor needs $1 Million net worth excluding their primary residence or $200k income per year (married couple $300k) in two consecutive years with the expectation to keep that income in the upcoming year. It could also be an entity that has over $5 Million in net worth, but this cannot be a fund with the sole purpose of meeting this requirement.
The SEC is generally interested in protecting investors in business matters and keeping private markets in check. Every offer has to take legal advice from a syndication lawyer to stay compliant and ensure that the type of investors they attract for their investment is respectful of the syndication filing.
The benefit of having accredited investors is that one can have an unlimited number of potential investors through general advertising.
What government agency are we speaking about?
The SEC, which stands for Securities and Exchange Commission, handles investments under the Howey test established in 1946. The Howey Test was initially devised to determine whether or not an investment contract was considered a security. In short, if the investment contract is found to be a security, it must register with the SEC and comply with all of its rules and regulations.
To determine if an investment contract is considered a security, the SEC looks at four main factors:
1. Is there an investment of money?
2. Is there an expectation of profits from the investment?
3. Does the investment come from third parties?
4. Is there an issuer or seller involved? If any of these four factors are present in your offering, it will most likely be considered a security and must register with the SEC before launching your ICO or STO.
How to Verify an Accredited Investor
It is best to outsource the legal liability of these additional steps to a third party. The third-party company will use tax returns, credit reports, bank balances, and other documents to verify the annual income to have accredited investor status.
There are private companies that specialize in this and make sure that these types of investors are actually in compliance with Regulation D. The verification of suitable for five years and is not used only for 90 calendar days.
It is safe harbor to outsource this liability for a minimal fee. This helps offset potential harm for smaller companies. Larger companies with more investment offerings might be able to do this part of the due diligence in-house.
General partners in any real estate syndication need to make sure they understand the private placement exemption their deal falls under and handle the communication with the general public accordingly. The sale of securities, significantly when raising capital from U.S. persons, always needs to happen within compliance with the SEC.
Passive investors should always know what kind of syndication they are getting into to make the necessary preparation to qualify for the available exemption. You never know what you’ll be getting into when you invest in syndication. But if you do, and you’re prepared for it, that’s a different ball game.
How to Find Recession Resilient Syndications Deals
The bigger question for many people is how do I find these private placement deals? Historically, these deals have been almost like a personal circle. Up until today, one needs to seek them out. This is nothing that your financial adviser will offer you next to the mutual fund they are trying to sell you.
These investment opportunities have outperformed the S&P 500 significantly, but also it takes some research and diligence to understand the landscape.
Generally, there are two ways to be part of these multifamily real estate syndications. One can become the deal sponsor and therefore put in the necessary leg work in building a network of brokers, vendors, and tax, and legal advisors to find suitable properties, which will bring higher reward but also comes with a steep learning curve and a lot of time commitment or one can become passive investor.
Recommended Video: How to Get Into Multifamily Investments: Tips for New Investors
Should I be a Passive Investor in Syndications?
Becoming a passive investor in syndications is an excellent way for busy professionals that love their job to diversify their portfolio into more asset classes that are potentially recession-resistant because of their strong fundamentals.
One could have a reasonable belief that people will keep paying, therefore, rent even during times like the COVID-19 pandemic or the 08/09 crisis.
Consequently, while outlined clearly in the private placement memorandum, the risks of the prospective investment are very predictable for the investor as long as they have the necessary understanding of the investment, which they should have as sophisticated or accredited investors.
Related: Multifamily Real Estate Investments: Easy Guide to New Investors
The only way to find these deals is by building relationships with the deal sponsors or finding companies that allow passive investors to participate in their contracts. There are various ways to have exposure to this kind of real estate.
One could directly invest in a single entity that holds property or in a fund of a company with a healthy track record. In both cases, it is crucial that you not only vet the horse but also the jockey.
When it comes to life savings, you want to make sure you place it with someone that acts according to your values. You know, like, and trust someone available to answer or get you the answers you want.
The Benefit of Scale
There is the scale to work with professionals at every stage of the process, from property management to legal and tax aspects, experienced professionals take care of everything, and the cost is carried by the property’s cash flow. These kinds of investments are well-positioned for different economic reasons.
Cash flow is the lifeline of any business venture, and a business must know how to weather the downturns that inevitably come over the years.
A company cannot sustain operations without enough cash reserves or ash flow, which is why it is a fundamental criterion for healthy investment strategy. But your business can run into trouble if you don’t have enough cash coming in or too much going out. It might even stop beating altogether.
That’s why ensuring that your cash flow is healthy is crucial. If it isn’t, you need to work on fixing it before any other problems arise.
People don’t stop paying rent, shaving, or having coke during the day. Warren Buffet looks for Gillette or Coca-Cola companies that still have a healthy level of revenue. Cash flow allows the lender to adjust his risk in the underwriting and passive investors.
Generally, a good syndicator will let their investors know the breakeven point of the operation and if the deal is underwritten with the right kind of debt. The property should be able to have a very healthy lifecycle.
While no property ever performs as projected in the original underwriting, the great operators will leave clues over the years of complete cycle deals they have. You have to look for someone who has done it and can show that they understand the seasons.
Local governments also establish certain zones called opportunity zones, which allow for further tax benefits and incentives since these areas are supposed to be developed.
Any investor looking at the tax code as an incentive to create a partnership with the government will benefit significantly from acting according to what they are looking to develop.
This is not only true in the United States but around the world. Large companies tend to deploy capital more effectively than government bodies, so they get the most significant tax benefits when creating jobs and infrastructure for the people and the nation.
Do your Due Diligence as an Investor
Prospective investors should always find out what they do not know yet to ask better questions because such offerings have different underwriting for every deal. The economic drivers of each value could be additional, so it is good to ask educated questions and clarify what the financial statements mean.
A well-strategized real estate portfolio can significantly increase your net worth and cash flow for your family. The right kind of structure could even help be more tax efficient. At the end of the day, the government incentives private investors and companies to invest in infrastructure such as housing, so the tax code is favorable.
What Might Change Soon
The existing rule around accredited investors will likely change as the SEC considers changing the federal securities exemptions. The SEC wants to protect the average person while expanding the opportunity of investing to more people. There will be more ways to become an accredited investor through exemptions like License Series 65.
The SEC has already posted that they are reviewing the existing exemptions and will post the new requirements for federal securities laws shortly.
This information is not legal or tax advice and only for educational purposes. If you have any legal questions, please seek legal or tax advice from a professional.
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