By Shuo Grimes

You may have seen the term “accredited investor” in wealth management company ads or on television. Perhaps you have a high-net-worth friend or relative who has mentioned it. Or, you may have received a multifamily investment offering labeled as a 506 (b) or 506 (c) opportunity for “accredited investors only.”

When new investors run across the term, they often ask syndicators the question,” Should I become an accredited investor?”

The reality is that “accredited” is not something one becomes through study and hard work. It is a strictly defined status determined by the Securities and Exchange Commission (SEC) rule 501 of Regulation D. The regulation arose from investor abuses during the Great Depression. The rules are intended to prevent investors from losing money in overly-speculative or fraudulent private investment deals.

Since 1985, the definition of accredited investor has been someone who

  • Has income that exceeds $200,000 per year or, if married, $300,000 per year in each of the two prior years. The investor must also expect that they will earn the same or more in the current year.

OR:

  • Someone with a net worth, excluding primary residence, of more than $1 million, either alone or together with a spouse.

Recently, though, the SEC made changes to the qualification standards in Rules 506(b) and 506(c) of Regulation D under the Securities Act of 1933. Also changed was the definition of “qualified institutional buyers.” for Rule 144A of that same Act. These changes took effect in November 2020.

What do the new amendments mean for you as a passive investor or potential passive investor?

Changes to the current rule have broadened categories of entities and individuals designated as “accredited” investors. This increased eligibility is due to the addition of certifications, professional knowledge, investing experience, or education as criteria. The 2020 amendments allow more people to take advantage of private capital markets. Because the definition of an accredited investor can now include things other than net worth and income alone, more people will qualify.

Some noteworthy changes to the definition of accredited investor are:

The addition of a “spousal equivalent.” Spousal equivalents may now pool their finances and qualify as accredited investors. The SEC defines a spousal equivalent as a cohabitant occupying a relationship similar to a spouse.

Use of professional designations as a qualifier. Amendments will allow “natural persons” to qualify as accredited investors solely because they have specific professional certifications or licenses. These include a Series 7 license, Series 65, or series 82. I anticipate that the SEC will add more designations to those that qualify. Updates to all investor rules are on the SEC website. (learn more here: https://www.investor.gov/introduction-investing/general-resources/news-alerts/alerts-bulletins/investor-bulletins/updated-3).

The creation of a “knowledgeable employees” category. The revised rule adds a brand new type of accredited investor in a private fund. This category applies to individuals who qualify as “knowledgeable employees.” Knowledgeable employees include directors, trustees, general partners, board members, executive officers, or others employed by the fund.

“Family Offices” can be included as accredited investors. “Family offices” are defined within Rule 202(a) (11) (G)-1 under the Investment Advisers Act of 1940 (a). These entities can now qualify to participate in private funds provided they are not explicitly formed to acquire the security offered. Also, family offices must have at least $5 million in assets under management.

Family office investments must be managed by a capable and knowledgeable individual who has experience in business matters and finances. This manager must have the ability to evaluate the risks and merits of any prospective investment.

While the changes to rules defining accredited investors aren’t drastic overhauls, they will result in more investors participating in 506 (b) or 506 (c) offerings than ever before.

How can qualifying as an accredited investor help you?

Many people don’t realize that they ARE qualified investors and assume investing outside of the public markets is off-limits to everyone except the super-wealthy. Even those who know they qualify often don’t realize the benefits of taking advantage of this status.

Here are some of the benefits of discovering you are an accredited investor:

You can take advantage of higher yields: Typically, when a company raises money outside of capital markets, they do so as a private placement. Private placements can frequently offer higher yields than those available in public markets due to the issuer’s access to more attractive capital.

Portfolio diversification: As Patrick and I have discussed before, investing on Wall Street offers limited options to create a diversified portfolio. If you only have money in public markets, your wealth is more exposed to systematic risk. Accredited investors have a unique opportunity to access alternative assets that are not correlated to the stock market, such as multifamily syndications.

If you have reason to think you qualify as an accredited investor, you may wish to participate in a 506(c) real estate syndication. The sponsor of that syndication will then ask you to undergo a third-party verification process.

Verification may involve obtaining written confirmation from an investment adviser registered with the SEC, a licensed attorney in good standing, a registered broker-dealer, or a CPA. You might also need to provide income tax filings, pay stubs, or other official documents that verify your income. Qualifying via net worth may require disclosing your assets and liabilities through a credit report or other means.

The SEC requires that your status verifications are dated within 90 days of investing in a 506(c) offering.

Summary: Many people don’t know they qualify as accredited investors. Even those who do may not fully understand the incredible possibilities open to them, such as investing in commercial real estate syndications.  Meeting the definition of accredited investor can open many more opportunities for investing in private offerings and adding a measure of diversity to your portfolio.

If you are curious about passive investment in 506(c) offerings, please contact me, and I will be happy to help you discover answers to all your questions.

As always, it’s a best practice to discuss all investment issues, questions, and concerns with your trusted financial advisor, broker, attorney, CPA, or other qualified professional.

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Patrick Grimes

Patrick has 11 years of real estate experience and a portfolio of four holdings in Houston, TX.

In addition to his real estate experience, Patrick holds a Bachelor of Science in Mechanical Engineering from University of the Pacific, and a Master of Business Administration and a Master of Science in Engineering from San Jose State University.