You Might be Surprised to Learn How the SEC Impacts Your Ability to Raise Capital for Real Estate Deals.
If you’re just starting out as a real estate investor and don’t have much money, or even if you’ve been at it for a while and would like to learn more about how to raise capital for real estate deals, you’ve come to the right place. Although your state SEC or commerce department can regulate how you advertise and go about raising private money within your state, the real boogie-man that has everyone scared to death is the federal Securities and Exchange Commission.
Some of the rules and regulations are quite simple, and others require the help of a securities attorney. Confusing, right? Well, to help you out, here is some basic information about the SEC.
The SEC steps into your life when you step out of your state
The SEC works across all state lines because congress has the power to regulate interstate commerce. Meaning when you do business with someone in another state – when you want to raise money from people in another state, or you want to spend money you have raised in your own state in another state to buy real estate or to pay for equipment or services for rehabbing a property – that is all interstate commerce. When you want to raise private money there may be both federal and state laws that apply.
In 1933 the first securities laws came into place. Until then there were only laws at the state level, and you could cross from one state to another and there were no rules or laws that applied to you. In 1933 the federal SEC was created, and over the years those laws have been updated. In 2013 something amazing happened. A law was passed that allowed real estate investors to start advertising to raise money from both accredited investors, who are generally wealthy people, or from people who aren’t accredited.
What is a security?
When you promise someone that you’re going to use their money and make a profit on it, you can offer to pay them in interest rate, you can offer them an income stream, meaning a piece of the action by giving them a percentage of the profits on a deal. The point is, when you make a promise to one or more persons, and you say either verbally or in writing that your company is going to make money for the lender, and you’re going to pay them back whatever the principal is, and something else, whether an interest rate or a share of the profits, that is a security. It has been set by law.
A security can pay an interest rate, or equity, or a share of the profits, which is an equity. If you offer any of these, you are involved in an offering of securities to your lender. The offering of securities is regulated both within states by state regulators, and when it involves multiple states it is controlled by the SEC. There are state and federal rules to protect people who are going to lend you money or invest money with you. There are also rules to protect you, the real estate investor, so you can make these offerings legally and safely. The last thing you need, especially when you’re first starting out, are legal problems involving the SEC.
Accredited and Non-Accredited Investors
There are two types of investors you can go after for private money: the accredited and non-accredited investor. Here’s a brief summary of each.
- Accredited Investor
To be an Accredited investor you have to have made a gross income of at least $200k per year for the past 2 years and expect to for the current year. If you’re an individual and you have a high enough gross income then you’re accredited. If you’re a married couple you need a $300k per year income for the past 2 years and expect to for the current year.
You can also be accredited based on net worth. If an individual or a husband-wife couple have a net worth of at least $1 million in anything but their primary residence home, then they can be accredited. Roughly 8% of America is accredited.
- Non-Accredited Investor
This is the category most Americans fall under. In fact, at least 92% of Americans are Non-Accredited Investors. The difference between Accredited and Non-Accredited is the SEC says Accredited Investors don’t need as strict protection as Non-Accredited Investors. If you have that kind of income or net worth, the SEC thinks the odds are that you have some understanding of how markets work, how private offerings work, and how debt and equity works. Therefore you’re still protected and can’t be ripped off, but they’re going to focus their regulations on protecting the vast majority of people who have some money to invest or lend to the real estate investor, but aren’t accredited. That’s the difference.
The SEC creates the rules to protect the non-accredited because they may not have the financial resources to hire financial advisors, attorneys, etc. to protect themselves. So it’s very important for the real estate investor to know if their private money lender is accredited or non-accredited.
Intra-State vs. Inter-State
Are you, the real estate investor, doing business only within your state lines, or are you crossing state lines to do business? Doing business strictly within your own state is called Intra-State and doing business between multiple states is called Inter-State.
If you, your business, your lenders, your investors, and your properties are ALL within the same state, you are regulated by that state’s SEC or state department of commerce, which also regulates securities. Not only that, but 80% of your earnings must come from within that same state.
If you’re a new real estate investor just starting out and trying to raise money, you should try to do it with the least amount of hassle and regulation, and for the least amount of money. So most of your initial projects should start with Intra-State deals.
Each state says there’s a certain amount of money, or notes, or funds you can raise before you have to do any kind of registration. However, there are 36 states in which there is no paperwork at all to file. You can raise a varying amount of money within each state, depending on the state. Each state sets the amount of funds you can raise to fund your deals.
Even if you’re doing a basic Intra-State Offering, and you’re talking to friends, family, colleagues and people you associate with about raising money, you still must demonstrate a prior, existing relationship before making an offer of securities to them. You need to demonstrate you’ve had interactions with them at least 3 times, and you’ve known them for at least 30 days at some time during your life.
Inter-State Offerings means you’re certified to offer deals to anybody anywhere. In fact, you can even offer deals to foreign investors. In this arrangement you are governed by the rules and regulations of the federal SEC.
If you’re new to raising private capital and you’re conducting all your business within your own state (the situation in which most new real estate investors find themselves), you don’t really need to worry about the federal SEC. But even trying to raise money within your own state involves adherence to the laws governing such activities. It’s the wise real estate investor who familiarizes himself with these laws and follows them to the letter, to avoid potential problems.