If you’re planning to raise capital for private real estate in the US - you’ll need to choose between a 506(b) or 506(c) offering. Our detailed guide will help you decide which is the best option for your capital raise, and the regulatory and technology changes that you should consider.
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Raising capital for real estate involves many important decisions - but one of the most important ones is selecting a proper structure for your private offering.
In the US, there are two primary options under Regulation D: Rule 506(b) and Rule 506(c). The Securities and Exchange Commission (SEC) established these rules as a safe harbor, offering assurance of compliance once the requirements are met.
But which of these rules suits your offering best?
While abundant with opportunity, the rules in the raising capital for private real syndications are constantly evolving.
In 2022, the SEC filed 760 enforcement actions, marking a 9% increase from the prior year, with total penalties and disgorgement reaching a record $6.4bn. The SEC emphasized individual accountability and also utilized data analytics for investigation and rewarded meaningful cooperation with reduced penalties.
These trends underscore the importance for private real estate syndicators to maintain strict compliance with regulations to avoid significant penalties.
But registering securities can be a costly process, which is why the majority of the market operates under exemptions to provide safe harbor.
There's a multitude of them, such as:
Within Reg D, there are several routes to take, but the most common for private real estate syndications are Rule 506(b), and Rule 506(c).
Rule 506(b) is a provision under Regulation D of the Securities Act, which permits the sale to an unlimited number of accredited investors and up to 35 non-accredited investors.
However, you cannot advertise the real estate investment, which means it requires having an existing investor base for successful capital raising. This is the most common path when you're getting started - and is typically just raising money from friends and family.
Data from the SEC, available via the EDGAR platform, shows that four out of five deals are conducted under Rule 506(b).
Introduced as part of the Jumpstart Our Business Startups (JOBS) Act, Rule 506(c) allows for public solicitation of an offering, but with a caveat: all investors must be verified as accredited.
This marked a significant change in the fundraising landscape by enabling issuers to leverage social media and other platforms to advertise their deals, opening up new avenues to attract and verify accredited investors.
Making the right choice between Rule 506(b) and Rule 506(c) for your real estate syndication depends on the specifics of your offering and your target investor audience.
In essence, the decision comes down to two key questions:
If your strategy involves extensive advertising or public solicitation, Rule 506(c) would be the way to go.
Under this rule, you're allowed to advertise your offering openly, a feature that's restricted under Rule 506(b). However, this freedom to advertise comes with a catch - you must verify the accredited status of all your investors.
If your potential investors include non-accredited individuals such as friends, family, or others who may not meet the income or net worth requirements, Rule 506(b) will be a better choice. While it prohibits public advertising, it does allow for up to 35 non-accredited investors.
When it comes to flexibility, the SEC provides room for issuers to change their fundraising strategy by allowing the switch from a Rule 506(b) offering to a Rule 506(c) offering, and vice versa.
In instances where an issuer starts with a Rule 506(b) offering and later decides to transition to a Rule 506(c), it's important to note that syndicators can no longer accept any non-accredited investors for that particular offering.
Conversely, when transitioning from a Rule 506(c) offering to a Rule 506(b) offering, the SEC implemented new rules in late 2020 that shortened the waiting period from six months to 30 days.
However, there are certain conditions that must be met for this transition:
It's not uncommon to see syndication sponsors, like those we work with at GP Flow, transitioning from Rule 506(b) to Rule 506(c). Understanding these nuances and regulations can be beneficial in effectively navigating the fundraising landscape.
The future of fundraising in real estate is dynamic and promising, with both regulatory developments and technological advancements poised to reshape the landscape.
On the regulatory front, the SEC continues to revise rules to increase market accessibility. An example is the Equal Opportunity for All Investors Act which is now paving the way for more non-accredited investors to become eligible to invest in private real estate investments.
Technological advancements are also playing a vital role in the industry's future. Blockchain technology, for instance, is making significant strides in the real estate investment space for more efficient and secure transactions between entities and counterparties.
As more investors move online, the expectation is for Rule 506(c) offerings to grow in popularity, taking a larger share of the market.
For real estate sponsors, these trends underline two critical areas of focus.
By embracing these changes, sponsors can better position themselves for success in the ever-evolving real estate investment landscape.
When it comes to raising capital for your real estate project, both Rule 506(b) and 506(c) have their strengths and weaknesses.
While your choice should depend on your unique situation and needs - in an increasingly digital world and media driven world, establishing a robust online presence and leveraging technology will be key to successfully scaling your capital base beyond your current network.