Real estate syndications have become increasingly popular in recent years as investors look for ways to experience the benefits of owning real estate without buying and managing properties themselves. Two common exemptions used in real estate syndications are the 506(b) and 506(c) exemptions under Regulation D of the Securities Act of 1933. While both exemptions allow for the sale of securities to investors, there are some significant differences between the two that investors should be aware of.
506(b) Exemption
The 506(b) exemption is the most commonly used exemption in real estate syndications, and is the one most often offered by Bright Sound Investments. Under this exemption, issuers can sell securities to an unlimited number of accredited investors and up to 35 non-accredited investors who meet certain sophistication requirements. General Partners must take reasonable steps to verify the accredited status of investors, but they are not required to do so for non-accredited investors.
One of the most significant advantages of the 506(b) exemption is that it allows passive investments from those who have a pre-existing relationships with a member of the General Partnership (active investors team). This means that General Partners can solicit investments from friends, family, business associates, and acquaintances who came to know the General Partner and their investment practice before an opportunity was offered. However, General Partner are not allowed to engage in any general solicitation or advertising to attract new investors to invest in a specific opportunity after a subject property has already been identified. For example, if an offering is filed as a 506(b), the General Partners cannot post on Facebook “We have a property under contract in __town with x% projected returns – who would like to invest with us?”
506(c) Exemption
- The 506(c) exemption, which was introduced in 2013, allows issuers to advertise and solicit investments from the general public. However, all investors must be accredited, and issuers must take reasonable steps to verify the accredited status of each investor. What is an accredited investor, you ask?
- Accredited investors are:
- Individuals who have an income greater than $200,000 in each of the past two years or whose joint income with a spouse is greater than $300,000 for those years, and a reasonable expectation of the same income level in the current year
- Accredited investors are:
OR
- Individuals whose net worth or net worth with spouse exceeds $1 million at the time of the investment, not including their primary residence.
Accredited investors must be verified as so, and General Partners are required (by the SEC) to collect more detailed financial information from investors to confirm their accredited status.
The primary advantage of the 506(c) exemption is the ability to engage in general solicitation and advertising, which can help issuers raise capital more quickly and efficiently. However, this exemption also requires issuers to provide investors with more detailed information about the investment, including audited financial statements.
Differences between 506(b) and 506(c) Exemptions
The main differences between the 506(b) and 506(c) exemptions are related to general solicitation and the verification of investor accreditation. While the 506(b) exemption allows for pre-existing relationships with investors and fewer verification requirements, it also prohibits general solicitation and advertising. Because 506(b) offerings are private, investors who have a substantive previous relationship with the General Partner can benefit by being on the short list of investors who are offered a particular opportunity. On the flip side, the 506(c) exemption, which allows for general solicitation and advertising, gives accredited investors a broader opportunity to search for and invest in a wide variety of real estate irrelevant of their relationship with the General Partners.
In summary, both the 506(b) and 506(c) exemptions can be used in real estate syndications, but they have different requirements and limitations. Investors should carefully consider the advantages and disadvantages of each exemption before investing in a real estate syndication. It is important to consult with a qualified attorney or financial advisor to understand the legal and financial implications of each exemption.
