What is an Accredited Real Estate Investor? How Do You Become One?
Accredited investors have access to investments that are not available to others. This may apply to some real estate investments.
An accredited investor has access to certain types of investments that are not available to other investors. The U.S. Securities and Exchange Commission (SEC) and state agencies like the Texas State Securities Board (SSB) regulate many investments to protect people from fraud and other misconduct. Accredited investors may invest in securities and funds that the SEC deems too risky or complex for people who do not meet the criteria for accreditation.
This article addresses how a person may become an accredited investor and whether accreditation is required to invest with Capstone Capital Partners in a private real estate lending fund or through fractional ownership of a loan.
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What is an accredited investor?
Before 2020, the SEC’s accredited investor requirements for individuals, found in Rule 501(a) of Reg D, were based solely on net worth or income:
An accredited investor’s net worth, or joint net worth with their spouse, must be at least $1 million. When calculating net worth for an accredited investor, SEC rules exclude the primary residence and any debt secured by the primary residence, except to the extent that the debt exceeds the property’s fair market value.
An accredited investor’s income must have been at least $200,000 for the past two years, with “a reasonable expectation of reaching the same income level in the current year.”
The SSB uses the same criteria, found in the SSB’s Rule 139.16. Note that these criteria are “either/or.” An accredited investor who meets the net worth standard does not also need to meet the standard for annual income, and vice versa.
Do I need to be an accredited investor to invest in a private real estate fund?
Although there aren’t laws prohibiting non-accredited investors from investing in private funds, most firms will require accreditation. Ensuring that all of their investors are accredited offers several benefits for firms like Capstone. It exempts them from a cumbersome registration process with the state or the SEC. It also assures them that they are working with individuals who understand the risks and rewards of real estate investment.
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How do I apply to be an accredited investor?
There is no application, test, or exam to become an accredited investor. If a person or business is offering an investment that is only open to accredited investors, they are responsible for confirming that all investors meet the accreditation criteria.
They may do this by requiring prospective investors to produce documentation establishing their qualifications, such as:
Balance sheets showing net worth
Tax or income statements showing annual income
Professional licenses and statements of good standing
A third bill that has passed the House and awaits the Senate, the Equal Opportunity for All Investors Act, would direct the SEC to develop an examination that anyone could take to become an accredited investor, regardless of net worth, income, or professional experience.
What is a security?
The accreditation requirements for investors are based on federal and state securities law. To understand how the accredited investor rules apply to private real estate lending funds, it is important to understand what a security is in a legal sense.
The word “security” can have at least two meanings. In investment terms, a security is a kind of property that an investor may buy or sell, and which may increase or decrease in value. Examples include stock in corporations, corporate bonds, public bonds, and Treasury bills. Owning a security may also include legal rights like the right to vote at shareholder meetings and receive dividends.
When someone borrows money from a hard money lender, they pledge a piece of real property as security for the loan. The lender has the legal right to foreclose on the property if the borrower defaults.
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Is an investment in a private real estate lending fund a security?
Anyone who offers securities to the public, such as a corporation’s initial public offering (IPO), must register with the SEC unless they are exempt under the law. Registration is a lengthy and expensive process with large amounts of paperwork.
Anyone can buy stock in a company after an IPO, so the purpose of registration is to gather information that can protect potential investors from fraud. An offering that is limited to accredited investors is exempt from registration since the law presumes that accredited investors will perform more due diligence than someone buying stock for the first time. The offering can move faster and more efficiently.
The private real estate fund investments offered by Capstone fall under both federal and state exemptions:
Rule 147 of the SEC’s Regulation D (“Reg D”) provides an exemption for companies that only accept in-state investors.
Section 5(J) of the Texas Securities Act exempts securities that consist solely of notes secured by primary liens.
Neither exemption expressly states that only accredited investors may participate.
Accreditation based on professional certifications or licenses
The SEC amended Rule 501(a) in 2020 to expand the accredited investor qualifications for individuals. The agency recognized that limiting the qualifications for accredited investors to income and net worth was “unsatisfactory.”
As amended, the SEC’s definition of an accredited investor also includes several categories of individuals based on professional credentials and experience:
Financial professionals with certain “professional certifications or designations or credentials from an accredited educational institution,” as designated by the SEC, in good standing
“Knowledgeable employees” of a private fund
The SEC has stated that holders of Series 7, Series 65, or Series 82 licenses qualify as accredited investors. It may expand the list of professional licenses and certifications in the future.
Possible changes to the “accredited investor” definition
The SEC has discretion over when and how it reviews the list of professional credentials that may be eligible for accredited investor status. The U.S. House of Representatives passed a bill, the Accredited Investor Definition Review Act, in 2023 that would require the SEC to review this provision at least once every five years. The Senate has not taken the bill up yet.
Another bill that passed in the House and is waiting in the Senate would further amend the definition of an accredited investor. The Fair Investment Opportunities for Professional Experts Act would make the following changes:
Allow the SEC to adjust the net worth requirement for inflation
Add licensed brokers and investment advisers as a permanent category of accredited investor
Allow individuals to become accredited investors based on “demonstrable education or job experience,” which shows that they have “professional knowledge of a subject related to a particular investment.”
Learn more about investing with Capstone Capital Partners
Investing in real estate financing can be an excellent source of returns. Real estate is a “hard” asset that secures a hard money loan and reduces the risk for investors. Trust deed investments and first lien investments with Capstone Capital Partners target a return of 10% net annual yields. Contact the team today through the online contact form to learn more about these investment opportunities.
