CRE Investing Might Get A Boost From SEC Rule Change
In late August, the Securities and Exchange Commission modified its definition of “accredited investor," changing who is allowed by law to invest in private securities offerings. The new regulations are less restrictive than before, and will likely allow a larger pool of investors to actively participate in private real estate offerings, though the exact number isn't clear yet.
Public capital markets, as the name implies, are open to even investors of modest means, but they represent only a part of the action. In 2018, according to the SEC, private markets raised about $2.9 trillion, compared with $1.4 trillion raised in public markets. The agency doesn't break its totals down into real estate and non-real estate investments.
"With this update, the SEC wants to expand access for individual investors to participate in the private investment space," CrowdStreet co-founder Darren Powderly said. "It's a modest step, but it is a welcome one for real estate investing."
Under the previous regulations, the definition of accredited investor was purely a matter of net income or net worth. The SEC defined an accredited investors as someone who earned more than $200K/year or who had a net worth of more than $1M.
Investors who didn't meet those thresholds were barred from taking part in private securities offerings by the agency, under the authority granted it by the Securities Act of 1933, with the current rules in effect since 1982. They were part of an overall effort by the SEC in the early 1980s to overhaul existing regulations to facilitate capital formation, with the additional goal of protecting smaller investors. Now, that pool of available investors has widened.
"It's likely that the agency will continue to allow broader access to private placements in the future, which is the most important takeaway from the recent change," Kay Properties and Investments Vice President Steve Haskell said, adding that an exact estimate of how many investors the change will add isn't possible.
The new regulations keep the income and net worth thresholds but add a new class of accredited investor that stresses professional education covering investment in securities.
"Natural persons qualify as accredited investors based on certain professional certifications, designations or credentials or other credentials issued by an accredited educational institution," the agency states.
Specifically, holders of certain SEC licenses now qualify as accredited investors. These include a Series 7 license, which qualifies the holder to broker securities; a Series 65 license, which qualifies the holder to be an investment adviser; and a Series 82 license, which allows a holder to buy and sell securities.
The new rules will also allow investment in a private fund by persons who are "knowledgeable employees" of that fund and add family offices with at least $5M in assets under management, which can include real estate.
For real estate investors, Haskell said the change could be most important in the context of Delaware Statutory Trusts. The DST ownership structure allows smaller investors to own fractional interests in institutional-quality commercial property along with other investors.
"The DST is a private security, and a way to hold title to real estate that allows investors to 1031 exchange into a factional ownership of real estate," he said. "You have be accredited to invest in a DST. The more accredited investors there are, the more investors who will be able to take advantage of DSTs."
Those additions may be fairly narrow in their scope, but the SEC also says it is open to expanding the number of potential investors by adding other certifications, designations or credentials that are acceptable under the new rules.
"The addition of people who are knowledgeable about investing aligns very well with what we do, which is help investors become educated about real estate investment," Powderly said. "In the future, there will be additional certifications that will expand the population of potential investors further."
Some experts argue that the SEC ought to loosen the income thresholds or do away with the notion of an accredited investor all together.
That includes IIRR Management Services CEO Jeff Holzmann, whose company specializes in crowdfunding real estate investment, and who advocates dropping the income threshold to $100K/year, which would include about 29.5 million Americans, or about 9% of the population.
As for the addition of real estate investors because of the change the SEC has made, Holzmann said that realistically the number is negligible.
"Still, expanding of the definition is a step in the right direction," he said. "More Americans deserve the opportunity to decide how to use their own money by themselves, with less government intervention telling you what you can, and can’t, do with your own money."
Haskell said he doesn't think that radical change would be a good idea, however, since the SEC does have a legitimate purpose in protecting small investors who stand to lose their entire net worth, whether by fraud or simply being unable to assess risk.
"The regulations should exist, though in the most minimal way possible," he said. "I think the SEC is now looking for where that line is drawn."
Other observers make the case that the wealth threshold to be an accredited investor ought to be raised. Robert Pozen, a nonresident senior fellow at the Brookings Institute, argues that the pool of accredited investors has actually expanded a great deal since 1983, because the income thresholds haven't been adjusted for inflation since then.
The number of people who may now be allowed to invest as accredited parties is substantial. In 1983, only 440,000 U.S. households met the income requirement, and 1.42 million people met the net worth requirement. In 2020, 11.36 million households met the income requirement and about 16 million investors met the net worth requirement.
"The SEC apparently has concluded that financial knowledge is a better indication of investor sophistication than annual income or net worth," Pozen writes. "While we can understand the SEC’s position, we strongly believe that mid-level investors, whose financial resources are not very extensive, need special protections on both financial knowledge and loss absorption."
This small step by the SEC will not, by itself, create significant new opportunities for CRE crowdfunding, Holzmann said. But it may potentially mark the turning point at which legislators and regulators started expanding definitions to allow millions of others people to take part in this form of investment.
"As someone of oversees one of the largest crowdfunded real estate portfolios in the world, I’m surprised each day by how little some accredited investors actually know, and how much more some other know but are prohibited from participating," Holzmann said. "This perpetuates the notion that the rich are getting richer, and contributes to the disparity in our society. We can, and should, do better than this as an industry."