Real Estate Syndication Regulations: The Difference Between 506B and 506C Offerings
The real estate investing world is expansive and full of opportunities to make high returns. From small fixer uppers to large-scale apartment buildings, there is a niche for everyone in real estate. Apartment syndications offer investors a unique opportunity to participate in the multifamily arena without needing to carry the weight of the entire project on their own shoulders.
Simply put, an apartment syndication is a way for investors to pool their money together in order to purchase a property that they wouldn’t otherwise be able to afford on their own. The general partner (also known as the sponsor or syndicator) is responsible for finding the deal, doing appropriate due diligence, coordinating funding, and managing the project from start to finish.
Limited partners, or passive investors, participate in the project financially and receive regular communication from the GP about the status of the investment and monetary returns. The collective effort is designed to be a winning situation for everyone involved.
What you may not know about real estate syndications is that they are regulated by the securities law under the SEC (U.S. Securities and Exchange Commission). A syndication must either be registered with the SEC or meet one of the legal exemptions.
This article outlines the two common exemptions that exist that allow a syndication to not be registered with the SEC, the difference between a 506(c) and a 506(b) exemption, and what you need to understand about each if you’re planning to participate in a multifamily syndication.
The two key differences between 506(b) and 506(c) determine how the project can be advertised and whether you must be an accredited investor or not to participate.
What is an accredited/nonaccredited investor?
The SEC states that an accredited investor must meet one of two benchmarks. They can either have a net worth that exceeds $1,000,000, excluding the value of their primary residence, OR earn an annual income of at least $200,000 (individual) or $300,000 (married). We will get into the details in the next section; however, make note that syndications that fall under the 506(c) category are limited to accredited investors.
Nonaccredited investors, also known as sophisticated investors, may participate in multifamily syndications by meeting certain knowledge requirements about real estate investing. Sophisticated investors must be able to analyze the deal accurately, have strong background knowledge in investing, and have a relationship with the syndicator. 506(b) syndications allow sophisticated investors to participate without the need to meet the income requirements of an accredited investor.
What is a 506(b) syndication?
A syndication that falls under the 506(b) exemption with the SEC is limited in the way it can be advertised. The GP/sponsorship team can not post on social media, send out paid ads, or participate in any other form of general solicitation in search of passive investors for these types of projects. Additionally, projects under this exemption are only allowed to accept 35 nonaccredited investors per offering. The reason for these restrictions is to protect nonaccredited investors who may be participating and to ensure they understand what they are investing in.
With these limitations, the slots fill up fast, which means if you are a sophisticated, nonaccredited investor, you should make your commitment to the project sooner rather than later. As a nonaccredited investor, you would be expected to have a sophisticated knowledge of the scope of the project. While you do not have to “prove” this status, it is important to have an in-depth understanding of the paperwork, legal jargon, and investment summary and know at least one of the sponsors before getting involved.
What is a 506(c) syndication?
Apartment syndications that meet 506(c) requirements are only open to accredited investors. While it’s not required under the SEC regulations, sponsors conducting 506(c) projects should still seek to establish a healthy relationship and communication with their investors. This ensures that everyone is on the same page with the same goal in mind. Remember, just because someone is accredited does not mean they actually have knowledge about what real estate syndications entail and what to look out for as an investor. As a passive investor, if a syndicator is not interested in relationship building, that should be noted as a big red flag.
As opposed to the 506(b) regulations, a project under the 506(c) exemptions can be advertised freely. This is why you may see some GPs or sponsor teams advertising their deals on social media while others do not. One type of deal is not better than the other; they simply must be handled differently from a compliance perspective. Remember, a good sponsorship team will still provide a detailed presentation of the investment and business plan backed with data, seek to educate, and be willing to answer all questions, regardless of your accreditation status.
Summary
As always, it is crucial that all investors involved in any large-scale project conduct their own due diligence before committing. We always suggest that you take the time to find a sponsor that understands your goals, has a strong track record of success and focuses on the relationship aspect of the business rather than simply the transaction.
To learn more about apartment syndications and passive investing, check out some of our short Youtube videos on our channel EZ Financial Independence University: