Understanding the Difference Between a 506(b) and 506(c) Syndication

What is a Syndication?

Simply in nature, commercial real estate syndications allow a group of investors to pool their money together to buy a larger piece of real estate than they could afford on their own, creating more opportunities for investors. Introduced to the public as a way to open up investing options to many people, the development of syndications greatly influenced the world of investment real estate — and continues to evolve everyday. Understanding syndications and their various types can help you decide if investing in one is right for you!

How it works

The firm or individual sponsoring the deal, known as the syndicator, uses their experience to invest the contributors’ money. Investors, sometimes called “limited partners” (LP), are completely passive in this investment, relinquishing decisions to the firm. This passivity is of great appeal to many investors, as it allows their portfolio to grow without monopolizing their time.

The syndicator will likely have a specific strategy in place for finding, sourcing, negotiating and offering on properties they believe will become lucrative investments. After the property is under ownership, the syndicator will enact their plan — either flip and resell for a profit, add value by making improvements -getting rent rates up with strong property management with the intention of holding for a longer term, or a number of other options.

Depending on how your syndication is structured, you can expect to receive payments in installments as the property begins to cash-flow, as a large payout after a number of years, or both! All of these details will be laid out in documents commonly called an operating agreement, private placement memorandum, or a subscription agreement. As always, talk this over with a trusted accountant or attorney to determine if this type of investing is right for you.

Rule 506 of Regulation D

Rule 506 of Regulation D provides two distinct exemptions from registration for companies when they offer and sell securities. These exemptions are called 506(b) and 506(c). They allow syndicators to raise capital without having to register the securities with the SEC, so long as they fill out Form D after they first sell the securities. Form D is a brief notice that includes the name and addresses of the company’s promoters, officers and directors as well as details about the offering.

506(b)

One result of Reg D, 506(b), allows real estate investors and developers to raise as much capital as they can from an unlimited amount of accredited investors. Simply put, individuals are considered to be accredited investors if they have either a net worth of at least $1,000,000, excluding their primary residence, or have an income of $200,000 each year for the last two years ($300,000 combined income if married). If you are not an accredited investor, do not worry! This regulation allows for up to 35 non-accredited investors to contribute capital as well.

Non-accreditation is not necessarily a negative — it just means you are on your way to becoming accredited by making smart financial moves — like investing in a syndication! It is important to note that a 506(b) can only take 35 non-accredited investors, unlike the unlimited amount of accredited investors it can raise capital from.

So how do you ensure you get in on the capital call without being accredited? The syndicator must consider you a sophisticated investor. You do not need to have endless funds — you just need to show you have knowledge about investing that makes you capable of evaluating the risks of the prospective investment. This opens the doors to newer investors who are looking to add to their passive income and diversify their portfolio.

506(c)

Another extension of Rule 506 from Regulation D, 506(c) resulted from the JOBS (Jumpstart Our Business Startups) Act in 2012. In an effort to provide more opportunities for investors to raise capital, the Act created what we know today as crowdfunding and it allows offerings to the public.

Under 506(c), the general solicitation ban was lifted by the SEC. Advertising the offering became a first, but with that came an exception: non-accredited investors were (and still are) not allowed to participate in a 506(c) capital call. Issuers can still raise unlimited amounts from any number of accredited investors, but the syndicator must ensure that each investor is, in fact, accredited. Verifying their status through tax returns, W2s, and other reported income is critical in calculating their net worth. Sometimes syndicators opt to have a third-party perform this duty. Additionally, there are no disclosure requirements in a 506(c), because there are no non-accredited investors.

Finding the Right Syndication For You

Whether you are accredited or non-accredited, syndications are a great method to increasing your passive income.

For accredited investors, reach out to your real estate agent and any other investor resources or groups you have access to. Many syndications are passed on by word-of-mouth, so be sure to ask around.

If you are non-accredited and want to start working your way to becoming an accredited investor, be sure to meet with an investment strategist such as your accountant or real estate broker. From there you can discuss your financial goals, your current liquidity, and how you will invest for passive income.

Once you are asked to be an investor in a syndication, be sure to read the fine details and discuss with your advisors if that syndication is right for you. After you have done your due diligence and buy in, sit back and enjoy earning that passive income!

For more advice or to get started investing in syndications reach out to me and I will get you on the right path to achieving your financial goals!