There are four types of commercial real estate investors you should know:
- Accredited Investors
- Sophisticated Investors
- Debt Investors
- Equity Investors
Here’s a deeper dive into what each title means.
What is an Accredited Investor?
An accredited investor is a person with a higher level of financial expertise than an average person. The U.S. Securities and Exchange Commission (SEC) created regulations around Accredited Investors because Accredited Investors have access to investment options that are not available to the general public. Hence, the SEC established rules to qualify as an Accredited Investor to ensure you have the financial know-how to protect yourself and make sound investments on your own.
How do You Qualify as an Accredited Investor?
To qualify as an Accredited Investor as an individual, you must have a net worth over $1 million (excluding the primary residence) or an income over $200,000 (individually) or $300,000 (with spouse or partner) in each of the prior two years with reasonable expectations to earn a similar income during the current year.
Regarding the salary criteria, it’s important to note that you must meet the income requirement using the same technique for all three years. For example, let’s say that two years ago, Spouse #2 earned $263,000 while Spouse #1 did not work. One year ago, Spouse #2 earned $170,000 while Spouse #1 earned $200,000 (for a total of $370,000). This year, the couple expects and can demonstrate they will earn the same or more this year.
It may seem the couple met the criteria for becoming accredited investors. In the first year, an individual made over $200,000, and then in years two and three, the couple made over $300,000. However, they did not use the same technique to compute income for each year, so they didn’t meet the requirements. To become an accredited investor, they must achieve the requirements for all three years using the same calculation, either alone or with a spouse.
The SEC also clarifies that it’s possible to become an Accredited Investor through professional criteria. The professional criteria apply to folks who are:
- Investment professionals in good standing holding the general securities representative license (Series 7), the investment adviser representative license (Series 65), or the private securities offerings representative license (Series 82)
- Directors, executive officers, or general partners (GP) of the company selling the securities (or of a GP of that company)
- Any “family client” of a “family office” that qualifies as an accredited investor
- “Knowledgeable employees” of a private fund
To learn more about becoming an accredited investor as an individual, read through the Accredited Investor criteria outlined by the SEC.
It’s also possible to qualify as an accredited investor as an entity.
How do Entities Qualify as an Accredited Investor?
Entities can qualify as accredited investors by meeting the criteria that the SEC lays out for entities. These criteria include:
- Investments: entities that own investments with a value more than $5 million
- Assets: corporations, partnerships, LLCs, trusts, 501(c)(3) organizations, employee benefit plans, “family offices,” and any “family client” of those offices with assets with a value of more than $5 million
- Owners: entities where all equity owners are accredited investors
- Financial Entity: a bank, savings and loan association, insurance company, registered investment company, business development company, small business investment company, or rural business investment company
Why Does the SEC Have Accredited Investor Rules?
In short, to protect investors.
If you decide to invest in the stock market by purchasing shares through a brokerage account from the New York Stock Market (NYSE) or the Nasdaq Stock Market, the firms you invest in must clear a series of regulatory barriers before their stocks are listed on the exchange. The firms are required to provide financial accounts regularly and report other relevant information. So, while stocks can lose money, there are significant precautions to safeguard investors from fraud and deception. This is one of the primary reasons the SEC feels comfortable allowing a non-accredited investor to participate in these investments.
In the case of commercial real estate deals, investors are entrusted to do their own due diligence. The Accredited Investor status exists to help ensure the investors getting involved have at least a fundamental level of financial competence to make sound investment decisions.
The regulations from the SEC distinguish between Accredited Investors and Sophisticated Investors (also known as non-Accredited Investors). Let’s look at what it means to be a Sophisticated Investor.
What is a Sophisticated Investor?
A sophisticated investor is a person who has a higher level of wealth, expertise, and net worth to more safely engage in more complex forms of investing possibilities.
The SEC doesn’t outline the same type of detailed criteria for a Sophisticated Investor as they do for Accredited Investors, so there’s no single definition of a Sophisticated Investor. In general, Sophisticated Investors can demonstrate through the wealth they’ve accumulated that they have more financial competence than the average person, but haven’t met the criteria of being an Accredited Investor.
Because of their higher level of financial competence, Sophisticated Investors can partake in commercial real estate deals, but there are different rules for how they participate compared to Accredited Investors.
Equity investors put money into a deal in return for a stake in the property. Equity investors are not guaranteed a return on their investment and may lose money if the property loses value. However, if the property appreciates and is sold, the equity investor is entitled to their portion of the asset.
An equity investment is a type of investment in which the investor becomes a stakeholder in the property they are investing in. The amount they’ve invested immediately correlates with their interest in the property.
When an investor invests in real estate as a debt investor, they are acting as a lender to the property owner or sponsor. The investor helps secure the loan and then receives a set rate of return based on the interest rate on the loan and the amount invested.
Summary of Real Estate Investors
As you learn how to invest in commercial real estate, it’s important to understand real estate investing definitions and how you can participate as different types of investors. Here’s a quick summary of the different types of real estate investors you can become:
Individual Accredited Investors
- Financial Criteria:
- Net worth over $1 million, excluding the primary residence (individually or with spouse or partner)
- Income over $200,000 (individually) or $300,000 (with spouse or partner) in each of the prior two years, and reasonably expects the same for the current year
- You must meet one of the criteria with the same measurement each year
- Does not meet the criteria to be an Accredited Investor, but has investment experience and/or Business experience
- Receive a piece of the equity in the property
- Receive their proportionate share of cash flow and profits from sale
- Can have the option to stay in the deal if you refinance the property
- Investor acts like a bank
- Receives a fixed return on their investment rather than equity
- You can refinance Debt Investors out of the deal