How To Become An Accredited Investor
Each week I enjoy having conversations with other doctors & high-income earners about passive real estate investing, specifically syndications.
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You maybe asking yourself, “What’s a syndication?“
A syndication is nothing more than a group of people pooling their money together to buy something such as an apartment complex or commercial real estate. The majority of these deals are for accredited investors only which seems to confuse people.
When I invested in my first deal, I had no idea what the accredited investor definition meant. So today I want to explain what an accredited investor is and why it’s so important to become one.
What is an Accredited Investor?
We get the definition of an accredited investor from the U.S. Securities and Exchange Commission (SEC). It defines the accredited investor status via Rule 501 of Regulation D of the Securities Act of 1933.
It states that an accredited investor is:
- A natural person with an annual income of at least $200,000 in each of the two most recent years or married couples making $300,000 joint income. There must be a reasonable expectation of the same income level in the current year; or
- A person or married couple with a net worth of at least $1 million which does NOT include a primary residence.
In other words, these are people with a high income and or high net worth.
Research shows that 8.25% of all American households – or roughly 10,000,000 households – count as Accredited Investors.
Whenever I’m explaining real estate syndications to someone, one of their questions involve why these types of investments are for accredited investors only.
The short answer, “to protect you” from high-risk investments.
The way I explain it to them is this:
If someone making $200,000 a year invests $50,000 in a deal and it goes south, it’s not the end of the world. Yes, it would hurt to lose that money but due to their high income, it wouldn’t set them back too much.
If on the other hand someone making $65,000 year were to lose that amount of money, it could potentially bankrupt them.
So the purpose of making a particular deal for accredited investors only is to act as a protective measure to keep them from getting in over their heads with riskier investments that could cause them financial ruin.
In other words, becoming an accredited investor provides access to higher risk investment opportunities with potential better returns not available to the general public.
Example
Here’s a real world example of what it means to be an accredited investor. Since we’ve been talking about syndications, let’s use that as the example.
A syndicator or sponsor is the person or group of people that locates property (such as an apartment) and puts the deal together. They make sure that the property is managed correctly, keep it occupied, market it, maintain it, etc.
In the U.S., these deals are under strict regulations especially since money is being raised. The syndicator has to follow certain SEC guidelines to make sure everything is done “by the book.”
Now there are a couple options for how syndicators set up their deals and these will determine what kind of investors are brought in, accredited or non-accredited.
For example, take a 506(c) fund. In these investments, the syndicator can broadly solicit and advertise an offering, provided that they’re ONLY to accredited investors and occasionally a sophisticated investor.
So if you’re an accredited investor, you can get into some pretty awesome deals that the rest of the population can’t.
Accredited investors find themselves in a financial class above the average investor. While the average investor only has access to opportunities limited within the regulated public markets, accredited investors are eligible to invest in private offerings such as:
- syndications
- early stage business startups
- angel investments
- hedge funds
- private equity funds
- Venture capital funds
- private equity investments
- private placements
- other investments with the potential for high returns but high risk
Here’s what the guys over at Bigger Pockets have to say:
Who Certifies Accredited Investors?
I recently spoke with a dentist that practices in North Carolina. Once we determined that she met the accredited investor criteria, she asked, “Is there a person that’s supposed to certify me?”
One component to the SEC’s rules on accredited investors is that it doesn’t require a government agency to issue certifications but it does have guidelines to follow.
Instead, the responsibility is on the issuing financial institution to qualify its investors. Usually they’ll have a screening process to see if you meet certain qualifications.
Typically you’ll have to provide one or more of the following:
- financial statements
- net worth confirmation via credit report
- tax returns
- earning documentation (i.e. W-2 forms, etc.)
All of the real estate deals I’m in (506b) had me self-certify that I met the accredited investor criteria but also that I understand the implications behind it.
Occasionally, some syndicators will request verification from a CPA or may ask to produce your tax returns.
Summary
To review how to become an accredited investor you must be:
- A person with an annual income of at least $200,000 in each of the two most recent years or $300,000 for a married couple. There must be a reasonable expectation of the same income level in the current year; or
- A person or married couple with a net worth of at least $1 million which does NOT include a primary residence.
As you can see, being in the accredited investor category opens up doors to potentially better paying investments than you’d otherwise have access to.
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