For the first 10 years of my career as a periodontist, I socked money away in the only investment opportunities I was familiar with….the stock market.
This was due to my limited financial knowledge.
At that time, the majority of our investments were in good ‘ole boring Vanguard index mutual funds (i.e. VTSAX Vanguard Total Stock Market Index fund).
It wasn’t until I began seeking out information on investing for cash flow vs the accumulation model that advisors push that I learned about passive real estate options.
Man I’m glad I did!
But for those of you that are just getting started with real estate investing, you’ll quickly understand that there’s a new set of terminology to learn.
It reminded me of the first year of dental school when trying to remember the difference between mesial and distal or where tooth #14 and #3 was located.
A few of the terms that I wasn’t aware of came up during my first attempt at investing in a passive real estate deal. I was told that in order to invest, I had to be an “accredited investor” as “non-accredited investors” were not allowed.
It seems that in order to be in the best position for real estate investing, becoming an accredited investor or a qualified purchaser is the best.
Let’s dive into the difference between the two.
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What’s The Definition of an Accredited Investor?
Before we discuss what an accredited investor and a qualified purchaser is, it’d be helpful to take a brief history lesson and learn why terms like these were created in the first place.
The term accredited investor dates back to the first major securities law, The Securities Act of 1933. This was passed as a result of the Great Depression to help with the lack of transparency and fairness in our financial markets.
Securities Act of 1933
This law is also referred to as the “truth in securities” law.
It requires investments to register with the federal governmental bodies.
The Securities Act of 1933 has two basic objectives:
- require that investors receive financial and other significant information concerning securities being offered for public sale; and
- prohibit deceit, misrepresentations, and other fraud in the sale of securities
Purpose of Registration
A primary means of accomplishing these goals is the disclosure of important financial information through the registration of securities. This information enables investors, not the government, to make informed judgments about whether to purchase a company’s securities.
The Registration Process
In general, securities sold in the United States must be registered and the registration forms call for:
- a description of the company’s properties and business
- a description of the security to be offered for sale
- information about the management of the company
- financial statements certified by independent accountants
Registration statements and prospectuses become public shortly after filing with the SEC. If filed by U.S. domestic companies, the statements are available on the EDGAR database.
Not all offerings of securities must be registered with the SEC.
Some exemptions include:
- private offerings to a limited number of persons or institutions
- offerings of limited size
- intrastate offerings
- securities of municipal, state, and federal governments
In Section 2 of this Act, “an accredited investor” is defined as either:
- a bank; an insurance company; an investment company; business development company; a Small Business Investment Company; an employee benefit plan…if the investment decision is made by a plan fiduciary…which is either a bank, insurance company, or registered investment advisor; or
- any natural persons who, on the basis of such factors as financial sophistication, net worth, knowledge, and experience in financial matters, or amount of assets under management qualifies as an accredited investor under rules and regulations which the Commission shall prescribe.
In other words, if you’re NOT a company but still want to be considered “accredited,” you need to be either smart enough to make your own informed decision or have enough money that losing some won’t matter.
If we move on to Section 4 of this Act, we’ll learn that transactions that are exempted from registration are defined and include “transactions involving offers or sales by an issuer solely to one or more accredited investors.”
But these investments must still provide certain specified information to investors. Because of the lower disclosure and reporting requirements, it’s much less work and costs less to put together an investment that is only offered to accredited investors.
The advantage of this is that the investment, due to lower costs, can offer investors (accredited) higher returns.
The SEC calls this Regulation D of the Securities Act (or Reg D) investments and their rule is Rule 506(c) of Reg D, which states:
Rule 506(c) permits issuers to broadly solicit and generally advertise an offering, provided that:
- all purchasers in the offering are accredited investors
- the issuer takes reasonable steps to verify purchasers’ accredited investor status and
- certain other conditions in Regulation D are satisfied
This rule was put into place in 2012 when President Obama passed the Jumpstart Our Business Startups Act (JOBS Act) that allowed businesses to advertise and sell securities, so long as they were made only to accredited investors that are verified using “reasonable steps.”
For eight decades before the JOBS Act was passed, companies wishing to sell private securities had to rely on friends, family, or their own networks because securities laws didn’t allow for general solicitation. The only way was via Rule 506 of Regulation D.
But in September 2013 things changed when Rule 506 was split into two sections:
Occasionally a new Passive Investors Circle member will ask, “Why haven’t I heard of these real estate syndication deals before?” The reason is due to the JOBS Act and being able to advertise where before the Act, companies couldn’t.
The SEC defines an accredited investor as:
- 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 high income level in the current year; or
- A person or married couple with a high net worth of at least $1 million which does NOT include a primary residence.
Research shows that 8.25% of all American households – or roughly 10,000,000 households – count as Accredited Investors.
What Is a Qualified Purchaser?
Private funds (i.e. hedge funds, private equity funds) are exempt from registering as investment companies if they are not making a public offering of securities and one of two criteria also applies:
- it must be owned by 100 individuals or less or
- it must be owned exclusively by “qualified purchasers”
So who are these so called qualified purchasers?
A qualified purchaser or qualified investor can be either family-owned companies or individuals who own at least $5 million in investments. The term “investments” should NOT include a primary residence or any property used for business.
The term “investments” is fairly broad and includes:
- cash and cash equivalents
- real estate
- futures contracts
- commodity futures contract
- financial contracts
- other alternative assets held for investment purposes
Notice the benchmark for a qualified purchaser is investments rather than net worth, which is a standard typically used for accrediting investors.
Qualified Purchaser Criteria
To be considered a “qualified purchaser,” at least one of the following criteria must be met:
- an individual (or family-owned business not formed just to buy into the fund) that owns $5 million or more in investments
- a trust sponsored and managed by qualified purchasers, which wasn’t formed for the sole purpose of investing in the fund
- an individual (or any entity not formed just to buy into this fund) which owns and invests at least $25,000,000 in investments (or someone who is acting on account of such a person)
- an entity, if all owners are qualified purchasers
Another Important Point
As you continue to learn the difference between an accredited investor vs a qualified purchaser, more than likely you’ll come across the term related to qualified purchasers, “qualified institutional buyers.”
This type of buyer is any institution that owns and invests at least $100 million in securities. It also refers to a bank that owns and invests securities worth a minimum of $100 million and that has a net worth totaling a minimum of $25 million based on an audit.
Qualified Purchaser vs Accredited Investor
The more you continue to learn about investing in real estate, you’ll often find that the terms “qualified purchaser” and “accredited investor” are often thought to be the same (which they aren’t).
Let’s take a closer look at what makes the two different.
The main difference between the two is that the financial threshold for an accredited investor is MUCH lower versus a qualified purchaser.
For this reason, it’s much easier to reach accredited investor status than it is a qualified purchaser.
Remember that to become an accredited investor, you need to have a net worth (excluding primary residence) of more than $1 million, or earned income above $200,000 per year as a single filer or $300,000 combined with a spouse for at least three years.
On the other hand, qualified purchasers must have at least $5 million worth of investments.
Accredited Investor and Qualified Purchaser Examples
Dr. RW is interested in real estate syndications. His first step in the process is joining the Passive Investors Circle. Once we connect for our first 15 minute call, he informs me of his intentions and that he has a stock portfolio worth $7 million. In addition, his total net worth is $12.5 million.
Due to the fact that his investments total over $5 million, Dr. RW is considered a qualified purchaser.
Mr. BG is a wealth manager at a nationally recognized company. He’s responsible for investing $21 million for his clients and some of are not qualified purchasers.
Even though he’s a wealth manager, he’s NOT a qualified purchaser as he would need to invest at least $25 million for his clients.
Dr. XR is a radiologist and her husband is a college professor. Their combined annual salaries are $650,000 and their net worth is $3.2 million dollars.
Dr. XR is considered an accredited investor because she earns more than $300,000 jointly with her spouse with a joint net worth greater than a million dollars.
Become a Successful Real Estate Investor
Part of becoming a successful real estate investor is by far, educating yourself.
I constantly do this on a daily basis as my goal for this blog is to pass along what I’m learning to you.
Learning new terminology is one of the best ways to accomplish this and hopefully you’re now comfortable with the differences between being an accredited investor vs qualified purchaser.
If you’re an accredited investor that is interested in generating income without having to work 8-5 then consider joining the Passive Investors Circle.
The best part is the price, it’s FREE!Join the Passive Investors Circle