You may have heard the term ‘accredited investor’ as you’ve become more familiar with multifamily investing, but what is it and why does it matter?
When taking part in a syndication, the Securities and Exchange Commission (SEC) requires that only accredited investors can participate. There’s also a certain approach that allows what’s called ‘sophisticated investors’ to participate as well, but we’ll cover that in a separate post.
Here’s how the SEC defines an accredited investor:
An accredited investor, in the context of a natural person, includes anyone who:
- Earned income that exceeded $200,000 (or $300,000 together with a spouse or spousal equivalent) in each of the prior two years, and reasonably expects the same for the current year, OR
- Has a net worth over $1 million, either alone or together with a spouse or spousal equivalent (excluding the value of the person’s primary residence).
There are more details to the definition that the SEC recently updated which you can read here, but the box above provides the essence of the definition.
One of the primary roles of the SEC is to protect investors when investing in all sorts of securities, multifamily syndications being one of them. Because this approach to investing in real estate pools the money of many investors, it is considered a security in the eyes of the SEC.
The ‘Accredited Investor’ definition ensures that only people who have a minimum income or net worth can participate in investments like these. Why this is important can be described through an example.
Say an investor named John wants to make a $50,000 investment into a multifamily syndication. He is not an accredited investor and has a net worth of $200,000. That investment would represent 25% of his net worth, which is a substantial amount. If, for some reason, that investment didn’t work out and he lost his money, it would have represented a big impact to his finances.
Let’s now pick another investor named Susan who also wants to make a similar $50,000 investment, but instead she is an accredited investor and has a net worth of $1,200,000. If she were to lose that investment, it would only represent 4.2% of her net worth. A much smaller impact.
It’s important to mention that the chances of losing all your investment is small, especially when investing with a strong general partnership team, but it still exists and is a possibility. The SEC want to make sure that any investment in a security like a syndication is done in a safe way. They also assume that, with a larger met worth, an accredited investor has more evolved knowledge of investments.
When we meet with individuals interested in participating in one of our multifamily investments, one of the things we try to determine is if the investment would make sense for you as an investor. We want to make sure we are pooling money from investors that have a strong balance sheet and can weather any potential loss of money. It is rare, but it is our responsibility to our investor community that we wear that hat and act responsibly.
Hopefully the above explains what an accredited investor is and why the definition is important. In another post, we will dive into the term ‘sophisticated investor’ and explain the differences.