Investing in large assets brings an abundance of complexities compared to smaller assets. Larger assets naturally cost more, and when expanding into larger assets, cash is often limited. It is very common to raise capital to purchase these assets and pay investors a return on their invested capital. The complexities begin when investors are onboarded with the sole responsibility of bringing capital. A person having the sole responsibility of bringing capital deems the project a "security" in the eyes of the United States Securities and Exchange Commission (SEC) and therefore the SEC steps in to ensure the consumer/investor is protected.
When securities are being offered or sold, the security must be either registered with the SEC or meet an exemption. Regualtion D under the Securities Act provides several exemptions that allow an offering or sale of a security without registering it with the SEC. This is important to apartment syndications because of the competitive nature of apartment investing (registering with the SEC takes too long to process). This is specifically the case with individually owned assets (what we at Volcan Capital do), not a fund. There are two primary expemtions that apply to the apartment investing industry. These exemptions are Rules 506(b) and 506(c).
506(c)
Rules 506(b) and 506(c) have a few stark differences between them. The most important aspect of a 506(c) is that the offering is allowed to be advertised. The offering can be advertised on any platform however, only accredited investors may invest in a 506(c). An accredited investor is a person that earned more than $200,000 per year (or $300,000 jointly if married) for two consecutive years or has a net worth over $1,000,000, not including their primary residence. A 506(c) must also have all accredited investors verified by a third party.
506(b)
The most important aspect of a 506(b) is that it allows non-accredited ("sophisticated") investors to invest. There can be a maximum of 35 non-accredited investors but unlimited accredited investors. There is no verification of accredited investors however there is significantly more information and disclosures required for non-accredited investors. A 506(b) offering is also not allowed to advertised. There is no advertising for the offering itself whatsoever. There must be a "pre-existing relationship" for any person that is offered the security. Therefore, 506(b) offerings are usually tight-knit, and are more difficult to find.
Which is better?
One is not necessarily better than the other, it simply depends on the sponsor/GP team's approach to raising capital. It is simpler to raise capital with a 506(c) because it can be advertised, however, it creates a barrier to some investors that are not accredited. A 506(b) allows non-accredited investors, but only a maximum of 35, plus there must be a pre-existing relationship. Each offering comes with its own set of challenges.
Whether an investor is accredited or sophisticated, there are options for each to benefit from passive income, tax advantages, and diversification.
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