Do you remember your high school lunches?
At our high school, juniors and seniors were allowed to leave campus if they got the coveted “off-campus lunch pass.” Only juniors and seniors with the pass could leave campus during their lunch period. Juniors and seniors were supposedly more mature, and could be trusted to be responsible and get back to class on time. Getting this lunch pass was the ultimate rite of passage.
Becoming an accredited investor is a lot like these off-campus lunch passes. The same way we couldn’t leave campus without a lunch pass, there are specific restrictions to the kinds of investments you can participate in if you are not an accredited investor.
Accredited investor status isn’t just some pointless hurdle meant to keep you out of an exclusive investment club. In reality, there is a multitude of investment opportunities available, ranging from different asset classes and investment strategies. Assessing risk and determining which investments are the best fit for you can be challenging and overwhelming for inexperienced and seasoned investors alike.
The Securities and Exchange Commission (SEC) is a federal government regulator in charge of overseeing and monitoring investments with the goal of protecting investors, maintaining fair markets, and facilitating capital formation. But, the SEC can’t track every individual investment in the market. This is why some investment classes are only available to accredited investors. This protects individual investors who may not understand the risks from severe financial losses.
Below, we’re diving into what goes into becoming an accredited investor, how to know if you’re accredited, some scenarios to break down being accredited, the process of becoming accredited, and more.
Defining an Accredited Investor
An accredited investor, according to Investopedia, is “an individual or a business entity that is allowed to trade securities that may not be registered with financial authorities.”
Accredited investors can invest in securities offerings that aren’t available to non-accredited investors. These securities are typically more complex investment opportunities. Being accredited means that the investor has the financial savvy to have a comprehensive understanding of the risks of any potential investment, which means they don’t need to be protected by a traditional registered offering.
An accredited investor has the “off-campus lunch pass” of investing. They are allowed to take advantage of more sophisticated and complex investment opportunities, because they are expected to be able to understand and evaluate the risks associated with them. This means they have more freedom, but also more responsibility when it comes to investing.
Private placements are a type of exempt securities offerings, which includes multifamily syndications.
There are some private placements that are available to non-accredited investors who have a pre-existing relationship with the general partners (like in a 506(b) offering), but a large percentage of private placements are available only to accredited investors (mainly 506(c) offerings).
How to Know If You Are Accredited?
This isn’t like the SATs or Final Exams. You don’t need to pass an exam to become an accredited investor. You do need to meet specific requirements outlined by the SEC.
If you fulfill a minimum of one of the following requirements, you are an accredited investor.
Please note: Depending on the kind of private placement offering, you might need to provide evidence of your accredited status in order to invest in the opportunity.
Becoming an Accredited Investor: Financial Requirements
A common way investors qualify as accredited is by meeting the financial requirements.
This means that an investor either satisfies the minimum income and/or net worth threshold.
To find out whether or not you qualify as an accredited investor based on income, it is pretty straightforward.
To be an accredited investor based on income:
Your annual income must be $200,000, or $300,000 for joint income with a spouse. You must have made this income for the past 2 years.
You must be expecting to make the same or more income in the upcoming year.
If you meet these income requirements, then you qualify as an accredited investor! If not, there is another way you can qualify as an accredited investor.
Another way an investor can qualify as accredited is by meeting the net worth requirement of $1 million or more. This does not count your primary house. The net worth requirement can be met as an individual or together with a spouse.
We know calculating your net worth can be confusing. Here’s how it works.
Determining Your Net Worth
First, put together a list detailing each asset you own, including investments and savings. Then, make a list of your liabilities such as loans and debts.
Add up the sum total of your investments, cash, and retirement account balances, and subtract any liabilities like student loans, car loans, etc..
The number you end up with is your net worth!
Becoming an Accredited Investor: Professional Requirements
To recap, the SEC’s mission is to ensure that any investor participating in these investments that could involve high risk are financially savvy. The professional requirements serve as evidence that the investor is able to evaluate the risks in a given investment.
The SEC expanded the accredited investor qualifications to include new professional criteria, which gave more investors the opportunity to qualify as accredited.
To meet the professional requirements, you must have at least one of the following (according to SEC website):
Be a “knowledgeable employee” of a private fund
Specific professional certifications, designations, or credentials
SEC and state registered investment advisors
Directors, executive officers, or general partners of the entity selling the securities
A family client of a family office that is accredited
NOTE: A knowledgeable employee can only be considered an accredited investor if the investment is being offered by their employers.
Accredited Investors Entities?
An entity CAN qualify as an accredited investor. But the qualifications for entities are different from the qualifications for individual investors.
An entity that wants to be classified as an accredited investor must fulfill one of the following:
Own $5 million or more in investments
Each equity owner must be accredited
Investment advisers (SEC- or state-registered or exempt reporting advisers) and SEC-registered broker-dealers
A bank, savings and loan association, insurance company, registered investment company, business development company, or small business investment company or rural business investment company
What’s the Point of Having Accredited Status?
Accredited investors can invest in investments with more risks, like startups, real estate investment funds, hedge funds, etc.
The SEC created the accredited status because these investments aren’t subject to the many rules that would typically protect a non-accredited investor from risk. But this doesn’t mean that accredited investors invest in risky offerings. Being accredited simply means that you have the financial net and experience to mitigate the risks associated with the investment.
Every investment you make involves risk. Being accredited allows you to invest with other accredited investors in exclusive offerings.
Usually, if a real estate private placement investment is being advertised to the public, it will only accept accredited investors. However, there are some real estate syndication investments that allow non-accredited investors to participate. These opportunities are not advertised to the public.
Verifying That I am an Accredited Investor
While there isn’t a federal process to be verified as an accredited investor, the investment managers you work with might ask you to verify your accredited investor status by providing a financial statement like a tax return.
Other times, the investment managers will require you to submit your tax returns and/or give them a signed letter from your CPA or legal advisor proving your accredited status.
Accredited vs Non-Accredited Investments
The offerings provided to accredited investors aren’t superior to those offered to non-accredited investors. The sponsorship team usually makes the decision of whether or not to only accept accredited investors based on multiple factors, such as their existing investor network.
How To Invest If You’re Not Accredited?
A non-accredited investor who wants to invest in real estate and would like to participate in a private placement in a multifamily syndication does have options. Although they can be harder to find, these opportunities offer comparable benefits as an accredited investor-only opportunity.
Becoming an accredited investor might seem complicated, but don’t get overwhelmed. Talk to an experienced financial adviser who has experience with accredited investor status and multifamily syndications. They can help you decide which path to take to reach your real estate investment goals.
After reading through this article, you now know the simple definitions that you can use to develop your real estate investing knowledge base. You can now begin to decide if it makes sense for you to begin the process of becoming an accredited investor.
As an accredited investor, you get access to exclusive opportunities that other investors don’t get. While these might come with more risk, it’s also possible for you to reap more reward as a result.
That way, you can begin searching for investment opportunities to help you reach your financial goals and build a life by design!