What is the Difference Between a 506 (c) and 506(b) Real Estate Syndication?

July 20, 2024
Shams Merchant

When considering real estate syndication, two common exemptions under Regulation D of the Securities Act of 1933 come into play: 506(b) and 506(c). Contact a specialized real estate syndication attorney like Shams Merchant to find out how offerings can be conducted and who can participate, each with distinct characteristics and implications.

506(b) Real Estate Syndication

506(b) is a longstanding exemption that allows for private placements of securities without the need for registration with the Securities and Exchange Commission (SEC). This exemption is widely used in real estate syndications due to its flexibility and relatively lower compliance burden compared to other options.

Key Features:

  • Accredited Investors and Up to 35 Non-Accredited Investors – Under 506(b), sponsors can solicit investments from an unlimited number of accredited investors (individuals with a high net worth or income) and up to 35 non-accredited investors who meet certain financial sophistication requirements.
  • No General Solicitation – One of the defining characteristics of 506(b) offerings is that sponsors cannot use general solicitation or advertising to attract investors. They must have a pre-existing relationship with potential investors or rely on traditional networking and referrals.
  • Information Disclosure – While not as stringent as with registered offerings, sponsors using 506(b) must provide detailed disclosures about the investment opportunity to all investors, including financial statements and other relevant information.
  • Verification of Accredited Status – Sponsors are required to take “reasonable steps” to verify that all investors claiming accredited status actually meet the SEC’s criteria. This verification process can vary but generally involves reviewing financial documents or obtaining written confirmations from financial advisors.
  • State Securities Laws – Compliance with state securities laws (blue sky laws) is necessary in 506(b) offerings, meaning sponsors must ensure they adhere to specific regulations in each state where investors reside.

Benefits of 506(b) Syndications:

  • Access to Non-Accredited Investors – Allows sponsors to include a limited number of sophisticated non-accredited investors in the offering.
  • Lower Compliance Costs – Compared to other exemptions, the compliance requirements for 506(b) offerings are generally less burdensome, making it attractive for smaller-scale syndications.
  • Flexibility in Investor Relationships – Sponsors can cultivate relationships with potential investors over time, fostering trust and confidence without the need for public advertising.

Considerations:

  • No General Solicitation – Sponsors must refrain from advertising the investment opportunity publicly, which can limit the pool of potential investors.
  • Verification of Accredited Status – Sponsors bear the responsibility of ensuring accredited investor status, which may involve additional administrative efforts.
  • State Compliance – Adherence to state-specific securities laws can add complexity and potentially increase legal costs.

506(c) Real Estate Syndication

Introduced under the JOBS Act of 2012, 506(c) offerings represent a modernized approach to private placements, specifically allowing for general solicitation and advertising under certain conditions. Approach the experts at a reputed real estate private equity law firm to learn how this exemption aims to facilitate capital raising by enabling sponsors to reach a broader audience of potential investors.

Key Features:

  • General Solicitation Allowed – Unlike 506(b), sponsors utilizing 506(c) can publicly advertise their investment offerings through various channels, including social media, websites, and traditional advertising mediums.
  • Accredited Investor Verification – A fundamental requirement of 506(c) offerings is that all investors must be accredited. Sponsors must use reasonable methods to verify the accredited status of each investor at the time they invest in the offering.
  • No Limit on Number of Accredited Investors – 506(c) does not impose restrictions on the number of accredited investors who can participate in the offering. This makes it suitable for larger-scale syndications seeking substantial capital contributions.
  • Disclosure Requirements – Similar to 506(b), sponsors must provide comprehensive disclosures about the investment opportunity to all investors. This includes financial statements and other relevant information necessary for investors to make informed decisions.
  • State Securities Laws – As with 506(b), compliance with state securities laws is mandatory in 506(c) offerings, ensuring sponsors adhere to specific regulations in each jurisdiction where investors reside.

Benefits of 506(c) Syndications:

  • Broad Investor Reach – Allows sponsors to use general solicitation and advertising, potentially reaching a larger pool of accredited investors.
  • Efficient Capital Raising – Streamlines the process of attracting capital by leveraging modern marketing techniques and broader visibility.
  • No Limit on Accredited Investors – Provides flexibility for syndications targeting multiple high-net-worth individuals or institutional investors.

Considerations:

  • Accredited Investor Verification – Sponsors must implement robust procedures to verify accredited status, ensuring compliance with SEC requirements.
  • Limited to Accredited Investors – Non-accredited investors are excluded from participating in 506(c) offerings, restricting access to a potentially broader base of investors.
  • Higher Compliance Costs – Due to the need for stringent investor verification and adherence to state securities laws, 506(c) offerings may involve higher compliance costs compared to 506(b).

Conclusion

Both 506(b) and 506(c) real estate syndications provide viable pathways for sponsors to raise capital while navigating the regulatory landscape of private placements. Understanding the nuances of each exemption and consulting with a professional 506(c) and 506(b) lawyer at CRE Lawyer can help sponsors determine the most suitable approach based on their specific needs and circumstances.