What is an Accredited Investor

What is an Accredited Investor?

An accredited investor is defined by the U.S. Securities & Exchange Commission (SEC) as someone who meets certain income or net worth criteria. Specifically, an individual must have earned at least $200,000 in income in each of the past two years (or $300,000 if married and filing jointly), or possess a net worth of over $1 million, excluding the value of their primary residence.

The main advantage of being an accredited investor is the ability to access investment opportunities that aren’t available to individuals with lower income or wealth levels. These investments often have the potential for higher returns, but they also come with increased risks. Another category is the sophisticated investor, who, although not meeting the accredited investor thresholds, demonstrates sufficient knowledge and experience to evaluate investment risks.

These regulations were put in place to protect the average investor from high-risk investments, but ironically, there’s little protection for individuals blindly investing in overinflated stock markets or mutual funds through their retirement accounts. The system is outdated, and while the 2012 JOBS Act made it easier for more people to invest in alternative assets through crowdfunding, it’s still not perfect.

When participating in syndications, it’s important to know and trust the lead sponsor or syndicator personally. Simply meeting someone at a real estate networking event and hearing their pitch doesn’t cut it. If they lack a solid network of reliable investors, that’s a red flag regarding their experience and track record.

How Can a Non-Accredited Investor Get Involved?

Being a non-accredited investor can be challenging from the perspective of a syndicator, and here’s why:

  • SEC protections require extra care in dealing with non-accredited investors.
  • Many non-accredited investors need more education on the process, as they often come from peer groups without exposure to these kinds of deals.
  • The minimum investment amount is often a significant portion of their net worth, so they tend to be emotionally attached to their money, which leads to constant communication with the syndicator.
  • Their funds can quickly be exhausted after just a few deals, limiting their lifetime value as a customer.
  • Their peer group is likely to be made up of other non-accredited investors.

Here are some tips for non-accredited investors looking to break into syndications:

  • Be serious about getting educated, so you stand out from the crowd of “tire kickers” when connecting with a syndicator.
  • Always communicate your intentions clearly, and if you’re unsure about an investment, be transparent.
  • Add value to the syndicator by respecting their time and showing that you’re prepared. Remember, they’re evaluating you as much as you’re evaluating them.

Two Types of Syndications

  1. Single-Asset Syndication:
    This type of syndication focuses on raising capital to purchase a specific asset, such as a 200-unit apartment complex. Investors are fully aware of what they’re putting their money into before the capital is raised, allowing them to thoroughly vet the property and the deal structure.
  2. Blind Pool Fund:
    In a blind pool fund, capital is raised before specific assets are identified. Investors trust the sponsor to acquire properties that fit within the fund’s strategy. While this offers more flexibility to the sponsor, it can be riskier for investors since they don’t know exactly what they’re buying into. This lack of transparency can lead to scams, so it’s crucial to thoroughly vet the sponsor’s track record before investing.

Syndication Property Types and Structure

  • Location: Properties are typically located in cities with growing populations and diverse economies. Most deals focus on Class B properties, which cater to working-class tenants.
  • Price Range: Deals usually range from $5 million to $75 million, with 20% of the purchase price (plus additional funds for renovations or improvements) needing to be raised by investors.
  • Equity Split: In a typical syndication, Limited Partners (LPs) receive 70% of the equity for providing most of the capital, while General Partners (GPs) get 30% for their role in finding, acquiring, and managing the property.
  • Timeline: Most syndications have an investment horizon of around 5 years.
  • Property Type: The majority of syndications focus on large multifamily properties (100-500+ units), often with value-add opportunities like renovating units or upgrading amenities, which help increase the property’s value over time.

Syndication Returns

When done properly, running your own rental property can generate 25-35% annual returns on paper. However, in reality, things can go wrong. For example, there are instances where 3 out of 10 rental properties lost money due to unforeseen repairs or vacancies, even though we aimed for $200-$300 in monthly cash flow per property. Managing multiple rentals comes with risks, and the only way to protect yourself from volatility is by expanding your portfolio.

Investing as an LP in syndications typically offers returns in the range of 80-100% over 5 years, or about 17-20% annually. While these returns are lower than being a direct operator of a small rental, they come with significantly less risk. As an LP, you’re relying on the GP to uphold their fiduciary responsibilities and deliver on the investment plan.

It’s important to remember that most LPs don’t fully understand how to assess a deal. Many invest based on other LPs’ opinions or flashy executive summaries, which often lack critical details like the property’s T12 P&L (Profit and Loss Statement) or rent rolls. Proper due diligence and networking are essential to making informed decisions. You need to build relationships and invest time in learning from others in the field, whether through conferences, masterminds, or paid coaching.

Preferred Equity

Preferred equity in real estate is a type of ownership that sits between debt and common equity. Investors who hold preferred equity typically get priority in receiving cash flow distributions and returns, but they don’t have the same upside potential as common equity holders. In the event of liquidation or sale, preferred equity investors are paid before common equity investors, reducing their risk but also limiting their gains.

Here’s what preferred equity offers:

  • Priority in Distributions: Preferred equity holders get paid before common equity investors.
  • Fixed Return: Preferred equity often comes with a set return, rather than one based on the property’s performance.
  • Lower Risk: Because of their priority in cash flow, preferred equity investors have less risk than common equity investors, though they may miss out on big appreciation gains.

Key Property Elements to Check When Touring

  • Outdated or poorly visible signage
  • Unkempt landscaping or mismatched exterior paint
  • Tenant spaces cluttered with personal items like grills
  • Inconsistent or outdated light fixtures inside units
  • Mismatched appliances in the kitchen
  • Lack of privacy fences in backyards
  • Insufficient or worn-out amenities (pool chairs, benches, outdoor grills)

Essential Steps in Multifamily Investing

  1. Research the Sponsor
    Look into the sponsor’s track record, how they handle challenges, and how they communicate with investors. Make sure they invest their own capital in the deal and understand their strategy.
  2. Understand the Market
    Evaluate key metrics like job growth, property appreciation, vacancy rates, and crime. Compare these to national averages and get specific market data from the sponsor.
  3. Assess the Property
    Determine the property class (A, B, C, D) and what improvements are needed to achieve cash flow or appreciation. Consider the risks associated with the class of property.
  4. Understand the Deal Structure
    Look at the equity split (typically 70/30), preferred returns (usually 6-10%), and the fees involved (acquisition, management, disposition). Be wary of sponsors who charge no fees.
  5. Conduct Thorough Underwriting
    Review both existing operations and projected performance. Confirm that the purchase price is backed by sales comps, rent growth projections are realistic, and exit cap rates are conservative.
  6. Review Legal Documents
    Always consult an attorney when reviewing documents like the Subscription Agreement, Operating Agreement, and Private Placement Memorandum (PPM). Understand your rights and obligations before signing.

By taking these steps, you’ll position yourself to make more informed decisions, potentially maximizing returns while minimizing risk.