Private Real Estate Investment Funds

Article #5 – Securities Law

In this 6-part series, I explain private real estate investment funds. You have a real estate fund when you accept money from passive investors to do transactions in real estate. A real estate fund is a hedge fund and it is subject to most laws that apply to hedge funds, including securities laws and ERISA. Real estate funds usually are LLCs or limited partnerships, and they have complex terms for investor rights, manager compensation and more.

These are the 6 articles in the series:
 

In this Article #5, I give an overview of the securities laws that affect a private real estate investment fund. 

Offerings of Securities

When your fund sells ownership interests to investors, the fund is conducting a securities offering.  A securities offering is a highly regulated and complex undertaking.  For every offering, the fund must comply with federal securities laws + the laws of each state where an investor resides.  This can add up to a lot of law. 

You can’t opt out of these laws – securities laws will apply to your fund whether you want them to or not.  Pretending the laws don’t exist won’t save you.

Go to my webpage Securities Lawyer for the basics of securities offerings, including these articles:

Introduction to Private Offerings and Private Placements of Securities

Introduction to Federal Securities Exemptions

Introduction to Federal Regulation D

How to Find Investors

The hardest part in any securities offering is finding investors.  If you break the law, you’ll probably do it here.  When selling interests in your fund, you may not advertise or otherwise solicit the public.  This applies to the fund and anyone acting on its behalf (usually managers and brokers).  Hence you may not use any advertisement, article, notice or other communication in any newspaper, TV or similar media.  You may not use seminars whose attendees have been invited by any general solicitation or advertising.  In brief, you may only sell to investors with whom you have a pre-existing, substantive relationship.

For more on this topic, see my articles:

How to Find and Solicit Investors for a Private Offering of Securities

How a Management Company, General Partner or Broker Uses General Advertisements and Solicitations to Get Investors

Brokers  

Not only must you sell interests in the fund in the manner described above, you also must be very careful about the people who help you sell the interests in your fund.  Extensive broker regulations apply to you and all other people who sell interests in your fund.  In brief, no one involved in the offering may be regularly engaged in selling securities unless that person is licensed as a securities broker.  Many professionals in the field forget about broker regulations (instead they concentrate exclusively on the exemptions).  This can be a fatal mistake if the investors bring litigation.

For more on this topic, see my 4-article series, Brokers and Finders in Securities Laws.

Investment Advisors Act

The Investment Advisors Act is extremely important for hedge fund managers.  Most hedge fund managers register under this Act.  A possible exception is the manager of a real estate investment fund so long as the fund only invests in real property (not securities).  This is a dangerous exception, however, because frequently real estate funds invest in mortgage notes and the like, which might be securities.

If the fund manager must register as an investment adviser with the SEC, then all investors must be qualified clients.  The fund manager may not charge performance fees to those investors who are not qualified clients.  Qualified clients generally need to have a $1.5 million dollar net worth under Rule 205-3 of the Investment Advisers Act.

Investment Company Act

The Investment Company Act (sometimes called the Company Act, the ICA, or the 1940 Act) applies to companies that invest in securities (e.g. mutual funds).  A company that invests solely in real estate is not subject to this Act (but remember, your real estate fund might invest in mortgage notes and the like, which might be securities).  There are two famous exemptions to this Act – the 3(c)(1) and the 3(c)(7) exemptions.  Most private funds avoid the Investment Company Act by using one of these exemptions.

Liability

Lastly, the consequence of violating securities laws is that purchasers of securities may bring an action against the fund and even you personally.  Generally, investors seek the return of the money they invested.  A technical defect in compliance can be the most frustrating for you, because the investors can leverage it into forcing you to return their money – you become an unwilling guarantor of the investment. 

The next and the last article in this series is ERISA and the Private Real Estate Fund.

Get a Securities Lawyer

Real estate funds, like all hedge funds, are very complex.  This is not something to learn as you go.  You need the help of accounting, tax and legal counsel who are experienced in the area.

Call me to schedule a legal consultation: 510-796-9144