Accredited vs. Sophisticated Investors…What Does It Mean?

by | Sep 5, 2020 | Investing Process, Real Estate Investing 101 | 0 comments

Once you decide to jump into the real estate investing world, you’ll start hearing the term “Accredited Investor.” Once you notice how many passive commercial real estate or crowdfunded investment opportunities are publicly advertised — and are therefore limited to accredited investors — you may start getting curious.

Even if you’re totally new to investing, it’s important to know the difference between an accredited investor and a sophisticated investor, and which one
you are.

Neither of these titles requires an application or an approval process. You can find out which category you fall into based on a few simple criteria.

What to Look For

To be an accredited investor, you must:

  1. Have had an annual income of $200,000 (or $300,000 for joint income with a spouse or non-married partner) for at least the past two years, and expect to earn the same or higher income this year.

OR

  1. Have a net worth of over $1 million, not counting the equity in your primary home.

(Investment professionals with certain securities licenses are also considered accredited, regardless of their financial qualifications. Similarly, knowledgeable employees of investment funds are allowed to invest in the funds they work for without qualifying financially.)

If you’re not accredited, you may still qualify as a Sophisticated Investor. There are no financial qualifications to be a sophisticated investor. Instead, it means you’re knowledgeable enough about the type of investment to be able to evaluate it properly and make an informed decision whether or not to invest.

Before we explain why it’s important, it may help to run through examples…

Meet Jordan 

Jordan’s had a corporate career for 15 years and is single. She just got a raise 2 months ago and now makes $200,000 per year. Her primary home is worth $850,000 (it’s in California). She has $600,000 in her 401K and $350,000 between her savings and a few brokerage accounts. She still owes $50,000 in student loans.

Is Jordan an Accredited Investor?

Even though Jordan currently makes $200,000 and has reason to believe she will continue making that amount or more in the coming year, she only just reached that threshold this year — her annual income over the past two years has been below $200,000.

Jordan’s net worth is: $600,000 (401K) + $350,000 (savings and brokerage accounts) – $50,000 (student loans) = $900,000. The value of her home can’t be included.

Since her net worth is under the $1 million requirement, Jordan is not an
accredited investor.

Chris and Mindi

Chris is a physician and earns $285,000 per year. Mindi is a stay-at-home mom, so she earns no income. Their primary home is valued at $550,000. They bought a single-family rental home for $300,000 that’s now worth $400,000, and they have a $150,000 balance on its mortgage. They have $250,000 in savings, plus $550,000 in retirement accounts. Mindi recently received $250,000 in inheritance.

Are Chris and Mindi Accredited Investors?

Based on income alone, they do not qualify, since their joint income is
below $300,000.

However, excluding their primary residence, their net worth is…

$400,000 (value of the single family rental) – $150,000 (balance owed on single family rental) + $250,000 (savings) + $550,000 (retirement accounts) + $250,000 (inheritance) = $1.3 million, which is above the $1 million threshold.

Because they meet one of the two criteria, Chris and Mindi are accredited investors. 

Mark and Sheri

Mark has been working as a program manager for a defense contractor since retiring from the military 4 years ago. He earns $150,000 a year from his W-2 employer, plus a total of $60,000 from his military pension and military disability benefits from the VA. He and Sheri got married 3 years ago after he retired from the military. Sheri is a pharmaceutical sales rep. While her income has fluctuated based on sales, she’s consistently earned at least $170,000 a year since she and Mark got married. Both of them are building their net worth back up after being significantly diminished by divorces a few years before they met. Together, they have $180,000 in savings, $400,000 in retirement accounts (separate from Mark’s military pension), and a nice home worth $975,000.

Are Mark and Sheri Accredited Investors?

Their combined income is $150,000 (Mark’s work) + $60,000 (military pension & VA benefits) + $170,000 (Sheri’s income) = $380,000. Since it’s been close to that level for more than 2 years, they do qualify as accredited investors based on income.

Their net worth is $180,000 (savings) + $400,000 (retirement accounts) = $580,000, so they don’t qualify by their net worth.

But fortunately for Mark and Sheri, you don’t have to meet both criteria to be accredited — only one of them.

What Are the Benefits?

The main benefit of being an accredited investor is that you have access to more deals. Why? In the SEC’s opinion, being an accredited investor means you’re savvy enough to have figured out how to accumulate some wealth. (Even if you inherited it…they don’t care.) Thus, more investment opportunities are open to you since you are in a better position to take on risk. This is intended to protect non-accredited investors from being taken advantage of.

If you’re a non-accredited investor who happens to love real estate, there are still plenty of investment opportunities available, including passive investments through real estate syndications — as long as you’re knowledgeable about them (i.e., sophisticated). If you’re not, we can help you learn. However, since SEC regulations do not allow investments for non-accredited investors to be publicly advertised, you’ll only find out about them if you have a relationship with sponsors who are offering them.

Sponsors have an obligation to ensure that even knowledgeable sophisticated investors have a suitable level of risk tolerance — that is, they could handle the loss of their investment without catastrophic consequences.

Related: Real Estate Syndications — Are They Right for You?

What Does This Mean for You and Us?

There are a few different ways we can structure deals. We may offer a deal in a way (commonly referred to as a 506c) where we can advertise it publicly. If we do this, we can only accept accredited investors in the deal. (Sorry, sophisticated investors!)

However, we may offer a deal in a way (referred to as a 506b) where we can accept both accredited and sophisticated investors. But if we do this, we can’t advertise it publicly — only to people we already have a relationship with. Then, accredited investors who don’t have a relationship with us have to miss out.

So, what can you do to ensure you find out about deals you’re eligible for?
Easy…join our BluSky Investor Club. We build a personal relationship with everyone in our club — people just like you who are interested in building wealth through real estate. So regardless of how we structure a deal, you’ll hear about it and be able to decide for yourself if it’s right for you!

 

Further reading: STOP!! Know Your Goals Before Investing in a Real Estate Syndication!