Real estate sponsors, developers, and private lenders have always relied on outside capital to fund their projects and portfolios. Whether the source is high-net-worth individuals, family offices, pension funds, or institutional limited partners, raising capital from investors almost always implicates securities law — a reality that many real estate professionals overlook, misunderstand, or underestimate until a problem arises.
This article provides a clear-eyed explanation of why securities law applies to most real estate capital raises, which exemptions are most commonly used, and what every sponsor should have in place before accepting investor capital.
Why Securities Law Applies to Real Estate Capital Raises
The most common mechanisms for raising capital in real estate — offering LLC membership interests, limited partnership interests, debt instruments, equity participation contracts, or income participation agreements — are, in most legal contexts, securities. The fact that the underlying investment involves physical real property does not change that analysis.
One persistent myth is that “friends and family” capital raises are exempt from securities regulation. They are not. Under both the Howey Test (which defines investment contracts as securities) and the Reves Test (which addresses notes and debt instruments), the threshold question is whether the investor is passive — expecting returns based on the efforts of others — rather than actively participating in the management and operation of the venture. If the investors are not actively involved in running the deal, the investment is almost certainly a security.
The practical implication: any sponsor who offers and sells securities must either register those securities with the SEC and with each relevant state regulator, or qualify for a valid exemption from registration. Failure to do so exposes the sponsor to civil liability and potential regulatory enforcement.
The Two Key Questions Before Choosing an Exemption
Before selecting a capital-raising strategy, sponsors should honestly answer two threshold questions:
Regulation D: The Dominant Exemption in Real Estate
For most real estate capital raises targeting high-net-worth and institutional investors, Regulation D Rule 506 is the exemption of choice. Rule 506 allows sponsors to raise an unlimited amount of capital across the United States. It has two primary variants.
Rule 506(b): Established Relationships, No Advertising
Rule 506(b) is the more widely used version. It permits sponsors to raise unlimited capital from an unlimited number of accredited investors, plus up to 35 financially sophisticated non-accredited investors. Critically, the offering must not involve general solicitation or advertising.
The prohibition on general solicitation is the feature most frequently misunderstood. It means the sponsor cannot offer securities to any investor who does not already have a pre-existing business relationship with the sponsor before receiving any information about the investment. The relationship must be substantive — the sponsor must have genuinely assessed the investor’s financial background, sophistication, and risk tolerance prior to any fund-specific discussions. Simply meeting someone at a conference and calling them the next day to pitch an opportunity does not satisfy this standard.
The practical consequence is that 506(b) sponsors must be disciplined about relationship development and documentation. Investors should not receive offering materials or fund details until a substantive relationship has been clearly established and documented.
Rule 506(c): Public Advertising With Verified Accredited Investors Only
Rule 506(c) is the appropriate option when a sponsor wants to market openly — through social media, events, digital advertising, or to prospective investors they do not already know. Under 506(c), general solicitation and advertising are fully permitted.
The corresponding obligation is rigorous: every investor who enters the offering must be independently verified as accredited. Self-certification is not sufficient under 506(c). Verification requires documentary evidence such as tax returns, bank statements, or brokerage account records, or a certification letter from a licensed CPA, attorney, registered investment adviser, or broker-dealer confirming the investor’s accredited status. Third-party verification platforms can also be used.
Annual Filing Obligations Under Both 506 Variants
Under both Rule 506(b) and Rule 506(c), the sponsor must file a Form D with the SEC within 15 days of the first sale of securities. The Form D must be renewed annually for as long as the offering remains open. In addition, the sponsor must file equivalent state notice filings (commonly called “blue sky” filings) in each state where an investor resides. These filing obligations are ongoing and must be tracked carefully to avoid compliance lapses.
State-Only Offerings: A Legitimate But Limited Option
Some sponsors elect to raise capital exclusively within a single state, relying on that state’s securities exemptions rather than Regulation D. This is a viable approach, but it requires careful analysis because every state has its own securities statutes and exemption standards. Sponsors who want to pursue a state-only approach should consult with counsel familiar with the specific state’s requirements before proceeding.
Regulation A: A Path for Larger Non-Accredited Investor Pools
For sponsors seeking to raise capital from a broad base of investors including non-accredited individuals, or those pursuing a real estate crowdfunding strategy, Regulation A provides an alternative framework. Regulation A is functionally similar to a public offering: it requires SEC review and approval of the offering circular, permits unrestricted advertising and general solicitation, and allows a significantly larger contingent of non-accredited investors than Regulation D.
Regulation A has two tiers with different capital limits. Tier 1 requires registration in every state where securities are sold, which creates significant compliance overhead. Tier 2 preempts state law but imposes ongoing SEC reporting obligations. Given this complexity and cost, Regulation A is generally most appropriate for sponsors raising substantial capital from a wide audience — it is rarely the right choice for a typical real estate syndication or private fund.
Do You Need a Private Placement Memorandum?
Yes. Regardless of which exemption applies, it is both standard practice and sound legal strategy to offer and sell securities using a Private Placement Memorandum (PPM) or equivalent offering document. The PPM serves a critical function: it discloses the material features of the investment, identifies the risks investors must understand, specifies investor qualification requirements, and establishes the legal framework for the offering.
Beyond the practical value of full disclosure, the PPM provides essential legal protection to the sponsor. Investors who later claim they were misled about material facts have a much harder time making that case when they signed subscription documents acknowledging receipt of a comprehensive offering memorandum.
A well-drafted PPM is not a commodity document. It should accurately describe the specific investment strategy, management team, fee structure, distribution mechanics, risk factors particular to the asset class, and all material terms of the investment. Sponsors should not rely on generic templates that have not been tailored to their actual offering.
Common Securities Exemptions at a Glance
| Exemption | Advertising Permitted | Non-Accredited Investors | Key Requirement | |—|—|—|—| | Rule 506(b) | No | Up to 35 (sophisticated) | Pre-existing substantive relationship | | Rule 506(c) | Yes | No | Independent accredited investor verification | | Regulation A (Tier 1) | Yes | Yes (with limits) | State registration required | | Regulation A (Tier 2) | Yes | Yes (with limits) | Ongoing SEC reporting | | State exemptions | Varies | Varies | State-specific analysis required |
Conclusion
Securities compliance is not optional for real estate capital raises — it is a foundational legal requirement. The penalties for non-compliance range from investor rescission rights to regulatory enforcement and personal liability for the sponsor. The good news is that the compliance framework, while complex, is well-established. Sponsors who plan ahead, select the right exemption for their investor base and marketing strategy, document their offering properly, and maintain required filings can raise capital legally and efficiently.
Geraci LLP has represented private lenders, fund managers, and real estate sponsors in securities matters for over 15 years. Our corporate and securities team is available to assist with fund formation, offering document preparation, investor qualification procedures, and ongoing compliance management. Contact us at (949) 403-3488 or at 90 Discovery, Irvine, CA 92618 to get started.
