November 7th, 2013
Los Angeles and San Francisco Daily Journal
Early Sullivan partner Stephen Ma was quoted in Andrew McIntyre’s October 25, 2013 Los Angeles Daily Journal article “REITs Look to Private Offerings.”
With the 2012 Jumpstart Our Business Startups Act, or JOBS Act, rule that last month lifted an 80-year-old ban on public advertising for investments, some nontraded real estate investment trusts have started looking at alternatives to a costly registration filing with the Securities and Exchange Commission. The move comes amid a record fundraising year for nontraded REITS, having already raised $12 billion – the most ever in a single year – according to a report by The Investment Program Association and Robert A. Stanger & Co. Inc.
Darryl Steinhause, a partner at DLA Piper in San Diego, said REITs, which already have a laundry list of complex requirements to meet in order to maintain their status, are now opting for so-called Rule 506(c) private placement offerings under the new rule. He recalled a REIT client who had earlier planned to register its securities with the SEC under an S-11 filing as saying, “Why would we do that? It will cost us $7 million to $12 million to get our REIT really going.” The client, which Steinhause declined to name, determined it could instead do a 506(c) offering for a matter of a few hundred thousand dollars to try to reach its fundraising target of $50 million.
Rule 506 offerings themselves are not new, but 506(c) offerings allow companies to advertise to the general public – on the radio, television, or even via billboards on U.S. Route 101 – and represent a potential game changer in the fundraising world. Such offerings can still only be sold to accredited investors, who are individuals with annual incomes of more than $200,000 – $300,000 for couples – or assets, excluding primary residence, of more than $1 million.
Lawyers use similar sets of documents for 506 and S-11 offerings, and disclosures are similar. But structure aside, the offerings are miles apart. S-11 offerings have to be reviewed by the SEC and, unless they qualify for an exemption, are subject to state-by-state review, while 506 offerings aren’t subject to any review. It takes months and costs millions to set up S-11 offerings, while 506 offerings take just weeks and cost thousands. Furthermore, companies that do 506 offerings don’t have to reveal information that their competitors might use to gain an upper hand.
“If I was putting together a REIT and wanted to buy distressed properties in Riverside, and had to put projections in a filing with the SEC, and someone saw that, someone could steal my thunder pretty easily,” said Samuel C. Dibble, a corporate partner at Farella Braun & Martel LLP in San Francisco.
The recovering real estate market has boosted fundraising for nontraded REITs, which this year has already broken the $11 billion record set in 2007. There has also been considerable transactional activity in the nontraded REIT space. American Realty Capital Trust IV Inc., for one, has a pending $3.1 billion sale to publicly-traded American Realty Capital Properties Inc.
“Many in the real estate industry will likely utilize this law to raise equity,” said David P. Lari, a real estate partner at Cox Castle & Nicholson LLP in Los Angeles. “I think you’ll see the new law used more in the higher-risk, higher-reward real estate transactions.”
The SEC on Wednesday voted to move forward with the second of its JOBS Act provisions, the long-awaited crowdfunding rule designed to help startups raise capital in so-called online “portals.” Lawyers say this would impact a host of companies including REITs, although the SEC still needs another vote on that measure before it could go into effect.
“The REIT scenario is very interesting. … There are people who have been sitting on money since 2008 who are looking to invest in real estate,” said Stephen Y. Ma, a partner at Early Sullivan Wright Gizer & McRae LLP in Los Angeles. “The trick is, they’ve got to have the resources – the lawyers, the consultants – to make sure they’re complying with the rules.”
Indeed, that question of compliance is a sticking point for some companies, but also a source of work for lawyers.
“I’ve had a lot of clients ask,” Farella Braun’s Dibble said, “and say, ‘We won’t be the guinea pig here.'”
The SEC can’t fault companies for advertising, but as the agency comes out with new guidance on the process of documenting accredited investors, it could fault companies for not complying in that arena, say lawyers. And, of course, whenever there is a loosening of regulations, there is a heightened chance for fraud.
“Any real estate type of entity out raising capital may want to avail itself to the loosened restrictions,” said Seith Weissman, a partner at Jeffer Mangels Butler & Mitchell LLP in Los Angeles. “Until the new regulations come out, there’s going to be a lot of cursory interest in the topic. I don’t think you’ll see a massive flood of new types of advertising or investment.
Michele W. Layne, director of the SEC’s Los Angeles regional office, declined to comment on the topic, and the SEC in Washington, D.C. couldn’t be reached for comment.
Despite the uncertainties, Steinhause said other companies have come to him. He thinks REITs may use the opportunity to advertise 506 offerings as way of testing the water before perhaps later filing an S-11.
“What I think what you will see is that some REITs will do a 506(c) offering to see how viable the REIT concept is for that sponsor,” Steinhause wrote in an email. “After they have established a track record and own specified properties, it will make it much easier to sell their REIT shares in a publicly registered offering.”