What is better in your opinion, 506(c) or 506(b) offering?

Question

Happy 4th of July (if you are reading this today)!

I wanted to start a discussion on multifamily syndication offerings and maybe shed a little more light on the subject for other multifamily investors.

The initial intention of Reg D was to allow smaller companies, which likely could not afford the standard SEC registration, a chance to access the capital markets. The primary difference in the 2 offerings lies in how the Sponsor can advertise the deal AND what verification/documentation is required.

If I had to answer the question “what is the most common filing status among commercial real estate sponsors?” (which I have, many times), I would answer 506(b). There is much larger audience of potential investors that are non-accredited, but you are limited to the number of non-accredited investors you can bring to your offering so..

If you are a passive investor -- Do you care about if the offering is one or the other?

If you are an active operator -- Do you like to offer one or the other? Do you have plans to offer 506(c) deals in the future?

What are your thoughts?

Charles Seaman · Answer

@Shane Thomas As an active operator, I prefer to use 506(b) offerings because it allows you to attract a larger audience of potential investors.  At some point, we might switch to 506(c) offerings, but I'm always more hesitant to go that route because it greatly limits who can invest in your deal.

The benefit to using a 506(c) offering is the way that you can market the deal, but I often find that most investors (accredited or sophisticated) are highly unlikely to invest with you if you don't have a preexisting relationship with them.  They typically want to know you so that they can feel confident in your ability to operate the deal and protect their money.  Because of this, having the ability to market the deal doesn't seem like much of an added benefit to me, unless you have a strong enough brand that people simply want to invest with you on name value alone (think Grant Cardone or similar people with strong followings).

From the passive investor standpoint, I don't think that accredited investors would have any preference for the offering type, but I'm sure that sophisticated investors would prefer 506(b) offerings simply because they're allowed to participate in them.  I'm curious to see what some of them have to say in response to the question that you posed.

Taylor L. · Answer

They both have advantages and disadvantages. I've only done 506(b) syndications, I do not currently have plans to do 506(c)s. 506(c)s put more work on the sponsor to verify the accredited status of the investors, which I see as one of the bigger downsides. There are services that perform that function, but it's just not something I care to deal with.

Additionally, much of my investor base are sophisticated but non-accredited, and I don't want to lock them out of a deal they might like.

Ellie Perlman · Answer

@Shane Thomas We have some deals with 506C and some with 506B. Since some of our investors are sophisticated (and not accredited), I won't want to buy a deal and not include them in it. The vast majority of our investors are repeated investors, and I'd like to include all of them if I can. The downsize is that we can't advertise it or offer it to an accredited investor we have no substantive pre-existing relationship with. However, I like to get to know my investors first and see if we are a good fit before I include them in a deal. It's not a deal machine. To me, it's a true partnership and we actually decided not to work with some investors with whom we though there was no good fit. It feels a bit like a family to us, and I'd like to keep it this way. So I believe we will keep offering 506B for the most part.

Andrew Hogan · Answer

BAM only did 506(B) for the first several years and enjoy the 506(C) route now. Yes, you need to verify that they are accredited investors which most CPAs will sign off for free.We enjoy being able to post about specific deals without crossing SEC violations. It allows you to get to the point which serious investors will appreciate.There are over 10 Million accredited investors in the US alone. All you need is a few hundred to raise 100M+ :)

Evan Polaski · Answer

@Shane Thomas if the investor is truly accredited, there is no real difference.  Most have a professional to issue the letter in 5 minutes anyways.

To me, as an investor, I also view 506(c) as a benefit.  The verification letter is protection for the sponsor against distractions of an SEC investigation.  But I agree with the others in that I still want to talk to a sponsor before I place a check with them.  The deal, to me, is simply an attention grabber, to open a conversation.

Rodney Robinson · Answer

@Charles Seaman great insight. I know the 506(c) was created to allow for marketing to those with whom a preexisting relationship did not exist, but did not consider the burden of verifying accreditation as well as challenge of marketing. I can understand why sponsors still prefer the 506(b)

Jack Martin · Answer

One is not necessarily better than the other.  It's more of a question of choosing the one that is the most appropriate for where you are at in your business, and what you are trying to accomplish.

AJ Shepard · Answer

@Shane Thomas

I’m gonna side with all the guys that answered already.  The 506(b) allows for a larger audience, especially when the audience already tends to want to have an existing relationship.

From an investor standpoint, I wouldn’t anticipate the deal to be any better or any worse by the code they subscribe to.  You may find yourself looking at some larger deals through the accredited only syndicators and most likely with more complicated waterfalls and debt structure, but I wouldn’t think it makes the deal any different better or worse.  I’ve read and learned that vetting the sponsor is way more important than the deal itself.

John Fortes · Answer

@Shane Thomas great question and Happy 4th to you as well.

Talk to a professional who can consult you and dig into your needs.

To really answer this for yourself you would have to first understand what is your situation.

For instance, are you seeking to syndicate? What kind of investors do you plan to work with? Is your investor database a mixed bag?

Jusg remember that 506c offerings you will need to verify their accredited status and that could be an added expense.

For me personally, I work with 506b offerings. I dig into my secure investor portal and can view my database who is sophisticated and who is accredited.

I have friends and family who are a mixed bag of accredited and non-accredited.

I can see in the future where I work on some opportunities strictly with accredited investors as my business scales. I'd also continue to work with my non-accredited investors cause I'm always a believer of dance with who brought you.

Hope this helps you in your journey.

Happy investing!

What is better in your opinion, 506(c) or 506(b) offering?

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