By Stuart Saft, partner, Holland & Knight
As a result of a change in the federal securities laws contained in the federal Jumpstart Our Business Startups Act (the “JOBS Act”), the nationwide sale of Condo Hotel Units with (or without) rental pools as well as other real estate securities including syndications is imminent.
No longer will sponsors be required to register the offerings with the Securities and Exchange Commission and avoid advertising. This change will also promote the sale of unsold condo units as investments.
Until the enactment of the JOBS Act, sales of condo hotels with rental pools was restricted as a result of the SEC’s position that a condominium unit would be treated as a security if it was offered in conjunction with either an emphasis on the economic benefits to the purchaser to be derived from the managerial efforts of the promoter, or the offering of participation in a rental pool.
Even after the SEC modified its position in a 2002 Private Letter Ruling that permitted the mention of the existence of a rental program in written and oral sales and promotional materials, it still required that only after a request by a buyer for further information about a rental program could a sales representative suggest that a buyer speak to a rental management company representative, who could not be in the same office as the unit sales office and the real estate sales person could not discuss economic or tax benefits of rental arrangements nor project rental rates or expected occupancies.
A violation of the foregoing restrictions turned the purchase of the unit into the purchase of a security and required registration with the SEC.
The SEC’s position created an impediment to selling more than just the condominium units and particularly hotel condo units, where the purchasers were purchasing their units for investment.
The alternative was to treat the offerings as securities and go through the time and expense of a filing with the SEC and the subsequent reporting requirements for public companies. However, the JOBS Act enables sponsors to acknowledge that the units are securities but, as long as the sponsor complied with an expanded Regulation D, the offering would not need to be filed with the SEC (other than submitting a simple Form D).
The change in Regulation D also allows the sale of any other kind of real estate security with few limitations.
Regulation D is a long-standing and much-used exemption from the registration requirements of the Securities Act of 1933, which enabled issuers to sell unregistered securities to an unlimited number of accredited investors (i.e., investors who have a net worth in excess of $1 million or net income above $250,000 a year for an individual or $350,000 a year for a married couple) and a limited number of non-accredited investors, but precluded advertising or general solicitation.
However, the JOBS Act permits the general solicitation and advertisement of such offerings, as long as all the purchasers are accredited investors. By removing the ban on general solicitations, sponsors would not have to rely solely on existing relationships for funding and can utilize the internet, seminars and other venues to find purchasers without violating the securities laws.
Although the JOBS Act eliminates the need to register these securities with the SEC, sponsors would still need to comply with the Blue Sky Laws of the various states and, if the property or the investors were located in New York State, an Offering Plan would have to be accepted by the Attorney General.
It would seem likely that both out of state offerings and in state offerings would file offering plans in New York State, one of a few states which require pre-offering acceptance of an Offering Plan for condo hotels anywhere in the United States and then offer the units and the availability of the rental pool through the internet or other publications throughout the country. As long as all the purchasers are accredited investors, the sponsor would only need to file a Form D with the SEC and comply with the blue sky laws in states in which sales occur.
The change in Regulation D contained in the JOBS Act is likely to increase the sale of real estate securities by smaller promoters because, by eliminating the requirement for a filing with the SEC and allowing advertising, the cost of the offering, as well as the market for the investments is expected to rise exponentially especially in a time of low interest rates.