There are many advantages to forming a commingled real estate investment fund. These include providing a pool of capital to draw upon quickly as competitive opportunities arise and allowing an investor to build a brand as an asset manager. However, in order to enjoy the numerous benefits of managing a real estate fund, it is necessary to have a working knowledge of the complex regulatory environment. Below is a high-level summary of a few fast facts to know about the top ten relevant regulatory areas that impact real estate fund managers.

SECURITIES ACT OF 1933

In order to bring investors into a fund, managers must offer and sell securities of the fund to them. Securities that are offered and sold to investors need to be sold under a registration statement or applicable exemption from registration. A private placement under Rule 506(b) or 506(c) is the most common exemption used by real estate fund sponsors and it permits the sale of securities to an unlimited number of “accredited investors.”

INVESTMENT ADVISERS ACT OF 1940

The fund manager must register as an investment adviser if, for compensation, the manager advises on the purchase and sale of “securities.” The aggregate amount of “securities” must exceed a threshold of $100 million assets under management (or $150 million assets under management for private funds) in order to register federally. The fundamental question is whether the real estate fund manager is providing advice regarding “securities” according to the definition used for these purposes. A fee simple interest in real estate is not a security, but investments in real estate investment trusts or passive minority stakes in real estate companies or joint ventures are likely securities.

INVESTMENT COMPANY ACT OF 1940

All private real estate fund managers will want to avoid registration of their funds as “investment companies.” Inadvertently being defined as an “investment company” is a problem because of the numerous stringent federal requirements that affect nearly every decision that the company will make. There are several exemptions that are typically used to avoid registration as “investment companies.” If the investment company is investing in “non-securities,” including fee-simple interests in real estate, then it will not meet the definition of “investment company.” Second, if there are securities, other exemptions may apply. For example, Section 3(c)(1) provides an exemption for investment funds with no more than 100 investors and Section 3(c)(7) provides an exemption for sales to "qualified purchasers,” a much higher investor qualification standard than that for “accredited investors.”

INTERNAL REVENUE CODE OF 1986

Statutes, regulations, and rules about taxes, including the Internal Revenue Code, are central for private real estate funds and their investors. It is out of the scope of this article to address tax issues other than to emphasize that it is extremely important that a private real estate fund leverages the expertise of its tax advisors for its structure and operations, particularly when tax-exempt or non-US taxpayers are investors.

EMPLOYEE RETIREMENT INCOME SECURITY ACT OF 1974 (ERISA)

If at least 25% of any class of equity in a real estate fund are owned by “Benefit Plan Investors,” then rules under the complex Employee Retirement Income Security Act of 1974 (ERISA) need to be analyzed. If that threshold is met and the fund is not a real estate operating company (REOC), then the manager will need to act as a “fiduciary” to the Benefit Plan Investors whose duties are often incompatible with the manager’s other interests and duties. The 25% calculation needs to exclude any investors with discretionary control with respect to the assets of the real estate fund (such as the manager and its affiliates).

COMMITTEE ON FOREIGN INVESTMENT IN THE UNITED STATES (CFIUS)

Historically, CFIUS primarily had the authority to review transactions in which a foreign investor was investing in a United States business. According to recent enhanced regulations from February 13, 2020, CFIUS has broadened authority to review pure real estate transactions that are within an extended range of United States military training centers, in close proximity to sensitive United States government facilities or other sensitive categories. Some common types of real estate transactions are excluded from CFIUS jurisdiction. If a real estate fund manager has a foreign manager or foreign investors, it may be worthwhile to conduct an appropriate CFIUS analysis.

FOREIGN INVESTMENT IN REAL PROPERTY ACT OF 1980 (FIRPTA) AND DEPARTMENT OF COMMERCE’S BUREAU OF ECONOMIC ANALYSIS (BEA)

Another complication with having Non-US investors invest in a real estate fund results from FIRPTA. Non-US investors investing in real estate funds, which are typically structured as flow-through tax entities (e.g., limited liability companies or limited partnerships), will generally obligate the investors to file US tax returns and follow withholding requirements. However, using an alternative structure such as a private Real Estate Investment Trust for an investment vehicle may be a way to solve for unwanted impacts of FIRPTA. If your fund has foreign investors, you will also need to analyze which BEA form is necessary to be filed to describe the foreign investment in a United States company.

GRAMM-LEACH-BLILEY ACT (GLBA) AND CALIFORNIA CONSUMER PRIVACY ACT OF 2018 (CCPA)

Many real estate finds have already been subject to GLBA, which requires that financial institutions disclose their practices with respect to consumer information and protect that information. The CCPA became effective on January 1, 2020, and, although personal information subject to GLBA is exempt, it adds new complexities to the scope of privacy regulation for real estate funds. For example, GLBA only covers information about existing investors but CCPA would also cover prospective investors. CCPA also provides additional rights to consumers such as the right to request that personal information is deleted and the right to know what specific pieces of information about the consumer have been collected.

ANTI-MONEY LAUNDERING (AML) AND OFFICE OF FOREIGN ASSETS CONTROL (OFAC)

AML laws relate to identifying movement of illegally gained money and OFAC laws relate to blocking transactions with certain specified persons and countries. It is best practice for a real estate fund manager to be aware of these laws and have a compliance program in place to address the most serious AML and OFAC risks to the business.

STATE LAWS

For many of the categories described above, there are also applicable state laws that need analysis. For example, if an investment adviser does not meet the threshold assets under management required for federal registration, they may still need to register as a state investment adviser or meet an applicable exemption. Also, even if an offer and sale of securities meet a federal exemption from registration, the fund manager must still examine applicable state securities laws.

CONCLUSION

It is clear that real estate investment funds operate in a highly complex and fragmented regulatory environment. Although this article has provided a very short summary of relevant regulatory areas that impact real estate fund managers, it has only scratched the surface. Allen Matkins can advise your company on the most important regulatory issues in forming and maintaining a real estate investment fund.