The Howey Test (aka Why Investing Private Money Involves the SEC)
Have you ever heard of the ‘Howey’ test?
If you want to raise money from private investors to finance real estate investments, you need to know what the Howey test is and what it means for you.
J. Howey was a Florida businessman who sold real estate contracts to finance the development of citrus groves he owned (a type of lease-back sale arrangement). Howey was offering people to buy the groves from him and then lease them back, so that the buyer would make his profit from the rents Howey received from tending the land.
And? Who cares? How does this impact you? she keeps reading…
The issue the SEC took with J. Howey and his real estate business was how he was marketing his investment opportunity. You see, Howey marketed his land sales through promotional materials at resorts in his area. He promised big profits to those who received the sales presentation expressing interest. Most of Howey’s buyers were not Florida residents or had farming or farming experience.
The SEC (which regulates securities laws for real estate investors) filed a lawsuit against Howey, seeking an injunction to prevent Howey from using the mail and other means of “interstate commerce” to offer what they called the sale of non-exempt and unregistered assets. security.
The Supreme Court ruled that Howey was offering an “investment contract” as defined by the Securities Act of 1933. As part of this ruling, the Supreme Court developed a test to see if an opportunity constitutes an “investment contract.” This test was called the “Howey Test”.
An investment contract under the Howey Test was defined as follows:
1. an investment of money due to
2. an expectation of gains derived from
3. a common company
4. Relies solely on the efforts of a promoter or a third party
What this meant to J. Howey, and to all future real estate investors, was that whenever you’re looking for investors, whether the investor signs the deed or has a mortgage, if the investor trusts you to earn your profit, you are considered to be selling a security. Howey’s test set the standard for securities laws in raising money for real estate investments.
Since you are selling a security when you raise private money, you must comply with securities laws.
I have found it useful when raising private money as well as teaching real estate investors how to raise private money, going over the basics of securities laws and how they came to affect us. Honestly, when you’re focused on your financial goals (and real estate investing as a vehicle to achieve them), nothing should deter you, especially regulations. Once you know the rules of the game, you can play the game much better.
You should always have a qualified securities attorney assist you with your private money offerings. I have a trusted team of professional advisors and my securities attorney is at the top of the list, and I seek his advice frequently. Never be wise or foolish when it comes to your powerful team of advisors.
***This information is for educational uses only. The content of this article does not constitute legal or tax advice. The author is not providing any type of legal, tax or professional advice. Before entering into any business transaction, please consult the appropriate legal and tax advisor.***