Howey’s test (aka why private money investing 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 to you.

J. Howey was a Florida businessman who sold real estate contracts to finance the development of the citrus groves he owned (a type of sale and leaseback arrangement). Howey was offering people to buy his groves and then rent them out again, so that the buyer would earn his earnings from the rents Howey received from caring for the land.

And that? Who cares? How does this impact you? Keep reading …

The issue the SEC took with J. Howey and his real estate business was how he marketed his investment opportunity. You see, Howey marketed his land sales through promotional materials at resorts in his area. He promised huge profits to those who received the sales presentation expressing interest. Most of Howey’s buyers were not Florida residents and had no agricultural experience.

The SEC (which regulates the securities laws for real estate investors) filed a lawsuit against Howey, in which they requested a court order to prevent Howey from using the mail and other means of “interstate commerce” to offer what they called the sale of property. not exempt and not registered. safety.

The Supreme Court ruled that Howey was offering an “investment contract” as defined by the Securities Act of 1933. As part of this decision, 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 earnings derived from

3.a joint venture

4. that it depends solely on the efforts of a promoter or a third party

What this meant for J. Howey, and for all future real estate investors, was that anytime you are looking for investors, regardless of whether the investor follows the deed or has a mortgage, if the investor trusts you to obtain your profit it is considered that you are selling a security. Howey’s test set the standard for securities laws in raising money for real estate.

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 when teaching real estate investors on how to raise private money, go over the basics of securities laws and how they came to affect us. Honestly, when you focus 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 will be able to play it much better.

You should always have a qualified securities attorney to help you with your private money offers. I have a trusted team of professional advisers and my securities attorney is at the top of the list, and I seek his advice frequently. Never be prudent with a penny or be stupid when it comes to your powerful team of advisors.

*** This information is for educational use only. The content of this article does not constitute legal or tax advice. The author does not provide any legal, tax or professional advice. Before conducting any business transaction, consult the appropriate legal and tax advisor. ***