Do securities regulations cover real estate investments?

Real estate investment opportunities can be structured in many forms. 

For instance, a developer may seek money from a few friends to acquire land and develop a project under an LLC. 

Another example is a real estate investor who creates a fund with a limited partnership structure in which the general partner manages the operation and the limited partners are passive investors. 

Finally, a third and most obvious example of a real estate investment opportunity is quite simply the purchase and sale of property itself. 

In order to determine whether a transaction involves securities, courts usually turn to what is known as the “Howey test,” as well the Securities Act of 1933 and the Exchange Act of 1934. We’ve discussed this before here as relates to virtual currency ICOs.

The Howey test was developed by the US Supreme Court in connection with a Florida citrus investment opportunity to determine whether the transaction involved “investment contracts.” In turn, securities laws include investment contracts within the definition of securities.

Notably, the Supreme Court in Howey addressed the distinction between a pure real estate transaction and an investment contract as follows:

“The respondent companies are offering something more than fee simple interests in land…they are offering an opportunity to contribute money and to share in the profits of a large citrus fruit enterprise.”

To summarize, the Howey test analyzes whether there is a) an investment of money b) in a common enterprise c) with an expectation of profits d) from the efforts of others. 

Thus, for instance, if the LLC in the first example has 3 members, each of whom is also a manager with similar powers and authorities and involvement in the work required to move forward the real estate project, the investment is less likely to meet the “efforts of others” aspect of the Howey test. 

On the other hand, if the LLC is one in which a manager or voting class of member moves the project forward while the other members are only passive investors, the “efforts of others” prong of the Howey test is more clearly applicable. 

Similarly, the LP in the second example is most likely— by its investment fund nature as a structure— a transaction in which the limited partners (investors) have an expectation of profit from the efforts of others (ie, the general partner, a fund manager, an investment committee, etc.). 

The third example- a sale of actual real estate by way of a straight forward fee simple deed transfer— is probably not a securities transaction unless there is more to it, such as a promise of future rental income through a management company, for example, or an accompanying transfer of shares or other equity in an entity.

Whether or not a transaction involves the sales securities and the legal consequences of that determination are complex legal questions that should be reviewed by an experienced securities lawyer. Contact our firm today for a legal consultation on your proposed transaction.