The Howey Test (Otherwise Known As Why Private Money Investing Involves the SEC)
Have you ever heard of the the ‘Howey’ test?
If you want to raise money from private investors to fund real estate investments, you should know what the Howey test is and what it means to you.
J. Howey was a Florida entrepreneur who was selling real estate contracts to finance the development of citrus groves that he owned (a sale-leaseback type of deal). Howey was offering people to buy his groves and then he would lease them back – so the buyer would earn their returns from rents received for Howey tending the land.
So what? Who cares? How does this impact you? Read on…
The issue that the SEC took with J. Howey and his real estate deal was how he was marketing his investment opportunity. You see, Howey marketed his land sales via promotional materials at the tourist resorts in his area. He promised large profits to those who received the sales presentation by expressing interest. Most of Howey’s buyers were neither residents of Florida nor experienced in farming or agriculture.
The SEC (which regulates securities laws for real estate investors) filed a lawsuit against Howey, where they sought an injunction to stop Howey from using mail and other means of “interstate commerce” in offering what they called the sale of non-exempt, unregistered security.
The Supreme Court ruled that Howey was offering an “investment contract” as defined by the Securities Act of 1933. As a part of this ruling, the Supreme Court developed a test to see whether 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 profits arising from
3. a common enterprise
4. which depends solely on the efforts of a promoter or third party
What this meant for J. Howey, and for all real estate investors in the future, was that anytime you’re searching for investors, no matter if the investor goes on the deed or has a mortgage, if the investor is relying on you to make their profits you are considered to be selling a security. The Howey Test set the standard for securities laws in raising money for real estate investments.
Since you’re selling a security when you raise private money, you must comply with the securities laws.
I’ve found it helpful when raising private money, as well as when I teach real estate investors about raising private money, to go through the basics of securities laws and how they came to effect us. Honestly, when you’re focused on your financial goals (and real estate investing as your vehicle to achieve them), nothing should deter you – especially regulations. Once you know the rules of the game, you can play it much better.
You should always have a qualified securities lawyer help you with your private money offerings. I have a trusted team of professional advisors and my securities lawyer is at the top of the list – and I seek their counsel often. Never be penny wise and pound foolish when it comes to your power team of advisors.
***This information is intended for educational purposes only. The contents of this article does not constitute legal or tax advice. The author is not rendering any legal, tax or professional advice. Before conducting any business transaction, please consult proper legal and tax counsel.***