Orchestras don’t survive on ticket sales. They also rely (and some primarily rely) upon grants and donations to pay their bills.

Because of this, during the pandemic, professional orchestras struggled financially. With public gatherings prohibited, ticket sales plummeted. Orchestras hoped donors would step up to the plate to keep them afloat. But based on the New York Philharmonic's experience, that revenue source also fell short.

The Philharmonic’s annual gala concert, a major fundraiser, was forced to go virtual. With no caterers, florists, or servers to pay, the virtual gala cost less than the traditional live galas. And the virtual gala reached 90,000 people compared to a maximum audience of 2,700 at the gala concert. Yet, the virtual gala raised only $1.1 Million – less than a third of the $3.6 Million raised the year before the pandemic.

Many orchestras sold subscriptions to stream old and sometimes new concerts. However, revenue from subscriptions failed to

During the pandemic, performing arts found it challenging to obtain donations from even their most loyal patrons. Faced with seemingly more pressing needs, such as hunger and racial justice, and a lagging economy, donors were stretched thin.

Interestingly, the pandemic didn’t bring about the same challenges in commercial real estate. Although mortgage loan processing slowed as employees transitioned to remote work, there was no shortage of mortgage funds.

Since mortgage lenders still wouldn't loan 100% of the purchase price, sponsors continued to need equity investors. Some sponsors continued to obtain private equity to co-invest with them, but many continued to use real estate funds to provide at least part of the equity. This article discusses the types of securities offerings real estate funds used and how that changed during the pandemic according to the Securities and Exchange Commission (SEC) data.

Securities Law Exemptions for Real Estate Funds

Under the Securities Act of 1933 (1933 Act), all securities offerings must be registered with the SEC unless there is an exemption. Registering securities is a costly and time-consuming process requiring SEC review and approval. So most real estate funds offer securities under an exemption and sell securities without SEC review.

Most real estate securities use the private placement exemption under Rule 506(b) of Regulation D (Reg D), adopted under Section 4(2) of the 1933 Act. Because Section 4(2) is a private placement exemption, Rule 506(b) prohibits general advertising and general solicitation of investors. A benefit of Rule 506(b) offerings is there is no requirement that the offering qualify under state securities laws.

Several years ago, the SEC adopted Rule 506(c) to Reg D, which gradually is becoming popular with real estate funds. Like Rule 506(b) offerings, Rule 506(c) offerings need not qualify under state securities laws. Unlike Rule 506(b) offerings, Rule 506(c) offerings may be publicly advertised. However, Rule 506(c) offerings may be sold only to accredited investors who meet net worth, asset, or income requirements. And, unlike Rule 506(b), Rule 506(c) does not allow investors to self-certify their accredited status. So, 506(c) offerings require more scrutiny into investors’ financial situations than Rule 506(b) offerings.

Also, part of Reg D, Rule 504 allows a company to raise up to $10 Million in a 12-month period. However, unlike Rule 506 offerings, Rule 504 offerings must qualify under state securities laws, which increases costs and the time to get the offering to the market. As a result, real estate funds rarely rely upon Rule 504 for their offerings.

Regulation CF (Reg CF), which allows equity crowdfunding, is another fairly new exemption. Reg CF can be used only to raise equity for operating companies, so it can’t be used for a blind real estate fund. And Reg CF offerings must be sold only through an authorized investor portal. Like Rule 504, Reg CF limits how much the issuer can raise. During the pandemic, the limit was increased from $1 million to $5 million in a 12-month period, which makes it more likely that real estate investments might raise funds using Reg CF. Also, dollar limits on individual Reg CF investments were relaxed, so there is no limit on how much an accredited investor can invest under Reg CF.

Rather than being an exemption from registration, Regulation A (Reg A) is better thought of as offering a less burdensome registration process. Sometimes called "mini-IPOs," Reg A provides two tiers of offerings under which companies can raise up to $75 Million in a 12-month period. Since Reg A offerings require SEC review, they generally take longer and cost more than Rule 506 offerings. Reg A also limits how much unaccredited investors may invest to the greater of 10% of the investor’s net worth or annual income.

Small Business Capital Formation Advocate’s Report

In December, the SEC Small Business Capital Formation Advisory Committee (SBCF) issued its 2021 Annual Report (2021 Report), which provided data on how small businesses raised capital in the midst of the pandemic from July 1, 2020 through June 30, 2021. Although the focus is on small businesses generally, real estate businesses are included in the report.

According to the 2021 Report, Rule 506(b) remains the overwhelming choice for capital raises among small businesses, with a total offering of $1.9 Trillion from July 1, 2020 to July 30, 2021 and a median raise of $1.8 Million. Aggregate Rule 506(b) offerings even edged out public offerings, which totaled $1.7 Trillian, despite a median raise of $350 Million for public offerings.

The next most popular exemption, Rule 506(c), was used to raise only $124 Billion in the same period, with a median raise of only $850,000. The remaining options lagged far behind with $1.7 Billion, $755 Million, and $313 million for Reg A, Rule 504, and Regulation CF, respectively.

In the real estate industry, the top three pathways to raise capital (excluding pooled funds) were through public offerings ($97 Billion), Regulation D ($45 Billion), and Regulation A ($755 Million). The real estate industry had more Reg D offerings than any other industry. While real estate Reg D offerings increased from 2020 to 2021, Reg D offerings in other industries, including technology, banking, and financial services, and even healthcare, decreased.

Plus, although Reg A real estate offerings decreased (from $923 Million to $755 Million) from the previous year, real estate continued to dominate the Reg A marketplace. Unlike with Reg D offerings, however, Reg A offerings in the technology, banking and financial services, and healthcare industries increased from 2020 to 2021. Those same three industries experienced significant increases in IPOs from 2020 to 2021, possibly explaining why the Reg D offerings decreased.

Why Rule 506(b) Offerings Still Dominate in Real Estate

Although Rule 506(b) offerings can’t be advertised, they enable an issuer to raise an unlimited amount of money at a reasonable cost without SEC review or reporting. Typically, there are only costs associated with the private placement memorandum and notice filing requirements for Rule 506(b) offerings.

Rule 506(c) offerings also are among the least expensive. But there’s a trade-off. Although Rule 506(c) offerings can be advertised, they can be sold only to accredited investors. And the verification process, while not difficult, can add to costs and may discourage investors who wish to keep their financial situation private. Reg A offerings provide an even greater regulatory burden and higher costs for real estate sponsors, explaining their third-place finish.

Established sponsors with existing investor relationships that need not advertise may favor Rule 506(b) offerings. But 506(c) offerings provide an opportunity for less-established sponsors to build a base of accredited investors through advertising.

This series draws from Elizabeth Whitman’s background in and passion for classical music to illustrate creative solutions for legal challenges experienced by businesses and real estate investors.