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How Securities Apply to Real Estate Investments

Instructor: Ian Lord

Ian has an MBA and is a real estate investor, former health professions educator, and Air Force veteran.

Real estate agents may come across investments that qualify as securities in their business dealings. Let's look at what a security is for the purposes of real estate and the laws that cover securities.

Security Definition

Bill is a real estate agent. He's been looking to grow his investment business beyond just buying and renting out properties. He would like to offer investments to others so that he can raise money to make more deals. In doing so he is branching out into the securities industry. Let's look at what a security is and the laws that apply to securities that affect this plan.

A security is a type of financial instrument. It can represent a share of stock ownership in a company or a creditor relationship as with a bond. Some types of real estate investments are classified as securities. A security must be registered with the Securities Exchange Commission (SEC), a US government regulatory agency. This isn't usually a concern for an investor who buys and sells individual properties. Bill can use securities such as real estate investment trust (REIT) shares to raise business funds. Let's look at the characteristics of a REIT, which will demonstrate some of the special attributes of securities.

Real Estate Investment Trusts

A real estate investment trust is a popular option for investing in real estate through securities. A REIT can collect a portfolio of properties to manage and share the profits with shareholders. It may also purchase mortgages on the secondary market and collect the underlying principal and interest payments each month. Bill could offer shares in the REIT and pool the money together to buy either option, or a combination of them. The profits would then be distributed to the shareholders based on the number of shares they own. A REIT allows shareholders to profit from real estate investing without the risk of owning a single property or the job of being a landlord. Shareholders can buy and sell shares in REITs in the same way they would purchase a share of corporate stock on one of the major exchanges.

Security Law in Real Estate

The Securities Act of 1933 is the source federal law that requires registration with the SEC. It came about following the Great Depression to expand upon previous state laws that sought to ensure full disclosure of information to prospective investors. The law affects the sale of securities across state lines, which is easy to do with the advent of telephone and Internet. This law also makes failure to comply a federal offense.

Various states previously enacted what are known as blue sky laws. The name comes from the notion that an investor might buy a fraudulent investment that has as much worth as a blue sky. In other words, worthless, financially speaking. The laws require Bill to register his investment offering and provide detailed information of his plan to the SEC. This allows prospective investors to review vetted details of this investment and make an informed decision.

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