The Arizona Corporation Commission is warning investors that the current real estate market is ripe for a variety of investment opportunities in which people unwittingly buy into unregistered securities. Consumers must also be wary of out-and-out scams.
Even when selling a legitimate product, some promoters do not recognize they have created securities, according to a press release from ACC spokeswoman Rebecca Wilder.
Wilder stated it is not always easy to determine whether a real estate investment is a security. It depends on the unique facts and circumstances of the transaction, not on what a promoter calls an investment product.
The ACC has come up with some basic guidelines to consider before promoting an investment opportunity or signing on the dotted line:
Are you buying an interest in real estate or in an entity that is buying or financing real estate? A promoter may form a corporation, a limited liability company or a limited partnership that will buy real estate or make loans to other purchasers of real estate.
The promoter raises money for the entity to buy or finance the real estate by selling equity interests in the entity. What the promoter is selling to investors is ownership interest in the entity, which is a security.
A promoter also may borrow money from investors to raise capital for the entity. In that case, the promoter is selling promissory notes, which are securities.
Are you buying real estate that you can control? A promoter may "package" real property or loans on real property with service agreements, such as property management, rent or debt collection and foreclosure services.
In this case, the promoter, not the investor, makes decisions regarding the management of the real estate or the real estate loan. If investors are buying a package and lack active control over or management of the property or the loan, they probably are buying an "investment contract," which is a security.
Are you investing in a deed of trust? While commonly called a deed of trust investment, the product the promoter is selling is a promissory note secured by a deed of trust on real estate. Under state law, promissory notes are securities.
The law exempts from registration requirements the sale of a note secured by a mortgage or deed of trust on real estate. However, if the note and deed of trust are packaged with other services that the promoter provides, then the package is likely an investment contract. The contract is not exempt from registration.
Three tri-city-area real estate professionals weighed in on the advice from the ACC.
"The amount of people affected by this is very remote," said Brian Biggs, co-broker with wife Nancy of Prudential Northern Arizona Real Estate in the Prescott Country Club. "There might be a handful of people that form small companies. They get together to purchase real estate to either rent or resell it. If you are buying shares in a company that does that, you are buying securities. If you are actually a member of that LLC or corporation, you are buying real estate."
Real estate investors need to engage in due diligence, said Allan Woodruff, director of the Prescott chapter of the Arizona Real Estate Investors Association.
"That means all the research, whether it is a financial interest or a piece of property," Woodruff said.
Woodruff, associate broker with Valentine Sales and Management in Prescott, advises investors to understand what they are investing in and know the parties involved. He also urges them to set a long-term strategy, and understand the risks and rewards of any investment.
Lenders also have recourse against a borrower if the borrower does not fulfill his or her obligations pursuant to the promissory note, according to Kim Horn, broker/owner of Nextage Southwest Premier Realty in Prescott.
That recourse is to foreclose on the deed of trust, gain possession of the real estate and then sell it, Horn stated. She is the past president of the Prescott Area Association of Realtors.
Wilder advises investors to verify the license status of the product and promoter by contacting the ACC's securities division at (602) 542-4242. The toll-free number is (866) 837-4399.