Air Date: 09.08.2020
The SEC recently adopted amendments to the “accredited investor” definition, one of the principal tests for determining who is eligible to participate in private capital markets, and today’s guest, Kim Lisa Taylor, is just the person to explain them. Kim is a nationally recognized corporate securities attorney, speaker, and author of the number one Amazon bestselling book, How to Legally Raise Private Money. She’s is also the founder of Syndication Attorneys, PLLC, and investormarketingmaterials.com. Its purpose is to provide quality legal advice, offering documents and professionally designed marketing materials for clients nationwide. Kim has been a responsible attorney for hundreds of security offerings and she routinely teaches subjects related to legally raising private money in front of groups, ranging between 50-1000 plus attendees. In this episode, Kim explains the SEC’s new accredited investor guidelines, who is eligible, and what the requirements are, so make sure to tune in today!
Key Points From This Episode:
- Kim explains the definitions of an accredited investor and how the definitions for retail investors specifically have changed.
- Very few people that have certain securities licenses have been excluded, says Kim.
- Other categories that pertain to retail investors – knowledgable employee of a private fund, and spousal equivalent.
- The spousal equivalent is an attempt to make it more inclusive for previously excluded groups.
- While you needn’t be married to be eligible, you still have to meet the net worth requirement.
- Kim explains how definitions have changed for non-retail and quasi-institutional investors.
- The third category is charitable organizations, where their assets exceed $5 million.
- New additions include SEC or state registered investment advisors, rural business investment companies, and foreign-organized entities.
- An additional qualifier is family offices with at least $5 million in assets under management.
- These rules are not in effect yet – they need to be published in the federal register and cure.
- Kim explains the necessary requirements for Regulation D Rule 506(c) and 506(b) offerings.
- There is a lot of value in employing an attorney to help you read between the lines.
- Kim thinks an accredited investors test or a more formalized program would be a great idea.
- The way Kim suggests that investors get accredited is they attend the same training classes the syndicators they are investing with do.
- You must understand the distribution waterfall, otherwise Kim would be cautious of the deal.
“How do you market on that? How do you make that marketable for your offering? I think you need to inform people that, hey, you don’t have to be married in order to do this if you have a spousal equivalent. You can now pool your resources and still qualify as an accredited investor as long as you meet this net worth or this income test.” — @KimLisaTaylor1 [0:10:37]
“Maybe not every lawyer is qualified to be able to understand the merits and risks, but certainly, a lawyer like myself or other corporate attorneys or business attorneys that have that kind of direct knowledge, why wouldn’t it be open to them? And why not just CPAs that do business tax returns? They are certainly savvy to all of that stuff.” — @KimLisaTaylor1 [0:17:47]
“The ways that I suggest that investors get educated, and I have seen a lot of investors educating themselves this way, is they attend the same kind of training classes that the syndicators they are investing with are going through.” — @KimLisaTaylor1 [0:23:10]
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—Full Transcript Below—
“There were comments that said hey, why isn’t it open to people with MBA’s? Why isn’t it open to finance professionals? Maybe not every lawyer is qualified to be able to understand the merits and the risks but certainly, a lawyer like myself or other corporate attorneys or business attorneys that have that kind of direct knowledge, why wouldn’t it be open to them?”
Welcome to Ritter on Real Estate, the show about how to passively invest like a pro. On each episode, I interview real estate experts who give their top investing advice, strategies, and tools that break down the insights and the practical steps to avoid the pitfalls and make better investments. I want to help you passively invest like a pro. This is Ritter on Real Estate, and I’m your host, Kent Ritter.
[0:00:42.9] KR: Hello fellow investors, welcome to Ritter on Real Estate where we teach you how to passively invest like a pro. Today we’ve got a returning guest, welcome Kim Lisa Taylor, she is a nationally recognized corporate securities attorney, speaker, and the author of the number one Amazon bestselling book, How to Legally Raise Private Money.
She’s the founder of Syndication Attorneys, PLLC, and investormarketingmaterials.com. Its purpose is to provide quality legal advice, offering documents and professionally designed marketing materials for clients nationwide. Kim has been a responsible attorney for hundreds of security offerings and she routinely teaches subjects related to legally raising private money in front of groups ranging from 50 to a 1000 plus attendees.
Kim, thank you very much for joining us back on the show today. We have a – Yeah, absolutely. We have a special episode today, very timely in the news, you know, I saw that the SEC has amended the definition of an accredited investor, and I thought that there would be no one better to explain to us what exactly happened than Kim.
Who spends her life as we said, working with the SEC and working with investors and making sure that we are all staying compliant and staying within the lines. With that Kim, I know that you’ve written an article on the topic and I wanted to just do that, just get your thoughts.
First maybe explain to us, again, because I think there’s a lot of folks that it’s still may not understand exactly what is an accredited investor and what does that mean historically? And then, how has it changed? What does this mean for us?
[0:02:24.4] KLT: Sure, there’s kind of two categories of the accredited investor definition. Actually, originally, there were eight definitions of an accredited investor, and two of them pertained to the individual investors, which the SEC refers to as retail investors. Retail investors are your individual, someone that you know, your friends, your family, acquaintances that are investing either their savings or self-directed IRAs, those are the people that we’re referring to when we say retail investors versus the other types of investors are people who are investing through a trust or maybe their own fund. Maybe some kind of a bank or institutional investor, that’s kind of the other category is retail investors versus institutional investors.Family offices, investment banks, employee benefit plans, those kinds of things.
I think it’s helpful for your audience if we can break it out on those two categories because most of our clients are dealing with the retail investors. We do have some clients that have kind of graduated from just having retail investors in their deals and are now starting to do some joint ventures, or preferred equity with some of these other institutional or quasi-institutional investors. The original definition included any natural person who had individual net worth or joint net worth with the person’s spouse that exceeded a million dollars, okay? And that excludes any equity in their primary residence and any indebtedness that was incurred within 60 days prior to the investment. The reason for that 60 day thing is because people used to actually borrow money and then use it to invest, and they don’t want people t do that anymore, they wanted to make sure they weren’t doing that.
The other definition that pertains to natural persons is any natural person who has $200,000 a year income individually, or 300,000 if they’re married, and it has to be for the last two years within expectation it’s going to continue into this current year. Another definition is any entity in which all of the equity owners are accredited investors. So somebody has an LLC and there’s two or three people in it, as long as all three of them are accredited investors, then that would qualify us in accredited investor, and then also, there’s a category that pertains to the people in management of that syndicate.
It’s any director, executive officer, general partner of the issuer of the securities, that is involved in the management. They are by definition, considered an accredited investor, so that just means that if you’re the syndicator, you’re a member of the management team in a syndicate, you don’t have to qualify by means of these financial tests. You just have to qualify just by virtue of your role in management. That’s kind of the private individuals, retail investors definition that we’ve had up until now.
This new amended definition added a couple of things that could be helpful but only marginally., okay? I don’t think that the SEC went quite far enough and what happens is they put out these proposed roles, and then they solicit comments for at least 90 days, and they get a lot of comments from other lawyers, individuals, big investors, but also from FINRA, who is kind of broker dealer registration group that oversees the registration and regulation of brokerage dealers. They always try to block anything that’s going to open up investing to ordinary people that don’t have to go through them, because they have a vested interest in protecting the livelihoods of tier constituents.
The SEC get a lot of weight to all of those questions, and you can actually read all of the comments that they got, and we have this article, we’ll give you a link to that a little bit, but in that article, there is a link to thee actual final rule, which is 166 pages long, that does the analysis of here was the proposed rule, here are all the comments we got, and here’s what the final rule is going to be.
And then also, there will be a synopsis that the SEC created a press release and sent out a synopsis of what the final rule was and that link will be there as well. Anyway, what is new, what’s been included? They’ve added a category for a natural person with series 765 or 882 securities licensees. You know, the question I ask all of my clients when I’m talking to them about this is okay, how many of those people do you know? And I always get dead silence.
[0:06:59.5] KR: Probably not very many people.
[0:07:01.5] KLT: No, it really isn’t that many people, so unless you just happen to know people in the securities worlds that happen to have one of those licenses, and also, they’ve excluded some of the other licenses like a series 22 that could have been even more inclusive. If you know people that have those kinds of licenses, and the other question is, are they really going to invest with you? Because they’re probably already exposed to a whole lot of securities and then you’ve got to convince them that your deal is worth it.
The one thing that’s interesting though is that the SEC did reserve the ability to add new categories who hold certain professional designations or certifications. They can do that by order so they don’t have to actually go back and go through the rule making process and the public comment period and all that, they could just decide, hey, we’re just going to open it up to this, and add it. They’re looking for people if they do that, expanded definition, which we really hope they will. That could be big because then they could include people like lawyers, CPAs, finance professionals, people who should have the ability to be able to evaluate the risks and merits of an offering on their own.
Anyway, right now, doctors, lawyers, CPA’s, finance professionals, sorry, we didn’t make it but certain securities and registrations did, that’s one category. There’s two more categories that they added that pertain to the retail investors. One is a knowledgeable employee of a private fund. We had already the definition that included the director, executive officer, general partner, so people are actually in management but now, if your syndicate employs people as employees, then they could become a knowledgeable employee of a private fund, and they would be able to also invest in the fund. That’s how –
[0:08:49.5] KR: That’s nice, it’s like the people actually working on the deal can now actually invest in the deal?
[0:08:54.1] KLT: Right. Without having to be an executive officer, general partner, or management. And then the third category, and perhaps this one will be helpful, is spousal equivalent, okay? Maybe that one hasn’t gotten quite enough press, but I do think it’s great and it’s important that we embrace the inclusivity that, hey, not everybody is going to go through the juridical marriage process, and there are certainly other people that are combining their finances for every other thing under the sun, why shouldn’t they be allowed to combine their resources to invest in this? I think that’s a good thing.
[0:09:28.7] KR: What is spousal equivalent, how is that different for what they said before where yo have your joint income?
[0:09:35.9] KLT: Well, because you had to actually be married before. So now, they’ve opened it up to people who are not actually married, maybe because of some regulation that prevents them or they’re just cohabitating or, you know, whatever. They consider to be a spousal equivalence and if you want to dive deep into that then read the final rule and there’s a discussion in that final rule about what that includes and what it doesn’t include.
I think the attempt to make it inclusive for perhaps what used to be an excluded group and perhaps unfairly. I think they call off the dual income no kids, they’re called DINKS. First spousal equivalent be you know, you have two incomes, they don’t have kids, they’ve got plenty of disposable income, let them go ahead and pull their resources to qualify as the present investor.
[0:10:20.4] KR: Got you, is it that they have to meet those same requirements though as what would have previously been a married couple have either, their income –
[0:10:27.4] KLT: The income or the net worth requirement, right. But they don’t have to be married in order to demonstrate they’re eligible. That could be helpful. I think that one might be helpful, the thing is, how do you market on that? How do you make that marketable for your offering? Well, I think you need to inform people that, hey, you don’t have to be married in order to do this if you have a spousal equivalent. You can now pool your resources and still qualify as an accredited investor as long as you meet this net worth or this income test.
[0:10:53.8] KR: Got you, that is interesting.
[0:10:56.1] KLT: Yeah, I thought that was pretty good and I liked that. Now, for the non-retail and quasi institutional investors, the previous definition included a bank, insurance company, registered investment companies, that securities broker dealers, a couple of other categories but companies that are registered that have said hey, we are an investment company and that’s what we do, and so they’ve always been allowed to be qualified as accredited investors.
There’s another unemployed benefit plan, so if you had a company that has an employee benefit plan and it’s making the investments on behalf of its member, then that could work but you still have to have a bank insurance company or registered investment advisor, making the investment decisions on behalf of that plan. Or, if the plan has over $5 million in assets. It’s one or the other, so, it has to be an employee benefit plan, either has to have some registered investment advisor or advisor to that plan making the investment decisions, or it has to have over $5 million in assets.
Charitable organizations is the third category that’s always been there, charitable organization corporation or partnership, if the assets of that entity exceed $5 million, a business in which all of the equity owners are credited investors, and a trust with assets in excess of $5 million. Your family trust or family office or something like that could probably have always qualified underneath that if had a trust as its entity, and as long as the trust was not formed specifically to acquire those interests.
That’s the old definition. Let’s see what’s been added. Okay, all that stuff is still there. Now we’ve just got some new additions to that. So there was clarification that any LLC with $5 million in assets can be accredited investors, and then also there are some other categories that were added. So any kind of an SEC or state registered investment advisor, or anybody who holds themselves out to be an investment advisor, and then there’s something else that’s called a rural business investment company that is another entity that can still qualify. There’s a new category for any entity including Indian tribes, governmental bodies, funds and entities, organized under the laws of foreign countries that own investments in excess of $5 million.
Not foreign for the specific purpose of investing so you know, I mean, there could be some opportunities there to reach out to some of these other groups and you probably have to do some digging to find out who they are, and then once you do, you could potentially do a targeted marketing campaign to them, where you would explain to them what kind of things your company is investing in, and find out if that might be something that they would now be interested in investing in.
Then the third category that they added for the non-retail investors is the family offices with at least $5 million in assets under management. That’s the other category. I think the family offices was probably always there but now perhaps they don’t have to have the $5 million in assets before they’re able to invest if they’re holding themselves out as family office.
[0:14:06.6] KR: Maybe this was from the initial piece of the old rule or some of the initial comments on this one, but wasn’t there an idea at one point that if you were being advised by someone that had a certain financial advisor or something that you might be able to invest in these types of investments? And it sounds like that just didn’t make it through?
[0:14:25.4] KLT: So what you are thinking of is a sophisticated investor. So if you are doing a Reg D Rule 506(c) offering, then each investor would have to meet one of these definitions of an accredited investor. Now just a caveat that these rules are not in effect yet, okay? They still have to be published for a 60 day period in the federal register before they take effect. So it is usually a lag time of a week or two before they get into the federal register, then they are going to have to cure for 60 days, and then they’ll take effect.
So we’re looking at some time before the end of the year these will be effective, and then you will be able to start using them. So if we are going to do a 506(c) offering, the retail or non-retail investor would have to provide some kind of verification that they meet one of these tests. If you are going to do a Regulation D Rule 506(b) offering, then you are allowed to include unlimited accredited investors, an unlimited number of accredited investors and they don’t have to be verified they can self-certify. So they can say that, yes, I do need this, and you don’t have to do any kind of further inquiry unless you have a reason to believe that it is untrue.
Then in that case, you would be obligated to either further inquire or deny them, but in 506(b), you can also include up to 35 non-accredited but sophisticated investors and sophisticated means people who are by means of their education, financial background, or investing experience have the ability to understand the merits and risks of the offering, either by themselves, or with the help of their investment advisor.
So I think that is probably what you were referring to is that somebody who is not accredited if they have a financial adviser that looks at the offering and says, “This is good for your portfolio, yes, you should do it,” they would actually have to complete the subscription agreement on behalf of that investor as the one who is making the decisions, and that person cannot be connected to your offering. So you can’t hire an investor or advisor to look at that stuff for them. It has to be somebody they’ve employed on their own.
[0:16:32.2] KR: Right, okay. I think that is helpful to understand. So the rule has been amended. It’s been expanded. It sounds like there is some more inclusivity and the folks that can now invest in these types of private deals.
Is this the tip of the iceberg? Is this them opening up to continued expansion or was this kind of moving the mountain and now we’re there? What’s your thought?
[0:16:54.6] KLT: Yeah, I think that the SEC got a lot of resistance. There was certainly a proposal to include these certain professional and certain certifications and designations beyond just securities licenses in the original proposal, but I think that there is a lot of resistance and push back. So the SCC just said, you know, in the interest in getting this passed right now, let’s just go ahead and pass what’s acceptable to the majority and then what interest proposing.
And well, a proponent of and at least get that through and then they reserved the right that by order they could add other people as they saw fit. So I think that there is probably going to be some continuing pressure to make that group a little bit more inclusive. Honestly there were comments that said, “Hey, why isn’t it open to people with MBA’s? Why isn’t it open to finance professionals?”
Maybe not every lawyer is qualified to be able to understand the merits and risks, but certainly, a lawyer like myself or other corporate attorneys or business attorneys that have that kind of direct knowledge, why wouldn’t it be open to them? And why not just CPA’s that do business tax returns? They are certainly savvy to all of that stuff so.
[0:18:06.1] KR: Right and a lot of it probably like most things comes down as you said there is some lobbying involved, right?
[0:18:11.8] KLT: Yeah, I think there is some lobbying.
[0:18:13.7] KR: There’s a lot of organizations that have an incentive not to have folks invest in private deals and continue to invest and deal in ways of investing.
[0:18:21.2] KLT: I mean there is a lot of value in those organizations. You know I’m not trying to discount the value of those organizations. They are designed to protect investors from the unscrupulous people who would otherwise take the money and run with it, and they are designed to help and prevent fraud in these kinds of offerings, because when you do use a federal licensed professional or registered investment adviser, then they are going to be trained to look at these offering, and to help you sort out whether it is appropriate for your portfolio.
It really doesn’t matter if you’re credited or you’re not accredited but trying to qualify as sophisticated, now maybe you are too busy, maybe this isn’t your thing. You don’t like looking at this kind of stuff. You are the operations guy. If you have somebody that can help you look at those things and help you determine if it is an appropriate investment or if there is any red flags early that you might not notice, then why not do that?
I mean, we reviewed offering documents on behalf of clients before, and what we typically do is look to see if they are following securities laws. Do we understand the deal, does it make sense to us? Because I have seen some deals that the lot are follow 16 steps long and it is incomprehensible and I see a lot of documents and a lot of big old firms that are very hard to decipher and understand and there is a lot of cross referencing and a lot of unique terminology.
It becomes very difficult for an ordinary person to really understand what they are getting into. So sometimes it’s helpful if you employ an attorney to help you sort out what it all means and read between the lines.
[0:19:54.4] KR: Yeah, I absolutely agree with that. I mean some investments, they are very complex and the documents that come with them are very complex, and so there is absolutely a need to be able to understand what you’re getting into, right? And that is essentially what these roles are about is trying to set barriers to protect people from bad actors, from folks that would be committing fraud, or unfavorable deals, and they can be too complicated to really understand what you are getting into.
[0:20:19.4] KLT: Well yeah, and sometimes I feel like it is intentionally made so complicated that the only people that can interpret it are the attorneys that drafted the documents, which is unfortunate, because if there is a read dispute then all of a sudden this becomes much more expensive to try to sort it out, because you’ve got these various interpretations and it is very complex. You know our firm prides itself on writing documents in plain English that both our clients and their investors understand.
We’ve gotten a lot of compliments from our clients and investors saying, “Hey, you know I have read a bunch of these and this is the first one I really understood.” We took great pains to really look at these clauses, like, what are we really trying to say here? Let’s just rewrite this the way that makes sense.
[0:21:01.2] KR: Right, there is legal ease. Now I think that is a fantastic service because, yeah, most of them are extremely complicated, it makes it difficult for those investors to understand and any investment you want to be there confident what you’re getting into.
[0:21:13.4] KLT: Well but it is not just the investors, it is also the syndicator themselves. If they don’t understand what the attorney has written for them, how are they possibly going to comply with it? They are always going to have to go back to that attorney and interpret every time they want to make a distribution, or pay themselves a fee, or do something different. So that can become costly and maybe it’s been a loss for the documents up front, but more for the documents in the end, you know?
[0:21:36.8] KR: Yeah that is securing your revenue stream right there.
[0:21:38.8] KLT: That’s right.
[0:21:39.9] KR: This is great. I think I appreciate your interpretation, some of the history around what went into it, and the different comments and guidelines. I mean it is a balance for me. I believe that some of these private investments are way better than deals and investments you can get publicly, you know? So there are great ones out there and it is an opportunity to build wealth in a way that can far exceed your typical gains you can get from stock market.
But there are a lot of risks, and there are bad actors out there, and there are folks that are doing bad deals. So I get the balance. Do you ever see it opening up further? Do you ever see there being, like, a test, where you could take a test and qualify as someone who understands these deals? Do you ever think it could go that far? How would you see it expanding further or it just kind of meant to be?
[0:22:23.3] KLT: Yeah, I haven’t ever contemplated that before but certainly I think that was the point that’s been run and the commenters that were proponents of these securities licenses getting included in this expanded definition I think that was the point, that these people have gone through that training and that process of understanding investments, so therefore, they should be allowed.
You know, would it make sense to have an accredited investor test, where you have to go through some kind of a more formalized training program so you can get to know and understand what’s a PPM, what’s an operating agreement, what’s a subscription agreement, how does it work, or how does this different from a public versus a private? Okay, I think that is a fantastic idea. Is [inaudible 0:23:04] likely to come up with something like that, who knows? It would be a great idea if they did. Are there other ways that somebody could do that?
The ways that I suggest that investors get educated, and I have seen a lot of investors educating themselves this way, is they attend the same kind of training classes that the syndicators they are investing with are going through. If you are learning the same thing that the syndicators are learning, then you are learning how they underwrite deals, and how they conduct due diligence, and what deals makes sense and don’t make sense, and what the documents are and what they mean.
So you know right now, in the absence of any formalized training to become an accredited investor I think that is probably the best course for people. Follow any of the real estate trainers that are out there that are teaching people how to buy the asset class that you are interested in investing in, and just get to know it that way, and in the same time, you’re going to need a lot of other people that are in those training courses who are actually finding the deals and putting the groups together.
[0:23:59.8] KR: Yeah, I 100% agree. I think that that’s kind of the general theme throughout the shows is, as even a passive investor, you have to educate yourself and you have to be just as educated as you said as the syndicators because you need to understand the deals. No one should enter a deal blindly that they don’t understand the mechanics behind, and how the underwriting was done, and how the returns will be paid, right? So I completely agree with you.
[0:24:25.4] KLT: Well, that, and you have to understand the distribution waterfall you know? If it doesn’t make sense to you or it seems too complicated and you don’t get it, then I would be cautious of investing in that deal. We try to get our clients to write fairly simplistic distribution waterfalls because we know that that’s easily marketable. The more complex it gets, the less marketable it becomes and because investors aren’t going to look at it, they don’t understand it, they’re going to say no.
So just make sure and we do have an article on our website at syndicationattorneys.com. It is called 10 Things Investors Should Know Before Investing in a Syndicate. So, that’s one that just gives you some questions you should be asking and things to look for if you are doing your own self-review of the documents. There is also a chapter in my book, I have a number one Amazon bestselling book called, How to Legally Raise Private Money, and there’s a chapter that is devoted to investors.
So that is another way to learn, you know read that book, because that is really educating the syndicators on how to legally raise the money, so you are going to be able to – if you read the book, understand whether they did it right or they didn’t and know what questions to ask. So I would recommend that. As far as this article on the amendments to the accredited investor definition that is available on our website. If you go to syndicationattorneys.com, then to the library, then select articles. There is about 40 different articles in there, but this one is called Accredited Investor Definition Expanded, and that’s the name that you will see on that article.
[0:25:55.8] KR: Great and I have actually read Kim’s book, so I can attest that it is a great source of information, and definitely invaluable to just educate yourself as an investor, especially on a legal side of what’s happening but behind the deal and how the deal structure comes together. So I 100% agree that is a great one to read. What I’d also say is if you want to know more about the legal aspects around syndication, check out episode number six where Kim was on.
And we actually went through fraud and how to detect fraud in a syndication. It’s a really interesting discussion, and Kim, thanks for being on today to update us on what’s going on with the SCC. If there is future updates, I want to have you back to continue to get your thoughts and educate us on what’s going on in our investing world.
With that, is there anything else you want to share with the audience and any other way they can get a hold of you or sound like the website is probably the best place to start.
[0:26:48.7] KLT: Yeah, our website is very, very content rich. We do free monthly tele-seminars every single month on a topic related to syndication, where either I will teach the subject or we will interview someone who has a service related to it, and we have been doing that for over three years, and those are all posted so you can listen to those or read the transcript. You can cruise the articles and then also when people ask me questions, I will post frequently asked questions.
So there is a lot of those as well. Check out syndicationattorneys.com. Also if you are interested in developing some investor marketing materials, so then check out investormarketingmaterials.com and we’ll look forward to talking to you. You can schedule an appointment with us at either of those sites there. It is pretty obvious how you can do that.
[0:27:32.1] KR: Awesome, well great. Kim, thanks again for being on the show and with that folks, take that information and go out and invest like a pro.
[0:27:40.1] KLT: Thank you.
[0:27:41.0] KR: So thanks everybody for listening today and we will see you next time. Thanks Kim.
[0:27:44.6] KLT: Bye-bye. Thanks.
[END OF INTERVIEW]
[0:27:45.9] KR: Thanks for listening to another great episode or Ritter on Real Estate. Hit the subscribe button to make sure you don’t miss out on the content that will make you a better investor. Also, visit kenritter.com for articles, videos and tools curated just for passive investors. Until next time, this is Kent Ritter on Ritter on Real Estate. Now go out and invest like a pro.