The daily fluctuations of the market are unpredictable and carry the inherent risk of investing. However, even when the market is on an investor’s side, they still need to be wary of the hidden risks that could lead to a loss. Due to its perceived complexity, hefty fees, and risk of Madoff-like schemes, many investors shy away from private real estate investments. While these points have some merit, private real estate is an asset type that can boost the returns of any investment portfolio. If you know what you’re doing, the world is entire of possibility, but you also have to be careful not to step on any land mines. There are many good sponsors available, but many scammers will take advantage of you and steal your money.
To be a successful long-term investor, you must place yourself in a position to win right from the start. That means staying away from the sponsor whose sole aim is to line their own pockets. That doesn’t guarantee a profit from any one investment, but it does boost your long-term chances of doing so. It’s not difficult to tell if you know what to look for a good deal from a terrible one. Doing even a little research can prevent you from making a massive error in many situations. In the following, I examine a private, non-traded REIT offering as an example of a real estate investment that could go wrong.
Parking REIT, formerly known as MVP REIT II, invests in parking garages around North America. To assist you in avoiding making a poor investment decision, I’ve compiled a list of six warning signs related to this opportunity.
Sign #1: A Chief Executive Officer with Doubtful Past Performance
Michael Shustek runs MVP REIT II as CEO. The CEO of a parking REIT worth $500 million should have considerable background in the parking industry. Shustek hardly has any at all. Before establishing MVP REIT II, Shustek oversaw two other real estate investment trusts, Vestin Realty Mortgage (Vestin) I and II. The two real estate investment trusts (REITs) he oversaw lost over 90% of their value in the past. At the same time, he was CEO and had little experience acquiring and maintaining parking garages.
Sign #2: Proposal with Minimal Service Fees
Any investment that promises high returns while charging minimal fees is likely a scam. MVP REIT II is a model from a recent essay describing the exorbitant price of low-fee real estate. According to the prospectus, all of MVP REIT II’s capital is put directly into the properties themselves. It was a significant red signal because the rest of the non-traded private REIT industry puts less than 90 cents on the dollar into a property. It is technically correct, but it is not only dishonest but also misleading. The backer wagers that the investor won’t bother doing additional research. But the actual cost of this investment would be enough to suffocate an elephant in fees.
Sign #3: Inconspicuous, Outrageously High Expenses
The footnotes in a prospectus aren’t always merely filler; they can also include crucial information. Take note of the image’s first footnote, which specifies that the “sponsor or its affiliates” will cover the costs of promotion and sales. Having an excellent sponsor cover an investor’s costs is a lovely idea but rarely occurs in practice.
MVP REIT II’s advertising is correct, but readers may find it murky and deceptive. After investing, the investor is hit with astronomical costs. Suppose MVP REIT II can successfully raise $500 million. In that case, the estimated fees investors will pay over ten years are below, predicated on the assumption that $1 billion in real estate is acquired using a 50% loan and 50% equity.
Moreover, the board devised a long-term incentive scheme to attract and retain qualified directors, officers, workers, and consultants, which the prospectus estimates may add another $50 million in expenditures over the life of the investment. When you discover that your sponsors withhold crucial information, you should wonder what else they could be concealing.
Sign #4: Extensive Fee Scheme in Favor of the CEO
Shustek negotiated a complex revenue-sharing agreement between his new REIT and his older REITs, Vestin I and II, to cover the cost of the REIT fees. He pays for MVP REIT II’s offering costs with money from Vestin I and II. The REITs receive a portion of the fees described above, but he structured the deal to receive a disproportionately significant portion of the total.
Following is a synopsis of the agreement between Vestin I and II, MVP REIT II, and Michael Shustek:
“The operating agreement of the Advisor provides that once we and VRM I have been repaid in full for any capital contributions to the Advisor or any expenses advanced on the Advisor’s behalf, or capital investment, and once we and VRM I have received an annualized return on our capital investment of 7.5%, then Michael Shustek will receive 40% of the net profits of the Advisor.”
The Vestin REITs are responsible for all of MVP REIT II’s operating costs, and in exchange, they will get a percentage of MVP REIT II’s revenue. After the REITs have been repaid in entire plus interest on their capital, 40% of the residual income will go to Shustek. Because Shustek serves as CEO for all three REITs, we can safely assume that he developed this strategy independently.
Sign #5: Interest Discrepancies
There would inevitably be tensions of interest in any business transaction. The question is whether the manager makes every effort to avoid these conflicts or merely discloses them to justify his potentially biased actions. Michael Shustek owns, manages, or has a beneficial interest in more than ten REIT’s associated organizations. The entities render services to the REIT, with the fees accruing to him as described above. Since Shustek has a vested interest in the outcome of the negotiations between the REIT and the other parties, he cannot be considered neutral.
There is little doubt about the potential for conflicts of interest. However, I was still taken aback by the following information: Shustek, as CEO, bought a Vestin II loan for himself at a discount of 60% off face value. He repaid the loan in full within ten months of the deal’s closing.
Vestin II’s 10-Q includes the following section:
“On November 25, 2014, Shustek Investments Inc., a company wholly owned by our CEO Mike Shustek, entered into a loan purchase contract with us to acquire a loan with a book value of approximately $2.4 million… The purchase price of the loan was approximately $3.0 million…”
Remember that he had a hand in making this loan and was the CEO when he bought it. He was paid to advocate for investors and increase the company’s value for its shareholders, yet he did a poor job. In his bio, he brags about teaching an ethics course and penning a book on the topic of first deeds.
“He is a guest lecturer at the University of Nevada, Las Vegas, where he also has taught a course in Real Estate Law and Ethics. In 2000, he co-authored a book, “Trust Deed Investments,” on the topic of private mortgage lending.”
Red Flag #6: Investigated and Filed Fraud Complaints Discovered Online
That this is a bad bet for your portfolio should be evident at this point. Investors should at least Google the company’s CEO, management team, and related companies. Some shocking facts about Shustek and his friends came to light after just a few minutes of searching the internet. Accounting fraud, many investor complaints, and self-dealing were some things that came to light during the probe. This article provides further details and an alternative viewpoint on the intricate plot.
Certain Goods Must Be Ignored
Non-traded private REITs are only one example of an investment vehicle that isn’t user-friendly for investors. All investment products fail when fees reduce your initial investment’s value by 10 percent. Institutional investors avoid non-traded private REITs because of the lack of disclosure and the high costs associated with investing in such vehicles.
Due to their familiarity among investors and accessibility to advisers, these products are unfortunately suggested far too frequently. The decline of unlisted private REITs during the past few years can be attributed to the widespread dissemination of negative information about them. The amount of money raised dropped from about $20 billion in 2013 to less than $5 billion in 2017.
Not all non-traded REITs are bad investments, but there are other options to consider first, and the finest real estate managers don’t have to pay commissions to sell their properties. Green St. Advisors found that public REITs beat private REITs by 3.6% each year, proving they are more cost-effective and a better investment alternative. Accredited investors have another excellent option in the form of private equity funds for gaining quick and easy access to private real estate.
Private real estate investments are simple to enter but can be challenging to exit, so it’s crucial to conduct your research upfront to avoid surprises. Although you can’t predict the future of any investment, you can at least try to position yourself favorably from the get-go. It’s considered luck when the results of a wrong decision turn out well. Successful investing is all about picking investments with a high probability of success. Choose a proven track record manager who invests in tandem with you, charges reasonable fees, and avoids conflicts of interest. Use the resources at your disposal to look for warning signs in a potential investment. A financial analyst is not required to conduct a web search or read the introduction and page two of a prospectus. If you’re curious and questioning, you’ll also be a brighter, more successful investor.
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Come join us! Email me at mark@dolphinpi.us to find out more about our next real estate investment.