by: Boruch Kimmesteil
The current multi-family investment atmosphere has been a roller-coaster. It has seen tremendous growth and success. It has also been manipulated with real, serious life-altering events. These events have shed light on local investing practices, especially the lack of oversight of how investor funds are utilized. Given the susceptibility of investors to unscrupulous practices, certain changes should be implemented.
A significant flaw in the current investing scheme demonstrates, at least in part, why many of these ponzi schemes exist. I firmly believe that the money managers who seek investors and then invest in multi-family projects are initially acting in their investor clients’ best interests. However, the money managers’ brand is that they can generate profits quickly. If they cannot deliver profits then they have no brand. While it is common for people to lose money on their investments, it must be noted that local money managers would likely have much difficulty informing their clients that their investments have failed because it would hurt their brand. If Prudential or Morgan Stanley investors lose money that does not hurt Prudential’s or Morgan Stanley’s brand; they are brand names called Prudential and Morgan Stanley. In contrast, a Lakewood money manager’s brand is that he generates revenue. If one person loses money then other people will not invest with that money manager and his brand is damaged.
Common sense investing requires two basic concepts: 1) only invest what you can afford to lose; and 2) perform due diligence prior to and during the investment process. It follows that someone who earns a moderate income should invest moderate amounts. Yet many people invest significant amounts into multi-family projects by borrowing against their house, which, on its face, is foolish.
Another unique factor is the lack of investor due diligence. Imagine a pizza store is for sale. The current owner drives an Aston Martin, gives significant amounts of tzedakah and is considered a decent, honest person. Would anyone just buy the business with any due diligence just because the owner seemingly possesses wealth and a good reputation? Any buyer would want to see the books, compare receipts, determine operational efficiency etc. Yet, with respect to multi-family investing, investors due no diligence and rely strictly on the money manager’s reputation. It seems absurd.
Continuing with the due diligence aspect, it would be prudent for investors to have regular audits on an ongoing basis of money managers to determine that all is as promised. In theory, an audit team should review the money managers’ claims of investment and efficiency and provide audited statements to investors.
For instance, a money manager raises money from investors to invest in a multi-family project in Louisiana. The price is $9,000,000. The money managers are looking to raise $5,000,000 and are in discussions with some banks for a $7,000,000 loan, with $4,000,000 in financing and an additional $3,000,000 for renovations. They say it’s a good deal because the area is up and coming and they can get much higher rents with a gentrified building. Auditors should review the sale contract to determine that the sale was finalized, review the bank statements to determine whether the financing is in place and compare receipts with contractors and other construction professionals to determine the authenticity of the renovations. This never happens.
The whole multi-family investing culture seems like a circus. Investors, many of whom should not be investing, perform no due diligence at the onset or during the process, money managers cannot inform investors that anything is not going according to plan and the process is susceptible to manipulation.
There is another factor that is a big piece of the puzzle. I discussed this matter with a friend who is an investor in several multi-family projects. This friend has an accounting background and is well versed in responsible investing and auditing. In the current environment where living standards are sky high, he feels compelled to invest under these less than ideal conditions. That is, his income from his day job, while a good income, does not cover his expenses. He needs an extra $50,000 plus a year to make ends meet. Therefore, in desperation, he invests in multi-family projects by borrowing large sums against his house. At the moment, the strategy is working. While he would like to have audited statements, he feels that requesting audited statements would fall on deaf ears.
He makes the point that if he did not feel desperation then he would approach investing differently. He would not borrow against his house to invest; only invest what he can afford to lose; conduct initial due diligence; and demand audited statements. He also knows that he is susceptible to a ponzi scheme the same way others lost money to ponzi schemes. He noted that many other people are also desperate investors.
I find the situation to be sad. My advice is for investors to band together and demand that the money managers submit to initial and ongoing audits. While one person requesting an audit is unlikely to yield results, a large group of investors saying that they will only invest if the money manager provides all information to an auditor can yield results.
Unfortunately, many hard-working people with moderate or good incomes are sitting ducks and one bad move away from ruin. An audit may be able to provide a layer of protection.
TLS welcomes your letters by submitting them to [email protected]