To be a true expert in any field requires a devotion to one’s subject and expenditure of a great deal of time going deep. Knowing a subject to its greatest possible extent is almost never fully achieved but the effort is worth it. The pursuer of such knowledge is rewarded (or cursed, depending on one’s viewpoint) with continually more complex questions about and deeper insights into the subject. The more the onion is peeled, the more layers are revealed, the more tender and delicate those layers become, and ultimately, the more multifaceted one’s understanding becomes.
For many years, I have been heavily involved in private real estate securities, namely 506 Regulation D offerings of various sorts that are exempt from registration under the Investment Company Act of 1940. Since our start more than 25 years ago matching individual deeds of trust secured by real property with individual investors – one of the simplest forms of securities – Fairway and I have been working with high-net-worth (HNW) accredited individuals and entities (and later family offices and institutions) to invest in alternative real estate asset-based investments.
Many other people (tens of thousands of them at least) also make their living in this field, raising capital from investors in order to invest that capital in real estate-based assets they manage and control on behalf of those investors. Like me, they all experience similar challenges in raising, deploying and managing that capital, and they all face the same regulations that govern what they can and cannot do legally in soliciting and managing that capital. The sheer number and complexity of those regulations that may or may not apply in any given situation, the interrelatedness and inconsistency from one statute and jurisdiction to another, the operational and practical nuisances they impose on both the sponsor and the investor, and their continual change and evolution make it difficult for even the most dedicated people to fully comply. And this is to say nothing of the human psychological and behavioral nuances at play that influence the interactions between the constituents of this two-sided market.
The layers of the onion are deep and complex indeed.
There are interminable factors that interplay with one another – many of which the average HNW investor cannot even begin to comprehend – that make it extremely difficult to navigate the playing field of both public and private securities with any degree of certainty. This is equally true of both but in completely different ways. The world of public securities, admittedly not my area of expertise, is in a separate galaxy than the one in which I have spent my life, but there are many lessons to be learned and applications to be translated.
I just finished listening to a fascinating book called “The Man Who Solved the Market,” by Gregory Zuckerman. It is a biographical story of a hedge fund manager named Jim Simons whose firm Renaissance pioneered the use of quantitative analysis to inform and make investment decisions, virtually independent of historical tried-and-true methods like PE ratios, balance sheets, and other mundane and manual applications. He has made billions for himself and his investors and outperformed nearly (or actually) every other highly regarded investment manager over the past 30+ years, including Warren Buffet, George Soros, Ray Dalio, and every other high-profile manager you can think of. What the book reinforced to me is that the preconceived notions I have long held about how hopeless it is for me to try to guess the direction of individual stocks, mutual funds, or even sectors are entirely warranted, making me even less enamored than I already was to invest in that arena.
My world of private real estate asset-based securities, both debt and equity, has just as many nuances, idiosyncrasies and multiplicities of factors influencing outcomes as its public counterpart. But since information is private, there is less publicly available historical data for quants and AI to cull from in order to discern patterns and tendencies, and thus the market is even less efficient. This gives rise to both opportunities and challenges for sponsors and investors to try to take advantage of those inefficiencies. Because there are fewer regulatory requirements than publicly traded securities (generally speaking, depending on the issuer and the offering), there is also less transparency and fewer structural frameworks for dissemination of information, driving up inefficiencies and costs, along with opportunities for deceit and fraud.
The world is constantly evolving, and the totality of events continually impacts performance of these private securities. Interest rates, availability (or lack thereof) of capital, impact of technology, changes in consumer behavior, government policy, acts of nature, spillover of equity market performance, competency and honestly levels of individual managers, regulatory requirements, reliance on vendor performance, tenant and business financial performance, title issues, historical environmental use, tax law changes, zoning restrictions, municipality requirements, and dozens – perhaps hundreds – of other factors all coalesce in varying quantities. This creates a kaleidoscope of dynamic possibilities. Generally, real estate moves at a glacial pace compared to equities markets, and discipline, patience, and resourcefulness can be well-rewarded.
The regulatory environment for private securities and issuers is often contradictory. What FINRA considers a correct answer to many questions on any examination to obtain a securities licenses would lead one to believe that ANY investment in a private real estate security is not a “suitable” investment for a licensed person to recommend to a HNW investor. Yet, the SEC, a completely different regulatory agency policing different laws, is now under a review period to relax the accreditation rules to enable more individuals to qualify as “accredited” investors and thus increase the number of people who are able to legally invest in many private securities.
Many, although certainly not all, issuers of private securities are exempt from registering as investment advisors or affiliating with a broker dealer. Many of those who are probably not exempt from doing so may be unaware that they are not, or, more aggressively, are deliberately taking what they hope is a defensible position that they are not and simply avoiding the associated operational burdens.
There are fantastic managers who know exactly what they are doing and there are fantastic capital raisers who are poor or even negligent underwriters. Most of this goes on extensively without much appreciation of the implications of it from HNW investors until it is too late to do anything about it.
These are only a few layers of the onion. There are many more, and some are razor thin and hard to peel. My main point is that things are often much more complex than meets the eye. Each of us is more of an expert in something than another thing or another person. The true expert knows he doesn’t know everything about a subject, even though he may know more about it than most. An expert often develops an ever-deeper appreciation of its complexities, wondering if the subject can ever be fully mastered. The novice often believes he understands more than he really does and argues his point more vehemently than warranted. It takes self-awareness to know where one possesses expertise and to choose experts to assist with the rest. We are all one or the other in different parts of our worlds and should do the best we can to know the difference.
Disclaimer: All information provided herein is for informational purposes only and should not be relied upon to make an investment decision and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Nothing contained herein constitutes investment, legal, tax or other advice nor is it to be relied on in making an investment or other decision. Readers are recommended to consult with a financial adviser, attorney, accountant, and any other professional that can help you understand and assess the risks associated with any investment opportunity. Private investments are highly illiquid and are not suitable for all investors.
