Monday, July 20, 2009

Equastone Issues - Why I Passed Several Years Ago

(A Wall Street Journal article appeared today that talks about the Atlanta, Georgia Equitable building foreclosure - involving Equastone).

Several years ago I was turned onto a real-estate company in La Jolla (San Diego area) by the name of Equastone. A few people I know invested their client money with the firm and had good things to say about them. I like the idea of investing in commercial real estate directly, if it can be done on a reasonable basis and thought it would add some diversification to client portfolios. So I decided to do some due diligence.

I went down to La Jolla, had a nice lunch with the owners and sales people (my first red flag was that one of the owners would actually have lunch with me, a relatively small advisory firm owner). The pitch was straight-forward, they bought properties that they thought were distressed, but had the potential to be turned around, filled with occupants and then sold. The strategy seemed reasonable, assuming it could be executed correctly.

However, the more I found out the more I decided it wasn't for me, or my clients. A few of the red flags that stood out for me might not have made others list, but here they are:

1.) One of the guys in charge of determining "good" value started bragging about his amazing shoe purchase, he told me that he got these great shoes at an amazing value of just under $300 a pair and decided he'd stock up. For me, $300 doesn't appear to be a great value for shoes (of course I don't put much value in shoes, thus perhaps my problem). However, the guy started using his shoe analogy to demonstrate how great he was at spotting real-estate values.......hmmm, perhaps he suffers from over-confidence. This was a red flag, his value quotient wasn't the same as mine.

2.) Leverage. All the properties were highly leveraged, usually in the 70 -80% range or more (according to them and recent reports). I didn't like the large leverage. I'm fine with a little leverage, but anything over 50% gets me nervous - especially if the financing is short term in nature. Clients can make a ton of money, but they can also quickly lose it all.

3.) The company offered to let my clients in on the current offering at the original offering price, even though they claimed the purchases were already showing profits of 20 - 40%. What this told me was they were willing to throw their current clients under the bus to get new clients. I knew that this meant either that they didn't have the returns they claimed or that my clients would soon be diluted by new investors - or worse, the whole thing was a Ponzi.

4.) I was told that no one who had examined their books had ever failed to invest with them.....being the contrarian that I am I thought this was weird and wanted to NOT invest just to be the first! Having said that, it struck me funny that not a single person ever declined.....that was a red flag.

I decided not to invest with Equastone, perhaps leaving huge upside on the table for my clients. However, time has vindicated that decision as Equastone (according to the linked article and today's Wall Street Journal) is having big problems with their properties. Even the sales guy I spoke with at Equastone has left the company (though I don't know why). Who knows, perhaps the offering that I was to buy for my clients is performing well.......but it just didn't pass the smell test. I think my clients are much better off.

Scott Dauenhauer CFP, MSFP, AIF