I continue to be fascinated with an evolving area of finance which could best be described as the social media motivational movement. Previous generations of the traditional motivational speakers (Jim Rohn, Tony Robbins) spoke about turning your life around by changing your outlook and your self dialogue. These traditional speakers also talked about money habits and some even went as far as to interview billionaires to try and glean new insights for their devotees on how the rich think and act. Their prescriptions for wealth were more anecdotal, not necessarily explicit wealth management strategies. There were some good takeaways though from these traditional speakers when they did try their hand at moving into personal finance advice. Specifically, Tony Robbins interviewed hedge fund manager Ray Dalio for his book Money, Master the Game where Dalio first revealed his “All Weather Portfolio” concept which he credits with some of his past returns. We also should give a lot of credit to these speakers who understand that a lot of wealth creation has to do with your environment, who you surround yourself with and taking measured risks outside of your comfort zone.
The new generation sends a similar message but tailored to the specific social media anxieties of millennials. One key difference is that some of them are crossing the threshold to not only tell you how to manage your money but to invest with them to get rich. I don’t want to paint all of them with this brush. There are many that I admire like Gary Vaynerchuck, who have built up their own multimillion dollar businesses and seem to have a genuine mission and purpose that goes beyond money.
Grant Cardone does not seem to be one of those people. Mr. Cardone has done very well for himself on social media gaining 2.8 million Instagram followers but also a strong cadre of devotees through books, online courses, conferences and YouTube videos. His 10X philosophy and strategy focuses on kicking up your own personal effort and approach to money to increase your net worth by ten times. Much of his angle focuses on his experience in real estate, specifically multi family residential real estate as well as commercial real estate. He has also moved into the space of money management setting up private real estate investment funds in which his followers can participate directly. These funds invest in his real estate projects and lock up their client’s money in illiquid assets over long periods of time.
This creates a stark conflict of interest, on the one hand, you have a motivational guru telling you how you should manage your money overall but also asking you for your own money to invest with him. His financial advice is cringeworthy, in this video he purports that the 401(k) is a scam, seemingly not taking into account historical volatility, liquidity and risk adjusted returns of the stock market, not to mention the current and future tax advantages of a 401(k). In this article he then discusses why investors should invest directly with his fund through their IRA. The only difference between a 401(k) and an IRA is that there may be more restrictions by your employer in terms of what you are able to invest in, his funds would likely not make it onto the platform of large money managers or employers through a 401(k) offering so he is making a play for the less regulated and scrutinized funds that may sit in an IRA account.
Taking a Left Turn
We all know that up until the pandemic, things were going relatively well in the US economy. When there is a large negative shock to the economy though, we always see cases where fraud and graft are exposed. On Wall St. there is a saying: “Only when the tide goes out do you discover who’s been swimming naked.” In the last downturn, this exposed Bernie Madoff. It has yet to shake out who will be exposed during this downturn but Mr. Cardone is making a case for himself in this odd video shared on Facebook where he seemingly admits to be at risk of civil lawsuits and jail time.
Fame and riches bring with them envy and a lot of detractors and Mr. Cardone has no shortage of these online. Many seemingly shrieked with glee at his alleged “admission” that he had been a fraud the whole time. Then came a flurry of commentators, mostly on YouTube, who were either investors or skeptics of Mr. Cardone who felt they finally had proof that he wasn’t really rich and was dealing with his investors in an underhanded and potentially illegal manner. The ones that caught my attention though were those that were actual investors into his funds run by Cardone Capital and their assertions that the terms of his funds were grossly unfair and set up to enrich himself at the expense of his investors.
There is some public information to go by. Private real estate funds taking in money from retail investors have filing requirements with the SEC which have to be published. The link here is to the offering memorandum for his Equity Fund V which was oversubscribed and raised $50 million from retail investors. After taking in his videos, pages and the quality of his advice, I became one of the skeptics. When I started to dive into the fund documents though, it becomes apparent that Mr. Cardone does take some hefty chunks of the fund for himself and his fee structure is both skewed and lacking transparency, even compared to other expensive private real estate funds.
Cardone’s Fees Versus the Rest
Below are some of the basic fees in Cardone Capital’s Equity Fund V:
- An acquisition fee of 1% of the property value;
- A disposition fee of 1% of the property value upon sale;
- An asset management fee of 1% of contributed capital, paid monthly;
- Carried interest of 35% of profits interest and 35% of distributable cash.
The devil is in the details when it comes to these terms. The fund also has 2 classes of shareholders, class A and class B. Class A shareholders receive 65% of distributable cash while class B shareholders receive 35%. In addition, there are provisions that make sure class A shareholders are made whole on 100% of their capital investment before the class B shareholders are returned their capital.
What does “distributable cash” mean? In the operating agreement of the fund, it means the operating income from the property less expenses for interest, property management, marketing etc, essentially the monthly gross profit minus the fees.
The only other thing that the operating agreement tells us is that the minimum investment for class A shares are $10,000. There does not seem to be a defined investment minimum for class B shareholders which receive 35% of the profits, and this is all before fees. If you have a 35% interest in the operating profits and Mr. Cardone takes a 35% fee on that profit as defined in his operating agreement, this leaves you with $0. He also gives himself a lot of discretion in how the funds are allocated, likely with little transparency. So in those YouTube videos, despite whatever letters or communication he is giving to his investors, according to his operating agreement, if you are a class B shareholder, he doesn’t necessarily have to pay you anything.
Are these fees normal? Let’s look at a comparison of some other private real estate fund fees as provided by a start up private fund service called Fundrise.
Source: Fundrise
Mr. Cardone’s explicit fees deal with acquisition and disposal and an asset management fee and he saves you any sales commission. This is seemingly his selling point as he uses “crowd funding” to start his ventures compared to the traditional distribution routes favored by traditional fund managers.
The carried interest is where the stark difference lies. In the traditional fund example above, there is an explicit return hurdle of 5%, below that return, managers cannot take their fees. Above that, they take only 12.5% of the return. In the operating agreement of Mr. Cardone’s fund, I found no definitions for hurdle rates or required returns, only a vague reference to a 15% return goal, which may or may not be reached.
Are You Being Banboozled?
One thing I have learned in 13 years of working in the financial industry is that you call a spade a spade. If it’s not transparent and understandable, there is usually something fishy going on. After reading through the offering circular and the operating agreement of Mr Cardone’s Equity Fund V, I see that class A shareholders get priority in payments, get made whole on their investments and shareholders have no protections in terms of minimum hurdle rates or transparency of fees or reporting. There is no transparency around how you distinguish between class A and B shareholders and I suspect that the class B shareholders are made up primarily of those retail investors who had hopes of getting rich with Mr. Cardone, while class A shares may be reserved for his friends and family, but this is just speculation. I would be surprised if Mr. Cardone’s other funds didn‘t have a setup like this where fees lacked transparency and investors were subordinated in the capital structure.
If you are one of the unfortunate investors in this fund and have received written communication which describes payouts or return hurdles that differ from what I described above, I would advise you to save this communication and retain an attorney. This may be exactly what Mr. Cardone was talking about when he mentioned he may go to jail. If you are informed enough like Mr. Cardone is, to file a form 1-A with the SEC, then you know exactly what you are doing to unsophisticated retail investors, especially if you have lured them in from social media where as I have already pointed out in other posts, fraud is rife. Funds like these are often reserved for accredited investors which requires you make over $200,000 a year or have over $1 million in investable assets. Large firms tend to stay away from retail investors for cases just like these. It takes time and financial education to sift through the documents and thoroughly understand the investment. It’s a process that few smaller, less experienced investors have the experience and knowledge set to make informed decisions.
It may be a painful lesson for some, but the story of the social media gurus and fraud just seems to be getting started.
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