There’s a story that in 1929, Joseph Kennedy, the father of the late U.S. President, John F. Kennedy, conversed with a shoeshine boy on a street in New York City where he lived.

The shoeshine boy expressed excitement as he offered Mr. Kennedy some unsolicited stock tips.

At that moment, Joe decided that when the shoeshine boys offer stock tips, it’s time to get out of the market. He sold off his entire stock portfolio. The crash came soon after, leaving him with his wealth intact at a time when many others lost theirs in the Great Depression.

True or not, this scenario, whether shoeshine boys, Uber drivers, or even doctors, plays out regularly toward the end of every rising economic and market cycle. It’s no different this time.

Over the past five to seven years, I have observed a proliferation of new sponsors and promoters selling real estate to private investors. These promotions often come in the form of large syndications (multi-family or commercial projects) or real estate funds that function as private Real Estate Investment Trusts (REITs). They are promoted by doctors who have very little or no previous experience or track record in the world of real estate and no experience in a full market cycle.

I understand the incentives and motivation. In every cycle, as the bull run (upswing) nears the top, anyone and everyone who has watched from the sidelines, or participated passively, decides that they want a bigger piece of the action. And why not? The greed factor, which is part of what makes capitalism and opportunities flourish in a free market, attracts people and entrepreneurs who want “in” on the action.

There is nothing illegal; it is simply a sign of the times. The majority of those creating their own Co-General Partner (GP) opportunities are well-intentioned. They honestly think that they know what they’re doing and want to make money for themselves and their investors. However, danger lurks. They don’t know what they don’t know — and neither do you.

I call this “Friends and Family” investing. Because they are “one of you,” a doctor or other “professional,” there is an assumed basis of trust ─ after all, your own peer group wouldn’t lead you astray, would they? Often, they set up private Facebook groups or other events where their “real estate deals” are pitched to the unsophisticated and unwary.

As long as the market cycle continues unabated, many of these syndications and funds work out okay ─ some even do relatively well. As the saying goes, “Everyone is a genius in a bull market.”

The problem is that, eventually, the music stops and so do the investment operators. It’s happening as we speak. And we’ve only begun the market correction/recession that has been anticipated by those who keep a close eye on the fundamentals of the economy, interest rates, the bond market, the banking sector, and credit liquidity. It’s all in a massive flux, creating the warnings herein.

When projects go south, as many will in the near future, the promoters and the sponsor-operators have already made their upfront fees. Many of the bank loans are nonrecourse, meaning there is no liability for the sponsor and promoters to walk away from the deal and claim, “we made best efforts.” 

Because the legal representations are so well-written to protect the sponsors and promoters, there is no recourse to the limited partner investors unless malfeasance or misappropriation of funds has occurred. The latter requires a legal fight, which can be expensive and protracted.

The bottom line is that, as a passive limited partner, you have very little in the way of remedies once you have invested and signed off on the legal offering documents. The promoters have minimal risk, if any.

How do these doctors become promoters for these deals? What is their incentive to sell these investments to us/their colleagues? Why are they sponsoring these projects?

What is really going on here?

The Co-GP Promoter Model: Fees, Commissions, and Little Skin in the Game

The “Co-GP Promoter” model involves individuals that partner with real estate operators or sponsors as a General Partner to assist in raising capital for investment projects. As a Co-GP, these promoters can circumvent securities regulations on raising capital without being registered and licensed by the Securities and Exchange Commission.

Often, these “Co-GP Promoters” are doctors or career professionals with little previous experience or a track record in real estate. They become General Partners to lend credibility in the eyes of colleagues and give the deal sponsors access to groups of high-net-worth investors (doctors, other practice professionals) to whom they would not otherwise have access.

Who are the General Partners, the actual operators? They could be anyone, and here is where the danger appears. Exactly what is the vetting or due diligence being done by the Co-GP Doctor Promoter? Aren’t you glad that I asked? Other than a relationship connection with all of the incentives geared towards the promoters… no real underwriting occurs. It takes time and expense, and during market hype, no one ever asks.

Sure, there will be talk of prior track records, but at the end of a market cycle, prior track records are of little relevance. Many sponsor operators have never experienced a full market cycle in their performance. That would be the first good question to ask, but nobody does. The assumption is that the promises of IRRs (Internal Rate of Return ─ which is how all such equity syndications are sold), in the high teens to high twenty percent, are as good as guaranteed.

Alas, these are only projections often based on very faulty assumptions. Again, not illegal. However, understand that the sponsor-operators hire the very best attorneys to write their PPMs (private placement memorandums) and Operating Agreements, which essentially dispel them from any liability for lack of performance outside of verified fraud.

As an “accredited investor,” the SEC (Securities and Exchange Commission), assumes that you are wise enough and have the resources to do proper due diligence. But do you? Do you have that experience? Do you have the capital resources to have adequate financial and legal underwriting, including full background checks on each principal sponsor?

The answer is “no.” Not only do you not have those resources, but you’re too busy to take the time, and that is what all promoters are counting on… plus the greed factor. Fear of Missing Out (FOMO) ─ you don’t want to miss this opportunity because you’ve felt you’ve missed out too many times in the past.

The fees assessed for these capital-raising efforts are substantial. It is common that the GPs have little or none of their own capital in the deal. This creates a model where GPs are incentivized based on the amount of capital raised (more capital = more fees), rather than the success and sustainability of the investment itself. They don’t have any personal stakes in seeing the deal through.

Early in the creation of Freedom Founders, I was advised by some to pursue this route. It is a very lucrative model. There are numerous doctors (on social media and elsewhere) making a fortune by selling these investments, which they often know very little about. I do not need to name names. Many of you know who they are and can easily find them.

By contrast, I do not sell real estate or any securities, and I do not have any financial interest in the investments my members choose. The reason I have and will continue to stay away from the “Co-GP Promoter” model has to do with malincentives.

The Malincentives at Play

The fundamental issue with the Co-GP Promoter model lies in its inherent malincentives:

• Fee-driven compensation: Co-GP Promoters typically earn fees based on the capital they raise and transaction fees for putting the deal together. There is an incentive to focus on quantity over quality. They always need a new deal to promote.
• Lack of skin in the game: Without a significant personal stake in the investment outcomes, Co-GP Promoters may not be as invested in the project's long-term success.
• Misalignment with investor interests: The primary focus on capital raising can lead to a misalignment between what's best for the investor and what benefits the Co-GP Promoter.
• Propensity to “oversell” returns: Because the sponsors often make the majority of their fees upfront, they are incentivized to gloss over risks and oversell potential returns. Their compensation is not dependent on making good on those promises.

Network Marketing Repackaged for the Investing World

This structure is nothing new. It has been used for decades in network marketing. It has simply been retooled to sell investment products to high-net-worth investors.

Network marketing = selling products to friends/colleagues for a commission, often products that you do not or would not use yourself.

The proliferation of Co-GP Promoters in the investment sphere has several implications for investors.

• Increased risk exposure: Investors may find themselves exposed to higher risks as Co-GP Promoters might not thoroughly vet opportunities with the investors' best interests in mind.
   
• Diluted returns: It’s common for these deals to be fee-driven on the front end. If the sponsors are receiving their profit on the front end, this reduces overall returns for investors.
• Lack of control and leverage: If the sponsors are making their profit on the front end of the deal, they have little incentive to manage well or stick with the project if complications arise. This means that if things don’t go according to plan, investors have very little leverage to ensure accountability and follow-through from the deal's sponsors.

My “Under the Hood” checklist for any Investment

Investors looking to discern quality from salesmanship should focus their due diligence in the following areas:

• Seek alignment of interests: Look for investment opportunities where the incentives of all parties involved are aligned with the success and sustainability of the project.
• Demand transparency: Insist on clear, transparent communication regarding fees, the structure of the investment, and the long-term strategy.
• Compare fee structures: Don’t just assume or take it on faith that fees are “industry normative.” Research and get counsel. Consider whether the fee structure properly incentivizes the sponsor to ensure the project is profitable for investors.
• Affiliated party relationships. Read or have someone competent review the legal offering and look for affiliate commissions and payouts that may strip the distributions to you, the passive limited partner.
• Limited partner rights. Understand the scope of control that the GP and Co-GP have and under what circumstances they can be replaced if needed.
• Educate yourself: Arm yourself with knowledge about different investment models and their implications to make informed decisions.
• Look for long-term players: Evaluate the experience of all GPs in the deal and look for operators doing business for the long-haul; building collaborative relationships with long-term operators is the pathway to success and profitability.

Resisting the Siren Call of Big Returns

Often Co-GP Promoters are selling deals touting larger-than-life returns - big promises, especially for where we are in the current market cycle.

Larger-than-life returns are tempting. Isn’t bigger always better?

Without a clear plan and defined strategy for your investing, you WILL be vulnerable to the seductive promises of big wins to create more perceived certainty in your financial future. Without a defined plan, “more” will always seem like a pathway to certainty. But beware. Chasing yield is a fool's errand. It is not a path to certainty but rather risk. You cannot bank your future on beating the markets for the long haul. Successful investors are often those who are the most disciplined to resist the temptation to chase yield, and instead, pursue a focused strategy of consistent, sustainable returns combined with risk mitigation. This does not happen by accident ─ a defined plan is needed.

Your Financial Blueprint should provide clarity in the following areas: 

• Setting clear goals: Establishing what you want to achieve with your investments, both in the short term and the long term.
• Risk management: Understanding the root causes of risk, assessing the level of risk you're comfortable with, and choosing investment opportunities that align with your goals.
• Diversification: Spreading your investments across various assets to mitigate risk and ensure a more stable return over time.
• Continuous education: Keeping abreast of market trends, investment strategies, and financial planning to make informed decisions.

Becoming Your Own Financial Advocate

I do believe that hardworking, high-income professionals and business owners need a Plan B investment plan outside of their primary source of income and at least a portion of their investment portfolio allocated in alternative, tangible assets (as opposed to Wall Street financial products). You achieved your success by relying on yourself throughout your many years of education, training, and perseverance to build your career. Why would you not do the same for the money that you earn and then invest?

Advocating for your own financial destiny rather than relying on third parties to “invest for you” does require a level of dedication and study. I call it a “reinvestment period” ─ a reinvestment of time and money to learn skill sets that will provide you with the security and peace of mind that you won’t run out of money during your retirement years. (Or the reality that your lifestyle has to be reduced.)

Despite the urging of some, I chose a different approach from the beginning. I do not sell real estate. I do not take commissions. My mission and goal are to help colleagues develop the knowledge and skills to become their own financial advocates, as I did. I invest right alongside my members. As a community, we attract, curate, and vet quality operators who have a proven track record and are willing to put their money where their mouth is.

I love helping colleagues become sophisticated investors who have the abilities and the relationships needed to create sustainable cash flow for years and decades to come.

No one else will care about your hard-earned capital as much as you will. The path to Freedom for anyone who wants to ditch the traditional Wall Street model in favor of alternative investments is to make the re-investments needed to educate yourself and find relationships/a tribe you can trust.

That is the pathway to Freedom!

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Dr. David Phelps created Freedom Founders to help its members achieve the freedom they wanted in their lives by building the necessary financial foundation. He is a noted financial expert who is regularly cited by the media, and recently helped the FL Dept. of Education develop its new financial literacy curriculum,