It was in the 1980s when President Ronald Reagan used the phrase “trust but verify,” a Russian proverb translated into English when he was in the nuclear arms negotiations with Mikhail Gorbachev.
At that time, these two superpowers had to establish a level of trust, meaning they needed to verify that each party was upholding their end of the bargain.
This concept served as a vital safety net in a world where one wrong move could lead to catastrophic consequences.
Not much trust in the world these days?
When I reflect on my 30 plus years as an investor, I’m reminded of a few occasions where I didn’t listen to these wise words, and I ended up being the victim instead of the victor.
In this “lessons learned” article today I’ll explain why I made these mistakes and how I learned from them, in hopes that readers will avoid some of these same pitfalls.
Verify Who’s in Charge
When I began my career in commercial real estate, I formed a partnership with a wealthy investor.
I had no money, so I had to operate under the so-called “golden rule” which means that when you have the gold, you make the rules.
So the partnership – C&T Investments – was created which became the holding entity for a series of investments ranging from net lease properties, to shopping centers, to warehouses, to land.
Over the course of two decades the partnership grew to nearly $100 million in assets, and most all of the properties had secured debt, of which I was a guarantor.
It just so happened that my business partner had other business dealings which I was not a party to. He owned a golf course, medical office properties, industrial buildings, and significant land holdings.
At some point he decided to build a hotel, but not just any hotel. He wanted to create a large-scale mixed-use project that included a golf course, housing, and retail.
I knew that this project was too large, he was undercapitalized, and I had no interest in being a partner. In fact, I decided to make an exit and cast my own shadow.
Since I wasn’t the managing member, it was impossible for me to unwind the business.
We owned more than 30 properties together and he was not willing to separate the business, he insisted that he manage the properties and collect the rent.
Shortly after I left his office, I received notices that the mortgages were not getting paid, which means that the rents were being redirected (to him) to help finance his hotel project.
Later I began getting demand notices from banks and things began to spiral. I had never been a party in a lawsuit up to that point, so I got a quick education.
At one point, one of my favorite assets, a shopping center in my hometown, was going into foreclosure. However, when I received the complaint from the lender, I noticed that there were four more mortgages on the property.
This property was worth around $10 million, and the loan balance was around $6 million, however, my business partner had taken out four additional loans on the property for a total of around $3 million.
So, without my consent, he had sucked out all of the equity (to finance his hotel) and to make matters worse, there was one million dollars of payments past due on the senior loan.
This means I lost around $4 million on one property!
I drive by this property almost daily.
It makes me sick on my stomach to think about this sham, but over the years I’ve become fixated on the golden rule, and I’ve decided that I will never again invest capital without either being in charge or vetting management teams in stocks that I invest in.
A Lesson in the REIT Sector
Specifically in the REIT sector, I learned that lesson with a REIT once known as American Realty Capital (formerly ARCP). Here’s the headline for an article I wrote on the company in October 2014 (that’s nine years ago):
In that same article I asked myself these questions:
- As an ARCP investor, how do I know that I’m getting the best acquisition team focused on sourcing the best net lease assets. Answer: You’re not.
- As an ARCP investor, how do I know that the fee income associated with the JV deal is sustainable? Will it be there to help cover the dividend. Answer: Who knows.
I then said, I see no value in the complex deal, and I’m not considering adding any more shares. So that means that I’m either Selling or Holding.”
“There’s plenty of cheese in the trap, but I’m not going to add more risk. Mr. Market has warned me by providing a signal that I should proceed with caution. I’m sitting on the sidelines for now.”
Most of you know the moral to the story…
Just eight days after I published the above-referenced article I wrote this:
It was revealed that ARCP had falsified its Q1-14 and Q2-14 earnings reports, and all trust was lost with the management team.
Having lost millions in my prior life as a real estate developer, I should have spotted this scheme miles away. That’s one of the reasons I spend so much time with senior level CEOs and CFOs.
However, I did raise the yellow flag, that hopefully enabled investors not to buy ARCP.
As most know, ARCP eventually became VEREIT (former ticker VER) that means “trust,” and eventually VEREIT merged with Realty Income (O) in November 2021.
Sometimes tough lessons become building blocks for investors, and I can certainly attest to the fact that my losses have made me stronger, in more ways than one.
I have a few rules that I live by with regard to stock picking:
- Always insist on buying quality stocks. We screen for hundreds of companies to invest in and our risk analysis includes consideration of balance sheets, income statements, and governance.
- Always insist on buying with a margin of safety. Insist on buying companies when there’s a quantifiable margin of safety. This is how investors can deliver above average returns over market cycles.
- Since income is critical to our investment thesis, a risk analysis should include an emphasis on dividend safety. Screen each constituent based upon the payout ratio, history of dividend performance, and future earnings potential.
- Always, and I mean always, remember to protect principal at all costs.
The last rule is the most important…
Having lost millions of dollars before landing on Seeking Alpha, I have a unique perspective when it comes to investing.
I worked for more than 20 years to build up my retirement nest egg, only to have it evaporate due to not having control of my finances (and trusting management).
It was extremely difficult for me to claw back from the dark times, and to build back my empire.
When it comes to investing, I must be in full control of all decisions, and I will never live under fear. This photo I posted on “X” sums up my life and experiences on Seeking Alpha:
I hope you enjoyed this “lessons learned” article and I look forward to reading your comments below.
“Adversity is bitter, but its uses may be sweet. Our loss was great, but in the end we could count great compensations.” Benjamin Graham
Note: Brad Thomas is a Wall Street writer, which means he’s not always right with his predictions or recommendations. Since that also applies to his grammar, please excuse any typos you may find. Also, this article is free: Written and distributed only to assist in research while providing a forum for second-level thinking.