This article is a segment of a four-part series titled, “Why I’m Excited For a Correction.”
– Part 1: Why I’m Excited For a Correction
– Part 2: Who Are the Predators and the Prey?
– Part 3: Who Are the Most Vulnerable?
– Part 4: Missteps That Cause Implosions
My goal a few years ago was to opportunistically embark into real estate development, by design, when tumultuous events are occurring. In my fifteen years, implosions are intermittent, but the fuse can be lit at any moment. Here are five archetypal commercial real estate combustions:
1. Falling in Love with a Piece of Real Estate
Good developers know their box and can walk away. Many will jam skinny deals through, and it does have significant repercussions should the winds change slightly against you.
Solution: Take the emotion out of the deal and look at each situation dispassionately. If you can’t tamp your feelings, seek counsel from someone who can.
2. Technology Disintegrating Barriers to Entry
When my development mentor, Jay Adams, was blowing out drugstores nationwide, you had to travel (monetary capital, human capital and mental stress).
That position required:
- Substantial travel and time away from loved ones
- Navigation into entrenched relationships
- Breaking through heavy barriers to entry. Any Tom, Dick or Harry can hop on a computer and find a drugstore site’s ownership and detailed site history.
- Quote from Jay Adams: “Optimizing yields in real estate development requires inside market intelligence because if the property has a sign, it’s been picked over by a herd of digital developers and their brokers. To find a dynamic deal, you need to have friends in the municipality, sit down in people’s living rooms and consistently call and track off-market opportunities. Eventually, persistence pays off and change equals opportunity.”
Solution: Only work with those that have proven, extensive and recent accomplishments. CRE is a relationship business! Also, read this book by Malcolm Gladwell.
Outliers, by bestselling author Malcolm Gladwell explains the 10,000 hours rule in detail, and I think this is very applicable to real estate development and other ventures with inherent risk.
“An extraordinarily consistent answer in an incredible number of fields … you need to have practiced, to have apprenticed, for 10,000 hours before you get good.” —Malcolm Gladwell
3. Emotionally Driven Decisions
We all have a flight or fight response, and if you’re reading this article, I assume you are on a path to enlightenment and self-improvement and emotional intelligence is critical. Think about a huge deal you have sunk hours and lament to others with terms such as: “I’m killing myself” or “I have so much blood, sweat and tears into this.” The margins become thin, but you have so much vested you hang onto real estate for sentimental or ego-driven reasons. You reluctantly pull the trigger after a lukewarm and hasty deliberation.
Fast forward a few years and this an economic albatross around your neck, and you lose personal time, waste mental energy, and sustain financial wounds over a protracted period of time.
Solution: Emotion driven decisions should be attentively monitored, and apportioned at a time well after the trigger event. Slow down, respond in time, do not react immediately.
4. Lucky Projects in Your Past Influencing Future Decisions
I can think of multiple glaring examples in my career of someone trying to play developer repeatedly because they pulled off one deal. I have seen so many instances where ordinary skills and happenstance luck turn into a lucrative transaction.
The same way everyone has one article they can write, I think every real estate person with a license can stumble into a development deal—it’s repeating the process under dissimilar and arduous conditions is what separates the tactically prepared from the inept that are blinded by arrogance. Those that are foolishly ambitious let one deal inflate their ego, do not examine how luck or shrewdness factored into their accomplishment and believe that they pulled off something they can easily replicate.
Delusional replication of a one-time event is a spell that inept thinkers will inevitably fall under. They feel that they pulled this off due to a recent uptick in their intellectual capacity, that timing and market conditions will stay on their side and that they’re pretty damn smart all of a sudden (Pew Pew Pew!!!)
They emulate successful developers, allocate their recently earned capital to a new exciting project, do not have the skills, dedication, reputation, relationships or expertise to pull off this more challenging and less teed-up venture. They ultimately go back to their previous jobs/lives with their tails between their legs because a self-planted minefield inductively obliterated their longstanding relationships.
Solution: Learn from your accomplishments and forget them immediately, they are fleeting, and seriously, no one cares. I was a pretty good high school basketball player who gives a sh**. Those who dwell on the past are inherently reactive, and even though situations can be similar, the underlying dynamics never conform as much as one would like. If we assume scenario conformity, we are vulnerable to surprise maneuvers from competitors and unforced errors.
5. OverpaID + Skinny Deals + Overleveraged = Disaster
No matter how smart you think you are variables got their name for a reason. Unless you ordered a new real estate crystal ball from Amazon last week (they already sold out I think), deal occurrences will typically not pan out the way you envisioned. When negative and unexpected situations manifest, and you have no dry powder in your musket, that is when you lose. That means a lender event, hopefully you only lose your original investment and your lender doesn’t have recourse.
Solution: It’s straightforward, the best developers that I’ve learned from play home games and stick to their guns. By that, I mean that they don’t shoot outside their kill box. If the return is decimal point too low, they need to reduce their risk or present the deal to a different party, potentially decreasing their financial gains, but hedging their risk. No matter how tempting, they don’t pull the trigger and kill the deal.
There is an income-producing asset I am observing that I think will be a disaster for the developer. They knocked down a perfectly good building, drastically overpaid and their pro forma drove the rents, not market conditions. It’s a building with a façade of strong Tenants that I think are inherently weak. There is one secure tenant, but the lease expiration is ticking down like the doomsday clock. A few of their tenants feel like Paper Tigers, and even a piece of origami can knock over a domino and trigger a chain of events.
In my opinion, the developer won’t be able to sell, it will begin to hemorrhage decimal points off his bank account and if there is recourse, he will be dealing with creditors, judgments and attorneys for years. When a lender event occurs or this the property trades, I will provide a full update.
Real estate entrepreneurism isn’t about vision, numbers or raw intellect. It’s about reasonable mental intelligence, market intelligence, emotional intelligence and relational intelligence. Enmesh yourself with the astute, dynamic and honorable.
Scenarios of financial duress are on the horizon, there will be winners and losers when cash is called in, and the recourse boomerang strikes. Don’t be the guy in this video.
Things will change, shift and sometimes implode. Out of the ashes, new opportunities for growth will arise. After all, you can’t have real estate development without real estate redevelopment.