Table of Contents
Acknowledgments v
Introduction ix
The game 1
Using numbers in real estate 13
From concept to commitment 44
From commitment to closing 82
Syndications and REITs 108
Development 145
Operations 191
The harvest 225
Back to the game 238
Appendix A Note on property types 259
Appendix B Commercial real estate due-diligence 293
checklist A back-of-the-Envelope Glossary 299
Index 318
Reading Group Guide
1. Why invest in real estate in the first place? What makes it different than investing in stocks and bonds?
2. Why is investing in real estate more personal, more people dependent than other traditional forms of investment? Why are there so many off-the-wall "personalities" involved in this field?
3. What's "back of the envelope" analysis, and how can it help you evaluate and price a property?
4. Where do you get the money to buy a building?
5. What else do you have to worry about when you're buying a building? What can go wrong?
6. How do positive and negative leverage affect your decision-making?
7. What's in a lease, and why?
8. Why do developers usually run out of money? How can you avoid running out of money?
9. Why do construction bids usually come in over budget? How can you avoid blowing your construction budget?
10. How are the private, institutional, and public markets for real estate different, how does one gain an advantage over the others -- and what does this mean for you?
11. How do you maintain your property while still meeting the financial expectations of your banks and investors?
12. What's so tough about timing the real estate cycle? Why doesn't everybody do it?
13. Do property owners have social and aesthetic obligations? If so, who defines them?
14. What constitutes "success" in real estate -- not only for your company, but also for you?
Forewords & Introductions
This is a book about the real estate business, and how you can increase your chances of being successful in it. The book explains, in simple terms, how you can take advantage of emerging opportunities in the property market when the capital markets -- and the world in general -- are going through dramatic changes. It should help you whether you're buying a small apartment house, or are involved in a large, multi-use project.
The Real Estate Game uses the analogy of a game to capture some of the complex and unpredictable interactions of the real estate field; it also lays out the "rules" that shape the game. It identifies the key players, and how they play their parts. It also follows the game through the distinct stages of a property's life cycle, from the initial conception of a project to its "harvesting." It uses a series of recurring case studies to illustrate key points -- and, I hope, to make the concepts more human and interesting by placing them in a practical, real-life context.
The book also draws on my experiences as a teacher and a practitioner in the field of real estate. For the past three decades, I've taught the real estate course at the Harvard Business School. This is an elective class for second-year students, which means that since they don't have to be there, they must have some enthusiasm for the field.
In the initial class session, I try to do two things with their enthusiasm. First, I try to temper it a bit. I tell them that real estate is not for everyone. If you want to be a passive coupon-clipper, real estate is not for you. If you're not interested in paying attention to a plethora of small but important details, in getting your hands dirty, in mixing it up with a wide range of people, then real estate is almost certainly not for you.
The other, somewhat contradictory thing I try to do with their enthusiasm is to encourage it. I've been in real estate for four decades -- I tell them -- and there is no more interesting, stimulating, or exciting field in which to make your living and your career.
It's a field where you can make a difference. For example, on a local level, you can build something that is architecturally significant, that makes a neighborhood better, that creates wonderful and humane spaces in which people can work or play. You can get to know all about how your city or town works, and use that knowledge to make good things happen. You can work extremely hard to create something, and at the end of that process, you have the sheer delight of going inside that thing and walking around in it. This concreteness, this immediacy, had great appeal for me when I was a young Harvard MBA, and still does today. My sense is that today's students are equally drawn to this aspect of real estate.
Going up a few levels, from the micro to the macro, you can change the way a city or an entire region operates. You can make deserts bloom. You can create new investment vehicles, and steer huge amounts of capital in innovative new directions.
To simplify greatly, today's real estate world consists of two mostly separate universes. One is the universe of individual properties managed by local firms and financed by means of a project-specific mortgage. The other consists of the large, mostly public real estate investment and service firms operating nationally, or even globally. These firms manage dozens (or even hundreds) of properties, often in a range of property types and markets.
No matter which universe you inhabit (I tell my students), you are very likely to work with all kinds of interesting people. Often, you will work with them in unexpected, antihierarchical ways. Not long ago, I was talking on the telephone with a prominent elected official from a nearby state when an emergency call came in from my plumbing contractor on line two. I told the politician I'd have to call him back.
Real estate is also exciting because it brings together all sorts of specific activities under one roof, ready to be managed by skilled professionals. At the Harvard Business School, we refer to this as the "general management" track. If you don't think you'd relish several decades of working your way up the ladder in corporate accounting, for example -- if you would rather try your hand at doing and managing a broad range of activities, or at least managing the people who are performing those tasks -- then real estate may be a good choice for you.
If you are seeking financial reward, real estate can be a very good game to play. But to succeed you have to play it well, especially when larger trends turn against you. This requires flexibility. Entrepreneurs in real estate (as well as in other fields) are often narrowly focused on their specific opportunities. As a result, they often lose sight of the macro-environment, which can sometimes turn hostile indeed. The number of real estate moguls tends to wax and wane as larger economic trends either favor or don't favor the industry. In 1988, in a good phase of the real estate cycle, 87 members of the Forbes 400 were described as having made their money in real estate (up from 48 in 1983). But on the down side of the cycle, in 1993 there were only 32 real estate moguls. Five years later, the number had dropped to 27.
And as a last thought in this opening section: if you enjoy taking risks, real estate may not be the best game for you to choose. In my experience, real estate entrepreneurs don't perceive of themselves as great risk takers, but instead as risk managers. In fact, they believe (rightly or wrongly) that they can calculate and deal with the many types of risks inherent in most real estate projects. One thing I hope to do in this book -- in addition to identifying opportunity -- is to help you spot risks, develop strategies for coping with risks, and assess whether those strategies give you both enough protection and an adequate return.
Aiming at Usefulness
Most existing real estate books don't help the professional who wants to be involved in -- or at least understand -- real estate. This book attempts to be different. It is designed to help you, personally, make decisions in real estate, by showing how successful practitioners actually think about and solve problems. Alternatively, it is designed to help you understand the decisions that other professionals are making at every stage of the process, and what might be motivating them. I hope this will make the book interesting and useful for people in allied professions, such as architecture, public-sector management, banking, law, and construction.
This book won't qualify you to take the real estate board examinations in any state. It won't make a technocrat out of you. Another point that I make to my students, and that I'll make in this book at regular intervals, is that real estate doesn't require a great deal of specialized education. Common sense can carry you a long way. Yes, there are concepts that one has to understand, such as the math skills that you will call upon almost every day in your professional life. But if you have mastered introductory algebra, you have all the training you need to do the kinds of "back of the envelope" calculations that are necessary for success in real estate.
But even the simplest calculations can be dangerous. Why? Because you still have to make the right assumptions, which is part of what this book is about. For example: Let's say you take a ten-year spreadsheet and assume that rents will go up by 5 percent per year, and at the end of ten years, you're going to sell the property at a very favorable capitalization rate and make a lot of money. Sounds good, right? Everyone should play this game!
But have you taken into account all of the problems you're going to have just getting the project going? Are you really going to end up owning that property for the full ten-year period? And what level of interest rates and inflation (or deflation) did you plug into your spreadsheet calculations?
As in most fields of business, you can make the projections come out any way you want. Most people want their projects to happen, and therefore jigger the numbers to fit -- either consciously or unconsciously. Most people, too, make the assumption that whatever is true today is going to be true tomorrow. In the real estate game both of these assumptions can be fatal, and yet, they're made all the time. As my colleague John Vogel (at Dartmouth's Tuck Business School) likes to point out, real estate is an industry characterized by ten-year cycles and five-year memories.
War Stories vs. Case Studies
The following pages will include a lot of what might be characterized as "war stories." I prefer to think of them as case studies, used to illustrate what can go right (and what can go wrong) in real estate. Sometimes I will cite my own experiences in the real estate field, mostly to clarify a specific point. It seems more appropriate to highlight my own numerous missteps than to beat up on my colleagues and competitors.
But when the examples are particularly instructive, I will also invoke the lessons of some of the biggest players in real estate in this century. Bill Zeckendorf, for example, was one of the most creative and productive developers who ever played the real estate game. He gave us Kips Bay in New York City, Mile High City in Denver, Century City in Los Angeles, Place Ville Marie in Montreal -- and eventually had most of his properties taken away from him. It's important to understand what Zeckendorf got wrong (for example, getting too far out in front of reality and overleveraging his properties), as well as what he got right (a vision of the future of our downtowns that was uncannily accurate). We've recently seen more or less the same phenomenon replayed at London's Canary Wharf, developed by the ambitious Reichmann family of Canada.
In addition, I will draw on what I've learned through teaching real estate at the Harvard Business School for more than thirty years. One reason why I chose to teach at the Harvard Business School in the first place was that HBS emphasizes the use of cases in the classroom -- small "slice-of-life" stories about real people in real business situations (although sometimes the identifying particulars are disguised). In my experience as a teacher, the case method preserves the true complexity of business situations, including real estate deals. It prevents me and my students from reducing real estate to a simple problem set -- in other words, a simplified collection of standard techniques to employ and punch lists to check off.
The case method also allows me to adapt the course quickly in response to changing conditions or emerging topics of interest. For example, we have recently added cases on projects in Mexico, Russia, and China. We have tackled new housing options. We can (and do) accommodate rapidly evolving markets, changing tax policies, and dramatic restructurings of financial institutions.
In some cases, the players are disguised to allow either more complete candor, or a gathering together of several themes into one composite story. I'll take the same approach in this book, disguising certain individuals involved in specific deals. This seems only fair. They didn't know, when they went into business with me, that they would wind up in a book one day.
I have tried to write The Real Estate Game less like a rule book and more like a friendly guidebook to an interesting, sometimes exotic land. I will help you spot the foreign in the familiar, and the familiar in the foreign. I will help you avoid some of the pitfalls into which some of the most prominent people in real estate have fallen -- some of them more than once.
My belief is that learning to be a "value investor" -- that is, buying at the right price at the right time, and finding creative ways to enhance the value of what you own -- is the best long-term strategy for real estate. How to make this work in practice for you is the main theme and purpose of this book.
I will debunk some of the truisms that you may have heard about real estate. For example: It's really not just a narrow focus on "Location, location, location." Instead, I'd say your rule of thumb ought to be something like, "Learn the dynamics of how locations change, and figure out how that knowledge can help you buy and sell properties."
And yes, changes in capital markets influence the behavior of real estate players. But what is important is that you have a choice as to whether you want to follow the crowd.
I'll constantly recommend taking a broader perspective. For example, I think real estate is as much about people as it is about property. It's people who add value or subtract value in the real estate game -- whether by design or by accident.
And people are only one of the many factors that can make the difference between success and failure in real estate. In the following pages, I'll introduce you to many more such factors.
Copyright © 1999 by William J. Poorvu and Jeffrey L. Cruikshank
