What Game Are You Playing?
When I was growing up, my favorite board game was Monopoly®. You know, the game with the 1900s capitalist wearing a top hat? The point of the game is to buy properties and charge the other players rent while using some combination of luck and negotiation skill along the way. Come to think of it, this is kind of what I do in real life. This reminds me of the four types of games to play in real estate.
1. Speculator
Speculatorsare known for their love of big risk and of big reward. There are many ways to speculate in real estate, but an example of one of the more popular games would be to buy a beach condo in a new high rise with the hopes of selling the contract for a profit beforeactually closing on the unit. This can work wonderfully during boom times, but the problem is most people—including myself—do not know when the boom times will end. Another example is buying vacant land in the path of population growth. I typically ask myself a few questions before making a purchase:
· There are much smarter buyers in this market; why am I so lucky to buy this deal?
· Is this to make a quick buck or can I add value to the property?
· What is my competitive advantage that I hold over other buyers in the market?
History has shown us the speculator’s strategy can produce huge rewards. But the problem is hope and luck will only take you so far. Most speculators start right back where they started: zero.
2. Developer
The second interesting game is development. It can produce large profits and provide abig ego boost with all the press andsocial media attention. When done right and in the proper market timing, this is the best strategy. The problem lies in a little concept known as “market timing.” It takes on average 36 months from architectural plans to the day a tenant can move in and start paying rent. A lot can change in 36 months. An added wrinkle is the fact that most cities are becoming more averse to new development and will make life generally hard. Ask a developer about“impact fees” and just wait for a 10-minutetirade on the state of local governments. If a professional can go bankrupt on development projects, what can happen to the average Joe who has a great idea? Sam Zell deserves a spot on my Mount Rushmore of Real Estate Investors as one of the all-time greats. He has amassed over $5B in real estate over his career and has done exactly two ground-up developments in 50 years. I think that says something.
3. Buy Stabilized
The third game is buying a stabilized property. The property is typically at least 85% occupied with tenant(s) on multi-year lease(s). Typically, a high net worth individual or group understands the value of commercial real estate and wants a passive-style investment. They typically will buy this from a real estate entrepreneur or developer. It is a relatively easy game to play. It is also highly competitive at price points under $2 million and above $10 million which drives down returns. This can be a great game, but it is wise to understand the basics like replacement cost and market rent so that you have a margin of safety should the tenant ever vacate.
4. Buy Value-Add
Finally, we move on to the value-add strategy. This is the most interesting game to me. If done right, it is a low risk/high reward game. A new owner can buy the property with tenants in place, paying rent, but because of deferred maintenance, the property is not performing to its full potential. Value can be added by rebranding the property and through cosmetic upgrades like new signage or paint. This gives the asset a new “lease” on lifeand because these assets can be purchased at fifty or sixty cents on the dollar,the owner can make a tidy profit.
It is important to know what game you are playing, and just as important that you do not become distracted by the games other people are playing.
