How To Out Perform in the Real Estate World

I start my thinking with a book I read by Howard Marks (of Oak Tree fame).  The book is called The Most Important Thing: Uncommon Sense for the Thoughtful Investor, and gives a good deal of thoughtful investment advice from a long-term successful investor.  By the way if you buy his book because of my article I think I get a penny from Amazon.  Just sayin…..

Anyway, Marks asks a question at the outset of his book, which is ‘do you want to outperform in the first place?’

Of course you want to outperform you might say, but that answer is very flawed.

In order to “out”-perform what must you do?  The answer – as Marks points out — is both obvious and at the same time quite worrisome:

You must be ‘different’

You must take a – huge – chance in not following the herd.  You have to be different or by definition you will do the same as everyone else and thereby not “out”-perform.

And – like it or not – if you are ‘different,’ there is a chance you will outperform and there is also a chance you will underperform.  This is mathematically tautological.

Now consider the implications of this in your organization.  Does your organization – or its clients – tolerate failure?

What happens if you outperform?  Probably a bigger bonus or economic upside.

What happens if you underperform?  Is it loss of your job, loss of your clients, going out of business?

If the downside of underperforming is worse than the upside of outperforming, then – obviously – you should not try to outperform as it is just plain old foolish.

So, therefore, the first thing one must do is decide if you want to take the risk and try to outperform or play it safe.

Marks makes this point in his book as well – that a company should decide up front if it wants to try to outperform or not.

And to be clear, there is nothing wrong with trying to be average.  Consider that Warren Buffett tells all of us (dumb investors like me) to just put our money in an index fund.  We are not striving to outperform –we seek to be average.

To conclude this first part of my article, if you want to try to outperform and your organization will not tolerate underperformance, then you should quit and go to another place with a different risk/reward tolerance.

So, now that you have decided you do want to outperform how should you do it?  Here are my thoughts – some of which have appeared in prior articles:

  1. Be ‘different’ – as stated above.   You simply cannot do what everyone else is doing.  And boy is this scary.

  2. Avoid the four classic food groups of real estate – those are almost by definition destined to be average.  Unless you have a special angle (i.e., you are ‘different’ within the four food groups) you will end up average on a long-term basis.  Perhaps if you really do this type of investing ‘better’ you might move the needle a little bit in the outperformance direction but I suspect not that much.

  3. Don’t try to time the market.  Sooner or later you will get nailed.  This is just long-term gambling.

  4. Build a Power Niche.  I won’t get into it here, since I have spoken about it so much in prior articles, but the essence of a Power Niche is creating something ‘different’ and ‘owning’ it.  It is the only thing I have really seen that is likely to drive outperformance on a long-term basis.  Strangely, most people just won’t listen to me here or if they do they just cannot understand what a Power Niche is.  Or even if they do they won’t spend the time to build it.  And the irony is that it is so easy to do.  If you want to talk about this in depth, feel free to give me a call.

  5. Cultivate a way of thinking that when ‘everyone’ tells you that you are wrong or stupid or worse that this means there is a decent chance you are really onto something.  I have done this myself.  It is almost like a bell-weather for me.  When everyone gangs up on me, saying ‘Bruce you have lost your marbles!’ that is a sign that I either have a brilliant idea or a really stupid one.  At that point, I dig deeper to hopefully keep the brilliant ideas and dump the dumb ones.  I mean who would build a law firm based on a hedgehog that stands for love?  Somehow I didn’t do too badly with that idea – an idea that everyone told me was ‘insane’ at the time I came up with it.

  6. Finally – I am putting below my list of “don’t’s” in driving long-term performance that I put in my previous article.  I think most of those ideas are useful to the goal of outperformance so it is good to have them all in one place.

I hope this is helpful and I wish everyone reading this the best of success.


The Real Estate Philosopher’s List of Don’t’s for Long-Term Real Estate Investment

Don’t do the following:

  • Don’t let the animal spirits in the market change your underwriting.  Those clients who tell me mournfully:  “Bruce – I haven’t done a deal in over a year,” don’t let that push you to do something foolish.  Not doing deals is a bummer – doing a bad deal is a terrible, awful, horrible bummer that you regret for the (sometimes many) years you are stuck dealing with it – not to mention what it does to your long-term track record.

  • Don’t try to time the market.  You just can’t do it.  The goal should be long-term value creation knowing that in the short run market swings will help or hurt you.

  • Don’t put yourself in a high-overhead situation where you are pressured to do deals that are not good ones

  • Don’t rush off to different geographies if the market you really know gets too expensive.  This is consistent with Warren Buffet’s admonition “If you can’t run your own business successfully it doesn’t make sense to then enter a new business you know nothing about.”

  • Don’t ‘hunker down’ – I would never advocate that as it implies you are trying to time the market based on the theory that it is too high now and it will go lower and of course you will know just the right moment to jump in.  Of course keep on looking for good deals, which are harder to find and/or require different intellectual capital to unearth.

  • Don’t sit by and let the brokers be the ones creating the value.  Instead of hoping brokers – or others – will call you with deals, I advocate that you be the one who “creates” the deals by figuring out a market – an assemblage – a change of use – or another way to “create” the value in the deal.

  • Don’t fool yourself into thinking that it is better to chase higher yields with higher risk.  If you do this, you haven’t really changed the risk profile of your business – it is really the same thing in the end in terms of expected upside.  The goal, of course, is to take advantage of situations in which the risk/reward does not balance but instead tips in your favor.

  • Don’t continue to do what you have already been doing.  The definition of insanity – we all know – is doing the same thing again and again and expecting a different result.  If doing the same thing day after day doesn’t result in deal flow, then try something else.

  • Unless you have a special strategy, considering avoiding the (four?) basic real estate food groups.  Everyone is looking at them and it is doubtful you will find a great risk/reward there right now.

  • Follow the view that “competition is evil,” so avoid competition as much as possible.  As Michael Porter (and other great thinkers emphasize) it is much more important to be “different” than to be “better.”

Double Trouble – We’re In A Massive Bubble

Of course, it is hard to know if one is truly in a bubble until after it pops.  And even if you could be sure that you are in a bubble, it is impossible to know when it will pop.  I am considering the signs of a bubble in wondering if we are in one now…..

The crash is now ten years old – does anyone remember anything about it other than how it was really smart to buy at the bottom?

Tax reform makes us all think that money will rain from the sky – and with a $1.5T tax cut, maybe it is raining money?

Bitcoin just hit $14,000 – I mean $16,000 – I mean $19,000 – and most people investing in it don’t really know what it is.  As an aside – and so I can be a humbug – I mentioned in my last Real Estate Philosopher article that if you wanted a good gamble, Bitcoin was a good place due to the Wave of Money still cresting out of countries with difficult political situations.  I admit I love when I’m right…..I hereby am not making any prediction about Bitcoin except that it is going to continue to be fun to read about it every day in The Wall Street Journal.

Stock markets keep hitting records and almost ‘never’ have corrections.  Does anyone even remember when the last bear market was?

Elon Musk keeps getting billions of dollars for money-losing businesses and every time things get worse he just says we’ll invest in something else and the stock goes up.  Somehow Tesla is worth more than Ford or GM.  Really?

For Amazon, the latest article says it will be worth a trillion dollars next year – and, as I have mentioned in prior articles, after one subtracts stock based compensation Amazon has never made a penny.  I think that without the cloud side business, it has lost an awful lot of money, and continues to do so.  It is disrupting the real estate world because it doesn’t have to make money.

Unicorns – supposed to be mythical beasts – are now roaming all over the place, including populating the real estate world.  Most of them lose money and have never made money.

Uber is supposedly worth $60B and (I think I was told) loses money on every trip – and it seems like a lot of parties are now going into the same business.  Indeed, little dinky companies like GM and Ford are going to compete with Uber.

Money gets raised for all sorts of things.  People are eager to invest in startups.

Economists are bullish – I think unanimously bullish – no better indicator of a bubble than that.

Interest rates are still ridiculously low.  No one – and I mean no one – dares to even predict interest rates will ever rise again.  They are permanently low- right?

Everyone knows that the key to success in life is just put your money into index funds and ‘no matter what’ never sell.  Indeed ‘buy on dips’ has been the rallying cry, and only suckers sell any more.

Tax cuts for businesses will propel the stock market dramatically higher.

Employment is at all-time lows but somehow inflation is tame.

Overall there is greed and not fear in the markets.  I mean I admit it myself – I feel, well, “greedy.”  I “feel” like buying Bitcoin and have to restrain myself not to actually do that.  When someone pitches me a tech startup, I “feel” like investing – and, full disclosure, I just wrote a pretty big check only a few days ago into a tech startup.

Also, when I read about a hot stock I “feel” like buying it.  And when a client approaches me about investing in a real estate deal I “feel” like saying yes.

Warren Buffett’s admonition is timely:  “Be greedy when others are fearful and be fearful when others are greedy.”  I bet Warren Buffet is fearful right now.

I ask you as you read this – are your investments in the black?  Are you eagerly looking for the next deal?  Are you stretching your underwriting standards just a bit?  Instead of distressed deals (your original business model), have you now ‘evolved’ to plain old ‘good’ deals?  Or have you further ‘evolved’ from ‘good’ deals to ground up development in order to hit your investment hurdle goals?

Do you remember what happened in 2001?  Many of us got caught up in the idea of investing in companies that didn’t make money.  It happened in early 2001 – Barron’s ran that famous report that showed all of the internet stocks and their cash burn and how many months they had left.  That made clear that the various emperors weren’t wearing any clothes and only about 90 days later it was all over.  Billions of dollars up in smoke and mirrors.

What I always find fascinating is how fast fear turns to greed and greed turns to fear.  If there is a selling panic going on and someone yells ‘this is the bottom’ – then everyone piles in.  And if things go up too high and someone makes clear this is the top, there is a selling panic and everyone piles in there too.  Have you seen the movie Trading Places?

This applies at market tops just as well when someone yells ‘look out below!’

Any day, any week, any month, any year, greed will turn to fear.

Okay, so if I am right, what will happen in the real estate world when greed does actually turn to fear?

The obvious answer is that those who got too far out over their skis will be hurt and those more prudent will not be hurt as bad.

So, I say to everyone “stick to your long-term game plan.”  And don’t do the following:

  • Don’t let the animal spirits in the market change your underwriting.  To those clients who tell me mournfully:  “Bruce – I haven’t done a deal in over a year,” don’t let that push you to do something foolish.  Not doing deals is a moderate level bummer – doing a bad deal is a terrible, awful, horrible bummer that you regret for the (sometimes many) years you are stuck dealing with it – not to mention what it does to your long-term track record.

  • Don’t try to time the market.  You just can’t do it.  The goal should be long-term value creation, knowing that in the short run market swings will help or hurt you.

  • Don’t put yourself in a high-overhead situation where you are pressured to do deals that are not good ones.

  • Don’t rush off to different geographies if the market you really know gets too expensive.  This is consistent with Warren Buffet’s admonition “If you can’t run your own business successfully it doesn’t make sense to then enter a new business you know nothing about.”

  • Don’t ‘hunker down’ – I would never advocate that, as it implies you are trying to time the market based on the theory that it is too high now and it will go lower and, of course, you will know just the right moment to jump in.  Of course, keep on looking for good deals, which are harder to find and/or require different intellectual capital to unearth.

  • Don’t sit by and let the brokers be the ones creating the value.  Instead of hoping brokers – or others – will call you with deals, I advocate that you be the one who “creates” the deals by figuring out a market anomaly – a non-obvious assemblage – a change of use – or another way to “create” the value in the deal.

  • Don’t fool yourself into thinking that it is better to chase higher yields with higher risk.  If you do this, you haven’t really changed the risk profile of your business – it is really the same thing in the end in terms of expected upside.  The goal, of course, is to take advantage of situations in which the risk/reward does not balance but instead tips in your favor.

  • Follow the view that “competition is evil,” and avoid competition as much as possible.  As Michael Porter (and many other great thinkers emphasize) it is much more important to be “different” than to be “better.”

Before this article gets too long, I will end it with a lesson I recall reading after the 2001 market crash.  It was in Barron’s, I think, when someone wrote a piece saying:

“We should have listened to Warren Buffett”

This time around, I don’t counsel hunkering down, but I do counsel not getting sucked in.  Bubbles always pop at some point.

Since I always say one shouldn’t make predictions and then do it anyway, I will make a prediction about what will happen to real estate when the bubble does eventually pop:

Development projects that are in mid-stream will get nailed; however, my sense is that, generally, commercial real estate with cash flowing assets will not get hit that badly and will be one of the ‘best’ places to be when the tide goes out.

The Wall of Money Pouring into U.S. Real Estate – Is It Slowing or Growing?

Almost every day – or at least every month or so – another country’s leadership announces restrictions on money getting out of that country.  There can be various reasons for this.  Sometimes it is just that they don’t want capital flight – and other times it can be that the leadership needs the money of wealthy people in order to fund other initiatives, i.e. Venezuela, Russia, and, most recently, Saudi Arabia.

Certainly, if you are in a country that has announced initiatives to control outflows of capital or is under autocratic rule, it is likely that you would be trying to figure out how to get your money out of the country to a safe location.

What about other countries with autocratic leadership that have not – yet – announced capital controls or wealth confiscation?  Wealthy people are more likely to be attuned to world events and world risks.  So one would think that people in those countries would be starting to think that it might not be the worst idea to move money out, ‘just in case…..’

And what about countries that don’t currently have autocratic leadership but might have such leadership in the future if political events turn out a certain way.  Maybe citizens with wealth in those countries might be wondering too.

And oh yes – let’s not forget wealthy people in countries with leadership that is just fine, but with stagnant economies.  There are fewer places they can send their money as, by definition, they will be excluding all of the autocratic countries I just mentioned.  If they send their money into these places, they might not be able to get it out.  Once again, I see the money flowing right here.

And finally, what about great countries where wealthy people just want to diversify.  The result is the same as the preceding paragraph.  There aren’t a lot of choices.  And, yes, again, more money flowing to the U.S.

In some of these situations, money will flow here quite legally and properly.  However, in other situations – the first few mentioned above — the odds are that those with wealth to protect would be thinking about how to move their wealth legally, but if not legally, then likely illegally if they have no really good alternative.

Money leaving autocratic – and non-autocratic — nations and flowing towards the U.S. is obviously nothing new, i.e. it has been going on for years; however, my belief is that rather than a wave cresting, it is, if anything, gaining in strength.  Yes – my view is that the wave of money coming towards the U.S. is growing and not slowing!

What does this mean for U.S. real estate?

I see two things:

First – it would point to continuously rising prices, especially in gateway U.S. cities.
Second – it would point to a lot of shady transactions and attempted shady transactions.

What should real estate players do?  Two things:

First – don’t let this wall of money pushing up prices push you away from your good underwriting.  The fact that other players are making a rational choice to overpay – based on their political circumstances, should not push U.S. real estate players to overpay when we don’t necessarily have those political circumstances.  Said another way, don’t fall prey to the greater fool theory that because prices are rising for the foregoing reasons it means that the underlying value of the item in question justifies its price.  And said still another way, the wall of money flowing into the U.S. pushing up prices will come to an end at some point, at which time the pricing could fall precipitously.

Second – in view of my prediction of increased efforts of frantic wealthy persons in other nations trying to get their money out, and the obvious benefits to third parties in assisting them in doing so, I suggest increased scrutiny of who you are dealing with.  In this regard, I suggest that U.S. real estate players be “over-careful.”  So called “know-your-client” and other protections should be increased.  It is never worth it to take a risk of breaking U.S. laws to capitalize on this otherwise potentially beneficial situation.  And, to belabor the point, turning a blind eye by pretending not to see something that has a funny smell to it, and hoping it will be ‘okay’ to claim ignorance if the matter is later challenged, doesn’t work either, as when it all comes to light everyone’s reputation is burned and sometimes irreparably.

Third – ‘if you can’t beat ‘em, join ‘em.”  What I mean by this is that in a gold rush the people selling picks and shovels always do well.  This means that U.S. real estate players with the reputation and ability should consider working with the foreign money in an advisory, co-investment or other similar capacity.  To be clear, I am not advocating taking advantage – I am advocating the opposite; namely, being an honest U.S. teammate to help the foreign money be invested safely in U.S. real estate in a win/win manner.

That is my philosophizing for today.

A last thought – if you feel the need/desire to speculate, maybe buy Bitcoin.  Jamie Dimon is no fool and he said the following about Bitcoin:

“If you were in Venezuela or Ecuador or North Korea or a bunch of parts like that, or if you were a drug dealer, a murderer, stuff like that, you are better off doing it in bitcoin than U.S. dollars,” he said. “So there may be a market for that, but it’d be a limited market.”

So if my theory that there is a wall of illegal money exiting autocratic regimes, it may result in pushing up the price of Bitcoin.

To be clear I am NOT advocating buying Bitcoin – and I don’t intend to buy it myself – but it might be a fun ride for the pure thrill of gambling and not having to fly out to Las Vegas.

Platforms – The Flavor of the Month In Real Estate Investing

In the old days a sponsor found a deal to buy a real estate asset and called up a financial party (either a fund or other institution).  They would form a joint venture and purchase the asset and that would be that.  Of course those – relatively simple – deals continue today; however, more and more we see clients entering into a more long-term relationship.

Here are some (philosophical?) perspectives on the various types of relationships that can ensue between sponsors and financial partners.  Since I have been (happily) married for over thirty years — and therefore know nothing about dating — I thought I would relate my thoughts here to the dating process.

The first level is the one I mentioned above, i.e. the sponsor finds deals on a one-off basis and when she finds a deal goes around to money partners until one is interested.  Then they form a joint venture and close.  I would call this casual dating since no one is obligated to do more than the single deal at hand.

The second level is what is often called a “programmatic relationship.”  This is where the sponsor and the financial partner enter into what we called a “Deal Production Agreement”, although there are other names for these types of arrangements.  Basically this means that the sponsor will seek out deals and give the financial partner “first dibs” on the deals.  Often the financial partner asks for exclusivity (or at least the first look) and sometimes the sponsor asks for the financial partner to pay part of its overhead or pursuit costs in return; however, these issues are typically heavily negotiated on both sides.  By the way, sometimes there is no agreement at all and the parties just handshake that the sponsor will show the deals to the financial partner and they will try to work together.  I would say this is like going steady (for old-timers) or being “in a relationship” (for people in the middle) or “making it Facebook official” (for the millennials).

The third level is a formal agreement to form a Newco, which is a joint venture between the Sponsor and the Financial Partner.  Newco will be used to do new deals, with typically Newco forming a special purpose subsidiary for each deal.  The Sponsor will pre-agree to post a certain (smaller) percentage of the capital needed for the new deals done by Newco and the Financial Partner will agree to post the rest.  There are quite a number of important issues to be negotiated in these types of arrangements since the parties are really joined together.  For example, are deals “crossed?  Can the Sponsor do the deal without the Financial Partner if the Financial Partner disapproves the deal?  How much discretion does the Sponsor have?  What if the Financial Partner just doesn’t fund any deals what can the Sponsor do about it?  How does the promote split work – does the Financial Partner get its pro rata share of the promote or some smaller amount; does the Financial Partner pay a promote or not?; does the Financial Partner participate in the payment of fees or receive a portion of any fees?  Going back to the dating analogy, this is like moving in together, but you aren’t really married yet – with the added twist that, when you move in together, you invariably need to think about how much you want to share and how much you want to keep separate.  But, at the end of the day, in a program, typically each party keeps its own business and if there is a divorce they are (moderately) easily able to go their separate ways.

The fourth – and final – level is typically called a “Platform Investment.”  To start off with our analogy, this is truly getting married.  In these types of deals, the Financial Partner invests directly “into” the Sponsor or, alternatively, just purchases the Sponsor whole-hog.  Often the theory is that the Financial Partner will have access to everything the Sponsor does plus the ability to recapitalize existing deals plus a share of promotes and even fees.  In return the Sponsor now is more credible in the market with the real backing of a major financial player.  Often, these transactions are used to set the stage for an eventual IPO and/or to grow the sponsor’s business.  Sometimes the goal is to have the now-recapitalized Sponsor raise a fund, using the Sponsor’s reputation and the Financial Partners financial backing, and sometimes the goal is just to do future deals as a team.  These deals are very intricate and involve significant negotiation.  There are numerous issues but some of the big ones are the valuation of pre-existing deals and whether and to what extent the Financial Partner participates in pre-existing promotes and future promotes, the split of fees between the Sponsor’s principals and the Financial Partner, the allocation between fees and promotes where the Financial Partner has different participation rights depending on the income stream, the nature of incentive compensation arrangements, the ability to reinvest funds into the business, the extent of future funding obligations of the Financial Partner or Sponsor, the ability of the Sponsor to raise additional capital from alternative sources, corporate loan facilities, discretion and decision-making, buy-out rights, the terms of an eventual unwind, and the degree of non-compete that the Sponsor’s principals will have to agree to.

Duval & Stachenfeld is right in the middle of all of this.  And what we are seeing is a gradual gravitation from the simpler deals to the programmatic to the formation of Newco’s and all the way to the platforms.  Indeed, we are seeing more platform deals than we have ever seen before.  My sense – as I survey the real estate industry – is that Financial Partners are fearful of being locked out of the “good deals” if they are not right in on the ground floor with a high-quality sponsor seeking those deals.  Correspondingly, the Sponsors are fearful that if they don’t have credible and real financial backing they will not be able to compete for the “good deals” as the sellers will gravitate towards buyers who have the ready cash to be able to perform.

Now for the sales pitch part of this – sorry……

At Duval & Stachenfeld, we have an entire team of lawyers that have dedicated their careers to corporate real estate transactions.  Our Corporate Real Estate Group consists of over 20 lawyers and is one of the largest of such practice groups anywhere.  But, unlike the corporate groups of most of our peer firms, our Corporate Real Estate Group focuses exclusively on real estate transactions, and this translates into a distinct competitive advantage for our clients in the area of corporate real estate because, put simply, we understand how real estate businesses work from top to bottom!

Notably, over the last five years, our Corporate Real Estate Group has spearheaded some of the most high profile transactions in this space including the formation of several up-and-coming emerging manager and operator platforms, the recapitalizations of several name-brand existing platforms, the launch of new business-lines by marquis managers through the formation of multi-tier joint venture or other arrangements for the establishment of new programs, and a host of other transactions (the list of which is too long to summarize).

Finally, there is one additional piece of information that is crucial to why the Corporate Real Estate Group at Duval & Stachenfeld is different from similar groups at our peer firms.  The practice– and in particular the practice in the specialty area of programmatic and platform arrangements – fits seamlessly with our core business model — which is “to help our clients build their businesses.”  Put simply, if you are considering any of the above transactions it is great to call us for two reasons:

First – of course we know how to do the necessary legal work – as it is our core specialty

But second – we have a wealth of counterparties – Sponsors and Financial Partners – many of whom are looking for high-quality counterparties to team up with through casual dating, going steady, moving in together or even getting married.

So if you are planning to team up with someone in the real estate world, please feel free to reach out to our Corporate Real Estate Group.

The Latest Bubble

Here are further thoughts about Amazon and its effect on the retail world, which I have named “The Amazon Retail Distortion”.  See the article I wrote in my last Real Estate Philosopher.

I note that roughly fifteen years ago – in mid 2001 – Barrons wrote a perceptive piece that, in one article burst the internet bubble.  It pointed out that no matter how many “eyeballs” internet companies were getting, almost all of them only had a few months left of cash to burn and if they didn’t raise more money by then they were broke.  And so it was.  Between three and six months later virtually all of these companies disappeared in a puff of smoke.

Of course, I am not Barrons, and I don’t see Amazon going bankrupt any time soon, but I continue to wonder when the Amazon bubble will burst.  When it does there will certainly be a mass celebration in the retail world.

Consider my last article where I made the point that Amazon has been given a now twenty-year gift from Wall Street and investors that it doesn’t have to make money.  And this still continues, incredibly.

Their last quarter – which came out after my last article – put them at breakeven or worse when taking out stock based compensation and losing significant money if their cloud business – which has nothing to do with their retail business model – is excluded.  Indeed the article I read said they made 40 cents a share (for a stock trading at $1,017 a share), they expect somewhere between a small loss or a small profit next quarter, their income fell 50% from last year, and their operating costs were increasing.  The same article – incidentally – mentioned that Jeff Bezos was temporarily the world’s richest man…

Face it – Amazon makes no money in retail!

Yet retailers that used to make money – or are making money – are getting clobbered by it.

My – continued and reinforced — view is that Whole Foods will reveal the lack of clothing of Emperor Amazon.  Consider a recent Wall Street Journal article entitled “Amazon Rewrites Rule Book for Grocers.”  The second paragraph starts with “while Amazon doesn’t need to make money from its grocery division yet, food sales are crucial for traditional players like Kroger, WalMart and Target….”  Seriously?  Amazon doesn’t have to make money on food but WalMart does?  Seriously?

And then a few days later what appears to be a “shocking” headline that Amazon is lowering some prices at Whole Foods crushes grocery stocks.  Again, I ask, seriously?

Whole Foods is known informally as “whole paycheck” and is struggling, so they lowered some prices.  Gee – wow.   I looked at the article and the price changes on some vegetables wasn’t enough to change my shopping patterns.  Amazon’s (brilliant?) strategy in groceries is to take on experienced behemoth players in a razor-thin-margin business and lower prices against WalMart?  Seriously?

If you are going to bet on WalMart – which makes something like $15B in cash a year — versus Amazon – which makes nothing – and you bet on Amazon, your bet has to be based on one thing; namely, that it will continue to have a free pass on making no money in its core business.

My last article generated a lot of responses – some favorable and some implying I had no clue.  The ones telling me I had no clue mentioned that a huge percentage of Americans use Amazon and they are brilliantly run, etc.  My response is that even if that is true, Amazon is still losing money or at least not making money.  Plus, I don’t know why the fact that you use Amazon to buy a book has much to do with groceries.

Maybe the theory is that someday, once they have put all the retailers out of business they will have a monopoly and raise prices then?

It is a lot like my partner coming in and telling me about a new client that wants our pricing so low that we are losing money.  He then says to me “Bruce, don’t worry, we’ll make it up on volume!”

I reiterate my prediction that Amazon’s ability to destroy the retail world is based on mis-placed hype and an irrational stock market valuation.  I do have to admit though that irrational stock market valuations can persist for a long period of time.

My advice to retailers is the same as in my last article:

  • Don’t freak out – this is a temporary phenomenon – albeit a long one – it will end at some point, and I think pretty soon.  Sooner or later someone more respected than me – like Barrons maybe – will poke at the same hole in Amazon I am poking.

  • Set up your business so that you can survive until the Amazon Retail Distortion ends.

  • Perhaps follow the other suggestions in my previous Real Estate Philosopher articles; namely: (i) don’t try to be “better” than others and instead try to be “different” from others, (ii) sell only exclusive branded goods in your store, (iii) consider yourself as much in the distribution business as the retail business, and (iv) don’t go nuts setting up expensive structures to enhance the consumer’s “experience” in the store, which I bet will get old awfully fast and be intensively expensive and difficult to maintain.

For An Edge In Real Estate Investing, Follow The Talent

My law firm has an internal message called “ATR”.  It stands for:

Attract, train and retain talent!

For a law firm it is the whole game.  Clients sometimes leave or even get merged or go out of business; however, if you have a high-quality legal product you can always get more clients.  If, on the other hand, you lose your talent – i.e. your lawyers – it is game over – because you have nothing left to sell.  Also, once the talent starts to leave it is like a run on a bank and almost impossible to stop.

So we focus relentlessly on this message internally.

Also – I can’t resist a very dramatic movie quote from a movie I like called Rock Star.  In the (dramatic) scene the band is shouting at each other and breaking up.  Mark Wahlberg – the lead singer – walks out angrily.  The remaining band leader turns to Jennifer Aniston and offers that even without Wahlberg she can still manage the band.  Aniston replies:

“There is one rule in the music business and that is ‘follow the talent.’  Well all the talent in this band just walked out the door.”

Aniston leaves and the movie unfolds and I won’t spoil what happens with more about it here….

In any case, I have been wondering whether that is what real estate investors should be focusing on when they determine where to invest?

Consider an obvious situation unfolding now – Hartford versus New York City.  Aetna – a long-time stalwart in Hartford – just took the step of going to New York City for its top brass – and it is big news.  Why did they do that?  Obviously New York City is a place where the top talent already is, and wants to go, and stays.  Even after 9/11 the talent didn’t leave.

Hartford is known informally as the insurance capital is of the US.  But – I genuinely mean no offense – for many people Hartford is not as attractive a place to live as New York City.  Does this mean that other insurance companies will follow Aetna’s lead?  Can they compete with Aetna without also being in New York City – or another place that would attract top talent?

Hartford is a lot cheaper than New York City, but where would you want to invest in real estate right now?

I made this point in my “Brexit and London and Talent, Oh My” article, where I took the position that London would be just fine post-Brexit, because London is a cool and exciting place where the talent just wouldn’t want to leave, so one way or another London would be just fine.  So far – a year later – that seems to be the case.

I made this point eight years ago in the depths of the financial crisis – when I was giving a speech to my firm.  They will no doubt recall how afraid we all were.  My speech said effectively that New York had nothing to worry about since the talent wasn’t going anywhere – indeed, where was the talent going to go after all?  I don’t like to be a humbug (that much), but I was certainly right about that as New York has continued its position as the global center of finance, and much more.  This is all because the talent has stuck around.

Indeed, our ATR message is one for cities – and you regularly see them competing for businesses that will attract jobs for talented people.

And you even see the ATR message for countries now, as they try to prevent their talented citizens – especially the wealthy ones – from leaving.  Indeed, sometimes they compete a bit unfairly, by making laws stopping you from leaving.

My point is that ATR is – or should be – the message for just about every organization – every city – and every country.  See also my article, “Why Are You in Business” from November 2016, which was my ‘first’ Real Estate Philosopher article, where I suggested that ATR should be a focal point for just about any organization.

If you follow my thinking, then a real estate investor that is considering where to invest should add to its demographic due diligence a Talent Analysis, which analyzes whether talented people are coming or going.

How would one do this?   I admit I don’t know.  Certainly just reading local news articles for the past three to five years would give insight.  And I bet the predictive analytics types and the tech people could come up with programs and heuristics to figure this out too.

In any case, that is my recommendation – before investing, do a Talent Analysis of the jurisdiction in which you are investing.  And if the jurisdiction (A) isn’t trying hard to do ATR and (B) isn’t succeeding in ATR, then just don’t invest there.

By the way – as an aside – for all those who think NYC is crazily overpriced, I wonder if your pricing determination takes into account a NYC Talent Analysis?

How To Beat Amazon

I have been reading all the articles about Amazon buying Whole Foods and how that ends the grocery business for everyone else, including Walmart.  And beyond that, it also means the end of retail since Amazon could buy other retail companies too.  From the articles it sounds like “game over” for not only groceries but all of retail.  This seems like kind of defeatist thinking.

So I was thinking about how one could compete with Amazon.   Here is how to do it….

First – let’s examine why Amazon is so hard to compete with in the first place.

It is brilliantly run for sure – but so are many other companies.

It has a dominant place in many markets, with a super-strong distribution network, etc, but it has one amazing thing going for it and that is that, for reasons no one can satisfactorily explain to me, Wall Street determined long ago that Amazon doesn’t have to make money!

I am certainly very impressed with Jeff Bezos, but I think this was just an (incredibly) lucky break.  I don’t think this break was due to Bezos’s amazing skill or Amazon’s incredible business model.  He just got (incredibly) lucky.

Look at the other major tech stocks that are consistently held up next to Amazon; namely, Google, Microsoft, Intel, Facebook, and Apple.  They are all the same except for one HUGE difference – the others are all printing insane amounts of money.  But Amazon barely breaks even after you take out stock-based compensation and the billion or so it is getting from its cloud business (which does actually make money).

For example:

  • Apple will likely make about $50B this year and is worth $750B

  • Amazon is on pace to make about $2B this year and is worth $450B

Seem a little funny to you?

So how do you compete with a company that doesn’t have to make money when your company has to make money?  It is like competing with the government isn’t it?

There is a simple plan that I espouse, which is to just wait a bit longer…..

My thinking is that buying Whole Foods is going to be a disaster for Amazon.  This is because, for the first time, it is going to be obvious that the Emperor’s core business model is not wearing any clothes.

Instead of just fulfilling orders and taking a cut – and loving every minute of not having to make money to have a high stock price – Amazon is now embroiling itself in one of the most brutally competitive businesses in the world and taking on the strongest competitor in the world; namely, Walmart and a fair number of other established players as well.  These players are not a bunch of patsies – they know the groceries business super well, which has razor-thin margins and has to be run pretty close to perfectly to make a profit.

In addition, Amazon is taking on a struggling business in Whole Foods.

This acquisition is not a layup for Amazon but a very poor risk/reward in my assessment.

My proposition is that Amazon will do well with Whole Foods only as long as Wall Street continues to give it a free pass not to make money.

And what happens if Whole Foods proves to be a major burden on a company that has never actually run a retail company – not to mention a groceries company.  At minimum a major distraction for management.  At maximum, maybe a further drag on the relatively small earnings……

In my assessment, what happens next is Wall Street – which is all of us who buy and sell stocks one way or another – and which can be so fickle as we all know – will start to wonder “why is it that a company that cannot make any money is worth close to half a trillion dollars?”

After twenty years of not making money – in its core business – for Amazon, investors might conclude that maybe they should put their money into business models that actually make money – and not put their dollars into a company which is dramatically over-valued by customary valuation metrics.

What happens then?

Suddenly, Amazon and Bezos – and Whole Foods – are judged just like everyone else.  The stock goes down to a normal number.  I have no idea what that number is, but certainly a lot less than it is today.  Maybe a company that is growing at 20% a year and earning two billion dollars might be worth, say, $40 billion?  Yikes – that is about 10% of what it is trading at now.  But I am just musing here.  My point is it would be an awful lot less.

At this point Amazon would have to actually make money in its core business, which means that – just like everyone else – Amazon will have to charge more money and do the same things retailers are doing.  At this point the Amazon-based distortion of the retail world, which I will call the “Amazon Retail Distortion”, will finally be over.

So I suggest that your game plan, if you are a retailer competing with Amazon, should be the following:

  • Don’t freak out – this is a temporary phenomenon – albeit a long one – it will end at some point – and Whole Foods might be the beginning of that end

  • Set up your business so that you can survive until the Amazon Retail Distortion ends – and yes get your costs as low as possible and your business run as efficiently as possible.

And consider following the other suggestions in my previous Real Estate Philosopher articles; namely: (i) don’t try to be “better” than others and instead try to be “different” from others, (ii) sell only exclusive branded goods in your store, (iii) consider yourself as much in the distribution business as the retail business, and (iv) don’t go nuts setting up expensive structures to enhance the consumer’s “experience” in the store, which I bet will get old awfully fast and be intensively expensive and difficult to maintain.

Am I right here?  I guess we shall see.  However, I do wish the retailers the best of success.  I run a real estate law firm and certainly know how emotionally draining it is to have business go up and down dramatically.

Also – this is my hobby as well as my job.  If you are running a retail company and struggling and want to brainstorm with me, just call me!

A Twist of the Dial to Rescue Troubled Retailers

In the last issue I wrote about retail and made the point that retailers should stop being about “retail” and be about “brands” that are “exclusively” sold in their stores.

To refresh, my point was that “retail” is merely a place – a location – where someone with branded (or unbranded) goods sells their wares to the public.

Retail is therefore a classic “middleman”.  And what does the internet do to “middlemen?”  It destroys them – or at least eviscerates their profit margins.

Retailers are trying everything possible to save themselves, which is admirable; however, I suspect most efforts will fail.  For example, the flavor of the month is for retailers to try to make the “experience” wonderful for their visiting customers.  Sorry – I just don’t see this.  Even if it is just so much fun to visit the new Widget Store, how many times are you going to go there for the “experience?”  Maybe twice and then it is just shopping and then you will care only about getting the brand you want at the lowest price.

However, I have another thought that may be a powerful one.  It may sound like just a twist of the dial in thinking, but sometimes rethinking the nature of the business you are in can be the catalyst for all sorts of unplanned upside.

Consider a major asset of what classic retailers have going for them?  They have locations!  And these locations are typically near people, i.e. customers.

Yes, the value of a “location” is in flux due to the technological disruption of the real estate world; however, location is still a critical factor and likely will be for some time to come.

So, pretend you are a classic “retailer.”  What should you do?

I would suggest you re-think your business and change your understanding of the “purpose of your business” from “retailing” to, instead, being “a distributor of branded goods!”

And I would add to that concept – if possible – a distributor of branded goods that are “exclusively” found in your store.

Now this may sound like just semantics, but I think it is a lot more than that.  If you look at some of the most successful businesses, they succeed because of their distribution network.

Indeed, this is part of Amazon’s magic.  Based on my thorough research – one click on Google – it appears that Amazon has about 100 “fulfillment centers” nationwide.  Sears/Kmart has I think about 1500 stores.  And many troubled retailers have networks with even more locations.

If (some) retailers rethink the purpose of their stores as essentially “fulfillment centers”, they may have a dramatic advantage – even over the likes of Amazon.  At this point I don’t see retailers thinking this way.  Meanwhile, Amazon keeps on increasing its fulfillment centers because Amazon is really in a lot of ways at heart just a distributor.  If no one wakes up to this it will soon be “game over” with Amazon winning.  But it really doesn’t have to be this way.

This re-thought business model – where a retailer’s many existing locations are essentially distribution outlets/fulfillment locations for branded goods – works neatly with:

  • The internet – i.e. the magic of having locations near people plus availability on the web.

  • The brands themselves – how many brands would make an exclusive deal with a retailer that has, say, 2000 stores near its customers nationwide?

  • Saving a fortune by not spending a ton of money on enhancing the shopping “experience”.  Instead of the experience, which costs a fortune and is incredibly hard to do in multiple locations – consider the much lower employee training time and cost for a fufillment location – all you do is put the stuff on a shelf in a “fulfillment” center and let the customer take it.

  • Saving a fortune with fewer employers.

  • Saving time and trouble with less focus on customer service and all the other accoutrements of classic “retail”.

  • Indeed thinking this way, might just be a major relief to retailers struggling with all these problems how to make their stores “better” to compete with a third party in a world that may not care about that in the first place….

As you peel away the onion, I am sure there are a lot of other ideas that flow from this that I haven’t thought of.

To sum up:  If you are a classic retailer, consider changing the essence and purpose of your business to be “Distributor of [Exclusive] Branded Goods”.

Hearkening back to my Power Niche theme – if properly effectuated, this mode of thinking would take a retailer from a weak position to a Power Niche position.

Retail Is Dead – Long Live Retail

The retail world is in turmoil.  That is nothing you don’t already know.  I will not bore you with the 100 or so articles on retailers closing and all of the negative press in the retail and real estate worlds.  Instead, I will give you my (philosophical) thoughts as follows…..

I start with a question as to what, in a big picture sense, is “retail” anyway?

It is a place – a location – where someone with branded (or unbranded) goods sells their wares to the public.

  • Retail is therefore a classic “middleman”.

  • And what does the internet do to “middlemen?”

  • It destroys them – or at least eviscerates their profit margins.

So what is happening to traditional retail?  It is being destroyed.  And the agent of destruction is a company that cannot seem to make that much money itself; namely, Amazon.  It is disintermediating retail and “taking over”; however, it is kind of, well, ironic, that even that company has had trouble making much money (especially when subtracting stock-based compensation).

Incredibly Wall Street – and investors – have decided that Amazon doesn’t need to make money to have a market cap in the hundreds of billions of dollars – but that is a side issue.  The point for retail is that the internet – largely through Amazon – is destroying the traditional retail industry.  Even the behemoth – Wal-Mart – is in the cross-hairs of this disintermediation.

But the “death of retail” has been largely exaggerated.  Indeed, I think that instead of the destruction of retail there is going to just be a dramatic industry shift as follows:

I would start the analysis – like I often do – with Michael Porter – the Harvard Professor who is a worldwide authority on competitive advantages.

Porter says don’t try to get “better” than your competition.  Instead try to be “different” from your competition.

From my analysis of Porter I have come up with the concept of the “Power Niche.”  This is a phrase I have coined that advocates developing pricing power in a small niche market – as opposed to having no such pricing power in a broader market.

Yet it seems like many – doomed – retailers are doing the opposite of what Porter (and I) recommend.

For example, there seems to be a rush to improve:

  • Efficiency

  • The “experience” of the customer

  • And a bunch of other things of similar import

I think overall these ideas will go nowhere because they are just making the retailer “better” and the laws of perfect competition – as exemplified through Amazon – will just grind on and on with this inexorable race to the bottom of profitability.

Instead, there is an easy way out for many – but not all – retailers and that is to just shift the dial from being a “retailer” to being a “purveyor of exclusive branded products.”

If you are a “retailer” who is selling something you can buy at Wal-Mart or Amazon or pretty much anywhere else you have zero competitive advantage.  If however you are selling Spiffy Jiffy Blue Jeans that can “only” be purchased in your store, and nowhere else, you hold all the cards for the customer who wants Spiffy Jiffy – there is nowhere else to go.

Does this mean you win?  No, of course not.  But now you have a fighting chance.  Instead of a race to the bottom of profitability you are now in the business of building a brand.  As one of the greatest investors of all time –Warren Buffet – has said, he buys brands because they permit the owner of the brand to sell the product at an above-market price for an extended period of time.

The brand is therefore the thing.  It is the “Power” in the “Power Niche” (if you are thinking like me) or the “being different instead of being better” concept (if you are thinking like Porter).

So to sum up:

I think traditional retail is close to dead and dying.  There will be a few survivors which are the low-cost producers – like Amazon and Wal-Mart.  Most of the other traditional retailers will go the way of the dodo.

However, branded retail (with exclusivity) is just getting started and I think will do very well over time.

For real estate players, if you buy my thinking, the analysis is easy; namely, look at the retailers in the buildings you are buying, lending on, leasing up, etc.  Ask, do they have Power Niches?  Are they selling branded exclusive products?  Or are they racing Amazon to the bottom of profitability.

Is Real Estate Becoming A Service?

Real estate just became its own separate asset class.  However, ironically, that may have occurred just at the moment it should have been morphing more deeply into other asset classes.

Don’t get me wrong, as a real estate professional I am very happy about real estate being named as its own investment class; however, it is worth taking stock of what is actually happening around us and its implications.

So far we have the disaggregation of real estate persisting in numerous directions, such as:

  • Co-working

  • Co-living

  • Crowdfunding and similar concepts to democratize real estate investing

  • Airbnb

  • The implications of self-driving automobiles

These are the obvious ones.  But roaming beneath the headlines is a slew of real estate players with different business models, with more being imagined and created every day.  Here is a quick list of some I know of:

  • LiquidSpace – Network for office space where startups and growing teams connect directly with real estate owners, operators and companies that have space to share.

  • Opendoor  and Nested – Offer simpler and easier ways to sell your home

  • Breather – On demand access to private spaces across the U.S. to be used as temporary working spaces.

  • Spacious – Uses restaurants during off-hours as co-working spaces for paying subscribers

  • Roam – Network for global co-living spaces and co-working spaces when you travel – providing everything you need to feel at home and be productive at your chosen destination

  • Remote Year – allows you to travel around the world while still being able to work remotely

  • Common – Manages shared living spaces

  • Storefront – Finds temporary retail or event space in the best neighborhoods

  • Fundrise – makes quality real estate investments available to everyone

And this list just scratches the surface as there are more and more things going on every day.  I certainly don’t know everything and even if I did, there are likely a bunch more things about to happen that I have no idea about, .i.e. to paraphrase Mr. Rumsfeld, “unknown unknowns.”

I have been wondering whether there is a way to make sense of all of this.  And the conclusion I have reached is that just as many people have been wondering whether they should really own a car when they can just rent or use one — through services such as Zipcar and, eventually, self-driving vehicles – I wonder whether people will reach the same conclusion about real estate?  I mean why own a house and why rent space under a long-term lease if you don’t have to make that kind of economic commitment and get pretty close to the same benefits without such a commitment?

What this means is that real estate may transform from a thing you buy to a service…..

Consider these thoughts……
Living space that has co-living and robotic movable walls (already in development) whereby a single room can morph from a bedroom to a kitchen to a party room to a study.

Restaurants that have a breakfast brand – a lunch brand – a dinner brand – and a swinging nightspot brand.  There are logistical issues; however, ultimately with the right cosmetic changes you could see that coming.

Retail stores that are one store on one day and another on another day or at another time of day.  Of course, there are devils in these details but you could see it coming.

Offices that are shared.  I guess we already have that.  At first it was companies like WeWork.  Then it was competitors to WeWork.  And now it is landlords themselves putting these spaces into their buildings without leasing to a WeWork or a competitor of WeWork.

Houses and homes that are like hotels and used and rented out.  I guess we already have that too.

Transient living uses that are being invented, largely under the concept of co-living.

Liquid space – Airbnb – and so much more

For some time, I have been idly thinking and wondering about this concept, but without really putting the intellectual pieces together.  Then I read a very insightful article by Mr. Dror Poleg entitled Don’t Think of a Building, Understanding Technology’s Threat to Real Estate Owners, Operators and Asset Valuations, where he synthesized my nascent thoughts better than I was able to do.  He makes the following points about how real estate is morphing:

  • “Space is broken down into smaller value units, allowing end-users to pay only for the specific components they wish to use — as desks, meeting rooms, bathrooms, beds, etc.”

  • Time is broken down, reducing the minimal commitment required from end-users to as little as 30 minutes — shifting profits to those who can secure large spaces “wholesale” and lease them out “retail” in smaller sizes for shorter periods of time.

  • Incremental use (smaller spaces, shorter periods) gives rise to dynamic pricing models.

  • Equity is broken down, enabling smaller owners to share their financial burden with other small and medium investors.

  • Visibility is no longer just about being seen offline. Accessibility is now partly about the ability to book space and other amenities within it on demand. Spaces with “good enough” locations become more valuable through optimized design and innovative marketing.

  • New attributes – community, curation (who else is there?), content (events), value added services, and availability on demand – are eclipsing location and accessibility as the key drivers of differentiation between assets.

So I wonder if real estate is morphing into a service more than an asset.  What does that mean and what should real estate players do about it?  Of course, no one can really predict the future and figure out what is going to happen.  However, I am getting more and more confident that real estate as we once knew it is going to be changing dramatically in years to come

The answer to appropriate strategy would be specific to the different asset classes and investment strategy of each real estate player; however, I will stick my neck out and advocate the following plan of action:

First read Dror’s article – this article – and whatever you can find about new business models in the real estate world.

Second – sit down with a pad of paper and a pen – and no iPhone – and think of what real estate related business you are in.

Then consider whether there is a deeper meaning to what you are “really” doing.  For example, the car companies are now wondering whether they are really in the transportation business?  Is there a deeper meaning about what you are doing that leads you to describe the heart of your business differently?  For example, instead of building houses, maybe you are in the business of giving people a comfortable place to live.

See where this leads you…….

Finally, I do think it behooves all of us (including us lawyers) to be as vigilant as possible regarding these changes because when an industry is disrupted, it is typically much too late to play catch-up once you fall behind.  And I will end with a Bill Gates (famous?) quote:

“People tend to overestimate what will happen in a year and underestimate what will happen in ten years”

I am comfortable in saying that whatever you are doing now, the odds are that you won’t be able to do that in ten years or, if you can, it will not be nearly as profitable.