Ten (Not So Obvious) Predictions for 2019 in Real Estate

Only foolish people try to predict things.  Well, actually, that is not true.  Smart people make continuous outrageous predictions.  When they are right – which happens by chance to pretty much everyone at some point – they crow about how prescient they have been.  When they are wrong – which usually happens way more than 50% for most predictors – they rely upon either (i) the fact that everyone will forget what they predicted or (ii) a revisionist claim that their prediction wasn’t really a certainty anyway, or what they meant was…..

Anyway, with that predicate, here is what The Real Estate Philosopher predicts for 2019 in real estate:
 
The Choppy World Markets Will be Great for Real Estate:  With wild swings up and down in the market – political uncertainty – the media loving and swirling controversy as much as possible – and fear and greed vying for control – a nice safe cash-flowing asset class will look very attractive.  I predict that cash-flowing real estate will do great.  However, projects with risk will have increasing difficulty attracting debt and equity capital.
 
For the First Time in Years Opportunity Funds Will See…..Opportunities:   Yes, I predict that the really long wait is finally going to be over.  The years of no deals or few deals or just wishing there would be deals is finally going to end.  There will be opportunities at last.  These will be generated by troubled deals that don’t provide sufficient cash flow to be attractive to those fleeing the uncertain markets.
 
Opportunity Zones Will Continue to be Hot:  I have written about this before so I will devote but little space to it here.  I will just reiterate my prediction that capital will flow here eagerly. Indeed, the more the stock and other markets gyrate, the more capital gains will be created, which are tax fodder for these deals.  The tricky spot however will be the fact that opportunity zone deals are by definition “development” deals, and as I noted above there is going to be increased difficulty attracting capital to deals of that ilk.  All of this will require creative structuring (to provide investors the tax upside with as much protection against development downside as possible) and – dare I say – lawyers who understand development, tax, and opportunity zone deals and who are not afraid of intellectual challenges.
 
Opportunity Funds Will Become Big Players in Opportunity Zones:  A second point vis a vis Opportunity Zones is a prediction that Opportunity Funds will become major players in Opportunity Zone deals.  They just don’t realize it yet.   Indeed, we have a perfect structure for this.  I have been talking about it a fair amount but so far I admit no one has actually done it yet.  Any day now…..
 
Auction Funds Will Hit the Real Estate World:  Yes, of course…..hmmmm…..what is an Auction Fund?  Few know right now but I think by year-end this will become a significant force in the real estate fund world.  In a nutshell, it is a creative way to provide liquidity to investors in real estate private equity funds that is backed by NASDAQ and blessed by the SEC.  This concept is just starting out so I would stay tuned here.
 
The Tokenization of Real Estate Will Become a Real Thing:  Right now it sort of sounds like a mixture between millennials and bitcoin, but I think this is going to be a “big thing” over time as it will eventually provide great liquidity to real estate. 
 
If the Bubble Pops it Will be Bad for a lot of Disruptor Wannabees:  Okay, this is hardly a prediction since I start it by hedging with the word “if”.  So I don’t count it – happily I have “ten” other ones so my headline is still accurate.  But I will say that “greed” can turn to “fear” in the blink of an eye.  Once that happens, all that ridiculously plentiful cash seems to vanish with the speed of an egg-timer.  Real estate tech companies with an expiration date vis a vis their burn rates will go belly-up or be bought for a song by bigger players or shrink dramatically.  Real estate players with projects that need more capital than they have will either be seriously distressed or pay for that money at exorbitant rates (see above about Opportunities for Opportunity Funds).
 
Co-Living Will be Ready for its Close-up:  So far it has mostly been all about co-working and co-living has lagged because it is a lot trickier to pull off.  However, I think you will see some major things happening in this space this year.
 
Creative Players Who Are Willing to “Create Value” Will Outperform Those Who Are Not:  This is an old theme of mine but I think it will become more and more obvious that with the continued instantaneous flow of information it will become harder and harder to take advantage of market opportunities that are based on lack of knowledge of others.  Instead, economic outperformance will have to be based on people thinking of ideas and angles to “create” value.   Peter Drucker points out that the “purpose of a business” is to “create customers,” which requires innovation.  It is the same in real estate and this will be more and more critical in a choppy market.  For investors, I urge you to look to invest with parties that have something more creative than just “looking for good deals” and for those who are doing deals, I urge you not to sit by and wait for brokers to call but instead “create” the deals and thereby capture the value yourself.
 
Retail Will Remake Itself but Not in The Way Many Expect:  Everyone is talking about the “experience” of the customer in the store – or the mall – and my sense is a lot of retailers are spending a lot of money on upgrading the customer’s experience.  Sorry, I don’t think that dog hunts that well.  For coffee, yes I love the Starbucks friendly “experience,” but if I am shopping for blue jeans, I can’t imagine how the “experience” will change my shopping habits, except maybe once I might go into a store if I am curious about the fact that they serve me some mint tea while I try on the jeans.  I think what will “work” for retail is the good-old Power Niche.  My prediction is that retailers with something they own – through a brand or a Power Niche – will do great – Amazon and Walmart and mega-players with pricing power from sizing will do great – and parties spending time and money creating an “experience” will be wasting their money. 
 
Choppy Markets Will Bring Out the Best and Worst in All of Us:  Everyone says “my word is my bond” in an up market.  I mean it is pretty easy to be honorable when it just means you are accepting upside.  It is when things go wrong that we will once again learn – or re-learn – who we should be doing business with.  I hope – but not sure I can predict it – that those who showed their honor and integrity during the Global Financial Crisis (now ten years ago) will be rewarded with deals, investments and upside during this go-round.
 

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!