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.

What is a Power Niche?

One of the most important things for any real estate business and, indeed, any business is a successful marketing program.  Of course in our hearts we want to believe that if we just do something great then everyone will figure it out and be impressed.  But alas, that is just not true.  Indeed, Einstein flunked physics and couldn’t land a job.  And everyone has an example of a super-talented person that ends up just toiling in the trenches for someone else.  Like it or not, the world belongs to the marketers.  And I believe that this will increase more and more over time.  Someone – but I cannot find the exact quote – said something like this:

“The world will increasingly belong to those who create the ideas rather than those who execute them.”

In the real estate world it is no different.  If you have a great “brand” (which of course is built by a successful marketing program) you typically succeed — and the converse.  This is the basic reason why Warren Buffet – arguably the world’s most successful investor – focuses on brands; namely, for their long-term premium pricing power.

So how do you create a strong brand in the real estate world?  The simple answer is that you do this by creative and intelligent marketing.

I have become a student of marketing over the past ten years, including both reading everything I can lay my hands on and at the same time analyzing what works and what doesn’t work and delineating the reasons for success and failure.  After thousands of hours of study, I have come to the conclusion that the secret of a successful marketing campaign and, concomitantly, the essence of building a successful brand (almost) always centers around what I call:

  • a “Power Niche”

This is a concept and phrase I have invented and coined; however, for any intellectuals reading my writings, you will quickly realize I am building on the works of Peter Drucker and Michael Porter and other great intellectual giants in the business world.

As an aside, I note that there are certainly other ways to be successful, such a being the low-cost-producer; however, generally the other angles (including being the low cost producer) are typically much more difficult to effectuate and maintain; however, just about anyone can build a Power Niche.

So what do I mean by a Power Niche?  Here is my definition:

In brief, a Power Niche is a small-sized niche within a bigger industry that no one else yet dominates or owns.  The niche isn’t obvious so you have to figure it out and “create” it.  You step in and learn everything about it and everyone in it.  You tell everyone about what you are doing – incessantly — and become the real “owner” of the niche merely by staking out your homestead in virgin territory.  This then becomes a virtuous cycle as the more you know, the more you do, and the more you do, the more you know.  Before long you are the world’s unquestioned expert in this (smaller) niche.  All of this enhances your bargaining power within that niche.  Instead of begging for business in the bigger industry, you now have eager clients paying you top dollar within this smaller Power Niche.  

A Power Niche is often difficult to identify and at the same time counterintuitive, and indeed kind of scary, but once figured out is very easy to accomplish and can be crazy-lucrative.  Indeed, just about anyone can create a Power Niche successfully.

Indeed, for my law firm, I am a lot better off as The Pure Play in Real Estate Law than I am trying to be all things to all people.  It was surely an unsettling decision, to become the Pure Play in Real Estate Law as when we enacted this we were theoretically scaring off the 99% of clients in the world who are not in real estate.

But consider that in the (smaller) real estate world my firm is a major player.  We are able to know everyone and everything.  This makes my partners and me very useful to our clients in ways that are in addition to “just doing great legal work”.  This of course includes effectuating our mission of “helping our clients build their business” due to our connectively, contacts and industry knowledge.  If I tried to make my firm full service, I would be competing with multi-thousand-lawyer global behemoths and I have no idea how I could convince a client we were the optimal, or even a useful, choice.

In the business side of the real estate world, it is the same thing.  Let me give you an easy example, which is deliberately quite simplistic.  Let’s say you are in the multi-family business.  You do what is called “build-to-core.”  This means that you find locations for multifamily buildings, you get a construction loan and you build a high-quality building.  Then you rent it out.  Simple, right?

However, if your building looks like other buildings, how are you going to make a profit that on a long-term basis will be greater than just average?  You could convince yourself that your building is “better”, but what does that really mean?  Does it mean you paid more for a better location?  If so, your costs are higher and hopefully your rent is higher to make up for it.  Or did you do a better job of building it with higher quality contractors?  Same thing – you paid more and hope to get more rent.  I wonder whether that is really much different from making it cheaper and charging less?  It is two sides of the same coin.  In the short term you are making bets that may or may not pay off.  In the long term, what you are doing is making a product better and hoping to charge more for it because of that.  Indeed, Michael Porter says that the biggest mistake people make in the business world is making things “better” when they really should be concentrating on making things “different.”  And of course that is what I mean by the Power Niche.

So instead of the usual plan (outlined above), what if, for example, you modified the marketing and business plan for your residential real estate company to more narrowly concentrate on the LGBTQ community?  I picked this concept at random but please follow my point through.  What would now happen?  A bunch of things:

  • You would learn everything about the LGBTQ community

  • You would learn what they like and dislike

  • You would target your building towards LGBTQ people (and figure out if in fact they wanted to live with other LGBTQ residents)

  • You would develop intellectual capital at your company around this

And you would build your building to make it one where LGBTQ people would want to go.

You would be building a Power Niche.

Your market would be smaller – much smaller – but if you did it right you would do what Dale Carnegie says in his famous book, How to Win Friends and Influence People, namely, to “arouse an eager want” in the customer.

Would LGBTQ people pay more rent to live in a building that was really about the LGBTQ community in New York City?  Honestly, of course I don’t know that and there is always risk in any new idea.

But this is just the beginning of the Power Niche.  Once it became clear to the market that this was your business’s focus, LGBTQ people would want to work for you.  LGBTQ businesses would want to do business with you.  Advertisers would want to advertise with and through you.  You would find all sorts of opportunities you wouldn’t otherwise see because you would be the “only one” focusing on this.  You would learn more and more and become a font of intellectual capital on the LGBTQ community’s interaction with the residential real estate world.  People would want you to speak at conferences.  You would be the expert’s expert in residential real estate for the LGBTQ community.

If the idea worked for a first building, your next building would be a no-brainer to get investors and lenders and other parties.  And after a while, everyone would be chasing you to invest with you and do business with you.

Instead of trying to be “better” and playing the odds on paying more for a better location, you would be a “brand” that had a small but targeted customer base.

You would have established a Power Niche in the real estate world and as Warren Buffet would presumably like, you would be able to sell your product (i.e., brand) at an above market price for a long-term period of time.

Guaranteed success?  Of course not.  Obviously there are social issues at play here as well (for this particular Power Niche), but I still like it a lot better than the other game plan in “build-to-core”, in which you are a lot more at the mercy of the market.  Indeed, when the market falls apart for multifamily, which place do you think will hold its rental value better?  All the buildings that look pretty much like each other, or the “one” building where LGBTQ people really want to be.

Why Are You In Business?

Let me tell you an interesting story about a professor who teaches a course in entrepreneurship.

He starts his course by reading the notes from the founding partners meeting from the original meeting of the founders (now about 70 years ago).  It goes something like this:

They said that they were going to do something in the electronics field.

The key was to make a “technical contribution” and only pursue opportunities consistent with this purpose, demand people give superior performance (but otherwise largely get out of their way), contribute to the community, and have great integrity.

But the question of what exactly they were going to manufacture was postponed.

In the meeting they considered:

  • medical devices
  • TV Receivers
  • welding equipment
  • an electronic oscillator
  • and even an electronic jiggle machine to help people lose weight.

He would tell his class this and ask them to rate them on a scale of 1 to 10 for entrepreneurship.

The students would give it at best a 3 – blasting these founders for lack of focus – lack of an idea – lack of a market – and lack of just about everything else.

Then the professor would mention – oh, by the way, the names of the founders were Bill Hewlett and David Packard.

The students are invariably stunned.  Are you a little stunned too?

Let me ask you a question – and throw out a proposition at the same time – if you can answer this question simply and easily and positively and powerfully without a moment of hesitation I suspect that you will very likely be – or already are – successful in your real estate business.  And if you can only hem and haw or burble around, I would like to not say you will fail (as that is not very nice) but I think you have an issue that needs to be addressed and maybe you are struggling in the real estate world.

The question is a simple one …..

Why are you in business?

Please take a moment to ask yourself this question.  Why do you go to work every morning?  Why did you start the company you work for?  If you work for someone else why did they start the company?  Do you know?  Do you have an answer that is exciting and thrilling?

Let me dig into this….

…..

There is a great book by Jim Collins called Built to Last.  The book is about great companies – companies that simply crush their competition – and no matter what happens they reinvent themselves and keep on cooking.  Companies like Merck, like GE, like Hewlett-Packard, like Procter & Gamble, like 3M, like Nordstrom, like Boeing, like Wal-Mart.

The core point that Collins makes in his book is that these companies have something special about them that allows them to always find a way to succeed.

I think it is very simple.  They have a core set of values that tells you “why” they are in business.  For example:

Merck – “We are in the business of preserving and improving human life.”
Boeing – “Being on the leading edge of aviation; being pioneers.”
Walmart  – “Exceed customer expectations.
Nordstrom – “Service to the customer above all else.”

These are all inspirations – these are the “why” of these great businesses.  It makes you maybe want to go work there and join them.  And many people of talent did exactly that.  Ultimately, I think that is what propelled them to great success.

Who would you want to work for…..a plain old “aviation company” or a company that has as its mission to be on the “leading edge of innovation” and to “be pioneers.”

To inspire you about these companies all I told you just now is “why” they are in business.

To complete unfolding the mystery of why I started this article the way I started – the real contribution of HP was not the things – the widgets – that they made, but the famous “HP Way” that the founders had “invented”.   This is because the widgets change over time but the HP Way is timeless.

So I think the students should not have been stunned at all.  The HP Way was an incredible invention.

As Steve Jobs famously said to John Sculley in convincing him into leaving Pepsico many years ago:

“Do you want to spend the rest of your life selling sugared water or do you want a chance to change the world?”     

He got Scully to join him because he did not tell Scully “what” Apple does (i.e. make computers); instead, he told him “why” Apple was in business – to change the world.  And he inspired Scully to join him.

…..

If you are with me so far, that “why” is the critical concept, now let’s try an experiment in the real estate world.

Assume you are a real estate development company and someone asks you “Hey, Toby, what do you do?”

What would you say.  Would you tell them:

“We are in the development business.  We take properties that are underutilized and renovate them into more successful properties.  Most of the time when we do this we create real value for ourselves and our investors.  We have an excellent track record.”

Or would you tell them:

“I am in the development business to take underutilized properties and renovate them into more successful properties.  This is because whenever I see a wrongly used piece of property I get this kind of burning feeling that I could make it better.  I can’t help it.  I immediately see things that could be done.  It is a passion with me.  So a few years ago I started this development company to do exactly that.  Our mission is to find underdeveloped or underutilized properties and turn them from something lousy into something that we are proud of, thrilled with, and excited by.  We have done pretty amazingly well – exceeding whatever I thought would happen – and I am proud of that, but the whole key to my business is finding people who share this dream and get excited about our mission.

I ask you, of the two people who answered the same question, who would you want to work for? Who would you want to do business with?  Who would you want as your partner?  Who would you want to invest with?

…..

Ultimately, in order to succeed in the real estate world – or probably any business – you have to attract talent to your organization – including both those who work for you and those who you do business with – and once you do that, you then have to retain that talent.

And in order to do that you need to be able to inspire people.

And the way to inspire people is to let them understand “why” you are in business.

It really works…..

Before I end here, I need to take a moment to give credit where it is due.  Although I am The  Real Estate Philosopher, often I don’t think of some my ideas.  I read a lot – often about successes in other industries – and I learn from others.  Today’s theme, and credit for this article, comes from a great book I read called “Start With Why” by Simon Sinek.

Failure in Business is (Mathematically) A Lot More Likely Than You Think

Sometimes someone tells you something that is so ridiculously obvious but so dramatic to everything you have ever thought about, that it kind of shocks the heck out of you.  So here is something that just sent me for a loop.  It is a certainly philosophical in nature, so that fits in well in this publication – and it concerns the juxtaposition between luck and skill and how the two are intertwined.

Consider if someone has a strategy for starting, growing and succeeding in a business.  His strategy is to be brutally honest with everyone about everything all the time and insist that every single person in the company do the same.  Anyone who deviates – even the slightest – is immediately terminated.

Possibly to your surprise – or maybe not at all – it works!  And it doesn’t just work – it works incredibly well.  It is a runaway success.

By the way, my belief is that there is a company that has exactly this strategy, which is Ray Dalio’s Bridgewater Associates.  Many believe it is an extraordinarily successful hedge fund with an exceptional track record.  On information and belief, the culture just “clicks” for some people who thrive in it and is awful for others who quickly depart one way or another.  It is self-selecting for those who will be optimal for the business.

So what are the implications of this?

Well, others starting businesses might consider whether this is a great strategy?  After all, it worked at one place and that implies it might work at another place too.  But then, let’s do the math……

Let us pretend 100 such businesses were started with this exact strategy.  Most businesses fail, but for the sake of argument, let us pretend half succeed and half fail.

So now we are out in the world with 50 businesses that use this strategy that we know about – that the newspapers are reporting on – and that we can analyze for our determination on optimal business strategies.

But what about the other 50?  We kind of don’t know about them any more since they are just…….gone.  And presumably the reason they are gone is that they used this strategy and failed!

So we are – foolishly, or worse than foolishly – evaluating a business strategy only by looking at the businesses that succeed with the strategy and ignoring those that failed with the same strategy!

How stupid is that?  We evaluate a strategy by only looking at those who succeed with it?

We do this all the time for a very simple reason, which is that it is super easy to find examples of successful strategies, but very difficult and close to impossible to find examples of failed strategies, since the failures just disappear.

I feel entitled to kick myself because I myself fall into this trap all the time.  I eagerly read articles about Google and other great companies and much of the time conclude that my law firm should emulate their (successful) strategies, without considering whether maybe Google – or Ray Dalio – just got lucky.  Maybe 99% of those who try Ray Dalio’s brutal-honesty strategy fail!!!  How do I know?  The answer is I don’t have a clue because I am under-evaluating failure when assessing a strategy.

I give credit for this line of thinking to Michael J. Mauboussin in his book The Success Equation (Untangling Skill and Luck in Business, Sports and Investing).  He is very insightful and, among other things, teaches at Columbia Graduate School of Business.  Also, from my daughter — a mathematics major and neuroscientist working for Google — she says that in the science world this is referred to as a variant of the well-known concept of “selection bias”.

So how does this apply in the real estate world?  It applies just about everywhere.  For example, if you are an investor you presumably have your own investment style and your own manner of evaluating deals, hiring people, putting a team together, etc., but unless you are incredibly arrogant you will naturally look at the strategies of others that have succeeded and evaluate what you think they are doing right for possible emulation.  Have you considered that maybe those parties you are looking at were just lucky and others that tried that particular strategy aren’t around to be evaluated any more?

So what should you do with this knowledge?  The answer is simple – take emulation of successful strategies with a couple of grains of salt.  Maybe the strategy is excellent, or maybe the strategist just got lucky…..

A Tectonic Shift is Happening in the Real Estate World

As you may have heard by now, real estate is set to become a separate asset class on the Global Industry Classification Standard (GICS) and the S&P 500, separating it from the Financials Sector.  Notably mortgage REIT’s will be left behind in the Financials Sector under a newly created sub-industry group called…you guessed it…Mortgage REIT’s.

What are the implications of this?  I think they are dramatic and possibly one of the biggest changes to the real estate investment world since the internet popped up twenty some-odd years ago and made information freely available.

There are a bunch of articles already written on this subject, and almost all of them deal with the effect on REIT’s themselves; however, here I am going to give my thoughts on the effect of this transition on the non-REIT portion of the real estate world.

For background, please click here for some of the articles (that pertain to REIT’s).  These articles make some possibly (obvious?) points as follows:

They predict that a lot more money will now flow into REIT’s.  One of the articles points out that right now the total market cap of REIT’s is about 0B and that another 0B additional dollars will now flow into real estate due to increased real estate investment targets by major investors, such as Norway’s 0B Government Pension Fund.  I suspect there is no real way to quantify this and the number is plucked from thin air, but it does seem like “a lot” more money will indeed flow into REIT’s.

They also predict that REIT’s will become a “have to own sector” for appropriately diversified investors and, logically, REIT stocks will go up.  I will not touch that prediction.

And one of the articles states that it “will increase the visibility of real estate as a distinct asset class and encourage investors, their advisors and managers to more actively consider real estate – especially REIT’s – when developing investment policies and portfolios [and this will] likely lead to the creation of new investment products, such as active and passive mutual funds and exchange traded funds.  Advisors and managers will have more real estate fund options to recommend to their clients, likely facilitating positive capital flows into listed real estate equities.”

Here are my thoughts on the effect of this transition on the non-REIT portion of the real estate world.

First – I hate to be obvious myself; however, I do think that overall this change means that a lot more money will flow into the non-REIT portion of the real estate world.  Real estate will be considered its own asset class and investors of many different kinds will take it more seriously.  Investment professionals will steer their clients into these investments to a greater degree.

Second – I think this will to some extent move real estate closer to a place where, for more parties, real estate assets are thought of by many like “widgets” that happen to be in the general category of “real estate”.  This is because many, new, investors will want some vague concept of “real estate” in their portfolios, without knowing (or even likely caring much) what the underlying real estate really is.  In other words, much real estate will be invested in by parties that have no idea exactly what they are investing in.  I will call these parties, who are buying real estate for diversification of investment reasons, “Diversification Purchasers”.  To be clear here, I do not think Diversification Purchasers are necessarily “dumb money”; instead, they are potentially very intelligent parties who may recognize that they have no real ability to analyze real estate assets and, accordingly, will want a diversified portfolio that includes real estate in it without specificity as to the exact nature of the of the assets themselves.

Third – I suspect that this latest development will “never, ever” change.  Things like this (i.e. real estate now being a separate asset class) never, ever reverse course, so my sense is that this change is here to stay forever…

Fourth – my suspicion is that a lot of money will slosh towards the (perceived) safest part of the capital stack where the theme is (perceived) safety in yields, as this will be the easiest to sell to the Diversification Purchasers.  Returns for core and other income-producing real estate will likely fall if this is the case.  And, since “core” often consists of assets priced for perfection, there is a good shot that Diversification Purchasers will lose money from time to time, even when they think they are buying the safest alternatives.

Fifth – I suspect that this change in asset class for real estate is brought on by interest rates staying so low for so long that real estate, with higher yields, looks better and better by comparison.  Sometimes changes like these are made at exactly the “wrong” time in the market, so I wonder whether this is the bell ringing that interest rates are finally about to go up?  But I don’t dare predict this.  Many people much smarter than me have predicted that interest rates will go up (for sure) over the past eight years and they may be smart, but so far they have been wrong in that prediction.

Sixth – since there will likely be an increase in the number of parties buying real estate without really knowing what they are buying (i.e., the Diversification Purchasers) – and possibly inadvertently paying top dollar for it for diversification – it will make a lot of sense for “players” in the real estate industry to buy or develop real estate and package it for sales to these Diversification Purchasers.  I suspect that this is a good real estate strategy that will become better and better over time.  Sort of an enhancement on “Build to Core,” it will essentially be “Build to Diversification Purchasers”.

Seventh – it will be plain old dumb to compete with Diversification Purchasers.  They simply will have a different motivation to purchase than a sophisticated investor in the real estate world.  Accordingly, if you have a fund that is buying core assets – or assets close-to-core – it will get harder and harder to acquire assets of this nature at prices that are within logical and traditional underwriting, since there will be more and more Diversification Purchasers competing for it.  So, I suggest – don’t compete with the Diversification Purchasers – sell to them or manage their money in a public or private vehicle.  I wonder here whether possibly public non-traded REIT’s will come into greater vogue.

Eighth – it will be more and more important to be “the guy who creates value”, as I pointed out in my earlier articles in The Real Estate Philosopher.  If you can create value, then the products you create will be in more demand than ever from Diversification Purchasers.  However – I think, a bit sadly – the pressure will be on you to “create” real estate assets that fit into the “checked boxes” of the Diversification Purchasers, so innovation may become harder to justify.

Ninth – the companies which are advising the Diversification Purchasers will do better and better.  Diversification Purchasers will logically gravitate toward the biggest and most well-regarded advisors and, in turn, those advisors will be able to increase their market share.  If you are starting a career, this will likely be a good place to get a job.

Tenth – I suspect there will be more and more deals that are huge in size, as more money-manager-type “elephants” that are really financial services providers wade into the real estate area.  They will need to have very large portfolios to provide necessary diversification to their investors.  They will probably not want to acquire these portfolios piece-by-piece, but instead will want to gain control of them in one fell swoop.

Eleventh – I suspect that the regulatory changes sweeping the real estate world will increase significantly.  Over time, as real estate looks more and more like a part of the financial services sector, it will become more and more regulated like the financial services sector.  This will be a good thing for lawyers, compliance officers and other parties who work in this part of the industry.

Twelfth – “average performance” will become the goal for most real estate money managers catering to Diversification Purchasers.  Since the Diversification Purchasers are not (almost by definition) looking to outperform, they will want a diversified portfolio that includes an “average-performing” class of real estate.

These are my thoughts. Of course, I likely will be right in some of them and wrong in others; however, one thing is for sure, and that is that as real estate becomes a separate asset class there will be a significant impact on the real estate world (both the REIT and non-REIT portions).  All of us – lawyers, as well businesspersons – would be well advised to be perceptive about how this will affect our businesses so that we will benefit from the changes afoot, rather than the converse.

Additional Links:

Real Estate Takes Its Place as the Fourth Asset Class

GICS Classification of Real Estate  

Real Estate to Receive Dedicated Sector Classification

Everything You Need to Know About the New Real Estate Sector Coming to the Global Market In September 

Real Estate Strikers Out on Its Own in the Stock Indexes 

Real Estate to Be a Sector on Its Own

Fail Dammit!

I was reading this morning about a superstar Olympic hopeful. A woman named Simone Biles (check her out). She is the top gymnast in the world right now – and the United States has high hopes for her in Rio. During her rise to greatness, she fell a lot (off the balance beam and in other places), but she kept on winning because she kept on doing things – and taking chances — that no one else could do, or dared to try. Maybe she fell a lot because she was pushing the edge of possibility in gymnastics rather than playing it safe. Maybe that is why she is the top gymnast in the world – because she was not afraid to fall – and to fail?

To move closer to the business world, in recent years I followed Ron Johnson’s attempt to revamp JC Penny. He was running a company that had only one certainty and that was that if they kept on doing what they were doing the company would slow and inexorably die off. It was a dead husk of a company that was slowly succumbing to irrelevance and everyone knew it. So Johnson, who had previously started the incredibly successful Apple store, joined up as CEO to try something completely different. He up-scaled the stores and brought in brands and created a completely different shopping experience. The idea ended up backfiring. Customers were lost and it just didn’t work, or at least it didn’t work quickly enough. In other words, it failed! Johnson was fired in early 2013. After that, everyone jumped on him. The media was relentless. The guy who had created the half trillion dollars of value in the Apple store had now blown it with the JC Penney store. Fortune wrote an aftermath article – writers Marty Jones and Susan Kramer — they ended the article with these words:

“It’s impossible to know if Johnson’s reforms could have succeeded but he does leave one legacy: Nobody will be attempting something similar for a very long time”

Wow. Think about this. The company was dying. Someone had the guts to try something new to save it and it didn’t work out. So let’s not only damn him for eternity but let’s publicly humiliate him and, for good measure, make as sure as possible no one ever tries anything like it again. After reading this would you want to take a chance like Johnson did? The downside of failure is so huge!

Consider this basic emotion we have, which is fear of failure and maybe even worse, fear of being humiliated and laughed at. Every time we try something new we have this fear. It is a natural emotion. And if this is what happens when you fail, there is good reason for this fear.

So how would this work in (most) organizations if someone has a new idea that no one else has done before?

First – she would bring the idea to management – to investors – to lenders – to partners. What would they say? Well, in most of these situations, you know exactly what they would say. They would come up with every possible objection. We are all awesome at that. They would poke holes and say “but what if this happened” [as a result of your idea]? We could be laughed at – we could lose money – this could harm our reputation – we wouldn’t be able to get future lenders, partners, deals – or (gasp) it could hurt the vaunted track record we have that we tout all the time and we can’t risk that – etc. The list of concerns would be endless and the more the idea was outside of the parties’ comfort zones the worse it would be.

Second – if she had major guts, she would fight everyone on this. She would point out that the issue is not whether there was a risk of failure, but whether the rewards outweighed the risks, coupled with the probability of a successful or failed outcome. Maybe after a great deal of back and forth, expenditure of political capital, and alienating the most fearful parties (maybe permanently), she would finally get her way.

Keep in mind that she doesn’t know if the idea will work. It is a new idea and by definition risky.

Third – she tries out the idea and – bummer – it flops completely! Now what? You know what happens next. All of the parties involved have different versions of “toldyaso”. They bring it up forever and ever. They roll their eyes. They say they “knew” it was a bad idea. They were naysayers and triumphantly proved right. The humiliation is complete and never-ending. The various people she confronted along the way are pleased, although they might not publicly admit it. Those who supported the idea are chagrined and think “that’s the last time I do something like that.”

Fourth – it gets worse. The person who brought up the new idea will certainly not bring up another one. Even if she had the guts to take a risk of the foregoing again – and how many of us have that much fortitude – she would never be able to win the political capital to make it happen. So she is out of the new ideas game for good. And maybe even out of a job….

Fifth – and to make it worse yet – everyone else who is watching from the sidelines, how are they going to feel about trying out something new? I think we know the answer to that too, and that is that there is no way they would make such an attempt, because the downside of a failed idea is obviously so high.

Now the organization has created a culture of no one ever doing, or even suggesting, anything new! No one ever innovating or trying things out. Certainly no cutting edge thinking will go on at this organization.

So I ask you, does the foregoing describe the company you work for – or the company you run – in the real estate world. We all know the real estate world is changing, and maybe even dramatically, what with all the technological changes and the increasing sophistication of the various counterparties with whom we all deal. No one can afford to have an organization that crushes the spirit of someone with the “guts” to push for trying something new.

As an aside, I note that my point here applies to new ideas as small as trying a new brand of coconut water in the cafeteria fridge to changing the “usual” place you go to lunch to moving your company into a new line of business. Big and small changes always make people nervous and ruffle their feathers.

I came to this realization many years ago for my law firm. If I tried to make my law firm just like all the other law firms, but better – there was only one thing for sure – and that was that we would fail – we would fail slowly – we would never realize why we were failing – we would just slowly go out of business – but the good news is that we would never be embarrassed along the way.

I didn’t like that outcome and decided we would have to try new things, and try a lot of new things, and when we tried them we would certainly fail. Indeed, the list of failures at my firm with new ideas I have tried out is endless. But there were a lot of successes too – and it is now possibly a surprise to many that little firm that few have heard of outside NYC is now one of the largest real estate law practices in NYC.

People often ask me – at interviews and otherwise – what is the secret to my success? How did I get where I am? I always answer the same thing and it is 100% true – that is that for some reason I just don’t mind making a fool of myself. In other words I am happy to try – again and again – and fail!

I can’t tumble like Simone Biles – although I can do a cartwheel – but one thing I share with her is willingness to try things neither I – nor anyone else – has ever done before. The bottom line is that it is awfully hard to have great success without a whole string of solid failures along the way.

So next time someone throws out a new idea at work – maybe timidly – treat the idea with respect. Thank the proponent heartily. When the new idea is evaluated, consider the risk and the reward of the idea, rather than everyone ganging up to poke holes in it. Then when the idea is ultimately tried out and turns out to be a complete flop, throw a party for the colleague who had the guts to try the new idea and make it clear how thankful the group is that she really took one for the team.

And maybe – just maybe – your organization will become one of the great players in the real estate world. Maybe – just maybe – you will always be on the cutting edge and out ahead of your competition, with new ideas that are rewarding to your employees and to the counterparties you deal with.

I will end by noting that John Wooden (one of the greatest coaches of all-time) is famous for saying that the team that makes the most mistakes is the team that is likely to win.

So go ahead – make some mistakes – and fail! Who knows what will happen.

Uniqueness – The Bane of Fundraising

I have seen this time and again. Someone uses their brainpower to come up with a cutting-edge idea for real estate investment. It is a niche (a “Power Niche” as I call it), or a way of looking at real estate that no one has done before. It seems pretty cool, but the lament is that “investors won’t go for it”, so, alas it is just not viable.

If the fundraiser doesn’t just throw in the towel at this point, the next question is whether the fundraiser should “tweak” the business model (or maybe in other words ruin the cool and cutting-edge part of it) so it will look like other investments and thereby become appealing to the target investors; or stick to his guns and try to find investors, even though most prospective investors will not be willing to take the plunge. That sounds kind of terrible too – like the sheepherder throwing in the towel and just deciding to follow the sheep.

As an aside, I don’t mean to imply that the investors who reject the new ideas are foolish. They are not dumb at all. Indeed, the prospective investors are smart to avoid the newfangled investment idea for the simple reason that if they all stick together and perform in an “average” manner, they will remain employed and their lives will continue on (probably happily) as they were before. If, however, they take on the risk of the new idea (and all new ideas have enhanced risk as well as enhanced reward), and it goes poorly, they may be out of a job.

I had been noticing and thinking of this irony – or paradox – for years, but then Todd Zenger wrote a really interesting article in The Harvard Business Review called The Uniqueness Challenge, which explains this conundrum in a very readable and understandable manner. He calls it the “Uniqueness Challenge” and that does describe it very well, as it is always a “challenge” to be “unique”.

I note that my law firm took this Uniqueness Challenge by making the determination to be The Pure Play in Real Estate Law®, thereby taking the enormous downside risk of being different (and unique). We “burned the ships” with this strategy and, fortunately, it worked out exceptionally well. At the time we did it, we were very nervous about it, but now looking at where we stand in the marketplace it seems so obvious – what were we worrying about?

So hats off to Mr. Zenger for his article – it is well worth reading.

Now we have this conundrum—this irony—this paradox. The question is how to solve it. Here is my best shot at it:

At the outset, I wouldn’t tweak (i.e. ruin) the business idea to appeal to investors. That is just like the sheepherder throwing in the towel to follow the sheep – and, in this case, even the sheep would (sheepishly) maybe admit privately that they don’t disagree with the strategy – they just don’t want to take a risk where the risk/reward isn’t to their benefit.

I will – very reluctantly – admit that tweaking/ruining the strategy’s novelty might be the optimal short-term economic strategy, and may result in more immediate fund-raising success. But where is the fun in that? What is the point? Where is the break-out upside? It isn’t there. You are just conforming to be like everyone else.

However, I wouldn’t waste a lot of time on a strategy that is doomed to failure either. If you know that the main investor group just can’t invest in your idea, probably for the reasons I outlined above, don’t spend two years with a fruitless private placement memo trying and failing to raise a billion dollar fund that is doomed to failure or, worse yet, that a Blackstone-type party will do itself if they like the idea. Nor would I use a straight-down-the-middle fund-raising advisor either, as such an advisor would advocate you soliciting the mainstream investors who will likely not be able to say “yes” for the reasons outlined above. Overall, the odds are stacked against you and you could waste two or more years of your life being essentially jerked around and come up empty.

What I would do is approach those who are outside the normal channels, i.e. instead of pension funds, insurance companies, endowments, and similar parties, I would look towards high net worth individuals, family offices, and investment funds that make it their bread and butter to seek alternative investments and that are deliberately set up to not follow the herd. There are a lot fewer of these parties, and the way forward will be tortured, like following a narrow bending path up a mountain; however, I think the chances of success are much higher.

As an outgrowth of this strategy, I would also dial down my fund-raising size dramatically. Instead of visions of billion dollar funds dancing in your head, consider a fund of, say, $25,000,000. All you would want is the bare minimum for a “proof of concept” and an amount you can invest quickly to confirm the strategy is doable. Once you have that, it will likely be a very different story when you go back to the mainstream investors. They will likely change from skittish to eager very quickly.

If you follow this strategy, the only thing you can be sure of is that you don’t know what will happen. However, a strategy where you don’t know what will happen is a lot better than a strategy that is likely doomed to failure (as is the straight-down-the-middle strategy), so mathematically, this strategy is optimal. Also, if things go badly, you will spend a lot less time and money failing.

By the way, if “you” mainstream investors are reading this when you are visited with a Uniqueness Challenge, consider giving the guy presenting to you a break. Maybe this is your big chance to stand out from the herd yourself. Maybe this is a time for you to take a chance too…

If you are a reader of The Real Estate Philosopher and have thoughts on this, feel free to email your thoughts to me and maybe I will put them out in the next article as a follow-up piece.

Finally, if you have an outside-the-box idea in the real estate world that perhaps rises to the level of a Uniqueness Challenge, I hope you will give me a call or shoot me an email. There is nothing I like better than trying to figure out how to make unusual, different and unique ideas successful.

Reinventing The Law Business: An Introduction

By way of introduction, I am the founder and managing partner of Duval & Stachenfeld LLP. We are a 70-ish lawyer law firm in midtown NYC that focuses strongly on real estate; indeed, we refer to ourselves as “The Pure Play in Real Estate Law.”

As managing partner I have spearheaded numerous unique initiatives that have distinguished us from other law firms. Many of these ideas were very scary when we tried them out — there was always a fear that we would not only fail but, worse yet, be laughed at. Some of these ideas did not work out so well, I admit; however, the ones that succeeded have been the fulcrum to attract both lawyers and clients to our firm and indeed been the bedrock of our success.

As a relatively small firm playing with the big boys and girls, one would think that our size could be a disadvantage. But that would be incorrect. Smaller players can be flexible and move in different directions. We can take risks and seize opportunities that large law firms cannot logically capitalize on….

Unless you live in a cave you have seen a plethora of criticisms of Biglaw, how lawyers practice, and just about everything else. People beat up on us lawyers a lot for just about everything. It doesn’t have to be that way. One can run a law firm where both the lawyers and the clients are really happy and getting what they seek out of the relationships involved.

This column will focus on innovative strategies for successfully running law firms — both large and small firms. Instead of just throwing out ideas because I suspect they may be accurate, I will instead give real-world examples and relate these ideas to things that we did that proved amazing and other things that we did that turned out to be failures.

Also, along the way, I will take the risk of opening our strategies up to our competition and I will give my thoughts on how best to succeed as a law firm in this competitive world.

Ultimately, my goal with this column will be to prove a basic point: That to be successful in the law “business” one must be creative and innovative and not be afraid to try out ideas and, yes, fail sometimes in order to succeed in the end.