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.

Power Niche Marketing: What Is A Power Niche?

Welcome to my new column, “Power Niche Marketing.”

This column has a very simple purpose: to teach marketing to lawyers and other professional service providers.

Astonishingly, all of us lawyers need clients in order to survive, yet when we go to law school and start our careers and our careers move forward, there is simply no one teaching us how to get these clients!

And we are desperate to learn. We see the big rainmakers, with their (figurative) cigars having all the fun and making all the money, while we toil away in the trenches wondering “why?”  It doesn’t make sense. It doesn’t seem fair. But we have no idea what to do about it.

In our desperation, we may ask a successful rainmaker, “How do you do it?  What is the secret?”

The rainmaker is always 1000% confident in her answer, and you hear things like this:

  • You get your clients from across the table.
  • You get them on the golf course.
  • You go to seminars.
  • You work the room.
  • You network relentlessly.
  • You get them from your high school, if it is connected.
  • You get them through just doing great work, and people hear about it.
  • You get them at the synagogue/church, etc…

The list goes on and on and on, with the only theme being that there is no rhyme or reason to it. And yet the rainmaker who gives you this advice is super-confident in it for an empirically misleading reason: whatever she is telling you worked for her!

Some of us in our desperation go to marketing courses, or seminars, but, alas, just about all of them (and maybe all of them) are taught by people who didn’t actually go out and bring in clients. Perhaps they are non-lawyers or, worse yet, people who failed at being lawyers and then turned to teaching marketing, thereby validating the old saying that those who can, do; those who can’t, teach.

There really is nowhere to turn. But meanwhile, our profession is becoming utterly relentless in the simple truth that:

No rain = bad career.

Your troubles are now over!  Just read my column for the next year, and you will be a great rainmaker. Simple!

Okay, it is not that simple; however, I will stick my neck out and say the following:

  1. I am not some guy who couldn’t succeed and so is now teaching. I am out there every single day marketing and trying to provide strong value propositions to prospective clients. I am in the trenches, and I know what clients respond to.
  1. I have gained my expertise by ruthlessly examining internally my own strengths and weaknesses and, with brutal honesty (to myself), I have analyzed what works in practice and what fails. At the same time, I have tried hard to understand what is really and truly important to my clients. After many fits and starts – and more outright failures than I like to think about – a lot has become clear to me. I will be sharing what I have learned in this column.
  1. Finally, of everything that I have learned in the marketing world, by far the most important lesson I have learned is the importance, and indeed the power, in the “Power Niche,” which is a term I have coined. Although there are numerous sub-parts to my marketing plan, at the heart of it is the Power Niche; accordingly, you will hear a lot about it throughout the articles.

Ultimately, virtually anyone can become a successful rainmaker by following a few simple teachings. This is really true. There are some tricks of the trade, but it is not a secret handshake – it is actually quite easy. Just keep an open mind, and I will be of great use to you.

I will get into the heart of the Power Niche in my next article, but so I don’t become one of those “annoying” serial writers who always puts the excitement in the “next” article to bring you back, I will let the cat out of the bag right now and tell you what I mean by a Power Niche:

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.

The goal of this new column is to teach you exactly how to build a Power Niche and become a rainmaker (or grow your book of business if you already are a rainmaker).

The End Game for Co-Working

I have been watching – and our firm has been participating in – the co-working trend.  It started with Regus when it was founded in 1989 but didn’t really go anywhere until the past few years.  Since then, numerous players have entered the market, each with its own twist to appeal to different parties.

There is an ongoing debate as to what will happen during the next downturn.  Some say that the co-working spaces – filled with millennials – will become ghost towns as these millennials will go home to work out of their parents’ basements for free.  Others say that in a downturn, co-working will boom even more because there will be more people out of work.

I am not wading into this debate except to say that I am certain that no one has a crystal ball and we will just have to see what happens at the time of the next downturn.  If I had to guess – and I shouldn’t guess publicly – I think the latter (i.e. the boom) is much more likely than the bust, but that is just my guess.  However, I do have a perspective here that I think is interesting….

To take you through my thinking, I hearken back to the internet.  When it started, everyone was so excited.  It was a “new business” and everyone was pouring into it.  However, it turned out that it was really not “a new business”; instead, it was “a new way of doing business.”  This meant that WalMart could be in the business just as easily as an internet start-up.  If you fast-forward about twenty years, I don’t think there is a single business that exists today that is truly an “internet business”, with the single exception of Amazon and, at least according to my calculations, it is only just now starting to turn a profit.   So much for the “internet business”.

I think the exact same analysis applies to co-working.  If you look at what is happening now, there are numerous competitors; however, recently, landlords themselves have started to enter the fray.  For example, if you own an office building, you might consider allocating a floor for co-working space.  The margins are dramatically higher than what you would get if you leased the floor – versus the risk that your tenants are sort of like hotel guests and could evaporate if the market changes.

To be clear here, since co-working is so labor and operationally intensive, most landlords will team up with a co-working provider.  I think you will see a lot more of this.

As a landlord you wouldn’t want to risk the entire building on this concept just yet and even if you did your lender wouldn’t let you, but for a single floor it probably makes sense to take a chance and enjoy the upside without that much downside risk.  And ten years from now, once co-working has proven to be a longer-lasting concept, your lender will probably let you co-work out half of your building or even more than that, i.e. co-working will likely morph to be more like a hotel concept.

In any case, over the next ten years I suspect co-working will become more and more ubiquitous.  Then what happens to the co-working companies?

My prediction is that there will be a couple of survivors.  The rest will fold or be absorbed or bought by other real estate players.

Meanwhile, I advocate that real estate players – worldwide – should be looking at how they can optimally apply this “new way of doing business.”

What is Up with China? Effect on the Real Estate Deals? News from the Real Estate Front in NYC

My law firm is in NYC handling real estate transactions in the US that originate from counterparties based all over the world.  A bunch of these transactions depend on money coming in from China (debt or equity or other structure).  It used to be there was always a degree of uncertainty about the viability of this capital, but this uncertainty was gradually diminishing as more Chinese players developed stature and reputation in the US.

However, there are some recent events that are hitting US real estate pertaining to the use of Chinese capital.  I cannot say we are a canary in a coal mine, but as a law firm in the thick of deals in NYC and other places in the US, I have seen the following just in the past couple of weeks:

A China law firm that I have been dealing with regularly had a client planning on doing US deals.  We were moving forward together until I received the following email:

“As you may know, recently China is facing to the emerging issues of increasing Chinese capital outflows and devaluation of the RMB.  Therefore, the Chinese government has tightened the regulation policies on out-bound investments in recent days, especially the investments by Chinese [investment funds] in the form of partnership and investments into foreign real estate markets.  This makes it difficult for the client to move forward with their US real estate projects.  They are now under internal discussion and evaluation of the situations so we may have to wait for some time.”

A friend of mine in China who is very connected to the US and the Chinese real estate industries gave me the following quote.  I respect him highly but he did not want attribution.  He said:
“….. the open tap of Chinese money for US real estate was if not shut completely this week then it is now at best left a dripping faucet.  The authorities may backtrack, or not fully implement the announced draconian controls, but the atmosphere has changed beyond recognition.”

A client of mine had its Chinese financial partner drop out of a deal due at the last minute due to the counterparty’s China office overruling the New York Office, which had approved and strongly backed the deal.

There is much more going on as well, including the new Presidential administration, the sharp rise in interest rates, general volatility in the markets due to a possible belief that the up-turn in the US economy is getting long in the tooth, public  statements from companies like Starwood that they are hitting the “pause button” on real estate acquisitions, stalled sales of luxury apartments in New York City, and much more.

As per prior Real Estate Philosopher articles, I do NOT make predictions about the future, except to state with certainty that neither I (nor anyone else) has a crystal ball; however, anecdotally it seems to be true that a fair number of investors in US real estate are indeed pulling back right now.  And the China money spigot slowing to a trickle may have a deleterious effect on pricing, deal flow and other matters pertaining to US real estate transactions.

Of course, one party’s troubles is often another party’s opportunity; accordingly, potentially all of this may spell a chance to make advantageous US real estate investments for opportunistic real estate players.  That is not of course a formal prediction but seems to be getting more likely every day.

One last point I will make about Chinese money is to distinguish between money that is “on-shore” (in mainland China) and money that is “off-shore” (outside of mainland China).  If the money is “on-shore” that likely means that it will be a lot harder to have it show up in a US real estate deal.  If it is already “off-shore” that likely means it will be a lot easier.  I don’t have the skillset to be able to dig much deeper here, but the foregoing is generally an accurate statement.  So, if you are a US player working with the Chinese right now, this should be a threshold question that you might use to gauge the likelihood of the investment succeeding.

Finally, if you have anecdotes you would like to share, I would certainly appreciate learning as much as possible.

Finally, finally, here are links to some recent articles on this subject:

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.

What “Inning” of the Real Estate Cycle Are We In?

I have now practiced real estate law for almost 35 years, which is a long time to do anything. I am not absolutely “sure” about many things; however, I am confident that no one has a crystal ball about what the markets are going to do.

Some real estate people seem to be so doggone smart. They sell before the market crashes. Then they buy low at the bottom. These people are revered as the smartest names in real estate. They go to conferences and speak at them. They are usually great speakers because they are smart – rich – and self-confident. After all, they pulled it off.

Often they talk about what “inning” of a cycle we are in. If not, the moderator usually asks that question. Those in the audience are busy taking notes like:

“Toby Jones thinks we are in the third inning [of a certain real estate product]”

Perhaps that makes the party taking notes, who has invested in a similar real estate product, “feel” a little better – and after all there are all sorts of articles written about our human emotional need for validation, etc.

However, the truth is that neither Toby Jones nor anyone has a clue what inning we are in. Toby talking about innings and you listening is as useful for investment decisions as going birdwatching.

But, you might ask, what about the fact that Toby Jones has been right for the last three downturns? He always seems to know when to get in and when to get out. However, if you really dig in, I wonder:

Is Toby really right that consistently? Did he really get in and out at the right times to begin with? If you look at a longer time period, was Toby right over a long time period or just the past few times? Did he get in a bit too early and maybe got out way too early? Did he miss a lot of upside and get hit with a decent amount of downside? Did he make almost all of his upside on one dramatically-outperforming transaction?

Did Toby make a lot of predictions and take a lot of actions that were proved completely wrong but no one really remembers that? For example, was Toby sure that interest rates are going up next year for the past seven years? If you are Toby Jones reading this, was that your prediction? Now, almost no one thinks interest rates will go up next year. What does that mean?

And, even if Toby has a great track record over a long time of, say, 30 years, even then it doesn’t necessarily mean Toby is really smarter or has a crystal ball. If there are thousands of real estate players (all dumb as a post) and all making recommendations and decisions over 30 years, it is a statistical certainty that some will be right just about all of the time during that time period.

Let me apply this to New York City (since I am based here). Pricing of most real estate assets here is exceptionally high, say most of the Toby Jones’s, which would lead one to conclude that buying now is a mistake and prices have nowhere to go but down. Indeed, sitting here in NYC, to me it “feels” like a significant correction is starting right now. Maybe prices will be down 50% in the next few years.

However, New York is the financial center of the world – a booming tech center – a cultural center – a diverse melting pot – an exciting and vibrant city – and a place where when you get right down to it, talented people want to go to and stay. It is one of only a few markets in the world in a stable democracy that is large enough to put down an enormous investment that will likely always have liquidity. There is every reason to expect that the flight of worldwide capital will continue and if so what better place than New York City. And with interest rates going to zero, or even negative, around the world, maybe a 3% cap rate in New York City is just fine. Maybe prices will double in the next five years?

The only thing I am sure about is that I don’t know. And I am also sure that no one else – including Toby Jones — knows either. Indeed, I would guess that there is “smart money” that has been waiting for a correction in New York City pricing of real estate for several years now and the only thing the smart money has achieved is that it has so far missed out on a lot of upside.

But maybe now there will indeed be a “correction” and the “smart money” will “pounce”! To that I say “fiddlesticks!”

For that to be true the smart money would have to know that the correction will be 13.5% rather than 35% and know when the bottom is and I don’t buy that the smart money will know that. How much “smart money” was there at the depths of the financial crisis when prices were down 35% in New York? Precious little – probably because the smart money thought prices were going to drop a lot further. It took quite a while before many would dip their toes in the market. And, yes, those who bought at the bottom look awfully intelligent, but what would have happened if the financial crisis had gotten worse or New York became victimized by more terror attacks or crime had gotten worse or a health panic had occurred or all sorts of things had happened?

I could go on here, but my point is simple; namely, that it is a waste of time making macro predictions about markets that no one can really be sure about. You may get lucky for a while, but sooner or later you will get tagged and I predict you will under-perform over a long-term time period.

Warren Buffet makes this point all of the time. He says he cannot predict the market, and no one can, so it is pointless to try. Instead, he looks for companies that are good value and uses his intellect to buy at good prices.

So, I will stick my neck out and say that if your company’s real estate strategy is based on timing the real estate market – and predicting what “inning” of a cycle we are in – then it is likely a flawed strategy that may work for a while but eventually will be upended with below average long-term returns.

So – enough negativity – what do I advocate? I advocate being market-agnostic and thinking through the best ways to “create value” in real estate (and maybe even looking at my prior – and future — articles on that subject). Just go about your business looking to create value and finding deals that do so. Sometimes the market will go up, and that will juice your returns to the upside. And sometimes the market will go down and your returns on that deal will be lower than you like. However, in the long run, if you follow this strategy, you will outperform.