Yesterday I shared my strategies on investing in residential real estate that have treated me favorably. But, as my friend Kristi Van Pernis pointed out, those strategies were only for homes you actually choose to live in. There are many other ways to make substantial money investing in real estate.
Today, I share my strategies on investing in commercial real estate. A very different animal indeed. Remember, the point of this group (you may not even be aware that you are in a group), is to inspire. I have always leaned on transparency to accomplish this, so please understand that I am not writing to brag. I’m writing to inspire you. I choose to do this by sharing real life experiences.
In commercial real estate, the really big bucks are made by buying property that has little value today in an area that developers will want to buy up and develop tomorrow. It actually doesn’t matter one bit if the property you acquire is a broke down building in the worst neighborhood, as long as that neighborhood has the right potential in the future.
In 2010, my wife and I bought an 83-year old historic building that nobody wanted in a downtown that needed a lot of work. It had the worst moniker of any city in the country besides “Murder City”. It was nicknamed “Deadwood City”. We paid $6 million for the property, buying it out of foreclosure.
I’m not gonna lie, the first three years of ownership were a struggle. Everything needed to be replaced. The bathrooms, the electrical, the theater seats, the marquee, the pipes, the stage curtain, the line-set, the doors, etc. That building was like a never ending trip to the ATM for us. It took just three years to accumulate a figure of $1,000,000 on the balance sheet from all the needed improvements. It was so bad, I even found a hundred year old urn with cremated human remains. Creepy as fuck!
However, the property had its attributes and potential. It was a historical beauty beloved by its community with good bones. It was massive, covering 3/4ths of an entire city block. It was once the crown jewel of this forgotten downtown that time had passed by. It sat right in the city center amongst dilapidated buildings in need of renovation in every direction with a few new ones already built. It was also right next to a well traveled commuter rail, another check in the potential column. The city it resided in was also known for its excellent year round climate with a City Council planning and hoping for change. Rents were super low throughout the downtown, another very good sign. The whole downtown might as well have had a big sign on it that said, “Potential - please give me some T.LC. and I’ll love you back!” Finally, there was some raw land behind the property that we were certain we could one day control and do something exciting with once purchased.
All we saw was potential. Our viewpoint was not shared by many though. I remember going to lunch with a super connected hot shot real estate guy from my hometown of Menlo Park shortly after we bought it. When I brought up our interest in having him be our developement partner, he laughed and called Rewdood City a shithole. He then discouraged us from making any additional investments there. Not exactly a resounding vote of confidence.
I remember calling my long-time mentor for advice around this same time. I asked him, what do you think I should do with this property. He firmly said, “you should buy a box of matches”. So, how do you really feel about it?
Neither individual saw what Lori and I saw. That’s ok. I didn’t take it personally, although I did find a new mentor. When it comes to my dreams, I live by a particular creed when I see potential nobody else sees, “Everyone tells me I’m wrong, so I must be right.”
Lori and I weren’t particularly wealthy yet. I had a solid annual salary as the C.E.O. of company I bootstrapped and built into a global lifestyle company, but no real savings yet. Lori had recently become an entrepreneur after a five year career as a stockbroker with Merrill Lynch and Morgan Stanley, so she was at the beginning of her big run. This investment would require us to borrow $5 mm and come up with a down payment of $1.2 million. Our life savings would need to go into this investment and it would only be a fraction of what we needed to close, leaving us with no money to operate it. I was 39-years old and comfortable. It was a very big risk.
Most of you know how this story ends. We put our heart and soul into developing that property over seven years. It was hard work. On too many occasions to count, it brought us to our knees financially. That property taught us both many lessons on perseverance. It was not for the faint of heart.
In the end, our faith was handsomely rewarded. After seven years of dedicated ownership, we sold the property for $18.5 million. We picked up another half million in interest on a carry-back note bringing our profit to a cool $13 million. And, along the way we further speculated by buying up the dirt parking lots I mentioned earlier. We partnered with the right developer, a good man, who treated us fairly and gave us a sizeable chunk of equity in a fantastic commercial development. We participated in building a 5-story commercial building.
Developing was hard too, but very worthwhile. The profits made from our development, added to the ones we already got from selling our theater property, provided game-over earnings. We never had to work another day in our lives if we chose not to. Turns out the hot shot real estate guy from Menlo Park was very wrong. When it comes to your Dreams, always trust your own belief. That is what the Universe rewards.
Along the way, Lori and I have learned, and developed, other strategies for commercial real estate investing worth sharing. One little trick is to follow the up and coming chefs. I’m talking about the Chef who actually works the hellish hours doing all the cooking while the original chef who made it, takes all the credit for their innovative menu and kicks it in their mansion with their newfound riches. The still struggling Chef will eventually break away to start their own restaurant. They are not going to be able to afford expensive leases in the already fancy downtown areas, so they are going to gravitate to the up and coming areas of downtowns where they can afford rent to start their first restaurant. You know the spots that I am talking about. The areas that just a few years prior might have been known for precarious reasons (crime, drugs, prostitution, boredom, etc.). Those neighborhoods!
I’m talking about the areas that artists gravitate to cause they can afford the low rents, allowing them to stay artists. Think Brooklyn twenty years ago. Once the artist community, including great up and coming chefs, move in and make a community a place that rich folks think is cool and come to for dinner and drinks (with only minimal concern that their fancy car might get jacked), that’s when you are sitting on a gold mine if you own commercial space or a lot. By the time the rich folks start moving there, you’ve missed your window by a mile.
Before you even hear the first complaint about gentrification in the local newspaper, developers will have already purchased every building or lot they can get their hands on. As mad construction begins, rents begin to rise like the Phoenix, unfortunately pushing out everyone that made the neighborhood cool in the first place. A raw deal for sure, as yuppies take over and artisan coffee houses open on every corner, but this is how you make the really big bucks in commercial real estate speculation. It’s a proven model and developers play it really well.
Lori and I had front row seats as developers poured several billion dollars in investment into our downtown in just five years time. All the action took place within four city blocks of our property and we were at the center of it all. It was the biggest gold rush I ever experienced. Developers are a bunch of slick operators I tell you. They play to win and pretty much always do from what we witnessed. You can too, if you have the stomach for it. I wouldn’t do it again. It’s a knife fight on a mull hill. I’m happy to have gone undefeated before retirement as a developer. I have plenty of scars. 1-0, is good enough for me!
So, very different strategies for residential properties you choose to live in, and commercial investments where speculation is the game. The ultimate rule of thumb still applies for all real estate. Try your best to buy low and sell high. However, don’t forget my tips. You have to actually live in your house before you can sell it, so pick a home you are going to enjoy living in. Fixer uppers are not for everyone. The opposite is true of commercial real estate. Learning Alchemy is required towin big at that game.
Thanks for reading. Here are a couple of photos of my development going up right behind our theater property.
