Friday, February 17, 2017

"'Alpha' in Real Estate"

Great essay in PIB about real estate investing:

I’ve met many rich men in my long life, and I must confess that the category of rich man that most annoys me is the real estate landlord, simply because he seems to do the least work for his wealth. I’m not talking about visionary developers who create buildings out of nothing, but rather those who allocate their capital—or, often, the capital of their ancestors—to existing real estate, leverage it up, and sit back passively for years collecting rent checks and refinancing along the way, secure in the knowledge that the government offers explicit and implicit subsidies to their “efforts.” It’s both amazing and annoying how well you can compound wealth over time in this way, provided you’re lucky enough to avoid a downturn in which your leverage kills you.
I've seen many real estate investors blow up. They seem to operate under the philosophy that they should have as little equity as possible in their holdings, constantly tapping it with refinancings and using the proceeds to buy more property.


ADL said...

Very interesting. I was just thinking about this the other day: the hallmark of the great New York real estate families (that is, those durable enough to last several generations) seems to have been relatively low leverage, the collection of rent to cover expenses, and a contentment with steady accumulation. Amazing how many fortunes from different sources come down to the old adage about avoiding excess downside.

This also brought to mind Fimalac's 2016 $525 million purchase of 693 5th Ave in Manhattan, a deal which made news primarily because the seller bought it for ~$140 million 6 years earlier (though quite a bit of work was then done). But the more interesting part, to me, was that Valentino for whatever reason had leased roughly 20K square feet at $3000/sf, so just from the prime retail tenant FIMALAC will earn an unlevered 11% pre-opex/pre-tax return. If the other 80k sf of the building cover expenses (I'd guess they bring in $6-8 million a year; current property taxes are around $2.6 million), that's the return. It's not 15% (it likely is after the mortgage, which comes out to a bit less than 50% of the purchase price), but it's not that far off, and an astonishing return, to my mind, for a splashy retail-anchored building in the heart of trophy territory, and the power of being a cash buyer (I believe the mortgage came after). Compare to rentals in outer Brooklyn bought at a 4 or 5% cap rate...

Anonymous said...

Grammar police: should have as little equity as possible, not shouldn't.

But to your point, as always, margin is great until it isn't. Then, like speed, margin kills. Same as it ever was.

whydibuy said...

So what? Someone is going for it at all times. Some will luck out and some will crap out. We only hear about the ones who scored big. The ones who flopped are forgotten like yesterdays newspaper. Its odd how the same formula that makes certain lucky guys rich bust out others who try the same bet. Its really the luck of the draw. Lucky timing being in the right place at the right time.
But the point is that there are always people going for the brass ring. And by gross statistical odds, some will win.