Clicky

Log of Lessons Learned

Mann Gulch
October 26, 2016
Ask Keith
November 7, 2016

In the late 1980’s, the real estate market in the Southwestern part of the US collapsed. As many of my friends and business associates were experiencing the inevitable catastrophic aftermath of one of the greatest real estate booms in the history of mankind, we collectively decided to record a log of lessons each of us learned.

We had made scores of millions in the preceding 6-7 years and subsequently had successfully lost every last penny we had, and then some. We truly had unmanageable debt loads, no cash or cash flow and personal liability which far exceeded the market value of our assets.

Of even greater significance was the hit our egos had taken. We had our identity wrapped up in our financial success. When the success vaporized, so did our sense of who we were and where our place was.

We were anxious to get this phase of our careers behind us, lick our wounds and get on with our lives, but we instinctively knew that if we weren’t careful, we would repeat the errors which caused the problem to begin with. We wanted to make sure that we accumulated twenty years of experience and not one year’s worth of experience twenty times. Without learning the lessons, we would be doomed to repeat them, which was an unacceptable outcome given the pain we were in.

Historians will tell you that history may not repeat itself, but it sure does rhyme. The economic reality of 2008-09 has many of the same characteristics of 1989-1991.  Imagine over 3,500 banks disappearing in a four year time period, which is what happened in the late 1980’s verses fewer than 100 banks in the current meltdown. Imagine commercial property being sold for 20% of replacement cost and rents for Class A office buildings being less than the taxes/insurance and Common Area Maintenance fees. This was our reality in 1989.

We wanted to be certain that we NEVER had to experience this kind of disaster again. The thinking was NOT that we could somehow control the economy or interest rates…. We can’t. But what we could control was the thinking and strategies that allowed us to get caught in the tsunami in the first place.

As you read the lessons collected twenty years ago, you might be tempted to say this doesn’t apply to me because I’m not in the real estate business. I can assure you the lessons are applicable regardless of the industry. You might be tempted to think these lessons don’t apply because you didn’t really have any debt or investments during this current crisis. The best time to learn the lessons is prior to making the mistakes.

Interestingly, most of us avoided repeating these mistakes in the ensuing 20 years…. Not because we were smart, but because the pain of the lessons twenty years ago was severe enough that we disciplined ourselves to avoid using our emotions to make what should be intellectual decisions. We established a set of rules and followed them maniacally.

Herewith are a few of my favorite lessons on Financing as collected during the week of May 23, 1989….

Strategy
  • Emotions, when mixed with unbridled greed, produce economic disasters.
  • Land eats three meals per day.
  • A good market tends to hide mistakes. Nothing takes the place of being actively engaged in the running of your business and being thoughtful as well as skeptical about the future.
  • Doing a marginal deal to keep the staff busy is stupid. Do not do marginal deals.
  • Last week’s marketing report has absolutely nothing to do with where the market is headed, what the economy is doing or what the demand will be next year.
  • How you run your business during the good times is the only true predictor of how well your business will cope with the bad times.
  • You must keep a conservative strategy during the good times because you generally don’t know you’re in a bad time until it’s too late.
  • No team has ever won the game with an ‘offense only’ strategy. Great teams, the ones who win championship rings, all have fantastic defenses.
  • Not all progress is measured by ground gained…. Sometimes progress is measured by losses avoided.
  • True wealth is built slowly. Speed and greed necessitate aggressive leverage and increase the odds of catastrophe.
  • It is better to go slower and avoid the do-over’s.
  • The successful people we admire are not the ones who made it…. We admire the ones who kept it.
  • Partners MUST be hands on and involved in every aspect of the business.
  • Do not be afraid to say, “NO!”. Too many deals got done because it was easier to say yes.
  • It is a mistake to believe the quality of our people and the quality of our projects can overcome a bad market. Our occupancy is 30% above market, our rental rates are 50% above market and we are still 75% below pro-forma.
  • Litigation is expensive, time consuming and to be avoided.
  • The best way to avoid losses and to stay financially healthy is to “sell too soon.” The old real estate maxim of, “In the history of the world, the seller is always wrong” is outrageously stupid!
  • Don’t fall into the trap of believing you can get more for it tomorrow. Regardless of which direction the market is moving, never hesitate to sell for a fair price today.
  • Never buy something because you think you might need it someday. Have a definite purpose or use in mind TODAY!
  • Keep working all your alternatives until something closes.
  • Putting all your energy and focus on one lender or one buyer or one tenant is a disaster if the one you were focused on disappears.
  • Success does not make you invincible or bullet proof.
  • What success does best is it makes you complacent and egotistical, which by themselves are sufficient to create disaster.
  • The euphoria of a hot market usually results in ignoring marketplace fundamentals.
  • Prudently gathering and evaluating market based economic information is the only prescription for avoiding smoking your own exhaust.
  • Never delay taking corrective action once the problem has been recognized. Hoping for better conditions in the future so the problem will solve itself is a fool’s game.
    Failure to recognize reality is delusional. You might be smarter and better than your competition, but when the market shifts, you’re still broke. Don’t confuse ability with economic reality.
  • Never rely on only your consultant’s recommendations….
  • Do the study and analysis yourself based on your familiarity with the market…. If you don’t have the familiarity, don’t do the deal.
  • A lack of rules and discipline caused every mistake we made.
  • We did not run our business as a business, but rather as a series of discrete events which we assumed had little bearing on each other. We did not pay attention to the aggregate fundamentals of the business.
  • We did not narrow our focus when we knew times were getting worse. This was due to two things: 1. The distraction of our prior track record and 2. A lack of maturity necessary to drawback and review the situation with a discerning eye and thus gain control of our direction.
  • A small percentage of a large number is a large number.
Deals
  • Just because rents have gone up 5% per year for the last 5 years doesn’t mean they can’t go down 25% in one year.
  • Lease first, then build.
  • Control your inventory.
  • The easiest sale is to another salesman.
  • Have an ongoing asset disposition program in good markets. Sell something…. Not every asset or building can be a core holding.
  • Sell when the market is good because when the market is bad, there are NO buyers… at any price.
  • Holding off on selling based on last year’s prices or what your pro-forma said is stupid.
  • Do not follow the market down…. Lead the market. Make cuts quickly.
  • Work renewals hard and early.
  • Beware of tenants with good stories…. Be skeptical.
  • Don’t let what your competition is doing influence your decisions.
  • Do what you think is right based on the facts. You can’t erect a fence to keep the competition out.
  • It’s better to start a building two months late and miss a deal than to start it two months early and face a shrinking market.
  • Secondary locations can sit empty no matter how low rates go.
  • No credit, no deal.
  • New projects must be based on current rooftops and existing infrastructure, not future population growth.
  • Do not inventory land at retail prices for future projects. A 20% increase in land price is only a 2-3% increase in total project cost.
  • Do fewer deals and do them better. You can be more profitable by having more time to focus on the few and you get the added benefit of keeping overhead low.
  • Too many deals dilute time and attention away from the good ones.
  • It takes 5 good deals to make up for one bad deal.
  • When a bad deal surfaces, 90% of management’s time is siphoned off from the rest of the business to deal with the problems of the bad deal. The result: The bad one is still bad and the good ones are now mediocre or troubled as a result of a lack of attention. 90% of management’s time should be spent on nurturing the good ones. Easy to say, hard to do.
  • The first markdown in price is the smallest. The mistake is to hold off on selling at today’s prices in the belief the market will come back.
Financing
  • Debt gives the illusion of wealth. True wealth is assets, cash flow and no debt.
  • Doing a marginal deal just because the money is available is stupid.
  • Take your personal guarantee seriously…. You only bring two things to the table…. Cash and your guarantee, neither of which has an unlimited supply.
  • Don’t rely on inflation to make a deal work.
  • Never finance long-term assets with short-term debt.
  • We covered a lot of mistakes with access to easy money and credit.
  • Easy credit, lots of liquidity and too much money makes you stupid.
  • A knack for innovative financing, a little bit of money and unbridled greed will produce truly crippling debt.
Personnel
  • Bench strength is critical. Hiring weak people begets weak results. Find the best people and compensate them VERY well…. It saves money in the long run.
  • The tougher the times, the better the people you need. There is no way to survive a bad market with weak people.
  • Mediocre people are easy to hire and difficult to fire.
  • Always be upgrading your talent and never be afraid to pay them what they need to make.
  • Any fool can make money in the good times.
  • One superstar is of greater value than an unlimited number of mediocre performers.
  • Never wait to address personnel issues or mediocre performance.
  • Either they are doing a great job, or they aren’t. If they aren’t, take action. My job isn’t to babysit or beg people to do their jobs.
  • The cost of being long suffering with an incapable or misplaced employee is far greater than the discomfort of having a tough evaluation and speedy termination.
  • A culture rooted in past successes, growth at all costs and aggressive bonus structures will produce employees who don’t think, who aren’t skeptical and who ignore risks.
Overhead
  • Stay lean even if you can afford to get fat. Keep overhead low!
  • Watch your cash VERY closely. Ask yourself, “Do I really need this?… Will this help me make more money?” Once you spend it, the cash is gone.
  • Each line item of your financials should be scrutinized on a continuous basis to make.
  • Conserve cash, especially during the good times. Spending money to look like a big deal is not the same as being a big deal.
  • When you’re out of cash, you’re out of business. Cash is truly KING.
  • When the market shifts, you can’t cut overhead fast enough.
  • It is easy to over pay or beef up when the world is viewed from only an upside perspective.
  • Cut overhead early and hard. Pride and hubris kept us from cutting our overhead in a timely manner.
  • Fancy offices, hot cars, lots of staff and high overhead are signs of significance, not success.
  • Knowing your numbers, what it costs to run each aspect of your business and having timely information, is critical to success.
  • Focus on the costs of doing business and not just the revenue potential.
  • Bringing “consultants/outside services” in house (architects, land planners, engineers etc) is a bad idea. The temptation is to look for busy work to justify the overhead and when the market shifts, they are expensive to cut. Contract out as much of the work as possible

Best,
Keith J. Cunningham