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    Making it in Real Estate: Starting Out as a Developer
    Making it in Real Estate: Starting Out as a Developer
    Making it in Real Estate: Starting Out as a Developer
    Ebook194 pages3 hours

    Making it in Real Estate: Starting Out as a Developer

    By John McNellis

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    About this ebook

    Expanded and updated with 20 new chapters about leadership, investment decisions, and the regulatory environment, plus guidance on how to survive an economic downturn. With over 35 years in commercial real estate, author John McNellis has taken the best-selling first edition of Making It in Real Estate and expanded it with new content, market-specific solutions, and real-life strategies to start and grow your real estate portfolio. Like a meeting over coffee with a mentor, McNellis entertains with witty anecdotes and wisdom on how to take advantage of opportunities and avoid pitfalls. Learn the ins and outs of financing; how to work with architects, brokers, and other professionals; and how to make a good deal and win approval for your project. Listed as required reading for students majoring in real estate at universities across the nation, Making it in Real Estate: Starting Out as a Developer, Second Edition, has readers calling it "the best book on development . . . that accurately describes the true upside, downside, and work involved" in commercial real estate.
    LanguageEnglish
    PublisherUrban Land Institute
    Release dateOct 12, 2020
    ISBN9780874204582
    Making it in Real Estate: Starting Out as a Developer

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    Book preview

    Making it in Real Estate - John McNellis

    Demystified

    Preface

    I LEARNED REAL ESTATE the same way I learned the facts of life. On the street. I learned development gradually—deal by deal—often acquiring experience just after I needed it. Had there been a practical book on development when I started out, I would have read it because we don’t always have to learn the hard way. On occasion, we can remember the advice of others and spare ourselves the first-degree burns of inexperience.

    That’s why I’ve written this book.

    As complex and risky as real estate development is—an encyclopedia rather than a primer would be required to cover all a developer should know—there are certain truths so obvious they can be book-learned. If they are not, lessons will be learned the expensive way, usually at the very moment the fledgling developer realizes she’s too far out over her ski tips.

    In this book, I ask you to consider whether you truly wish to leave the comfort and security of your salaried position and whether you—and your family—might not be better off if you were to pursue your desire to develop on the side. I have no statistics on this, but a career’s worth of observation and anecdotal evidence have taught me that a considerable majority of developers might have been far better off, financially and emotionally, limiting their real estate pursuits to an avocation.

    The true developers among you will brush aside this advice as meant for others. And it is for you—the true developer—that I offer what I hope will be useful advice on everything from what you should buy to how you should focus your objectives, run your own firm, and deal with the players in our world—the bankers, partners, politicians, consultants, and brokers. If there is an overarching theme in these pages, it is simply this: the best way to survive, and thrive, is to manage every risk within your control. So many risks are beyond your control—interest rates, global tectonic shifts, the bankruptcies of your tenants, even the weather—that you will, like the rest of us, invariably lose money one day. Whether that loss proves a temporary setback or the end of your career may depend on how you have managed your other risks. If you have created firewalls by limiting your exposure to your lenders, partners, vendors, and service providers, you will survive. If, however, your first loss is the domino that causes your other risks to tumble, you may not.

    My desire, then, is to leave you holding the same admiration, caution, and healthy respect for real estate development that a zookeeper has for his lions.

    I wrote that preface in summer 2016. Much has happened in the past four years. The longest economic expansion in U.S. history was felled by a virus, and I realized that in the first edition I had not addressed surviving a recession. Also, astute readers have on occasion raised questions I hadn’t considered. I hope this edition—with its 20 new chapters—addresses these issues and others that have occurred to me as I continue to ponder life and the craft of developing real estate.

    September 2020

    Part 1:

    Making It in Real Estate

    1

    Quit Your Job?

    OVER A BEER, A YOUNG FRIEND RECOUNTED his progress with a retail development firm. I was surprised to hear how much he had learned and how much responsibility he already had. When he explained his lead role on a mixed-use project, I asked how profitable the development would be for the company. He guessed about $10 million. I asked if he had a profit share. Reluctantly, he explained that he had been promised a percentage in the deal but that his employer, a man of infinite wealth, had gone silent on the issue. With nothing in writing and the project’s final entitlements days away, he could only hope his boss would honor his word.

    Business has few certainties, but one is this: employees are seldom paid more than go money. That is, companies large and small, public and private, will pay enough to keep their key employees from going elsewhere. The publics blame their parsimony on their duty to their shareholders, and the privates blame their silent but surprisingly stingy partners.

    If your dissatisfaction is with the job itself—and not your income—you should quit. That is, if you can afford the cash flow hit. If you’re an entrepreneur at heart and the only decision you’re making at work is where to park in the morning, quit. If you can cobble together a year’s worth of living expenses and go into business and fail, what’s your downside? Merely the salary loss from your crappy job. And if you have to white-flag it back to the corporate world, you will be more valuable because of your experience. Potential employers will know you are ambitious, that you have an owner’s perspective, and that—let’s face it—you’re unlikely to bolt again.

    It’s a different story if it’s all about the money. If you love your job and your hunger is only for wealth, then ask yourself if you’re really worth more than go money. If you still think so, explain to your boss how valuable you are, ask for a big raise, and then listen hard to the reply. He’s your boss for a reason. He has more experience than you do, and it’s even theoretically possible that he is smarter than you or better in business (these are two entirely different things: many of the smartest people I know are terrible at business). And if your boss says your compensation is fair, he may be right. In my experience, those who start a business just to get rich almost never succeed. The ones who make it are those who love what they’re doing and start their own companies only because they have no choice (no one will hire them), because they want to be their own boss, or because they think they can do it better on their own. They believe they will be more productive—and have more fun—if they can peel away the corporate bureaucracy, the weekly team conference calls, the Sisyphean reporting requirements, the multiple sign-offs needed for deals, and even the mandatory company socializing.

    I asked George Marcus, one of the most successful men in American real estate, what he thought about starting a company for the money. Anyone dreaming of going into business just to get rich is fooling himself. You start a business because you have a passion to improve a business strategy or an industry. George knows what he’s talking about. At 25, he started Marcus & Millichap and finally took it public in 2013 (the stock price has since doubled). He is also the founder and principal shareholder of another public company, Essex Property Trust, arguably the country’s best-performing real estate investment trust over the past 20 years.

    Mervin Morris, a giant in the retail industry and founder of the Mervyn’s department store chain, told me simply, I went into business for myself because I wanted to be my own boss and make a comfortable living. Personally, I switched from real estate law to development because it seemed to me that developers have a lot more fun than lawyers do (I was right). My financial ambition at the time was to make as much as a developer as I would have as a lawyer.

    Turning Gordon Gekko’s aphorism on its head, greed is not good enough.

    Where does all this leave my young friend who loves his job and its challenges but who will likely end up unhappy with his compensation? (By the way, if you can succeed at running your own business, you will always be unhappy with your compensation.) If, like George, he thinks he can do it better on his own or, like Merv, he wants to be his own boss, or if he simply wants to have more fun, then he should consider setting up shop.

    But to paraphrase the teachings of Siddhartha, there is a middle way that we will explore in the next chapter.

    2

    Doing It on the Side

    ARE WE IN THE WRONG BUSINESS?

    On the Best Jobs in America lists, a career in real estate rates lower than carjacking. In fact, commercial real estate doesn’t rate at all on these ubiquitous lists. The closest we come is real estate agent, a distant #89 on U.S. News & World Report’s Top 100 Jobs list, lapped by such swell careers as substance abuse counselor (#36), bill collector (#57), and exterminator (#61).

    And at $80,000 a year, real estate brokers earn #159 among the Top 300 Highest Paying Jobs published by Myplan.com. That list’s top 20 paying jobs, by the way, are all physicians, starting with anesthesiologists at $233,000 and ending with general practitioners at $181,000.

    Should we be applying to med school, or is it possible these data don’t tell the whole story? Misreading data is a common failing—Son, you got four F’s and a D. What’s that tell you? the father asks. That I’m spending too much time on one subject, Daddy? To deduce that one should elect for a career in exterminating rather than real estate courtesy of U.S. News is likely such a mistake.

    What best-jobs data will never reveal is one of real estate’s greatest strengths—that one can amass a considerable fortune by doing it on the side. What other part-time work or avocation is so lucrative? You could probably work part time as an exterminator or perhaps even as an anesthesiologist, but as long as you are working by the hour—as long as you’re working and your capital isn’t—you will always be working.

    If you love your day job but are unhappy with its compensation—the dilemma posed in chapter 1—you don’t have to quit. You just need to start a new hobby: give up fantasy football and spend your free time on a dilapidated house. If you take the long view—you should: real estate is the classic get-rich-slow business—you will do well.

    My late father-in-law was a bright man who came home from World War II devastated by his experiences as a combat medic in the South Pacific. Bill found solace in the bottle and was an alcoholic by his mid-30s—drinking a six-pack of beer and a bottle of vodka every day. Yet somehow he found the fortitude to quit drinking and start life over at 45. With no savings, no formal education beyond high school, and no marketable skills other than a talent for sales, Bill slowly amassed a small collection of San Francisco Bay area real estate—a couple of houses, a few promissory notes, a duplex or two, and a five-unit building—worth several million dollars at the time of his death 40 years later. More important, his real estate allowed him to retire in his late 60s with a secure income of $150,000 a year.

    How did he do it? One small building at a time. Bill made his living by day but his fortune by night, buying a property every year or two, fixing it up, sometimes selling it, sometimes keeping it. His properties were never pretty—they probably lost money at first—but 25 years later when it was time to retire, he had paid off their mortgages and his cash flow was as free and clear as a Sierra stream.

    And it’s really that simple.

    If you love your job or find the prospect of going out on your own—of working without a net—overwhelming, and yet you still want a future independent of a corporate pension, buy a neglected house in a quiet town and get started. If you can cobble together enough of a downpayment—perhaps with family and friends’ money (the topic of a later chapter)—so that you at least break even after paying your expenses, you’re set. Even if your rents never increase a cent, you will eventually pay off the mortgage and all that cash flow will be yours. If you can pull this off a few times, you can retire as comfortably as my father-in-law did.

    3

    Playing Small Ball

    "I HIT BIG OR I MISS BIG. I like to live as big as I can." A winning formula for the greatest baseball player ever, but unless you’re determined to become real estate’s Babe Ruth, you might consider following in someone else’s spikes. Mortals make the Hall of Fame by hitting singles. The late Tony Gwynn was dearly remembered as a better person than a hitter, and he was the greatest hitter of his generation. Tony hit singles. Derek Jeter made the Hall hitting singles.

    And so can you. But this is where the baseball metaphor strikes out—players make the Hall of Fame batting .300. You won’t. Unless you’re making money on eight out of every 10 deals, you’ll enter a different hall, the one where you file Chapter 11.

    Don Kuemmeler, a founding partner of Pacific Coast Capital Partners, is more precise. Don says PCCP, a $6.5 billion real estate management firm, has to bat .850 on its equity deals and .990 on its debt placements to maintain its targeted profitability.

    How should you choose real estate investments? The same way you take a lion’s temperature—very carefully. Hitting those numbers isn’t easy—$6.5 billion firms are few and far between for a reason—because sooner or later, everyone loses money in real estate.

    If you bought anything in the 2004–2007 bubble, you lost big. But this is the point: if you didn’t have to sell, your losses were merely on paper. And if you could afford to wait long enough, you actually turned a profit. If, however, you were forced to sell bubble-era acquisitions in 2009–2011, you lost, somewhere between a lot and everything. What three factors force one to sell

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