Which of your real estate projects are you truly proud of? That drive-up retail strip center? The 15-year-old one that looked good in its day, but has already lost its shine? Or the 2-year-old one that’s bleeding tenants dry because they signed leases just before the bottom dropped out? How about that suburban subdivision? You know, the one that you would never live in, but everyone knows the market demands a 4/3, so you clear-cut and leveled the land, then sandwiched together uninspired houses and planted two shrubs to “hide” the garage?
“But I made a good profit!” So did the investment bankers at Goldman Sachs who pushed “[bad] deals.” There’s such a lack of accountability in society today that anyone can get away with just about anything. Regrettably, you can see such lack writ large on our American landscape. Over the past 70 years, our beautiful country has been all but covered up with ill-conceived, poorly-executed real estate developments built on a single premise: “the numbers work.”
I’m not saying that the world will all be alright if everyone hugs a tree. But you can do well while doing good. In fact, with an appropriately elongated timeline and an increase in a project’s internal velocity of money, you can generate far greater returns than you can with the cookie-cutter approach that most use. It takes a little more thought, but fortunately, there’s woefully little of that out there, so you’ll be miles ahead of the competition.
Just let patient capital be your touchstone.
The foundational principle of patient capital is a long time horizon. There is not going to be much quick, easy money in real estate for a while to come (when there is, again, watch out), so the real estate world needs to get used to the idea. A long time horizon shapes everything else about the investment. For example:
- Reasonable debt. The pinch of interest payments can hurt enough on a three year deal. Imagine the bite taken out of your apple over a longer term. Do you really want the bank to profit-share with you? Debt per se is not bad, but it does constrain what you can do with your development. You’re answering to a stakeholder whose interests are not aligned with your ultimate success. A proper debt load—even a healthy debt aversion—will return the profits to him who actually works to earn them.
- Less capital. Since you’re not spending someone else’s money (i.e., the bank’s), you have to manage your capital wisely. A quarter mile of asphalt is the minimum order? How about 100’ of brick pavers instead? Sure, the pavers are more expensive per square foot, but 100’ of pavers costs much less than a quarter mile of asphalt. And it’s more durable, requiring less maintenance (again, less cost) over the long term. Caveat: think “inexpensive,” not “cheap.” Vigilantly guard your capital!
- Reinvestment. Since you’re starting with less capital and keeping it invested for longer, you will have to rely on reinvestment to complete successive phases. Sold a house fronted by those pavers? Lay 100’ more, build four more houses, and do the same thing again. Work your capital hard. IRR may look slim on the front end, but by increasing the velocity of your capital, you’ll multiply returns every time it turns over.
- Quality. In order for real estate developments to make it in the long term, they must have good form and substance. For examples, look at old European developments as well as pre-WWI American ones. In them, parcels do not stand alone. They all “talk” to each other in a harmonious way and each says something of value. When form and substance are both present, in micro and macro, projects remain useful hundreds of years later. Do you really think your strip center has lasting power? A relentless pursuit of quality and usefulness will assure that your project will succeed.
Patient capital makes good sense. It also makes “cents” because when you deliver actual value in this day and age, people will pay a premium on account of its short supply.
This just scratches the surface of the idea of patient capital and thoughtful development in the new economy. If you’d like to discuss them further, give us a call at 205-533-9261.