Lessons from the top and my old boss??!!!!!!

When pricing out a loan, my old boss would tell me that "pigs get fed and hogs get slaughtered". After reading several articles on Harry Macklowe's problems with his lenders, my old boss's voice echoed in my head. Ironically, Mr. Macklowe's issues can provide a lesson to all real estate investors: Don't get greedy.


For those who might not be following the situation, Mr. Macklowe - a very successful real estate investor - is tied in a knot with his Senior, Subordinated and Bridge Loan lenders over the $7.1 billion he borrowed (fifteen months ago) to buy seven Manhattan office buildings. To get the deal completed he offered his crown jewel as collateral to secure a $1.2 billion short term bridge loan from Fortress Investment Group. The crown jewel is the prestigous General Motors building on the southeast corner of Central Park. Mr. Macklowe purchased the General Motors building for $1.4 billion from Donald Trump, who bought the approximately 2.0 million s.f. office building for $800 million in 1998.


Well, last week, Mr. Macklowe turn over the property to Fortress, but kept the title to avoid expensive New York City transfer taxes. Yesterday, three bidders put forth term sheets to acquire the property for $3.0 billion. While the 114% appreciation is nice, the equity in the property is going to go to Fortress and the rest to Mr. Macklowe's other lenders.


Mr. Macklowe got greedy with his desire to purchase the seven Manhattan office building portfolio from the Blackstone Group. He put in less than 1% of his own money, and borrowed the rest on short term money. His assumption was that he could easily refinance the short term money after acquiring the property, but today's credit market felt differently as many of the banks were suffering from large write-downs on both their residential and commercial loan portfolios. What seemed as a safe bet in putting up his crown jewel as collateral is now in someone else's hands. So what can we learn about Mr. Macklowe's situation?

1. Don't stretch for a property. Evaluate every property on a stand alone basis. I know that real estate fortunes are framed by the Donald Trump's of the world, but leveraging everything for that big deal doesn't make sense. Also, leave emotion out of the buying equation.
2. Have a back up plan! Structuring the deal as Mr. Macklowe did is sometimes required especially when you have to put a deal together quickly. However, having your eggs in one basket isn't smart. Be prepared to bring partners into the deal if necessary. I know I said the "P" word, but the equity give up by bringing in a partner is less than the cost of a bank coming after you for their money.
3. Be aware of where you are in the Real Estate and Credit Cycles. If you are going to put your net worth at risk, make sure you are fully aware of where you are in both the real estate and credit cycles. Yes, that's right credit availability goes up and down just as the value of your building or house. Banks quickly adjust credit standards and availabilty overnight based on market developements. Usually the adjustments are to harsh and take time to settle out. Talk to commercial realtors, bankers and other real estate investor's before pulling the trigger.

So remember the words of my old boss: "Pigs get fed and Hog's get slaughtered" and you should be ok.

"Property Play - A Primer for Investors who are considering commercial real estate to build up their nest eggs" by Kemba J. Dunham

In case you missed yesterday's Wall Street Journal article "Property Play - A primer for investors who are considering commercial real estate to build up their nest eggs", here is a review of this great introduction into real estate investing.

In this article, Kemba J. Dunham puts forth a basic outline to consider when looking at commercial real estate. Commercial real estate investments can range between retail strip malls, office buildings to real estate investment trusts (REITS), apartment buildings, and even five family residences. Unlike twenty years ago, financing is readily available for the purchase of commercial properites - making commerical real estate investing an option for the average American. However, as the article states commerical real estate investing is not for everyone and there are key considerations to follow.

First, Ms. Dunham states that every fledgling investor GET HELP. In every market there are commercial real estate brokers that can assist investors in selecting properties. They can add insight into local market rents, comparables, and even lenders. Other key advisors include a real estate attorney, and an accountant.

Second, the article points out several forms of ownership the investor should take title to the property. Direct Ownership or a third party vehicle, such as a Limited Liability Company or General Partnerships are the basic title considerations. Each form has its pluses and minuses. Direct Ownership is means that you take title to the property in your name. Some benefits include favorable tax consequences (consult a expereicned tax consultant), the ability to later conduct a 1031 exchange, and you're your own boss and don't have to share profits. The big downside to direct ownership is the liability - which is squarly on your shoulders.

Ms. Dunham provides a smart consideration to those investors that want to invest in commercial real estate but don't want the headaches of managing the property. In every market, there are capable property management companies that will manage the day to day on the property for a fee - usually 5% to 10% of the gross rent. The article suggest that "when hiring a management company, check out its references and see how well it is regarded locally".

Third, going alone scares many would-be investors, so partnering up with other investors makes sense. Partnering spreads the risk and lowers the personal contribution to get things going. However, an obvious drawback is the fact that you have to share the profits. The article suggests that those who don't want to go it alone find sponsors who buy commercial properties on behalf of small investors for a fee.

It goes on to suggests alternative forms of third party or sponsored ownership methods such as general partnerships, limited liability companies, or tenant-in-common arrangements (TIC). In a TIC arrangement each tenant owns a fractional share in the property. Limited liability companies offer the tax consequences involved in direct ownership while offering a direct liability shield against claims. There is a cost to set up a limited liability company or general partnership and a good commercial lawyer can assist in that process.

The last bit of advice in this great article focused on Triple Net-Lease Properties, which are properties that the tenant covers the utilities, taxes, and insurance in the rent. While the advantge to the owner is just collecting a check every month, the tenant would most likley require a long term lease as incentive to agree to those terms. As Ms. Dunham states in the article, "Because of the long leases, net lease properties can be very illiquid".

Overall, the article is a solid start for anyone looking to enter the commercial real estate market. The best piece of advice is get professional help - a commercial realtor, a real estate attorney, and an accountant.