Caught Between a Rock and a Hard Spot
Have you ever been caught between two highly contentious factions with your personal vote determining who wins and who loses? To make matters worse, whichever side doesn’t get your vote, considers you their enemy. That happened to me recently. It’s no fun being caught in the middle. But I apologize, I’m starting in the middle of this true story. Let me start this time from the beginning. So here goes:
I was one of seven CRE investors who formed an LLC to purchase a run-down apartment. The previous owner had died and the heirs to his estate had no interest in the property so it slowly deteriorated. Eventually they decided to sell. When we acquired the property it was one sorry looking property.
Investor Mutiny Grows
During our first year of ownership the renovation of the property proceeded at a slower pace and at a higher cost than originally anticipated. Some investors were disappointed in the progress and had no qualms making their opinions known. Well into the second year the property had not yet provided any ownership distributions causing growing dissension among the investors.
An owner’s meeting was called by those who wanted to oust the managing member of the LLC as well as the property management company. All the owners were present as well as a representative of the property management company. Civility soon gave way to finger pointing and name calling. The management company representative walked out after a heated exchange. I’ve never been in a meeting this contentious. A vote was called and eventually everyone realized that I had the deciding vote. All eyes were on me. How would I vote?
Mutineers Ignore 5 Principles of CRE Investing
Actually the decision which side to support was an easy one. There were five reasons why I voted in favor of retaining both the managing member of the LLC and the property management company. In my opinion these five reasons are timeless CRE investing principles that all of us who in invest in CRE should follow:
Principle #1 – Have realistic expectations – Investing in commercial real estate requires patience. Nothing happens quickly. In a value-added acquisition, especially one that was in as poor of condition as this property was, it was not reasonable to expect owner distributions of any amount in the first couple of years.
Principle #2 – Focus on long term benefits, not short term gains. The real priority was not near term cash flow but how well was the property going to operate after the renovation? Specifically,
- How much cash flow would be generated in three to five years? And,
- How much would the property appreciate after improving the tenant profile? That’s where the focus should have been.
Principle #3 – Focus on growing income, not cutting costs. The cost of gopher extermination was one of the reasons why they wanted to oust the property management company at the owner’s meeting. I was thinking to myself, “You’ve got to be kidding me. Why get all hot and bothered by such a minor issue?” But they did. Those who focused on cutting costs didn’t understand that turning a property around is all about growing the property’s income and that requires spending money, not cutting costs.
Principle #4 – Listen to the counsel of those who have CRE investing experience. The managing member of the LLC had 40 years of experience in commercial real estate. He was not some newbie to CRE; he had a distinguished track record. The LLC members wouldn’t have even had the opportunity to invest in the property if he hadn’t identified the property’s potential investment opportunity. There is a time to challenge leadership but 18 months into a project is way too early to jump ship.
Principle #5 – Don’t micromanage those who have decision making authority. I applaud members of an LLC that ask probing questions to those who have day-to-day responsibilities managing the property. But they need to allow those who have operational responsibility to do their job without the Monday morning quarterbacking. Their philosophy should be to give those in charge of the daily affairs of the property, “enough rope to hang themselves.” If sufficient time has elapsed and they’re not performing up to your expectations, then and only then, do you think about replacing those in charge.
Results Prove My Choice Was Right
After the vote I received the heartfelt thank you’s from those I sided with and the animosity of those I voted against. There was no way to reconcile differences so as the weeks passed I asked if I could buy out the two partners who had instigated the uprising. They both were eager to get out of the LLC and we came to a mutually agreed upon price for their interests in the property.
From the vantage point of time there is no doubt in my mind I made the right decision. We recently refinanced the property resulting in cash back to the owners that was slightly less than their original investment in the property. The appraised value of the property after the renovation nearly doubled from what we paid for it three years ago and the property is now yielding healthy monthly owner distributions. The lesson I learned from this difficult experience was to trust these five time-proven principles of CRE investing.