The old gods of CRE

And why they matter in PropTech

Let me tell you how to build a commercial real estate empire.

It’s going to take some time and patience, but it’s not terribly complicated.

First, spend a couple years in and around deals. 5 to 8 years is more than enough to get to know how the system works, how deals are sourced, how debt and equity are structured, etc. While you are doing this, start warming up a few investors. If you grew up wealthy or went to an Ivy League school, it will be easy. Your friends and family will do your first deal. If not, you just have to hustle your way to people with LP money. Sorry.

Then, when you find an above-average deal and you have saved enough to invest 20% of the equity in TWO deals, make the plunge.

I say above-average because you will NOT find a great deal as your first deal. Brokers won’t give you access to great deals (unless you were born in a super-wealthy family). More on that later. Just find a decent one, take the plunge, close the deal, and get going.

Now, two important things need to happen during this first deal - 1. Make a little bit of money for your investors and 2. Immediately start working on your second deal.

Like I said, you won’t get a great deal here. You’ll likely have to overpay for the property and you won’t have any leverage over lenders, investors, or tenants. They will all work against you (not on purpose, they are just worshipping the god of Track Record and you don’t have any) and you’ll get the worst terms in the market. Still, grind it out, don’t worry about making any money for yourself (you’ll get paid on that second deal), and return money to your LPs while the second deal is coming together.

Once those two deals are done, and assuming the second deal is better than the first, all you have to do now is rinse and repeat for the next 30 years and you will be worth tens of millions of dollars. Go find similar deals, chase similar tenants in similar neighborhoods, find-close-fix-sell. Bing, bang, boom. Your track record from your first and second deal will get your your third, your third will get your fourth, and on an on. It becomes a self-sustaining engine of just showing up with track record and LPs will give you capital.

And that’s it. Just follow that process and you’ll be very wealthy in your CRE career.

Here’s why it works:

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Let me start by saying that there are a ton of wonderful and creative people in commercial real estate. When I paint trends with a broad brush it can sometimes seem like I’m decrying everyone in my industry. I am not. My entire family is in real estate and some of the best people I know are here. So, if any of this comes across as slightly negative, please do not take it personally. I’m aiming for a general truth and not an absolute law.

Having said that, the reason the above scenario works is that CRE professionals worship two gods - Track Record and Skin in The Game.

If you have both, you can do pretty much any deal you want no matter how smart you are, how hard you work, how creative you are, etc. This is exactly why unremarkable wealthy kids can do well in CRE. They can simply buy their way into track record (overpay for a few deals, squeak out some basic returns, then use that momentum as their track record. Boom. CRE empire.) They show up with extra Skin in the Game and can do mediocre deals until they find a winner. Then promote-the-living-daylights out of that winner to get the next deal. If the next deal is a winner (let’s say high-teens IRR), you have a portfolio and momentum. All you have to do now is not screw it up. You’ll get good deals from brokers (who before didn’t want to risk their reputation on someone with no track record) and investors will line up to invest with you.

But let’s start with Skin in the Game.

The idea is that you are investing personally in any deal that you’d like for me to invest in. It’s a fair concept - If you won’t invest your money in this deal, why should I?

Over the years, it has served as a mechanism to prevent overly-ambitious (greedy?) deal sponsors from doing so many deals at once that they can’t actually invest in their own deals. What it has actually turned into is a false positive for underwriting risk. The assumption is - “If she is putting that much of her own capital in this deal, it must be a winner.”

It’s signaling. And it’s a weak/lazy signal.

Know any less-than-brilliant rich kids who will invest their money in questionable deals? Know any doctors who have lost their shirt in real estate? Know anyone who has made money in another industry and then strolled into CRE to build an empire only to have their lunch handed to them by the pros?

I can’t even count the number of people who fall into these categories. Thousands and thousands of people.

But they all have “skin in the game.” Why didn’t it all work out with all that skin in the game?

See what I mean by false positive?

LPs are busy. I get that. They need mental shortcuts so they don’t have to start from zero on every new deal and relationship. Skin in the Game is a shortcut for “The GP isn’t scamming me or going to walk away when problems pop up.” Still, it’s a weak signal and gets WAYYYYYY too much power.

Track Record is similar.

You know how all investments that are registered by the SEC and all mutual funds have a disclaimer about “past performance does not guarantee future results?” This is why.

People VASTLY overweight track record. If you think I’m exaggerating, go to any non-REIT CRE firm’s website and look for the “combined years of experience” stat that is on 99% of them.

And take it from someone who had to work out 150 distressed loans in the last recession. My average borrower’s age was in the late-50s or early 60s and they had all done plenty of successful deals. Track record means far less than investors think it does.

Still, I get it. We are all busy (lazy?). Someone did this before, they can do it again. Right?

Madoff. Ponzi. LTCM. Blockbuster. Sears. Kodak. Lehman Bros. Should I keep going?

It’s another weak signal that gets far too much power in CRE.

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The weird thing is, these two weak signals combined somehow make a strong signal.

“Well, honey, his last couple deals did well and he has over $1M of his own money in this deal.”

I don’t care what they ask you about your tenants, the neighborhood, debt structure, timing, market risk, etc. They are just “checking boxes” in a diligence work flow to tell themselves they are thorough. All that really moves the needle is track record and skin in the game. You can fudge on demographics and have a vague leasing strategy. Get these two weak signals right and nothing else really matters.

And that’s it. Use track record to convince brokers to bring you deals and both track record and SITG to get LPs to give you dollars. Don’t get greedy and you’ll build an empire and spend your time between golf outings and fishing trips fretting over tenant trends and debt structuring.

Have fun.

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So, why does that matter to PropTech?

Well, friend, you need to know that this is the mentality you are selling technology in to.

Think about this - How do you sell creativity and innovation into a group of people who worship at the alter of track record and skin in the game?

It’s a nuanced question, but I would tell you to work it into your pitch. Speak their language and reference their gods.

If you have invested substantially into your own startup, mention it. Multiple times, if possible. If you have forgone a salary to get the company started, mention that. That is your skin in the game.

And this may be obvious, but hammer those Case Studies for all they are worth. If you have a successful pilot with one company (where you can quantify the results), then you need to reference those every time you speak to a sales prospect. That is your track record.

That’s the secret sauce of sales in PropTech. Just like any sale, you need to speak the buyer’s language. In CRE, the faith is built on Track Record and Skin in the Game. If you can work those into your pitch, it will resonate with these people who have built their own empires under the watchful eyes of these old gods.