Timing, Timing, Timing
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G5 Enterprises, Inc. is a group of five former real estate brokers who have joined forces to develop residential projects, primarily new home construction and condominium conversions. Many readers have heard some G5 success stories and have chatted with Chet Allen, S.E.C., and Virgil Opfer, S.E.C., about forming their own partnership to take on development projects.
In New York, Chet recently presented his nationally recognized seminar, “Developing & Syndicating: Big Money Real Estate,” in which he lays out the important steps in getting started in the development arena. Because of the current housing market conditions, Chet has introduced a new element to his seminar-a section on what to do when the market turns on you.
In that same cautionary theme, it occurred to me that it might be worthwhile to share some of the lessons that we at G5 have learned in the past couple of years. This article is intended to encourage the reader to follow the reader’s entrepreneurial goals, but to do so with an added word of caution.
Probably, the most important lesson that I’ve learned in the past two years is the fallacy that I feel exists in the popular adage, “The three most important words for success in real estate are location, location, location.” I strongly suggest that we replace these three words with “timing, timing, timing!”
You can have a premier location and build the very best product, but bad timing will trump a great location every time.
From the outset of G5, we have been keenly aware of the cycles in real estate. For each project, we work hard to plan our timing for the sales effort to be as solid as possible. However, even with meticulous planning, a planned 18-month to 24-month project can be delayed and turn into a project taking three years, or longer, before the project is ready to be brought to the market.
In developing, there are countless sources of delays that are beyond your control. Delays are not only costly because of ongoing carrying costs; significant delays can alter your schedule for coming out of the project. Even though you planned to sell out the project in a strong market, long delays can find you trying to sell in a market that is like today’s beleaguered housing market.
You can have the perfect product in the best location, but there are unpredictable occurrences that can affect the timing and profitability of the project. Here are a couple of issues that we have personally encountered that have created unanticipated delays.
An unexpected delay came from an under-staffed utility company. The plan check time for processing improvement plans through a utility company usually involves a two- to three-week turnaround time. However, the shortage of experienced personnel in this water district led to turnaround times of two to three months. To exacerbate the situation, when the corrected drawings were resubmitted, the utility company assigned a different plan checker to review the corrections, with each plan checker having a different interpretation of the district’s requirements. The result was a one-year delay in receiving final approval for the water and sewer improvement plans. Even the most careful planning could not have foreseen this delay.
On another project, we needed to build a short road with an existing water main located underground where the road was to be built. We were required to wait for seven months while the water district and the County argued over which agency would be responsible for future road repairs if the new road ever needed to be torn up to replace the water main. You just can’t plan for that kind of nonsense.
Here’s the point. You can meticulously design a plan to the smallest detail and still have your timing go astray from causes that are impossible to predict. If those delays bring your sales period into a weak market, the unpredictable delays can change a very profitable project into a challenge just to break even. As stated above, it is all about the timing.
The unforeseen delays are inevitable, but here are a couple of ideas to reduce the risk of losing all of your profit.
First, select a project that will have at least one feature that makes it unique in the marketplace. On our desert project, our marketing program was delayed and we found ourselves in a weak market. However, we had great success even in today’s housing market because we built ten homes with a special amenity. The large homes, priced in the mid-$800,000’s, featured a separate luxury motor coach garage. The motor coach garage was sized to house even the largest high-end motor home. The 20′ x 50′ garage had a fully finished interior, air conditioning, its own bathroom, and other features designed to appeal to the wealthy traveler. Even in a market where neighboring projects were struggling, all ten homes were sold before they were completed. All ten buyers had expensive motor homes, with some motor homes valued in excess of $1M. Every one of the buyers was attracted first and foremost to the motor coach garages, the one amenity that was not offered by any other project in the area. Our project closed out last month, and the neighboring projects are still struggling with their sales.
It is not always easy to set yourself apart from your competitors. Therefore, the second and more important suggestion is to create a very high standard for your estimated profit. This sounds very simple, but sometimes it is tempting to ignore. For this suggestion, I will assume that the reader is, like G5, a relatively small developer. Large developers with very high sales volumes can work on smaller profit margins. However, a large scale, low-margin project is not for G5, and it should not appeal to you.
We have learned that a project with a marginally high profit is not worth doing. You must set your profit level at what many would consider an obscenely high level. Given the risk associated with development, the projected profit for any proposed project must be exorbitant, or just pass, and leave it for someone else.
Don’t get caught up in the dollar amount of the profit. The rate of return on capital should be your measure of profit, not the dollar figure. A $1M profit sounds attractive, but not if it takes $2M of invested capital to arrive at that profit. I would look for the deal that makes a $2M profit with a $1M capital investment.
If you only accept the projects with exceptional returns, the timing for the sales becomes less critical and the delays that will inevitably occur will not have the same impact. Using this strategy, when you sell in a good market your profits can be enormous. Just as important, when you sell in a weak market, your exit strategy can be extremely competitive in pricing and still make a reasonable profit. Without this “high profit or pass” strategy, you can lose your assets.
You might ask, “What if all the deals out there fail to meet my criteria. Don’t I have to live with market conditions and accept the best deal that I can find?” My answer is, “No, you have the choice of waiting.”
“But, what if I want to get started, shouldn’t I take on a deal that makes a little money, at least while I’m getting my feet on the ground?”
Emphatically, “No!” Especially when you are starting out because there is so much to learn in your first projects it is even more important to have a very high projected profit.
“What if my marketplace never has the kind of opportunity that you describe? All the developers in my area work on much lower profit margins.”
That happens in some areas, so my suggestion is to look for your development project in a community where the opportunity does exist. Don’t give in to the temptation of competing with the more experienced developers in your area using their rules. You won’t win.
By its nature, the high-profit deal is not readily available; you will need to work to find it. My point is that when it does come along, you can’t afford to be tied up and spending your time on a project with only a marginal profit. Your commitment to a marginal project could preclude you from accepting the “home run” project.
Being patient and waiting for the “home run” project is consistent with my new mantra, “The three most important words for success in real estate development are timing, timing, timing.”
