It’s a beautiful Sunday morning here in Malibu and I have drained the coffee pot whilst enjoying the view and reading the news from around the world. Today, I’ve decided to share one of my early real estate investment stories with you. Here goes:
In or around 1978, I was presented with an investment opportunity in an area of Los Angeles that is now known as “The Grove” or “The Third Street Shopping District.” At the time, this area was not particularly well defined (meaning there was a blend of older commercial properties primarily serving the local community), but gentrification began to stir just after the great recession of 1975. The area demographics were strong, and nearby CBS Television City and The Original Farmers Market were fast becoming world famous destinations, attracting an ever-growing pool of entertainment industry employees and tourists. I studied the market, saw the growth potential, and at the ripe old age of 23, jumped in with open eyes, empty pockets, and a vision of what might be possible.
Great real estate deals are rarely cut and dry. There are lessons to learn from every one of them. Here are some of the challenges + solutions of this particular deal:
Opportunity: For a fee of $75,000, the second-floor lessee of a two-story commercial building offered to assign his lease to me. The first floor was occupied by a real estate school that was approaching the end of its lease term. The second-floor lease provisions included an option to purchase the property for a price of $500,000, which, at the time, was quite attractive given that my market research suggested that the property was likely worth at least $700,000.
Challenge: Assignment of the lease (and option to purchase) was prohibited.
Solution: Enter into a joint venture agreement with the second-floor lessee, contribute $75,000 to the lessee entity, and include a provision in the joint venture agreement for the second-floor lessee to retire upon my exercise of the option to purchase. Presto, no assignment occurs to trigger a breach of the lease and the option to purchase is exercised.
Challenge: Where to get the equity to complete the purchase?
Solution: Form a limited partnership entity and seek out investors. Having read Sam Freshman’s book “Principles of Real Estate Syndication” and following the advice of Dr. Jerry Buss (“investors need a sponsor”), I wrote up my thesis, followed the prescribed format provided by these two great minds, and raised sufficient equity to purchase, operate, and re-position the property.
Challenge: Where to borrow the difference between the equity raised, the purchase price, and the working capital needed to operate and re-position the property? Interest rates were reaching record highs under Fed Chairman Volker and lenders were not keen on making loans to inexperienced borrowers secured by soon-to-be-vacant real estate.
Solution: Present the lender with a compelling proposition. My research indicated that the property was under-improved. City zoning for the property allowed for the ability to double the size of the second floor and provide covered parking. This potential had been overlooked by the previous owner and the second-floor lessee. The lender was favorably disposed to making the loan, subject to only one major condition…deliver the City approvals.
Challenge: How to get City approvals to add the extra second-floor space and covered parking?
Solution: Locate and retain an architect that understood the concept and could deliver the necessary approvals. I figured it wouldn’t be too hard to do this. I was wrong. Navigating the process from architect retention, design, engineering, and permit issuance was daunting. Sheer determination was the solution…and permits were issued.
Challenge: Construction. Who would build for the budget I had in mind?
Solution: Retain a contractor that had the capability and needed the job.
After all was said and done, the building expansion was completed on time and within budget and the entire building was leased prior to completion. New financing was obtained with excess proceeds distributed tax-free (loan proceeds are not income and therefore not taxable) to the equity investors, and the property was producing positive income offset by depreciation expense, which allowed the income to be tax-sheltered. After just a few years, the property was sold, and the equity investment was doubled. Forty-two years later, after repeating a similar process with over one hundred properties, the results have been strikingly similar. I invite you to explore our new website to learn more.
Lessons learned: Dare to think outside of the box, when the data supports it. Look for opportunities that others may not see or might have missed. Proceed with determination. Follow the advice of experts that you trust.
With luck and the desire to succeed, anything is possible…even for a guy at age 23 with no money or proven experience who was emblazoned with creative thinking and the grit to make it happen.