This review originally appeared in Real Estate investor’s Monthly.
A number of readers asked for my opinion on James Randel, so I asked readers to give me a copy of his book and one did.
This book mimics my advice in many respects, although the author, Connecticut investor James Randel, puts a slightly different spin on it and emphasizes development deals more than existing buildings.
Randel says his main focus is “adding value,” but I think he uses that phrase incorrectly. I favor either a bargain purchase or an upgrading strategy. Often, a deal combines both.
A bargain purchase is buying a property for at least 20% below its current market value.
Upgrading means paying up to as much as market value, then increasing the value of the property by changing it in some way. The changes can be physical, like renovation, or intangible, like getting better zoning.
Upgrading is adding value. Bargain purchases, however, do not strike me as any type of adding value.
Randel is a lawyer. I’m not, but I still thought some of his legal discussion was a bit off.
Future subordination clause
He advocates the use of future subordination clauses in mortgages. These say that the mortgage will be subordinated to some other mortgages to be obtained in the future. Generally, I do not believe a future subordination clause is enforceable unless it contains much of the actual language and terms of the new mortgage in question.
‘Meeting of minds’
There is a basic principle of contract law that there must be a, “meeting of the minds,” between the parties and in real estate, one-sentence clauses that obligate a party to something that normally takes pages to describe would generally be insufficient evidence that a meeting of the minds occurred. For example, the owner of the first mortgage could say, “Your honor, it’s obvious that my client never contemplated nor was told that the new mortgage would have this or that onerous term.”
Actually, Randel’s book seems to say that the subordination clause per se was not key or challenged, rather, the owner of the first mortgage simply signed the additional paperwork submitted by the new mortgage lender and title company. That, I agree, would be quite legal. Unfortunately, I suspect Randel may leave many readers with the impression that a one-sentence future subordination clause would be enforceable. I doubt that.
Randel is also off with regard to non-recourse mortgages. He says you aren’t going anywhere in real estate unless you agree to recourse mortgages. That is very Connecticut of him.
In fact, in California, recourse mortgages are quite hated and, I suspect, rare. This is a really big deal. When I lost $750,000 in Texas in the late eighties, it was not a great deal more because the mortgages in question were non-recourse. Thank God I had not read advice like Randel’s and blithely agreed to recourse mortgages when I did not need to.
Whether you have to be personally liable on a mortgage seems to be a function of the region as well as the size of the loan and the percent of equity. Generally, you should try very hard to avoid personal liability, although I will acknowledge that it is much harder to do in the East than in the West.
Randel’s discussion of assuming mortgages also seems offout of date. He says “Not all mortgages are assumable." Ya think? Hardly any are. Assumable mortgages are a thing of the past. He says you can get around due-on-sale clauses with wraparounds. This is very crude old-time seminar real estate. There is an article called the, “Truth about getting around due-on-sale clauses,” at my Web site www.johntreed.com/dueonsale.html.
One of the strengths of the book is that Randel often depicts the back-and-forth dialog between himself and a real or theoretical other party to the deal showing how he persuades them to go along. Although I occasionally disagree with what he says.
Tying up property
One early point Randel makes is that you should try to tie up a property in a way that has low risk to you. Then you try to find a commercial tenant or get zoning changed or some such to increase the value. If you fail, you walk away from the deal.
I’m fine with all that. You do that with an option. It’s standard practice in those situations in commercial real estate. However, Randel says that the seller will often not agree to an option per se, so he tries to create a disguised option in effect with a purchase agreement and various weasel clauses.
He loses me there. I have no objection to his getting an option. Nor do I have any objection to his being willing to walk away from an earnest money deposit if the clause governing that deposit says it is the total liquidated damages the seller can get. Nor do I object to his going through with the purchase even though he did not succeed in getting the tenant or zoning or whatever he was seeking.
But leading a seller to believe that you are a buyer and not an optionee, then bamboozling the seller into contract language that, in effect, turns the purchase agreement into an option, strikes me as unethical and immoral and possibly illegal. It also strikes me as a violation of the old saying, “Honesty is the best policy.”
Randel, oddly, uses the word “player” a lot. In the context of male-female relations, a “player" is a skillful, successful cad. In the business world, “player" seems to be a lowbrow word for a guy who is important in the local marketplace because he can do a lot of deals.
There is nothing wrong with being such a business person, but I would simply call them “active investors.” The word “player” sounds Runyonesque to melike calling a thousand dollars “a grand.” Anyway, Randel calls himself a “player” and the purpose of his book is to teach you how to become a “player.”
To be active, or a “player,” you need to be trusted in the local marketplace. Randel’s discussion of tricking sellers into granting him options disguised as purchase agreements is not likely to endear him to other “players” in his southwestern Connecticut market.
At all levels, real estate is like a small town. You quickly earn a reputation and everybody who is active knows your reputation. This would be far more true if you wrote a book like “Confessions" in which you brag about your tricks as Randel has.
In Rich Dad Poor Dad, Robert Kiyosaki bragged that he always put a clause in his purchase agreements that the deal was contingent upon approval of his business partner and that he did not tell the seller that his business partner was his cat. Right. And if he really did try to do a real estate deal with a major investor in his hometown Phoenix market, they would be asking, “Where’s your cat, Bob?" just before they admonished him not to let the door hit him in the butt as he was leaving.
If you want to be a “player,” you need people to be glad they did business with you when the deal is done. Trying to tie properties up with purchase agreements that you intend to walk away from if you cannot pull off some action not spelled out in the agreement would quickly make you a pariah in your local market.
Randel urges readers to consider suitability when dealing with other parties. I thought I was the only one in real estate who did that, although I must say that his suitability advice is slid over a few notches from mine.
Suitability is a well-known concept in the securities industry and almost unknown in real estate other than when real estate is offered to the public as a security like limited partnerships.
It refers to the need to refrain from offering sophisticated financial instruments to unsophisticated people. In real estate, it generally means avoiding asking unsophisticated sellers to take back mortgages and asking unsophisticated would-be home buyers to lease-option a house.
OK if wealthy/sophisticated
In discussing his use of a purchase agreement with escape clauses as an option, Randel says it’s OK to do this with wealthy, sophisticated people but maybe not with others. If I understand correctly, he is saying the wealthy, sophisticated people ought to know better than to let you talk them into a purchase agreement that is really an option.
My version simply says that you do not do certain deals at all with the unsophisticated and that even with the sophisticated, you have to be truthful, keep your promises, and abide by the Golden Rule.
To use his example, I say you should not even attempt to get a disguised option from an unsophisticated seller. And if the seller is sophisticated, I say you may try to get an option or perhaps a liquidated damages clause in a purchase agreement, but you may not try to convince the seller that you plan to go through with the deal when your real intention is to abandon it if your undisclosed plans do not pan out.
Another trick Randel advocates is to get a long-term tenant to agree to above-market rent, thereby jacking up the building value, by agreeing to rent concessions that are not revealed to the buyer. I do not feel this is ethical and moral and, depending on how it’s done, it may not be legal. Plus, my various writings about such things always tell you to investigate whether tenants got rent concessions. For example, page 137 of my Residential Property Acquisition Handbook says to ask the tenant and manager if the tenant received any rent concessions. You should also get the seller to state in writing that there were no concessions or state what they were if there were any.
Randel tells readers how LLCs and corporations protect them, but he says virtually nothing about the ability of a plaintiff to sue you as an individual and pierce the corporate veil with alter ego and other allegations. He does acknowledge that lenders often will require that a loan to an LLC or corporation also be guaranteed personally by the individual principals.
The best part of the book is the actual case histories. They are generally non-residential and often development or closer to development than the buying of existing ready-to-rent buildings. But they are still quite instructive.
Many residential investors have told me that nonresidential is terrible for various reasons. Randel more or less says the opposite. His rare forays into residential seemed to be losers.
One of the advantages of nonresidential that is evident in Randel’s stories is that there is a wider variety of opportunities because nonresidential is more complex and because it is less well understood by the public in general, including many of those who own or lease it.
Randel is also good about telling about his failures as well as his successes. Some stories:
• losing a good deal because he got only one seller’s signature (he checked the assessor’s listing, not the actual deed)
• made big profit by finding land for a Wal-Mart and getting it re-zoned and closer to development before selling out to a developer more suited to finishing the project
• profit from converting industrial property to outlet retail which has a lower cap rate. This is a form of profiting from cap-rate compression about which there was an article in last month’s edition.
• increase the value of an office building in part by planting large hemlock trees to screen off the eyesore back of a nearby restaurant
• profit from buying a pre-foreclosure office building with economically correctable oil contamination on adjacent property and a deteriorating three-level parking garage
• profit from converting industrial building into self storage
• lost $1 million trying to convert an industrial building into a retail building when nearby retail owner sued to stop. The suit was thrown out when Randel found that the store in question was 10 feet more away from the conversion building than the 100 feet that gave that owner standing to stop the conversion in that manner. But damage had been done.
• lost $1.5 million trying to turn a horse farm into 20 homes because permits took longer than expected, sales were slower, more roads than expected had to be built
• lost several deals because he tried to negotiate to make a good-enough deal better
• increased a nonresidential building’s value by replacing a financially-shaky long-term tenant with a strong-credit, long-term tenant
The case histories are good. I recommend the book because of them.
I have long said that the risk that many developers take is off the scale, mindless, and reckless. Think about it. You start with a piece of raw land that is typically not zoned for what you want to build.
It will take at least several years to get permits, if you ever get them, and start building the building. There is no way to forecast demand for what you are building or to forecast or lock in interest rates that far in advance. It’s a crap shoot.
You can be smart about it in many respects. I interviewed Malcolm Prine when I was in grad school. He was then head of Ryan Homes, the second largest U.S. home builder. I asked how much land his company owned. “None!” he shot back seemingly horrified at the thought of owning any land. He explained that his company only optioned land and did not exercise the option until just before the backhoe blade hit the dirt to begin construction. So you can eliminate or minimize some of the risks and you should.
But Randel talks about such risks and tactics in a way I do not likea way that I have seen others talk about themthe sort of “No guts no glory” rationalization of reckless behavior. For example, he describes himself and other successful people in his field as “scrappy" and “aggressive.” These cannot be characterized as virtues per se. It depends on the situation.
Randel repeatedly mentions inability to sleep because of risk as an amusing aspect of development. I disagree. If you are suited to this sort of activity, you do not lose sleep in situations where others would. If you are losing sleep, find another business.
While it is true that unwillingness to take risk limits reward, it is not true, as so many seem to say, that willingness to take risk increases reward.
Lack of risk means that there are one or a few possible outcomes, all of which is moderately attractive. Risk means there are multiple outcomes, at least some of which are very unattractive.
There is no guaranteed reward or compensation for risk taking. If you take a risk, you may get hurt or you may do well. The good results tend to be better than those available when you refuse to take risks because the presence of risk depresses the price which, in turn, elevates possible profits.
Similarly, investors should not confuse risk-taking with proof of manhood. Risk-taking is not a virtue. It depends on the circumstances, including the amplitude of the possible outcomes, their probabilities, if known, the alternative paths available for achieving the goal in question, and the worthiness of the goal.
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John T. Reed, a.k.a. John Reed, John T Reed, Jack Reed, 342 Bryan Drive, Alamo, CA 94507, Voice: 925-820-7262, Fax: 925-820-1259, Email: email@example.com