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Posted on
Monday 6 July 2009
Is long form, professional writing dead?
I think the world needs some longer form articles not just 500 word
specials to the editor stuff. What I write is meant to educate and
entertain not only inform…
Have you ever heard the story of Hansel and Gretel as told by a reporter? (This is my version.)
“Once upon a time, two kids, a brother and sister, had a great life
living on the edge of a wood with their Mom and Dad. Mom died. For
reasons that were unclear to the kids, Dad remarried an unpleasant woman
who was mean to them. When times got tough, the stepmother told her
husband to get rid of the two extra mouths to feed by losing them in the
woods. He did. But the clever kids, one of whom had overheard the
stepmother, made plans: they laid a path of bread crumbs down as they
walked into the woods with Dad. When Dad disappeared, the kids were able
to find their way back in the moonlight. The process repeated itself
but this time the bread crumbs were eaten by birds. The kids got
hopelessly lost. They got hungry. They stumbled upon a house made out of
candy. They started eating it. Turns out the house was owned by a
witch, who made the girl work as a serf and the boy was imprisoned. The
kids figured that the witch planned to fatten them up and then eat them
but the girl tricked the witch one day and shoved her into an oven—to
her death. They ransacked the place and found treasure which they took
with them. Somehow they found their way back to Dad. The stepmother was
gone. They lived happily ever after.”
It is the same as the Fairy Tale but then again, it really isn’t. Right?
Prof Bruce
Prof Bruce @ 1:44 pm
Filed under:
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Writing, Research and Experimentation
Bootstrap Capital—Reducing Capital Requirements
Posted on
Saturday 4 July 2009
A student recently introduced me a new form of Bootstrap
Capital, or at least, one I hadn’t considered before. It seems obvious
to me now but I think it takes some creativity to apply it to any
business model.
She is in the Executive Travel Apartment (ETA) business—those are
extended stay suites that executives use and many prefer to a long stay
in a hotel room.
It is a very capital intensive business: she needs equity to buy her
units, renovate them and furnish them. She can reduce her capital needs
by mortgaging the units using high LTV (Loan to Value) ratios and
leasing (or leasing to own) the furniture she needs for each unit. Still
her equity requirements are non-trivial.
She came up with a very inventive method of expanding her budding
empire without having to bring in a partner or sell her soul to finance
companies.
A form of bootstrapping is to lower the level of capital you require in the first place.
She can charge about $3,500 to $4,500 per month for her ETAs, about
$120 to $150 per night for a one, two or three bedroom unit which is
fully furnished, the Internet and TV work, the VOiP phones are on and
there is a starter kit (soap, salt and pepper, bread, milk, etc.) on
hand. Just let yourself in using the lockbox combination, and relax,
you’re home.
Because these are ETAs, she comes under the Innkeepers Act and not
the RTA (Residential Tenancy Act) so she is much less likely to have
trouble with her tenants than a typical residential tenancy where
delinquency is high, collections are tough and getting rid of them
(evicting them) is even tougher.
A typical unit can cost her $200,000 or more to buy (with anywhere
from 5% to 25% equity required), $20,000 to renovate and another $10k or
so to furnish. So each unit can easily consume $70 or $80k of equity.
Other ETA operators solve this problem by selling the units to investors
and keeping management in their hands plus a share of ownership.
She came up with another way—what if she went to residential
landlords and told them: “I will lease some (or all) of your units for
repackaging as ETAs.” From a Landlord’s POV, that takes him or her out
of the purview of the RTA and he or she now only has to manage one
tenant (the ETA operator). The ETA operator worries about furnishing the
units, renting them out, managing and maintaining them, etc.
In the buy scenario described above, she will need $80,000 in equity
per door. If she rents each unit out for $4,000 per month and has a
mortgage at 6% with a 20 year amortization period, she will be left with
a NOI (Net Operating Income) after deducting a vacancy allowance,
marketing costs, admin and contingencies of about $1,077 per unit per
month.
If she sublets units from a cooperative Landlord at $1,400 monthly,
she is left with less—just $766.49 per month per unit. This is because
she is paying less on her mortgage than she is in rent to the Landlord.
But in the first case, she needs $80k of equity; in the second case, she only needs $30k.
Now her simple ROE (Return on Equity) is 16.2% p.a. when she buys her
own units versus a whopping 30.7% when she rents them instead. (See the
spreadsheet below.)
Now this model ignores the wealth effect of owning your own units
(the annual paydown of your mortgage principal, in effect, by your
tenants) and real estate inflation (that goes solely to the equity
holder).
If I took those factors into account, the ROEs would probably be a
lot closer*. But that doesn’t matter if she can’t afford to expand her
business because the equity demands of the first model are too high for
her to handle.
So the obvious choice is to do both—own some units and sublet some.
As her cashflow improves, she should probably be buying relatively more
of her units.
But at least initially, from her POV, her capital requirements have
dropped from the $70 to $80k per door range to $10 to $30k per door and
her ability to grow the business faster has just taken a quantum leap
upwards.
Prof Bruce
Ps. Another client recently showed me how he could acquire inventory
for his retail store at a negative cost to him—other retailers are
paying him to feature their products and services in his outlet store.
They pay him a monthly fee for this plus they give him a percentage of
each of their products or services that he sells for them on
consignment.
Pps. We are now busy applying this philosophy to other types of businesses with great effect.
* If we take into account the wealth effect and the impact of real
estate inflation, the two rates of return (this time measured using the
IRR instead of the simple ROE ratio) are, in fact, closer. In the ‘buy’
scenario, the return increases from 16.2% p.a. to 22.8% while for the
‘sub let’ scenario, the return remains that same at 30.7%.
The latter doesn’t change because, in this model, I have assumed that
when she sells the business at the end of year 7 (an arbitrary time
line, I might add), she realizes exactly what she put in initially for
renovations and furnishings. Of course, in reality what she gets for the
business would depend on what she and a Buyer agree to which could be
greater or less than this amount. Nevertheless, in order not to bias the
comparative analysis, it seemed reasonable to make this assumption.
You can examine the spreadsheet below or download it in .xls format from my server at: https://www.ottawarealestatenews.ca/ETAs.xls.
ETAs
Buy the Units
Cost per Unit $200,000
Equity ($50,000) 25%
Mortgage $150,000 75%
Interest 6% p.a.
Amortization 20 years
Monthly Payment ($1,089.81) to Lender
Renovations ($20,000)
Furniture ($10,000)
($30,000)
Interest 10% p.a.
Amortization 7 years
Monthly Payment ($513.51)
Total Cost ($1,603.32)
Monthly Rent $4,000
Marketing ($320) 8%
Vacancy ($480) 12%
Other ($240) 6%
Contingencies ($280) 7%
NOI $1,077 per month
Equity ($80,000)
ROE 16.2% per annum
Year
0 ($80,000.00)
1 $ 12,920.15
2 $ 12,920.15
3 $ 12,920.15
4 $ 12,920.15
5 $ 12,920.15
6 $ 12,920.15
7 $ 167,186.31 $ 12,920.15 $ 124,266.15 $30,000
IRR 22.8% p.a. Assumes the business is sold
and the sale price of the biz
R.E. Inflation 2.75% equals the investment in
Selling Price $ 241,825.90 furniture and renovations.
Agency Fees ($12,091.29) 5%
Legal Fees/Closing Costs ($1,105.00)
Net $ 228,629.60
Principal Repaid
1 ($5,436.91)
2 ($5,763.13)
3 ($6,108.91)
4 ($6,475.45)
5 ($6,863.98)
6 ($7,275.81)
7 ($7,712.36)
Total Principal Repaid ($45,636.55)
Mortgage Balance Due $104,363.45
Net to Seller $ 124,266.15 on completion
SubLet the Units
Cost per Unit 0
Equity 0
Mortgage 0
Monthly Payment ($1,400) to Landlord
Renovations ($20,000)
Furniture ($10,000)
($30,000)
Interest 10% p.a.
Amortization 7 years
Monthly Payment ($513.51)
Total Cost ($1,913.51)
Monthly Rent $4,000
Marketing ($320) 8%
Vacancy ($480) 12%
Other ($240) 6%
Contingencies ($280) 7%
NOI $766.49 per month
Equity ($30,000)
ROE 30.7% per annum
Year
0 ($30,000)
1 $9,197.84
2 $9,197.84
3 $9,197.84
4 $9,197.84
5 $9,197.84
6 $9,197.84
7 $39,197.84 $9,197.84 $30,000
IRR 30.7% per annum Assumes the business is sold
and the sale price of the biz
equals the investment in
E&OE. furniture and renovations.
Prof Bruce @ 3:26 pm
Filed under:
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Bootstrap Entrepreneurs– Case Studies
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No Money Down Real Estate Investing
Posted on
Saturday 4 July 2009
Business models are usually a one page diagrammatic
depiction of the engine of your business. On the left hand side (LHS),
you have your suppliers. In the middle is your business. On the right
hand side (RHS) are your clients and customers. Information and products
and services flow from your suppliers to you, you add some value
(hopefully) and then they flow from you to your customers and clients.
In the reverse direction, money and information flow from your clients
and customers to you and from you to your suppliers.
There is also an orthogonal (3rd) dimension—your marketing. You need
to have a way of connecting with your clients and customers that is
cost-effective. If you need to run a Super Bowl commercial before you
get your first client, your new enterprise is probably doomed.
Sam Palmisano, CEO of IBM, has said he spends more time on IBM’s
business models than practically anything else. Why? Because, according
to Mr. Palmisano, any new products or services that IBM comes up with
are very likely to be reverse engineered in a hurry and competition
won’t be far behind. Knocking off a product or service is relatively
easy, but knocking off a b. model is not.
When former CEO, Lou Gerstner, turned IBM into a services company as
much as a products company, he understood this—when IBM manages a
network for a large client, like, say, a Bank, they can and do spec
equipment that is non-IBM. This makes IBM a trusted consultant
who is effectively sitting on the same side of the table as the Bank.
They are making recommendations to the Bank—use this HP product or this
Cisco product—and if the Bank doesn’t like either option, IBM can spec a
third or fourth. In any event, IBM doesn’t get fired if the Bank
doesn’t like any of the options, the supplier does.
So the change in the business model (to emphasize services) has
served IBM well and has sustained them in the on-going economic downturn
while Nortel is on the verge of going oob (out of business). The latter
focused on Six Sigma in their processes and getting their financial
ratios right. It wasn’t even a problem with a focus on cool new products
that caused Nortel to go off a cliff. That would have been an
improvement over what they actually did. If NT had focused, half a dozen
years ago, on their biz model instead, they might not be in the shape
they are in now.
Now we have found it is useful to also add a fourth dimension to most
biz models: by adding another column on the RHS and a second one on the
LHS. These are, respectively, the clients of your clients and your
suppliers’ suppliers. (You can, of course, continue this ecology in as
many dimensions as you think are needed to properly describe your
business model.)
Let’s take the simple example of a spa. A typical spa’s clients are
mostly female. Who are your clients’ clients then? Well, it would most
likely be their boyfriends and husbands who are ‘consuming’
(appreciating) the results of spa treatments on their female partners.
If the spa looks at their hairstylists, manicurists, pedicurists,
massage therapists, etc. as part of their supply chain (as indeed they
should), then who are your suppliers’ suppliers? That would be the
colleges and institutes who train these folks and the manufacturers of
the products that they use—hair coloring dyes, shampoos, creams, oils,
equipment and tools and so on.
Now you are starting to view your business as part of an overall
ecology. What might clients (the males) of your clients be interested
in? The guys might, for example, buy gift certificates from the spa at
Xmas time. So now you have a whole new line of (very profitable)
products to sell, which you discovered simply by studying your business
model.
This happened to a client of mine, several years back, who by
studying their ecology, reluctantly (change can be difficult in such a
mature industry) introduced spa gift certificates about six weeks before
Christmas. They found out that about 30% of their gift certificates
were never redeemed (they had a rider in the form of a one-year best
before date). They now sell about $250,000 worth of gift certificates
every year and $75,000 of that (the never-redeemed certificates) goes
straight to their bottom line with a near infinite gross margin.
What can you learn from viewing your employees as part of the supply
chain? You could visualize that your real business is matching up
suppliers (your hairstylists or manicurists, for example) with your
clients. So now your service business becomes a match making business
(like eHarmony) and, through the power of the Internet, you can at least
partly automate the scheduling process by reversing out the work to
your clients (who log on and book an appointment or call your ‘call
centre’ for one) and to your suppliers who can go online and see when
they are needed or they can schedule their time themselves and take on
new and existing client appointments.
You might also be interested in developing closer relationships with
training colleges so you can get a line on the best new hires.
There is also the opportunity to reverse the direction of money on
the supply side—Grade A Techs, for example, requires their techies to
take and pay for a Grade A Techs certification program.
Returning to the spa model, suppliers of tools and equipment, lotions
and potions might also be induced to pay you, in the form of volume
bonuses or nice trips overseas to special events, learning opportunities
and conferences for top performing employees and owners.
Even on the client side, there is the opportunity to reverse the flow
of money. You might, for example, pay a celebrity to visit your spa and
experience some of its services. Their endorsement might help you more
effectively connect with (market to) other clients…
Once, you have positioned yourself as part of a business ecosystem, your business almost can’t fail.
When Power Rings were being introduced to indoor arenas in North
America in the last few years, the provider could show arena owners that
the roughly $2 million initial cost could be recouped in about 18
months in a typical marketplace. (Power rings are those animated signs
that circle an arena, usually, under the first balcony. Many of them are
low enough to show up on TV… an irresistible proposition for potential
advertisers: a relatively inexpensive way to get on TV.)
Thus, they could say that to arena owners that the cost of buying a
Power Ring is a negative $11,333,333! (This assumes a ten year life for
the installation. See below.)
Power Rings
Time
0 ($2,000,000) ($1,333,333.33) 18 month payback
1 $1,333,333.33
2 $1,333,333.33
3 $1,333,333.33
4 $1,333,333.33
5 $1,333,333.33
6 $1,333,333.33
7 $1,333,333.33
8 $1,333,333.33
9 $1,333,333.33
10 $1,333,333.33
$11,333,333
IRR 66% p.a.
Put another way, if the arena owner spends $2 million on the
installation and nets $1.333 million per year for the next ten years
after taking into account the cost of selling time on the Power Ring to
sponsors plus the annual cost to have the supplier maintain and upgrade
the Power Ring, they will see a 66% p.a. return on their investment (as
measured by their IRR, Internal Rate of Return). Not too shabby.
Arena operators always want to keep up with the Jones’ so once there a
few installs, many of the rest will soon follow. It doesn’t hurt to
have a good value proposition too.
This is what I call negative cost selling and it is one of the keys
to making the sales process easier. It always amazes me that so many
organizations never look at what their products or services really do
for their customers (let alone extend that to their customers’
customers.)
If the Power Ring allows the arena owner to become a more important
part of their advertisers’ marketing campaigns, something they can’t do
without, that means that the Power Ring provider has successfully become
part of the overall arena-experience ecosystem. Their $2 million
installs and their annual maintenance and support fees can help to make
their business a lasting success with a sustainable business model and
competitive advantage.
You should always have a spreadsheet handy that shows your client (or
your client’s client) that the cost of buying your product or service
is negative. You have to be able to walk a mile (or two) in your
client’s shoes.
Prof Bruce
Prof Bruce @ 2:53 pm
Filed under:
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Pre-selling, Finding New Clients, Keeping Existing Ones
and
Value Differentiation and ‘Pixie Dust’
An Alternative to Multi Res Real Estate Investing
Posted on
Monday 29 June 2009
For the Small Investor
I get a lot of calls from former students – from the b. school, from
engineering, from architecture – and from consulting clients to tell me
that they are now ready to invest in real estate. The calls are all
pretty much the same: “Hey, Bruce, I have a few dollars kicking around
and I want to buy a multi res property. Can your team help me with
that?”
I have yet to hear from anyone that they might look at a
different class of property, say, for example, industrial property or
commercial retail. That is because they don’t believe that a small
investor can play in the commercial space and because the multi res
market is all they have ever heard about.
Investors are all the same everywhere – they only tell you about
their winners. So you will hear someone talk about the multi res
property that they bought a few years ago in Deadmonton that went up by
30% in two years and they sold for a humongous profit.
People like to tell stories where they are the hero and there is
always a happy ending. But before you run off and buy your first multi
res property think about this:
1. Are you ready to be a residential Landlord?
2. Do you know anything about the RTA (Residential Tenancy Act) that
governs relationships in Ontario between Landlords and Tenants?
3. Can you stand to get a midnight call: “My plumbing is plugged and I need you to come over right away and fix it?”
4. Are you any good at collecting rents, doing credit checks, looking at
the background and references of prospective tenants, fixing stuff that
gets broken, property maintenance, etc.?
5. Have you got the time and expertise to go down to the Rental Tribunal
and start and complete the process of evicting a tenant that does not
pay their rent or causes trouble for you or other Tenants?
6. Can you market your multi res property effectively?
Now you might be thinking that you can delegate some of this or out
source some of this to, say, a property management company. You can but
it will cost you. Have you taken those costs into account?
I am not trying to discourage you but residential rental is not a
game for the faint hearted or the time-pressed executive. It is in an
industry in itself and you need expertise in a lot of different areas to
become a proficient, profitable Landlord.
When I was younger, I looked at other opportunities and I try to get
some of my clients to, at least, think about alternatives. One area I am
keen on is the industrial condo market.
You can buy industrial condos in the Ottawa area for between $125,000
and $300,000 for anywhere between 1,000 and 1,500 sq. ft. I like this
market because:
1. Industrial tenants tend to be more reliable than residential tenants.
2. They tend to pay their rents on time.
3. If something goes wrong, they fix it themselves most of the time and
don’t even bother to phone you. These folks are independent people to
begin with.
4. They tend to stay a lot longer – five year leases are common.
5. Cap rates in the industrial sector are higher than in multi res so returns can be higher to the investor…
6. There is less competition for the product. Your main competitor is,
in fact, the sitting owner (owner-occupied space). The big guys: REITS,
Banks, Insurance Cos., Pen Funds, publicly traded r.e. firms – don’t buy
little spaces like these. Plus other small investors are all running
after multi res product.
7. Vacancy rates are generally low in this class of product.
8. The property management function is low intensity so you should be able to manage it yourself.
9. If a tenant does not pay their rent, you can distrain – lock them out
and seize their property as liquidated damages for unpaid rent. You do
not have to wait months for the Rental Tribunal to allow you to change
the locks and kick a tenant out.
10. Leasing is relatively straightforward. You can hire any number of
commercial brokerages to assist you with marketing and drafting up the
Offer to Lease or Agreement to Lease or you can do it yourself.
11. Most commercial leases these days are triple net. That means that
the tenant must pay (in addition to their basic rent or minimum rent
which goes to you, the Landlord): operating costs (like snow and garbage
removal, common area charges, insurance, property management fees),
property taxes and utilities. The Lease is ‘carefree’ to the Landlord.
This gives you some inflation protection too. Think about what has
happened to utility bills or property taxes, for example, over the last
few years.
There is a long-standing tradition in commercial real estate to
prepare two documents for a new tenant – an Offer to Lease (OTL)
followed by a Lease. To me, this is anachronistic.
The reason it is done is to get the Offer drafted and signed by all
parties relatively quickly. The Lease (which can often run 30 to 60
pages long versus the OTL at maybe 5 to 10 pages with Schedules) takes
much longer and usually requires lawyer involvement for both the
Landlord and the Tenant.
When I was a developer, we signed an OTL (which all parties agreed
would be the Lease) for 80,000 sq. ft. with Nortel which was four pages
long. As many of my readers already know, when you have a 60 page
document, it is presumed by a Judge in any future dispute between the
parties that you were trying to anticipate any or all eventualities.
When you have a four-page document, the reverse is true. So in the
former case, the Judge will usually look to the document for answers, in
the latter, he or she will look to the merits.
Speaking personally, I would rather take my chances on the merits of a case. Nortel felt the same way.
This was a huge competitive advantage too – we could draft up a short
from Agreement to Lease, written in English as opposed to legalese, and
have it executed by all parties in a few hours or days while our
competitors were fussing about with two documents and their lawyers,
sometimes for months. It is also a heck of lot less expensive.
I certainly would not recommend an OTL followed by a Lease for a
1,000 sq. ft. transaction. But some people won’t make a move without
their lawyer and that is OK with me as long as they understand that
there are alternatives.
When you sell an industrial condo, you are basically selling into
either the owner-occupied market or the investor market so your exit
strategy has two options. Often, the place to find your Buyer is your
existing tenant.
Real estate is a ‘get rich, slow’ field. You should not buy a
property to flip it – the transaction costs are just too high – real
estate agency fees, LTT (Land Transfer Tax), legal fees, commissions
paid to REALTORS for their assistance in finding a tenant (even if you
represent yourself, the tenant may have a Brokerage representing them
and they will want you to pay a Brokerage fee), maintenance and repair
costs, etc.
The stuff you see on TV – Flip This, Flip That – is just
entertainment. Don’t be misled – there is no easy way to get rich that
you can plan for. Hard work, effort, focus and expertise are needed.
Some luck doesn’t hurt either.
There may also be some added value that you can bring to your
industrial condo. My Dad loved basements – he always put a basement in
the buildings he built. I like mezzanines – we used to add legal
mezzanines to roughly double the space we had for rent.
We had numerous 1,000 and 1,500 sq. ft. industrial condos with 18 to
24 foot ceilings. As the nature of industrial companies has changed over
the last 25 years, they use relatively more office space and less
warehouse space. (A higher proportion of the value of products and
services these days are produced by what Richard Florida calls the
creative class. These people need high end PCs not warehouse space and
loading docks. See: The Rise of the Creative Class and How It’s Transforming Work, Leisure and Everyday Life, 2002. Basic Books.) So we might decide to put in a mezzanine that could add anywhere from 40% more space to 87.5% more.
Other cool things that we used to do included putting in a double
door and fire separating the upper and lower levels so you could rent
out the upper level separately from the main level. In real estate, it
seems that every time you draw a line on a piece of paper (create a
severance, create a separate floor, have a second entry, create a second
tenancy), you increase the value of the property.
One of the negatives about this type of investing is that you need to
put up relatively more equity – maybe as much as 35%. Banks and other
lenders view commercial property as more risky. Plus any type of
commercial financing can be hard to come by today.
Real estate provides some tax advantages – you can deduct your CCA
(Capital Cost Allowance, i.e., depreciation) from your income. When you
sell your investment, it will in all likelihood be treated as a capital
gain and not income and tax rates will be lower. Remember though that
when you sell, even if the gain is treated as a capital gain, you will
have CCA recovery; that is, you will pay taxes on the depreciation
reserves you took earlier against income. Like so much in the taxation
field, taxes are deferred not avoided. Also, how you set up your
investments can be important.
Many of my clients already have a personal holding company (PHC). If
not, I tell them to get one. The PHC is a fundamental building block to
successfully owning and controlling different classes of investments.
Your primary residence is not usually owed by the PHC because (at least
in Canada), increases in value on your primary residence are tax free.
The ownership of the principal residence is usually in the name of the
spouse with a lower risk profile. But shares in, say, your tech company
or your r.e. company would be held by the PHC. Note that your tech co.
and your r.e. co. are separate corporations. If anything bad happens to
your operating company where liability and the chances of something
going wrong are much higher, hopefully, you will still have your r.e.
co.
In Canada, you can move funds from your subsidiaries (for eligible
Canadian Owned and Controlled Companies) to the PHC without paying any
taxes using tax free inter-corporate dividends. Once you have money in
your PHC, you may also be able to dividend out funds to your
shareholders (i.e., you) tax-free if you have a capital dividend
account. You can also do some income splitting – pay your spouse some
money or your kids (after they turn 14 or 15). Like my Dad used to say:
“Proudly pay your taxes in a great country like Canada, just don’t pay
any more than you have to.” Never invest to intentionally lose money.
That is a sucker’s strategy.
The types of returns you will see from owning real estate include:
• Cash on cash returns;
• Real estate inflation;
• Wealth effect from paydown of mortgage principal;
• Tax advantages (mortgage interest deductibility, capital cost
allowance deductions, capital dividend account for tax free dividends,
capital gains taxes are lower).
You can deduct not only interest you pay on the mortgages for your
commercial property but if you mortgaged your principal residence to put
up equity, the interest on that mortgage also becomes deductible from
your income.
It is also a heck of a lot easier to build up, say, $2 to $3 million
in real estate (using leverage, aka mortgages, and principal paydown
facilitated by your tenants’ monthly rent payments) than it is to save
that amount in cash from after tax, personal income, or to develop a
stock or mutual fund portfolio of that size. So if you ever plan to
retire, buying say 20 industrial condos and paying off those mortgages
in the next 25 years might not be a bad strategy. If you got $1,000 per
month net from each unit after taking into account all factors including
a vacancy allowance, you would have $20k a month to live on – somehow,
you might find a way to squeak by on that.
Prof Bruce
Ps. It is also likely that your cash on cash returns from your
industrial condo portfolio will be higher than on your T-bills or a
conservatively managed stock portfolio or mutual funds. And it could be a
lot more predictable too. The downside is that r.e. investments may be a
lot less liquid.
Prof Bruce @ 3:18 pm
Filed under:
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Posted on
Sunday 28 June 2009
Using the IRR to Measure Real Estate Returns for a Seller
I have done a lot of spreadsheets for clients about to purchase
residential or commercial property—to give them some idea of the rate of
return they can expect in the future. But I recently had the
opportunity to do one for a couple of investor friends of mine who were
thinking of divesting one of their residential properties by looking back to measure their return on investment.
The subject property is on a nice residential street; has five
bedrooms and two full baths; it is rented out to students from a nearby
university on a room by room basis. Because of this, they are exempt
from Ontario’s RTA (Residential Tenancy Act)—they are free to raise
rents as they see fit and evict roomers with a minimum of fuss if they
are troublesome.
They are active Landlords in the sense that they are over at the
rental property at least once a month and they keep a close watch on
their tenants. They paint each room when it becomes vacant and have a
good relationship with their tenants.
We prepared a CMA (Comparative Market Analysis) for them and the
value of the property, based on what comparable homes have sold for in
the neighborhood in the last eight months, was estimated to be between
$289,000 and $299,000. They were not particularly happy with the news
that their property had not appreciated more.
In fact, they looked at it this way: the property had ‘only’
increased in value by $19,826 after deducting prospective agency fees
for listing and sale plus closing costs (basically legal fees). With a
purchase price of $262,000 in 2005, this seemed to our clients like a
pretty puny increase in the four years that they had owned it. By their
calculation, they had only seen a return of around 2.8% p.a.
(The subject calculations are shown below. For a more useful tool, you can download the spreadsheet in .xls from my server.)
Now these folks are bright, talented people but the analysis they did
on the spot was far from complete. First of all, they will make
(assuming that it sells in the range we expect it to) $19,826 not on the
original purchase price of $262,000 but on the cash equity they
actually put up to buy the building, which was $65,000. So right away,
the rate of return jumps significantly from 2.8% to 6.88% p.a. Not
especially great but certainly better than you could get from your bank
or on a T-Bill or from a Term Deposit (maybe you would get 2.5% on a
$20,000 Certificate of Deposit these days).
Next, they had forgotten that they were cash positive
throughout—their cash on cash return amounting to an average of about
$645 per month. This yielded them a second return on their equity (ROE)
of an additional 11.9% p.a.
Lastly, every month that they owned the house, their tenants were
helping them to pay down their mortgage. This is a wealth effect or, in
an owner-occupied building, a form of forced savings. This amounted to
another $18,911 paid off during their ownership period—a third form of
return. Their ROE from this is around 6.6% p.a.
So if we now simply add up their three types or return (real estate
inflation (all of which goes to the equity holder and none of which goes
to the mortgage company), their cash on cash return plus the benefit
they receive from the paydown of their mortgage), we get an estimated
total ROE of 25.4% p.a.
Now this is just an estimate; to get a clearer picture, we need to
use a somewhat more advanced technique—we need to measure the IRR
(Internal Rate of Return) for their project.
When we do this, the IRR comes out a little bit lower: it is 22.6%
p.a. (The reason it is lower than the ROE is because the IRR calculation
properly takes into account the time value of money. For example, a
cash on cash return of $7,744 is more valuable to our investors in year
one than in year four.)
But still, a 22.6% p.a. is a lot higher than what you could get at
your Bank and a lot more than their initial view that they had only seen
a return of 2.8%. (It is also a heck of a lot better than they did with
their stocks and mutual funds which last year and this year alone had dropped 29%.)
Now there are a lot of assumptions that are implicit in these
calculations like, say, we did not put in a fee for their monthly
management of the building. Also, there is very little in here for
marketing. (It turns out that Kijiji and other free websites were pretty
much all they needed for this well located property.)
But if the alternative was sitting on the couch watching more TV, we can be forgiven for this oversight.
The happy news is that the spreadsheet gives them confidence that, if
they do decide to sell, they have done not so badly after all.
Prof Bruce
Ps. It is also interesting to note that the Cap Rate (Capitalization
Rate = NOI/SP, where NOI is Net Operating Income and SP is Selling
Price) is just 8% p.a. Cap Rates are a rule of thumb that has a lot of
traction in the R. E. biz but it does not capture real estate inflation
nor does it take into account the wealth effect from forced
savings/paydown of the mortgage so it is a very limited tool indeed. To
properly inform a client of their prospects in real estate, the IRR is a
preferred method.
Pps. The numbers and facts have been changed somewhat to protect the identity of the property.
Ppps. Note that this analysis is done before tax. Since tax
calculations can be complex and highly subject to individual situations,
each reader is advised to look at the tax implications of asset selling
with their accounting advisor.
129 Anywhere Crescent Confidential
Purchase Price $262,000 2005
Equity ($65,000)
Mortgage $197,000
Rental or Imputed Rent $2,200 per month $550 per month 4 bedrooms
$26,400 per year
Property Taxes ($2,489) per year 0.95%
Vacancy ($1,452) per year 5.50%
Marketing ($118.80) per year 0.45%
Insurance ($1,310) per year 0.50%
NOI $ 21,030.20 per year
Cap Rate 8.0% per year
IRR
Equity ($65,000)
Mortgage $197,000 4.50% 25 year amortization
($1,107.12) per month
($13,285.49) per year
Year
0 ($65,000) 2005
1 $ 7,744.71 2006 $ 645.39
2 $ 7,744.71 2007
3 $ 7,744.71 2008
4 $111,483.12 2009
IRR 22.6% per year cash on cash return + real estate inflation + forced savings (paydown of mortgage) Total Return
$ 30,978.85 $ 19,826.71 $18,911.69 $ 69,717.25
Principal Repaid ($4,420.49)
($4,619.41) Original Equity $65,000 $84,826.71
($4,827.28) Real Estate Inflation $ 19,826.71 (net of realty fees and closing costs)
($5,044.51) ROE(1) 6.88% $ 84,820.17
Total Principal Repaid ($18,911.69) Cash on Cash $ 7,744.71
ROE(2) 11.91%
Paydown of Mortgage $18,911.69 $83,911.69
ROE(3) 6.60% $ 83,934.82
Real Estate Inflation 3.25% per year 25.39%
Selling Price $297,756.69 after 4 years
Real Estate Fees ($14,887.83) 5%
Legal Fees & Closing Costs ($1,042.15) 0.35%
Net Selling Price $281,826.71
E&OE
Prof Bruce @ 1:14 pm
Filed under:
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Density Increases Property Values
Posted on
Tuesday 16 June 2009
(All Else Being Equal)
I recently wrote a letter of support for a Dharma project (not the
Dharma that is in the hit TV series LOST but an Ottawa-based developer)
that wants to bring more people to live and work in or close to
Stittsville Main Street. Here is what I wrote to the Secretary-Treasurer
of Ottawa’s Committee of Adjustment:
“I am a Broker at Partners Advantage GMAC Real Estate and we have a
branch location at 1445 Stittsville Main Street. In addition, I have a
background in urban economics, development and entrepreneurship.
I am aware that there are some concerns on the part of the Stittsville Village Association about this development.
I believe that rezonings, official plan amendments and applications
to the Committee of Adjustment should, in principal, be a process of
affirmation between the proponent and his or her neighbours.
To that end, I would like to point out a number of factors that tend
to support this development and this application to the Committee.
1. Do we build cities for cars or for people?
I believe that we should build cites for people; cars are an important consideration but they should be a lower priority.
Stittsville Main Street is a major commuter road but achieving high
speed for through-traffic should not be the top planning priority. High
speeds make vehicle ingress and egress from the many small buildings
along Stittsville Main Street more dangerous and make it more dangerous
and less pleasant for pedestrians.
In other parts of the City of Ottawa, such as Westboro and the Byward
Market, drivers tend to good naturedly accept lower traffic speeds as a
price they pay for a successful mixed use zone—where people can live,
shop, work and be entertained and where pedestrian movements are
fostered and protected.
Neo-urbanist planning encourages:
a. on-street parking is allowed (this buffers the pedestrian and encourages pedestrian traffic).
b. people can live and work at home.
c. people can shop nearby.
d. there is a mixing together of folks from differing socio economic strata.
e. people build close to the road.
f. they have front porches.
g. roads are narrower.
h. densities are higher.
i. elders can stay in their communities.
j. the gardener, nurse, school teacher can find affordable housing in the neighborhoods where they actually work.
k. in-home apartments and granny flats and apartments above the garage increase property values not decrease them.
l. rooming houses and live-in students are tolerated.
m. apartments above shops are built.
n. there is a tolerance for diversity.
o. problems are solved at ‘town hall’ style meetings.
p. schools, government offices, post offices, libraries, places of worship get the best sites in town not the worst.
q. short blocks are common.
r. roads are grid based.
s. every road is two way.
t. left turns are permitted.
u. connectedness is the underlying principle of town design.
v. everyone suffers some through traffic so that no one suffers all of it.
w. grided systems prove that the slower the individual vehicle goes, the
faster you move traffic over the entire system (i.e., average vehicle
speeds are higher not lower even though there are no ‘collector’ roads
designed by traffic engineers to move vehicles at 60 or 80 kph (which
they never do because every trip is a car trip and all cars have to be
on the one collector)).
x. there are no beggar-thy-neighbour policies whereby you put speed
bumps, no through traffic, no left turn, one way and other self
defeating traffic management policies in place.
y. cities use vertical transition lines and the wow effect
(window-on-the-world, where all buildings open to the street at grade).
z. density bonusing is coming to encourage mixed use (read residential use) in commercial zones.
(Build-To Lines Instead of Setbacks + On-Street Parking = Walkable Cities)
Orville Station, in my view, embraces many of these principles and
should be a welcome addition to both the business and residential
communities.
2. Does increased density help or hurt real estate values in the neighborhood?
Prima facie, if density increases in a neighborhood, property values
should climb. If a mixed use project such as Orville Station is
approved, it brings more people to live, work and shop in the area. This
increases demand—people who live in the area tend to shop there. People
who work in the area may also want to live in that area.
When demand increases, prices follow, otherwise the rent curve in
downtown Manhattan would be the same as downtown Ottawa, which is
patently not the case. Density, all else being equal, does increase
property values, not only for the specific site but for the neighborhood
as well.
The major proviso on this statement is that crime rates in the area
do not increase. Experience has shown that when a city encourages mixed
use, the area sees a decrease in crime and vandalism. This is because
you do not have a suburb where all its residents leave during the work
day and a business core that does not see all its workers leave at
night.
Eyes on the street, both during the day and at night, have been shown to improve public safety.
3. Can we relax parking requirements without jeopardizing quiet enjoyment?
The proposed variances to the parking requirements appear to be
justified and minor in nature. Again, there needs to be a decision taken
to encourage more density while providing reasonably for the private
car.
Neo-urbanists believe that some flexibility on the part of planning
authorities will result in more interesting and, frankly, better urban
design.
It is expensive to operate, maintain, occasionally replace, insure
and store a private automobile. Cities should accommodate people of all
social-economic status, even those who do not own or do not wish to own
cars.
Accommodating the parking ratio for Orville Station will be a step in
that direction and may even have the effect of improving transit
ridership as well.”
Prof Bruce, June 3rd, 2009
(Disclosure: since we have a Brokerage branch on Stittsville Main
Street, there could be a direct or indriect benefit to Salespersons or
Brokers who are selling residential real estate from having more product
in the area.)
Prof Bruce @ 4:04 pm
Filed under:
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Livable Cities and Neo-Urbanism
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Malcolm Gladwell Ottawa Appearance
Posted on
Friday 12 June 2009
June 11, 2009
Malcolm Gladwell appeared at the National Arts Centre yesterday in an interview format with Ottawa-personality Mark Sutcliffe.
Malcolm is a Canadian living in NYC and is a leading thinker about
the key ingredients leading to success, as well as a perceptive observer
about unconventional solutions to daunting social problems. He is a
best selling author of The Tipping Point, Blink and Outliers.
Here are a few notes that I took during his lecture yesterday:
On Homelessness:
• It is more expensive to ignore the problem than to solve it.
• The hard core homeless can cost society more than $1 million per year each for police and health and social services.
• The problem can not be solved until you give a person a permanent
address. (Hernando de Soto also recognized this—without a permanent
address, a person is a vulnerable human being with limited rights and
prospects, Ed.)
• Singling out individuals for help may not be fair to many others in
less dire need, but society has to solve problems, one at a time and
this will not always be fair but so what? That’s just the way it is.
• Some people may take advantage of the opportunity to have a ‘free’
home and support services but nothing can be done about this. (Chapters
made a decision in its early days to allow people to sample its wares
even if it meant tolerating a minority who would read an entire text and
put it back on the shelf without purchasing it. But so what? The cost
of policing this small group and ejecting them from stores would be more
costly than permitting it and more alienating of the general customer.
NHL star players are certainly treated differently than journeymen
players; it’s just the way it is, Ed.)
On Entrepreneurship, Success and Life:
• “We make it up as we go along.” (That is so typical of
Entrepreneurs. Plans don’t tend to last very long in a world that
changes all the time, Ed.)
• John Rockefeller was the world’s richest person—worth over $400 billion in inflation adjusted dollars.
• Malcolm met John’s great, great, great grandson and he said: “I read
that you said that my great, great, great grandfather was the richest
person who ever lived. I don’t know where all the money went!” (Watch
your costs and each generation has to apply itself and work hard or the
money, no matter how much you start with, will be gone, Ed.)
• To make money, you need to match ability to opportunity. Timing is
important—you need to be born at the right time to become a Silicon
billionaire like Bill Gates. (You want to position yourself in an
industry where all boats are rising, Ed.)
• Success is a function of: talent, desire, luck, work, love of what you
do, intensity of effort, timing, exposure, parental influence.
• Love of what you do tends to come from: meaningful work, autonomous work and sustainability.
• Mozart was successful not only because he was talented but also because he was the hardest worker.
• Most times, we overstate the importance of talent and understate the importance of effort.
• Success is not a zero sum game.
• It takes 10,000 hours to get good at anything. (One has to wonder if
the recent appointment of the new Head of GM who has NO experience in
the car biz can have any success. People who say a business is a
business and that running AT&T is the same as running GM have not
studied the unfortunate career of Mike Zafirovski at Nortel. Every
business has ‘secrets’ to success that are not easily verbalized or
known. They are things that come from experience and are discovered in
the process of building a successful enterprise. There are buttons that
you push to make a business (or Non Profit or Charity or NGO or, for
that matter, a Governmental Department) successful. A great player like
Wayne Gretzky may not make the best coach or CEO—admonitions to “Just do
what I did for goodness sake!” doesn’t work when you can see the play
in slow motion and know where everyone will be on the ice 30 to 45
seconds ahead of time, which almost no one else on the Planet can
actually do, Ed.)
• Excellence is open to someone who is willing to put in the effort and
love. KIP (Knowledge is Power) Schools prove this. They can turn a poor
Hispanic child in the South Bronx into a math prodigy by having the kids
work Monday to Saturday, 6 am to 11 pm and all of July.
• There is a seemingly inexhaustible need/demand for education.
• Society needs to provide places where kids and people CAN work hard.
(We should have a High School for the Technological Arts in Ottawa in
addition to a High School for the Arts (Canterbury), Ed.)
• Medieval society in northern England worked from Dawn until noon then
began drinking. They had lots of holidays and not a lot of hard work.
Rice planting nations, on the other hand, worked incredibly hard at
their agriculture.
• Underdogs can win if: they are highly motivated, thick skinned and
willing to embrace the unconventional as well as defy the conventional
and, of course, work harder than their opponents/competition. (The
harder you work, the luckier you get. When any of my students ask me for
an extension on their assignments, I say: “When I was 22 I was living
in Australia (in Sydney). I was recently married, our first child was on
the way, we bought our first home, I was building an addition on it for
the baby, I was working for the New South Wales Government solving a
critical waste disposal problem and working long hours with ten other
people in our research division, I was taking my M. Eng.-Sci. degree,
part time, at the University of New South Wales where I was not only
taking courses but also writing my Masters thesis, I bought a motorcycle
that I maintained myself because it was the only way to get across the
Sydney Harbour Bridge and make class on time, I wove between lines of
static cars, trucks and buses, it was incredibly dangerous. I still had
time to see my friends. What I didn’t have time for was drinking and
smoking dope and such. So why can’t you get your essay in on time?” One
thing the iron ring of an engineer connotes is that they know how to
work hard, Ed.)
On Societies:
• Canada is a low hierarchy/high collectivist society.
• It allows us to experiment with things such as Medicare.
• Solutions to social problems may be obvious but still hard to do.
• How you frame a questions or an idea can significantly affect its acceptance.
• Seat belt laws were a huge failure as long as it was the Government
bossing people. But when it was rephrased as a ‘child protection’
measure, parents buckled up their kids and then kids forced their
parents to do the same. Acceptance went from the teens to more than 70%.
• CEOs tend to be tall people. CEOs should be selected behind a
screen—we want the best CEOs not the tallest. (Walt Disney knew this. He
auditioned the singing voice of Snow White behind a screen, Ed.)
• “We should all band together.”
Prof Bruce
Prof Bruce @ 8:39 am
Filed under:
Posted on
Tuesday 26 May 2009
GETTING THE RIGHT PEOPLE IN KEY SEATS
There is nothing more important in an enterprise than HR. It isn’t
great assets or great ideas that create value and wealth—it’s the people
in your organization that do that. Once you get past the point of being
a sole practitioner, the first hire is your most important decision.
Now I am a terrible judge of character—I like everyone so the most
important decision I made when I ran Terrace Investments Ltd. (the first
parent company of the Ottawa Senators) was to hire Cyril Leeder, a CA,
an excellent executive and, fortuitously, a good judge of character.
Cyril remains with the Sens to this day as the COO of both the team and
the building (Scotiabank Place). My next best decision was to let Cyril
hire EVERYONE else.
Jim Collins (author of classics like Good to Great and Built to Last)
published part of his research in a recent issue of BusinessWeek (May
25, 2009). His findings are of such importance that I repeat them here
and strongly recommend you read them, twice—whether you are running a
SMEE or a charity or a Not-For-Profit or a major Fortune 500 firm, I
think Jim has got it exactly right.
We are going through a process where I work—there is debate going on
about how much management is enough or too much. I tend to fall on the
not too much end of the scale and some others think that staff need much
more hands on, daily management. While I agree that there is no such
thing as a ‘fire and forget missile’ in management and that you as a
manager must always follow up, I don’t want to be around people who need
to be told what to do every day or worse, five or six times a day.
That is why at the University of Ottawa’s Telfer School of
Management, we are teaching entrepreneurship not only to would-be
entrepreneurs but also to intrapreneurs who will take the entrepreneur’s
skill set into established organizations. Skills like being a
self-starting, self-correcting executive who initiates things, completes
things, constantly innovates in both big ways and small ways, learns
new stuff, adopts and adapts best practices from wherever they arise
(from colleagues, direct reports and superiors to competitors) plus
knows how to use smart marketing, social marketing and guerrilla
marketing, knows how to get launch and pre-launch clients and how to
raise bootstrap capital, can squeeze a dollar and make it go further,
understands the cash flow cycle and the cash conversion cycle, tries to
collect early and pay later, can build a successful business model with a
strong value proposition which also includes many of the above
attributes; all of this is crucially important to organizations of all
stripes.
Anyway, here is what Jim Collins has to say:
“The specifics can vary, even within companies, but our research delivered six important traits that identify ‘the right people’”, Jim Collins, Author of Good to Great and Built to Last (as quoted in BusinessWeek, May 25, 2009.)
1. The right people fit the company’s core values:
Great companies build cultures in which those who don’t share the
institution’s values are surrounded by anti-bodies and ejected like
viruses. People ask: “How do we get people to share our core values?”
The answer: Hire people already predisposed to them – and keep them.
2. The right people don’t need to be tightly managed:
When you feel the need to tightly manage someone, you may have made a
hiring mistake. You need not spend a lot of time “motivating” or
“managing” the right people. It’s in their DNA to be productively
neurotic, self-motivated, self-disciplined and compulsively driven to
excel.
3. The right people understand that they do not have “jobs” – they have responsibilities:
They grasp the difference between their task list and their true
responsibilities. The right people can complete the statement, “I am
the one person ultimately responsible for…”
4. The right people fulfill their commitments:
In a culture of discipline, people view commitments as sacred – they
do what they say they’ll do, without complaint. Equally, this means
that they take great care in saying what they will do, careful never to
over commit or to promise what they cannot deliver.
5. The right people are passionate about the company and its work:
Nothing great happens without passion. The right people display remarkable intensity.
6. The right people display window-and-mirror maturity:
When things go well, the right people point out the window,
giving credit to factors other than themselves; they shine a light on
others who contributed. Yet when things go awry, they do not blame
circumstances or other people; they look in the mirror and say: “I’m
responsible.”
Prof Bruce @ 11:50 am
Filed under:
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Pre-selling, Finding New Clients, Keeping Existing Ones
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Value Differentiation and ‘Pixie Dust’
Can you Create a World Class Org
Posted on
Monday 4 May 2009
In a Small City Like Ottawa?
(Guest blog by Dale Craig, Chairman, J. L. Richards & Associates Limited, Ottawa ON)
Bruce:
I think that one of the greatest differentiators between mediocre and
superior businesses is the constant desire to excel (both for your own
fulfillment and the knowledge that your clients will appreciate the
effort) backed up by the inner confidence that you have the people and
skills to do so. I truly believe that JLR’s success has been fueled by
employee ownership and a top down mutual respect, and support, for each
other.
I remember talking to my associates when we were about to embark on
the Palladium project (now Scotiabank Place, ed.) and promising them
that I would try to get the contract and lead the effort but only if
they felt they could deliver a world class product on time and one that
we could all be proud of for years to come. Accomplishing those goals on
what was our biggest project to that time made us realize we could take
on almost anything as long as we believed in ourselves and were honest
about our own limitations. That has proven to be right on many occasions
since then.
Finally, treating everyone in an organization, from the least to the
greatest, with respect and honesty is so empowering that I am amazed
many business leaders don’t get it. Witness the result of the
unmitigated greed and hubris in the world financial system over the last
year. I think to many smart people get caught up in their own self
importance and forget that any enterprise is like a chain, only as
strong as its weakest link. I believe that leaders should not hog the
credit and but rather share the praise (and the wealth) and things will
work out beyond their wildest dreams!
Please keep on inspiring young people to dream big and deliver bigger.
Dale
Dale C. Craig, P. Eng.
Chairman
J. L. Richards & Associates Limited
864 Lady Ellen Place
Ottawa, Ontario
K1Z 5M2
Phone: 613-728-3571
Fax: 613-728-6012
Cell: 613-277-3571
Email: dcraig@jlrichards.ca
Web Site: www.jlrichards.ca
Prof Bruce @ 9:43 am
Filed under:
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Why Canadian Tire Centre is Where it Is
Posted on
Tuesday 28 April 2009
I can’t speak to the issue of what we should do with
Lansdowne Park or whether a snow dump in Kanata should be the home to a
new MLS team. But I can answer the question—why Canadian Tire Centre is
where it is?
I get asked that question a lot. Why isn’t Canadian Tire Centre (CTC)
at… (pick one) Lebreton Flats, Lansdowne Park, in Orleans somewhere
along Highway 174, at South Keys, at Lac Leamy in Gatineau or right
downtown like the Bell Centre in Montréal or the Air Canada Centre in
TO.
All of these locations were ones we looked at from 1987 to 1989
before we decided on the current location for the Palladium—in Kanata
along Highway 417 with its ‘own’ interchange.
First, here are a few observations that came primarily from Gino
Rossetti, the Detroit-based architect who was the architect-of-record
for the Palladium (the first name for CTC) and who pioneered the concept
of consecutive rings of suites with his successful first effort at
stadium and arena design—the Palace of Auburn Hills where the Detroit
Pistons play. A city needs an arena site that has:
1. A large horizontal surface for parking;
2. A site that is not less than 85 acres and preferably 100;
3. Access to a major transportation corridor;
4. Access to public transit;
5. A site that would allow the structure to be half in the ground and
half above the surface to distribute guests more efficiently and to make
the building more human scale.
Other things on our collective wish-list included:
a. Access at grade;
b. Double loaded storefronts at grade so that on days when the arena was
dark, there would still be life in and around the facility;
c. Opportunity for architectural signage to maximize that revenue stream;
d. A curtain-wall entrance that left no doubt as to how to access the arena.
Let’s first look at some of the alternative sites. Lebreton Flats is
owned by the NCC and the NCC informed us that they had a (very) long
term plan for the site that did not include an arena, even if was going
to be a ‘very nice arena’, it was still just a rink to them. The NCC
felt that national priorities such as a new museum (which turned out to
be the War Museum) or a new SCC (Supreme Court of Canada) building would
take precedence. They gave us two opinions—a private view which just
said “No.” And a public version: “We’ll study it.” In bureaucrat’ese,
that is the same as a “No.”
We also looked at the Lac Leamy site where the Casino du Lac Leamy is
now. It’s a beautiful site, next to water, close to a major highway and
just five minutes from the Parliamentary precinct. Better yet, it was
for sale at that time. After all, you can’t build on a site that doesn’t
belong to you (i.e., in the case of NCC ownership of Lebreton Flats).
But there were already two NHL teams in the Province of Québec
(unfortunately, les Nordiques have long since moved from Québec City to
Denver) and the majority of our potential fan base did not want to see a
third team headquartered there while Ontario only had one team.
What about locating the team at Lansdowne Park? There were two
significant issues with that choice. Firstly, there are more lawyers
living in the Glebe than practically anywhere else in Ottawa. How would
they and the Glebe community react to having another two million
visitors descend on their neighborhood? I can tell you from hard
experience—not well. The planning for a new arena might have taken years
to get approved, if ever.
Secondly, the NCC would never allow OC Transpo to run buses on Queen
Elizabeth Drive. Hence, the only way to get people in and out by public
transit would be Bank Street. The MAXIMUM number of people that OC can
run up and down Bank Street would be about 2,500 pph (people per hour).
For an arena with a 20,000 capacity, it would take four hours to exit
everyone from the building using buses and another three hours or so to
get them there in the first place, if you were to rely on public transit
for, say, 50% of our attendance at a game or an event. (Arrivals tend
to be more spread out than departures since, if you lose to the New
Jersey Devils in Game 7 of an Eastern Conference Final as the Sens did,
EVERYONE wants to go home at exactly the same moment. Hence, departures
for OC buses on Bank Street would have been problematic since the mix
with cars would effectively lock down the street.)
Now that tells you something about why the ACC and the Bell Centre
are downtown arenas. We could have built the Palladium on a downtown
site if Ottawa had a big time people mover like the Métro in Montréal or
the subway in TO. Those two systems can move between 20,000 and 30,000
pph—a huge increase from what OC can do.
When we used to go to Montréal to see Expos games, we used to drive
to downtown, have dinner and then take the Métro to the Big ‘O’; we
would never think of taking our car.
But I can tell you that if we relied on buses, we would have had one
sellout—opening night and after that, there would have been a fan
revolt.
Even in 1987-1989, we thought the event horizon to get a rapid
transit system here in Ottawa was a generation away and given the way
our City is currently proceeding (or not proceeding), I am not holding
my breath to see a high capacity light rail system appear in Ottawa any
time soon.
In fact, people coming from Orleans by car would have taken more time
to get to Lansdowne Park than to get to CTC—sure, they can get to the
Queensway and Bank Street in 20 minutes but threading their way off the
Queensway and hunting and pecking their way to a parking spot, who knows
where, could easily take more time and gas than going to the Kanata
site.
So why not build a big, multi-level parking garage somewhere? Well,
for the reason discussed above, you can’t actually park more than 7,000
vehicles vertically. Since everyone will leave at the same second the
team loses in overtime to the Maple Leafs, a multi-level garage will
simply not work. It will become grid locked. If you have ever been in
the Rideau Centre on Christmas Eve (the only time of the year when men
outnumber women there) and everyone leaves at the same time (i.e.,
closing time), the public garage becomes such a nightmare that the cops
have to come and untangle the mess—one car backing out while another is
moving forward on every level results in an unsolvable puzzle. I know, I
was in just such a mess one Xmas eve.)
So I knew when we were looking for a site that we needed one that we
could own, that would have enough room for 7,000 cars and 500+ buses on
one level. The soil conditions had to be right to bury half the
building. (If you have ever been to Madison Square Gardens, you already
know what a pain it is when everyone has to go UP to get to their seats
for a Knicks game or whatever.) There had to be room for a new
interchange and there had to be more than one way to get to the site. It
couldn’t be imposed on existing communities who would react in NIMBY
fashion to the extra traffic and noise that would be generated by a MCF
(Major Community Facility).
(Communities are now being built around CTC by Mattamy, Minto,
Richcraft and others but the key difference here (a matter that caused
me a great deal of worry at the OMB Hearing that would eventually
approve the construction of the Palladium) is that people who buy these
homes are self-selecting to be near CTC. We are not imposing on an
existing community. We believed that this would happen—if you look at
our original plan called West Terrace (now expanded on and improved by
the City of Ottawa and called the Kanata West Concept Plan Area), it
called for significant residential development as well as other
employment and commercial development.)
Well, we looked for a long time for an appropriate site and we didn’t
find one—the CCEA did that for us. The Central Canada Exhibition
Association has thought about moving out of Lansdowne Park for quite a
while. Their Board found the site where CTC is now—not me. One day I
woke up to read in a local newspaper that the CCEA had optioned a site
of some 500 to 600 acres at Huntmar and the Queensway. I jumped in my
car and drove to the Huntmar overpass; I stood on the bridge looking
east. I could see the homes of Kanata marching like ants over Moodie
Hill towards me and I knew that the CCEA had beaten me to a great site.
I silently saluted them and cursed them too.
I told the guys at Terrace Investments Ltd., the first parent company of the Sens. We were all disappointed.
But a couple of months later, for reasons known only to the CCEA,
their Board decided to release their options on these lands. Again, I
read about that in the same local newspaper. By 10 am, Jim Steele (still
with the Sens) and I were sitting in one of the local farmer’s homes
drinking rye and trying to convince the family to sell their lands to
us.
Fortunately, many of these fine people did—we ended up with 600 acres.
Now, finally, I have to deal with the real estate play.
We told only a few people what we were doing—Des Adam, then Mayor of
Kanata knew as did Jimmy Durrell, Mayor of Ottawa and Andy Haydon, Chair
of the RMOC.
We told them and then Premier of Ontario, David Peterson, that they
each had a magic wand and we wanted them to use it—we said that private
money would buy the team ($50 million) and build the building ($240
million) but we needed three things from Government*. One, we needed the
Palladium site (100 acres) and the remaining lands (500 acres) rezoned
for a MCF and for other uses. Two, we needed public monies to fund the
new interchange (a $30 million cost) because the day the interchange was
completed, it would have to be given to MTO (the Ministry of
Transportation for Ontario) for $2 and you can’t finance something you
don’t own—it would be like me putting a mortgage on your home. Three, we
needed their support to tell the NHL what a great place Ottawa is, how
much hockey is loved here and what a great place Ontario is to invest
in. Alberta had two teams, Québec had two teams but the largest (and, at
that time) the richest Province only had one.
(*We told Mr. Peterson that this was not another Sky Dome which cost the Ontario taxpayer about $450 million in losses.)
We asked them to focus their wands on the Palladium lands and,
presto, the lands (after all due process) would be rezoned. The average
price we paid for the lands was $12k per acre and we made no secret of
the fact that, after rezoning, we hoped the value would increase to
$112k per acre (lands in the area are now trading for $300,000 to as
much as $546,000 per acre). The $100k per acre increase in value
multiplied by the 500 acres of ‘surplus’ land we had bought (and which
we planned to resell) would exactly equal the $50 million purchase price
for the NHL expansion team.
But we told the guys we wouldn’t keep that money—we would put it in
Brinks trucks and take it to then President of the NHL, John Zielger’s
office on Park Avenue in Manahttan and give it to him. In return, we
would get a (pretty crappy looking) piece of paper called a NHL
franchise under the NHL’s Plan of Sixth Expansion. We would put Ottawa
on the map and it wouldn’t cost the City of Ottawa a dime.
We won local votes in Kanata and at the RMOC by a margin of 32 to 1
and we obtained the agreement of the Liberal Government of Ontario to
our three requests. Things were looking pretty good in the summer of
1990.
But for some reason, Mr. Peterson decided to call an election two and
a half years early and, with a nearly impossible splitting of the vote,
Bob Rae and the NDP came to power later that summer with a majority in
the Legislature based on 35% share of the total vote.
As a result, after we won a conditional franchise for Ottawa in
December 1990, we knew that we faced a brutal 13 and a ½ week OMB
Hearing where we would faceoff with our own Provincial Government who
would: a) not support a franchise for Ottawa, b) use all the power of
the Provincial Government to defeat the rezoning of the Palladium and
the surrounding lands and c) not pay for any public infrastructure (aka,
the Palladium Drive interchange).
It is, to this day, the only interchange in Ontario built privately.
I was on the stand for three and half days of examination and cross
examination along with Doug Logan of Ogden Corp., our arena manager.
Doug got so sick of the proceedings that, during a break in the hearing,
he offered us $20 million to relocate the franchise to a recently
completed Ogden building in Anaheim. Imagine, the Sens could have been
the Ducks and maybe, in a parallel universe, we actually won the Stanley
Cup in 2007. I told Doug: “We didn’t Bring Back the Senators to play in
Anaheim.”
Anyway, when our lawyer told us we were losing the hearing, I decided
to make a public offer—if the OMB would approve the 100 acres for the
Palladium, we would try to keep the other 500 acres in agricultural use
for a generation. This would allow the NDP, hockey fans and Ottawa to
find a win, win, win solution. The NDP could claim they had preserved
farmland for a generation (even though Cyril Bennett, who had tried to
farm the land and whose lands the Palladium actually sits on today, told
the OMB that his land was heavy wet clay and the most money he had ever
made in a year from the farm was less than $10,000.) Hockey fans would
have another NHL team to cheer on. And Eastern Ontario would get our
‘Honda Motor Car plant’—much needed (union) construction jobs in what
was then a pretty tough recession.
The offer was rejected by the NDP and the matter was litigated to a
conclusion. The Board ruled that the MCF zoning for the 100 acres needed
for the Palladium could proceed. But it was silent about the fate of
the other 500 acres. Plus we would have to pay for the new interchange.
Consequently, we wrote down the value of our land holdings by $50
million and took another equity hit of $30 million (the value of the
interchange). That is why we have NHL hockey in Ottawa today, why other
people own those lands now and why yours truly is the
Entrepreneur-in-Residence at the University of Ottawa’s Telfer School of
Management and a real estate Broker and not involved in hockey or land
development.
Prof Bruce, Founder, Ottawa Senators.
Ps. I had a hand in the traffic solution for CTC. Our original plan
included a connection to Highway 7 by extending Huntmar south to
intersect with Hazeldean Road (which the NDP also opposed) and a slave
on-ramp to Highway 417 from what is now Parking Lot 9. The Huntmar
extension was finally completed by Mattamy and opened in 2008 but the
on-ramp from Lot 9 does not yet exist. I didn’t realize the on-ramp was
left out until one event day, I parked in Lot 9. It took me 45 minutes
to get out of there—I couldn’t believe it. When I got home, I looked up
the plans and realized the slave ramp had been left out. It turns out
MTO wouldn’t allow us to build it—the distances between the Palladium
Interchange and Terry Fox Drive were too close to permit it, in their
view. Ridiculous. The ramp would only be open for 45 minutes after major
events when traffic speeds are reduced from 100 kph to 45 kph and,
obviously, safe distances are likewise reduced. So there is hope yet for
Lot 9 parkers that this can be rectified as CTC undergoes further
development.
Pps. I stood on the Huntmar overpass one other time with Gino
Rossetti. The first time he saw the site, he loved it. There is only one
problem he told me: “The Highway has to be at least eight lanes.” I
replied: “Gino, you know that and I know that but that is the last time
you ever say that out loud because if the Province ever hears that, they
will make us pay not only for the darned interchange but also for a
brand new Highway and that will certainly sink the boat.” One day, the
transitway will extend to CTC (for buses, not LRT) and you will be able
to travel from the core to CTC on a double decker bus without ever
mixing with cars. This will be a major improvement; I believe that the
City has made such a mess of LRT that it should focus right now on the
doable—finish the bus transitway to Kanata, Orleans and Barrhaven before
doing anything else.
Prof Bruce @ 1:07 pm
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Rules? There are no rules in entrepreneurship.
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Posted on
Wednesday 22 April 2009
For Residential Real Estate
When you think you might be in the market for a new home, look for a
REALTOR who is the right fit in terms of personality and experience in
representing you as your Buyer Agent.
Look for someone who is thorough—there is lots that can go wrong in these transactions.
A Buyer Agent will have access to the backend systems of MLS.ca
(called MLX) and can help you find the right home in the right area at
the right price. He or she will do a CMA (Comparative Market Analysis)
for you so you know what comparable homes are selling for in the
immediate area.
By narrowing done the choices, you will save a lot of time and aggravation.
Your Buyer Rep does lots of these deals so he or she can help with: a
buy low/sell high strategy, arranging for a building inspection and
building inspector, selecting a mortgage broker, determining your
closing costs (like legals and LTT, Land Transfer Tax) and help in the
negotiations as well as the legal agreements that go along with these
negotiations and completion of the transaction.
I recommend that your principal residence is put in the name of the
spouse or partner who runs the lowest risk of being sued assuming you
are in a long term relationship. It is a bit of a creditor proofing
strategy for you and your family. If you are not sure, put it in your
own name or in joint names.
Your principal residence should be in your own name(s) because, in
Canada, the capital gains from the sale of your principal residence is
tax free.
Any business or any other real estate you may buy should probably be
in a personal holding company. This has some tax advantages as well as
income splitting possibilities and represents the possibility of
diversifying your portfolio.
To learn more about creditor proofing, see: https://www.dramatispersonae.org/CreditorProofing.htm.
One final note, although your Buyer Agent represents you, he or she
almost always gets paid by the Seller so it costs you nothing to have a
professional REALTOR represent you in most cases. If you think you can
negotiate on your own, remember the Seller’s agent may not be
representing you and that agent will get the entire commission so you
haven’t saved any money or time and you may have deprived yourself of
representation. Plus REALTORS are insured, so if anything goes wrong,
you may have something to fall back on. Litigation is a very expensive
alternative.
Prof Bruce
Ps. The reason I am so strongly in favour of using mortgage brokers is explained elsewhere on my blog. See: https://www.eqjournalblog.com/?p=34.
Pps. Get yourself a good real estate lawyer. One who provides value for service and cares about you as a client.
Ppps. Here is why I think real estate investing can be a good idea: https://www.ottawarealestatenews.ca/WhyInvestInRealEstate.html.
And here is why home ownership has been a boon to the economy and the
sub prime mess is blamed on the wrong people: home buyers (https://www.eqjournalblog.com/?p=169).
Prof Bruce @ 11:24 am
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Value Proposition Of a Commercial REALTOR
Posted on
Monday 20 April 2009
The value proposition of engaging a Commercial REALTOR as well as owning your own real estate can be summarized as follows:
1. The Agency has access to MLX, the back end system of MLS.ca, as
well as a list of established Sellers. More than two thirds of all real
estate transactions are derived either from web based searches or from
existing clients’ inventory.
2. A Commercial REALTOR typically does dozens of Agreements per year
and develops a facility with these agreements that is unmatched even by
most lawyers.
3. The probability of completing an Agreement is significantly higher
through their involvement. Real estate transactions are the only area
of commerce where, by law, the Agreement MUST be in writing. Real estate
is complex and a lot can go wrong*.
(* The list of what can go wrong is endless. Due diligence is
especially important in terms of building inspections, examination of
leases, timely fulfillment of Conditions, completing financings,
arranging for Seller Take Back Mortgages, environmental audits, ensuring
that chattels and fixtures are properly accounted for and included,
examination of maintenance records, understanding building systems,
examination of contracts and sub-contracts for property management and
maintenance, equipment rental agreements, appraisals, providing law
firms with the paperwork to complete deals on time, etc.)
4. Legal disputes are also a costly reality: for example, many
arguments revolve around fixtures, chattels or outbuildings in dispute.
REALTORS are insured in Ontario to provide Sellers and Buyers with
additional protection. Deposits are held in trust accounts, which are
also insured.
5. The Agency brings a sense of what the market is doing at any given
time. CMA (Comparative Market Analysis) gives Buyers the confidence
that they are entering into a sound arrangement.
6. Spreadsheets that estimate the Internal Rate of Return (IRR) for a
project are one of the key decision tools that a Buyer needs to have.
The IRR takes into account the three types of returns that real estate
provides: cash on cash returns, forced savings (the pay down of the
mortgage principal each month) and real estate inflation.
7. There is also the additional potential financial advantages of
owning real estate including the sheltering of income using depreciation
reserves.
8. One other item needs to be mentioned and that is the value of a
professional’s time. It takes time to gain the expertise of a REALTOR
and also it takes time to sell or buy a property. Professionals are
often better off using their time more productively in the things that
they do for a living rather than trying to be REALTORS.
9. The Agency will do most of the negotiating. It is not easy
representing yourself and many Canadians find it difficult to negotiate
aggressively. Buyers often do not feel comfortable representing
themselves.
10. It may also take longer to source your own property, negotiate
the Agreement and complete it if you go without representation.
11. Owning your own real estate can alleviate future rental
increases, provide for security of tenure, allow the owner to develop
brand equity in the location that they can retain over long periods of
time, diversify their asset mix, provide for retirement, make the
operating business more sellable and/or provide for a hierarchy and
diversity of ownership that makes tax sense and operating sense.
12. Real estate investing is quite stable in Ottawa—it is get rich slow.
13. It can be less expensive to own than to rent.
14. Owning your own real estate gives you more financial flexibility
too—if there is a sudden need for cash, you can re-mortgage your
property to obtain that.
15. Interest rates are hitting historic lows and prices have come off
their peaks. You make money in real estate when you buy not when you
sell. That is, buy low, sell high. Or buy when everyone else is selling
and sell when everyone else is buying.
Prof Bruce
Prof Bruce @ 11:15 am
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