What’s your strategy in allocating capital between buying finished projects and doing development deals, what percentage of each do you buy, someone asked me at a ULI conference. Flustered, I had to admit that not only didn’t we have a strategy, but we’d also given it so little thought that I had no idea how many of each we had done. I explained that we simply bought the deals we liked as they came along. He seemed satisfied with that, but I was left wondering about my unexamined belief–and oft-stated tagline–that the only way to make lasting money in real estate is to add value, to be a real developer.

The funny thing about unexamined beliefs (eating carrots improves your eyesight) is that they can crumble like Middle Kingdom papyrus upon the least scrutiny. 

I checked our records. Since 1983, we’ve done about 70 deals. 56 of those–80 percent–were development projects, either ground-ups or major renovations. And we bought 14 finished, fully-leased properties. 

Based on this tiny sampling, I tried to determine–for us at least–whether one tactic was better, whether one was safer or more profitable. Which had more losers? For this purpose, I assumed that a loser was a project in which not all of the contributed capital was ultimately repaid. Forget about tax breaks, fees or interest, just a bright-line test: was the equity returned? (By the way, if you’ve been around real estate long enough, this is also a working definition of a home run.)

Business is like sex; even when it’s bad, it’s good

Using these criteria, we had 5 losers, 4 of which were development deals and one a leased office building. This means that our failure rate for both approaches was identical: 7 percent of our developments and existing buildings were losers. It’s worth noting that all our failures had occurred by 2000, suggesting we became better at developing over time*. One possible conclusion from our improving fortunes might be: The day you no longer have to do deals is the day your batting average jumps a couple of hundred points. 

Then I turned the analysis upside down and solved for our 10 best deals. Interestingly, our big winners were evenly divided between building and buying. Because a development deal can require 100 times the effort of buying a leased project, you might infer that you should spend your time chasing existing buildings rather than running multi-year marathons getting dirt lots entitled, designed, built and leased. 

But our experience has also been that finding great deals among existing buildings is an order of magnitude more difficult than finding solid developments. Why? Because everyone wants a piece of cake. The easier an asset is to underwrite, the fewer its risks, the greater its price. Of those 14 buildings we purchased, 10 were effectively off-market. They found us. They’d either been listed so long the world had forgotten them or they had challenges far beyond the abilities of neophytes or the attention span of the bigger, volume-driven players. And just as our losers came early in our career, these winners came late. Why? Because great deals usually start with a great purchase, and how do you pull that off? You step up and close for cash with a very short escrow, a tactic beyond a beginner’s reach. 

In hindsight, our failure to strategically allocate our equity between building and buying cost us nothing and may have been a boon. If we’d stuck to an allocating strategy of, say, 50-50, we would have missed out on good deals. Jumping back and forth freely between the two tactics let us do rather well with both. 

To put a cork in this, veteran developers will tell you to build in good times (because you can’t find decently-priced existing buildings) and buy-in bad (when projects sell for less than replacement cost). A pretty decent rule of thumb. 

Finally, back to losers. We weathered ours, not everyone does. When I was 14, I asked the well-off father of a friend how his contracting business was going. Chewing an unlit cigar, he mulled it over a moment and said, “Stretch, business is like sex: Even when it’s bad, it’s good.” Having no experience with either, I thought him an oracle and looked forward to both. Not so many years later, my early role model went bankrupt, never recovered and died a broken man before turning fifty. He was wrong about business–it can be terrible. Draw your own conclusions about sex.

*My partners would like me to point out that no “friends and family” investor ever lost a nickel with us. In the eighties, it was institutional money; by the ’90s, we’d stopped using outside money, and the losses were ours alone. Nor has any lender ever gone after us.