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REAL ESTATE Basic Question About Leveraged Real-Estate Developers

WheelsRCool

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Aug 12, 2007
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Hey, I've read of about three major real-estate developers who became wealthy, then went broke and were in deep debt because the market crashed and they had been so leveraged in their real-estate developing. I also read on this website in a thread where someone mentioned about how many of the big guys can be very leveraged.

My question is, doesn't that put a lot of your wealth at risk? I mean, if the market crashes, you can lose it all overnight it seems.

Or is the ideal way, if you are leveraging for real-estate development, to have half your net worth in other investments, companies, etc...along with a good supply of cash on hand, so that if the real-estate market does crash, you don't go completely bankrupt?
 

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bflbob

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Or is the ideal way, if you are leveraging for real-estate development, to have half your net worth in other investments, companies, etc...along with a good supply of cash on hand, so that if the real-estate market does crash, you don't go completely bankrupt?
There is a big difference between RE investing and RE developing.

In investing, you can predict your downside with some degree of certainty.
Obviously, if the world ends or another Great Depression hits, all bets are off.

But in development, you are typically buying an empty lot and building it into a 'project'.
The upside potential here is great, but so is the risk.

Investing involves taking an existing structure and flipping or renting it.
Sometimes you'll improve it, as Steve-O does.
Other times, you'll keep it just as is.
You are working off cash flow and appreciation, along with a discounted purchase price.

In developing, you start with a blank slate and a big vision.
You might buy a group of run-down properties near a highway.
Your vision is to tear them all down and build a convention/hotel complex.
There are a lot of up-front costs before you'll see a dime from revenues.

Obviously, you might have enough money to buy a small starter house to rent out without leveraging.
But try to do the same with the convention/hotel complex.
You need to leverage in order to build it, but the high risk factor increases the odds of failing.

I hope this helps clarify what you were asking.
 

SteveO

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You need a plan if heavy leverage is your idea to get ahead rapidly. I started a thread a while back that talked about risk.

http://www.thefastlanetomillions.com/showthread.php?t=626

I also talk about adding value through inproved income (thus minimizing exposure) on this thread.

http://www.thefastlanetomillions.com/showthread.php?t=588


On top of all this, there are other modes of safety that I try to incorporate. One of the big ones is getting non-recourse loans. These are a lot easier to obtain if you have a well run and income secure property. So, I typically purchase using temporary or bridge loans and refinance once the financials get where they need to be. You can purchase using these loans directly if you want to get a well run property from the start. That is how I like to sell them. :icon_super:

A lot of legal work goes into these non-recourse loans. I have an attorney that sets them up for me and then the lenders attorney will review them. They want to see that they are solid and "bankruptcy remote". Their preference is that they are single entity, Delaware LLC's. My accountant does not like single entity LLC's for taxes (doesn't want to put them on schedule E) so I do some extra work to accomplish it with a typical multi entity LLC.

If I lose the property to the lender, they have no recourse for taking any of my other properties or going after me for more money.
 
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WheelsRCool

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To an extent it does, however the one guy who went broke, Tim Blixseth, is now a billionaire from developing resorts. He said going bankrupt was the best thing that ever happened to him, because it taught him to never take on debt again. But if he became a billionaire from developing resorts, wouldn't he have to take on debt to construct the resorts?

Also Donald Trump, he continues in the same business he almost went bankrupt in, what exactly does he do differently to prevent himself from ending up $9 billion in debt again (I still can't get over that number everytime I hear it!)? He still builds his resorts and skyscrapers and all that I know.
 

bflbob

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To an extent it does, however the one guy who went broke, Tim Blixseth, is now a billionaire from developing resorts. He said going bankrupt was the best thing that ever happened to him, because it taught him to never take on debt again. But if he became a billionaire from developing resorts, wouldn't he have to take on debt to construct the resorts?
I would think so...or else he has a heck of a job.:iagree:
 

Sid23

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WheelsRCool,

The answer to your question is "it depends." The beauty of development (and the challenge) is that there is no set way deals get created, financed, etc.

Some developers take on tons of debt to make their projects happen, know the inherent risks involved and decide to forge ahead because they think they can make a large profit. In my experience, most developers by nature are risk takers and they have a great deal of self-confidence that allows them to think they will always be able to handle anything that comes their way. This is their greatest blessing, but also their greatest curse. It allows them to get deals done and make things happen, but can also bite them in the a$$.

Take Trump for example. At one point in the 80s he had $9 BILLION in debt and didn't blink an eye because he figured he'd make it work. The market turned against him and he lost it all. But that confidence and risk taking ability allowed him to get it all back and then some. Most people would have a hard time with that much exposure at one time. I know I would.

From what I've seen (and there ARE examples that prove the contrary), most developers understand passive income and how it would provide a safety net for them in their developments if they never leverged those assets. But most developers also don't think they "need" passive income to support themselves because of the can-do attitude.

Then again, Don Bren of the Irvine Company makes over $300 million a year in passive income.

But as a breed, developers are brash, bold and confident. Again, they make it happen. But the ones who crash and burn often aren't too concerned with covering their asses. It's all sport to them.

I often ask the developers I work with why they don't own a couple of apartment buildings or something as a safety net. They just don't think they need it.

However, the guys I work for often do "nothing down" development deals so often only have their time to lose.
 
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WheelsRCool

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WheelsRCool,

The answer to your question is "it depends." The beauty of development (and the challenge) is that there is no set way deals get created, financed, etc.
I see; I guess that's what Ivanka Trump and Donald mean when they say they love doing deals.

Take Trump for example. At one point in the 80s he had $9 BILLION in debt and didn't blink an eye because he figured he'd make it work. The market turned against him and he lost it all. But that confidence and risk taking ability allowed him to get it all back and then some. Most people would have a hard time with that much exposure at one time. I know I would.
Yeppers, I am wondering though, is he in a similar situation where he could go broke again if the market turned or does he have other reserves so that the same thing won't happen again...? I believe he listed as part of his supposed $6 billion net worth (he says he's worth $6 billion, Forbes estimates $2 billion, so no one knows for sure) $500 million cash. He also has his other businesses.

But as a breed, developers are brash, bold and confident. Again, they make it happen. But the ones who crash and burn often aren't too concerned with covering their asses. It's all sport to them.
I would think the best way is to be bold, brash, and confident, but at the same time, pursue it as a game of skill, not just as a pure gamble.

I often ask the developers I work with why they don't own a couple of apartment buildings or something as a safety net. They just don't think they need it.

However, the guys I work for often do "nothing down" development deals so often only have their time to lose.
There was a Russian immigrant woman named Alla Wartenberg on one of the seasons of "The Apprentice," she owned two salons (though she sold one recently I believe) and she also builds million-dollar custom mansions for resale, her profile and website said. Now she is starting her own beauty products line.
 

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