From a small northwestern observatory…

Just to bring new readers up to date, back in the winter, I began a series on real estate investment mistakes I’ve seen over the years. Partially, this was a follow-up to my new book, Real Estate Valuation and Strategy. Before Covid-19 changed everything, we’d planned on a speaking tour to promote the book, and so these blog posts would serve as the notes. Well, we see how THAT worked out!

Anyway, let’s get started. (By the way, at the end, I’ll give newbies a quick link to the first 4.)

Mistake #5 — Right property, wrong location

This is actually a two-edged sword. In some circumstances, finding such a unicorn can provide a great investment opportunity. More often than not, though I observe this as a very real investment mistake.

What makes a property “Class A”? Any sort of property can be in the top tier — offices, hotels, etc. One of the factors that dictates a Class A office, for example, is frontage on a major street in a market with other Class A offices. Think about how many top-tier firms are located in Manhattan on Fifth Avenue, Avenue of the Americas, or Madison Avenue. Now, imagine if that address was moved to a side street. This is an overly simplistic example of how location drives the investment decision.

As another example, think about market demand. How much demand exists in this market for Class A office space? Is the market in transition? Is there growing or shrinking demand for top-tier space? Where are we in the overall market cycle? Overbuilding for a site, for a city, or for a market can be a terrific waste of investment. What is worse, a Class A building, with all the fancy bells and whistles, that only commands Class B rents because of location mistakes, will quickly suffer from lack of maintenance, upkeep, and modernization. The NEXT investor, thinking about buying this property, would probably prefer the Class B building next door in good repair rather than the Class A building that is falling apart due to poor management or lack of funds for upkeep.

Now, I noted that there may be very real opportunities for investors. One of my favorites is locating a Class “C” property in a Class B or A location. Often, such properties are fully depreciated and can be purchased at a discount (thus, resetting the depreciation meter!) but throw off above-average rents due to proximity to high-end investors. Let’s say you are in a business that requires a lot of face-time with high-end, Class A tenants, but your own firm does not need such fancy office space. You may be willing to pay a premium to be in a Class C office, in the central business district, that provides you access to Class A customers. Class C properties may be owned by investors who have simply run out of steam. These properties need some tender loving care, perhaps a bit of fix-up, and can often — not always, but often — become Class B properties with a bit of effort.

Of course, there are limits to this analogy. Class “C” hotels in Class “A” locations are usually just candidates for tear-down (although there are some exceptions!). Conversely, Class “C” restaurant space in Class A locations are often candidates for chic dining establishments. Class “C” rental residential can often be kicked up the ladder to Class B with only minimal expense. Naturally, these opportunities depend on market demand and are situationally specific. However, a fulsome understanding of how properties fit into the market are key to avoiding costly investment mistakes, or on the other hand finding very real investment gems.

Now, I promised you links to the first four tips —

Mistake #1 — Misuse of Leverage

Mistake #2 — Over Paying

Mistake #3 — Not Realizing You Own Real Estate

Mistake #4 — Trying to Catch a Falling Knife

We’ll be back with #6 and #7 in the next few weeks. Until then, stay safe out there!