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Wharton Emeritus Professor Peter Linneman explains how company management can add value to a portfolio of properties.
BRUCE KIRSCH: In chapter 10, we talk about real estate company level analysis. And naturally, a lot of students are attracted to real estate, because it’s very entrepreneurial in nature and have some vision for themselves somewhere down the road of running their own company, whether it’s doing investment or development. And so chapter 10 tells us about, how does the company level analysis differ from the property level analysis. And for one thing, there’s corporate level operating costs, and then also corporate level depreciation elements that are introduced.
And so we see immediately that, at a minimum, the management has to outstrip its own operating costs in order to create a little bit of value. What’s your opinion on the best ways for management to add value to a portfolio of real estate, and where does management most often miss the mark?
PETER LINNEMAN: You hit it right on the head. I remember my first exercises in business many years ago were where I could figure out how to cover my entity level expenses, so to speak, but I couldn’t figure out how to cover the overhead. You know, and that’s a problem a lot of us face in business, and real estate is no different than any other business. Covering the overhead is the hard problem.
And it’s funny. When you start out, it’s easy to cover overhead, because maybe you’re doing another job, and you’re covering your overhead by your day job, and you’re just kind of sidelining and picking up. And it’s easy to cover your overhead when you get really large, because a little slice out of a lot of pieces can effectively cover overhead. It’s that in-between that’s hard, that early start full time that’s hard, where you’ve got to be competitive.
How do you add value? Well, you’ve got to be doing something more clever than others. You’ve got to be doing something cheaper than others. The phrase I used to use in my entrepreneurship class was, better, cheaper, faster. You’ve got to be doing something better, which is not easy, than others are doing it. You’ve got to be doing it cheaper than others, which is not easy in a competitive market, or faster, which is not easy in a competitive market. If you’re not doing something better, cheaper, or faster, what’s your reason to exist?
And the number of people who believe they have a right to exist as opposed to a rationale to exist– I used to say, wanting to work for yourself is not a good enough reason to be able to exist. There are a lot of things I’d like to do. It doesn’t mean I can effectively do them. So how do you really do it?
One of the things is, for example, if you start out, you’ll do your own renovations. You’ll do your own leasing. You’ll do your own fix-ups, depending on your capacity. As you mature in business, your advantage tends to come from relationships. People trust you. They’ll show you something. It may not be a big advantage, but it’s enough of an advantage. You only have to be a little bit quicker or a little cheaper or a little better.
And so it usually comes from relationships, that you’ve dealt with somebody. They trust you. They will give you a shot at it. They’ll give you a chance at it. Then you have to execute. But a lot of times, people are just dead weight, and it’s why mergers occur. Mergers occur when you are just dead weight– not evil, not bad. It’s just you’re not adding anything. You’re not better, cheaper, or faster.