Real estate is an entrepreneurial business where almost everyone aspires to do their own deals. That’s part of what makes it so interesting. There are a lot of really smart professionals out there eager to do their own deals, however starting your own firm is incredibly challenging. I recently spoke with a group that spent the last 24 months chasing deals with no success. They’re back in the market looking for a job.
At Atlas, we did our first deal in 2010 and we made plenty of mistakes. However, in hindsight, we were bailed out by an improving real estate market and we were able to learn from our mistakes, while also building a nice track record.
If we were starting the company today, what would we do? I’m not sure we’d be able to get the company off the ground and we certainly wouldn’t have been able to scale as quickly as we have.
Here are the 8 challenges of starting a real estate investment firm in today’s hot market:
1. Timing is often the biggest driver of deal success: The sentiment is that today’s market is hot, but it may run for another 24-36 months (your guess is as good as mine). The reality is that timing is often one of the biggest factors in determining the outcome of a deal. Your goal needs to be to hit singles and doubles, trying to hit one out of the park in this market could land you in bankruptcy, and that can be tough to come back from. Remaining a prudent investor is more important now than ever.
2. It’s hard to get comfortable and pull the trigger on the first deal: In a hot market where a lot of smart groups with great track records are net sellers and being patient on the acquisition side, it’s really challenging to get comfortable with that first deal. Doing your first deal is the most difficult, because it has to go well. If that first deal goes poorly, good luck doing a second.
3. Investors have unlimited investment choices: Your first few investors will likely be family and friends who invest because they trust you, think you’re smart, and have faith in your ability to execute. However, with the introduction of crowdfunding, investors have more options to invest into real estate than ever before. Why would they pick you?
4. The opportunity cost of leaving your job is higher in a hot market: In a hot real estate market, companies are ramping up their hiring due to recent success, increasing compensation to existing employees. This makes it even more challenging to go off on your own. Go make mistakes with someone else’s money so you won’t make them when great buying opportunities come your way. That said, when is the right time to go off on your own?
5. Hard to efficiently sift through all the over-priced deals: I talk to a lot of sponsors who all share the same sentiment; for every 50 deals they analyze, about 5 are decent deals and maybe 1 is worth bidding on. When you go off on your own, forego your salary, and begin cutting into savings, time is of the essence. How can you efficiently use your time when there are so few good deals out there?
6. Unlikely to experience a near-term capital event: Over the past 5 years, we’ve seen rapid rent growth in most asset classes and markets that likely won’t continue. Real estate is a long-term investment and while sponsors receive acquisition fees and some ongoing cash flow though their pari-passu investment and asset management fee, you don’t make real money until there’s a capital event that gets you into the Promote. With slowing growth, it’ll take longer to get to that first capital event. It’s hard to support yourself with only 1 or 2 deals.
7. Hard to be patient even though that may be the best course of action: In certain stages of the real estate cycle doing nothing is the best thing to do. As a new firm, that’s not an option. However, if you’re considering going off on your own and you’re waiting for that next disruption, it’s a great time to start a relationship with a family office and set yourself up for that “remember when I told you about what an awesome buying opportunity down markets are and how we should save for that day? Well the day is now so give me some money…”
8. Also tough to start an investment firm in a down market: Okay, you’ve come to the conclusion that this is not a great time to go off on your own. Well a down market presents its own challenges, primarily lack of liquidity. While the recession created an incredible opportunity for real estate investors to buy stuff on the cheap, accessing capital was challenging. Most investors lost all they had, and those that did not have a lot of exposure pre-crisis and had a way to get capital, absolutely killed it. Now, of course, we’re seeing the opposite. Money is everywhere but there isn’t a deal to be found.
Bottom line, it’s tough to start your own investment firm, but it’s especially hard in today’s hot market. However, even those who attempt and fail, learn a ton and make a lot of great connections in the process. Being successful requires a little luck, but everyone luck. It’s what you do with that luck that makes all the difference.
What do you think?