There’s been a lot in the news recently about WeWork delaying its planned IPO, which inspired me to talk about real estate.
My journey in real estate began when I was about 10 years old and my father got involved in a restaurant franchise. And because of how franchises worked back then—and as I’ll discuss a bit later, still today as well—he was very aware of how he was not holding all the cards going forward.
Everybody thinks that Ray Kroc started a McDonald’s hamburger business, but what he really started was a heck of a genius real estate model. Franchise costs vary from small towns to metro downtowns because of the cost of land, but let’s say he buys a nice acre on the corner of First Street and Main for $500,000, and it takes another $500,000 to build and outfit a 4,000-square-foot restaurant on it, for a total cost of $1 million.
If someone comes in and buys that McDonald’s franchise for $1 million, McDonald’s owns that land and building free and clear and signs them to a 10-, 20- or 30-year rental agreement. Every month, tens of thousands of franchisees pay McDonald’s to rent this facility, where the land and building is already paid for. It’s a real estate business that happens to have restaurants on its sites.
Who’s the best tenant when times are tight?
WeWork thought that an IPO would be possible this year because times are great: The co-working space company occupies high-cost downtown real estate in the biggest cities around the world. But potential investors were concerned about WeWork’s susceptibility to one of the biggest problems with real estate: What happens in the inevitable downturn, when its tenants don’t renew their rates? When times go down, WeWork could be the largest real estate company in the world with the most vacancies in some of the highest-dollar cities in the world.
In real estate, the only variables are: (1) What does it cost me to own this for a month? (2) And what can I rent it for? Price doesn’t matter; it’s always the terms. For example, I could buy a car for $1 billion if the terms were $1 a month for a billion months, because I could rent that car out to an Uber or Lyft driver and make $500 a month and make a gazillion percent return on my investment.
Amateurs are always trying to negotiate the best price for their house, and don’t realize that if they would have gotten the 30-year loan down to a 15-year loan for the same interest rate as the 30-year loan, they could’ve bought their house for half the price.
So, if I can build this structure for $1 and I can rent it for $2, I can double my money. What is the variable? The renter.
Who’s a better tenant: a commercial rental, a B-to-B or a B-to-C? Well, obviously, if I own a business and don’t pay my rent and I get kicked out, I have no chance of surviving. But if I’m a renter and I lost my job, I got a divorce, everything went south, I’ll say “to heck with it” and walk away and go move in with my mom. Renters have nothing to lose. That’s why commercial real estate is so much better than residential real estate.
Making the initial investment
I see a lot of dentists who want to go into real estate, and I’m starting to see a huge uptick in older, wiser dentists who are networking with some of those 6,000 students graduating from dental school every year. The young dentist says, “Well, I want to come back to your small town, but I don’t have a place to rent. There’s a great building over on First and Main—I wish I could go there, but I’ve got $285,000 worth of student loans. I don’t have the money to buy the land and the building.”
The smart dentist says: “Well, I’ll buy that land and building, and dig that thing out to a dental office.” Plus, maybe he plops some of his old dental equipment in that new location and buys new stuff for his own dental office. Then, the new dentist gets his new office and the older, wiser dentist is in real estate now: He’s in passive income and his tenant is a dentist who ain’t going nowhere—it’s not some guy off the street, it’s a doctor who signed a 10-year lease.
Guess what happens in 10 years? That younger dentist will have paid off his student loans, he’s now debt-free and wants to buy that land and building. Well … do you have the power to price? I mean, this isn’t just some residential condo that’s listed on MLS and everybody’s bidding on. The tenant is a doctor whose average median household income is more than 3.5 times the combined median household income and he’s been operating in this location for 10 years. He wants this location. He has no power to price.
So if you bought that whole thing for a dollar, you rented it out for 10 years, so now you’ve got another dollar, and now he’s sitting there and you say, “You know what? I want $1.25 for that,” he’ll likely say, “Absolutely, because I don’t want to move my office.”
Everything old can be new again
You can buy used buildings for significantly less than developing them. When you develop from scratch, you have all these costs: blueprints, developers, architects. The smart dental real estate developers are out there buying 20-, 30-, 50- or 100-year old buildings for about the size of what an average dental office would be, renovating them into dental offices and leasing them to dentists fresh out of school as owner–operators.
They’re going to work all day, every day, and they’re going to have peace of mind because they own that business. And you’re going to make money because you’re in the real estate business. If you’ve got a good location, that’s all that matters.