| The proper action when things are going well | | | | new level of security. That was, using the |
| is to pay off debt and consolidate your | | | | buildings profits after paying all of his |
| position. Then you will be financially strong | | | | loan payments to buy and remodel more |
| and can go for further expansion without fear | | | | buildings. Nick just couldn't wait and |
| of loosing what gains you already have. When | | | | consolidate his position. He had every |
| you are not deep in debt you do not have to | | | | building he owned loaned up to the maximum |
| worry about your creditors getting paid. | | | | value that he was able to. The rents were |
| Since the usual history of a business is | | | | more than enough to cover the payments on |
| cyclic (boom and then every 7 years (plus or | | | | each individual building. So what happened? |
| minus) bust) you can predict when it is time | | | | |
| to consolidate. | | | | Two things. The first was his greed. We |
| | | | entered the 1991 recession, and the price of |
| When the prices are "too good to be true, | | | | buildings went down. The banks were starting |
| they are." In the two years just before the | | | | to foreclose on buildings and put them back |
| top of the market is reached, prices are | | | | on the market for very cheap prices. Nick |
| going up at very incredible rate. I have seen | | | | just couldn't let a deal pass him by. He |
| real estate go up 25%, per year, right at the | | | | bought 3 of them. He borrowed the last dime |
| top. This is incredible and I guarantee you | | | | he could squeeze out of every building he |
| it cannot sustain itself, at that rate. As | | | | owned to buy these buildings, thinking that |
| hard as it is to give up a profit, it is | | | | he could do no wrong. One bank made him the |
| harder still to sell an investment when it is | | | | deal of a century. They wanted a lot of money |
| going straight up. But, understand this is | | | | down but the price "was just too good to be |
| when you need to sell. If that is not what | | | | true." |
| you want to do then you need to go to plan B: | | | | |
| pay off your debt and get ready for the | | | | Nick was so much in a hurry to get his hands |
| market drop. | | | | on this great deal he didn't bother to do his |
| | | | normal structural inspections and research. |
| If you are debt free you can survive the drop | | | | After all, Nick owned 17 buildings in |
| and then be solvent and financially secure | | | | Hollywood by now and knew the market better |
| when the recovery comes. I would like to tell | | | | than anyone else, he thought. He looked at |
| you a story of the largest apartment owner in | | | | the building and saw it was only 20 years |
| Hollywood. | | | | old. The building was empty, which meant it |
| | | | brought in no income. That didn't bother |
| It was 1980 when I met Nick. He owned 11 | | | | Nick, he would just get it rented quickly and |
| buildings at that time. He bought the worse | | | | the building would support itself. What Nick |
| buildings in town. These had the best cash | | | | hadn't noticed was that the foundation was |
| flow. He owned mostly brick buildings. This | | | | damaged and a $100,000 repair was needed. |
| was because they cost less money than stucco | | | | This was a repair that Nick couldn't afford. |
| and wood buildings. This lower price allowed | | | | I begged Nick to walk away from this building |
| Nick to generate higher profits. Nick would | | | | and let the bank have it back. He refused and |
| buy a building. He then did a market study, | | | | squeezed more money out of his collection of |
| and figured out what size apartments and what | | | | buildings. |
| numbers of bedrooms were generating the | | | | |
| highest rent, per square foot. Then he | | | | As you can imagine, Nick was loaned to the |
| remodeled his building to get the highest | | | | hilt and had no money set-aside for an |
| price per square foot he could. He spent over | | | | emergency. At his peak he owned 17 buildings |
| $100,000 per building to do this. He also had | | | | worth $45,000,000 with him estimating his net |
| to earthquake proof all of his buildings. | | | | worth at $7,500,000. He was definitely worth |
| | | | a lot of money. That was for sure. Before we |
| One of the reasons that brick buildings sold | | | | get jealous of him, lets look at these |
| so cheaply was that they needed to be | | | | numbers a different way. If Nick was worth |
| earthquake reinforced. When Nick finished | | | | $7,500,000 then his real estate loans had to |
| remodeling a building, it was producing a | | | | be the difference. That is $37,500,000. These |
| very nice cash flow. Nick would use that cash | | | | were sure big numbers. |
| flow to buy and remodel the next building. | | | | |
| This was very smart thinking. Where did Nick | | | | Let's look at these numbers in terms of their |
| fall off the rails? First he would find a | | | | percentages. This $37,500,000 was 83.3% of |
| great deal, while he was still in the middle | | | | $45,000,000. $45,000,000 had to be the |
| of a remodeling job. He just couldn't pass it | | | | retail value of all these buildings. Nick |
| by. He borrowed on one of his finished | | | | would not think in terms of selling them. He |
| buildings to get the down payment to buy the | | | | never sold a building. He only bought, and |
| building. | | | | bought, and bought. What Nick saw was the |
| | | | potential. If property values went up only |
| Then he would borrow on a second building to | | | | 10%, Nick's net worth would go up $4.5 M. |
| get the money to remodel the new building. | | | | Property values had gone up over 20% in the |
| Now he was remodeling two buildings at the | | | | 1980's but the recession that had started was |
| same time. By borrowing on two of his | | | | of no concern to him. It is clear that he had |
| successful buildings, he now had to pay the | | | | stretched himself to the limit. The last |
| loan payments on the two new loans. The rents | | | | building the bank sold him put him in |
| from the older buildings now went to the | | | | trouble. He might have even survived it if |
| lenders instead of to Nick's remodeling | | | | he sold one, two or maybe three buildings. |
| project. The new building, just bought, | | | | No, Nick wouldn't do that. |
| didn't produce enough income to cover the new | | | | |
| loan on it because half the building was | | | | One year later the recession was not over. |
| empty due to the remodeling. Nick now needed | | | | Unemployment in California went up and up. |
| to keep borrowing money to fix the buildings | | | | Businesses were closing, President Reagan was |
| and pay the loan payments on the buildings | | | | closing down Aerospace, and workman |
| that didn't generate enough income. When a | | | | compensation insurance was so high no one |
| building was completed it then supported | | | | could stay in business. Vacancies in |
| itself very nicely. | | | | apartments were going from 1% to 5% to 10%. |
| | | | Then it happened, we had the LA riots. |
| Was Nick happy with that? No, he wanted more | | | | Hollywood became a ghost town and then it |
| and more buildings. If at any time Nick had | | | | happened again, the earthquake of 1994. Brick |
| stopped borrowing to buy new buildings, and | | | | buildings fell down on Hollywood Blvd, none |
| just finished all his buildings in | | | | of Nick's buildings. People moved away and |
| remodeling, he would have been able to catch | | | | vacancies rose in Hollywood too as much as |
| up with himself and started expansion from a | | | | 17%. |