I’ve come across a few things recently that I’ve found interesting, but they didn’t seem substantial enough to warrant an entire blog post so I decided to combine them here.
The first is an excerpt from Bill Poorvu’s book, The Real Estate Game (which was my only form of entertainment on my 12 hours of bus travel this past weekend to and from Boston). The book was published in 1999, a time when CMBSs were a relatively new concept that were gaining momentum. At the time, the CMBS market had grown to $150 billion over the previous few years. Here’s the exert:
“Here’s a case, as implied above, where Wall Street deserves credit for its creativity. But we haven’t yet lived through a down market that could put CMBSs to the test. Were the tranches appropriately priced? How will the foreclosure mechanisms work? Price volatility for commercial properties has historically been much greater than for single-family residences. I, for one, think there’s reason for concern.”
Fast forward 10 years, we’ve experienced our first downturn, albeit more severe than anyone could have expected, and Poorvu was right, “there’s reason for concern.” Despite the current issues, I believe that CMBSs were a much-needed way to get mortgage money back into the commercial arena and will continue to be in the future.
The next interesting thought comes from the Peter Linmenan talk from last week that I left out of my post covering the event. Mr. Linneman made an analogy between pro-formas and a football playbook. In football he said, I’ve never seen a play that didn’t work in the playbook. However, once on the field, not every play works and even the plays that do work, they usually didn’t go as planned.
The same can be said about your pro-formas. If you’re really good, your revenue estimates will be within a 15% swing, and your cost estimates within a 30% swing. And that’s only if you’re really good. In real life, your revenues will not rise consistently at 3% per year, things change that either help your project succeed or cause it to fail.
Of course pro-formas are extremely important, however you must take them with a grain of salt and don’t be shocked when the numbers don’t follow your projections. Things change, like football, it’s those who react to the changes that will succeed.
