By: Earl Pabellano

Have you ever heard the phrase “build it and they will come”? I know I have heard that repeatedly, not just in a real estate aspect.  At times, I have felt as though I witnessed it as much as hearing it. For instance, have you driven past new developments and wondered, where are all these people moving from?  Or you could see many empty houses in a brand new subdivision one month and then a few months later you drive by and see for sale signs have been removed, cars are parked in the driveways, and children are playing in the yards.  Now what do you think when that happens? Perhaps you thought the developers built it and the people just magically showed up.  More often than not, there exists a great deal of research and analysis that the developers conduct before a new community is created.  Also, banks lending to the developers to bring these planned developments to life conduct their own research before approving loans to ensure there exists a big chance that they will profit from the loans.

In a certain part of China, developers and the government tried to create their own version of Manhattan.  Yet after borrowing billions to create this utopia, people are left asking “where is everyone”?  This place is in Tianjin, China, whereby the government borrowed billions to build their dream called the Yujiapu Financial District.  This attempt to recreate Manhattan has resulted in just twenty percent occupancy for its office space.

In designing and creating a city or area from the ground up, what comes into play? You want businesses to come, schools to be there, shopping, restaurants, hotels, and green space.  Within these spaces, what do you expect to find?  Hopefully, there will be many, many people.  There needs to be people living, working, and utilizing the spaces.  This part of Tianjin has been lacking all that.  However, that’s not to say that the government failed to try.  They were successful in convincing the Juilliard School to open their second campus there, a campus that would end up costing around $225 million.  Such was the hype surround Juilliard’s new campus, that it was discovered that they had ordered 150 Steinway pianos to occupy their climate-controlled rooms.

Surprisingly, Juilliard is not the one spending the $225 million to build their new campus.  The government is the one spending the money.  You may wonder where all that money is coming from.  From debt, of course.  This Yujiapu Financial District is far from being the next Manhattan. It resembles more of a ghost town. This ghost financial district boasts a twenty percent occupancy rate for its office space, halted construction on high-rise buildings, a mall with very little foot traffic, and a pet store without any pets to sell.  Even though Juilliard will be opening, that alone cannot bring all the businesses and people to this area.  

Supply and demand has become a major driving force in prices in Yujiapu.  With only twenty percent occupancy in the office space, there is clearly a severe oversupply of office product with virtually no demand.  Thus, businesses renting office space are given an entire year without having to pay any rent.  This is a virtually unheard of concession in the world of office space. China does not boast about their borrowing.  However, local governments have reportedly borrowed $4.5 trillion for this project. Rumors are circulating that the depth of borrowing is actually at $10 trillion.  No matter what the real amount is, that is definitely too much for this development to be able to comfortably service.  When you have such low occupancy that your concessions include one year of free rent, there is definitely a dark cloud looming over your development. Normally, during the market study that takes place years before a development like this even begins, a simple market study would analyze how many businesses would be interested in expanding or moving to this new area.  That could help to prevent overbuilding.  Another idea could be to stagger the development process.  For example, if your new financial district has plans to have 50 high rise office towers, you could build the first one and wait until that reaches a desired occupancy before beginning construction on the next tower.

What happened in Yujiapu demonstrated what China has been doing to grow.  China borrowed extensively in developing other metropolitan areas.  However, in the past, the growth was there to make the developments sustainable and justified, allowing for repayment of the debt. China would sell land to developers. After that, China would borrow money in order to subsidize construction.  In the past, the jobs were there to furnish these projects, which created new cities. The major problem is that China’s growth has slowed, and projects such as the Yujiapu Financial District have become caught in that decline.  China’s business model has been built on building for the future.  The problem now is that they have overbuilt.  So in this instance “build it and they will come” does not last forever.

Tianjin, the city in which the Yujiapu Financial District is located, used to be one of the fastest growing cities in China. Government officials in the economic zone that includes Tianjin have admitted that they overstated growth. Now, Tianjin’s growth is one of the slowest in China.  Added to that is their financial issues.  As a developer and investor, you rely heavily on growth rates.  When an area is growing, you want to be part of that growth and develop property or buy existing property.  However, when you find out that the government had been manipulating their stated growth rates, what are you supposed to do?  If you have already committed capital, you see that relying on government facts alone could be detrimental to your business model.

In that, I would say trust but verify.  You know what the government in China says the growth rate for a certain area is, but do you feel certain that is the correct number?  If you build a beautiful office tower, ask yourself if you are an investor, or a speculator.  The phrase “build it and they will come” without the proper market research and stated demand leans more toward speculating.  In a case like Yujiapu, it would be very beneficial to your investment to have space preleased before beginning construction.

Tianjin’s government, businesses, and households collectively have $760 billion in debt.  Aside from that, the bigger issue is that their annual interest is 12 times larger than Tianjin’s annual economic growth.  The emptiness in Yujiapu is as large as its debts.  With streets empty, unfinished skyscrapers, and almost empty completed skyscrapers, when will all the people arrive?  Residential buildings are empty and even the six lane roads do not have crosswalk lights.  But then again, why would there be crosswalk lights when there are no people crossing the road?

Sadly, Yujiapu is not the only failed development district. Not far from Yujiapu is Xiangluowan. This district is reminiscent of yet another ghost town.  In Xiangluowan, private Chinese developers built this district using their own capital. Just like in Yujiapu, the “build it and they will come” mantra failed.  Loans are now overdue on dozens of buildings.  If you look for the people to blame for the failed developments, where do you look?  Perhaps at the developers, their market research teams, or maybe high up, to the government.  The borrowing for Tianjin can be traced back to a man who used to be the No. 2 Communist Party Official in Tianjin.  This man, He Lifeng, is now the person in charge of the government agency that approves development projects.  He has the power to tell the banks to lend money to Tianjin.

However, you could say that He Lifeng is playing a real life version of the old computer game The Sims.  In The Sims, you could build an entire community of buildings and enterprises to be housed in those buildings.  Unfortunately, Yujiapu is not a computer game.  There is real capital involved.  Even though Yujiapu has so many empty buildings, the local government has not stopped borrowing.  Last year, Tianjin borrowed $36 billion.  There are optimists in Yujiapu who say that the growth will return.  When that growth will arrive remains to be seen.  

Once again, real estate development is about market research, growth, and building accordingly to accommodate for that growth.  In Yujiapu and also in Xiangluowan, building occurred, clearly too much building, occurred before the growth arrived to justify any building.  There is no point to having unfinished or even completed buildings that are unused. Hopefully, the growth will arrive soon. The two ghost districts will need unbelievable growth to get out of the massive debt they are drowning in.  They have so much debt that not even the beautiful music that will be heard coming from the Juilliard campus can save a potentially drowning ship.

Source:  The New York Times

In life, there are things that can be done individually as well as in groups. For example, solitaire is played alone whereas poker is played in groups. There is the saying “two heads are better than one”. You can also look at it from the perspective of a team sport such as soccer. With the team sports, a group of people is working together to achieve a common goal of winning the game. The saying “there’s no ‘I’ in team” resonates with many sports and activities.

The same mentality can be associated with investing in real estate. Sure, many investors are able to purchase property by themselves. Some like not having anyone to deal with but themselves. However, there comes a point when investing alone can only take you so far. Real estate investing itself should be considered a team sport. There are several reasons why real estate investing should not be done just individually.

First, there’s the exposure. When an investor is completely alone in a deal, all the capital required for that deal is shouldered by that one investor and his/her resources. Surely if the deal provides a windfall, all the profit goes to that one investor. This is probably a big reason as to why investors want to go it alone most of the time. Also, there is the avoidance of disagreements with business partners. However, on the other hand, if the investment were not to perform as expected, that one investor alone would lose all the capital that was needed for that transaction. With investing in groups, an individual’s initial capital is reduced, since there are others with whom to share the amount of money needed. Furthermore, the amount of money at risk for an individual is reduced.

Second, the cheaper the prices of the real estate, the more investors there are who are qualified and able to purchase them. Therefore, this creates more competition for the individual investor, making it more difficult for them to find the deals to create the returns desired. However, as investors bring their funds together, they are able to focus on buying larger, more expensive properties that the individual investors cannot easily purchase. This reduces the competition and allows the investors to find the deals that will bring the returns desired. Also, since the group would be able to purchase bigger properties, economies of scale will come into play, increasing the returns further for the investors.

What really separates the individuals from the groups is their ability to produce the needed down payment amounts for the different sized properties. Group investing lowers the competition.

Group investing allows the investors to climb to a specific niche of properties, primarily the $1,000,000 to $5,000,000 price point, where most of the individual investors cannot readily afford, and just below where the institutional investors want to be. Here, there is less competition, and more good deals to be made. The economies of scale appear, along with the bargaining power that comes with less competition and higher financial ability. All this results in amazing profits for the group.

Lastly, when one is investing in real estate alone, that one person in solely responsible for everything, from finding the property, organizing the renovation, creating a plan of action to increase revenue, managing the property, and disposition. When investing in groups, the individual investors do not have to partake in everything, or even anything. The investors can rely on the individual(s) in charge of the partnership to do the work and make the decisions. Therefore, the investors can sit back and allow passive income and equity appreciation to work for them.

Group investing is the best way to passively allocate a portion of your portfolio into real estate.

Copyright 2015: Earl Pabellano
All Rights Reserved

Many things in life require making difficult decisions. Whether it may be moving to a new place, starting a new job, or starting a new chapter in life, difficulties exist. Adding to the complexities of decision making is an object, a trait, a powerful mechanism within us all, fear. Fear exists within us as well as within the circumstances surrounding choices that need to be made. Fear itself is a very general trait within us that can overpower our lives. Specifically, you can have a fear of failure, fear of rejection, fear of embarrassment, etc. No matter what specific fear, it is there and can impact or hinder the choices we make or need to make.

What would have happened with conflicts or wars if all the soldiers involved were too scared to do anything? Perhaps those wars would still be ongoing or would have escalated to much larger conflicts. What would have happened if medical researchers were too scared about the consequences of their findings? We probably would have less vaccines or medicines and more deaths from untreated illnesses.

The same goes for investing. Would the Rockefeller, Getty, or Pritzker fortune have been created if they were too scared to try pursue their ventures or expand their businesses? The answer would likely be “no”. With fear ruling your mind, you will end up not taking action. This leads to missed opportunities like certain experiences in life. For our purposes, fear leads to missing chances to improve your portfolio’s returns. Also, you can miss opportunities that exist in the current cycle of the markets to make money.

In order to conquer your fears, you to look at the bigger picture. Fear exists because of what is unknown. Therefore, to reduce your fear, you need to research and understand better what you are getting into and investing in. Once you understand that, your fear will be mitigated and you can properly take action. Also, you can work with others to invest your money. Working with someone who has the understanding and the drive to put your money to work can significantly reduce your fear, as well as create passive income for your portfolio.