FLIP OR HOLD? The Great Debate

Two of the most persistent questions I get at TCI are “How did you learn the business?” and “Who were your mentors?”



And probably the third most common question is, “Flip or Hold?”



I was very fortunate to get into the real estate business from the construction business. So I got to hang out with real estate guys and learn from them while I was collecting a salary to manage their construction projects. And from each of those people I learned important lessons about how to do (and often even more importantly how not to do) the real estate business.
Even after I started my own company I was involved with investment groups and builders associations where I got to meet people who were doing real estate both for a living and on the side and from each of those people there were lessons to be learned. It’s a very big industry; nobody knows more than a small piece of it. But the people who are making a living at it tend to know at least one area very well. I try to find out what they know best and then try to learn as much as possible from them about that area.



I also learned a big portion of what little I know about real estate out of books. Every day I use lessons I first learned in “guru” books, in academic books, in college and graduate school law classes. Perhaps the most helpful course I ever took was a general business law course which had almost no real estate in it. That was almost 20 years ago but I still keep the textbook on my bookshelf just over my desk for reference. I just took it down and checked: the real estate law section covers 15 pages in a textbook of over 800 pages. By contrast the section on Contracts is 150 pages long. But the reality is that more of what you do in real estate buying and selling is Contracts than Property so that balance may be about correct.



Anyway, I learned even more about real estate from people than from books. In the end this is a people business. The technical side of the business-- zoning law, financial analysis, structural engineering, construction methods, whatever-- is, in fact, the easy part of the business. First because it doesn’t really change that much from project to project and second because there are, as a rule, only a few basic principles you need to know up front. After that you can research the specifics or hire the experts as the need arises.



But the people, they are infinitely complex. Each person has a different set of motivations, of methods, of life experiences that they bring to the table. Understand people and the rest of the expertise to succeed in real estate is pretty easily acquired.



So I thought I’d try to do a series of articles about great real estate characters I have known and what I learned from them. And to start the series I thought I would talk about two fellows who came down firmly on opposite sides of the “Flip or Hold?” debate.



The Characters

Many years ago when I was a young man starting out in the real estate business (though I already had a good bit of construction experience) I had a job working for a German guy who had come to this country right after WWII looking for opportunity and who had made a lot of money in Real Estate. Gene hired me to run a couple of renovation projects he had underway—an apartment building on the south side and a Hotel in Franklin Park.



So in those days the big renovation lender in Chicago was a bank called the Bank of Ravenswood which had been largely owned by a Jewish guy who really understood real estate lending. Had a degree from the University of Chicago in Theoretical Mathematics and for Saul everything was numbers. Saul had built Ravenswood up from a tiny neighborhood bank into something of a powerhouse which eventually got bought by the 1st National Bank of Chicago which in turn got bought by somebody else. But a big part of the reason that First Chicago bought it was to get the real estate lending expertise that Saul had developed there in his period of ownership. I noticed as I was doing research for this that at least two of those people have since left First Chicago to be principles in start-up banks in the same area trying to do real estate lending.



Next to the Bank of Ravenswood there was this bar and restaurant named The Oyster where the real estate guys would hang out hoping to buy the loan officers from Ravenswood a drink or dinner after work and pick their brains about lending and real estate and life in general and how to get their latest project through the loan committee.



Now Gene could drink like a fish. Even though he was twice my age he could drink me under the table 5 nights a week. I always claimed it was because I was starting construction crews at 7:00 a.m. and he was coming into the office at noon. But the truth of the matter is he just had more capacity than I did (maybe it was years of practice.) So “dinner” at the Oyster often ended up around midnight at the bar with playing some drinking game called Canodle or something like that that nobody other than Gene had ever heard of but which Gene claimed originated at Oxford.



Now on the night in question Gene and I came into the Oyster rather late (maybe 8:00) to find Harry there. Harry was sitting at the bar where he had obviously already had several drinks and was feeling friendly and without pain. So he invited Gene to join him and Gene said we’d come for dinner and why didn’t Harry join us? “Excellent idea” said Harry and we asked for a table. Soon we were seated.



Flip or Hold?



“I’m glad I ran into you Gene” began Harry. “’Cause I’ve been wantin to talk to you. I heard you sold that building you renovated over on Lincoln Ave. Why did you do that Gene? It was a nice building and you did a good job of renovating. You shoulda held onto that building forever.”



“Well,” says Gene, “I fix ‘em up and I sell ‘em, and that’s what I do.”



“That’s what I’m telling you Gene, you been doing it wrong all these years. After you fix it up and rent it up you hold onto the building. You keep the positive cash flow and every year values go up a little and every few years you refinance and take out the added value and you go and do it again.”



We then proceeded to have a 3 or 4 hour long dinner accompanied by liberal amounts of alcohol and one of the most interesting real estate conversations I have ever heard as Harry tried to convince Gene that in 30 years of doing real estate Gene had mostly been doing it wrong. In essence the three paragraphs above went round and round over and over again. Each time Harry would add reasons why you should buy and hold and each time it came back to Gene he would say the same thing, almost word for word



“Well, I fix ‘em up and I sell ‘em and that’s what I do.”



“Yeah,” Harry would say, “that’s what I’m telling you, you been doing it wrong.” And on this turn he would explain how he averaged $1,000 per unit per year just in appreciation value and since he now had almost 5,000 units he was making half a million dollars a year just keeping his doors open if all he did was break even on the operations of the buildings.



And Gene replied, “Well, I fix ‘em up and I sell ‘em and that’s what I do.”



“That’s what I’m saying, Gene, you been doing it wrong.” Harry tried again. “You don’t have to sell them. You can borrow all that increased value from the renovation and keep the buildings and you can still keep buying buildings and renovating them ‘cause you can leverage the equity back out and use it to buy more buildings and your personal financial statement looks even better because you got all these buildings on it with all this equity.”



And Gene replied, “Well, I fix ‘em up and I sell ‘em and that’s what I do.”



So Harry would try again, “That’s what I’m saying, Gene, that selling them thing is costing you a lot of money. Look at me, I started out as a concrete finisher down on my knees with a trowel making the sidewalks smooth and now I am a rich man and its all because I never sell anything. I just keep buying more buildings and fixing them up and refinancing and I live off the positive cash flow and I put all the appreciation back into doing more buildings.”



And Gene replied, “Well, I fix ‘em up and I sell ‘em and that’s what I do.”



I could see Harry getting frustrated with this conversation and I was thinking about just exactly how much alcohol had been consumed and whether there was ever a recorded event of two real estate guys coming to blows in a nice restaurant over an academic discussion of whether flipping or holding was the correct strategy when Harry started looking for allies,



“Look,” he said, “even the kid here understands what I am saying, don’t you kid?”



“Hey,” I said, “don’t get me involved, I like your position Harry but Gene signs my paycheck.”



So in the end it got down to a size contest. Harry brings out his biggest gun, his final argument:



“Gene, I’m telling you I started with nothing, I started as a concrete finisher and now I have a financial statement of 8 figures and its all because I never sell nothing.”



So it takes me a minute to figure out that a financial statement of 8 figures means old Harry the concrete guy is worth somewhere between 10 and 99 million dollars. I’m impressed.



And then Gene answered almost like he was responding to Harry point by point:



“Well, Harry as a matter of fact I started with nothing too. I got off the boat from Germany with $217 in my pocket and I didn’t even speak English. And I have a financial statement of 10 figures. . . . And I’ve got 4 ex wives.”



Property manager or Deal Maker?



So Gene claimed that the reason he sold all those buildings he had renovated was that he needed the money to make the settlements in his various divorces. But after working for him for a year or so I realized that wasn’t quite the truth.



The truth is that Gene was a lousy property manager. He didn’t have it in him to keep track of the hundreds of details week in and week out that is managing 5,000 units. But Harry did. Harry actually liked that constant “go to work every day” part of the business. 5,000 apartments would have made Gene miserable. His whole life would have been filled up with broken toilets and angry tenants and checking rent rolls and none of that was what Gene wanted to do.



What Gene liked was doing deals. He liked negotiating to buy and sell. He liked negotiating with contractors to do the renovation. He liked taking prospects out to dinner and sitting around trying to come to terms.



Harry, on the other hand, never cared much for negotiating. He liked getting the renovations done, and he liked the way the apartments looked when they were finished and he liked making sure that the toilets were fixed and the lawns mowed and the units rented.



So the answer to the question “flip or hold?” had a great deal more to do with the people than it did with some theoretical “correct” answer. It even had more to do with the individuals than some abstract “depends on your situation”. From the point of view of their respective situations Gene probably should have been holding on to at least some of those buildings by that time in his life to build cash flow for his retirement. And Harry probably should have been thinking about liquidating part of his empire to let at least part of his portfolio be managed by others in case he got to where he couldn’t manage the company (although he did have a son in the business). But none of those considerations carried more weight (nor should they have in my opinion) than the simple fact that they each liked the way they were running their business. They were happy doing what they were doing and in the end business ought to be about happiness too.



Which brings us to a final story about Gene: years later, after I didn’t work for him any more I ran into a mutual acquaintance who’s name was Sol and I said to Sol, “So what is with Gene? Every time I talk to him he says he wants to sell everything in Chicago and move to Southern California but I heard he just bought that building from you over on Clark Street.”



“Oh,” says Sol, shaking his head and looking grave, “Gene is a very sick man.”



“How’s that?” I said, “I mean I know he’s got some health problems and a bad heart but . . . “



“Oh, not that kind of sick.” Says Sol. “ I understand this disease of his perfectly because I happen to suffer from exactly the same malady. Its called Real Estate disease. If you asked me I would like nothing better than to sell all my property and take the money and retire. But if some guy whispers, two rooms over “hey Sol I got a great deal” I gotta go look at it.”



So there it is. Flip or hold? Depends on whether you want to be a property manager or a deal junky. Either answer is perfectly ok. Just depends on what kind of person you want to be. The beauty of real estate is that you get to decide not some boss sitting in a corporate board room someplace.