243 Prof. Peter Linneman, Long Term Investing

Peter Linneman

For many years, I was on the faculty at the Wharton School of Business at the University of Pennsylvania, in the real estate, finance, and public policy departments. I did that for 34 years, and was part of creating the real estate program there. I'm still an emeritus member of the faculty, but not in any ongoing day-to-day sense.

I've had an advisory business, a boutique advisory business to private equity firms, to some public firms, to high wealth individuals. A few endowments that I've had, and the corporations that I've called Linneman Associates, which I've done since 1979.

I'd say today, 90 percent of what I do in that is commercial-real-estate focused. We also have an investing arm, which has bought some land, and some apartments, and some other things over the years; very boutique-y stuff, off the beaten ... Not off the beaten path, but not buying a giant shopping centers, not buying giant office buildings.

I have my book, which we're in, whatever, I think fifth edition, with Bruce Kirsch, called Real Estate Finance and Investments Risks and Opportunities, which is in use in the industry and in universities. I have a publication called Linneman Letter, which is a quarterly publication we've done for about 18 years. That's done by the same kind of client base I was referring to before - some institutions, some public companies, some private equity, some high wealth, et cetera.

Then, obviously. charitable stuff. I'm involved in a fairly, for me, large effort which supports about 140 children in poverty, and orphanages in rural Kenya. That's me.

Debt Can Be the Killer

On the other hand, as long as you can be in there, you don't have much chance of losing all your money. It turns out, and when you look at the data, as long as ... Where people get in trouble investing in real estate is two ways. One, they put on a lot of debt and take something that fundamentally is not all that risky, but when you put a lot of debt on it, the equity part gets risky. During that one-and-a-half/two years of down, you lose it. You just lose it.

If you look back, most of the people who got squeezed out of their properties during the various down periods, at least in my life, were right; they just were wrong in their capital structure. That is, they were right, it's a decent building in the long run. They were right that tenants are going to want to be there in the long run, but they weren't able to stick around, and find out they were right because they got foreclosed.

The other mistake that people have made ... I use mistake in that people are making these decisions with their eyes open. Why did they put on the debt? To juice the return, if they're right. The other is they adopt short hold periods. What's a short hold period? Two years, three years, four years. The problem is that what I just said is kind of accurate over a decade, but I don't know which year and a half is going to be the down year. I'd like to think I know, but you don't know which year.

If you go in with 10 years ... We've done a lot of work on 10-year holds, only because it's an easy thing to do. Ten years has a ring to it. You do okay. As I say, it's not like you invent high tech or something, but you do just fine. You do sort of ... Over a decade, even during the bad times, even if you bought at the peak, even if you sold into a period that was down, at the end of your 10-year hold, you're doing 8- to 10-percent annual return, typically; sometimes better, sometimes worse. Very seldom negative.

Why it Works in the Long Run

If you go in with a three-, or four-year hold, you're going to pick up that's sometimes, the time you "want to sell" is the time you either can't sell, or won't sell because it's the down period. You take the risk, but that risk comes at a price.

If you say, "Why does it tend to work in the long run?" It tends to work in the long run, if you think about it ... Just do a very simple cycle. Everything's in balance. Then, the economy goes down; demand falls. That's got to get sloppy, and people get fearful, and that hurts values even more. There was new supply that's finished, because it got started a year, or two earlier, and it finished during that, so it even got sloppier than just the demand fall. Then people panic.

Then, what happens is since it's so sloppy in the market, since values are down, everybody stops construction. It's self-adjusting, because if you don't build anything for three-four years, and after a year or two, growth starts again, the growth fills the empty space, and then gets a little ahead of the no building. Then, eventually, the supply catches up. When you look at it as a decade, it kind of balances out, but not in any window. The supply shutting down is the key, as long as the economy grows.