I had a tremendous chat earlier this week with fellow BiggerPockets member Frank Gallinelli (also the guest of Episode 004 of the BiggerPockets podcast). Frank and I were following up on an earlier discussion about the importance of thorough and proper due diligence for real estate development projects and property acquisitions. It’s a topic I’m passionate about because it’s one of the few times you truly have a blank slate in real estate development and investing—one where you can flex those creative muscles and analytic muscles at the same time. It’s also the time when you can decide to move on with little or no pain if a project doesn’t pencil out in your favor.
Frank brought up a compelling point in our discussion about how everyone, no matter how experienced or sophisticated, makes mistakes when underwriting and building pro forma models (he placed extra emphasis on the word everyone). Frank’s perspective is backed by over 30 years of experience in real estate development, acquisitions, and investing. He also happens to be an accomplished author and Ivy League professor on the subject. So when he talks, you better believe I listen!
His point emphasizes the importance of quality control. When I hear the term quality control, images of men and women in white lab coats scrutinizing over freshly minted assembly line products comes to mind. Yet, as professionals in the real estate industry, quality control is a mentality that can and should find its way into our daily routines, research, and execution in the built world. After all, our “products” are often several orders of magnitude larger than those produced in other industries. Because of this, the stakes are that much higher if or when we get things wrong.
Given the complexities that come with developing and investing in real estate, mistakes can even happen with the simplest assumptions and inputs. These simple mistakes can become dangerous if not corrected or noticed.
To combat this, here are a few ways to inject some good old QC into your next development or investment project:
- Ask a professional friend or colleague to run through your project and scrutinize every assumption, projection, and output. Tell them to be as blunt and honest as possible. This helps immensely when you’re buried in project details and may have missed something technical or within the realm of best practices. Your professional friends and colleagues offer a second set of eyes on your project and could highlight any aspects that don’t seem quite right.
- Stress test the absolute worst case scenario. In a previous post I discussed how to implement sensitivity tables into the due diligence process. These tables allow one to look at different inputs simultaneously to see how bad a worst case scenario is compared to a best case scenario (and every step in between). If you’re looking for ways to stress test, common inputs to start with include different acquisition prices, vacancy percentages, rent levels, and terminal/resale values. By understanding how your project will perform under the absolute worst case scenario, you gain an added level of clarity that might reveal additional ways to improve the project.
- Take a break and come back with a fresh, clear head. Any real estate project has hundreds (sometimes thousands) of decisions to make—many of which change by the day. If you’re bogged down, try taking an extended break. It could add clarity to your analysis.
- On non-technical elements, ask someone outside of the real estate world for their opinion. People use our “products” every single day and can provide insightful feedback that may improve your project.
- Start over. Yep, just start over from scratch. Depending on where you are in your analysis process, this may take more time than you’d like (and it isn’t always possible with looming deadlines or constraints). But, through the process of analyzing a deal and starting over, you may view your project with a different perspective. If this perspective improves the quality of your end product enough, it could be worth the hassle of rebuilding from scratch.
Regardless of where you are with your real estate endeavors, the points above could help you double and triple check your work. The overall risk involved in real estate development and real estate investing can be reduced by maximizing one’s quality control measures. If you have any additional quality control techniques that work for you, add them in the comments section below!
Photo: Idaho National Laboratory