Greed may not kill, but it does have a way of clouding one’s judgment.
By John E. McNellis, at real estate developer McNellis Partners:
This is a true story.
A well-to-do investor—let’s call him Sam—owns a charming three-story brick office building in a city that was once the envy of America. His building is in an elegant quarter that has suffered less than the forlorn city itself, but a restoration to its former grandeur is some years off. Meanwhile, this neighborhood’s rents have plummeted.
Sam is well versed in real estate, but he’s an old man, halfway through his eighties, and this building is his biggest and best asset. And like a proud but deluded tract homeowner, Sam is sure it’s superior to the other commercial buildings in his neighborhood.
25 years ago, Sam leased his ground floor to a small, but elegant bistro. The rent was high then—the restauranteur Umberto was dying for the space—and rose ever higher with annual increases. The rent peaked last year at $140,000 for the 2,000-foot restaurant ($70 per square foot a year). But like all things, good and bad, the bistro’s lease term came to end. Actually, it didn’t quite end. Umberto had an option to extend his term for five years at current fair market rent. And, as leases typically do, his provided that the new rent would be determined by arbitration if Sam and Umberto were unable to agree upon it.
Umberto exercised his option and asked Sam for his thoughts on market rent. Sam insisted upon $60 a foot ($120,000 a year). A genius in the kitchen, but largely ignorant of real estate, Umberto nevertheless thought this sounded crazy and asked one of his best customers—a savvy leasing broker—about market rents. After checking recent comps, she assured Umberto that his rent should be no more than $20 a foot ($40,000 a year). In other words, a financial gulf as wide as the Mississippi lay between landlord and tenant.
Your correspondent saw this broker’s comps, concluded she was right and, as chance would have it, had a couple dispiriting conversations with Sam about their import. While sharp as a prosecutor on other topics, Sam went stone deaf upon hearing something he didn’t like. He wouldn’t listen to the facts; instead, he countered with nonsense in support of his $60 stance.
Not a hard man and as wary of litigation as immigrants can be, Umberto offered to meet Sam more than half way, suggesting he could live with $45 a foot as his new rent. Sam said no. Months dragged on, the parties lobbed market data at one another, but still Sam wouldn’t budge a dollar. At last, they went to binding arbitration and—to no one’s surprise—Sam lost, the arbitrator setting the rent at $20 a foot.
Putting aside the thousands he spent on legal fees in this battle, Sam lost $50,000 a year in rent by failing to accept Umberto’s compromise. Capitalize that $50,000 by five percent and Sam’s obstinacy cost his building a million dollars in value. Greed may not kill, but it does have a way of clouding one’s judgment.
It’s been a dozen years since this column railed against litigation as a way of solving business disputes. Arbitration is no better. While quicker than an old-fashioned lawsuit—there’s less lingering on death row—it can be, well, arbitrary. Yes, the result with Sam’s proceeding was correct, but it could have gone the other way, or the arbitrator could have done the Solomon split, that milquetoast practice of which arbitrators are all too frequently accused.
Win or lose, one spends a minor fortune on lawyers in any legal proceeding and often far more in anxiety and emotional capital.
To sum this up, two old sayings come to mind. The first—a bad settlement beats a good lawsuit—should be a forearm tattoo. The second is actually a sorcerer’s curse that comes to us by way of Mexico: “May you have a lawsuit in which you truly believe.” McNellis is the author of Making it in Real Estate: Starting Out as a Developer
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