Do Owner managed real estate companies have a high inherent risk ?

 

 

Do Owner managed real estate companies 

have a high inherent risk ?

 

 

Owners provide bandwidth and long term commitment. Professional CEOs provide risk mitigation. Where does the balance lie? Can the same be achieved in Real Estate business ?

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Last week in Italy, the owner and CEO of a large listed Indian Real Estate Development company met with a major car accident. The video showed the high level of intensity of the accident.

 

This incident has put a new thought in minds of some of the institutional investors who have invested in Real Estate Companies - Do owner managed real estate companies have a high inherent risk ? 

 

One might immediately counter - why limit this question only to real estate business ? The answer is simple…. more than 95% of the real estate companies are managed by the owners. 

 

Now, before we move forward, it would be important to understand the structural reasons that necessitate owners to manage real estate businesses

 

 

 

Need for dominance of People over Processes

 

Businesses like Banking, Automobile, Retailing etc. are largely driven by corporate boards. In board managed businesses, processes are critical. Rarely do individuals have the right to disregard the process. However, there are certain businesses where it be may inappropriate to allow processes to dominate decision making. In such businesses, processes can only take the organisation so far and not beyond and therefore mandate a larger role for people and therefore for owners. Real Estate  and Film Production and are classic examples. 

 

 

What drives the above phenomenon are the high linkages and high inter-dependence of business functions (finance, operations, sales etc.) within such businesses.  This phenomenon makes decision making a complex exercise. For example, the amount of funds required to execute a project (a financial decision) is computed based on the expected number of sale of units sold during the project’s launch phase ( a sales function). Sales during launch phase depends on the time period for delivery (an operational function) which in turn depends on the ease of construction ( a design and architectural function). And since the choice of design depends on the amount of funds available, we have a classic case of circular logic.

 

Complex scenarios like these are very common in real estate, where an approach that is driven largely by SOPs (Standard Operating Procedure) cannot provide the right answer. Here, SOPs can at best provide a list of various sub-optimal solutions. Choosing the most apt option among the numerous sub-optimal solutions needs high bandwidth and high commitment. This makes the role of owner very critical.

 

 

Owners are born general managers

 

Professional CEOs, typically,  rise up from a functional responsibility (marketing, operations et al), hence, their decision making often has a bias towards a particular function. Owners are born general managers and naturally possess the nuanced judgement capabilities to handle complex decisions making.  Their higher stakes in decisions (due to their skin in the game and the longevity in the organisation) becomes additional comforting factor for a financial investors.

 

 

 

Boards demand reasoning and documentation from CEOs

 

Professional CEOs are generally required to provide documented reasoning to the board. This limits their potential to overrule processes or take decision on issues where no acceptable process would work. If during purchase of land purchase,  market hearsay informs that government is likely to double the FSI in a particular city pocket, then can a CEO recommend the board to buy land in that city pocket at a price that is much higher than what is provided in the valuation report ? An owner, however, can. 

 

And here lies the key difference. Professional managers make decisions using all available information; but owners possess the knack of finding that ‘missing’ information needed to complete the decision-making process.

 

 

Characterised by the abovementioned structural differences, real estate companies are permanently in the start-up mode. Like for start-ups to deliver results, founders need to have veto powers over many decisions, in real estate too, Risk-Reward ratio would generally be higher when the company is managed by the owner.

 

However,  with increasing capital being raised from institutional investors, risk mitigation will demand larger focus than before. At the same time, any change in organisation structure needs to consider the distinct characteristics of real estate business. One possible solution lies in having two or three co-owners. This would reduce the risk associated with a single individual. However, the more sustainable solution lies in transforming the businesses from being “owner managed” to being “owner driven”. This would have the twin advantages of sustenance of business even in absence of the owner and the benefit of the bandwidth and commitment of the owner.

 

The above solutions are definitely not easy to implement. However, Real estate developers would see themselves motivated and enthused towards the same when they start seeing themselves not just as being builders of their personal fortunes but as being the builders to the nation.

 

-       - DEEPESH SALGIA 

Director Shapoorji Pallonji Real Estate

Author of REAL ESTATE : THE GOOD, THE BAD & THE UNANSWERED