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Welcome to the Commercial Real Estate Mastery podcast, where you'll learn the correct way to identify, negotiate, perform due diligence on, renegotiate, finance, turn around and operate real estate in today's market -- a market in which volatility creates opportunity, and sound principles defeat fads and bubbles. And your host is a 25-year commercial real estate veteran and co-owner of over $1 billion in real estate assets, Frank Rolfe.
We all know what a pessimist is. Someone who sees the worst in everything. The glass is always half empty, everything is always dark and depressing. And many people think being a pessimist is bad. But there are some attributes to the pessimist that even the optimists need to adopt. This is Frank Rolfe with the Commercial Real Estate Mastery Podcast. We're gonna talk about how pessimism is a beautiful thing in many cases, how everyone should add a little pessimism to the way they look at real estate deals. And let me say on the front end, I'm a pessimist. I always see the worst in everything. I can't drive a car down the highway without imagining the 18-wheeler on one side of me is gonna have a blowout and push me right off the highway, that the guy behind me will be texting, not paying attention, and ram into me anytime I hit my brakes. It's just the way I'm wired. I'm just very, very, very negative. But I'm not the only one who is negative.
There's a guy named Sam Zell. He's now dead, been dead a few years. But he was the greatest real estate guy of all time. He was kind of the Michael Jordan of commercial real estate. And he got that fame because he was the largest owner of office buildings, apartment buildings, and mobile home parks in America. Nobody in history has ever been the largest in more than one category. So he, for most people, is considered ground zero. When you talk about great real estate investors, he comes to the top of the pile. And he wrote a great book before he died called Am I Being Too Subtle? It went over his different theories on life and real estate. And in the book, Zell says, "The key to my success is that my focus is never on how good it's gonna get. My focus is on the percentage that it doesn't work." So Zell, in fact, also was a pessimist, a very negative kind of guy. And you wouldn't imagine that a guy who was the biggest in office and apartment and mobile home park could be a pessimist. You'd think to get big like that, you'd have to be an optimist. You'd have to see only the good things. Otherwise, how do you psych yourself up to buy all those different properties? But if you really think about it, there are some definite benefits to being kind of a downer. Number one, because you always think poorly of everything, you're more likely to do really good due diligence. And as Benjamin Franklin once said, "Due diligence is the mother of good luck," because people who do great due diligence seem to always win. So we consume winning as good luck, and it seems like if you did good due diligence, you just had better luck.
What's shocking, though, is how many people who are optimists, they don't even do due diligence. They'll buy a property from a broker, from a seller, they'll believe everything that that broker or seller tells them. They don't double-check anything. They buy it, and oftentimes after buying it, they find that they were lied to. It's too late. You've already closed on it. Can't get your money back. So there's no question that pessimists do better in the due diligence department. That's for sure. And also, pessimists are seldom disappointed when properties don't pan out in due diligence, so it's easier for them to cancel them. The optimist assumes it will always work out. They tell all their friends and neighbors, they tell their spouse, "Yeah, we're buying this building. Isn't this cool?" And then it's really hard to not buy it because you told everyone you were. You look kind of stupid then when you don't. But pessimists always leave their lab coat on. They always assume the worst, and so they're not worried or afraid to say, "Yeah, I canceled that deal," because they already assumed they would be canceling the deal before they even started working on the diligence. Also, when you're a pessimist, you're more attuned to bad gut instinct. Everyone has this gut instinct, this gut feel. It ties back to being cavemen originally, they think. They call it the fight or flight mentality.
And it means you can look at a bear and you can decide if you think that bear is gonna attack and eat you or if you can outrun the bear. This kind of instinct of fight or flight is what makes humans alive today because back in the early days, we weren't the ones out there hunting. We were the ones being hunted by all these giant, giant creatures back in prehistoric times. And as a result, if you had a good sense about yourself of when you should run away, that was great self-preservation. But we all internally have this, and pessimists are more attuned to it because we always think bad things will happen. So we're always, always looking from a kind of a negative gut instinct side. And why that's important is the optimist always is too gung-ho. They're too positive. So when things come up on the property, they're gonna go continue forward anyway because, gosh darn it, they think it's a great deal and whatever they come upon that's negative, well, we can disregard that. But the pessimist always comes from the side of gut feel, so they're ready to pull the eject button and get out. Also, when you are a pessimist, it also makes you double-check things which don't make sense to you. True deal killers. Things like flood plain. If you're looking at a piece of commercial real estate on the banks of a lake or a river or the ocean, you know that flood plain is definitely something to watch out for. But what if the seller or the broker tells you, "Oh no, we got no flooding issues"? The optimist might say, "Oh, well, that's great news." But the pessimist would say, "No, that looks wrong to me." Pessimist might call the neighbors, "Hey, have you ever flooded?" "Oh yeah, we flood." "Has this building I'm looking at buying, has it ever flooded?" "Oh yeah, it flooded five years ago."
So I guess pessimists are more prone to dig even deeper. And then finally, the pessimist never tends to believe anyone but themself. So going back to due diligence, but even in the world of financing, the pessimist is the one who is always out there double-checking everything and believing no one, whereas the optimist likes to believe people. They always think the best in everyone, and so someone tells them something, they take it as the gospel truth. Pessimist, no, they always disregard it. So if pessimism is good, how can we all become more pessimistic? How can we, as commercial real estate buyers, tend to become more negative inherently? Well, I think even if you're the most eternal optimist, you gotta put yourself into frameworks where you have to explore your pessimistic side. Now, some banks call this concept stress testing. And what it means is you take a property, might be a wonderful property, might be fully occupied and running perfectly, but you model what would happen if it wasn't. Let's say you're looking at buying a strip shopping center and it's got five tenants in it, fully occupied right now. But you might model, well, what would happen if I lost one of those five tenants? What if my revenue dropped by 20%? And then what if I lost a tenant and then I had to do the finish-out to put the new tenant in and I have to add all that cost in the deal, what happens to me? What if I lost two tenants? What would happen to me? Stress testing a property gives you a very good idea of the absolute limits at what point that property, as far as a deal, would fail. And even if you're an optimist, you probably want to know, based on the events that unfurl themselves in life, what that's gonna do to your overall return level. I can see no problem with stress testing whatsoever. I think it's great for pessimists and optimists alike. Another thing to do if you're an optimist is still make yourself go through the exercise known as best case, worst case, realistic case. One of the first things I learned when I got in the business decades and decades ago was this theory. Here's how the theory works. If you run the worst-case scenario, and in the worst-case scenario, which means you're losing occupancy, rents decline, whatever the case may be.
Can you still cover the mortgage, or will it put you out of business? Will it bankrupt you? Never do a deal where the worst case is gonna destroy you. Now, the best case is what happens if it all works perfectly. Hopefully that's very, very exciting. And then the realistic case, how good is that? And if you say, "Look, this deal, the best case is amazing, the worst case will not bankrupt me, and I'm perfectly happy with the real case," well, then that might work. But even the optimist can rapidly get sobered when they look at that worst-case scenario and realize although the best case is wonderful and the realistic is good news, that the worst case would put them out of business. Finally, whether you're an optimist or a pessimist, every deal has its own hurdles. Just depends on what it is. It can be something to do with the infrastructure, the utilities, the permit, the demand, whatever the case may be. You need to think through on those troubled areas what the plan B is. Even an optimist should be able to come up with a plan B for everything bad that could happen. Maybe look at the worst-case scenarios and what do you do in the event those happen. The bottom line to it all is that everyone, regardless of how bright your disposition, how optimistic you are on life, you need to inject a little pessimism into your life strictly just on commercial real estate. I'm not saying when you play with your family, when you go on a vacation. No, remain the optimist. Be the eternal smiler, the happy person. That's great news. But don't let being an optimist get in the way of successful dealmaking. This is Frank Rolfe with the Commercial Real Estate Mastery Podcast. Hope you enjoyed this. Talk to you again soon.