"Why am I buying this property?" The types of real estate people who buy/own for different reasons

Let me start with a synopsis of the most common conversation I have with clients: Client: "Where do you think interest rates are headed?" Me: "Higher?" Client: "When and how much higher?" Me: "In the future, and a little to a lot!" Client: "So what type of financing should I be focusing on?" Me: "What is your plan for the property?" The above dialogue is not meant to be coy on my part, for if I had certain knowledge of the future my clients and I would all be on a beach trading interest rate derivatives on-line. The purpose of this type of dialogue is to steer the client to focus on the matter at hand, which is the reason he/she is purchasing or refinancing a property, the business plan for the property and the performance of that plan under different scenarios. Purpose Just like San Francisco is a tech town and Houston is an oil town, New York is a real estate town. Owning a piece of real estate here is the pinnacle of having arrived as a New Yorker and New York real estate investors run the gamut from owning a two-family home in Queens to a trophy office building in Midtown Manhattan. Regardless, investors need to ask themselves, "Why am I buying this property?" I have found that there are several types of real estate people who buy/own for different reasons as follows: * The collector: Conservative owner who takes pride in top quality assets. * The defender: Owner focused on preservation of capital and hedging inflation risk. * The investor: Owner who invests for cash flow and capital appreciation. * The entrepreneur: Active investor focused on value-add properties poised for a short-term gains. Each of the above strategies has a different business plan and financing strategy. Plan There are many plans to successful ownership of a real estate asset that can be implemented, but they need to fit the purpose of the owner in each case. Below we match the business plan with appropriate financing strategy: * The collector: This owner of high-quality assets is often best suited to employ low to moderate leverage with a long-term fixed rate. The owner who is looking at a property as a collectible is taking a long-term view, and thus the financing should match that horizon. * The defender: This owner is similar to the collector but maintains an emotional distance from real estate assets and thus would sell if presented with the right offer. The defender is also well suited to employ low to moderate leverage with a fixed rate that mirrors the term of the event horizon. For example, if the view is that we are headed into a five, seven or 10-year cycle of inflation, the financing employed should mirror that term. The defender may choose to hold the asset long-term or sell and move on to another asset over the cycle, but the key is to maintain a view and act accordingly. * The investor: This investor is an opportunist who will buy an asset with the expectation that cash flow and capital appreciation will provide an adequate return over a certain period of time. This could be an asset providing in-place cash flow, little cash flow but in an emerging neighborhood, or a combination of the two. This is typically the arena of a professional owner/operator who also takes a long-term view on an asset, but may choose to use medium-term financing, such as five-year bank debt, in order to capitalize on the systemic growth of rents and values as the neighborhood matures with the flexibility to tap into the increasing value within five years. * The entrepreneur: This is the owner we most often read about. They are the visionary dealmakers who buy a property and make some changes and subsequently flip it at a handsome profit. These are often investors who pay above market prices for value-add assets, execute their value enhancement plan and ultimately sell the property 18-24 months later to a longer-term investor less interested in getting their hands dirty. In these cases, the use of short-term floating rate debt is most common, and often high-leverage comes into play based on the exit strategy and value expectations. Performance While I have oversimplified the universe of real estate players and employable financing strategies, the theme is common in that financing should match the business plan. While it is an elementary factor, interest rates should not be the key driver of a real estate investment. The amount of leverage and term must follow the business plan for an asset, not drive it. While one can structure around variables by negotiating extension options, prepayment penalty flexibility etc., the underlying investment thesis should be robust in its own right, and the financing will follow. Accordingly, the question of "Where do you think interest rates are headed?" becomes less significant. Tal Bar-Or is a managing director at Meridian Capital Group, LLC, New York, N.Y.