How do you solve political issues and risks when investing in a commercial property?  How to deal with bank problems? How to prepare and ride the next downturn? We are interviewing Michael Flight, an expert retail real estate entrepreneur who has been active in commercial real estate over the past 34 years. Michael has handled more than $500 million worth of real estate transactions. Him and his partner formed Concordia Realty Corporation in 1990 which has grown into a premier boutique shopping center investment and redevelopment firm.

How would someone go about understanding the political environment of a particular city?
The best thing to do is, when you have it under contract, to call up either the building department or the Economic Development Department and say "We're interested in buying this. And here are some of the things that we're looking to do. So what's it going to take?" Your local retail brokers or commercial property managers will also know how difficult the city is to deal with. Then the other really good way to get a handle on how cities are is to speak with individual tenants, or you'll hear about it. Because we deal with properties nationwide, there are nationwide brokers. For example, the guy that represented Pet Supplies Plus does Pet Supplies Plus and a number of other national tenants across the country. So I can just call him and say, we're looking at this area and I see you guys did a store down here, how was it for you? And he'll say, oh, it's fantastic. Or "I'm just going to tell you, won't be able to get any signage out there and everything. You'll be pulling teeth. And then they'll come out just randomly and inspect you and then create all kinds of other problems which we've had in the past."

Tell us about one of your worst deals and what you learned from it?
My friend Jim, who was the real estate broker, and I ended up doing a bunch of properties, doing house flips (separate from Concordia Realty). We had set up a separate company to do the house and the residential investments around 2008. We saw that there was going to be a lot of houses on the market and we were in a position to buy. I was speaking at a conference down in Florida, and after I got done speaking, an institutional investor out of Canada came up and said "We're really interested in buying real estate, so we'd like to joint venture with you." So we put together a fund. We went out and bought a tranche of single family, two flats in the western suburbs of Chicago. I was the financial partner. I raised the money, and was also the tax matters partner. Jim and I would go out and find the properties, know what they would sell for, and we'd back into the price. So on one particular property and again, it's political risk, in Cicero, Illinois, which was when Chicago cracked down on Al Capone, he actually moved his headquarters out to Cicero.So it's a little bit of a corrupt town and still is a little bit of a corrupt town. And it's also a town that made Martin Luther King Junior cry. There have some issues over there.

Our contractor kept asking for money in advance saying that he was in a bind. I didn't have the controls and I didn't have somebody go over because I trusted him. And he was doing a lot of work for us, but we got out over our skis on this particular deal, we gave him him thirty five thousand dollars. And he never did any of the work that he said he did, and then he disappeared. We had to bring other people in to do the work and pay twice for the same amount of work. I didn't want our institutional investor to take the loss on that. And at the time nobody else had the money. So I had to advance the money personally out of my other companies to finish this project.

And then the city kept coming in and inspectors kept basically looking for a bribe to stop looking for problems. We had to end up going to get another mayor from a neighboring town in as our attorney to go and talk to their mayor to get everything worked out because they were political friends. It's just the corruption, working in Cook County is like working in a third world country.

How do you sleep at night during those times?
I had some real issues with the downturn of 2008. I had some things happen where the banks didn't renew my loans. On one of them we had a very conservative loan and I had started to renew the loan with the bank a year in advance, and worked with them for more than nine or ten months, the loan was coming due. And all of a sudden, everybody that I was working with was gone from the bank. The last guy who was let go, calls me up from a new bank and says that they're not going to renew my loan. I said "What do you mean?"  And he said that they don't have any money, they're not going to renew my loan.

And I said that we've always paid. And he answers "yes, but the problem is that you can pay them off and the other ones can't". And we had already been in the middle of doing workouts for mezzanine lenders, we were still dealing with banks. So then this new woman comes in and she says, you need to pay this right away and we're going to come after you and blah, blah, blah. And they sent the default notice to my house and my wife opens it up and asks if we are going to lose our house. I said, no, we're not going to lose our house.

So I called her up because I had done workouts before and I knew how to go about this. I said, look, I'll move my loan in an orderly fashion over to this other bank. In the meantime, you're going to extend my loan. And she said no, we're not going to do that. And I answered, no, you need to listen. You're going to extend my loan because if you don't extend my loan, I gave her the name of my foreclosure attorney who was helping me out with some other things. And this guy actually argued about foreclosures all the way up to the Illinois Supreme Court. I said, "We will tie you up for four years, you won't get any money, so we could do it the easy way, or we could do it the difficult way. I'm going to be out of here in six months. You can rest assured that if you touch any of my deposit accounts in the meantime and freeze anything, I will sue you, and I will throw all these other properties into foreclosure, too.

Very creative way to deal with this problem.
I thankfully got to learn on somebody else's dime, so when it came to that point, I knew a little bit about what was going on. The other thing is what I tell potential investors and people that we've worked with, especially institutional investor: I can't tell you that everything that can happen has happened to me, but I can tell you that I'm not going to panic anymore. And we are not going to panic as a company anymore because we've gone through and figured out solutions to most of the problems.

Maybe you should write a book on "101 ways that retail could go wrong".
I'm trying to work on a book on how to buy and own retail. There are a ton of ways that retail can go right. I like to look at it from the positive part of it. The little parts that went wrong, and sometimes they're big, sometimes they're a little. But they've always been a fun adventure, not necessarily fun in the middle of it.

That's what I do like about doing redevelopment. I don't really want to do tremendous redevelopment anymore, but we've taken malls and actually knocked them down, rebuilt, and put in a strip center. So we've done de-malling and we've done large scale redevelopment. And I do like the ability and the creativity to say we could do all these things, and know that the plan is there, and in five years it's going to be completely different.

I'm very bullish on retail. And we think the returns right now are just incredible. We're seeing a lot of things at an 8 and even approaching 9 cap rate So we're hoping to close on at least two by the end of the year, or first quarter of 2020. We're negotiating the PSA right now. We think there are some real opportunities out there right now.

You have been through the savings and loans fiasco. You have been through the recession in 2000. You have been through 2008. What are some pieces of advice that you can give investors to prepare and ride a downturn?
Because they were each different types of recessions and caused by different things. The only thing I can say is that trees don't keep growing into the sky. I'm very concerned about some of the multi-family things that I'm seeing. Some self-storage is really getting overbuilt. My only advice would be that the good times are going to come to an end, and I'm really concerned about some of the projections on properties, especially with people that are just making minor cosmetic things. As a matter of fact. I just saw from somebody I know, they're doing a shopping center deal and the cash on cash was right, it was throughout the term of the project, an 8 to 9 percent cash on cash, but then they're projecting a 17-20% IRR. And it was only at the end of the presentation, luckily I listened all the way through to the end of the presentation, that they're buying it at a 7 cap and they're saying they're going to sell it at a 6 cap rate. And I just don't see that that's a really good strategy. Investors are looking at this massive internal rate of return and the only way you're going to get that type of internal rate of return is by doing some extensive renovations, and extensive redevelopment and taking a lot of huge risk.

And there wasn't a lot of turnover on this deal. Their internal rate of return is all based on the fact that they think that, for some magic reason, the cap rate would be lower than when what they bought it for, after they hold it for five years, which I don't see is the case because if interest rates do go up, then cap rates are going to go up. When I started out in the business, we would use a 10 cap as your average cap. And for me who is math challenged, it was really easy to figure out what the price of any deal was because your average cap rate was a 10 cap. And when somebody bought something at a seven cap or a six and a half cap, it was really unusual. But the interest rates were also much higher back then. So when I started out, the business interest rates were probably 10 to 12 percent.

I had an episode that talks about how people can potentially lose 50 percent of the value of their property in one downturn, and those are the exact points that we talked about. Especially the people that have been in the business after 2008 who have only seen things go up.
I have to listen to the rest of your podcast because I didn't hear that one. I think there are some very sharp investors out there. I think there are some very sharp operators out there that have gotten into the business after 2008. Also, there's a lot of people that don't know what they're doing and have made really good money because they happen to buy in 2013 and then sell or refinance. I don't see those same type of returns. I could be wrong, but in my experience, I don't see those same type of returns going into it. And I don't know if this correction is going to be the type of correction where real estate is going to take a huge hit and you're going to find a lot of opportunities.

Even after 2008, the banks held on to their properties longer, especially in commercial real estate. We were looking for a bloodletting. We were looking to pick up some really good opportunities. There were good opportunities. But the banks held onto them because the banks were aware that if they don't dump these all on the market at the same time, they can get some of the value back. And sometimes that worked and sometimes it didn't. But in the next downturn, I don't see that there's going to be a huge amount of dealsavailable to pick apart. I could be wrong, but I just think right now and going forward, there are a lot more sophisticated investors in the real estate world than there were in the 1990s, especially in the 1980s. And there are a lot more institutional investors. There's just a lot more money. Even after a downturn, there's going to be a bunch of money chasing a lot of deals.

Michael Flight