OCTOBER 27, 2023 – Sure enough, Cliff returned from Florida with a positive weather forecast. Steve would take another look at the concept drawings we had, make a site visit (his second since having heard of our project) when he could squeeze it in, and make some kind of offer.
I’d need to summon more patience, but I could do so knowing we were boarding a well-fitted ship under fair skies bound for friendly latitudes and no longer icebound aboard a frayed rigging and tattered sails.
I could easily bug Cliff and leave him at his discretion to badger Steve. Cliff never procrastinated about anything, and our project had his top priority. Plus, his social and emotional IQ was off the charts. He’d know exactly when and how to check in with Steve.
That’s the course we followed, and eventually, Cliff called with an offer from Steve.
It was low without being lowball. I was optimistic. Steve’s offer was within what I considered a negotiable range of acceptability. I based this conclusion on conversations with the appraiser I’d retained years before in the course of helping Tom Sullivan assemble our inheritance tax return—and taking into account previous unsolicited offers I’d rejected because of the borough approval contingency.
But the offer created an awkward situation. Cliff had had to cajole Steve into making any offer. Sure, Steve was a real estate developer of the sort who’d be interested in our kind of envisioned development, but only of a far grander scale; “Above a hundred million,” according to Cliff. Steve was taking a stab at our project solely as a favor to his friend, golfing buddy, and producer of Steve’s backyard rock ’n’ roll extravaganzas.
Given our circumstances, we didn’t have a good alternative. Either we sold to Steve or we’d liquidate the property in the next decade or two—perhaps before Nina reached 90, by which time Elsa would be 88, I’d be 85 and Jenny, 82, with Cliff at his goal of 80 (“Anything beyond that is bonus territory,” he’d once told me). But I needed Steve to boost his offer.
The situation was delicate because of interwoven personal and business relationships between Cliff and Steve and Cliff and me and by extension, between me and the rest of the family—in more direct terms, these relationships were rife with conflicts of interest. I had to step carefully.
From my years of practicing law in the arena of commercial real estate finance, I was familiar with how developers—and the bankers who financed them—analyzed prospective deals. One thing that experienced developers and lenders were good at was basic math. Distilled to its essentials, every real estate project, big or small, plain or snazzy, brick and mortar or glass and steel, was nothing more than a math equation. In negotiating with a developer, you had to be of the same mindset: you had to be mathematical; you had to think analytically.
Whether he was doing Cliff a favor or not, Steve was looking at our property from an analytical perspective. That is, how many units could he get approved ultimately; where were construction costs headed (i.e. and e.g. “What’s happening to the price of lumber?”); what are market rents in the locale of our properties and what is the current applicable cap rate[1]; what would the lease-up period be; what would interest costs be during the construction period and lease-up period; would the property be held for investment (by Steve) or sold after lease-up; what recessionary risks clouded the horizon. And so on.
In short, rather than say, “How about [your offer + x%, for example]?” or worse, “I need [your offer + x%],” I had to focus on his analysis—and assumptions about scale of the project, cap rate, market rents, building costs, and soft costs (financing expenses, architectural, legal, survey, title insurance, etc.). In addition, I had to give Cliff the right cues and script to convey to Steve without creating a hint of friction or offense—or too big a distraction with a smallmouth bass project for a deep-sea fisherman of marlin-size real estate developments.
I remembered the (simple) wisdom of Ron Sorenson, one of the most esteemed members of my first old law firm and chair of the corporate law department. “Keep it simple, stupid,” he was always telling young associates—and reminding senior partners. If in all your diligent studies at fancy schools you’d never encountered the “KISS” method, Ron made sure you knew it from your first day of practicing law at the venerable St. Paul firm of Briggs & Morgan.
I knew Cliff and Steve hailed from the same school of thought as Ron. When I called Cliff to give him my reaction to Steve’s offer, I kept it simple. “When you can,” I said, “tell him Eric is really, really grateful—and encouraged. Then ask him if he’d have a minute or two later this week maybe to go over his analysis.”
“You got it,” said Cliff. A day later, Cliff forwarded me a spreadsheet that Steve himself had assembled on the fly depicting the “math” he’d used to produce his offer—and said Steve “would be happy to go over it with me.”
This was perfect. It was Steve’s “math equation,” and I could examine it carefully for soft spots that I could potentially negotiate over to get him to improve his offer.
My first observation was that Steve had undercounted the number of units contemplated by our concept drawings. From this alone I could add significantly to the bottom line. Other items required more investigation on my part—researching apartment rentals in comparable projects in Rutherford and neighboring communities and increasing Steve’s numbers to correspond correctly with unit size; checking lumber prices in the commodity markets and seeing the downward trend in six-month and nine-month contracts (versus spot prices) and confirming the trend by picking the brain of an experienced guy in the purchasing department of our local Menard’s lumber and building supplies chain store store; examining Steve’s assumptions about soft costs, and finding a gross error—his figure for the cost of title insurance.
By using Steve’s cap rate, which seemed reasonable based on my research, but adjusting items according to convincing evidence, “my math” would support a significant increase in Steve’s offer without undercutting his projected profit. I emailed Steve my revised and annotated spreadsheet and invited him “to call me when convenient to discuss.”
The call was cordial and easy. To start things off on a positive note, I paid tribute to Cliff’s mighty talents, and Steve was quick to affirm. We then plunged into a review of my spreadsheet. We had a solid discussion with a good exchange. In the end it did result in Steve improving his offer to a level I knew I could sell to my sisters—and to Byron, my trusted confidante with lots of business acumen and growing bank experience. He advised acceptance. After a Zoom meeting, my sisters likewise supported the deal.
Next, the lawyers proceeded with drafting and revising the purchase agreement until it matched the terms to which Steve and I had conceptually agreed. This dragged on longer than it had to and was obfuscated by a bad case of “lawyer-syntax syndrome”—largely irrelevant, highly obscure, archaically convoluted language that is the cumulation of decades of boilerplate formulations, all in active defiance of the “KISS” approach to legal writing. In the midst of taking a machete to a bamboo forest of contract drafting, I had to work in Cliff’s compensation.
Conceptually, Cliff and I had easily agreed to a percentage, but when I considered the adverse tax effects—for Cliff—I realized that a more complex approach was required.
Enter the tax accountants. The upshot was for Steve to give Cliff an equity share—including any upside that could be realized from the project once we closed on an “as is” sale of the properties to Steve . . . and a compensating discount of our agreed-upon sale/purchase price. This process consumed more weeks, pushing us to the end of 2021.
Before the purchase agreement could be finalized and executed, however, my world imploded.
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© 2023 by Eric Nilsson
[1] Short for “capitalization rate” is the principal method by which the rate of return is established for commercial real estate. Expressed as a percentage, the cap rate reflects the ratio of a given property’s net operating income (“NOI”) to its current market value. Cap rates vary depending on the nature of the property, its location (from a general market standpoint), and the general economic environment. Generally, in evaluating an opportunity, a buyer/investor will determine the applicable cap rate, examine the current (in the case of an existing building) or prospective (to-be-developed property) NOI and divide it by the cap rate to determine market value (price). Buyers and sellers can dicker somewhat over cap rates and NOI but the range has its limits.
