Skinning Your Knee vs. Breaking Your Leg
Strong Towns member Johnny Sanphillippo blogs at Granola Shotgun. This post is republished from his blog with permission. You can view the original, with additional photos, here.
Some months ago a friend reached out to me about a problem. She and her siblings were scattered far from their elderly parents and there was some family business that needed to be managed here in San Francisco. She asked if I could help and a cautionary tale unfolded. Partly it was about her family. But it was also about where we as a society happen to be at the moment.
San Francisco, like a number of global gateway cities, is currently in a super heated economic bubble. This isn’t the first time San Francisco has boomed in its relatively short history. And when the inevitable bust comes it won’t be the last decline either. History runs in long slow cycles. Things go up. Then they fall. Then they go back up again. The seeds of failure are always planted in the fertile soil of speculation and malinvestment. These things tend not to end well. But while the music is still playing it’s irresistible and people can’t help but get up and dance. Then again, the green shoots of future success generally thrive in the fallow fields left behind by the last crash. Individuals are well advised to think long and hard about where we are in that cycle.
One manifestation of too much cheap easy money sloshing around town is insane housing price inflation and speculative building. A falling down shack can be bought for a million-plus dollars, massively expanded and renovated, and sold for three or four million. So long as the easy money keeps flowing the construction continues. But only at the high end of the market. The more nearby properties sell for, the more the market values the next round of construction. How much of that sale price is profit and how much gets chewed up along the way varies greatly from project to project.
What was once a modest 1920s-era two-bedroom one-bath home is transformed into a five-story cavalcade of suites, excavated garden levels, penthouse additions, and invisible glass terrace railings. Some of these properties are purchased and renovated by people who received generous stock options, proceeds from initial public offerings, and performance bonuses. (Read: money hallucinated from the ether by central banks, the Federal Reserve, quantitative easing, zero interest rates, stock buy backs, et cetera. In the biz this is called “value creation” and “monetizing synergies.”) Others are bought with huge loans with the expectation that high salaries will continue indefinitely. Still others are acquired by investors who have cash to mobilize and understand that keeping their money in a bank is about as savvy as keeping it in an old mayonnaise jar since they both pay the same interest—and the mayonnaise jar is probably more secure.
Okay. Let’s go back to my friend’s family. Her parents, now in their 80s, were born into humble circumstances in the backdrop of the Great Depression and World War II. They retained the qualities of thrift, industry, and making do with what was on hand. And they were longterm planners. Mom was a school teacher. Dad was handy with tools. Beginning in their early years together they gradually saved their money, purchased modest imperfect properties, fixed them up on a tight budget, and rented them for steady income. When one property was complete they moved on to the next. The goal was to build security for themselves and their five children. By the time they finally retired they had a respectable portfolio of properties all around the Bay Area. Until fairly recently mom and dad were still cleaning and painting each vacant space between tenants themselves.
When they began to step down their youngest son was eager to take this pattern to the next level. He persuaded his folks to borrow against all the existing properties in order to finance two magnificent projects in keeping with the current trends in luxury flips. The son was competent and capable and had already demonstrated his abilities in numerous past projects, although they weren’t quite this ambitious.
One property was a Victorian-era triplex in the best hilltop neighborhood in the city, complete with views of the Golden Gate Bridge and the bay. The site was excavated in order to accommodate multilevel parking using a special elevator for vehicles. The back of the building was blown out. Whole walls were opened up with glass. There were cantilevered terraces. LEED certification. Passive house standard. All the latest bells and whistles. It was pretty impressive stuff.
The second property was a greatly expanded duplex in an “up-and-coming” area with plenty of renovations and upgrades underway in many of the neighboring properties.
Unfortunately, things went pear-shaped halfway through these projects. The details are so ordinary that they’re hardly worth mentioning. And that’s a story for someone else to tell. But there was a chance that things could be salvaged if the right investors and/or contractors could come on board and sort things out. After all, the end result of these completed buildings would be worth millions. There was enough meat on the bones to make the effort worthwhile for the right people.
I personally have no skills. And I absolutely don’t have that kind of money. But I know plenty of smart, capable, prosperous, and adventurous people. My job was to make introductions and occasionally show up with the keys and open the doors.
In the end, the results were predictable. The projects were too far down the repossession path. The people who might have been willing to make things work walked away. The short term loans were called in. The collateral was taken over by creditors. Mom and dad lost just about everything other than their own home which was spared in the negotiations.
It’s necessary in life and in business to take calculated risks. But it’s wise to make sure the consequences of any potential downside are things that can be lived with if it all goes south. Seasoned professionals have an expression: “It’s better to skin your knee than break your leg.” Some environments lend themselves to skinned knees. Others are highly likely to lead to broken legs.
