The Past As Prologue And How To Avoid Repeating Mistakes Again

I’m a collector of books on thought process/decision making/cognitive biases/investing process. I’m not really sure if it’s education/a hobby/an obsession. Hard to tell the difference sometimes. It started in 2007.

I had moved from the West to the East Coast and was meeting a new group of builders and developers. I’d left Sacramento, which fell off a cliff in August of 2005. Housing seemed headed from bad to worse. But I was hearing things that did not make sense to me from people who clearly were extremely successful over a long period of time. I was further confused that the people making the most sense to me, were largely divested of assets. I’d grown up in the business believing, listen to those with skin in the game. What was going on?

Having spent most of my career trying to improve my technical knowledge, I started to focus more on decision-making and biases. As I observed those in the business around me, I saw a couple of patterns:

One, your conclusions as to what you thought would happen in the cycle was highly dependent on what that would mean for you and your business. If you were faced with conclusion A and conclusion B, and A meant making very painful decisions and B meant it would be difficult, but OK, you’re likely to believe B. It is extraordinarily difficult to step outside yourself when analyzing your company and see it as an unemotional outsider. But it can be the difference between survival and collapse.
Two, anything you’ve experienced personally is a fact. Anything you have not is a theory. I found that individual’s analysis of what was coming was based on the worst thing that had happened to them, plus a cushion. Which seemed and especially FELT conservative to them. So, if you were old enough to have experienced the oil bust in Denver or Houston in the mid-80s, or the aerospace collapse in southern California in the early 90s, you were prepared for devastation. If not, you weren’t.
My third big lesson of the cycle was coming out of the downturn. Working with private builders to buy distressed lots had served us well after the aerospace collapse. Builders were wounded, there were plenty of distressed lots, and more margin in building them out than buying and flipping (and much faster monetization). It seemed like it was time for the old play book. So we avoided what we derisively termed “have a hunch, buy a bunch” underwriting on lots and started to work with private builders. And we did well. But we did not do as well as those hoovering up lots. What did we get wrong? Or I suppose, less, right?
In the early 90s, public builders were also wounded from the rolling real estate crises across the country and had limited capital to buy lots. And they were simply not as ubiquitous across markets and price points. So, there were few builder bidders for available lots. In the great financial crisis, public builders had next to zero secured debt and no covenant bonds. When they closed a home, no matter what the loss, they kept the cash and could redeploy it. That was not the case in previous cycles when they had bonds AND secured borrowing bases from banks. Many now focuses on their tax refunds, and those were important. But the most important part was the ability to recycle all the cash from closings. So much more rapidly than our previous experience, they were back to buying lots. And that happened quickly enough that our private builder clients had to develop lots much sooner than expected. We and our partners did fine, but it was not the optimal business plan with hindsight (we should have "had a hunch and bought a bunch"…………..).

We tried to learn from history, and saw a strong analogy to the present situation, but missed thinking through what was DIFFERENT. And that made all the difference.

What’s the point, beyond telling old guy stories? Just a reminder that hardest things to do at this moment in deciding what to position your business for are:

To separate your analysis from the outcomes you are rooting for;
To not let your personal history limit your imagination as it relates to outcomes;
When drawing analogies and comparisons to the past, be careful not to miss what is different, and pause to reflect as to how that affects the applicability of past lessons.

I reflected on all this after a great ULI Fall Meeting last week in Dallas. A lot of thoughtful conversations and much less denial at this early stage of the downturn than last time. But I also heard a constant litany of how the things that made last time so terrible were not present – over-building, sloppy mortgages, resale market distress, etc.

That’s true and fair.

But [what's different now is ...] we’ve not had a spike in rates and cratering in affordability this fast before. And for the first time in a long time, the Fed does not have our back. It actually wants prices to come down (until it doesn’t…….). So, as you absorb what is different, how your past played out, and what you feel like you’ve learned, pause a moment to think about what you don’t know and haven’t experienced.