Imagine that you inherited a large apartment house where a core of tenants pays enough rent to cover all your costs and then some.
Life is good. You could retire on the income and live well, but there’s a catch. You’re not that old and it occurs to you that now and then one of those tenants dies. You can’t wait them out; you need to replace a few now and then, and there’s no guarantee that the replacements will pay as steadily as the tenants before them.
How do you maintain yourself in the style to which you’re accustomed?
Well, you’re a businessperson, right? So you decide to expand the apartment house, calculating that, though not all of the tenants in the new apartments will become steady payers, enough of them will break out to broaden the core, making your business more reliable and more profitable.
This works pretty well for awhile, but another snag comes along. You have more apartments now, more moving parts. You can’t do it all yourself anymore. Those apartments require supers and porters and rental agents. You have to add on layers of management. And management is expensive.
So you keep expanding. You build apartments of all sizes. Some of them are grand sprawling four-bedrooms, major commitments of money to build and market that you hope will command big, big rent. Others are studios that cost a mere bag of shells to build and require little marketing but don’t yield much.
Business chugs along. You’ve grown now to the point where you don’t just have the one giant apartment house, but also all these other apartment houses that you’ve built or bought, all on the same business model — a few steady-paying tenants carrying those who are more problematic.
You’re sitting pretty for a number of years, but trouble looms. It’s a bitch; nothing in life lasts forever. There are always new complications. It turns out that some other landlords have begun poaching your best tenants, offering them new kitchens and nicer amenities. So you have to match or exceed them, leaving you less money for the tenants in the studios, some of whom may become your best payers, but they aren’t yet — and who knows which ones ever will be, because you can’t predict where your next best tenant will come from, which makes you pretty reluctant to invest much in any of those studios.
Meanwhile, you now have this vast empire…all these managers requiring office space and big salaries and paid vacations and health insurance — ugh, health insurance! Every week, regardless of who’s paying his rent or not paying, these managers expect to receive their paychecks. They expect to come to the office and have the lights go on. They expect to be rewarded a little bit more this year than last year, and so on. It’s to the point where you have to allocate forty percent of every rental dollar to overhead.
You’d like to be lying on a beach somewhere, but instead you feel like a guy on one of those old steam ships, sweating to shovel in more coal the faster the ship goes. And that boiler is a beast. You’re now living to feed the beast!
To make matters worse, because of competition with other landlords these days you’re hardly making any money on the authors — er, tenants — in the penthouse. You wish you could cut them loose, but you have two problems. The first is social. You’ve gotten used to talking at cocktail parties about the glamorous movie stars who live in your buildings. If you turned all your penthouses to studios, who would you talk about — the bookkeeper in 23D?
The second problem is a business problem. All those people in the newer studios barely add up to the revenue of the tenants in the penthouse. If you let the penthouse tenants walk out the door, you won’t have a big enough rent roll to feed your peeps. Crapola! You may be tired of shoveling coal, but you can’t just stop the ship without the whole thing breaking apart.
So what choice do you have? You keep throwing money at the penthouse tenants, trying to keep them happy to cover your overhead, while you wait for an unpredictable few studio tenants to strike it rich and become good payers.
To keep the studio people coming, you make a lot of promises you know you can’t keep. You tell them they’ll receive new tile in the bathrooms and new fixtures and the wallpaper of their choice when in reality they’ll be fortunate to get a slick of new grout and a paint job. And if they don’t become good payers really fast, they’ll be lucky if you even bother to repair that leaky toilet. Maybe they’ll get tired of stepping in puddles and resolve to do it themselves — that’s happened before. Better yet, maybe they’ll depart and make room for a studio tenant with shorter odds of financial breakout. Because you’ve learned that if a studio tenant doesn’t break out really fast, he’s unlikely ever to do so.
Boy, you’ve put yourself in a corner — not that you’re proud of that. In fact, you’re harboring a dirty little secret. The secret of your operation is that you’ve been playing a numbers game all along, and you can’t change that now. All you can do is try not remind yourself that each of those numbers you’re playing involves a person’s life — or, at least, his or her pursuit of happiness.
Speaking of happiness, your management team wants to take a meeting. They’ve just learned that a new competitive threat has crested the horizon. Someone out there has created a way for tenants to cheaply build their own studios. And now you also hear that the rental agents — seeing how you’ve been treating your studio tenants — are getting into the game to compete with you.
Your dilemma is this: you have to pay through the nose to keep the penthouse people happy in order to feed the beast, but your source of new penthouse people — less demanding than the old penthouse people — will dry up if you don’t have enough studio people moving in.
What to do? You sit around the conference table with your management team. They’re your friends, your colleagues. If they lost their jobs, how would you spend your time…dealing with the studio people yourself? Becoming just another schlep? No way!
Your legal counsel hits upon a solution, buried deep in clause XXX.14(b) of all existing leases. She thinks you can argue that if there are any studios to be built — no matter how easily, no matter how cheaply — those tenants must go through you. Tell them they have no choice.
Why would a studio tenant take that lying down, you wonder. Then it hits you, double-barreled: there’s a business reason and a social reason. The business reason is that it would be very expensive for the studio tenants to fight you, and they don’t have the chops. But the social reason is more powerful.
You know that most of the studio tenants are socially insecure. They put up with the treatment they receive because by living in your buildings they can tell their peers that they live next door to celebrity tenants. They even occasionally share the elevator with one of these celebrities on the way up to the penthouse. Although the studio tenants never ride all the way to the top, living as neighbors with the celebrities gives them a sense of validation that they wouldn’t get if they built their own cheap studios off somewhere in an unknown neighborhood. People sniff at those new neighborhoods at cocktail parties. In fact, you’ll reinforce that insecurity every chance you get. Those new neighborhoods — they’re Nowheresville, man!
For these reasons you leaving the meeting feeling pretty good about your attorney’s solution. But then the phone rings and you learn that you just lost two penthouse tenants to the company that produces the do-it-yourself studios.
Uh oh. You’ll have to spend even more money retaining the old penthouse tenants or the beast will starve, but how much less can you offer the tenants in lower apartments before those self-built studios start looking all the more attractive to them? What happens when most of your existing tenants choose to become authors of their own fate?
This is not a problem you can solve by constructing another building. Come to think of it, when was the last time you checked that original apartment house for structural integrity?