Don’t Blow Your Money on a White Elephant!

May 6, 2020

Real Estate

For many, real estate has been the path to tremendous wealth, but some unfortunately head toward the “White Elephant” property (WEP) trap. In ancient Asian cultures, receiving a rare white elephant as a royal gift was both a great honor and a financial calamity. Putting the trophy to work or disposing of it was disrespectful, but its upkeep was a terrible drain for the “fortunate” recipient. Today, “White Elephant” describes anything that seems very attractive on the surface but, in actuality, is a crushing financial burden with limited practical use.

Novice investors scoop up WEPs, which seem attractive but can’t be profitably leased, developed, or sold. Excitement quickly turns to fear as WEP owners realize they’ve got a gigantic problem on their hands.

Great Building in the Wrong Location

One common WEP is the former trophy corporate headquarters. A successful founder or CEO who grew up in a small town or city sometimes insists on locating their company’s headquarters in the “alte heim.” As the only significant employer, the town’s favorite son brings hundreds or thousands of jobs with him and spares no expense on a new office building with all the trimmings. But companies today often merge, get bought out, or go bankrupt quickly, and CEOs get thrown out, too. When that happens, the trophy building, which may have cost tens, even hundreds of millions to build, becomes a WEP.

No one needs a massive office campus in Yahupitzville, regardless of how stunning and luxurious it may be. After the company closes or consolidates, this beauty languishes on the market with little demand from local tenants or purchasers. When an uninformed out-of-towner scoops up this “metziah,” whom will he lease it to? Even at pennies on the dollar, an out-of-place building is often a disastrous investment.

Also in the “right building, wrong place” category are far-flung and vacant school buildings or medical facilities. These may have been built at great cost with public dollars, but if the politics or demographics around the location change, demand can completely disappear. In that case, these special-purpose properties are often worthless and more costly to maintain than any lease will bring in.

Great Location, But the Wrong Building

Sometimes, the opposite WEP scenario unfolds: a property is well located, but the building is so flawed that it can’t even cover its maintenance costs. For example, one otherwise excellent industrial property in Central Jersey that I reviewed some time back had serious and unquantifiable environmental contamination. It’s in an excellent location, but a purchaser of that building can easily go bankrupt on the cleanup.

Another property that passed my desk was an assisted living facility in a major city in the Midwest that has been sitting vacant for years, “eating” but incapable of producing. This WEP doesn’t conform with strict medical building codes, and the cost of fixing it or tearing it down makes it a losing proposition. If someone naively jumps into such investments, he will probably burn through much money, time, and effort simply getting rid of them.

Residential White Elephants

Residential real estate has its share of WEPs, too. Many old houses in rough sections of Detroit, Cleveland, St. Louis, and many other urban areas cost more to upkeep than they are worth. Crime in the 1960s and 1970s drove huge portions of the population to flee to the suburbs, leaving behind houses in areas where no one wants to live. Unfortunately, many frum novice investors from NY, NJ, and even Eretz Yisrael have been duped into buying worthless homes for tens of thousands of dollars.

At the other extreme, celebrities sometimes build mansions with grandiose and ostentatious upgrades only to find that no one wants to buy their meshugasen when they choose to sell. These homes can sell for pennies on the dollar, often just for the land value, and are then torn down!

Indulgence or Investment?

Even in strong real estate markets like NYC and Lakewood, upgrading a home well above average community standards is usually an expenditure, not an investment. Whether it’s $200,000 kitchen cabinets, a private mikvah, or a wing with ten guest suites (all real-life examples), those wealthy enough to afford such things usually want to put in their own chatchkes, not pay full price for a previous owner’s. These upgrades may bring a lot of personal joy and benefit but very often don’t increase the resale value of the home. Real estate indulgence is not a real estate investment.

From White Elephant to Cash Cow

There are exceptions to every rule. Some investors with a combination of mazal, deep pockets, hustle, and creativity can take something everyone else considers a WEP and turn it into a cash cow. Because WEPs are practically given away, those who turn them around can make spectacular sums of money. During the 1980s and 1990s, abandoned buildings in much of Brooklyn and the Bronx were WEPs, but those who somehow held onto them made many millions as NYC’s prospects dramatically improved.

Post-covid, many office buildings around the world have become obsolete. It’s mind-boggling, but skyscrapers, which were trading for many millions, even billions, are now struggling to find buyers at any price! Buying one of these WEPs can be a financial calamity. On the other hand, those who can pick through the rubble and identify the diamonds in the rough will make fortunes. These elephantine-sized complexities are what make commercial real estate investing so interesting, risky, and potentially lucrative.