How Real Estate Developers Think. Peter Hendee Brown

estate development is an entrepreneurial pursuit, and the qualities that Fogelson describes as being critical to his success—vision, persistence, and tenacity, along with his obvious self-confidence and optimism—are the qualities required of any successful entrepreneur. In the next chapter we will go back to the beginning and look more closely at ideas about the entrepreneur—from the origin of the word itself and the personality traits entrepreneurs have in common to how they think about making money and how they use social and political skills to carry out their work.

       Chapter 2

      Deal Makers

      Entrepreneurs are simply those who understand that there is little difference between obstacle and opportunity and are able to turn both to their advantage.

      —Victor Kiam, American entrepreneur¹

       Entrepreneurs and Entrepreneurship

      Rather than working for other people and earning a salary in an established business that makes a marginal profit, real estate developers seek to create and sell entirely new products in the hopes of earning a much larger entrepreneurial profit. They do this by purchasing property, construction services, and professional services—the project costs—and combining them together into a new product that can be sold for a price that is greater than the sum of those costs. The difference between the total cost and the price is the entrepreneurial profit.

      This is not as simple as it sounds. Not everyone has the risk tolerance to try it, and of those who do try, not all succeed. Many successful developers, however, seem to have certain traits in common. People who work closely with developers often describe them as visionary, creative, open-minded, optimistic, persistent, tenacious, and charismatic. Developers use these traits, their ample interpersonal skills, and their social, political, and business connections to structure a series of arrangements with individual landowners, consultants, contractors, elected officials, community members, and other interested parties. Then they assemble these many and varied arrangements into a single real estate development project or “deal.”

       Table 1. Profit = Sale Price Less the Sum of Costs

      Note: This table shows how entrepreneurial profit can vary widely. In the first, pro forma version, if everything goes according to plan, the developer can expect to earn a healthy 15 percent profit. If the developer can successfully raise prices 15 percent, then profit doubles to 30 percent. If, on the other hand, prices drop just 10 percent, then the developer’s profit drops to 5 percent or just one-third of the original pro forma profit. If prices drop 15 percent or more, profits disappear and the developer’s invested capital is at risk.

      Because deals are the basic product of entrepreneurial behavior, this chapter will consider how economists, geneticists, and sociologists think about “the entrepreneur” and the field of entrepreneurship. I will discuss their observations about the entrepreneur’s role in the economy, why some people are genetically predisposed to entrepreneurial behavior, and what entrepreneurs really do on a day-to-day basis—the social and political work they engage in as a part of doing deals. I summarize these characteristics through a portrait of the entrepreneur and then introduce a Chicago developer whose career story illustrates and brings these ideas to life. First, let’s begin with the basic character of the entrepreneur.

       The Economist’s View

      In his 1942 classic Capitalism, Socialism, and Democracy, the economist Joseph Schumpeter equated the capitalist entrepreneur with medieval warlords and generals from the Napoleonic era. For these men, “generalship meant leadership, and success meant the personal success of the man in charge, who earned corresponding profits in the form of social prestige.” The nature of warfare at the time—before mechanized armies—meant that the individual decision-making ability and driving influence of the leading man, including “his actual presence on a showy horse,” were essential to success in the strategic and tactical implementation of warfare. So too for the entrepreneur, says Schumpeter.²

      This militaristic metaphor may seem extreme but in fact the word “entrepreneur” has military roots. In their book about successful business people, From Predators to Icons, the French sociologists Michel Villette and Catherine Vuillermot traced the origins of entrepreneurship to thirteenth-century France. Then, the noun “entreprise” meant a military action and the verb “entreprendre” meant “to attack a person or a castle for pillage or to take prisoners for ransom.” By the early eighteenth century, “entrepreneur” had come to mean an individual who engaged in risky economic behavior by relying on a self-interest-based strategy and by using skills and trickery to achieve his objectives. He cared little about social, cultural, and professional norms and was somewhat of a deviant, operating at the margins of society. By the late eighteenth century, however, all reference to pillage and deviance had disappeared as a more positive meaning emerged, and the entrepreneur became “a man of action who achieved something or accomplished a task—an activity that was highly valued in protestant thinking.”³ This new entrepreneur, according to Schumpeter, was someone who used an invention or new technology to create a new product or to revolutionize production methods, or who created a new market, opened a new source of supply of materials, or reorganized an industry. And like his militaristic forebears, say Villette and Vuillermot, he was motivated by a desire for independence, he sought a field that would allow for the full expression of his creativity, and he had a great need for public achievement. The entrepreneur, however, is just one half of the equation, and he cannot realize the full scope of his ambitions without one other key factor—an opportunity.⁴

      Enterprising Individuals + Lucrative Opportunities = Profits

      In “The Promise of Entrepreneurship as a Field of Research,” the economists Scott Shane and Sankaran Venkataraman emphasized that, despite a prevailing “cult of the entrepreneur” that overemphasizes the role of the individual, entrepreneurship actually requires two ingredients: “enterprising individuals and lucrative opportunities.” Entrepreneurship involves finding new ways to combine goods, services, materials, and methods in what economists call “joint production.” The entrepreneur buys different resources at one set of prices, combines them together, and sells them for a total price that is greater than the sum of their original prices. Success requires making different assumptions about the values of those resources than providers and competitors who would otherwise raise their prices to capture a share of the entrepreneurial profit. Entrepreneurship therefore requires people to value resources differently, and there are two reasons why that might happen. First, estimating the value of individual resources—as well as their final combined value—requires guesswork. People will guess differently, however, so the individual who guesses correctly stands to profit. Second, ongoing technological, political, regulatory, and social changes ensure that all participants have imperfect information and people who possess information earlier than others have an advantage. But while asymmetrical information creates opportunities for some, it rarely lasts. As information and knowledge spread throughout the community of consultants, vendors, and materials suppliers, they will all raise their prices as they try to capture a share of the entrepreneurial profit for themselves. Competitors and imitators will enter the market too, and over time, the diffusion of knowledge will lead to ever-increasing competition between suppliers, competitors, and imitators until the entrepreneurial profit becomes divided among so many actors that the incentive to enter the market is eliminated. This cycle applies to the development of every type of product from condominiums and automobiles to cell phones and personal computers.⁵

      How Entrepreneurs Identify and Exploit Lucrative Opportunities

      But where do entrepreneurial ideas come from? Usually from very smart people. Each of us possesses different types and amounts of information, say Shane and Venkataraman, and the sum of a person’s information and life experience serves as the mental framework through which they view the world. A person who obtains a new piece of information before others do may have a brief advantage but, more important, they are able