The hundred-year-old telegram worth $5 million, with Jim McKenzie
I'm joined this week by my father, Jim McKenzie, who worked in commercial real estate development in Chicago for most of his career. He has been telling me stories of deals, and what they implicitly show about the system that is Chicago, since before I knew how to spell "real estate." When I've recounted them to people over the years, I've often been asked for more, and so thought I'd let folks hear them from the horse's mouth once.
Although I ran screaming from the field (for reasons which may be alluded to in our conversation), I think real estate is a useful window for systems afficionados. It is a necessary component in any infrastructure project of note. The practice of it also gives a window into parts of government and other bureaucracies which must function in a way differently than they are described to function. Also, selfishly, there is no way for the U.S. to achieve Tokyo's level of housing abundance without convincing capable people of going into real estate development, so perhaps this can showcase the field decently.
[Patrick notes: As always, I put my other-than-contemporaneous thoughts in the transcript, set off from the rest of it in this fashion.]
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Timestamps
(00:00) Intro
(00:27) Understanding real estate development with Jim
(03:13) The great rail lease story
(20:02) How real estate ownership is conducted
(25:58) Real estate acquisition strategies
(28:39) Sponsor: Check
(29:41) Banks and location
(34:25) Day-old bread: an opportunity
(38:45) The Walgreens development dilemma
(40:22) Strategic offers and unusual numbers
(42:25) The power of personal relationships
(46:37) Navigating real estate offers and execution quality
(52:51) The LaSalle Bank acquisition and its impact
(54:39) The 2008 quadruple whammy
(58:39) The West Town shopping center opportunity
(01:05:29) The complexities of real estate deals
(01:14:24) The 2008 financial crisis and its ripple effects
(01:15:36) The energy industry resurgence post-Ukraine incursion
(01:16:07) Navigating utility easements and real estate
(01:21:43) The complexities of curb cuts and driveway permits
(01:23:46) Chicago's political landscape and real estate development
(01:32:37) Lobbying and political influence in development
(01:51:58) Wrap
Transcript
Patrick McKenzie: Hideho everybody. My name is Patrick McKenzie, better known as Patio11 on the internets, and I'm here with guest who is near and dear to my heart today: my father, Jim McKenzie.
Jim McKenzie: Hey, I'm happy to be here.
Understanding real estate development with Jim
Patrick McKenzie: We’ll be speaking about real estate today. This is mostly an infrastructure podcast, but all creation of infrastructure, and the infrastructure itself, sits in some place in the physical world. Real estate is the interface between the physical world and the rest of us. [Patrick notes: Incredibly, that was not intended as a joke.]
I often think that people underappreciate how much work is done to actually get properties into a usable condition and deal with the sort of complex legal and logistical issues that are involved in bringing real estate into being actively usable.
So, you worked for real estate developers for much of your career. Can you explain, for an audience without background knowledge: what does a real estate developer actually do?
Jim McKenzie: A developer goes out and acquires, most commonly, land, though sometimes they redevelop existing buildings. They then organize the construction of improvements on that property, and then lease it out to tenants, who hopefully pay excellent rents for new, usable real estate.
They then make money on the difference between the purchase price plus the cost of improvement and the value of the property once it has been leased up.
Patrick McKenzie: Some developers will carry the new buildings on their own books, to earn rent over time, while others will then sell the improved real estate to a longer-term owner of it, correct?
Jim McKenzie: Exactly.
[Patrick notes: You will note that in this conversation I frequently interject things that I learned from my father when I was seven, because he assumes (accurately) that I remembered those lessons, and I am trying to be the voice of audience members.
For example, many people don’t understand that real estate developers and landlords are not necessarily the same people. As a trivial example: I am a landlord. The condo in Tokyo I originally purchased for our family is now occupied by another family; they pay me rent for a bundle of services (including e.g. committing to interface with professionals on their behalf or pay a designate to do so, providing capital, and absorbing all risks from “Gozilla stomped it” to “we’d prefer to not live here anymore, so we can stop paying you, right.”)
I did not develop that condo. A large Tokyo real estate firm acquired the condo unit from its prior owner for X, put a six figure USD sum into modernizing the unit (paying people to swing hammers, buying new appliances, and similar), and then sold it on the market (to their mild surprise, to me). They earned a six figure USD spread between the cost of the unit plus the cost of repairs (and their capital being tied up for half a year), and revenue from the sale.]
Patrick McKenzie: So let’s talk about the capital stack for commercial real estate, which you spent most of your career in. How are these projects financed?
Jim McKenzie: Typically large banks make the loans. The equity largely came from private equity. [Patrick notes: Equity for real estate developers doesn’t necessarily come from “PE firms” in the way that word is understood by most people who read the newspaper, although it can. Some developments are “below institutional scale.” In this case, the partners at the developer may self-fund the equity required. They may also raise private capital by any of a variety of approaches.
If you look around your town at commercial developments, down to individual small apartment buildings or strip malls, many of them are funded by consortiums of (without loss of generality) dentists, small business owners, or landlords.
If we had had another few minutes to talk about the capital stack specifically, I would have loved to dig into the difference between common equity and preferred equity, which is a debt-like instrument that is quite common in commercial real estate, and how real estate sponsors have a compensation scheme similar to VC's carry except they call it promote.]
Patrick McKenzie: What range of sizes of projects did you work on during your career?
Jim McKenzie: During the development years of my career, between approximately $2 million on the low end and low $100 million range on the high end.
[Patrick notes: There are multi-billion dollar real estate projects in the world, but they are relatively rare; nine figures, on the other hand, happens in every major city with a bit of regularity. And, of course, there do exist projects below $2 million. Many of them are done by so-called mom-and-pops. Anyone who “flips” a single family home, which is something my parents did when they were much younger, is in effect a real estate developer. (A “flipper” buys a house, improves it (frequently through the sweat of their own brow), and attempts to sell at a profit.)
Patrick McKenzie: So presumably those mid-range real estate projects have 20% or so equity and then the balance being bank loans?
Jim McKenzie: It was more typically about 30% equity, except for unusual circumstances. As an example, Walgreens has exceptionally good credit. If you have a signed lease from Walgreens for a property you have committed to develop on their behalf, banks will be more inclined to be generous with their underwriting terms, perhaps including requiring you to have less equity in the deal.
[Patrick notes: Equity takes losses first. The more equity you have in the deal, the more protection the bank has, both due the simple fact that you spend your dollars first and the bank’s last, and the more indirect implication that you are far more incentivized to make the project work when you have accepted more downside risk. And there is always, always something threatening the project with failure. It will default to failing, any day you default to not showing up.
This is a very elementary point, and it needs to be said explicitly: the thing society compensates real estate developers for is going out and making buildings happen. No amount of happy accidents has ever, even onced, caused a building. They are fractally complex engineering projects with substantial project management risk, far more complicated financial engineering than most equivalently valuable tech startups, legal/regulatory complexity, and an uncaring physics engine which will kill your people and ruin you if you get the math wrong.]
Patrick McKenzie: People may not appreciate this, but in commercial real estate, bank underwriting is substantially more complex than in residential real estate. It isn’t as simple as getting a credit report on the borrower [Patrick notes: laughs in residential underwriting], right? The process is very bespoke on a deal-by-deal basis, for one thing, right?
Jim McKenzie: Yes. It is very rigorous. [Patrick notes: Flagging this as McKenzie family humor, because rigor is certainly present in some deals, but as we discuss later, it’s a complicated topic.]
Patrick McKenzie: Certainly rigorous. Also, there is a bit of competitive pressure possible with respect to banks, with the developer being able to play them off each other. This can result in some underwriting requirements being negotiable.
Jim McKenzie: Yes.
The great rail lease story
Patrick McKenzie: So let’s walk down memory lane and examine some of the sort of unusual circumstances real estate sometimes exposes one to.
I recall that you have a story about once negotiating leases on behalf of a railroad, while having recently become a paralegal. Care to recount it for people?
Jim McKenzie: Early in my adult life, I considered going to law school, and took a paralegal training course to see if the field would suit me. This was about the time your mother and I got married. [Patrick notes: Dad would have been in his mid-twenties. His jobs before this including driving a bus and shooting Cheerios out of a cannon, which is apparently a production step.]
On the day of our wedding, we sold the contract to purchase a small two flat on Ashland Avenue in Chicago just off of Diversey. This is a very, very hot neighborhood today, but back in 1979, it was kind of an edgy neighborhood, with some gang problems, with great future promise.
[Patrick notes: I say this explicitly later in the episode, but Dad has nearly a photographic memory for recollection of the map of Chicago, the social organization of a large chunk of it, and minutiae about real estate deals from 40 years ago.
I definitely can’t do any of those things, specifically, but you can sort of see where some aspects of my personality come from.]
Jim McKenzie: The upshot to the story: we had contracted to purchase a property which had come on the market for $18,000. It was not financeable.
[Patrick notes: There are a few fact patterns which can lead to residential real estate not being financeable. A theoretical one: some properties are below the effective minimum to get a bank interested in loaning you money. That is not the issue here, though.
Real estate, like many fields, occasionally thrives in euphemisms, and I’ll spell this particular one out: a bank will not underwrite a loan for this property because, at the time of sale, it was not in a livable condition. Some buildings have structural defects with mechanical consequences like e.g. being illegal to rent out in the city of Chicago and not being safe to be present in during e.g. temperatures reasonably foreseeable in a Chicago winter. Banks won’t lend against those properties, because absent someone willing to put in work to remediate them, they’re effectively worthless, and the time and attention of someone qualified might well push the worth to negative numbers. (Also the supply chain for mortgages can’t metabolize them, for effectively policy reasons, outside the scope of this parenthetical note.)
Jim McKenzie: We offered the owner $20,000 with $3,000 down. The owner, an 80 year old woman, was to hold her existing mortgage until we would be able to rehabilitate it to a point where we could refinance.
[Patrick notes: Explaining this transaction: Mom and Dad bought a house for $3,000 with a promise to pay $17,000 more later, with them to do substantial work swinging hammers and similar. The aim of this was to make a house that was not suitable to live in suitable to live in. After demonstrating to the satisfaction of a bank that the house was now suitable to live in, Mom and Dad were going to borrow the $17,000 and pay it to the seller.
Stating explicitly: there is enormous risk in this transaction, obviously. What if Mom and Dad can’t successfully swing hammers? What if the problems are beyond their capabilities or they run out of money to buy new lumber and paint? What if their amateur shenanigans degrade the house from its already impaired state? These are important considerations for the seller, who (despite the state of the house) very likely considered it financially significant to them.]
Jim McKenzie: There were four other offers from developers and commercial purchasers. Our number was the highest and, being an 80 year old woman, she didn't look at the details and took the highest number in the pile.
[Patrick notes: Many, many sellers of real estate are advanced in their years, and their priorities shift versus their younger years. This is a very important thing for professional buyers of real estate to understand, and Dad is (if you accept my surmising almost 40 years of stories) very good at being empathetic about it. Sometimes the priority is cleaning up one’s affairs to prepare one’s heirs with a cash inheritance instead of an albatross. Sometimes it is freeing up money to join one’s sister in Florida.]
One prospective purchaser was the owner of a factory adjacent to this two-flat. [Patrick notes: This is a Chicago-ism for what is sometimes called a “duplex.” Effectively, it is two single-family homes in the same physical building, sometimes with more shared infrastructure than would be normative in an apartment.]
Your mom and I were getting weak kneed about the amount of work the place needed and our inexperience in doing rehabilitation. Happily, around that time, our broker came to us and said that one of the other prospective purchasers would like to buy us out of the contract.
The end of the long story is: We were under contract to buy it for $20,000. We sold our contract for $26,500, of which we made $5,000 and $1,500 went to the real estate brokerag. I looked at all the risk we had taken, all of our life savings, to earn $5,000, versus the possibility of earning $1,500 for having no capital at risk, and decided I needed to get a real estate license. It would be a good way to earn money and then execute on my plan, which (at the time) was finding more houses to fix-and-flp.
So I joined a paralegal program, intent on going into real estate. Now, as far as I can recall, there is only one Class I railroad that has ever gone bankrupt: the Chicago, Rock Island, and Pacific Railroad Company.
[Patrick notes: And a left turn straight from real estate into real infrastructure, right?
Two quick notes: a Class I railroad is simply shorthand for a large freight-centric railroad, which ChatGPT elaborates thusly: “A Class I railroad in the U.S. is a freight railroad with annual operating revenues above a certain threshold, as defined by the Surface Transportation Board (STB). As of 2023, the threshold for Class I designation is $943.9 million in operating revenues.” Dad is not correct in his off-the-cuff recollection; the largest bankruptcy in U.S. history (at the time) was a railroad, and there have been others. The industry had a few rough decades.
We now return you to hard-hitting real estate action.]
Jim McKenzie: CRI&P RW went bankrupt due to financial machinations. In bankruptcy, it was liquidating all of its assets. These included substantial real estate holdings.
Patrick McKenzie: Can I interrupt you for a moment, on behalf of the audience? A railroad has either an easement or some other sort of right associated with every foot of track along the miles of its network, and extending a few feet to the side in either direction from the track. Even if it is not operating on those tracks anymore, like CRI&P at this time, they still own something valuable and very, very messy. They have a massive, distributed real estate position, and the unwinding of it requires an intense amount of work, because it isn’t a collection of single, valuable buildings. It is tiny slices of real estate, scattered over a dozen or more states.
Jim McKenzie: Excellent point. So the real estate department of the bankrupt entity recruited me out of the paralegal program. I thought it was an interesting opportunity. Also, because they understood this to be only a three to five year career, they offered more money than I imagined would be available elsewhere.
[Patrick notes: As always, professionals have an expectation of their employment being effectively indefinite given successful execution. If you specifically intend to employ them for project work, even multi-year project work, you need to pay a premium to the wage offered for standard indefinite employment.]
Jim McKenzie: I went to work for the debtor. At the interview for the paralegal position, they said it would make more sense to employ me in a real estate position, which paid $5,000 more. I thought this was silly, as I had just gotten through paralegal training, and didn’t want to have to go train for another license. So I declined to do real estate work, and for the time being focused on being a paralegal.
The most typical issue was responding to complaints from adjoining property owners. The most common complaint was this one: “There are some kids riding dirt bikes and motorcycles in the railroad’s right of way. Do something about it.”
My solution to this was sending the complainant a form letter that said: “I’m sorry about that behavior on property adjacent to yours. While I cannot commit to a sale, I would be willing to recommend to the trustee that we sell the 10 acres you’ve inquired about for $12,000. If you are interested, send back a check for $1,200 of non-refundable earnest money. We will respond if and when the sale is approved.
After three months of answering letters in this fashion, my boss sat me down. He told me I was not really doing paralegal work; this was real estate manager work. I should take the pay raise and stop pretending.
And so I did, though I moved back and forth between work which was closer to paralegal and closer to real estate manager.
Patrick McKenzie: So, to be more explicit about what this proposed transaction is offering: There exists a rail line which either cuts through or is adjacent to thousands of individual properties, with the majority of them being e.g. farm plots. That line is presently unused and unmaintained; this is vexatious for the neighbors. The contour of the line was established decades or a century ago, and due to those long-past negotiations, the railroad either owns the land under the line directly, or they have a right with consequences similar to ownership. And they’re not a particularly good owner at the moment, being in bankruptcy, with no trains running.
So your suggestion to anyone complaining is: just buy us out. It is a win-win: you return your property to the original shape, without the irregular railroad modification to it, and you can operate it how you operate the rest of your property, where there are no trespassing teenagers to annoy you. And we get money, which we will return to the stakeholders of the bankruptcy estate.
Jim McKenzie: That's it.
Patrick McKenzie: So how did you end up reading hundred-year-old telegrams?
Jim McKenzie: The real estate for the great bulk of where the railroads are today was purchased in the boom after the Civil War, approximately in the 1860s through 1880s. Many railroads were attempting to increase their footprint. Many robber barons [Patrick notes: a generally-seen-as-disparaging term for a new class of capitalist operating at a scale never seen before] either owned railroads or wanted to extract money from the railroads.
And so, if word got around that someone like the Rock Island Railroad was looking to build a line segment from Denver to Colorado Springs, competitors would attempt to send land men out and acquire land to either flip to RIR or to block them from being able to complete the segment. Or, sometimes, a robber baron might send a crew out to complete a competing segment, to attempt to sell to either RIR or a competing railroad.
[Patrick notes: Fascinatingly, this sort of thing still happens. A so-called assemblage in real estate is when one needs to stitch together a (typically, commercial) site out of individual parcels. Those parcels are worth a lot more as a whole than they are in parts, because they are being redeveloped from a current less-productive use to a more productive use. Part of the art of real estate acquisition is being able to complete an assemblage without leaking to current owners or the real estate community your intention to complete an assemblage. This is because, if your assemblage has six hypothetical properties and physical reality makes it impossible without parcel #3, the owner of #3 can “hold out” and extract a very large share of the potential profit attributable to the entire enterprise, but only if they know that there is in fact a deal to hold out from.]
Jim McKenzie: What would typically happen back in the day was that the robber barons and/or railroads would… come to an arrangement. [Patrick notes: Note that this was significantly more rough and tumble than any capitalism you’ve likely experienced. I’d recommend a book, but I don’t have one at hand, so instead look at whatever Byrne recommends for the period. Oh, Byrne also has a book coming out about capital bubbles creating long-lasting infrastructure: Boom, available for pre-order as of a day or two ago, through Stripe Press.]
Anyhow, in the present day, the railroad had a special project manager, brought in when the real estate department’s single person couldn’t handle an issue. That person usually had their hands full managing all of the leases.
One day, Jerry shouted over the cubicle wall at me that he had a problem: We co-owned a line segment between Denver and Colorado Springs. The co-owner, who managed that segment, had cut their payments of the rent revenue, from $40,000 a month to $2,500 a month. Half a million a year in revenue just went missing.
When Jerry had simply asked them what happened, they told him that they reviewed the terms of the agreement. They maintained it had been misinterpreted… for a hundred years. And, privately, I think they were doing this because, as a bankrupt railroad not running any trains, they figured they could get away with it since we were unlikely to object.
And so this was my special project: figure out what had just happened.
Now, a thing about railroads in 1980: they kept every piece of paper about every project they had ever touched. Archives was not particularly well organized, but it was in a room in the same building I worked in. So I went down to Archives, and I searched, and eventually found everything roughly together.
I found the original agreement. And I also found the steps which were involved in getting to the agreement, all the ones that got put to paper. Memos from board meetings. Telegrams back and forth. Proposed changes to the definitive agreement. And I was able to tell from this correspondence that there was a very clear agreement, struck 100 years ago, as to the proposed rent structure.
The two parties were to jointly contribute equity, with a mortgage taken out to construct the railroad segment. After it was paid off, the revenue would be split on a 50/50 basis. Most revenue would be generated by the lease of property known as “station grounds.” Every 10 miles or so, the railroad bought a larger chunk of undeveloped land, to put a station on it (for passengers and freight to get loaded and unloaded). The grounds were larger than the physical station. Before the railroad was constructed, most were out in the wilderness. But the railroad predated the development of the American West, and some of those station grounds are now in fantastically valuable real estate, in the heart of cities like e.g. Colorado Springs or Denver.
[Patrick notes: Beginning Japanese students sometimes wonder why department stores names sound like e.g. Osaka Express. It is the same basic mechanism.]
The revenue from the leases was to be split 50/50. The cost of maintaining the railroad was to be pro-rated based on wheel mileage, basically how many trains ran how many miles over the track. And since our railroad had ceased operation 10 years earlier, we should have paid nothing for maintenance, but shared 50/50 in the great revenue from the station grounds, as agreed.
So I wrote a memo. I described how the problem had come about. I was discrete about blaming the joint venture partner, per se, but unambiguous that we were owed what was, to me, a gobsmacking amount of money.
That railroad at that time, like many 100 year old institutions, was very structured. This was, formally, a responsibility for the Legal department. But Legal had many issues. We were liquidating many line segments. A complex bankruptcy demanded more than 100% of the attention available from lawyers.
This would not have risen to the level of their attention, but the numbers involved certainly seemed like they were worth my attention, and so I wrote up a memo.
Then the memo came to the attention of the trustee.
Patrick McKenzie: The trustee is the person appointed by the bankruptcy court, uh, to maximize value for all the creditors and other stakeholders in the bankrupt entity, right?
Jim McKenzie: It is. And as a humorous aside, the trustee was the former law partner of the federal court judge responsible for the liquidation. And the attorney for the trustee was the former partner of the trustee and the chief justice of the Northern District of Illinois. [Patrick notes: have I mentioned Dad has something of a memory for social dynamics of people peripherally involved in individual business deals 40 years ago?]
William Gibbons declared at a meeting that he had received an interesting memo. He was a crusty old WWII veteran, with a personality to match. And of course those of us at the meeting had no idea which memo it was that had so taken him.
And he said it involves the Denver and Rio Grande co-ownership. And I raised my hand and said, I wrote that memo. He said, are you in the legal department? I said, no, I'm in the real estate department. And he said, are you an attorney? No, sir. And he said, then why would you write a memo concerning our ownership interest in a particular track segment.
I said it was a matter of urgency. They were shorting us by $35,000 a month. The company was bleeding $420,000 a year. And, while not an attorney, and very willing to be corrected if I was wrong on the law, in my lay opinion, the correspondence about the contract was very clear and what they were doing was wrong. And so I was simply trying to do the very no-attorney-required ordinary work of the real estate department and collect the rent we were owed.
Shortly thereafter, we worked out a deal with the co-investor to buy us out of our 50/50 interest in the line segment.
Patrick McKenzie: Essentially what we have here in some is there is a, uh, a set of agreements that were struck over literally telegraph wires a hundred years ago. These are real, live contracts. The law has not meaningfully changed. The fact that one of the companies is distressed does not change the clearly agreed upon formula within the the four corners of the piece of paper and the voluminous supporting record.
And so, by default, the co-owner would likely have gotten away with shorting the bankrupt entity by about half a million dollars a year, eventually paying nothing at all. Because you discovered these agreements, the asset continued being valuable, and because the claim to the asset was obviously facially enforceable, this conversely is an enormous liability for the co-owner, and so the two parties negotiated a price. That price maximized value for the creditors and other stakeholders of the bankruptcy.
[Patrick notes: Alert readers might see that I put a number in the title of this episode. I have made up a cap rate to value this deal, rather than using an exact figure, out of some residual salaryman propriety.
Cap rates are simply a property's net operating income divided by market value. A class C apartment in Chicago might have a cap rate of 5.5, for example. In general, higher cap rates suggest higher risk. In general, class A (a polite way to say "high-quality real estate with desirable tenants") trades at a lower cap rate than class C (a polite way to describe another kind of real estate, which exists in quantity in Chicago). This is partly because the market expects A to appreciate faster and partly because being a class C landlord is a very stressful way to earn a living.
A cap rate of 10.9 (implicit in $460k of net income trading for $5 million) is almost absurdly high in quality property in Chicago, but might make some sense for a make-this-problem-go-away-cleanly dealings in bankruptcy.]
Jim McKenzie: Correct.
How real estate ownership is conducted
Patrick McKenzie: I love so many things about this. One, people familiar with some of my previous work can now understand where I got it. Two, you have substantial active recall of the blow-by-blow of procedural details of a trip down to Archives to look at hundred year old records 40 years ago.
But more fundamentally, it illustrates an important fact about how real estate is conducted in the fifty United States. There is typically no authoritative record of ownership. How is real estate formally recorded in, say, Cook County?
Jim McKenzie: In Cook County, which is the county that makes up Chicago and a good chunk of its suburbs, there is the Office of the Recorder of Deeds. [Patrick notes: Name changed recently as a result of a minor bureaucratic restructuring; see here.]
In essence: if I purchase from you, Patrick, in exchange for my money we sign a “warranty deed” transferring your interest to me. That deed is recorded at the office. This puts the world on notice of that transaction.
To switch gears back to the railroad, a hundred and fifty years ago, it was the Wild West, so to speak. The people in the real estate department would travel from Denver to the Rio Grande and, depending on which tablet of contracts they took, they might be styled as a warranty deed. Or they might say deed at the top but in form be a right of way agreement.
A right of way is, typically, an extinguishable interest, by the face of the agreement. That meant that, if the railroad ever stopped operating after paying for the right of way, the interest would revert back to the owner of the property.
Patrick McKenzie: Huh. So, if it reverts to the then owner of the property, but the property has been sold in the interim, uh, you could potentially have this kind of dangling clause that identifies someone who hasn't been involved in the property in 80 years.
Uh, am I understanding that correctly?
Jim McKenzie: That was a potential issue. More commonly, it would re-attach itself to the property it had been severed from. If that property had been sold in the interim, it would now be owned by the new owner of the adjoining property. But there were many instances where reversions lead to errors. And we have many laws about the statute of limitation on these types of inheritances.
[Patrick notes: And, because real estate is insufficiently complex, the laws change every few miles. Keeps you on your toes.
Less sardonically, one of the reasons for the Uniform Commercial Code was making national institutions computationally tractable.]
Patrick McKenzie: Presumably adverse selection also comes into play.
Jim McKenzie: Yes. So, if you happen to own a property in the middle of nowhere, and your neighbor decides that you aren’t using it, they might simply decide to encroach upon it. If they start using it, and you don’t object, after a certain period of time, typically 20 years, of “open, notorious, and hostile” use of the property, they can make a claim that they have succeeded in acquiring an interest in the title of the property. This doctrine is known as “adverse possession.”
It is sometimes faster if, in the interim, they pay the real estate taxes and you do not.
Patrick McKenzie: Go figure: the government, in charge of enforcing property interests, prefers to enforce the interests of whomever pays the taxman against other potential interested parties.
And so the records at the County Recorder of Deeds don't record ownership. They sort of record an authoritative history of transactions that happened [Patrick notes: pipe down, Satoshi!] without promising that that history is a complete history.
There could potentially be side agreements or divorce proceedings or similar that have modified the ownership of the property between the last recorded agreement and the present day, correct?
Jim McKenzie: Correct.
Patrick McKenzie: One of the joys of real estate practice is determining whether the apparent owners of property are the actual owners of the property. [Patrick notes: You know the phrase “I’ve got a bridge to sell you”, meaning that someone considers the listener naive? It comes from cultural memory of a period where people routinely misrepresented their ownership of complex, valuable engineering marvels then sold them, including to wealthy and sophisticated people, fraudulently. This form of fraud does still happen.]
Another joy: in the case where the actual owners are the apparent owners, how does one actually get into contact with them?
As a brief aside: I’ve written about this in the context of title insurance. Patrick McKenzie: Title insurance is a specialized form of insurance—bordering on a graft these days—that originally arose to protect buyers or lenders. If you spend or loan a large amount of money to acquire a property, and then someone comes out of the woodwork claiming, “Your contract to buy this property is not valid because I’m the true owner,” title insurance theoretically reimburses you for the money you've put into that invalid transaction.
In practice, this happens very rarely today because most property records are now online and far better organized than they were in the so-called "Wild West" days. The chances of someone successfully asserting an unexpected ownership claim are much lower now. The process of investigating a property’s history before purchasing it is also more thorough than it used to be, back when you had to go down to the county seat and sift through poorly organized paper records.
Real estate acquisition strategies
Anyway, one recurring theme of our conversations over the years, both at the dinner table and in the car, has been about tracking down property ownership. To set this up for the audience, you were a real estate acquisition specialist for much of your career. What does a real estate acquisition specialist do for a developer?
Jim McKenzie: A real estate acquisition specialist goes out and finds the property needed for a development to move forward. For example, I went to work for a mid-sized real estate developer about 20 years ago. One of the first projects I worked on involved LaSalle Bank. They were expanding their footprint in the Chicago area, and I went in for a meeting where they told me their top priority was relocating a branch in Glen Ellyn, an upper-middle-class suburb in the western suburbs.
They described where their existing branch was located, and I was familiar with that intersection because a home builder I had worked with recently developed a subdivision about a quarter mile east of that branch. As part of the development, they had built a shopping center anchored by a large grocery store—exactly the kind of place banks love to be. So, I had an idea and offered to check it out for them. I drove out to take a look.
Patrick McKenzie: Can I interrupt for one moment?
So, we’ve talked about the joys of real estate for banks many times over the years, but there’s an important distinction to make between a destination location and the other kind of commercial real estate. Can you explain the difference between those two types of locations, and what does a bank typically consider itself to be?
Jim McKenzie: Sure. On the other side of a destination location, you have a convenience location. For example, with McDonald's, as you're driving along, you see it, and as long as it's easy to pull over and get in, they'll make a sale. But if it's too complex, you might just keep driving and stop at the Burger King further down the road. Does that make sense?
Patrick McKenzie: Yep. And a destination location is a place where you leave your home or workplace specifically to go there, navigating directly to it, right?
Jim McKenzie: Correct.
Banks and location
Patrick McKenzie: So, is a bank a destination location?
Jim McKenzie: It's a mix. I’d say roughly 70 percent of the business comes from people who specifically bank at that branch. The other 30 percent is people who need an ATM that’s part of their network, and they stop by because they know, for example, that Bank of America is nearby and they can get cash without paying a fee.
Patrick McKenzie: And when the bank’s real estate department is working with developers to relocate its branches, part of what they’re doing is trying to predict which commute corridors will have desirable customers. Someone new to the neighborhood might decide to open a checking account at a branch that’s convenient to their daily route. Or, someone who finds it most convenient on their commute might open a Bank of America account because they frequently pass by a branch.
[Patrick notes: I have written about the real estate angle to bank branches previously, largely informed by a conversation with Dad which was almost a podcast episode before I realized that, tragically, the mics were not hot.]
Jim McKenzie: Correct.
Patrick McKenzie: Right. I think it’s helpful for people to have a good model of the counterparty here. What does the real estate department for a large national chain like Bank of America or Walgreens look like? How many people are involved, and how many of them are physically located in Chicago if they have real estate there?
Jim McKenzie: In the past, there was usually a significant local presence. For example, Walgreens had a robust real estate department. But over the years, outsourcing has become an attractive option for many commercial companies, including banks and pharmacies. About 20 years ago, I would deal with just one person at Walgreens who was responsible for all the real estate in the Chicago metropolitan area. Similarly, there was one person at LaSalle Bank, which is now Bank of America, who was responsible for all of Northern Illinois.
Patrick McKenzie: So, back in the day, when large national institutions had at least one local person, they had some level of local knowledge—about the neighborhoods, the contours of the city, things that aren’t well reflected on maps or surveys. Chicago, for example, has plenty of quirks like that. But increasingly, these companies either use centralized national operations based out of headquarters, where a team manages real estate acquisitions across multiple states, or they rely on local developers for that on-the-ground knowledge of where to place branches. Is that correct?
Jim McKenzie: Correct.
Patrick McKenzie: So, one of the key value exchanges here is that real estate is an intensely local business. Sometimes, a difference of just a few feet can matter a lot. In many cases, you’re buying that local knowledge from real estate firms that specialize in particular areas, right?
Jim McKenzie: Exactly. Going back to my example in Glen Ellyn, I drove out the next day to look at the shopping center. Unfortunately, the available lot for a bank was a bit too far from Roosevelt Road, the main arterial road, which would make it tough to convince LaSalle Bank to relocate there. But across the street, I spotted something more promising: an 80-year-old building housing a day-old bread store. After some research, I discovered it was owned by whoever had succeeded Wholesome Bread. Wholesome had gone through several corporate reorganizations, sell-offs, and consolidations, and it was now part of a larger company based in St. Louis.
Patrick McKenzie: Mm-hmm.
Jim McKenzie: And I thought to myself, this should be pretty easy. We can pay a lot more than what that property is worth as a day-old bread store.
Day-old bread: an opportunity
Patrick McKenzie: So, to explain the business model of this location to people: a conglomerate has accidentally ended up with a retail presence where their model is to go out to commercial bakeries, buy bread that’s just about to expire, and then sell that bread—which is almost stale, but still legally sellable—at discounted prices. They target very cost-conscious, typically lower-income consumers who are willing to eat nearly stale bread if it’s available at a good price. One thing you mentioned to me when we previously discussed this is that the existence of this business is implicitly a bet against the neighborhood, right? Can you explain that logic?
Jim McKenzie: Sure. Glen Ellyn is an upper-middle-class suburb, and in my experience, the people who live there aren’t the type to think, "Hey, I can get four loaves for a dollar fifty, freeze three of them, and eat one now." They aren’t trying to nickel-and-dime their bread purchases. The demand for this kind of store is much lower than it was when they first opened 70 or 80 years ago. One small correction to your description: the bread conglomerate owns all that bread. They couldn’t sell it at full price, or they took it back as it expired from stores like Jewel or Dominick’s. This outlet was their last chance to make any money off it before it went to the landfill.
Patrick McKenzie: Okay. So, this quirk of economic history has left a large company with an asset that no longer makes sense. From a macroeconomic perspective, this nearly stale bread store doesn’t fit in an upper-middle-class neighborhood like Glen Ellyn anymore. What’s the concrete action you took to convert that store to a better use?
Jim McKenzie: The first step was to track down the current owner of the Wholesome Bread operation. Their headquarters was in St. Louis, so I left a series of voicemail messages for the real estate department. At the time, I was training someone about your age, Patrick—he was 25 or 26 and fresh out of law school. My job was to show him the ropes, so we’d have a weekly meeting with our boss to discuss the projects we were working on. For several weeks, I reported that I had left more messages but hadn’t heard back. After about the fourth or fifth week, my trainee suggested that maybe I wasn’t pursuing it aggressively enough. So, I took the opportunity to help him develop by saying, “Excellent suggestion! I’m going to turn it over to you, the more aggressive member of our team, and let’s see how you do.”
Patrick McKenzie: [laughs]
Jim McKenzie: He then became the one reporting each week that he had left messages but hadn’t been able to speak to anyone. Eventually, I did get in touch with someone in the real estate department. They remembered our company and said, “We’ve tried to do business with you before, but you weren’t willing to pay enough to make us sell.”
The Walgreens development dilemma
I explained, “That was years ago, and back then we weren’t working for a bank—we were trying to site a Walgreens. The bad news for you is another owner on that strip of property sold us their lot, and we built a Walgreens on it. The good news is we now have a different tenant, and we’re still in the business of developing. You should strike while the iron is hot because things go in cycles.”
They laughed me off, and we made zero progress. So, I said to my trainee, “Go ahead.”
Patrick McKenzie: Ultimately, there’s a structural reason for this, right? The bread conglomerate has no immediate pressure to sell this underperforming property. They presumably own it free and clear, and it’s buried within a large corporate structure. There might not even be anyone at headquarters actively looking to sell it. So, what was your next step?
Strategic Offers and Unusual Numbers
Jim McKenzie: My next step was to explain to my trainee that I used to work for a company with a similar situation—the liquidating real estate department of a bankrupt railroad. What happens periodically is, when you get to the end of a quarter or fiscal year and need to generate results, you go back to offers that were interesting but weren't pursued at the time. You find some that can be closed quickly, and that’s how you meet your targets.
I told him, “What we want to do is put an offer in the hopper.” But the challenge is, your memory is going to be tested when someone calls and says, “I’m holding an offer in my hand.” So, I said, “What we want to do is put in a really unusual number—something attractive enough to be noticed and unusual enough that we’ll remember it.” I think I proposed $1,544,544. That way, when someone rattles off that number, we’d recognize it immediately.
Patrick McKenzie: Right. I think another rationale you've mentioned before is that a specific number like that suggests to the person reading the offer that there’s been some real thought and analysis behind it. It’s not just a speculative offer—someone has actually underwritten this deal. When they're sorting through multiple letters, you hope they prioritize yours because the number signals you’re ready to move quickly.
Jim McKenzie: Exactly. So, about 18 months after this discussion with my young trainee, I get a voicemail from a real estate broker—a name I recognized. She said she was responding to my recent offer and rattled off the number. At first, I had no clue what she was talking about. I went back to my trainee, and he didn’t know either. But the great thing about our computer system was that I could punch in that number, and sure enough, it popped up. That was a great moment.
The Power of Personal Relationships
I was trying to remember who the broker was, and then it hit me. Personal relationships are key in our business. Coincidentally, I had sat next to her husband at a golf outing for the same home builder who developed the subdivision in Glen Ellyn. He was the president of a building supply company that did windows and doors. As we chatted, he said, “Oh, you do land for that company? My wife and I are looking for a lot to build a new home in Lincoln Park.”
I asked where he lived, and he told me he lived just off Wrightwood and Racine. I thought about that intersection and asked, “Are you in the townhome development or the loft on the southwest corner?” He was impressed with my recall and said, “No, we’re in a home right across the street from the townhome development.” I asked, “How many doors down from the 1950s ranch building are you?” And he said, “How do you know that? That’s our home—the ranch-style building.”
I explained, “Well, the owner of the development company I’m familiar with funded that rehab, and presumably the rehabber he funded sold it to you.”
Patrick McKenzie: If I can jump in here to talk you up, since you won’t do it yourself: I have something close to a photographic memory for books and other things, and I used to think everyone had that. But Dad has a near-photographic memory for the city of Chicago—its corners, streets, and the complex web of relationships between people, especially around South Side high schools. So every time you tell one of these stories, it’s always something like, "Oh, that person is the cousin of Cindy, who went to Brother Rice," and so on. We won’t go through the entire family tree here, but the key point is that understanding those personal relationships is how real estate gets done at the local level, and almost all real estate is done at the local level.
Jim McKenzie: I’ll try to make this brief. The husband told me that the deal I eventually worked on with the owner of the company I went to work for was the one he regretted most. I thought he might have lost $25,000 or so, which is a rounding error.
Patrick McKenzie: Right, $25,000 plus or minus.
Jim McKenzie: Exactly. But he said, "Oh, no, you don’t understand. When my wife has any issue with the property—rehabbed 10 years ago—she doesn’t call a plumber or a handyman. She calls Arthur and says, ‘Your sink is leaking.’" Arthur, who had used a contractor that later became a developer, eventually said, “Look, my total billings on this rehab were $20,000, and my profit was $3,000. I will pay you $3,000 right now if you promise never to call me about that property again.” She still kept calling, of course.
Navigating real estate offers and execution quality
Now that I was reminded of who she was and where she fit in, I thought, "We have a shot here." When I followed up on the offer, she said, “We’re in the early stages of marketing this property for the bread company. We’re going to put out an RFP, and the whole world will be able to make proposals.” I thought, "This is going to be a mess," because at that time—around 2004—banks and retailers were expanding like crazy.
Patrick McKenzie: So, plus or minus, 2004?
Jim McKenzie: Yeah, give or take. So, I considered her connection to the development company, and I went to the principal. I said, “We have a deal where we need your help. This woman represents the bread company, and you’ve been helping her out for 15 years. Presumably, you like each other, and we need her to be on our side—not to cut the price, but so we can control the property and move forward with our development.”
We had a tenant lined up—LaSalle Bank—but even if not them, plenty of other banks would have wanted to be there. The property was perfect: a signalized intersection, kitty-corner from a large grocery store, with all the traffic that location brings.
Patrick McKenzie: Quick timeout to explain some things I’ve learned over the years. Being near a signalized intersection means you have twice as much traffic, as you have frontage on two roads. Plus, cars are traveling more slowly, making it easier for drivers to turn into the bank. And being kitty-corner to a large grocery store is crucial because the typical bank customer—someone the industry calls “mass affluent”—is often an upper-middle-class American who does their own grocery shopping. They’ll often do their banking right before or after shopping, so the grocery store acts as a magnet for desirable customers. The hope is that they’ll walk in the door and open a checking account.
Jim McKenzie: Exactly. So, the principal contacted the broker, reminded her of their past relationship, and she called me. I submitted an offer—if I remember correctly, it was $2 million. After collecting all the offers, she called back and asked if I could increase our offer to $2,450,000. I gulped hard because we had left a little room in the budget, but not that much. Still, we had a 90-day due diligence period, so I said, “Sure, we can do that.” I went ahead with the amended offer.
Two or three days later, she called and said, “I presented your offer. The developer you were bidding against was very unhappy to hear he’d been outbid and went up to $2.65 million.”
Patrick McKenzie: Uh-oh.
Jim McKenzie: Yeah, we were already beyond what I thought we could do. But she said, “Don’t worry—you have a deal.” I asked what she meant, and she explained that no one in the bread company’s real estate committee makes extra money based on getting a slightly higher offer. They want a deal that’s going to close. She had told them, “You guys are straight shooters, unlike the other developer, and you’re going to do the deal you agreed to.” So, even though there was nothing legally binding, we were moving forward with our deal. And we closed it. That site now has a bank.
Patrick McKenzie: That characteristic is called "execution quality" in some sectors, and it applies not only to real estate but also to things like buying companies. For example, when I sold my small software businesses, one of the things the broker evaluated bids on was the perceived execution quality of the buyer.
Which is partly a euphemistic way of asking, "Is this person a flake?" But it’s also about other risks to the deal beyond just the individual’s reliability, like the quality of their financing.
You mentioned earlier that in commercial real estate, banks do bespoke underwriting. So, someone might claim they have all the money needed to buy a property, but typically, they don’t have the cash on hand when they commit to the purchase. Instead, they have a contingent offer from a bank to potentially finance it. That contingent offer could be firm, or it could be more like, "Yeah, show us some documents and we’ll think it over."
One of the things the real estate community does is evaluate whether someone who says they have a bank ready to finance 70 percent of the purchase price can actually get that bank to commit and close the deal within the next 90 days. Or, if you think someone has lower execution quality—maybe they’re only 80 percent likely to complete the deal—you might prefer a buyer offering less money but with higher execution quality.
The LaSalle Bank acquisition and its impact
Jim McKenzie: That’s a good summary. And if I can segue: at the time, the bank we and most other developers in the Chicago market used was LaSalle Bank. They were an aggressive real estate lender and were willing to finance deals based on projections and proposals made on the back of an envelope. They were a great bank to work with.
Unfortunately, during the expansion of banking in Chicago, Bank of America wanted to establish more branches. They eventually decided it would be more efficient to just buy LaSalle Bank and incorporate its branches into the Bank of America network.
That not only removed them as a prospective tenant for our bank pads, but more critically, Bank of America—despite buying LaSalle Bank for its branch locations and borrower network—was horrified to discover that LaSalle Bank did commercial lending to real estate developers. They tried to put an immediate stop to that, which really scrambled things for all of us.
Patrick McKenzie: And this is one of those big corporate infelicities where, clearly, they should have understood this going into the deal. But after the fact, trying to harmonize operations—underwriting standards in particular—became a big issue. The relevant sub-fiefdom of Bank of America was very displeased with LaSalle’s real estate department’s underwriting standards and basically harmonized them right out of existence, right?
The 2008 quadruple whammy
Jim McKenzie: Yes, and if I could segue into a story from later in my career—the capstone of my career—during the depths of the recession. I went into the break room at the development company I worked for, and we had shrunk from nearly 100 employees to maybe 12 or 15. One of the jobs that was eliminated was the receptionist, who also managed the coffee room and mailroom. So now, we as individuals had to make the coffee, and the mail was only distributed by whoever arrived first in the morning. They would sort through the mail and put whatever fit into the 12 mailboxes we had left. Anything else would go on a table, where it would pile up until the cleaning person—who now only came once a week—threw it all away on Fridays.
One day, as I was starting the coffee pot, I glanced at the table and saw five submissions for commercial real estate. With 30 years in real estate, I immediately recognized that these were all properties developed by one of our competitors—a deal junkie. This guy was willing to do much riskier developments than we were. Our paths had crossed back in 2002, when my company had been offered a joint venture opportunity with him.
They asked me to check out a neighborhood at Division Street, just west of Ashland and Milwaukee Avenue. The developer had built a shopping center there some 15 or 20 years prior, aiming to serve the lower-middle-class population that lived there at the time. The center had a Jewel food store and a Kmart as anchor tenants. In 2002, he was purchasing adjacent land for expansion, buying up three-flat buildings with commercial spaces on the first floor. He was paying what I thought were insane amounts of money for that real estate, based on the existing rental rates. I reported back, saying, "I don’t see this paying off in 20 to 25 years, and beyond that is beyond my ability to predict." So, we opted not to get involved.
The West Town shopping center opportunity
Now, I’m looking at these submissions. The first development is in North Aurora, the second is somewhere else on the outskirts—places like West Evanston. They were all flawed sites for a developer to have built anything. But then I get to the final one: West Town Shopping Center. I recognized it right away and thought, "Wow, this looks exceptional." The developer had continued buying lots next to the shopping center. The reason these properties were now available was that he had gotten into a dispute with Bank of America, which had inherited his development loans after acquiring LaSalle Bank. There had been a very public spat, with the developer claiming he had been defrauded by Bank of America. As a result, someone in Bank of America’s real estate department in North Carolina decided to call all his development loans.
Patrick McKenzie: So, calling a loan means demanding immediate repayment, which commercial real estate contracts often allow for with a wide variety of rationales, correct?
Jim McKenzie: Correct.
Patrick McKenzie: So now, the developer either has to sell the properties to repay the loans or find another bank willing to refinance and pay off Bank of America. But if you’re busy making a public spectacle of your bank in the press, it’s not easy to find another lender on short notice.
Jim McKenzie: Especially in 2008, when there were virtually no other lenders available.
Patrick McKenzie: winces in sympathy
Jim McKenzie: So, I thought, "This is great!" I called the broker, who knew me well, but given the recession, he was skeptical. I explained, "We wouldn’t be the buyers. We have our own problems with Bank of America. Our joint venture partner—a large private equity firm out of New York—would be." I dropped the name, and the broker immediately perked up. "Would they really do this?" he asked. "They would, and they’d be willing to close before year-end," I told him. This was September 2008, a very sensitive time. He was interested, but then I asked, "Has anyone else from my operation contacted you?" He said, "Yes, Michael called, but he only wanted the Evanston property."
I thought, "That idiot lives in Evanston; he should know better." The property in West Evanston wasn’t on a major arterial road—it was behind the north branch of the Chicago River. Even in the best of times, that’s not something we should be looking at, especially not in 2008. But I was thankful because that meant I would be the procuring cause if a deal happened.
The complexities of real estate deals
Patrick McKenzie: To explain, being a real estate acquisition specialist is similar to being in sales. Depending on the firm, there can be commissions for getting deals under contract or across the finish line. Much like sales, where many people might talk to a prospect but only one person gets credit, in real estate, you don’t want to be fighting a coworker for that credit. So this deconflicts that potential issue. Anyway, back to you.
Jim McKenzie: Right. The short version is, I went to my immediate boss—the guy I had trained six years earlier—and told him I’d found a great deal. He asked if it was a single-tenant deal, meaning for a bank or Walgreens. I thought about it and said, "Eventually, yeah, but that’s not the nature of this deal." He snapped at me—understandably, given the miserable time we were going through—telling me to focus. "There’s no point in talking about deals other than single-tenant ones; we can’t get those done," he said. But I disagreed. I told him this deal would make our long-time joint venture partner very happy, and this was a chance for them to start recovering some of the half a billion dollars they’d written off in the past few years.
Jim McKenzie: But this was still a matter of, well, if it wasn’t me that brought this deal in, who do you think did?
I said, it wasn’t like a premature Christmas present just fell into our laps. I found it. I put the team together. I proposed that we bring in our joint venture partner. The rest of the team will back me up on that. And yet, he defaulted to, “Well, it was on the open market. I would have found it eventually.”
I said, "You might’ve eventually found it, but by then one of the other 30 bidders would’ve had it under contract." I brought it in. I brought it in a timely fashion. It’s my deal.
There are two issues here: First, am I owed money? That’s undeniable. I registered the deal in my name on your behalf. And second, how do you pay me?
Patrick McKenzie: Right.
Jim McKenzie: I absolutely understand the need for flexibility on how I get paid, but I’m not flexible on whether I should be paid.
If you think someone else brought this deal in, make your case, and we can argue about it. But I suggest we focus on the second issue.
The 2008 financial crisis and its ripple effects
Patrick McKenzie: Let me emphasize something for the audience: Real estate is incredibly cyclical. Partly because it’s tied to the economic cycle, partly because it’s tied to interest rates, and partly due to factors internal to the industry.
2008 was a quadruple whammy—it was caused by the subprime mortgage crisis in the U.S., which severely impacted the financial industry’s ability to function, especially when it came to underwriting commercial real estate loans. The industry went from feast to famine overnight. And the kind of drama that played out in your office was happening across Chicago, and in real estate markets everywhere.
The energy industry resurgence post-Ukraine incursion
On a somewhat different note, I recall you sharing a story about applying for a job in the real estate department of an energy-related firm. You didn’t get much response, but then in 2021, when Russia invaded Ukraine, the fallout led to a sudden demand for energy projects that had been shelved. You got a call about that job based on a years-old resume—because of your real estate expertise and experience in the energy sector.
Navigating utility easements and real estate
Jim McKenzie: Exactly. Understanding a bit about real estate for energy companies went back to the early days of my career. One of the special projects I worked on involved the easement department of a bankrupt railroad.
We, as a utility company, had always been willing to provide the necessary rights for other utility companies to use our property. It was a sideline income activity. We allowed them to cross our right-of-way with licenses—sometimes for as little as $25 or $50 a year. One company, Oklahoma Natural Gas and Light, had maybe a thousand such agreements with us.
Now, when we knew we were liquidating, we tried to convert those license agreements into permanent easements. That meant charging $1,000 apiece in a bulk deal.
Patrick McKenzie: Mm-hmm.
Jim McKenzie: It was a great way to make money in the short term and justify keeping me on the payroll.
Patrick McKenzie: Right.
Jim McKenzie: One of the more interesting negotiations involved an aviation fuel pipeline. The railroad provided longitudinal easements for things like pipelines, which saved companies from having to negotiate with multiple property owners.
We were charging a petroleum company $2,000 a year for a seven-mile pipeline that could be canceled on 30 days’ notice, running from their storage tank to Dallas-Fort Worth Airport.
I did a back-of-the-envelope valuation and figured the rent should be closer to $250,000 a year. I sent off a rental increase notice, and they were not happy. I got a call saying, “Do you not know the annual inflation rate?” So, I told them, "Based on that logic, I should get a rebate for the gas I bought since 1970 when it was 29 cents a gallon, and now it's 10 times that."
Patrick McKenzie: (Laughs) Contracts don’t work that way.
Jim McKenzie: Exactly. I didn’t say “take it or leave it,” but I made it clear there wasn’t much wiggle room. They could either pay or find an alternative, like building a new pipeline.
I probably got myself blacklisted among right-of-way departments in the utility world after that. It certainly didn't do me any favors when circulating my resume there many years later.
Patrick McKenzie: (Laughs) You might have! But it’s a great story. One more takeaway: In addition to the complex web of commercial and contractual relationships, some of which have been passed down for centuries, there are so many moving parts to these projects.
A lot of them involve dealing with the government. Two small takeaways: First, everything you see in the built world was planned, drawn, and constructed by human hands. Whether it’s inch by inch or millimeter by millimeter, someone physically made it happen.
The complexities of curb cuts and driveway permits
Second, there’s always a backstory. Even something as simple as a bank branch has details most people don’t notice—like how people enter the property from the road, which is negotiated through something called a “curb cut.” Can you talk a bit about curb cuts?
Jim McKenzie: Yes. Curb cuts involve various governmental entities potentially being involved. For example, in the city of Chicago, the curb cut is a very political instrument used by the powers that be. It’s the last step before the driveway permit is issued.
Patrick McKenzie: Before we get to driveway permits, can we help the audience understand? The curb cut is essentially permission from the entity that owns or controls the road—whether it’s the city of Chicago or the Illinois Department of Transit—that allows a developer to make a small engineering change to the road to allow access to their property. Without the curb cut, cars can’t get onto the property, which means no real estate deal is possible.
So, what’s this driveway permit?
Jim McKenzie: The driveway permit is more of a formality, in my opinion. The reason it exists is because an alderman gives their blessing to a developer roughly 18 months before the development moves forward.
From the perspective of the voters in the ward, demolition starts when the driveway permit is issued. At that point, the developer gets flooded with calls when demolition begins.
Patrick McKenzie: Or more likely, the alderman gets the calls, right?
Jim McKenzie: Yeah, right. My mistake. The process serves as a notice to the developer’s office that the driveway permit has been agreed to, and action will happen soon. It’s essentially a reminder to everyone that we signed off on a deal, and there’s going to be a Walgreens built there.
Chicago's political influence on real estate development
Patrick McKenzie: For those unfamiliar with Chicago, though this is a pattern common to many large American cities: The city of Chicago is divided into wards, each represented by an alderman on the city council. Due to a variety of reasons we don’t have time to fully explore, aldermen run their wards like small fiefdoms. One of their key powers is the ability to permit or block new real estate development or the reuse of existing developments.
[Patrick notes: This is not entirely a matter of corruption. Aldermen are elected officials notionally responsible to the mores of their local polity, and many local polities in the United States, in particular the organized parts of which that strongly signal their intent to vote in the next election, really, really hate building things.]
Patrick McKenzie: This also allows them to control how smoothly city bureaucracy functions for people involved in various projects. Chicago has a long history of corruption, whether it’s outright corruption in some cases or more subtle forms of graft. The driveway permit isn’t usually where this happens, though.
Jim McKenzie: Right. The development in question was the purchase of a rundown property in Albany Park, an up-and-coming—but still a long way from fully developed—intersection at Lawrence and Kimball. We proposed buying an old loft building, tearing it down, and putting a Walgreens there.
The first step in Chicago is to take your plan to the alderman. Sometimes you meet with the chief of staff first, but at our level, we were able to meet directly with the alderman. We showed him what we wanted to do, and he either gave us the green light or told us to meet with community groups or follow his preferred way of handling things.
In this case, we were dealing with an old-school alderman who saw this as a great opportunity. It was going to revitalize a corridor in his ward, so he said, “Sounds great, you have my blessing.” That’s what we were looking for. With his support, we were willing to spend the necessary hundreds of thousands of dollars on engineering and due diligence.
Patrick McKenzie: Quick question—what kind of engineering is involved between evaluating a site and actually starting the project?
Jim McKenzie: The first step is an environmental analysis, which is critical in Chicago, especially at intersections. A lot of properties used to be gas stations, and the way those were regulated 40 or 60 years ago was very different. Environmental issues on corner properties are pretty common.
Patrick McKenzie: If you take possession of a property with unresolved environmental issues, you could be on the hook for millions or even tens of millions in cleanup costs under the Superfund Act or other environmental regulations, right?
Jim McKenzie: Exactly. That’s why environmental analysis is the first step. Then you look at other engineering studies to see if the property can support the development, which is more important for multi-story buildings than for a single-story retail space. After doing all that due diligence, you get a go or no-go decision.
At the same time, you’re negotiating with your tenant—like Walgreens—making sure they’re on board with the proposed development.
In this case, we moved forward with designing our Walgreens and got to the final step of applying for the driveway permit. Once we had that, we’d get the building permit, and demolition could start. But, meanwhile, the alderman had decided it was time to retire—although it wasn’t entirely his decision. The mayor had been pressuring him, and he agreed to step down if he could name his successor—his daughter.
So, we had a bit of a political dance where they pretended to consider three candidates, but of course, the alderman chose his daughter.
Patrick McKenzie: This sounds like something out of Game of Thrones, but welcome to Chicago!
Jim McKenzie: (Laughs) Exactly. So, we show up at a meeting with his daughter and explain that our driveway permit is being held up due to the change in administration. We ask for her blessing to release the permit, and she says, “This is the first I’ve heard of this. Did you go through a public process?”
We tell her we followed the usual process—went through her father and did everything he wanted—and she responds, “Nope, we’re starting over. You’ll have to meet with the neighbors.”
We set up a meeting, but the demographics in Albany Park were shifting from an immigrant community to younger people in their twenties, priced out of the nicer neighborhoods to the east. These new residents said our Walgreens looked like a suburban development and wasn’t what they wanted.
I thought, "It’s a huge improvement over what’s there now." Instead of paying $4 at a bodega for a gallon of milk, people could get it for $2.50 at Walgreens, and the store would be open 24/7. But there’s no fighting City Hall. We got nowhere.
The irony is that about a month or two after we were shown the door, they gave an award for the best commercial tenant in the neighborhood to an adult theater, where young women, including presumably some from the neighborhood, were tempted into stripping by the prospect of making $100,000. But what the new residents appreciated was that they had a very strict policy about keeping their parking lot clean!
[Patrick notes: There is, of course, a lot of Chicago social commentary between the lines of this interview, and maybe a bit of America-across-the-decades commentary if you squint a bit.]
Patrick McKenzie: Quite a story. So, what’s the takeaway here? Even in parts of the bureaucracy that aren’t formally control points for development, they can become spots for graft or other forms of obstruction. The existence of these control points allows elected officials—or, in this case, not-so-elected officials—to have a lot of power.
Jim McKenzie: Right.
Patrick McKenzie: So, as you’re designing a system, unless you want people making arbitrary decisions like this, you need to minimize the number of control points available, or something as simple as a driveway permit can kill a deal at the last minute.
[Patrick notes: To be fair, we will return in a few minutes to the pitfalls with designing A Perfectly Scientific System With No Room For Human Judgement in traffic control. Curb cuts are a gripping study in the human condition.]
Jim McKenzie: Exactly.
Lobbying and political influence in development
Patrick McKenzie: This is a great example of what happens when government relations don’t go as expected. But you’ve also had success navigating this over the years, right? Wasn’t there one time when you had to hire a lobbyist to help with a curb cut? How did that turn out?
Jim McKenzie: So, the usual and customary practice in the suburbs is somewhat similar to the city. As a developer, when we're under contract to purchase a property, we go in and show our proposed development to the suburb. Sometimes they have a development director. In a small suburb like the one in question, we went directly to the mayor and showed him our plan. The 75-year-old mayor said he loved it.
So, we then drew up a preliminary site plan and tried to get an informal blessing, rather than an actual written agreement, from the Illinois Department of Transportation, which controls the access points on Cicero Avenue, a state road. No one driving on it thinks of it as anything other than Cicero Avenue, but it's actually State Road 50.
We met with the regional head of permits for the area, showed him our plan, and proposed a right-in, right-out access on Cicero Avenue, with a full curb cut on Route 83, the other arterial bordering the property.
It took us several years to move forward with the development. By the time we were ready, Bank of America was eager to put a branch there.
Patrick McKenzie: Uh-huh.
Jim McKenzie: We went back to contact the same person at the Illinois Department of Transportation, only to find out he had retired. The state hadn't replaced him yet, so his boss was now in charge of responding to inquiries.
I sent in a copy of what the retired employee had approved years earlier, saying, "We're ready to move forward. We just need your blessing." She responded with a bureaucratic letter stating that Cicero Avenue, as a strategic regional arterial, is governed by Regulation 27B, which requires curb cuts to be no closer than 850 feet from each other.
Cicero Avenue, of course, has curb cuts much closer together—sometimes only 50 feet apart—so this response was quite a surprise. It felt like a slap upside the head.
Patrick McKenzie: That’s classic Seeing like a State in action, where even someone in a position of authority knows the policy but is quoting something that very clearly doesn’t match the reality on the ground. So, you had to engage the political process. How did that go?
Jim McKenzie: I called the mayor and explained the issue, saying we had been working on this development, but the Illinois Department of Transportation was refusing to honor the informal agreement we had from a few years ago. He suggested I use the village's lobbyist.
I asked, "When you say ‘we have a lobbyist,’ is he your lobbyist or our lobbyist? And who pays for his services?" The mayor said, "Oh, he's our lobbyist. We have him on retainer." I thought, "Great, that doesn’t cost me anything."
I met with the lobbyist, who was surprisingly young—about Jim’s age at the time, late twenties. I explained the problem, and he said, "That shouldn’t be an issue. I’ll keep you in the loop." A few days later, he told me he had made progress and needed me on a conference call with engineers from the Illinois Department of Transportation.
I was impressed and said, "I’m ready whenever you are." The next day, I joined the call, which the lobbyist, John, initiated. The acting head of the Department of Transportation was on the call for less than 30 seconds. He apologized, saying he had to get the budget approved by the legislature and couldn’t stay, but he told the engineers to review the proposal. He added that John was a trusted person who wouldn’t bring in a client unless it was safe for people and property, then left the call.
After that, I was dealing with a hornet’s nest of angry engineers. Typically, engineers are even-keeled, but this group was furious. They said, "There’s nothing here to review! You haven’t submitted engineering drawings." I responded, "We don’t submit drawings until we get preliminary approval. If you say a right-in, right-out on Cicero Avenue might work, then we’ll engineer it. But if the answer is no, we’re not going to waste time and money on drawings."
Patrick McKenzie: When I was a child and heard this story, I did not understand the subtext, and so I will spell it out for others. The engineers here are annoyed and they believe they are reasonably annoyed. Their established process for requesting work is not being respected, and they have very obviously had rank pulled on them, by a (probably non-technical) executive.
Jim McKenzie: Exactly. In a nutshell, that’s what happened. To fast forward a bit, within 10 days, we got preliminary approval, subject to review of drawings. I was amazed. I called John to thank him and asked, "How did you do that?"
He said, "It’s not what you think. This isn’t a dirty business." He explained that the acting head of IDOT had once bumped into him at a restaurant in Springfield and complained that, although he had been the acting head for 12 months, he wanted the permanent role. It didn’t affect his pay or benefits, but it was a matter of pride.
John didn’t take money for that favor; instead, he told him, "I’ll see what I can do." In the lobbying world, that’s how you bank favors. John had helped him with something small, and when the time came, he called in a favor without ever saying, "I did you a favor."
While waiting for the formal approval, I got a call from the 75-year-old mayor, who said, "Just wanted to give you a heads up—John’s going to call you with the amount on his invoice." I asked, "What do you mean? I thought he was your lobbyist." The mayor replied, "As you might know, we’ve recently introduced a new impact fee of $350,000 for any new bank branches in our village. But since your project was already in motion, we’re not charging you that fee. However, if you want to stick to the letter of our agreement, I’ll pay John, and you can pay the impact fee."
I quickly said, "No, no, no, I misunderstood. It’s fine. I’ll pay John’s fee."
Patrick McKenzie: (Laughs) Smart move.
Jim McKenzie: So, I got a call from John. After a lot of preambles, I told him, "Just tell me the amount." More preambles followed, so I repeated, "John, I need to know the amount. I have to get this approved." Finally, he said, "Twenty-five."
I thought, "Wow, that’s not bad." He had been involved in one conference call, and I had met him once—maybe two other phone calls, tops.
Patrick McKenzie: Right.
Jim McKenzie: I went to the development company’s leadership and explained the situation: "We had been told the lobbyist wouldn’t be our expense, but now we’re being asked to pay John $25,000." I expected all kinds of grief from them, but instead, the only question was whether John could handle another emergency deal for a different development that was currently stuck. No one even blinked at the $25,000.
Patrick McKenzie: The lobbyist’s business model was about banking social capital and doing favor trading. People often think of lobbying as just bribery, handing over money in envelopes. But, at least in this case, it was much more subtle than that.
Indeed, though we’ve certainly seen the more underhanded end of the lobbying spectrum over the years. Recently in New York, there was a case in the papers about a lobbyist for the Turkish government who was bribing the mayor with discounted airline tickets...
Patrick McKenzie: For an executive of a multi tens of billion dollar budget every year [Patrick notes: a dollar isn't worth what it used to be, I am reminded again], getting indicted over tens of thousands of dollars of airline tickets seems like poor risk/reward calculus.
But on the more salubrious end of the spectrum, there are these frictions that happen in government. The amount of friction perhaps not fixed, but it can't be reduced to zero. And so there is a need for a cadre of young people who go to all the departments, learn all the names, and then help the process unstick itself.
[Patrick notes: We call these specialists lobbyists, who get a very bad reputation. Sometimes I wonder if this is similar to JIRA getting a bad reputation. Sure, as a software artifact, there are parts of it which are not wonderful. But often, when an engineer is complaining about JIRA, they are really complaining about the difficulty of managing a project with thousands of moving parts and a dozen stakeholders local to them. Those stakeholders often have competing interests.
It is rude to complain about your coworkers, and socially acceptable to complain about JIRA, and so JIRA “catches strays”, as the kids would say.]
Jim McKenzie: If you have a second, I’ll tell a story that you can edit out if you’d prefer.
Patrick McKenzie: Sure. [Patrick notes: While I have negative a billion desire to be partisan, particularly during an election year, the story is a deep cut for the political system that is the Chicago Machine, and so I’m keeping it in.]
Jim McKenzie: So, in one of my discussions with John, he told me a story. Back in 2004, we had a Senate campaign, and John’s candidate was the son of the Cook County Assessor, a guy with great name recognition. Several people were positioning themselves to win the Democratic primary, which is typically the way to become a senator from Illinois.
Patrick McKenzie: And one of the candidates was Barack Obama.
Jim McKenzie: Right. So, John had a fundraiser scheduled at a local country club. Three days before the fundraiser, he got a call from the local state congressman for that district. The congressman said, “John, I understand you have a fundraiser at Beverly Country Club this Friday afternoon, and I’d like you to change the beneficiary of that fundraiser from your guy to my guy, Barack Obama.”
John replied, “The people I invited are more aligned with my candidate than Barack’s supporters.”
Patrick McKenzie: This was when Barack Obama was still basically a national political unknown, right? Maybe a state legislator? [Patrick notes: Politically aware Americans in the early 2000s asked to name the young black Democratic politician with a good shot at becoming president someday would have picked Harold Ford Jr., following a quite buzzy appearance at the DNC in 2000.]
Jim McKenzie: Yes, he was a state legislator. John’s aside during this conversation was, “I’ve been down in Springfield with Barack Obama. We see each other at a poker game every two weeks. He treats me and the other lobbyists like we’re some kind of criminals. We’re just doing a job, providing a service like he is, but he acts like we’re involved in something shady.”
John said he had no interest in seeing his name in the Tribune for any reason other than people being upset about how much the village pays him or the amount of money he makes. He had great clients, like United Airlines and American Airlines, who paid him for the results he generated. The last thing he wanted to do was jeopardize that.
But now, the real source of his political capital in Springfield was making it clear: “John, you didn’t hear me. I didn’t ask if you wanted to do this. I’m telling you, you have to do this for me, or I’ll never take your phone calls again.”
Patrick McKenzie: So what did John do?
Jim McKenzie: He went home that night and discussed with his wife if they could get by on just her income. He realized he had no choice but to call the congressman back and say, “I’m in.”
He couldn’t back out, so he called Cecil Partee, who I believe was the president of the Illinois Senate at the time, and told him he was in. Then, John had to go to a different set of lobbying clients than his usual road builders. He went to the people who run nursing homes, and they wrote checks in the amounts Cecil Partee wanted for Barack Obama’s Senate campaign. They didn’t complain—they had gotten good results from John over the years, and when he asked them to write the checks, they did.
About six to nine months later, Barack Obama was seated as a senator. We were in Washington D.C. for some kind of hearing, and John thought, “Hey, why don’t we drop in and get a picture with Senator Obama?” He didn’t expect it to work, but it would make the nursing home operators feel better about writing those $10,000 checks.
So, we went to his office, explained to the receptionist that we were there with some big supporters of the senator, and asked if we could say hello. She said, “He’s in a hearing right now, but I’ll check.”
Patrick McKenzie: You expected her to come back with a “no,” right?
Jim McKenzie: Exactly. But instead, she said he’d be back in five minutes. And sure enough, within five minutes, Obama showed up, happily posing for pictures. At that moment, John thought, “Oh no, he’s running for something. What could it be? He’s already a Senator… And the only higher office is…”
When Barack Obama announced he was running for president, John’s three nursing home clients were thrilled to have gotten in on the ground floor. They wrote even bigger checks.
Patrick McKenzie: Well, that’s the way of the world. I’ve got one more note, and this is less real estate-related, but it’s something funny I noticed when I was growing up.
You have a different voice that you use on the telephone than you do when you’re talking to me or other people at home. Can you do the voice you use when you answer the phone, and then explain why you do that?
Jim McKenzie: I don’t remember any special voice. People have told me I talk differently at home, but I don’t recognize it.
Patrick McKenzie: My description is this: your voice at home sounds a lot like how you’ve been speaking on this program—a soft-spoken, sometimes nebbish, but engaging storyteller. But when you answer a phone call, especially from an unknown number, you put on this booming baritone voice that says, “I will not be denied.” It’s like, “Jim McKenzie, speaking!” Is that intentional?
Jim McKenzie: No, not at all.
Patrick McKenzie: Oh, okay. Maybe I invented that bit of Jim McKenzie lore!
[Patrick notes: I remember this as having been a persona Dad adopted intentionally as a result of how much real estate work is done by phone calls, and the importance of projecting presence in a way that suggests to counterparties you are worth talking to. As listeners to this podcast can attest, I cannot summon this vocal performance on demand, but have often thought that being able to do so would be useful.]
Jim McKenzie: (Laughs) I don’t deny it.
Patrick McKenzie: Well, thanks very much for coming on the program, Dad. I hope people got something out of this exploration into the built environment of our lives. We’ll be back next week.
Jim McKenzie: Thanks.
[Patrick notes: This is ordinarily where I’d plug a guest’s Twitter handle or blog, but sadly for fellow aspiring real estate nerds, Dad has neither.]
