The Passive Real Estate Investing Lie: John McNellis on Commercial Real Estate Mistakes

John Mcnellis (00:00)

Well first of all, I think the biggest lie in real estate is passive investment. You you there’s no such thing as a passive investment. I mean every single day we we’ve got issues at at at our properties and oops, you know, the d this roof is leaking, oops, we have a homeless issue here. we’ve got a tenant departing, we’ve got a tenant bankruptcy. So ⁓

Michelle Tack (00:04)

Aha. That’s okay.

John Mcnellis (00:24)

For for you gl anybody dear listeners who tells you, gee, this is a great passive investment, be wary about that.

Michelle Tack (02:04)

Welcome to Real Estate Pros. I’m Michelle Tack. I am the podcast leader for today. Welcome to our listeners. We’ve got a great operator, John McNellis, is with us today. ⁓ John has a really interesting background of ⁓ putting in shopping centers, but in geographical ⁓ locations in Northern California. ⁓ And also

John Mcnellis (02:04)

Yeah.

Michelle Tack (02:31)

⁓ is a very well-lauded ⁓ author. ⁓ he has written three editions of Making It in Real Estate. he recently spoke at Stanford University, and the book has required ⁓ reading in a multiple universities, including Stanford, Berkeley, and others. ⁓ thank you, John, for being with us. ⁓ for those that do not come from the world of shopping centers and commercial shopping centers.

can you explain your business and what markets you serve, please?

John Mcnellis (03:03)

Sure. ⁓ first of all, thanks for having me today and Michelle. It’s it’s my pleasure. So what we do, ⁓ and again you’re correct, ⁓ I’m based here in Palo Alto. ⁓ all of our developments are is

Michelle Tack (03:06)

Absolutely.

John Mcnellis (03:16)

Within sort of the Greater Bay Area, about a two-hour drive from, say, San Francisco. We build from the ground up neighborhood shopping centers. And by that I mean a center of maybe five to ten acres in size, fifty to a hundred thousand square feet. They’re usually anchored by a supermarket or ⁓ a a major discounter, like say Walmart. ⁓

In the old days we used to do barb what we would call a barbell shopping center. And by that I mean a a big supermarket on one end, a a narrow ⁓ strip of shops in between, and a drugstore on the other. And then a couple of small buildings, we call them pads, out in front, a bank, pizza, gas station. that’s what we’ve been doing for the last forty plus years here in Northern California.

Michelle Tack (04:01)

That’s awesome. You obviously have the understanding and the operational skills and experience to have as much as it can the business run smoothly. Can you talk about the and and in real estate is not smooth all the time, obviously, especially in shopping centers, right? But can you talk about the the the tenants? And I mean by that not the tenants that are

John Mcnellis (04:20)

No, it’s never smoking.

Michelle Tack (04:29)

you know, maybe leasing from you or what how or buying from you. But the major core items that you cover off and ensure that the business is running smoothly as much as it can in times like ⁓ these that change and what have you.

John Mcnellis (05:32)

Well first of all, I think the biggest lie in real estate

passive investment. You you there’s no such thing as a passive investment. I mean every single day we we’ve got issues at at at our properties and oops, you know, the d this roof is leaking, oops, we have a homeless issue here. we’ve got a tenant departing, we’ve got a tenant bankruptcy. So ⁓

Michelle Tack (05:37)

Aha. That’s okay.

John Mcnellis (05:56)

For for you gl anybody dear listeners who tells you, gee, this is a great passive investment, be wary about that.

⁓ what we do to ⁓ limit our exposure to the the the slings and arrows of outrageous fortune is we keep our debt levels quite low. And okay, we we put a lot of equity into our properties, our own equity ⁓

Actually, we don’t have outside partners. And we s try to stay on top ⁓ of all of our properties. We look at them every single month, even when we have outside property managers, you know, we have to manage the managers. But it it’s a constant effort to to keep everything running as smoothly as we can.

Michelle Tack (06:40)

Yeah, I I

I can imagine that. In terms of can you share an experience where either a deal or a situation sort of went sideways on you and but you were able to pivot quickly to either rectify it or even if you weren’t able to pivot quickly, that it became a central experience for you that you know, catapulted your

business to a higher level because you had that experience.

John Mcnellis (07:10)

well ⁓ Yeah, no it’s a good question, in fact.

Michelle Tack (07:11)

That’s a loaded question, I know.

John Mcnellis (07:16)

You know, in this you kindly mentioned my book, Making It in Real Estate. In this last section, because I I’ve I’m essentially I’m aging out, so I figured it was okay. I I devoted a whole section on the the worst mistakes we’ve made. And so I th I think I picked seven or eight of of the the the worst mistakes we’ve made and and what we did to overcome them or or or at least we survived. But ⁓ a point I’d like to make for again is that if you’re doing more than a handful of deals,

Michelle Tack (07:25)

Ha ha.

John Mcnellis (07:46)

In commercial real estate, you are going to lose money. There’s just no way around it. You can be as smart as Warren Buffett and still get slammed by, say, the COVID. If you bought a piece of property or all the really genius guys who bought office buildings, you know, in the office building market has been decimated. So back to us. I think we made every mistake you can possibly make, but the

The one in the early days, you know, when we first starting out, when we had this terrible need to do busin to get deals done, the the mistake that we made, ⁓ we we overpaid for properties. and so what happens then is that if everything works out great, you know, you do the development and you break even because you basically paid too much to the seller and you gave him your profit for redeveloping it in advance. ⁓ now if you’re s

if you’re successful, ⁓ you get over that, you know, after a number of years where you don’t have to do every deal and that

that need to ov to t to get deals done, the tendency to overpay goes away. The other another problem that we did in the early days, because we started out if put your thumb and forefinger together, this is how much money we had in the beginning, we overleveraged. and if you have too much debt on a property, then it’s great in a a raging bull market, but as you know, it can kill you a ⁓ when the carousel eventually stops. And of course it always does eventually stop.

But you know, we got past

those two and I th we’re still making mistakes and we’re still losing a little bit of money here and there to d even today, but not on the order of magnitude we did early in our careers. And just for the record, guys, I th I I counted it up for the first edition of the book.

And at that time, this is a dozen years ago, I think we’d done about 70 projects. And between ones that we actually lost money on, and by that I mean buy it for a million bucks and sell it for 800,000, or where we didn’t make any money, where all we lost was a lot of time, was probably like 15-16% of the deals that we did. Now, I’m here today because you can flip that around and say, well, 85% of his deals were successful.

Yeah, I’m pretty happy with that rate. But I would just be again, listeners, anyone tells you they’ve never lost money in real estate and they want you to invest with them, I would be very c wary of that.

Michelle Tack (10:49)

Yeah, John, I I think

that really is what you just said really summarizes the difference between someone that’s dabbling in real estate and thinks that may l you know it may lead to, you know,

something, you know, that’s massive, ⁓ versus someone that’s really committed to real estate over a period of time, ⁓ long period of time. And because you’ve gone through different situations where you’ve had to adapt and change and ⁓ you know that’s that’s what happens in real estate. So I appreciate you mentioning that. When you look at opportunities, I know that

You know, you said earlier to me that you’re, you know, wanna pass on this this great ⁓ you know, business that you built to others and you’re going through the planning process over the next decade to do that. Can you talk about what that looks like for you in terms of opportunities and or changing the business ⁓ currently?

John Mcnellis (11:41)

Yes.

to take the both second part of your question, what we’ll

Transitioning into as as I’ve mentioned, my two partners and I, ⁓ Beth Walter and Mike Powers, we’ve been together for forty three years. ⁓ and among us we have eight children who are all bright, l lovely kids, but they’re not really interested in the business. So what we’re trying to do ⁓ as we we plan for the future is pair our portfolio down to like our most essential the best assets ⁓ gradually and then take on a a

⁓ the next generation manager, I think the way the company will evolve, it will do less in the way of development and more in the way of just maintaining the existing portfolio and perhaps upgrading that portfolio over time.

Michelle Tack (12:36)

That’s awesome. and you know some of our listeners are in that same position, so they may ⁓ want to ⁓ reach out to you. besides your book, you I found it interesting that you’re also you know, a writer and that you’ve ⁓ been published locally. Do you want to talk about that a bit?

John Mcnellis (12:45)

Sure.

Sure. I I was a journalism major in college. ⁓ always loved to write. and my handwriting was so terrible that but I was a good typist, so that that that I’m still a good typist. ⁓ and w writing was fun for me and you know, I always as a as a sideline I I wrote. ⁓ and then

Michelle Tack (13:06)

Ha ha ha.

John Mcnellis (13:19)

Fifteen, sixteen years ago the the Registry magazine, which is a West Coast commercial ⁓ real estate magazine, i invited me to become a columnist. And that’s how I started writing ⁓ this nonfiction. and I took like five years worth of columns to write the first edition of my ⁓ book, Making It in Real Estate. And I all right, I’ll I’ll

I have to be the true leader for myself. It was my publisher’s number one best selling title. ⁓ sold over forty thousand copies. It’s required reading from like like you kindly said, from from Stanford to Clemson to Vanderbilt to Georgetown across the country. ⁓ and I continue to write pretty much every month. for either the ⁓ registry magazine or the San Francisco Business Times. And I I do it because it it’s a fun hobby.

Michelle Tack (14:03)

Good.

Awesome.

One th I wanted to touch on your network. ⁓ you’ve been at this for, you know, multiple decades, right? Four decades. And I asked you previously in preparation for the podcast about your your network. How did you develop can you give that that information? I I thought it was really interesting about longevity and sort of the nature of the business. So ⁓ John, can you explain that a little bit?

John Mcnellis (14:19)

Right.

Yeah, you you made a an interesting distinction a couple of minutes ago, Michelle, where you said there are those who dabble in real estate and then those who go into it as a full time profession. ⁓ and actually in the book, ⁓ I suggest to to readers that what they should do, ninety-nine percent of them is just dabble. They should keep their day job and then, you know, buy the worst house in the best neighborhood and and do the real estate on the side. Much safer, much simpler approach. But

If you’re going ignore that good advice of mine, which most people do, and you want to jump into it full-time, ⁓ particularly if you’re starting out, then the way you to develop that network, first thing I would do would be to join the ULI, the Urban Land Institute, which is nationwide. It has chapters in all the major cities, and that’s where you’re going to meet your peers, the other people who are interested in commercial real estate, the other developers, the bankers, the architects, the engineers.

so on. ⁓ and as you grow, you know, I joined when I was about 30, and as you grow up with them, you know, that underassistant banker gradually becomes a vice president and maybe even the president of the bank. And so over the years you develop really good contacts. The other thing I would do if I were serious about being a professional in in real estate, I would join the organization that is aligned with your particular field in real estate. So for me

The shopping center world, it’s called the ICSE, the International Council of Shopping Centers. It meets many, many times a year, but every year I go to to two or three of the of the ⁓ conferences and conventions. It’s a great way to network, you know, to meet the people in the business, to learn and and and frankly to make money. So if you’re serious about it, you if you know I sit in my office, you sit in yours, but ⁓ and you get this kind of narrow parochial view of the world.

But getting out and and and network as much as you can in these organizations I think is a great way to ⁓ give your career a kick start.

Michelle Tack (17:25)

That’s great. ⁓ in again, we’re very ⁓ glad that you joined today. you had a lot of great information. Again, your book, Making It In the Real Estate, is ⁓ highly recommended ⁓ by universities. So folks that are listen there it is. There it is. Right in red and black and yellow. ⁓ The third edition. Thank you, John, for showing that. ⁓

John Mcnellis (17:38)

There it is. There it is, folks.

Michelle Tack (17:49)

I’m sure there’s a lot of folks that would like to contact you, ⁓ maybe about your book or maybe they’re getting into the commercial side of you know, you know, shopping centers, what have you. Can you provide your contact information and then spell it out? ⁓ whatever contact you information you’d like to provide.

John Mcnellis (18:07)

Sure, of course.

So my name is John McNellis, J O H N M C N E L L I S. That’s M-C-N-E-L-L-I-S. My email address couldn’t be easier. What do you know? It’s john@mcnellis.com I have another email address which is john@johnmcnellis.com. ⁓

And I’m all over LinkedIn. I’m pretty much all over the the network. I’m very easy to find. ⁓ if you want to read ⁓ my essays, you you can find them on LinkedIn, you can find them on our website, which is mcnellis.com and I’d love to hear from you.

Michelle Tack (18:49)

You’ve been a great guest. We appreciate it. Thank you for our to our subscribers. We hope you found value in the content today. And for those that may have just joined that are not subscribers, please stay tuned. Thanks a lot, John, and much success in the future.

John Mcnellis (19:04)

Thank you, Michelle. My pleasure.