evaluating management: Donald Trump and real estate

Last year Forbes published an analysis by James Elkins, a professor in the finance department at the University of Texas, that concludes Mr. Trump has underperformed the average real estate professional in the US by a whopping 57% over his career, despite the boost to returns he achieved by maintaining almost twice the average amount of financial leverage.

The results are highly tentative.  Prof. Elkins uses a REIT index as a proxy for overall real estate returns.  He also employs Mr. Trump’s statement of his starting net worth and the Forbes $4.5 billion estimate of his 2016 wealth (the 2017 estimate is $1 billion lower).

On the industry benchmark, my experience with real estate moguls, mostly outside the US, is that the returns on their private real estate investments are generally higher than those they achieve in their publicly traded vehicles.  In Mr. Trump’s case, his net worth also includes his considerable earnings as a reality show star, as well as the potentially positive effect of debt forgiveness through bankruptcies.

In short, the 14.4% annual return on equity Elkins uses for the industry is probably too low and the 12.5% return he figures for Trump is too high.

 

My question is what the returns on capital are in the Elkins example.

According to Elkins, REITs have an average debt to equity ratio of about 30%.  This means they have a mix of roughly three parts equity, one part debt.  Assume that their average cost of debt has been 8%–a figure that seems reasonable to me but which I’ve just plucked out of the air.  If so, their 14.4% return breaks out into roughly a 12.5% return on capital (actually operating real estate ventures) and 2% from using financial leverage.

This calculation implies that Mr. Trump’s 12.5% return breaks out to something like 9% from real estate and 3.5% from financial leverage.

At first glance, the difference between a 14.4% annual return and a 12.5% return doesn’t seem like much.  Prof. Elkins’ point is that over a career being a relative laggard adds up.  In this case, it translates into having $4.5 billion instead of $23 billion.  Mine is that the numbers flatter Mr. Trump’s planning and management skills, which fall even more deeply below the average in the real estate industry than his overall results.

(5/20/19. Note:  the consensus today is that Mr. Trump never had assets anywhere near the Forbes figure and that in real estate, he added no value–doing little more than preserve in real terms the capital he inherited from his family.  That is, the idea that he made a fifth of the return of the average real estate magnate–and perhaps a tenth of what the best did, he appears to have made nothing.  Even so, that’s without factoring in the personal lifeline he may have received from security holders of his ill-fated Atlantic City casinos.

Together with the tax returns published by the New York Times, the picture that emerges is of a brilliant self-marketer, who has been able to recast the reality of a singularly maladroit businessperson.  Again, even this assessment may prove too flattering, if there is any substance to the money laundering allegations that are now surfacing.

One more thing:  I’ve taken a second look at my return calculations and revised them slightly.  None of my conclusions change:  Mr. Trump’s performance comes out slightly worse than before.)

 

 

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