The Real Estate Espresso Podcast

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This Quote is Valid for 30 Minutes May 07, 2021

Show notes

You’ve no doubt heard the stories of people struggling to make ends meet in an inflationary environment. You’ve heard of hyperinflation in places like Argentina. This is a place where inflation is currently averaging 42.6% per year. Inflation in Argentina has been running between 25% and 52% over the past 5 years. Venezuela’s inflation is currently running at 3000%. Prices are rising so fast, that quotes for services are only valid for less than an hour. Prices are increasing at a rate of about 1% per hour in order to maintain pace with the devaluation of the Bolivar.

When you are in an inflationary environment, prices change fast. People become conditioned to the idea that prices are constantly changing. They know that they can never get ahead really. All they can hope to do is tread water.

But this raises the question of what are things worth?

We’ve grown accustomed to knowing what things cost, when our reference point is dollars. But separating the notion of price and value is sometimes a little difficult when the price changes frequently.

Has the value of a clay brick changed from one week to the next? Not really.

Has the value of a 2x4 piece of lumber changed from one day to the next? Not really.

Has the value of a chicken for dinner gone up? Not really. It contains the same amount of calories as it did last week.

But we’re increasingly seeing prices change quickly. So quickly in fact that suppliers are often willing to quote a price for only a short period of time.

Lumber quotes are only valid for half a day.

Chicken prices have surged nearly 100% in the past year. Lumber is up by a factor of 5.5 times. Fuel prices are up since the beginning of the year. This is largely due to a fall in domestic production. Higher energy prices definitely have a ripple effect through the economy. But a gallon of gas is not worth any more today than it was six months ago. It may cost more dollars to purchase, but it’s no more valuable than it was six months ago.

In my home city of Ottawa Canada, the price of a single detached residential home has gone up an average of 42.3% since this time last year. Let’s have that number sink in for a moment. 42.3% price increase for a single family home since this time last year.

Will this price stick for the long term? Is this the new normal? That means that prices have increased by $221,000 in the past year. That comes to a price increase of $605 per day, or a price increase of $25 per hour. When you consider that a work day is 8 hours a day, 5 days a week, the price increase comes to $105 for every hour of the work week. Most working people don’t earn $105 an hour. Even if you did earn that much, you would have to put 100% of your income towards paying only for the price increase.

As a real estate property owner, you look at these asset price increases and feel good. But as someone who is servicing increasing debt levels if you're buying in the current market conditions, the prospect can seem daunting. It’s all good until interest rates rise just enough to make the affordability of that massive mortgage loan problematic.

In the world of commercial real estate investing, these rapid increases in prices tend to favour landlords. Higher housing prices make it more difficult for tenants to transition from renting to home ownership.

But when everything is going up in price the key question is whether rents will increase fast enough to keep ahead of increasing expenses.

Prepare to live in a world of very fluid pricing, and try to figure out what that means for the prices you’re going to set in your business.

Situational Awareness Of A Different Kind May 06, 2021

Show notes

On today’s show we are talking about another form of situational awareness.

When you buy a property in a neighborhood it’s pretty common to drive up and down the streets and look around.

Are people leaving trash on the front lawn? Are there broken down cars in the lane way?

Are people taking care of their property?

That’s one form of situational awareness. We live in a physical world.

But that form of situational awareness is a bit like looking in the rear view mirror.

What if you could look at a property and see into the future?

Well it turns out that you can. When I look at a neighborhood, I want to see who owns each property and what zoning applications have been filed.

Let’s imagine that you drive down the street and you see homes, one after another. There is nothing particularly remarkable to see. Some driveways have kids bikes. Some driveways have a basketball net. You might conclude that young families live here.

But a search of title might tell you something that is not readily visible to the naked eye.

You might discover that one group of houses are owned by the local housing authority. The people living there are receiving some form of social assistance. There is nothing wrong with that of course. But if you were making assumptions about how property values in the area would appreciate, your assumptions might be incorrect.

If you found a group of properties that were all owned by the same company, that might point to future development of those properties.

If you found a property where the ownership had 5 names on title, you might research the ownership further. When did the property change hands? Was there a death in the family? Ownership by multiple next of kin is rarely a stable situation. Chances are high that the property could appear on the market for sale in the near future.

You’ve probably heard investigative reporters use words like “Follow the money and you will understand the motives”. This can be true when you’re looking at property as well.

When you look at the chain of title on properties in the area you get to ask questions. Questions like,

Why did that commercial property change hands five times in the past three years? Why did that property change hands for $10? Clearly it didn’t change hands for $10. What’s the real story behind what happened?

Why is there e mortgage recorded on a property that is clearly above the market value of the property? I wonder what’s happening here?

Why did this property have three mortgages recorded on title in less than a year? Who are the lenders? Are the lenders traditional banks or private citizens? That tells you something about what might be happening on a property.

You see none of this is visible by driving down the street.

A recent search of neighbouring properties uncovered that one of our neighbours could be considered a really good neighbor. The owner of this property has not initiated a zoning application, nor have they done anything to the property. But this particular owner has a reputation for development. Could new development next door add value to our property?

Revenge is Sweet May 05, 2021

Show notes

Using historic data to predict the future seems to be getting more and more difficult. It used to be the case that you could rely on recent history as a predictor of near term demand. But that’s become increasingly difficult.

On today’s show we’re talking about a new phenomenon that has become so common there is actually a phrase that is used to describe it.

We’re talking about revenge spending.

Revenge spending is not a new term. It’s often associated with a spending spree that happens when a member of a couple is mad at their partner. This podcast is not about marital troubles. We’re not talking about that kind of revenge spending.

The kind of revenge spending that is trending in 2021 is pandemic revenge spending. This is the feeling that somehow we have missed out on treating ourselves for the past year. That somehow the universe owes us something.

We’ve put up with no celebrations, no dining out, no concerts, no vacations by the beach, no new clothing and so on.

People have the urge to go out and splurge on themselves, almost as a reward for being locked down over the past year.

Revenge spending is going to take many different forms. People are spending money on luxuries, but not just in North America. All over the world.

For many this is going to mean vacation travel in the second half of the year. So instead of just revenge spending, it’s going to be revenge travel.

I’m talking with many people who have their finger on the mouse button, just waiting to purchase their airfare. I also know several who had travel booked for the Spring and have cancelled their plans. It’s still a little too soon in a number of locations to travel.

Some countries have stated that they’re willing to accept tourists who are fully vaccinated. But even the global cruise industry is still on life support. In 2019, that industry brought in $57B in revenue and served 29.7M passengers. That’s a lot of vacations that are seeking alternate forms of vacation this year, and possibly into next. It’s going to be some time before the global cruise industry recovers to pre-pandemic levels.

The pandemic has caused a number of people to rethink their priorities. Some have quit their jobs. Others have separated from their spouse after being locked up for a year with them. Some have decided to start a new business.

One thing that we can easily predict is that the velocity of change in 2021 will be unlike any other year in recent memory.

Supply chain shortages are testing the whole notion of supply elasticity of demand. Prices are being bid up across the board.

This is true in real estate as well. We are continuing to see white hot market conditions in multiple markets. I have not moved to control as much land in a single time period as I have since the emergence from the pandemic began.
The recovery is exposing those who are out of position. The examples are everywhere. The car rental companies had to reduce the size of their fleets in order to survive. Now they have a shortage of cars on holiday weekends. Business travel has not returned, and the demand is coming from the leisure sector. But here too, the demand is changing week by week.

The emergence from the pandemic slowdown will be chaotic and exhilarating. It will also be frustrating for those who are out of position. It will be downright dangerous for those who forecast the spike in short term demand to continue.

Revenge spending is an isolated event and not a long term trend.

Where Millennials Are Getting Their Investment Education May 04, 2021

Show notes

On today’s show we’re talking about putting information where people are looking.

Gary Vaynerchuk is the CEO of Vaynermedia, a NYC digital marketing firm. Gary is one of these guys that has the notion of attention deeply ingrained in his being. He tells the story of how when he was a young boy he would run a bunch of lemonade stands.

The lemonade stands were operated by older kids. Gary would post signs for the lemonade stands on trees and sign posts. Then he would sit by the side of the road and watch the eyes of motorists to see if they posted signs were catching the attention passing motorists.

This is understanding the basics of attention at its most basic level.

The fact is, we are overloaded with marketers trying to vie for our attention. So we tune the vast majority of it out.

If you as an investor, a sponsor, or a developer want to connect with potential investors, you want to be paying attention to where people are looking.

On February 22 of this year Magnify Money which is a wholly owned subsidiary of Lending Tree published a paper based on some market research they had conducted with their clients. There are a number of fascinating findings in this report.

Nearly 6 in 10 investors 40 or younger are members of investment communities or forums, such as Reddit or a group of like-minded investor friends.

YouTube is the top source for investing information among young investors, with 41% turning to the site in the past month.

22% of Gen Z investors say they were younger than 18 when they started investing, versus 8% of millennial investors. In fact, 40% of Gen Z investors say they were encouraged by their parents to begin investing, which backs the earlier start.

Only 36% of young investors plan to use that money for retirement. Instead, 35% will primarily use those returns to make additional investments, while 19% will use the money to pay for a major purchase like a home or a car.

As an investor, you might be thinking that having a YouTube channel is not the best way to reach your potential investors. You might be thinking that TikTok is an app for sharing short dance videos.

But the fact is, a significant portion of the investing public are turning to these sources for information. Now you might decide that your ideal client is not a Tiktok user. But you should remember that Tiktok as 689 million active users on a monthly basis. That may seem like a small number when compared with Facebook’s 2.7B users or Youtube’s 2B users.

That doesn’t mean you should ignore those other platforms. But 689 million users is a significant potential audience.

You might be thinking that your investors are likely not millennials, and perhaps not even Get Z. There are not that many accredited investors in that age group. We’re really talking about targeting less than 1% of the population. But if you’re speaking to 1% of 689 million people, that’s still nearly an audience of 7 million people. Perhaps you want to be more selective and speak to the top 0.1%, that’s still an audience of 700,000 people.

The key is to find the way to connect with people who are out there looking for you. This particular study provides new insights that were not part of the conventional wisdom when it comes to investment education.

The Three Deadly Spreadsheet Sins May 03, 2021

Show notes

On today’s show we’re talking about three of the spreadsheet, the most common mistakes I see investors make. The first is the dreaded rule of thumb mistake.

Somewhere along the way, a real estate trainer provided some rules of thumb about what things should cost. In particular, we’re talking about expense ratios.

The logic goes something like this. In a multi-family apartment building, you should allocate about 45% of your revenue to expenses.

Well folks, I’m here to tell you that this approach to analyzing your apartment complex is just plain inaccurate. In fact it’s so inaccurate that it’s not even useful as a tool for quick math.

I’ve seen the exact same product with the same management company experience two dramatically different expense ratios. In one city, the expense ratio was 31% and in the other it was 42%. The rents were basically the same. The difference was in property taxes and insurance. One city had much higher property taxes which accounted for a massive difference in the total operating expenses for essentially the same product. So rules of thumb don’t work.

The only exception to that would be if you had another similar building in the same area with a good bit of operating history. In that case, you can borrow actual expense numbers as an estimate from a similar property in the same area. But you’re not blindly multiplying by a percentage. In that case you’re using real data as a point of reference.

Expenses tend not to care how much you’re getting in rent. If you have a lot of common area, you’re going to need to spend money on energy to provide lighting and climate control for those common areas. How old is the building? How much will you need to spend on maintenance?

How high is your tenant turnover? The higher your turnover, the more you’re going to spend on unit turns.

When a water heater decides that it has reached end of life, it doesn’t care whether you’re getting $700 a month in rent or $3,000 a month in rent. It’s going to cost the same to replace the water heater. But clearly as a percentage of rent, the cost of maintenance is going to be much higher.

I’ve then seen investors take this flawed assumption and build a financial house of cards on top of it.

There are three deadly sins when it comes to underwriting a deal. Excel will give you beautiful reports and charts and graphs. That creates an aura of legitimacy that far outstrips the integrity of the underlying data.

Push the rents above the market. Nothing too aggressive, maybe just $50 a month above market. I’ve seen so many investors delude themselves using this approach.
Use the aforementioned expense estimates.
The cap rate assumption.

The market cap rate is often used to determine the value of a property. But since cap rates these days are so low, even a small change in cap rate can result in a large change in value.

I would have valued a new property in that C class location at about a 6% or 6.5% cap rate. But this investor chose to underwrite the value based on a 4.5% cap rate. That 2% difference in cap rate may not sound like that big a difference. But in reality, we’re talking about a 32% difference in value. Simply by choosing a lower cap rate, this investor had inflated the value of his proposed property by 32%.

This particular investor had accepted another investor’s pro-forma as a good model without digging deeply into the numbers. It turns out that his expense ratio was below 20% which is unrealistic.

When you layer the other sins on top, you find that the cumulative error is a whopping 76% overestimation of the value of the property. But Excel is perfectly willing to dutifully perform the math and show glowing numbers.

In short, proper underwriting requires a deep analysis of all the variables that make up the income and expenses for a project. There is no shortcut.

George Ross on Market Cycles May 02, 2021

Show notes

On today's show George shares his view on the market cycle. He's seen no less than 7 market cycles in his career. George's perspective is only possible with experience of having lived through so many cycles.

BOM - Essentialism by Greg McKeown May 01, 2021

Show notes

Essentialism by Greg McKeown

Greg McKeown is a speaker, bestselling author, and host of a popular podcast. He has been featured in The New York Times, Fast Company, Fortune, HuffPost, Politico, and Inc.; is among the most popular bloggers for LinkedIn; and has been interviewed on NPR, NBC, and Fox and on Steve Harvey and more. He is a Young Global Leader for the World Economic Forum. Originally from London, he now lives in California with his wife, And four children.

Essentialism is not about how to get more things done; it’s about how to get the right things done. It doesn’t mean just doing less for the sake of less either. It is about making the wisest possible investment of your time and energy in order to operate at our highest point of contribution by doing only what is essential.

The way of the Essentialist means living by design, not by default. Instead of making choices reactively, the Essentialist deliberately distinguishes the vital few from the trivial many, eliminates the nonessentials, and then removes obstacles so the essential things have clear, smooth passage. In other words, Essentialism is a disciplined, systematic approach for determining where our highest point of contribution lies, then making execution of those things almost effortless.

Today, technology has lowered the barrier for others to share their opinion about what we should be focusing on. It is not just information overload; it is opinion overload.

But when we try to do it all and have it all, we find ourselves making trade-offs at the margins that we would never take on as our intentional strategy. When we don’t purposefully and deliberately choose where to focus our energies and time, other people—our bosses, our colleagues, our clients, and even our families—will choose for us, and before long we’ll have lost sight of everything that is meaningful and important.

What if the whole world shifted from the undisciplined pursuit of more to the disciplined pursuit of less…only better?

What if we stopped celebrating being busy as a measurement of importance? What if instead we celebrated how much time we had spent listening, pondering, meditating, and enjoying time with the most important people in our lives?

Essentialism is not a way to do one more thing; it is a different way of doing everything. It is a way of thinking.

When we forget our ability to choose, we learn to be helpless. Drip by drip we allow our power to be taken away until we end up becoming a function of other people’s choices—or even a function of our own past choices.

Do setbacks often only strengthen our resolve to work longer and harder? Do we sometimes respond to every challenge with “Yes, I can take this on as well”? After all, we have been taught from a young age that hard work is key to producing results, and many of us have been amply rewarded for our productivity and our ability to muscle through every task or challenge the world throws at us. Yet, for capable people who are already working hard, are there limits to the value of hard work? Is there a point at which doing more does not produce more?

Essentialists see trade-offs as an inherent part of life, not as an inherently negative part of life. Instead of asking, “What do I have to give up?” they ask, “What do I want to go big on?” The cumulative impact of this small change in thinking can be profound.

The book Essentialism goes beyond preaching about the benefits of thinking deeply about what is important. The author creates a discipline and a series of daily habits that act as an antidote to the gravitational pull of trying to do too much.

The Times They Are A Changin' Apr 30, 2021

Show notes

On today’s show we’re talking about the tipping point of home valuations. This is really a discussion about situational awareness. It’s important to be aware of your surroundings. Most people would not walk alone in a dark alley in a rough part of town. It might be too difficult to have complete situational awareness to know whether it’s a safe move or not. The same situational awareness that would help keep you safe in a dark alley is what you need to stay safe as a real estate investor.

I’m starting to see an increasing number of people who are baffled by the rapid rise in home prices. The biggest factor affecting home supply is the lack of willingness to move.

I hear the same refrain over and over again. I love my neighborhood. If I sell, I can get a great price for my house, but where will I go? I can’t buy back into the area at a reasonable price. If I sell, I would have to move to a less expensive area.

This week, I had a conversation with a home owner in Dallas who said his house has gone up in value by $400,000 in the last two years. He’s willing to buy a larger house on some acreage in a less expensive area and cash out, and put the spare change in his pocket. A large family move is a daunting prospect. I’m hearing people who are contemplating making these moves, or have outright made the decision to move. One or two of these are interesting. But trends are the result of thousands of small independent decisions.

Real Estate markets are inefficient. They’re slow moving. They’re slow moving because people don’t move quickly. People move slowly.

Real estate has always been about location, location, location. The question is what does that really mean?

The definition is secular. It means different things to different people. For one person location means walking distance to their favourite coffee shop and grocery store. For someone else it means being close to their family members. For another, they want a view of the water and as much distance as possible to their closest neighbour.

It used to be the case that distance to work was a primary factor in deciding where to live. That is still going to be a major factor for the majority of the population. The number of jobs that are truly location independent still make up a minority of the working population. It’s a growing minority, but still a minority.

As the economy opens up, I believe we will start to see some mobility within the population that has been far below the annual averages over the past year of the pandemic. As people start to move, you will start to see more inventory of homes for sale coming into the market. The lack of inventory of existing homes for sale has been one of the largest factors driving the rapid increase in prices. Demand for houses due to household formation, and low interest rates, have both created a fear of missing out for new home buyers. New home buyers have been priced out of home ownership as prices have risen.

When you look at the rapid increase in values in some areas, coupled with the virtual freeze on movement that has been the story of the pandemic, I have to stand up and take notice.

When I know half a dozen people personally who are actively looking at rural acreage, I have to stand up and take notice. This is not a scientific survey by any means.

I can’t ignore a few data points like this. There is definitely something happening here.

I’m seeing migration at play. I’m talking to realtors who are looking for new supply. They’re looking further afield for that new supply. I’m talking to other developers who are seeing new demand in areas where demand was light in the past.

108 Degrees In The Shade Apr 29, 2021

Show notes

The year was 2011. It was a hot summer day in August and it was around 108 degrees Fahrenheit or 42 degrees centigrade in the shade in Phoenix. There were about 50 people assembled on the patio next to court house steps on Jefferson street. They were all there for the same reason. Most people had a clipboard with the the list of the days properties to be auctioned.

In a few minutes time, the auctioneers would arrive with their ruggedized laptops. Today there were three auctioneers and each one set up on a separate picnic table, separated by about 15 feet. If you stood between two of the tables you would probably be able to hear two sets of auction properties at once.

You could tell who were the professional bidders. They had an ear piece connected to their phone in one ear so they could communicate with the head office and they were listening to the auctioneers with the other ear.

This day’s list had 260 properties to be auctioned. The list was made public at 9AM the day before the auction. So you had at most 27 hours to review the list and perform a drive by inspection of the properties on the list.

But before you did that, you would need to carefully review the list and determine which properties would be of interest. You would need to search title to determine whether any other liens were recorded on title. Knowing the full picture of the liens on title was key to knowing what the likely minimum sale price would be at the auction. If the price didn’t meet the reserve price and didn’t sell, then the lender would become the owner as a result of the auction.

If you looked around you could tell who were the professional bidders and who were the amateurs. The pros all knew each other. The rookies were looking around, taking it all in. They were unsure where to stand, unsure of how it all worked.

There was a police officer from Toronto. There was a mother and daughter who arrived with one specific property in mind.

Each time a property sold, the winning bidder confirmed their information with the auctioneer and handed over a cashiers check for $10,000. They would have 24 hours to bring the balance of the purchase in the form of a cashiers check. The auctioneer would read out the lot number from the list of auctioned properties and then read out the address and the starting bid. Within a minute the property would have a new owner or it would revert to the foreclosing lender if there were no bids.

Many of the properties sold for $25,000 to $35,000.

The professional bidders wanting to protect their value in the process would bid against rookie buyers to force the price up before backing down. They forced the purchase price up to $50,000 when the mother and daughter

Many of those in attendance were shocked that the mother and daughter were forced to pay too much. On that day about 1/3 of the properties went back to the bank with no bid. Another quarter that were originally on the published list did not get auctioned. It was an average day on the courthouse steps in the noon sun. That year, 36,000 homes went into foreclosure.

Mother and daughter overpaid by about $20,000 that day. But today, their home would probably sell for between $400,000-$450,000. With the benefit of hindsight, we can see that there were no bad deals that day.

Back then we were looking upon the auctions as the new normal.

Here we are in 2021, in the tail end of the largest pandemic induced economic disruption in recent economic history. Homes are selling above asking price in multiple offers. The current market conditions have no end in sight. This is the new normal. Back in 2019 the market appeared hot. Here we are nearly two years later and the market seems hotter than ever.

As I reflect upon the auctions of 2007, those were not normal market conditions. The frenzied market conditions of 2021 are not normal either.

But It Looks Like A Good Deal Apr 28, 2021

Show notes

On today’s show we’re talking about risk taking when a good deal presents itself.

This past week, another investor who is developing a residential subdivision had their source of funding evaporate. The timing, a week before closing is awkward for the buyer. They have alternatives but are definitely going to be scrambling to maintain some level of control.

The challenge is that completing the due diligence in such a short time period is going to be difficult and there will be some corners cut in the due diligence process out of necessity. The true question is whether the risk being assumed in cutting those corners is enough to step back from the deal or not?

The value of the land is tied entirely to the development potential. If the land remains farm land, then the purchase price is too high. If the land can be fully developed as has been represented by the seller, then it’s a bargain.

If the land can even be partially developed, then it’s a fair price. So how does a buyer segment the due diligence in order to find that ideal balance between risk and reward?

We have an extensive due diligence checklist that we apply to our own projects. In this particular instance, the other developer has not completed what we would consider a complete due diligence.

When performing due diligence, the work falls into three basic categories.

The specific submarket.
The people
The deal

In our case, we’re 100% comfortable with the specific submarket. We know that there is demand far in excess of supply.

The specific market we are focused on is Boise Idaho. This is the third fastest growing market in the country over the past few years.

We have all of the major national home builders now active in the market. Some home builders who had been absent are now competing with us for land.

We believe the purchase price being offered is a fair price. Somehow we need to get comfortable with the risk, knowing that the planning department has not made a recommendation to city council, and that city council has not voted on the entitlement.

At a price of under $20,000 per lot, the property is a fair price, provided they can be entitled. We believe that fully entitled lots will capture a higher price in the open market once shovel ready. The profit potential is there. But then we also need to look at the big picture and the downside risk.

At this moment we have land to develop about 500 homes in a single market. At what point do we become overly concentrated in a single market? When does the risk become too large? What percentage of the overall market do we alone represent in terms of growth?

At this stage, we don’t know if this new project makes sense yet. We’re going to be conducting our own due diligence and making an assessment of the downside risk. The upside is clear. The downside is not as clear. Unless we can get enough information to satisfy our own due diligence process, we will have no choice but to decline the opportunity. Tempting as it might be, we simply cannot sacrifice the discipline in our business for what might be a good deal, or equally could be dud.

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