The Real Estate Espresso Podcast

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We're Here From The Government And We're Here To Help Dec 18, 2020

Show notes

On today’s show we’re talking about the help that comes with many well intentioned government initiatives. Today’s show just makes you go Hmmm. I wonder what they were thinking.

Today we’re taking a closer look at a number of pandemic help programs that seem to have veered off their originally advertised objectives. There are so many of these stories, I’m just going to give you a sampling. There’s simply too many to cover in 5 minutes.

Back in the Spring, the Federal reserve announced with much fanfare that it would take $75 billion dollars appropriated by Congress and through the magic of its printing press turn it into $600 billion dollars in assistance for mid-sized businesses through its main street lending program.

Now 8 months into the program, and the banks have written less than $6B in loans. This is 1% of the funds that were promised under the program.

The Fed doesn’t have the ability to give away money, but they can lend it. The banks would still have to absorb 5% of the loan losses and the fed would absorb 95% of the loan losses. Banks don’t like to lose any money, so they underwrote the loans very conservatively. If a borrower qualified as a good credit risk, then the banks loaned money through their commercial loan desks without help from the Fed. If they didn’t qualify, then the banks generally declined to fund the loans, despite the Fed assurance of backing 95% of the loan losses. The sliver that actually qualified was less than 1% and it wasn’t because the businesses don’t need the help this year.

The pandemic has put enormous burden on healthcare systems around the World. Canada welcomes about 49,000 refugees or asylum seekers into the country each year. While they’re waiting for their refugee claim to be assessed, they have the right to get a job. Many end up working in numerous low paying jobs like call centres, or as personal support workers in long term care facilities and nursing homes. During the peak of the pandemic in the Spring, Canada’s Federal Government announced with much fanfare that it would allow personal support workers to shortcut being accepted as permanent residents in Canada if they commit to continuing to work as personal support workers for a minimum six month period. It took 7 months following the announcement for the government to publish their 60 page guide on how to apply and the 25 page application form. Within a week of the forms and the guide being available, a new guide was published with new qualification regulations.

The Small Business Administration department of the US government was tasked with administering two different programs to assist small businesses. The first was the pay check protection program which would provide up to 12 weeks of salary in the form of a loan provided you kept your employees on payroll for a minimum of 8 weeks. But the problem is that 12 weeks of payroll assistance is not enough to support businesses that are now in month 9 of a pandemic. Very few businesses are sitting on enough cash to survive 9 months of economic collapse.

The second SBA program was the Economic Injury Disaster Loan. The EIDL is not a grant, although the first $10,000 could be a grant under certain circumstances. It’s a loan at 3.75% for up to 30 years.

Governments all over are scrambling to try and figure out how to help save the economy. I don’t envy the job of government. They have a nearly impossible job. Even the assistance that some businesses are receiving will not be enough to save them. So if your business has been impacted by the pandemic, don’t just sit back and wait for government to save you. You have the agency to act and be responsible for your own business success.

Home For A Buck Dec 17, 2020

Show notes

Demographics can be used to predict the future of real estate markets. Nowhere is this more true than in the hundreds of small towns and villages all over the world. Younger people have been moving out of the small towns in search of fame and fortune in the big city.

Some countries have been experiencing very low birth rates resulting in rapidly aging populations. In the US, birth rates were at 1.77 in 2017 and have fallen another 2% in since 2017. That’s not high enough to sustain the population at a constant level. Demographers will tell you that you need a birth rate of 2.2 in order to hold population constant.

Some countries have increased immigration in order to offset the drop in fertility. In Spain, the number of deaths have exceeded the number of births for years and shows no sign of changing.

Bulgaria’s population is shrinking faster than any nation on earth. Despite having a growing expat population, Bulgarians are leaving the country in droves looking for more lucrative employment elsewhere in Europe. Combined with a birth rate of 1.46, the country is expected to lose 23% of its population over the next 30 years if current trends continue.

A similar trend has been reported in Latvia.

In Italy, the birth rate sits a 1.34, one of the lowest in the Europe. Cost of living, low wages, and difficulty in finding steady employment is the #1 factor that most Italians cite in their decision not to have more than one child.

Dying towns exist all over the country. Italy has been running an experiment to bring new investment into small towns. The most visible was the small town name Sambuca which started offering abandoned houses for auctions starting at 1E. The houses come with strings attached. They have to be redeveloped and a minimum amount of investment in renovation needs to be made.

These auctions have been highly publicized and have attracted thousands of bidders from all over the world.

Some of these centuries old houses in historic medieval villages have sold for 1E. But most have been bid up in price. Some sell for $5,000, 10,000, 20,000 euros. Still, that’s a reasonable deal. After renovation, some owners report total investments of around 140,000 USD for a newly rebuilt home in a slice of paradise in the Italian countryside.

These are small towns where everyone in town knows your name. The owner needs to commit to spend a certain minimum amount of time there each year. Ultimately, the towns want these residents to start businesses and to bring economic activity back to these smaller centers.

Some have been purchased and owner occupied for part of the year, and then put up as short term rentals for a portion of the year.

About 16 towns have initially participated in similar projects 1E home projects. These programs give you a house and Italian residency. Now you will need to pay a 5,000E deposit to make sure you don’t walk away from your obligation to complete the purchase and the renovations. If you don’t complete the renovations within the contract term, then you will lose your deposit that might be more than your purchase price for the property.

Many of them are in the poorest provinces like Sicily, Puglia, Calabria and Sardinia.

But in today’s environment when you can be connected to the rest of the world through the internet, the actual physical location of your home matters less than it might have mattered in the past. There are so many people operating location independent businesses. Their clients are in one location, and they choose where to live based on a lifestyle choice.

AMA - Should I Get a Realtor License? Dec 16, 2020

Show notes

Aaron asks,

I’ve been listening to your podcast for several months now and really like it. Thank you for all your insight into real estate investing. I was curious do you have an episode where you discuss further about whether or not someone should get their real estate license if they are getting serious about personal real estate investing. If you haven’t answered that question what are your thoughts?

Aaron, this is a great question. Real estate agents and brokers have access to a lot of tools that regular folks don’t easily access. If you go back 30 years, before so much of the real estate world became accessible online, it seemed like realtors had a monopoly on access to the information.

However, as technology has progressed, we find increasingly that the tools realtors used can also be accessed by the general public, sometimes for a modest fee.

Some jurisdictions have stricter privacy policies than others.

The other benefit of having a realtor on your team is that you can collect a commission on your transactions if you represent yourself. That can amount to a 2-3% saving on the gross purchase and a 2-3% saving on the sale. That’s significant and can improve your profit margins quite a bit.

Not only that, you can often market yourself as an investor friendly broker and many investment colleagues may throw business your way. That steady flow of transactions can smooth out your income stream. The life of a real estate investor can often be pretty inconsistent from a cash flow perspective. That income roller coaster can be great one month and swing to negative the next month.

In many real estate boards, new listings go out to the realtor community a few days before being published to the public Multiple Listing Service website. That two day head start in front of the buying public can be a real competitive advantage.

On the other side of the coin, there are responsibilities that come with being a realtor that you carry with you everywhere you go. If you are at a cocktail party and you hand someone your business card, your real estate licensing board will probably require that you disclose that you are a licensed realtor at the same time. You will have to hand out two business cards, one for your investment firm, and one for your real estate firm.

The biggest issue you have with being a realtor is that you have a duty to fully disclose. You might be selling a property that has a historic problem. It might have been a past water damage that was repaired, or perhaps asbestos that was remediated. It might even be an existing risk item that you would expect the buyer to examine in their own due diligence. As a seller, you can allow the buyer to conduct their own due diligence and you have no duty to disclose. But as a realtor, you have a duty to disclose no matter what. If the buyer finds a problem after closing, your risk of litigation is much much higher.

Everyone knows that realtors carry errors and omissions insurance. So even if the realtor has no money, the plaintiff in a lawsuit knows that there is a good chance of collecting from the insurance policy if they sue the realtor.

For that reason, realtors attract more than their share of litigation.

Failure to disclose is enough to trigger a lawsuit and a sanction by the regulator for your real estate license. The thinking is that when you are in a conflict of interest position, you have a fiduciary duty to protect the public and your clients ahead of your own self interest. When you’re a realtor and a principal in a transaction, you are in a conflict of interest position.

I can’t advise you on which way to go on this question. There are pros and cons that you will need to weigh. I know investors that carry a real estate license. I also know many investors that have tight relationships with brokers who are not direct owners in their projects.

Economic Forecast, Part 3 Dec 15, 2020

Show notes

On today’s show I’m going to share the final segment in this forecast based on highlights from Dr. Duncan’s presentation that I believe are relevant for all real estate investors. On today’s show we’re focusing on new construction. Here we go.

People who are currently homeowners are more fearful of the Corona virus and are not listing their homes for sale. Sellers don’t want strangers come into their house and possibly infect the family. On the other hand, those who are tenants in multi-family apartments are more fearful of the virus in the high density environment than they are of moving. They are taking advantage of the low interest rate environment as an opportunity to buy and lock in an interest rate for a long time. This surge in demand, with a drop in supply is putting a lot of upward pressure on prices. Both Fannie Mae and Freddie Mac are reporting record years for loan originations.

Across the nation there are 2.7 months of inventory on the market. That’s the lowest level since data has been collected.

New home builders have seen a surge in contracts for new homes. The builders will eventually need to catch up and build those homes. It’s hard to say how they will respond to demand for new sales if they get too far ahead of construction. Availability of skilled labor is the constraint in the construction industry right now.

We can anticipate that once the pandemic is under control, whether that is through a an effective therapeutic, or widespread adoption of a vaccine, supply of houses on the market will increase. Depending on the locations for that supply, interest rates for new loans, and the demand at that point in time, we could expect to see a softening in prices.

For now, new home builder backlog is at record levels.

If we go back to 2005 through 2006, the industry had a capacity to deliver 1.4 million new homes a year and sales peaked in 2006 at that level. In the aftermath of the 2008 downturn the industry delivered about 300,000 new homes a year at the bottom of the market. And has been averaging between 500,000 and 600,000 new homes a year for the past 5 years. It’s fair to say that the industry is sized to deliver that volume of new homes. In October, sales peaked at an annualized rate of 1M homes a year which is well above the capacity of the market at current staffing levels. The question is whether the industry can and will grow to to meet the challenge of the higher sales volumes without becoming overheated and perpetuating a boom and bust cycle yet again.

Based on the Fannie Mae data, the outlook for new home construction shows demand for 830k new single family home sales in 2020, a 21% increase over 2019. This is expected to grow a further 6.2% to 881k units in 2021 and remain flat at 881k units in 2022.

2020 has been a banner year for refinance activities, representing a 127% growth over 2019. Next year, refinance activity is expected to contract by 56.5%. Normally a 56.5% contraction would be a huge deal. But it will basically match 2019 refinance volumes and 2019 was a banner year for refinance activity.

Based on everything I’m hearing, I going to go out on a limb and predict that single family new construction for rental is going to be a product that is in high demand. In particular, I believe that new construction townhouses which live like a single family home are going to be in high demand because they are more affordable than a detached home. The drive for affordability is going to influence demand for the coming next several years.

Economic Forecast, Part 2 Dec 14, 2020

Show notes

We covered part 1 of Doug’s predictions on Friday’s show.

On today’s show I’m going to share a few more highlights from Dr. Duncan’s presentation that I believe are relevant for all real estate investors.

This year the Federal Reserve changed their stance on inflation. The Fed doesn’t see moving the overnight funds rate above 0.25% until the end of 2022. This is the part that is significant. They have also changed their stance on inflation. Rather than setting a 2% ceiling on the rate of inflation, the Fed is now saying that they’re going to be fine with an average 2% for inflation. That’s a dramatically different stance. That means that the Fed might not raise interest rates when core CPI creeps up above 2%. They will wait until the average is above 2%. For 2020, they’re estimating inflation below 1.8%. This means that inflation would need to exceed 2.2% next year before they take action to cool inflationary pressures.

So as real estate investors we can count on low interest rate policy for some time to come.

Dr. Duncan shared data on the office market for a number of cities across the US. He noted that many office markets can expect it to take more than 6 years for local office vacancies to return to pre-Covid levels.

Part of the reason has to do with the amount of new office construction in the pipeline. Most cities are experiencing growth in supply that is far in excess of demand over the next three years. That new supply was already committed prior to the pandemic.

San Francisco is expecting a 7% growth in office supply over the next 3 years, with a 0% increase in demand. Many of the major markets are experiencing flat demand over the next several years and increasing supply. Doug believes that many businesses will want to return to the higher productivity environment of an office. Nevertheless, office space is one of those areas that is under extreme pressure over the next 5-7 years.

The only city that is expected to show a fast rebound in office is Washington DC. That’s largely driven by government.

Cap rates in multifamily don’t appear to have changed at all during 2020.

Fannie Mae is looking hard at migration. They’re looking at where applications for new loans are being from, and the location of the loans for the subject properties. From this data, they can clearly see that migration is underway from more dense zip codes to less dense zip codes. They have the actual data from real transactions. This isn’t a survey or a statistical poll. It’s based on boots on the ground activity. Whether that is sustainable remains to be seen.

Job prospects for millennials over the past 5 years have been in the urban core. Not surprisingly, they have moved close to their jobs. Do they want single family homes? Yes, but those don’t exist in the downtown core. Now that they aren’t tied to being in the core, millennial are migrating to the suburbs.

When it comes to rental properties, Fannie Mae is seeing much more tenant rotation in the A class properties than in the B and C properties. Those who are upwardly mobile and can afford a house are buying a house and moving out of a high density property to low density.

Mike Wolf Dec 13, 2020

Show notes

On today's show I'm talking with Mike Wolf about strategies for the coming quarter. Mike has been in the business for 31 years and is wintering in Puerto Vallarta Mexico. To connect with Mike, visit MikeWolfMastery.com

Joel Block Dec 12, 2020

Show notes

Joel Block hails from Los Angeles California where he has been a fund manager for many years, specializing in hedge funds, real estate syndications, and all kinds of businesses. On today's show we're talking about the latest impacts of the pandemic on real estate assets.

You can reach Joel at bullseyecap.com.

Economic Prediction Part 1 Dec 11, 2020

Show notes

Last week I attended a small private presentation hosted by my good friend Tom Wilson at the BACOMM monthly meeting held in Silicon Valley. The guest speaker was Dr. Doug Duncan, Chief Economist for Fannie Mae. Doug has been a guest on the show before. Doug leads a large team of nearly 200 economic analysts and have consistently won awards for having the most accurate economic predictions anywhere in the US. When I speak with Doug, he’s not just reciting data. He has layers upon layers of evidence to support the conclusions drawn. This one hour talk was packed with market insights that I have not seen anywhere else and I want to share these with you. If Dr. Duncan’s observations are correct, they will serve as a guide for what’s to come in 2021 and beyond.

On today’s show I’m going to share a few highlights from Dr. Duncan’s presentation that I believe are relevant for all real estate investors.

What we’re dealing with in 2020 is a pandemic and not an economic variable. We simply don’t have economic models that have a pandemic built in as an economic variable.

The Fannie Mae forecast is based on data over the past 4 quarters and is making reasonable assumptions about the trajectory of the disease in the first half of 2021.

There are a number of conclusions that can be drawn from the data that Dr. Doug Duncan presented.

What they found is that the highest percentage of renters are in the food and beverage, retail and hospitality sectors of the economy. These are the very sectors that have been most impacted by the pandemic. Therefore, they conclude that the impact to home owners has been proportionately much less.

The folks at Fannie Mae looked at the loans that are in forbearance. Again, the lenders are in direct communication with their customers. Fully 25% of those who took the option of a forbearance agreement did so out of an abundance of caution. They did not experience job loss, nor a reduction in income. They took the forbearance just in case.

Another 25% of those who took the forbearance option did experience a partial loss of income, but still had sufficient cash flow to make their mortgage payments. Strictly speaking, they didn’t need to take the forbearance agreement. When those forbearance agreements expired, those home owners were in fact able to resume mortgage payments and have not gone into default. Based on this, we can conclude that the state of financial distress for home owners is about half of what the total numbers would suggest. That’s a good sign.

So let’s see what’s going to happen to the remaining 50% of the homes that are in distress. Dr. Duncan believes that loan modification agreements will be signed with the borrowers that the banks believe are good credit risks. If a borrower is 6 months behind on their payments, they may extend the loan by a year, add the outstanding payments to the loan, spread over the remainder of the loan and bring the loan into good standing. Those properties will not go into foreclosure. That leaves a much smaller number that will actually go into foreclosure.

Dr. Duncan also shared that several large institutional players who are sitting on large sums of cash are prepared to step in and purchase portfolios of distressed properties in bulk. Therefore the impact to the lenders can be reduced with a few large transactions, rather than the waves of auctions on the court house steps that were daily occurrences in 2009 and beyond.

On this basis, I’m going back on what I’ve reported previously. Will there be distress in the coming months? Yes there will. But I believe that distress is going to be confined to specific sectors of commercial real estate. Specifically, I’m referring to retail, office and hospitality. I’m concluding that we will not see a repeat of 2008 with millions of homes appearing on the market at deep discounts.

Does Zoning Contribute To Racial Discrimination? Dec 10, 2020

Show notes

There is a growing movement aiming to address the perception of racial bias when it comes to housing.

The US has a history of racial division dating back to the days of segregation. Those practices were outlawed in 1917 when the US Supreme Court deemed those practices as contravening the law. The law was further strengthened in 1964 with the Civil Rights bill was signed into law by Lyndon Johnson. The practice of designating certain neighborhoods as white only, or black only clearly violates every moral and ethical and legal principle in a free and modern society. To be clear, our society has made huge strides since those days. At the same time, it’s also clear that racial inequality still exists on multiple levels.

The question remains whether certain newer regulations have the unintended consequence of discriminating against racial groups.

The City of Minneapolis has tackled this question with respect to the zoning code. The argument is that a high proportion of dark skinned people are tenants in Minneapolis, and a high proportion of light skinned people are home owners. Therefore, it could be argued that the zoning code that limits certain zones to single family homes that are predominantly owner occupied has the same effect as racial segregation, even if that was not the intent of the regulation.

In response, the city has decided to eliminate the single family home designation in the zoning code. In fact, a number of states and the department of housing and urban development (HUD) have started to tackle the question as to whether zoning is exclusionary. They added provisions for higher density in transit oriented areas.

This approach seems both balanced and positive. As a developer, the creation of more opportunity for higher density development within the core of the city is a positive step. This could be one of those rare moments when there is consensus on what might be a politically charged, or perhaps racially charged topic. Developers welcome a more relaxed regulatory environment. Home owners and tenants grappling with affordability would welcome the move as well.

Curiously, some cities like Philadelphia have gone in the opposite direction. The city has moved to reduce the areas in the city which are zoned for multi-family development. I’ve personally owned property in the city that has had the zoning arbitrarily changed from residential multifamily to residential single family. Those properties that are zoned multi-family are arguably more valuable because you can build higher density.

If you look at cities like Houston, which has no zoning code whatsoever, the city functions without a problem. Market forces and practical considerations like traffic and utilities provide the only broad constraints. Unless a property has a deed restriction specific to the property, you can build a warehouse next to a single family home, next to a school, next to an office building. The city has assumed that common sense will prevail and the free market will determine whether a project will succeed in a specific location or not.

When you look at the work of almost any municipal government, if you take the time to read the minutes of the city council meeting, or watch the video replay of the meetings, you’ll find that more than 90% of the work of local government is tied up in land use. The amount of resource that is frankly wasted in bureaucratic red tape is astounding. Some residents will argue that maintaining the historic nature of some areas can only be done with the protection of strict regulation.

No doubt, cities all over will be looking at what Minneapolis has done to help guide their own future land use policy.

A change in zoning regulations has the potential to change the supply demand balance dynamics within a city. This one factor can do more to determine the long term viability of a new multi-family project than most people recognize.

Show Me The Incentive Dec 09, 2020

Show notes

Charlie Munger, is Warren Buffet’s partner in Berkshire Hathaway. He’s famous for saying, “Show me the incentive and I’ll show you the outcome.”

Society and government alike have been conditioned to think of regulation as the path to controlling market behaviour, to eliminate so-called “bad behaviour”.

The internet is the great equalizer that has broken many business assumptions. We live in a physical world. People live in houses. They eat real food (mostly). The doctor cures the physical ailments. Governments pave the streets so you can travel with ease from your house to your destination.

Local, state and provincial governments tax their residents in order to pay for these items. The local governments try to control what happens in the local communities through regulation.

The recent runup in share price for Tesla has increased Elon Musk’s paper net worth to the point where he is now the second wealthiest person on the planet. This week he announced that he moved from Silicon Valley in California to Austin Texas. In May of this year he announced that he was selling all of his properties in California. He clearly cut all ties to California to make it abundantly clear that he is no longer a California resident. Apart from needing to raise a bunch of cash to exercise his stock options this year, his nearly $1B in stock option compensation, which become exercisable this year would bring a whopping tax bill.

Texas of course has no state income tax, compared with California’s new proposed 16.8% top marginal tax rate. So if Elon Musk cashes in on $1B in stock option profits, he could conceivably save $168M in tax just by moving to Austin. Would I accept $168M in cash in order to move to Austin? I suspect that virtually anyone would.

On the first of December, Hewlett Packard Enterprise announced it was moving its corporate headquarters from San Jose to the Houston suburb of Spring. Spring is located in the NW of Houston, very close to where HP had it’s enterprise server and storage division.

HP has said that it is listening to its employees who want greater choice on where to locate. They want a place where there is a lower tax rate, a lower cost of living, and more ability to spread out without the congestion of traffic in Silicon Valley. Hewlett Packard split into two companies in 2015, with the more profitable server and IT services business forming HPE, and the consumer computer and printer business remained as HP Inc and is still based in Cupertino near the original HP headquarters.

Here again, we have a company that is a fixture in Silicon Valley, one of the Silicon Valley originals, making the move to a lower cost, lower tax, lower regulation environment.

I hired engineers in both Silicon Valley and in Texas in my hi-tech career. I can tell you from first hand experience, that equally talented people cost 25% more in Silicon Valley, simply because the cost of living in that area is so much higher.

I used to hire organizations from India and relocate portions of the team to North America to facilitate the communication. The bulk of the team remained in Bangalore. Today, that model is gone. I regularly hire top talent in India even today. Not only do I save money, the main reason I do it is for speed and quality. North Americans culturally tend to work in isolation. My team in India will throw 4-6 people at solving a design problem and deliver a high-quality result in a quarter of the time and at a fraction of the cost of a comparable North American team. In my case, the incentives are cost, quality and time. Those are strong incentives.

If there are local regulations that make work here locally more expensive, or more cumbersome, we’re not obligated to conduct business or invest in a particular geography.

We will invest where the numbers make sense. As Charlie Munger says, Show me the incentive and I’ll show you the outcome.

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