The Real Estate Espresso Podcast

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Mike Simmons Sep 19, 2020

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Mike Simmons is from Try Michigan. Today's conversation is all about how to scale your business from a solo-preneur to a larger business.

You can connect with Mike at mikesimmons.com

AMA - First Multi-Family Investment Sep 18, 2020

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Today is another AMA episode (ask me anything)

Ryan asks:

"I live in Los Angeles and have been working on my education and networking to break into the Commercial Multifamily Investing space (particularly in Arizona); however I do have an opportunity to possibly break into ground up development of built to rent units here in Los Angeles. A buddy of mine who develops (completed 24 units, 6 units and currently raising capital for 33 units in decent areas such as West LA, Hancock Park) is willing to let me tag along on his projects to learn while being a passive investor.

Any advice on which path to choose (B & C class MF in AZ vs. ground up build to rent here in Los Angeles, CA)? I am leaning towards MF in AZ given the business friendly atmosphere there, but it's hard not being in the market."

Ryan this is a great question.

You’ve presented your question as one of two choices. Either new construction in Los Angeles, or B & C Class in Arizona. For reasons that I’ll go into in a minute, I probably would not choose either of the two asset classes you’ve presented.

I’d like to encourage you to consider additional alternatives. In fact, I’d suggest that before you commit to a single project, you get clear on the type of project that is going to meet your investment criteria. In my world, an investment needs to follow the laws of supply and demand. That means I want to be in a market with growing population, growing employment, and a shortage of supply for housing.

Los Angeles lost population in 2018, 2019, and it has lost population in 2020. In fact, LA ranked fourth in the nation in terms of population loss in 2018. All other things being equal, that means that prices will drop for both rentals and purchases. The problem with rentals in an expensive market like Los Angeles is that the cost to deliver a finished product is quite high compared with the net income you can generate. In addition, many submarkets are rent controlled. That means that the properties often don’t meet their potential because the rents are being artificially held down.

I’m not a fan of C-class properties in Arizona. I’ve owned investment property in both Maricopa County and Pinal County. The problem with C-class is that the income strength is not there. If you’re renting property to people who don’t have stable income, then your investment is at risk every month. If they’re relying on government subsidies, you’re renting to people who are broke. They’re not going to take good care of your property. I’ve never lost money in A-Class properties. But I have lost money in C-class. You will find that C-class properties tend to have more than their share of surprises and unplanned maintenance.

In terms of meeting your investment criteria, it’s important to get clear on what constitutes a good investment for you. I can’t decide that for you, I can only share what my investment criteria are.

1) I’m looking for projects that generate 30% net profit margin within 12-24 months. That means I’m buying at enough of a discount that I can generate that 30% margin after all expenses and interest carrying costs.

We’re at a unique cross-roads in history. This is an exceptional time to start in investing. We are on the cusp of a repeat of 2008 all over again. Except this time it is happening in slow motion. We know it is coming. We can prepare. The moratorium on evictions, and the moratorium on foreclosures are both holding the market in a form of financial hibernation.

I would hate to see you jump into the market a few months too soon in what amounts to the absolute top of the market, only to have a huge number of distressed properties hit the market all at once. When that happens, even with low interest rates, the laws of supply and demand dictate that we will see a precipitous drop in prices in some markets.

Fed Keeps Interest Rates Near Zero Sep 17, 2020

Show notes

On today’s show we’re talking about the latest guidance from the Federal Reserve regarding interest rates. Yesterday the Fed announced the result of their latest committee meeting. They reaffirmed their guidance on maintaining interest rates low for the next 18 months, and then they extended that guidance by another year until the end of 2023.

The Fed talked about the role for monetary policy which simply describes interest rates. The Fed has made it clear that simply lowering interest rates won’t do much to further stimulate the economy. Whether interest rates are 2% or 0% isn’t going to all of a sudden get people to run out and make new investments in The Fed chairman also spoke about fiscal policy. This is controlled by the Treasury department’s spending of money to stimulate the economy. Naturally the Fed has a hand in this as well because the treasury is empty and any spending requires the treasury to come back to the Fed with cap in hand asking the Fed to print more money. Right now, political wrangling has created a stalemate whereby the losers are those who are in need of financial help. The politics of an election have come ahead of helping a crippled economy. After nearly a month with little congressional progress on a renewed assistance package, the economy is in peril from lack of government action.

So interest rates are at historic lows. What do you do with that information? What decisions should you be making knowing that interest rates are going to remain low for some time to come?

As I see it, low interest rates may possibly reduce your income if you’re in the business of lending money.

But if you rely on debt to fund the growth of your business, then you have a series of decisions to make.

1) The best think you can do in this environment is reprice existing debt into a lower interest rate vehicle with as long a horizon as possible.

When you borrow money in an inflationary environment, you are basically shorting the dollar. You banking on those future dollars being worth less than today’s dollars. If your interest rate is, say 2%, and let’s say that inflation is running at 3%, then the debt is being devalued at a faster rate than what you’re paying in interest. The money is essentially free at that point. I believe we are at the cusp of free money for that reason. But even more important than shorting the dollar, refinancing the debt into a lower interest rate facility gives you stronger cash flow and makes your business more resilient to economic shocks. We are not out of the woods yet with the pandemic and all the economic side effects. Lowering the cost of your debt is just plain responsibility.

2) It’s tempting to go and secure additional debt to grow your business. After all, the debt is so cheap, it’s tempting to go get as much capital as possible to take advantage of the low interest rate environment.

But here is where you need to think carefully. What is the purpose of the debt?

Is it to provide a cash buffer for the business? Is it to fund a growth in the business that is based on verifiable sustained demand? Is the growth speculative?

In today’s environment of uncertainty, you want to be establishing clear criteria for how you make investments. When are you going to make incremental investments? Have you established a high bar for making investment decisions?

Investments are made within a context. That context makes a number of assumptions.

For example, in 2010 the context was a distressed market where assets could be purchased for 30-40 cents on the dollar. Today’s context isn’t fully known or understood.

For that reason, my guidance is that new projects need to be undertaken very carefully. New debt should first be used to reprice existing debt and improve cash flow.

Take Your Vitamins Sep 16, 2020

Show notes

On today’s show we’re talking about where are we with this darned pandemic that has dominated this year 2020.

There are lots of conflicting data points and individuals, business leaders, public health officials, elected officials, and investors are trying to figure out where this is all heading. This is an area I’ve been studying deeply for a long time.

The Corona Virus is new in the past year, it’s not that well understood to the medical community, and it threatened our global society with a very high mortality rate. We’ve had a bit of a reprieve over the summer months.

The weather is getting cooler and people are spending more time indoors. We are seeing infection rates rising dramatically in many countries including Spain, Israel, France, India and Brazil.

The United States will pass a grim milestone in the next day or so with 200,000 deaths so far this year from the pandemic.

There are some potential vaccines undergoing early clinical trials, and it’s reported that a few hold considerable promise. However, even if these are found to be effective, it will be many more months before they can be manufactured in sufficient quantities and administered to a large enough percentage of the population to have a meaningful impact.

We’re hearing of outbreaks in the school system as children return to school. We’re hearing first hand accounts of outbreaks in university residence buildings.

So where does that leave us? It’s possible that we have a second wave coming. Some point to the Spanish Flu pandemic of 1918, which infected 1/3 of the world’s population in four successive waves. It was the later waves of the Spanish Flu that were the most deadly. Is history about repeat itself with the Covid-19 virus?

I’ve been following the work of Dr. John Campbell from the UK. He has been reporting on a number of recent studies showing the correlation between the severity of Covid symptoms and Vitamin D levels. There are numerous studies showing that there is a strong link to severe Covid symptoms and vitamin D deficiency. A recent small scale experiment of 76 patients conducted in Spain showed that out of 50 Covid patients chosen at random who were given the best available treatment and high doses of vitamin D, all survived, and only one out of 50 deteriorated to where they needed to be admitted to intensive care. Out of the remaining 26 cases, all were given the best available treatment, and no vitamin D supplements. From this control group 13 / 26 deteriorated to where they needed intensive care and two died. Fully 50% ended up in intensive care.

You can find the videos from Dr. Campbell on Youtube at https://youtu.be/iNji13yoW9g

Over the past week, Dr. Campbell has presented numerous other papers and studies from the Journal of the American Medical Association, two large scale studies from Israel, to name just a few. It’s strange that the WHO, the CDC, the Oxford Center have not initiated a large scale clinical trial of Vitamin D. But the studies to date seem pretty compelling.

I’ve maintained for a long time that it would take one of two things to bring the pandemic to an end from a social and economic impact.

1) Full herd immunity. Either everyone got it, or large scale deployment of a vaccine

2) An Effective treatment

If you look at the statistics coming from Europe, we see that case counts are rising dramatically. Paradoxically the death counts have not been rising correspondingly.

It’s too early to declare the pandemic over. Some of the studies have shown Vitamin D to be effective as both preventative and as a therapeutic. Vitamin D is produced within the body by exposure to sunlight. As a supplement, it is readily available, and is easily manufactured in high volume.

The Most Boring Real Estate Document Ever Sep 15, 2020

Show notes

On today’s show we’re talking about the usefulness of your property and how the title report can help you understand what you’re buying.

You’re buying a piece of property. You pay the purchase price, and now it’s yours. But the truth is, it’s not that simple. There are so many things that can encumber the use of your property.

All kinds of things that affect your property can be recorded in the official records of a property.

To start with, the title report can tell you a lot about your property. There is an enormous amount of complexity in what seems like a pretty straightforward transaction. Sometimes these reports can be lengthy and boring to read. But they contain a ton of information about the history of a property. I recently received a title report that was 96 pages in length. It had all kinds of details, including when transfers happened between family members, loans taken out against the property, when they were repaid, when the owners were behind on their taxes, or their water bills. So much information is contained in the property records.

The first and simplest item is the deed. This is the ownership. Who owns it and under what kind of structure is it owned? Is it owned by a person, an entity like a company, or a land trust. If the property was transferred as a result of a foreclosure, the new owner would be listed on the property. But some areas have a right of redemption period after the transfer whereby the original owner can get their property back. For example, there is a rule in Philadelphia that says if a property is sold at the Sherriff’s tax sale, and the original owner was not properly notified of the impending sale, they have a right of redemption period whereby they can pay the back taxes owing and get their property back. How long is that redemption period? Get ready for this. It’s 21 years. That’s right, 21 years.

There is additional complexity coming from the various forms of encumbrances that can be attached to a property. This can be a lien. But there are other forms of encumbrances. There could be a right of way or an easement. These are sometimes used to provide utility companies the right to have a pipeline, or an electric transmission line cross your property. It might be a right for a neighbor to access your property for a driveway in order to prevent their property from being isolated.

Sometimes there can be a deed restriction recorded on title. It could literally say anything. It might say that the property is transferred on the condition that the any structure built on the property must be painted yellow. You can literally put that kind of restriction on a deed. That restriction might be temporary or perpetual. Unless you perform a full title search, you may not know what burdens you are signing up to. They’re contained in the history of the property.

I’m dealing with an issue on a property right now where one of the owners granted an easement to the electric utility company to have wires crossing the middle of the property. That easement was granted in 1938 and the property owners were paid a grand total of $4 for the right of way from the utility company.

From a practical standpoint, the electric utility is highly unlikely to ever enforce their right to access the property. But if I build a house in the easement, they could theoretically come to me one day and ask me to demolish the house.

Then you have to consider what new regulations might be in place. Just because a house exists on a property, doesn’t mean you’re permitted to modify what’s there. Many elements of the building code allow existing structures to continue in their current location. These are the so-called grandfathering clauses. But sometimes, the new rules say that if you make any modifications to the property then the new rules apply.

Pay very close attention to the title report and I recommend that you read every word contained in it.

AMA - Hotel Investment Fund Offering Sep 14, 2020

Show notes

Today is another AMA episode (Ask Me Anything). Brad from Ottawa asked me to look at a prospectus for an international hotel fund. He is asking for my opinion on the offering.

Clearly the global environment for hospitality has changed dramatically. Nobody knows what the new normal will be for hospitality following the pandemic. We’re talking about hotels in warm weather getaway destinations. We don’t know what airline capacity will be in the coming months or years for those destinations. Without knowing the airline capacity on those routes we have no way of assessing the demand for hotel nights. There’s no basis for building a new hotel without that data.

The offering memorandum document is out of date with respect to the current market conditions. There’s no way that an investor should be even thinking about putting capital into a new construction hotel.

I want every listener to understand that I’m not preaching about someone elses’s project.

I say this even for myself. I have a development project in the core of the city in one of the hottest neighborhoods. My original plan was to build a 4-star hotel in that location. It would have been the perfect location and an ideal product in that location. I really wanted to build that 120 room hotel. And then the pandemic hit. I know that in an environment where hotel occupancies worldwide are below profitability for the existing hotels, there is no basis for engaging anyone in a discussion about building a new hotel.

The most knowledgeable investors for hotels are those who have invested in hotels in the past. Many of these investors have decades of experience having invested in the hotel sector. It makes sense to talk to those investors and ask them about their strategy for hotels going forward.

Understand that we have a set of market conditions where a large percentage of existing hotels are in default on their debt. The actual percentage depends on the location. On August 28 of this year, just a few weeks ago we dedicated an entire episode to what is happening in the CMBS market for hotels. In NYC, the default rate is 38%, in Houston 66%. While these hotels have not gone into foreclosure yet, I predict that some of them will. When they do, there will be high quality assets for sale in the market at a discount. In that environment, would an investor rather acquire an existing hotel for a deep discount or would they roll the dice on a new development project that won’t generate revenue for another 2-3 years?

I’ve been saying this for a while. Now is the time to be patient. I’ve had a number of conversations with investors in recent weeks where they’ve had funds available. It seems like the money is burning a hole in their pocket and they want to put the money to work. I totally get that money sitting in a bank account is earning essentially zero interest. I have the same situation and it’s tempting to put the money to work.

I know we’re in what appears to be a hot market. In the residential market prices are continuing to rise, largely fueled by low interest rates. But that doesn’t translate into higher prices in the investment market. As investors we value property based on its income potential. In my home city, sale prices for condo’s are up 24% this year over last. That means that at the entry level of the market, people are willing to pay more and they’re gobbling up inventory in order to avoid being priced out of the market. But that has nothing to do with the valuation of rental apartments. Unless rents have gone up 24%, and I can tell you that they have not, the valuations for rental properties has remained steady or perhaps gone down a little. The valuations for hotels have gone down a lot.

Live Presentation - Project Management (How to Hire) Sep 13, 2020

Show notes

This talk was given earlier this week at the Durham Real Estate Investors meeting in Toronto. When we think about project management, there are so many facets to consider. The goal of this talk was to give attendees something tangible and actionable to use the very next day.

Enjoy...

Britnie Turner Sep 12, 2020

Show notes

Britnie Turner is CEO of the Aerial Development Group in Nashville, Tennessee. She is also the founder and CEO of the Aerial Recovery Group. On today's show we're talking with Britnie and her chief of operations Jeremy Locke about the initiative that she and her team are taking to aid in the disaster recovery from Hurricane Laura in Lake Charles Louisiana.

If you want to learn more, you can direct message @AerialRecoveryGroup on Instagram, @BritnieTurner on Instagram. You can also find out more ways to help at laura.usastronger.com.

The Law of Large Numbers Sep 11, 2020

Show notes

On today’s show we’re talking about the law of large numbers. The law of large numbers is a mathematical theorem in statistics thatdescribes the result of performing the same experiment a large number of times. According to the law, the average of the results obtained from a large number of trials should be close to the expected value and will tend to become closer to the expected value as more trials are performed. But we’re not going to be talking about statistical theorems today.

We’re talking about the ability of the human mind to process large numbers when presented with these big numbers.

We have so many facts and figures that are so big that they become incomprehensible. If I said to you 100,000 or 1,000,000,000, the impact is almost the same.

I mean think about it.

The wildfires in California have burned 2.3 million acres so far this fire season. Most people can’t process what that means. Yes, I know it’s a lot. But how big is 2.3 million acres. It’s not a unit of area that most people can process, let alone multiply by a large number.

An acre is a unit of area that measures about 208 feet by 208 feet. In a dense urban setting you will often get between 6-8 houses per acre, and 12-15 townhouses per acre. An acre isn’t huge, but it’s not small either.

Maybe square feet are easier to understand. A square foot is a unit of area that measures 12 inches by 12 inches. Or if you prefer metric, it’s a unit of area that measures 30 cm x 30 cm. We’re talking wildfires that have burned 100 billion 188 million square feet. Somehow, I’m not finding it any easier to comprehend how much has been burned in California in this year’s wild fires. Perhaps it’s easier to talk in square miles. This year’s fires have burned about 3,600 square miles. Even that is hard to process. If I told you that this is an area equivalent to 12 times the size of New York City, it’s starting to get easier to understand. Or if I told you that it’s about 40% of the total area of the Dallas-Fort Worth metro area, you’re now starting to be able to comprehend it. In truth, I haven’t told you anything different in any of these examples. But when I give you a frame of reference, it’s starting to become easier to process.

So far this year, the Corona Virus pandemic has killed 196,000 people in the US over a six month period. Exactly how many people is that? Yes, that’s a lot of people. It’s a massive human tragedy. It’s three times more American soldiers than were killed in the Vietnam War. That doesn’t really help either.

Think about taking Fenway Park in Boston where the Boston Red Socks play. You would need 5.2 stadiums the size of Fenway park to hold that number of people. That’s a jarring visual image.

Numbers by themselves are abstract, even for mathematicians to comprehend the scale and proportion.

If I told you that the newest Amazon fulfillment center to be built in my home town was 1 million square feet, how many people could truly comprehend what that means? But if I told you that you could put 60 NHL hockey rinks in the same area, or you could fit 17 football fields, it is starting to get easier to understand.

So why am I telling you this?

As you communicate with your investors, with your stakeholders, with your business partners, or with you grandmother, don’t throw numbers at them. Make sure you create a frame of reference that is understandable when you communicate a number.

Have an awesome 86400 seconds.

AMA - Higher Property Taxes Sep 10, 2020

Show notes

Today is another AMA episode (Ask Me Anything) John from New York asks:

With states, cities and towns possibly being under financial pressure due to decreased business during pandemic, how would you underwrite the purchase of a multifamily asset? How much of the increased tax can be passed along in a rental increase?

John, this is a great question. If you look at most cities, they get their cash from one of several sources.

1) Property Taxes

2) Service Fees

3) Other Levels of Government

4) Borrowing

Despite the pandemic, I don’t expect property tax collections to go down very much. Eventually, the city will get the property taxes, whether it means a tax lien on a property, or an outright tax sale, the city will get their money.

Service fees are the area that have been hit the hardest during the pandemic. Services fees include everything from the revenue collected when a someone rents a meeting room for an event, to parking tickets, to library fines. This is where cities have experienced the most impact during the pandemic and it’s also the area where the cities have reduced staff. You don’t need to hire life guards if the swimming pools are closed this year.

Transfers from other levels of government have been largely unaffected.

Borrowing is restricted to capital projects in most cities. Most cities are prohibited from borrowing to fund day to day operations. The only way to cover the shortfall is to either raise property taxes or to beg another level of government for more money. How each city will deal with the problem will vary from one to another. Nashville increased their property taxes by 34% in their most recent budget. Hopefully most cities don’t experience that kind of increase.

One problem in your question is how can you pass on these costs to tenants and recover some or all of the income lost to higher taxes? Some jurisdictions have rent controls. Where you’re from in NY is famous for its complex web of rent control regulations. Where I live in Ontario Canada, the province limited rent increases to zero % for 2020, arguing that the pandemic has caused enough pain for tenants. In most communities, taxes, utilities, insurance, have all increased rates in the past year. A zero percent rent increase is basically legislating landlords to lose money.

So back to your question which is how to underwrite a new project?

When there is uncertainty, you need to build safety into the project. That means increasing the debt coverage ratio to ensure you have a higher profit margin and lower debt service.

Most lenders require a debt coverage ratio of 1.2. Let’s look at a simple example. Let’s say that your project generates 120,000 in profit before debt service. In that scenario you would have $100,000 in debt service and $20,000 in free cash flow. But that’s the minimum your lender would allow and it doesn’t leave much margin for things to go wrong. For example, if your property taxes went up $10,000 and your occupancy dropped, and you had some unplanned maintenance, you could find yourself in a negative cash flow situation.

I would urge you to borrow a little less money, and bring more equity to the table. You might lower your borrowing from 80% loan to value to something lower, like maybe 65% or 70%.

You would want to target a higher debt coverage ratio like 1.5. In that scenario you might take that same $120,000 profit and target $80,000 of that to go towards debt service and $40,000 in free cash flow. The stronger cash flow on paper makes the project more resilient towards surprises. You could need that extra buffer. In our projects we are targeting higher debt coverage ratios above the minimums in order to bring that extra level of safety into the projects.

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