The Real Estate Espresso Podcast

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Can Stagflation Happen Again? Feb 03, 2020

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Consumption accounts for 60% of GDP.

Back in the 1970’s many of the western economies experienced the so-called stag-flation. The simultaneous occurrence of both economic stagnation and inflation. Traditional Keynesian economists postulated that monetary stimulus by governments would create economic growth.

Until the 1970s, many economists believed that there was a stable inverse relationship between inflation and unemployment. According to this theory, the growth in money supply would increase employment and promote economic growth. The 1970’s proved that this theory was not true.

Fast forward to today. We have central governments printing money like never before. However, it’s not having much of a stimulative effect on the economy. It’s inflating asset prices, but not creating a substantial jump in economic growth.

The other major factor that can’t be over-looked is demographics. If I observe my own behaviour, there was a time when I was willing to spend money on a large scale.

I remember ordering matching custom made leather sofas for our home. They were stunning. Today, my values have changed. I would never do that today. Perhaps it’s because I’m over 50. Maybe it’s the result of spending considerable time on board a boat and realizing that I don’t need all that stuff. There’s no question. I’m actively opposed to spending money these days. I want to invest, not consume. I’m putting increasing amount of money into assets and not into consumption. Am I also responsible for the economic slowdown?

I see other people my age spending less on consumption, even if they’re not investors. In our family, we took the decision to reduce our household from two cars to one. The number of times when both my wife and I need the car at the same time is hardly worth justifying the extra expense.

We have an economic system that requires never-ending growth in order to survive. Unless you have growth, there is no way to practically retire debt. Debt is borrowing from the future to spend money today. The only way that debt makes any sense is if you can have more money in the future.

If the growth isn’t there, then the only solution is the inflation of the money supply. In the world of inflation the currency get devalued. This has the effect of increasing prices. When prices rise, three things are affected.

People on fixed income have their purchasing power eroded. They can’t spend as much on consumption. The only way to feed the consumption side of the economy in those cases is to make more consumer credit available.
Savings get devalued.
Debt gets devalued just the same way that savings do.

So the question is, are there new barriers to employment which are not influenced by monetary policy or fiscal policy?

If you live in California, the state government continues to make it less attractive to do business there.. New laws are making it less attractive to hire in the state of California. If the fed prints more money or lowers interest rates further, you’re not going to see a lot of new hiring happening in California. Access to credit isn’t what’s preventing more people from getting hired.

If you look at Japan, as soon as their population peaked in 2005 and started to shrink, you saw economic stagnation. In fact, today there are over 11M vacant, that’s right 11M empty homes in Japan. The birth rate and immigration are not sufficient to sustain the population. Japan’s population has continued to shrink and their fertility rate is currently 1.4, far below the 2.1 needed to maintain population constant.

The US population is growing through immigration, but only barely. If you want see our economic future look to Japan for a clue on how it might unfold. Increases in government spending and higher debt to GDP ratios have not help stimulate economic growth.

Special Guest David Barnett Feb 02, 2020

Show notes

David Barnett is a business sale consultant. He can be reached at davidcbarnett.com. Such a great conversation.

BOM - Get Smart by Brian Tracy Feb 01, 2020

Show notes

Brian Tracy has developed a massive following over the years because he has figured out how to connect with his audience. He’s studied with the likes of Jim Rohn, Les Brown, Og Mandino, Zig Ziglar, and Wayne Dyer. He’s part of that upper echelon of self improvement gurus.

Brian Tracy’s book is “Get Smart: How to Think and Act Like The Most Successful People and Highest Paid People In Any Field”.

Core to this book is the notion that there is a correlation between successful people and their time horizon. Successful people plan further into the future and are highly future oriented. Everyone, and I mean everyone is on a quest to improve their situation. How they approach that improvement is where the differences lie. The alcoholic seeks to feel better in the moment and uses a drink to get an immediate change in emotional state. The further in the future, the greater the impact and the greater the compound effect of working toward a specific goal.

Brian Tracy’s premise is that your most powerful tool is the one you carry with you everywhere you go. The ability of the human mind to develop solutions simply by thinking is unparalleled in our universe.

Thinking is the hardest work we do as humans, which is why so many people avoid it at all costs. There are those who think. There are those who think that they think. Finally, there is the vast majority who would rather die than think.

It’s not enough to think. We’re thinking all the time, but most of that thinking is useless stream of consciousness. One random thought after another. Some people think quick, some think slow. Both have their place. Driving a car requires quick thinking. It’s almost instinctive natural reaction. But quick thinking is not the way to develop a strategy, to solve a difficult problem. This requires slow thinking, and slow thinking is best accessed in solitude in stillness.

The author contrasts informed thinking versus uninformed thinking. He compares goal oriented thinking versus reaction oriented thinking. He compares result oriented thinking versus activity oriented thinking.

These are just some of the ideas explored in the book Get Smart by Brian Tracy. In the book the author illuminates the path to the habits that when made part of you will enable you to access your best self, to harness your inner potential.

Brian Tracy simplifies his ideas and makes them almost universally accessible. If you’re going to embrace an idea and translate it into action, you need a very specific reaction.

You need to say to yourself, “I can do that”. If on the other hand you say to yourself, “I don’t know if I can do that. It seems pretty hard to me” chances are you won’t embrace it. But if you can visualize the idea and see how you can make it part of your daily practice, it becomes possible.

Brian Tracy is a master at communicating the same idea in multiple different ways. It doesn’t matter whether your preference is analytical, philosophical, story based, or methodical, he finds a way to connect with the broadest possible audience. He brings an idea into the open and shows it up to the light from several angles, without being repetitive or boring.

If you’re looking to diagnose why you might be stuck in some areas of your life, the book “Get Smart” may just open the door you’ve been looking for.

AMA - Contractor Underbid The Job Jan 31, 2020

Show notes

Ramon asks,

I recently purchased a small multifamily property at which I am doing a renovation project with a budget of approximately $300k. My contractor and I have a long relationship, spanning more than 10 years, and have successfully completed numerous projects together. At the beginning of the project we defined a clear scope of work, timeline and payment schedule. After getting off to a good start, we are now 8 weeks behind schedule and I’m noticing some work that is not up to his typical high-quality standard. I had a conversation with him about these issues and he said that he underbid the job and wasn't making any money, but despite that he plans to honor the deal (he pointed out that many contractors would just abandon the job in that situation). I believe that because of this underbid he is skimping on certain things and has a smaller crew than is required to speed up the process.

As I see it I have 3 choices: (a) I can let him finish which will likely result in the project falling another month behind schedule, (b) I can increase the agreed upon price if he agrees to hire more people (this may be a wash compared to the extra holding costs if I go with option (a)) or (c) fire him and hire a new contractor to finish which will likely result in more delays. How would you approach this situation?

Ramon, This is a great question.

It does happen that contractors underbid projects. When they do underbid, they start taking steps to protect their profit margin. They use lower cost labor. They start pulling quality out of your project and using cheaper materials. They slow down to preserve cash flow since they’re going to be losing money. They will do more of the work with in-house labor instead of using the proper subcontractor for the work.

They will cut corners at every turn. Put yourself in their shoes. You would do the same thing. Even good people make mistakes.

I don’t think you should just let him finish the contract, even on a slower schedule. I believe that the impacts will extend beyond just time. You will find quality and materials will be short of your expectations.

If you fire the contractor, there will be costs to break the contract. The contractor will claim that they are owed money for work completed. From there, you will bring a new contractor into the job. They will recognize that the job was underbid, and they will make sure that they don’t lose money. So you will definitely pay more. By the time you put the project out to bid, you will lose even more time and you will definitely pay a lot more. If you don’t agree on the amount owing to the previous contractor, you can expect a mechanics lien on the property, in which case your lender and a new contractor will have a problem with the presence of the mechanics lien. Think about it, would a new contractor take on a project knowing that he might not get paid?

I would recommend the following.

Require complete transparency on the scope of work.
Agree on a fixed profit margin for the GC. If their normal profit margin is say 10%, you’re going to agree on a haircut for that number, maybe 5%, or better still a fixed amount and it won’t be payable until the job is done.
Review the scope of work and get agreement on the pricing for all the subs and in-house labor. In-house labor would be treated the same as a subcontractor for the purpose of the
You can at that time value-engineer any of the finishes and make material tradeoffs yourself. I don’t know the details of your project. So I’ll just through out some ideas for you to explore. You might choose a less expensive flooring material, or eliminate the trench drain in the showers for a lower cost center drain. You might choose a lower cost granite for the kitchen counters, or lower cost windows.

You can recover some of those costs in a value engineering exercise.

Recession Goes Viral Jan 30, 2020

Show notes

On today’s show I’m going to make a bold economic prediction, and its not a popular one.

I don’t frequently make large predictions, but this one seems obvious to me. I haven’t seen anything in the media talking about this as of yet.

I believe that we will see a global recession in 2020. The trigger for this recession is the outbreak of corona virus that has the city of Wuhan in China as the epicentre.

British Airways suspended flights to China today, and it remains to be seen if governments or other air carriers will implement travel restrictions.

Air travel is one of the most effective methods for transmitting illness. You have a few hundred people in close proximity for several hours with a high percentage of recirculated air. The older the aircraft, the more air is recirculated.

Even if infection isn’t transmitted on the aircraft, you have the possibility of infected persons exporting the disease to other parts of the world making it that much more difficult to contain.

The Spanish Flu pandemic of 1918 infected an estimated 500 million people and killed an estimated 50 million people. Think about it, the world had just experienced WW1, and all of the horrors of that multi-national conflict. It was the war to end all wars and hot on the heels of that, along comes a strain of H1N1 that killed another 50 million people.

Back in 2003, the SARS outbreak killed an estimated 800 people worldwide and it too had a high mortality rate.

A few years later in 2009, the so-called swine flu pandemic was another H1N1 virus. Remember, the world was already in recession in 2009. We were in the middle of the largest economic downturn since the great depression. So the impact of a downturn in the global travel and leisure industry was hard to measure. It was just more bad news on top of a mud puddle of bad economic news. There are no official estimates. Some economists estimate the impact of somewhere between 0.5% of GDP and 1.5% of GDP.

But here’s what we do know. After 911 in 2001 travel on a global basis was hit hard. It triggered a downturn in hospitality. People still took vacations at that time, but they were increasingly driving vacations that didn’t involve air travel. In 2001, the global airline industry was weak and were already forecast to have somewhere between $1-2B in losses. In the wake of 9/11, the industry losses grew to $11B and a portion of this was offset by government bailouts of the airline industry. Midway airlines shut down. US Air went into bankruptcy and United Airlines was on the brink of bankruptcy. The only profitable airline in the US that year was Southwest. In total, 13 airlines applied for relief under the stabilization act.

With the SARS outbreak in 2002-2003, the same thing happened. Travel numbers were down dramatically for leisure. Even business travel was restricted and business people held more video conferences than ever before. At the time, video conference technology was not nearly as widely used as it is today.

So here we are at the beginning of 2020. Several countries are working hard to develop a vaccine for the corona virus. It will be at least 6 months before a vaccine is approved for use in humans and still longer before it is manufactured and available in meaningful quantities. A lot can happen in the spread of the disease in 6 months. We have already 6,000 reported cases in Wuhan, an increase of 50% in about a week.

The virus is now reported in 17 countries. Containment is vitally important to prevent a global pandemic. This will affect global travel patterns.

I’m going on record as saying that 2020 will experience a global slowdown in the travel industry that will be of sufficient magnitude to push most major economies into economic recession. This will have a ripple effect into other sectors of the economy.

AMA - Small Mobile Home Park Jan 29, 2020

Show notes

Ray from Florida asks,

I am talking to an owner that will owner finance 100% of a small 20 unit mobile home park, that also has 3 commercial buildings.

The problem is that 16 Mobile Home sites are occupied and the homes are PARK-OWNED. From everything I’ve read it seems wise to see if I can get the tenants To own these homes through a rent to own program or gifting.

The sellers business would then be very different than mine and therefore value the different differently, right? This park has been on the market for over a year.

How would I go about valuing this property while also understand if he is going to finance the whole thing for me.

Thanks for your help!

Ray, this is a great question.

The problem that I see with the park is that it is too small. Even if you get the park to 100% occupancy, you're only looking at income from the ground rent in the mobile home park of about $4,000-$6,000 a month. That doesn't even pay for the staff to operate the park, let alone pay taxes, maintenance, and so on. Even if you got the park for free, I'm not sure it's worth the effort. If the seller is going to seller finance 100% of the park, then you are sort of getting it for free.

If they’re offering seller financing from the beginning, it means that other have tried to buy it already and passed on the opportunity.

If you aspire to become an investor, as opposed to simply buying yourself a job, then you need to look at assets that generate enough income to hire staff.

You only have four vacancies, and therefore your upside is pretty limited. You can only collect an additional $800-$1200 a month depending on how much you charge per home site.

If you’re serious about getting into the mobile home park business, I suggest that you build relationships with people who are experienced mobile home park operators who can help mentor you on what makes a successful park.

The fact is, you can have a vision for the community that you want to build. Some parks are the housing of last resort for the economically weakest members of our society. These are sometimes the worst slums in an area.

At the other end of the spectrum, there are amazingly beautiful parks that are well kept, retirement communities with great amenities, and some of the new high quality modular homes that are built by the nation’s best modular home builders.

All too often, I see newer investors going after smaller assets because they don’t have the cash to buy something larger. The skill that’s missing is the skill of raising capital.

The conventional way of thinking is to only use the money you currently have available at your fingertips.

I personally believe that the ideal mobile home park should have at least 150 spaces. If it’s distressed, then it should be at about 50-60% occupancy and operating at break-even. From there, we can take the park to full occupancy and add significant value with minimal downside risk. Those larger parks might cost more to purchase, and you probably need more cash than you have available.

A larger park brings enough income to justify the staff. If you want to be a real estate investors, then you need a project that can fund employees.

If you had the skill of raising capital, then the purchase price ceases to be an obstacle. If you had a team of specialists where one of you was an expert at operations, another was an expert at raising funds, and perhaps a third was an expert at construction management you could grow and scale your business without limits.

Don’t be scared of a larger project. The path to financial freedom is found in those larger projects, but only when combined with the skill of raising capital.

Making Sense of Statistics Reported In The News Jan 28, 2020

Show notes

Today the Wall Street Journal reported that we could be facing a synchronized slowdown in home prices. On today’s show we’re talking about how to make sense of the conflicting data out there. But what’s reported in the news for individual home owners is very different from what investors will experience.

The Wall Street Journal reported that across 23 countries, an index of inflation-adjusted home prices compiled by the Federal Reserve Bank of Dallas grew 1.8% in the third quarter of 2019 from a year earlier.

The report said that home prices in many countries were falling, including prices in Canada have fallen 0.5% in the past year.

A key catalyst is the global slowdown over the past two years that kept a lid on housing demand and home-price gains. In large cities, affordability constraints are deterring many would-be buyers, and foreigners’ appetite for overseas properties has cooled.

Broad Statistics like this drive me crazy because they’re meaningless. At the same time that prices have fallen in some markets, we’ve seen prices rise dramatically in others.

It is true that foreign buyers in many major cities have fallen. We see this in Miami, Toronto, San Francisco and Seattle.

The claim of a slowdown in Canada is simply not accurate, even in inflation adjusted terms.

Here’s my take on what is happening.

Toronto is the fastest growing city in North America with over 125,000 population growth each year. There were only 27,410 housing completions in Toronto in 2019, down from 37,750 in 2018. The fact is, there is very little developable land left in Toronto. There is a huge reduction of single family homes and townhouses being built. Getting new projects approved in Toronto is a slow and expensive process. The vast majority of new construction is in the condo asset class and fully 60% of new product is high rise condo, 27% single family or townhouse, and 13% rental.

This shortage of supply is what is driving prices up.

The Bank regulator in Canada implemented additional credit tightening to try and cool what was seen as an overheated real estate market, specifically in Toronto and Vancouver.

By making it more difficult to borrow, that has put a cap on prices, but only in some segments of the market. We have seen prices falling at the top of the market. At the same time, we’re seeing prices rising at the bottom and the middle of the market. People will only pay for a home based on what the bank will allow them to borrow. This has reduced the rate of price increases, but prices are still increasing as long as people can borrow.

Home sales increased 14% in November and active listings are down 27% compared with last year. Prices have increased on average 7.1% in Totonto.

In my home city of Ottawa Canada, prices have increased 10.3% for single family homes and 11.5% for condos. Active listings are down 33% compared with last year. Sales volume is up 14%.

There is an increasingly loud chorus of people predicting that home prices will crash in several markets once the current generation of boomers exit home ownership. There’s no question that new supply will open up when that happens. The big question is demand, and how immigration will impact the balance of supply and demand.

If you’re making a financial decision for the next 25 years, I suggest you look out more than the next 90 days to predict where home prices are heading.

AMA - Lender Asks For Additional Security Jan 27, 2020

Show notes

This question came up on Saturday where it was part of a lunch discussion with a group of investors over the weekend.

This particular sponsor was trying to figure out how to work with a private lender who would be lending funds that the project sponsor would ultimately use to fund the earnest money deposit and the equity for the project. The lender wants a 10% rate of return on their money. He’s also asking which property will be used to secure his loan. But the property has not been purchased yet. How can the sponsor convince the lender to keep money available until it’s needed so the 10% interest isn’t being spent on money that I can’t put to work yet.

This is a terrific question. The first thing to pay attention to is the fact that money is not all green. Money always has an agenda.

When I wrote the book Magnetic Capital, I found that raising money was straightforward when there is a perfect fit between the goals for the money and the goals for the project. In fact, there are 5 elements to raising money and if one or more of these elements are missing, then raising money becomes problematic.

The 5 principles are:

Relationship
Trust
Results
Compelling Opportunity
Alignment

Where you’re having trouble is in the last element called alignment.

It’s very important to match goals for the money and the goals for the project. If you don’t have a perfect match between those objectives, don’t take the money because you’re trying to force a square peg into a round hole.

Alignment covers the structure and the terms of the transaction. These are things like the

Size of the investment

The length of time the money will be tied up

The rate of return

Are the funds secured on title?

What’s the tax consequence?

What’s the control structure?

What’s the risk?

The first thing to be aware of is that you are proposing a structure that might be governed by securities laws. Now let me say that it’s not my role to provide legal advice. I’m not a lawyer, and I’m definitely not a securities lawyer. I definitely recommend you get legal advice from a securities lawyer.

Any time you have a situation where there is an active party who brings effort, and a passive party who brings money, you could be walking in securities territory. You may qualify for one or more exemptions. A mortgage exemption is one of the securities exemptions that could apply. But if you’re going to be using the funds for the earnest money deposit, those funds are needed prior to closing the land purchase. Unless you’re prepared to cross-collateralize another property it’s not going to be possible to use the mortgage exemption.

It seems to me like you have a fundamental mismatch between the goals for this particular lender and the goals for the project.

There should never be anything in the process of raising capital that feels forced.

It seems to me like you are ideally looking for an equity partner. An equity investment is not a secured investment. It is an ownership investment, not a loan. You can get a loan for the rest of the project, but you will need some equity in the project.

If you bring an investor into a project to co-invest with you, then you might also consider a joint venture partnership. This could involve you investing a small amount of your own cash, and involving the investor directly in the decision making. That way, you are both contributing money to the project, and all the partners are active in venture. They become a full partner in the joint venture, and then you don’t have to worry about compliance with securities laws, because a joint venture where all the members are active is not a security.

Special Guest, JP Albano Jan 26, 2020

Show notes

JP Albano skipped over single family homes and small rentals and dove directly into the world of multi-family investing. His first investment was a 28 unit building.

You can connect with JP at jpalbano.com

Designing The Real Estate Espresso Podcast Jan 25, 2020

Show notes

Today's show is an extract from a talk that I gave at a thought leadership conference in Toronto on Jan 23. If you've ever want to know how the show is put together behind the scenes, this is the show for you.

Enjoy...

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