The Real Estate Espresso Podcast

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AMA - Qualified Opportunity Zones Jan 24, 2020

Show notes

Dr. Kevin Hsu from NYC asks

I like your idea of buying on the line and moving the line. Does that concept ever apply to what the US government calls “opportunity zones” as well , those designated areas generally which are considered bad and in need of development , Rehabilitation.

Supposedly they have significant tax incentives if selling after ten years?What are your thoughts on investing in Opportunity zones?

Kevin, this is a great question.

Over the years we’ve developed this strategy called buy on the line, move the line. What is that line? It’s that line between the hot fashionable neighborhood with coffee shops and art galleries. You go two blocks too far in the other direction and you’re in the hood. Wherever you live, I can virtually guarantee that every city in North America has that situation. The idea is to buy a property just on the wrong side of that line for pennies on the dollar and redevelop that property. Once you’re done, the line is now on the other side of your property. When you go to get an appraisal, your only comparable property is in the hot area next door. There are no comps in the hood.

A Qualified Opportunity Zone is something that was introduced in the Trump Tax Code of 2017, the single largest revamp of the tax code since Ronald Reagan was President. The idea is to stimulate development in some of the poorest and economically disadvantaged areas in the country. Each state had the opportunity to designate up to 25% of the lowest income areas as opportunity zones which would qualify for preferred tax treatment by sheltering capital gains from taxation.

The short answer is yes, Qualified Opportunity Zone investments can often dove-tail nicely into the buy on the line strategy. In particular, we’ve seen several cases where the boundary of an opportunity zone is actually in a good area, or across the street from a good area. How these maps were arrived at is anybody’s guess.

It’s not my role to provide you with tax advice. I’m not an accountant. I’m not a tax lawyer. Everyone’s tax circumstance is different and what I’m saying may or may not pertain to you.

If you take the time to do the math, what you will discover is that the rate of return for something that is fully sheltered from Capital Gains Tax for the full 10 years, will give you an internal rate of return that is 2% points higher than one that is not.

So if your investment would naturally give you a 12% IRR, then the equivalent project in an opportunity zone would give you 14%. If your IRR was 14% in a vanilla project, now you could expect 16%.

As you know, you need to assess the risk on that 14% IRR. After all, the 14% IRR is only a forecast, constructed by a financial model that has a number of assumptions and risks.

Finding the right opportunity requires extensive work and due diligence. If it’s a new development project, then you want to know that the developer who is developing the project has strong experience and track record. In my experience, the greatest risk is in fact the developer and not the project.

You want to perform due diligence on the deal sponsor, the project, and the submarket. The deal might look good on paper, but unless the sponsor can execute on it, it doesn’t matter how good it is on paper.

Beware Auction Fever Jan 23, 2020

Show notes

On today’s show I’m talking about a property that I placed an offer on, and ultimately lost. The West end of Ottawa Canada has extremely low inventory. Some realtors estimate that there are 75 potential buyers for every one seller. Inventory is less than 10 days.

In fact, in my suburb of the city which represents a population of 90,000 people, there are only 16 homes listed for sale, 14 of them are South of a major freeway and in a less desirable area, and only two of them are North of the Freeway and one of those is already conditionally sold.

So to say that there is zero inventory in our market is not much of an exaggeration.

The home I placed the offer on was about 21 years old. The builder had acceptable build quality, and I know the builder first hand having purchased another home from them several years ago.

The owner of the home was the third owner in 21 years, and none of the owners had made any upgrades to the property to speak of. There was no backsplash in the kitchen, the appliances were new. The furnace was original. The windows needed replacing. There were many signs of deferred maintenance. The furnace was sitting in a puddle of water and there was a dehumidifier set up next to the furnace.

Needless to say, there was a lengthy list of items to investigate.

As is often the case in a sellers market like this, the agent for the seller set up the sale process as an auction. Offers would be accepted up until 3PM the day after the showing and I submitted my offer on time.

Our offer was a cash offer and had only a 10 day contingency for inspection. Given the scope of problems we saw in our short initial visit to the property, an inspection by a professional inspector was clearly warranted.

An hour later, the agent came back and said there were multiple offers. Did we want to amend our offer?

In response, I increased the offer price by $10,000 and reduced the inspection contingency period by 5 days.

The agent came back an hour later and asked if we could come up another $5,000 which we did.

Then by dinner time, the listing agent came back and informed me that we did not win the bidding war. The seller was not comfortable with the inspection condition.

They went with another offer at a lower price with no conditions.

So here’s the interesting situation. The buyer took the risk of a significant amount of deferred maintenance. I saw about $30,000 of work with the naked eye in less than 15 minutes on the property at night time. I probably would have seen more with a proper daytime inspection, and still more with a professional building inspection.

I think the buyer was silly to take the risk on that much deferred maintenance. I’m not scared of repairs and upgrades. In fact, I was glad that the seller didn’t try to do a poor quality renovation. A poor quality remodel would have made the home even more difficult to purchase.

One agent told me that in the current market, placing a condition of any kind on an offer means losing the auction.

I don’t regret losing the auction. I don’t like auctions, and I don’t like the artificial scarcity that an auction represents. Auction fever is real, and when it takes hold, paying too much is almost always the result.

I’m not an anxious buyer. I’m never an anxious buyer.

It’s far more important to me to purchase a property using the right process and not cut corners. Just because other people are willing to be desperate, doesn’t mean I need to be desperate.

Decisions made out of haste or desperation are rarely the best decisions in life.

Fixed Price Versus Floating Jan 22, 2020

Show notes

On today’s show we’re talking about how to save money by unbundling.

There’s two ways to buy a service. You can pay an hourly rate, or you can pay a fixed price. It’s attractive for a buyer to pay a fixed price from a budgeting standpoint. If you are raising capital for a project, you need to know how much something is going to cost. You can’t simply write a blank check and hope that it will all work out the way you want.

Some contracts are a guaranteed maximum price contract. In those contracts, you go through tremendous pains to make sure the scope of work is fully understood and you conduct a detailed review of the specifications to make absolutely sure that nothing has been missed. In a fixed price contract, the price is fixed, and so too is the specification. If there’s an error in the specification, you can expect to pay more to have it fixed.

It’s often the case that when items are packaged together in a fixed price contract, you end up with some of the things you want and then other things you are not that keen on. You might feel stuck because you’re buying services and products that are not to your liking, in exchange for the certainty of a fixed price contract.

I’ve seen this happen many times when dealing with construction contracts.

There are some times when a construction contract is priced too high. That’s particularly true when the contractor doesn’t know how much time something will take. They tend to quote high to protect their margin. In those cases, it’s in your best interest to pay for the work on an hourly basis instead of paying a fixed price for a package. If you still want a guaranteed maximum price contract, then the solution might be to quote a time allowance for a particular line item in the contract. Any time over and above the allowance would be charged at an hourly rate.

A simple case in point was a drywall plastering job that had three extra line items that were priced above the original scope of work. Each of the line items when bid at a fixed price came to $2,600 in extra work on top of the base contract.

When I asked the person doing the work on site how much effort it represented, he estimated about 8 hours of work. There’s no way that I would spend $2,600 for only 8 hours of work. There’s no way I would spend that much if I paid for the extra work on an hourly basis.

In that case, I went back to the manager for contractor and asked him to quote me an hourly rate for the extra work and then I gave him a blanket authorization for the extra hours.

In the end, the extra work cost me $800 instead of $2,600.

This was all with the same contractor. I don’t feel like the contractor was trying to rip me off in any way. They were estimating the job the way I would expect contractors to estimate the job.

We are often conditioned to think that fixed price contracts are the best way to go. I’m here to tell you that it’s not always the case.

Before you can realistically negotiate this with your contractors, you need the expertise in house to estimate the work and figure out what it should really cost.

Sometimes the local knowledge of the site conditions can give you an advantage over the estimator who is trying to do their work quickly and efficiently. Their goal is not always to get you the lowest price. Their goal is to get the job done, to keep their people busy, and to minimize the time lost to mobilizing staff on and off the job site.

World Economic Forum Outlook Jan 21, 2020

Show notes

On today’s show, we’re talking about a global perspective of growth. The World Economic Forum opened this week in Davos Switzerland. The price of admission to that conference is high, but the networking is awesome. If you’re like me and have projects to get done, you’re probably limited to watching a handful of the video recordings.

The International Monetary Fund’s World Economic Outlook was part of the opening statement from the World Economic Forum this week. It highlighted their growth projections for the next two years.

In that forecast, the advanced economies like the US and Europe are expected to grow by 1.6% this year and next. The emerging and developing market economies are expected to grow by an average of 4.4% this year and 4.6% next year.

The big talk is about a slowdown in China. But frankly, it’s hard to see 6% growth, down from 6.1% growth in the Chinese economy as a slowdown. 6% growth of an economy that’s almost the size of the US economy is still massive growth. That’s 735 billion dollars of growth. Just the growth in China next year is larger than all of Spain’s GDP. It’s larger than all of Austria’s economy. It’s larger than Portugal, Hungary, Serbia, Bulgaria and Croatia and the Czech Republic combined. Here’s the kicker. China’s growth alone is larger than the entire Argentinian economy.

We’re conditioned to think historically of Russia and the US as the two global Superpowers. That was certainly the case for the second half of the last century.

That’s no longer the case. China dwarfs Russia and all of the former Soviet republics.

The US economy is the largest, followed by Europe, and then China. The other emerging market economies of Brazil, Argentina, India, and Russia are a rounding error by comparison.

Gita Gopinath is the director for the research department at the IMF who issued the forecast. In her update she said that the risks to the global economy have reduced in the past quarter. The two major risks were US China trade, and the risk of a no-deal Brexit.

The biggest downward revision of 0.1% in the global economic forecast comes from a slowdown principally in India.

Gita sees the US China phase 1 deal as offering a bright light. Risks remain to the downside according to the IMF.

I bring the World Economic Forum to your attention because it’s an event where some of the most influential people in the world come together for a week. There are the prepared statements which often are not that impactful. What I do find useful is to hear the questions.

Some of the panel discussions are taking questions from the Internet, not just from the attendees in the room.

By participating in the World Economic Forum even from an armchair vantage point, I feel more strongly connected to the major forces that are shaping our world.

I get to see the spectrum of political opinions directly, and not through the lens of the news media’s interpretation of what was said. I’m a huge believer in bypassing the intermediary and going directly to the source.

AMA - Broken Stove in Tenant Apartment Jan 20, 2020

Show notes

This question is from Carol in Toronto.

My husband and I have been living in the same rental for 18 years. For the past 6 weeks, our stove has stopped working and the landlord has not fixed it. He claims he doesn’t have the money. My landlord has been increasingly elusive. We have some evidence that he’s trying to push us out so that he can get a new tenant and raise the rent. The property has other problems with moisture and mold which could be affecting my health. In the past 18 years, he has only raised the rent twice. It would cost me far too much to move. I’m hearing that my landlord may claim that the landlord tenant act doesn’t apply because the home we live in is zoned commercial and not residential. There used to be a business located at our property before we lived here. I want to avoid confrontation, but the way the landlord is treating us isn’t right. I can’t afford to be forced out of my home.

Well Carol, this is a complex question. First of all, I’m not a lawyer and don’t want to be giving you legal advice. There are a number of aspects to your question.

You are clearly paying below market rent. Rents in Toronto have gone up significantly in the past 18 years and you’ve been getting a good deal for all these years and continue to do so.
In the province of Ontario, landlord tenant issues are governed by the residential tenancies act. If you have a dispute with your landlord for items regarding your lease, these are judged at the landlord tenant tribunal. As you’re probably aware, this is a slow process. But there is one major exception to the rules.
The issue with the stove is not a landlord tenant issue but a property standards issue. The same is true for the mold in the property. That too is a property standards issue. The enforcement of property standards is not a provincial matter, but has been delegated to the city. A simple phone call to the bylaw enforcement office will have a bylaw enforcement officer come to visit your property. This is a simple phone call, and they will show up in short order.
The province of Ontario instituted rent controls a few years ago. The landlord has the right to increase your rent. He can’t evict you simply because he failed to increase your rent all these years.
The only circumstance that I know of where a landlord can evict a tenant for anything other than non-payment of rent is that they intend to owner occupy the property, something the owner of the property has the right to do. They don’t have the right to evict you because they don’t like the rent you’re paying and then turn around and rent it to someone else at a higher rate.

I appreciate your desire to avoid a confrontation with your landlord. But the fact that you’ve been without a stove for 6 weeks is unacceptable. In my opinion, you already have a confrontation in the sense that you’re having to spend extra money to buy prepared food instead of cooking at home. A stove is not that expensive and you’re paying your rent on time each month. Ultimately, you need to decide if you believe your landlord is trying to force you out of your property by making it too unpleasant to live there. That is, in my view against the law. The residential tenancies act is pretty clear about that.

Again, the purpose of this podcast isn’t to provide you with legal advice. I’m not a lawyer. But I can point you in the direction of some publicly available information that is easy to download from the city’s website. Getting bylaw enforcement involved is as simple as a call to a 3 digit number. If you dial 311 within the city of Toronto, you will be connected directly with the city.

George Ross on China Trade and Iran Shooting Civilian Aircraft Jan 19, 2020

Show notes

On today's show, I'm talking about negotiation with George Ross. I love getting George's insight's.

Special Guest, Roy Smoothe Jan 18, 2020

Show notes

Roy Smoothe hails all the way from the UK, where he specializes in helping business and entrepreneurs with their brand image. You can learn more about Roy at RoySmoothe.com or at his music website success2music.com. Join me for this fascinating conversation about how to get noticed in today's noisy world.

Tiny Movable Accessory Dwelling Units (No It's Not A Trailer) Jan 17, 2020

Show notes

On today’s show we’re talking about an innovation in creating more affordable housing. The city of Los Angeles has amended their definition of an accessory dwelling unit. The history of an accessory dwelling unit has has be the traditional in-law suite, or the nanny suite. This is sometimes an attic apartment, or a basement apartment. It’s usually attached to the principal home and forms part of the home, but is a separate unit. In these secondary units, the utilities come from the main house and they’re really considered to be part of the main house.

Under the latest change, the city of Los Angeles is adding movable tiny houses to the definition of ADU. I’m going to read the definition directly from the text of the municipal ordinance.

MOVABLE TINY HOUSE.

An enclosed space intended for separate, independent living quarters of one Family as defined in Section 12.03 of this Code and that meets all of the following:

Is licensed and registered with the California Department of Motor Vehicles;
Meets the American National Standards Institute (ANSI) 119.5 requirements or the National Fire Protection Association (NFPA) 1192 standards, and is certified for ANSI or NFPA compliance;
Cannot move under its own power; Is no larger than allowed by California State Law for movement on public highways; and
Is no smaller than 150 and no larger than 430 square feet as measured within the exterior faces of the exterior walls.

So these are truly tiny houses.

There are a few restrictions. For example, No ADU is permitted on any lot that is located in a Very High Fire Hazard Severity Zone designated by the Los Angeles Fire Department.

One parking space is required for an ADU, except that no parking is required for an ADU that is: (i) Located within one-half mile walking distance of a public transit.

All exterior walls and roof of a moveable any tiny house used as an ADU have to be fixed with no bump outs, slide-outs, 7 tip-outs, nor other forms of mechanically moving room area extensions.

Even if your lot is large, you’re only allowed one of these on the property. If the tiny house has wheels, they have to be covered and hidden. The house has to sit on a paved surface. You can’t just put down some gravel and bring in a trailer.

The question is why would the city of Los Angeles want to bring movable tiny houses into the city? Who is it helping? Is it creating more affordable housing?

The fact is, it is creating a small amount of affordable housing for those who reside in the tiny homes. Equally important, it’s making home ownership more affordable for those who wish to purchase a single family home, but can’t quite afford it.

The city is also putting restriction on the types of homes. It’s pretty clear that you can’t just by an RV and hope that it will qualify as a tiny home. They have put rules in place to make it extremely difficult to use an RV for this purpose, without coming out and explicitly saying that they’re outlawing RV’s.

For example, the home must have square cornered windows. You’re not allowed to have radius corners on the windows.

Materials used on the exterior of a moveable tiny house shall exclude single piece composite, laminates, or interlocked metal sheathing.

The home can’t be more than two stories and you’re not allowed to place the tiny home between the main house and the street.

Those who live in tiny homes have given mixed reviews on the experience. On the plus side, you save money because your property is small. Equally important, you have so little space, that you tend to not buy stuff. There’s no point purchasing consumer items that you have no space to store.

California Solar Power Mandate Jan 16, 2020

Show notes

On today’s show, we are talking about solar energy. Let me be clear, I want solar to work. I have solar electric panels on both of my sailboats. I love the idea of getting energy for free.

If solar energy is going to take hold on a large scale, it will be because it makes financial sense for all the stakeholders including consumers of electricity to make the investment. Governments in California don’t trust the population to do the right thing. So starting Jan. 1 of this year, all newly constructed homes and low-rise apartment buildings in California are required to have rooftop solar panels. The state is the first in the nation to carry such a mandate. Prior to the enactment of the law, about one in 5 new homes came equipped with some form of solar energy supplement. All new building permits in 2020 and beyond will require it.

The law also requires better insulation and air filtration for new homes. Some areas also are seeing mandates on the use of natural gas.

The rules for energy use are intended to help alleviate the state’s greenhouse gas emissions. The new laws apply only to newly constructed homes.

The California Energy Commission estimates that the solar mandate and additional building code changes could add between $8,500 - $9,500 per home in construction costs. However, they say the changes will save homeowners $19,000 in energy and maintenance costs over 30 years, or $55 a month. From my perspective, that’s an optimistic view. The solar contractors I contacted estimate the savings at closer to $35 per month per home. That means we’re talking about a 22 year payback on the solar installation. I don’t know about you, but these solar systems have not been tested to a 22 year life. If they don’t last beyond 22 years without maintenance or repairs then it’s likely that the solar installations never fully return their investment.

Many states have implemented financial incentives to sell power back to the electric utility at favourable rates. These rates are often higher than the cost of producing electricity using convention power generation, and certainly higher than the retail price of electricity.

Most utilities, including California have switched from buying power at peak rates to a method called net metering. So let’s say that your home generates more electricity than you use, will the utility write you a check?

The answer is no.

The problem is that the economics don’t yet support solar on its own merits. The cost of electricity from your utility is driven by two major costs. The first is the variable cost. That is, the cost associated with producing an incremental KWH of electricity. If you are burning natural gas to produce that electricity, then the cost of the fuel is the variable cost. The bigger problem is the cost of the infrastructure required to produce and distribute the power. The power system provided by the utility is designed to handle the peak power demand, not the average. Solar power systems produce electricity that lowers the average consumption, but doesn’t really lower the peak demand.

The problem is that the majority of the cost associated with delivering electricity to a residential home is fixed. That is, the infrastructure is so expensive, that the majority of the cost is the amortization of the fixed infrastructure over a number of years. The actual variable cost associate with the energy burned to deliver that electricity to the end customer is tiny by comparison. The problem is that the revenue model for the utility is based on consumption. Lowering consumption lowers the revenue for the utility, but doesn’t actually lower the cost by very much.

The problem is that politicians in this instance are pandering to an idealistic notion that is not born out in reality. If they could shut down a power generation plant, or retire the transmission infrastructure, they could save some real money.

It's An Honest Mistake Jan 15, 2020

Show notes

On today’s show, we’re talking about math errors that some contractors make. These are simple errors to make, but ones that can cost you money.

There are many places where a contractor can hide expenses and it can be difficult for you to figure out where they are.

When you are dealing with high quality contractors, they will be transparent in how their bid was put together. They will clearly show what it costs for each division of work. There will be a line item for framing, for foundations, for site work. Electrical, plumbing, mechanical and so on. There will be somewhere between 15 to 30 separate line items. Then they will show you a line item for their fee, and a line item for what are called general conditions.

General conditions are the items that are needed on the job site that don’t pertain to any particular subcontractor. These are things like the perimeter security fence, rental of the portable toilets, rental of cranes, the waste material disposal and a portable site office. The general conditions are required to mobilize the construction team.

When there are problems in a quote, it’s usually because there is an error in one of the underlying calculations. I take the time and double check the math to make sure it’s correct. For example, I will divide the cost for flooring by the floor area and make sure that the correct rate is in use. Sometimes there is an error. Sometimes the error is in the materials, and sometimes it’s in the labour.

Let’s start with the material allowance. Let’s say you have a room that is 10 feet by 10 feet. We would agree that the room is 100 square feet.

Most people would also agree that you need to purchase more than 100 square feet of material to cover that floor. The cuts won’t match the room exactly and you will have left-over pieces that are too small to use. The usual material allowance is about 10% above the floor area or the wall area. But if you have irregular geometry, the material waste can be even higher.

So let’s say that the tile contractor purchases 110 square feet of tile. I’ve seen that same tile contractor charge for 110 square feet of tile installation. That’s mathematically incorrect. There’s only 100 square feet of floor area. They should charge you for 110 feet of tile material and 100 square feet of tile installation. If the tile comes in boxes of 15 square feet per box, then your will purchase will need to be 120 square feet of tile, because 105 square feet of tile probably won’t be enough. Will the contractor now charge you for 120 square feet? Again, they need to charge you for the exact floor area when it comes to installation, not more.

Then there’s the contractor who charges you for their insurance as a separate line item in the project. If its a large project, then its absolutely fair for the project to bear the burden of the builders risk insurance. But if you’re paying for the builders workman compensation insurance or the builders general liability, and then paying for it in general conditions, that’s double dipping.

Sometimes, the contractor will calculate the labour component based on the materials and not the actual area or length shown on the drawings. That extra is a little bit like the waiter in a restaurant who charges a service charge of 15% and then gets another 15% tip. It’s double dipping. I can tell you that the addition of 10%-15% in cost on a project can make the difference between a viable project and one that’s not.

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