The Real Estate Espresso Podcast

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When Your Project Budget Is Too High Jan 14, 2020

Show notes

On today’s show we’re talking about what to do when the numbers don’t work.

You look at a property, you think there’s a deal. But then you run the numbers and pretty quickly conclude that the margin is too thin to take the risk.

At the same time, you see multiple examples of larger projects in the same area. If your costs are similar, then those other projects should not be getting built. They too would be suffering the same risks, costs, and market conditions. So what do you do when it seems that the projects in the same area are getting done, and your virtually identical project doesn’t make sense on paper?

Profits on a project are the result of pretty simple math. So why are your projects not passing the math test? What do these other developers know that you don’t? What are they doing differently?

Profit is simply sale price minus expenses. Your expenses are pretty simple too. They’re the cost of land, labour, materials, design, management, and the financing cost for the property and the inventory of materials.

Are the other guys cutting corners? Are they negotiating deeper discounts? Are they getting access to lower cost financing? Are bringing more equity and borrowing less money? Are they negotiating better hourly rates for the labour component? The answer is yes to most of these, except for one.

The bigger developers don’t cut corners. They negotiate. They make sure that their numbers work without cutting any corners.

One of the biggest differences I’ve noticed is that major developers tend to land bank. We’ve done this in a few markets with excellent results. When you buy land at today’s price, the land often appears too expensive to justify developing it. In some cases, the developer buys the land and just sits on it for a number of years. They also buy the land with equity and not debt. That way their holding cost is kept to a minimum.

Fast forward another five or ten years and that land all of sudden looks like it was bought really cheap.

The most established developers get access to the lowest cost money. They have a strong enough track record that they can get funds that are guaranteed by a mortgage insurer.

I’ve seen major builders negotiate amazing pricing compared with the retail price for materials. You can count on discounts of 30-50% compared with the retail price for materials at the big box home improvement stores.

When it comes to materials, the pricing of materials varies widely with volume. If you buy a truckload directly from the manufacturer, you can save about 15% compared with buying from a distributor. If you’re buying in volume from a distributor, you can expect a huge price break from them too if you order enough material.

Job costing is an art form, and the larger builders have professional estimators whose job it is to source the right quantity of materials, scheduling delivery, and getting the lowest price. If you pay an estimator, say, $80,000 a year. Then you need to know that you’re going to get way more than $80,000 in savings in order to justify hiring that position. In order to get more than that amount in savings, you need a volume of business.

They buy quartz counter tops by the container load from the factory. They’re paying $35 per square foot for quartz instead of $75 - $100 per square foot at the big box home improvement store.

All these little discounts add up over the course of a project.

The big contractors are also the fastest. They show up at the job site with all the materials and tools to get their work done effectively. They expect the delivery truck to be late. So they bring the needed materials for the first few hours of work each day.

It could be that your project is too small. It could be that your contractor is too small as well.

Getting Good Quality Construction Quotes Jan 13, 2020

Show notes

On today’s show we’re talking about how to get construction quotes that make sense. It’s easy to be confused by multiple quotes. On today’s show we’re going to do a case study on a small commercial office build-out in an office.

The scope of the work was to partition about 550 Square feet into three offices and a lunch room. There is the addition of a small sink a fridge and a dishwasher. The existing space has almost all the lighting and electrical needed. We only needed to add electrical circuits for the dishwasher and the fridge.

So all in all, the scope of work seem pretty simple. In total, we’re talking about adding 55 linear feet of new wall partitions. They’re 8 feet high, and the work obviously needs to comply with the building code.

The fact is, this is a very simple project. There’s no doubt that mobilizing a team for a small project would cost a little more.

In order to comply with commercial codes, we need to use metal framing instead of wood framing. The doors should be solid commercial quality doors instead of the hollow doors that are common in residential. The electrical must be done with armoured cable, and the drywall must be 5/8” thick instead of 1/2”. All these things will cost more compared with residential construction. But there is nothing too outlandish so far.

The first quote we received was for 18,000. That seemed high to me. The second quote we received was for a better number, about $14,000, but it left many items open for further refinement. It did not include appliances, nor any electrical work. The scope wasn’t clearly understood.

The third quote was for $37,000 and did not include appliances.

In the end, I contacted a high volume contractor that only works on large commercial projects. What I discovered was that they were going to charge me the same price that they charge the high volume builders. I’m used to paying high volume prices for work on development projects. This fourth quote came in at a great price of under $5,000. The scope was narrow and it didn’t include the entire project. But I was willing to hire the electrician and the plumber. In the end, the project would get done for under $10,000.

When it comes to negotiating construction contracts, even a simple one like this, I tend to focus on getting a detailed breakdown of the work and the cost for each line item. That way I can see if there is a missing assumption or perhaps if the contractor is way off on their view of the scope of the project.

If all you have is a lump sum price, then you have no tools to assess the quote. You can’t tell if the contractor is greedy, or if they’re simply mistaken. Sometimes, the number is too good to be true. That’s as much of a risk as a number that’s too high. When the number is too good to be true, it could mean that they failed to include a portion of the scope in the project.

You can still get a bad quote from a great contractor. It’s tempting in those cases go looking for another contractor. That would be an unfortunate loss for both you and the contractor. Great relationships are hard to find and equally hard to maintain.

By focusing on understanding the scope of work for each line item, I managed to save about 50% compared with the reasonable quotes.

In fact, the contractor I chose didn’t even ask for any monies up front. They simply asked for a purchase order and they would bill me at the end of the month for the completed job.

Sometimes the biggest companies with the largest overhead are precisely the ones you want to do your work. Stay away from the two guys and a pickup truck. They’re the ones you can’t count on to get your project done on schedule or on budget.

Special Guest Matt Shields Jan 12, 2020

Show notes

On today's show, I'm talking with Matt Shields about how he made the transition from single family investing to multi-family apartment buildings. Matt is based in Cleveland Ohio and is investing in multiple markets including Atlanta.

Loe Hornbuckle and Austin Good Jan 11, 2020

Show notes

On today's show I'm talking with Loe and Austin about the merits of purpose built townhouses for rent. This particular product offers some advantages and differentiation in the market when compared with large scale higher density multi-family complexes. Loe can be reached at loe@thesageoak.com and Austin can be reached at austin@angdevelopment.com

The Missing Middle Jan 10, 2020

Show notes

On today’s show we’re talking about the missing middle.

Modern cities tend to get most new housing in either very low-density (usually suburban), or very high-density buildings. In many North American cities, most new units are either detached, semi-detached and townhouse units, or else condo apartments in high-density high-rise towers. The mid-density stuff in between tends to be harder to produce. Larger developers don’t want the hassle of these smaller projects. So the lowest cost developers won’t build these. It leaves the field wide open for the smaller developers to try their hand at developing these types of buildings. Frankly, this is precisely where I started my development career.

Which part of that middle is missing, depends on the city.

In some cities, the missing middle refers to the kind of small walk-up apartment buildings and stacked dwellings that can be built on urban infill lots. This range of mid-density infills, of up to three full storeys and containing perhaps eight or twelve apartments, can serve a wide range of household types. They are more cost-effective to build, and so can be made more affordable to residents, than both lower- and higher-density forms.

A generation ago, there was plenty of affordable housing in the city. Most people chose to move to the suburbs, leaving a large supply of old, pre-war housing behind.

But a lot has changed. People are coming back to the city, and that growing demand for urban housing has put relentless pressure on supply.

People want walkable communities. People want lower maintenance. They don’t want to mow the lawn or shovel the driveway, and they want affordability.

It has become clear that affordability and rental supply isn't just about building more housing: it's about enabling more of the right kind of housing.

In order to keep costs down, you need to create density. Density, means going vertical in order to reduce the land cost per unit.

The limiting factor in virtually any type of housing is not actually the housing. The limiting factor is parking. You might have a parcel of land of, say, 6,000 SF. The city might let you build, for example 16 units on that parcel. The problem is that the parking for 16 cars would consume almost the entire lot. So either you limit the parking, or you find a way to incorporate structured parking. But structured parking is incredibly expensive.

If you want parking, then each parking spot costs as much as a brand new car. Many developers opt to build without parking if there is adequate public transit. But here too, the market still demands some amount of parking.

If you want to build ground level structured parking, and elevate the building, then the height restriction becomes the constraint. If the city won’t let you build higher, then you can’t get the parking. Once you introduce the parking underneath the building, then you need to factor in an elevator to get up to the 4th floor.

The key to lowering housing costs when land is expensive is to allow greater density. If you can get more apartments on the same land surface, then you can lower the cost of housing for everyone. If the rents aren’t high enough to pay for the building, then that building won’t get built. When new buildings don’t get built, then rents go up because there is less supply in the market.

Retiring on Cruise Ships Jan 09, 2020

Show notes

On today’s show we’re talking about one vision for retirement that a number of people are actively doing.

For some people, the vision of retirement is that they will take time and travel the world. There’s no better way to do that than aboard a cruise ship.

From the early 1970’s my parents traveled extensively on cruise ships. In fact my father spent no less than 800 days aboard a cruise ship. He had taken the around the world cruise no less than 6 times. He did numerous ocean crossings, and dozens of Caribbean, European and Alaska cruises. Think about it, that’s more than two years of his life, spent aboard a cruise ship. When he was traveling that extensively on board, it was pretty unusual. In fact, from the time I was about 12 years old, my parents were gone for anywhere from 2 to 4 months out of each year. If that were to happen today, I’m guessing they would have been charged with abandonment. But that’s an entirely other matter. My sister and I lived at home, went to school, and did our homework. We cooked our own meals and looked after the house. That was pretty unusual too.

These days, the cruise industry has grown dramatically.

Last year, the cruise industry hosted 27 million passengers. Demand for cruising has grown 20% in the past 5 years and growth has been averaging about 4% a year. An additional 32,000 beds of capacity was added just in the past year alone.

So let’s look at the economics of living aboard a cruise ship. The average cruise passenger spends $213 a day. But that’s with drinks, photos, tours, and all the various sales in the gift shops. If you’re living aboard, the real cost can be much lower.

The average person spends $46,000 a year in retirement. That comes to a daily spend of $112 a day.

I can tell you with a high degree of confidence that you can definitely live aboard a cruise ship for $112 a day on average. Even if you increase the budget to $150 a day, there is a large percentage of the population that could easily afford $55,000 a year. Understand, that if you’re living aboard, that pretty much covers all your daily expenses. Your bed sheets get changed every day, all your meals are included. You might need to buy some clothing and spend a little money ashore, and pay for medical insurance. Apart from this, you have no other financial obligations.

Compared with the cost of senior living in an independent living complex, a cruise ship is still a bargain.

There are activities, shows, entertainment, and a high level of service. Your cabin stewards, waiters, deck hands are all available to help guests at any time.

The ships hospital is equipped to handle any emergency situations. But just beware, if you have a health issue, you can expect the cruise line to transfer you to a hospital at the next port.

An increasing number of people are making the cruising lifestyle part of their retirement plan. I know of some people who have been doing this full time for over 10 years.

Some people don’t like the cruise experience. They don’t like the crowds at the lunch buffet, and they don’t like the party crowd who can be a bit boisterous. But some cruise lines like Holland America and Royal Caribbean have built more of a reputation for being a bit more tame. They don’t attract quite as much of the Spring Break kind of crowd.

While we don’t expect cruise ship living to represent a first choice for many retirees, it is definitely a choice for some. Even those who would consider a sunbelt destination in the winter months are choosing the cruise ship alternative to a permanent second home for those colder winter months.

Government Over-reach Stopped in One Case Jan 08, 2020

Show notes

On today’s show we’re talking about government over-reach which has been partially stopped in one instance.

Municipal Governments all over North America are trying to implement rules to improve the quality of rental accommodations in their cities. One of the methods is called proactive enforcement. That’s code for inspections.

The theory is that if landlords know their property will be inspected, they will have a stronger incentive to make sur their property complies with the building code and property standards that make a property considered inhabitable. Not only do things need to be in working order, they have to be safe, and free from health hazards like molds or other toxins.

You would think that if the goal is to improve the quality of rental properties, then the tenants who have problems with the quality of their units would favour these inspections. Well, in the Commonwealth of Pennsylvania, that rule just got challenged in court.

In June 2015, The Borough of Pottstown Penn enacted a number of housing ordinance amendments. At issue here, the amendments included provisions requiring each owner of a rental property to permit inspections of all rental units every two years. If voluntary access for an inspection is denied, the ordinance allows the Borough to apply for an administrative warrant. The new rule does not disclose what criteria, if any, the Borough must satisfy in order to obtain such a warrant.

In the case before the court, the tenants, and the landlord refused voluntary access to their rental units by Borough inspectors.

The Commonwealth Court overturned a lower court’s ruling in favor of Pottstown in a lawsuit challenging the borough’s rental inspection ordinance. The lower court upheld the right of the borough to enter residents’ homes without cause and without the residents’ consent.

Tenants in the case asserted that the use of administrative warrants is unconstitutional because such warrants are issued without requiring and individual probable cause to believe any building code violation exists. Tenants also pointed out that each inspector is instructed to share with police any observation of an item in the rental unit that the inspector in their sole discretion considers an indicator of criminal activity. This effectively gives police the ability to obtain information about the contents of a dwelling without the need for a search warrant.

The tenants also argued that the privacy protections under the Pennsylvania constitution are more extensive than the protections under the United States Constitution concerning individual rights of privacy and freedom from unreasonable searches.

The actual article in the constitution says,

“The people shall be secure in their persons, houses, papers and possessions from unreasonable searches and seizures..."

This language is similar to that of the Fourth Amendment of the US Constitution, but provides broader protection than the 4th amendment.

In June of 2018, the Borough filed a motion for Judgement on the pleadings. They argued that the inspection provisions of the housing ordinance were not unconstitutional.

On Monday this week, the Judge who heard the cased rules in favour of the landlords and tenants who opposed the new rule. Judge Ceisler’s ruling said, “To require Tenants to endure the inspections before challenging the inspection requirement would render Tenants’ Article I, Section 8 privacy rights illusory,”.

Essentially what the judge was saying is that Pottstown’s rental inspections regime was a way to get around constitutional protections for privacy rights.

This ruling could ensure that every Pennsylvanian who resists a search of their home can only have the government enter with a warrant supported by probable cause that something is wrong inside.

Hotel California - You Can Check Out Any Time You Like Jan 07, 2020

Show notes

For better or worse, we are addicted to growth. Our financial system that is heavily based on rising debt, virtually requires perpetual growth. When businesses shrink, bad things happen. Not only do people lose their jobs, businesses face problems meeting their debt obligations. If they shrink too much, then really bad things happen.

When governments create conditions that are intended to help workers, they sometimes have unintended consequences.

I’ve had the experience of managing employees and contractors in France which is one of the most difficult labour markets that I’m aware of. Every enterprise over 50 employees must have a union by law. On of the consequences of an overly regulated labour environment is that it’s very difficult for workers to find a job, because the liability associated with hiring someone often outweighs the benefits. Employers are very reluctant to hire in that environment. What was supposed to help workers, in fact has the unintended opposite effect.

The State of California took the unprecedented step of requiring companies that hire contract workers to convert them into employees if they work for more than a specified period of time. AB-5, which went into effect Jan. 1, requires companies to reclassify a wide category of California contract workers as employees.

A relatively new California company called Wonolo specializes in connecting workers and businesses. So far they have over 300,000 people working on their platform. Last month Wonolo secured an additional $35M investment from Bain Capital. At the same time, a couple of weeks ago, the company also announced that as of March 1, they would no longer allow businesses based in California to use their platform. This decision will affect tens of thousands of workers who currently use the Wonolo platform in California.

The gig economy has all kinds of contract workers spanning everything from Uber, to drivers for Fedex and UPS. Their customers include all kinds of businesses from Coca-Cola, to Six Flags to Papa-Johns Pizza.

Th company took the decision in order to protect businesses from any unnecessary risks associated with the new legislation. Wonolo doesn’t have the time or the resources to police compliance with the new AB-5 regulations.

So what does temporary contract work have to do with a healthy thriving economy?

So what does this have to do with real estate?

One thing that drives demand for real estate is jobs! Jobs, jobs, jobs. If employment is falling, if it’s too hard to do business in a particular area, then jobs are one of the first casualties. After that then comes real estate as the second casualty.

California legislators may finally get their wish, more affordable real estate. What that means is that prices will fall as more and more people exit the state. The problem is, the ones who are leaving California are precisely the ones that the state really needs to keep. The one’s who stay will be the least mobile lowest earning members of the population. Those who don’t pay taxes don’t really care that California’s taxes are high. It doesn’t affect them.

The folks at Zillow have a nationwide view of real estate. In their latest survey of real estate sentiment, they are predicting that the San Francisco Bay Area will be the worst performing of all real estate markets in the nation.

Of the survey’s markets most likely to underperform in 2020, six are in California and include Los Angeles, Sacramento, San Francisco, San Jose, San Diego and Riverside.

The lyrics in the song Hotel California by the Eagles say “You can check out any time you like, but you can’t ever leave”. I suspect that California legislators have been listening to that song for far too long, because it’s actually not true.

AMA - Wait For A Correction? Jan 06, 2020

Show notes

Dr. Kevin Hsu from NYC asks,

“ I’m curious your opinion on something I heard Jeremy Roll and various other experts say on podcasts in 2019 - that the market is very hot in Multifamily in the past several years, cap rates getting compressed, and the best thing would be to wait on the sidelines for the correction and then jump in.”

Kevin, that’s a great question. There are two schools of thought when it comes to investing. The first is to treat the marketplace as an auction. Properties sell to the highest bidder. In an auction environment, there is a mindset of scarcity. The idea is that there is limited supply of deals, and more money chasing deals. In that environment, the fear of missing out creates an emotional reaction in many buyers.

You’re proposing to not be an anxious buyer and that’s absolutely the right attitude. You never want to pay too much.

You’re absolutely right that prices for investment properties are being bid up in the market to valuations that don’t make sense. In our business we have not engaged the market in the that most investors are. We’re not willing to pay too much.

A simple example was of a property in South Dallas that we looked at last year. It was over 100 units, and decidedly a C-Class property. It’s not in a great area. In fact it is in the middle of an industrial area backing on a manufacturing facility, with a warehousing and trucking property on either side. This is never going to be a B class property, not in that location. The asking price put it at a 5% cap rate. Not only that, the seller was demanding 30 days due diligence, and $200,000 non-refundable deposit even to accept an offer. I have no idea if the seller got their price or their deposit. The argument for the high price and the incredible terms was that the market was supporting those conditions. But it made no sense to me. I would never pay that much for that property.

It’s true that the money is made in the buy, not in the sale. If you pay too much for the purchase, you’re really setting yourself up for failure.

You can go find deals, or you can create them. I personally prefer to create the deal. When you’re finding deals, there is a lineup of people bidding for the same deal. It’s truly an auction.

In that environment, it’s tempting to wait things out until there are better prices in the future. But nobody can predict the future. Will you wait 6 months, two years, five years? What if prices don’t fall enough in a downturn to make the numbers work?

I prefer to have a clear financial model for what makes a deal work. You can either

Find those deals. They do exist, but there are not that many.
Create them.

So how do you create deals? Well, you look at the supply and demand imbalance in the market and you figure out what a project needs to look like to make the numbers work. You figure out how much profit you need per unit, what your construction costs would be, and ultimately what you can afford to pay for the land in order to make that all work. I’m finding that I’m able to build new product for 25%-30% less than the equivalent product is selling for in the open market.

Yes, these projects take longer, and yes there is the additional risk associated with new construction. But when you can build brand new product that is in demand, in the right location, at the price you want, the risks can be managed. That’s proven to be a good tradeoff for me. That doesn’t mean it’s ideal for everyone.

There are a handful of opportunities that appear as the result of special situations. These are things like an older property owner aging out of the ownership process. Sometimes, these opportunities come off-market through relationships with brokers.

Special Guest Sean Gray Jan 05, 2020

Show notes

Sean Gray has a special message for those under 30, and in particular, those who are twenty-two without a clue. By getting in the right environment, by hanging out with Robert Kiyosaki and Ken MacElroy, he's managed to develop skills that are unusual for someone so young. Sean is on a mission to help those young folks who are trying to figure out their path in life, and how to ask themselves better questions. Check it out.

You can reach Sean at SeanDGray.com.

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