The Real Estate Espresso Podcast

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Opinions, Opinions Dec 16, 2019

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On today’s show we’re talking about opinions. The nice part about opinions is that there is no shortage of them. The world is unlikely to run out of them any time soon. Last week we reported on the podcast that Fannie Mae had published their housing confidence metrics showing a very high consumer confidence index as it relates to housing.

A new report published by CCN paints a far more pessimistic view of the market. The report referenced new guidance from Home Depot which has lowered its guidance on both revenue and earnings for 2020. They cite several factors for the lower guidance. There is an acute shortage of homes at the entry level of the market. Homes in this category are those priced below $200,000. The housing market is also experiencing a shortage of mid-tier homes, that is, those priced between $200,000 and $750,000.

The author draws the conclusions that the shortage of supply combined with a possible future increase in interest rates could cause the housing market bubble to burst in 2020.

The author went on to say, “In all, the U.S. housing market is suffering from a lack of supply. This could prove to be its undoing next year as buyers are likely to be priced out of the market if mortgage rates continue to tick up. Americans are already under duress, as evident from four straight months of declining consumer confidence.”

When I read things like this, I sometimes find it hard to make sense of the logic. So I read the article 4 times. Each time, I tried to follow the chain of logic that would lead to the outcome the author is claiming.

Yes, the consumer confidence has fallen for four straight months. It fell from a high of 135 to 125.5. In the past month the index fell from 126.1 to 125.5. A measure of 100 is considered neutral. While it is true that consumer confidence has fallen slightly, it is still considered well into positive territory and is consistent with what the folks at Fannie Mae reported last week.

The author says “Consumer confidence is also low” which is an outright misrepresentation of the data. I’m sorry, consumer confidence is not low, it has dipped slightly, but remains incredibly high, well above historic averages. For contrast, consumer confidence hit a low mark of 60 back in 2013 and didn’t reach 100 until mid-way through 2016. The author of the report seems stuck on pushing a particular narrative and is quoting numbers that actually contradict his conclusions. It’s almost like they’re asking the reader not be confused by the facts.

When there is a shortage of supply and an excess of demand, it has the effect of pushing prices up. That’s exactly what we’ve seen. The shortage is driven by population growth and by the millennial generation finally getting into home ownership. The number of new homes constructed is not keeping pace with population growth.

Where we are starting to see bargains is in the upper segment of the market. These larger homes are selling at a relative discount to the market on a per square foot basis. We call this price compression.

Unless the demand evaporates, we can expect continued upward pressure on housing prices at the bottom of the market. We are seeing prices fall in areas where people are moving out.

So did Home Depot lower its guidance? What does it really mean, and what is driving it? Could it be that a smaller number of homes on the market would in fact reduce the revenue at Home Depot as the author suggests? I read the entire transcript of their investor conference. The author has it wrong.

In my view the author of the article has an agenda. They’re trying to paint a picture that the real estate markets have some downside risk. I get that. I have no problem with having that point of view. If the author wanted to hi light the downside risks, there’s ample data they can find to make that argument. There’s no need to make stuff up.

George Ross on Liquidity Dec 15, 2019

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On today's show, I'm talking with George about how to maintain liquidity in your business. Having cash on hand is vital for dealing with the unexpected. I love George's practical wisdom and common sense approach.

Work Life Balance with Josh McCallen Dec 14, 2019

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Josh McCallen is the CEO of Renault Winery and specializes in redevelopment of distressed resort properties. On today's show we talk about what it means to be a parent and integral to the family when the business life of an entrepreneur can pull you in many other directions. Join me for a very intimate and vulnerable conversation.

AMA - What Do I Do With A Bad Appraisal Dec 13, 2019

Show notes

Today is another AMA episode,

Hayden from Atlanta asks:

I received an appraisal which in my opinion does not reflect an accurate picture of the property value. The comparable properties listed in the report include agricultural land with zero entitlements, versus my property which already is zoned for development, is fully paved and has 46,000 SF of buildings on it. The appraiser ultimately ignored the comparable properties and used an income multiple approach. But the cap rate he chose was a national average which does not reflect the local market conditions in South Florida. I understand that the appraisal process must be independent so that the bank can have an objective view of valuation. But this one is out to lunch. What do you recommend?

Hayden,

This is a great question. Unfortunately, this type of situation is far more common than you might think. Fortunately, it sounds like the errors are pretty grave. The most difficult situation to correct is the appraisal that’s only a few percentage points off. This one sounds like it’s way off.

You are completely correct in saying that the appraisal must be independent and you can’t be seen as directing or otherwise tainting the appraisal.

You want to keep the communication to the appraiser through the lender and under no circumstances should you communicate directly with the appraiser.

If you can get a hold of a market study for your submarket, you may be able to ask the lender to direct the appraiser to narrow their radius and use local data and not national averages which are not meaningful. A third party market study should align with the appraisal quite closely. By showing the lender that the market study and the appraisal are far apart, you can likely convince the lender that there is a problem with the appraisal. The lender can have a dialog with the appraiser, but you can’t.

I had a recent situation earlier this year where just like in your situation, the appraiser used five properties in their comparison. Three of the properties were not good comps at all and like you, compared land that was zoned agricultural with land that was zoned for development. When we replaced the bad comps with relevant comps, the picture changed considerably.

Finally, you can research who are the best commercial appraisers in the submarket and provide a list of three to the bank, asking them to choose a new appraiser. This will requires paying for a new appraisal, and it could delay the closing date.

If you need to delay the closing, you can often negotiate an extension with the seller by offering them an increase in the earnest money deposit, along with a daily interest charge for every day that the closing is delayed past the original closing date. The purpose of the daily interest is to cover the holding cost for the seller so that they don’t incur any losses as a result of the delay in closing. It shows the seller that you’re serious about closing and you should let them know that the cause of the delay was out of your hands.

These types of situations are incredibly common and have to be handled very delicately. Sometimes a bad appraisal can taint a loan approval. I’ve had situations in the past when a bad appraisal meant abandoning a lender and starting fresh to get a new loan approval from a brand new lender and a completely new appraisal.

National Housing Survey Dec 12, 2019

Show notes

On today’s show we’re talking about home buyer sentiment. The folks at Fannie Mae have some of the best research in the country and last week they published their The Home Purchase Sentiment Index® (HPSI). It is a composite index designed to track consumers’ housing-related attitudes, intentions, and perceptions, using the net results of six questions from the National Housing Survey® (NHS).

The index increased 2.7 points in November to 91.5, reversing the decline from last month and re-approaching the survey high set in August. Three of the six HPSI components increased month over month, including large increases in the percentage of Americans who believe it’s a good time to buy and that home prices will go up over the next 12 months.

The data guessed correctly that the Federal reserve would not change rates and that’s exactly what they did. The Fed also signalled that rates would remain steady for some time to come.

The analysis of the data mirrors what I’m seeing first hand in several markets. We are seeing price increases at the entry level in the market. The lower interest rates are creating conditions that enable first time buyers to bid up the price at the entry level. There is an acute shortage of housing at the entry level and many first time buyers fear being frozen out of the market.

This is creating frothy conditions at the affordable end of the market, even if prices at the top of the market are flat and in some cases slightly down.

So what does this mean for real estate investors?

It means that we can expect some movement out of rentals into starter homes for first time buyers. Those leaving rental accommodations will be primarily millennials who are getting married, having children, or otherwise looking to buy a first home.

We are seeing high variability in labor costs from market to market depending on the supply demand balance of construction labor. This translates directly into construction cost. Even a few percentage points difference in construction cost can affect the price of starter homes and the financial viability of new development projects.

The result is that more and more developers are building smaller homes in order to maintain affordability, and they are focusing more on density. This means more townhouses, more stacked townhouses, and more condos.

In higher priced markets, a starter home is not a detached home, but a condo.

The populations of both the US and Canada are growing. We expect about 0.9% population growth in the US this coming year and about 1.6% in Canada. That translates into demand from an additional 2.9M people in the US and about 438,000 in Canada.

New construction in the US is expected to maintain an annual rate of about 1.32M units. That’s barely enough to keep pace with the population growth. When developers In areas that have excess demand, we can clearly expect prices to rise.

Areas that are losing population, like the traditional rust belt addresses can expect prices to remain flat or increase modestly.

Sunbelt addresses where population growth, combined with migration inside the country are seeing very strong demand, in excess of supply. These are the market conditions that I find interesting as a real estate investor.

The same short list of markets keep coming up. This includes Nashville, Atlanta, Dallas, Houston, Charlotte, Raleigh Durham, Austin, Orlando, to name just a few.

If you can find opportunities to acquire development land in the path of progress in any of these markets, you can often create a tremendous amount of value.

Remember, it’s population growth that drives demand, and jobs that drive the ability to pay.

AMA - What About Portland's Mandated Rest Spaces Dec 11, 2019

Show notes

Today’s episode comes to you thanks to Wayne in Austin Texas. His keen eye noticed that there might be some changes coming to the building code in Portland Oregon. In reference to the new initiative in Portland, Wayne asks, “Victor, will this kill commercial and residential investment in Portland?”

Portland is not immune to a growing homelessness problem. Like San Francisco, Los Angles, Miami, New York, and Seattle, Portland is overrun with people sleeping in public spaces and on private property, many of whom suffer from drug addiction and mental illness.

It’s a large and growing social problem that many of these people who desperately need help are not getting the help that they need.

The state’s one mental hospital, Dammasch, which opened in the 1960’s was overcrowded and closed its doors in 1995, and released its patients with no follow up care, turning hundreds out on to the streets, ill-equipped to handle living on their own.

Portland has the dubious honour of having the worst homelessness problem in the nation.

The city estimates its homeless population in excess of 14,000.

Now the City’s Planning and Sustainability Commission has accepted language into its recommendation to City council that would have new construction be required to incorporate mandatory “rest spaces” where the homeless can get safe shelter.

Every city has the right to have their design guidelines. These define the character of the city. The preamble for the design guideline says that proposals that meet all the applicable guidelines will be approved, and those that don’t will be denied. The fact is, the design guidelines contain terms that are in fact at odds. Design is always a tradeoff of conflicting requirements. An absolute statement that says all guidelines must be met is a mathematical impossibility. In practice, it means that the approval will be at the discretion of the review board.

The commission which writes and enforces the city’s building codes, approved a change to building guidelines last month that would require new construction to feature “opportunities to rest and be welcoming” for those who do not number among that building’s residents or customers. This does not apply to all new construction. It applies only to projects of a certain size. It applies for buildings taller than 55 feet, or more than 40,000 SF in buildable area.

A review of the minutes of the meeting shows the motion from Commissioner Magnera where he says that wants to propose a change to the language to say that spaces should “Provide opportunities to rest and be welcome, pause, sit, and interact”.

During the exchange in the meeting, Chair Schultz said: “I’m supportive but am a little concerned about what it means to “rest”... does this relate to sitting or sleeping or both?“

Commission members were asked for clarification on what the new recommendation meant. All of them refused to clarify the language.

After the meeting, the chair of the commission, did offer a written statement. He said, “how private development can provide places for people to feel welcome and safe, as well as allow space for people to rest, especially in light of our current housing shortage.”

Design guidelines like these are not the worst we’ve seen. California has become much more onerous by requiring solar power generation for all new construction, they’ve outlawed gas stoves for new construction, and they are requiring a long list of additional items to comply with the new regulations. The short answer is yes, this increase in requirements will deter some new construction. Will it eliminate it? No, but it’s becoming death by 1,000 paper cuts. It’s no surprise that Texas is leading the nation’s growth and is not burdened by many of these initiatives.

Is CoWorking Profitable? Dec 10, 2019

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On today’s show we’re talking about the office real estate market. And no, we’re not talking about WeWork. I had the opportunity to take over a co-working space that had been operated by an accountant. they had the master lease for about a 7,000 square foot office space that had been divided up into small offices ranging in size from 100 square feet up to about 800 square feet. There were a total of 25 separate spaces, of which all but three were leased. The accountant who owned the accounting firm died, and the wife of the accountant didn’t want to manage the real estate. In fact she was also in the process of trying to sell the accounting firm. The owner of the building was a major national landlord with billions in assets. The offices were renting for $500 to $800 per month for the smaller ones capable of housing one to two professionals. The accounting firm had fallen behind on its rent payments to the building owner was in default under the terms of the lease. The owner had since engaged with another company in the co-working space who ran the floor for a year and they too had fallen behind on their lease payments. The building owner had finally taken over operation of the floor, but in reality didn’t want to be dealing with 25 individual tenants. I already was running another small shared office rental business and the building approached me to take over the running of this 7,000 SF space. I reviewed the financials and the master lease agreement. The tenants were paying below market rents. The expenses were pretty simple to analyze. There was the rent for the entire floor, a few miscellaneous expenses for the photocopier and printer, insurance, and the salary for the receptionist for the floor. The two major expenses were rent at $14 per SF NNN, about $28/SF gross, and the receptionist. The rent wasn’t a bargain, but it was certainly quite fair for a modern B-Class office building. As the business was currently operating, it would break even at 95% occupancy and would generate about $40,000 a year at 100% occupancy. I might be able to raise the rents over time, but it wasn’t clear how many tenants would seek alternatives if I increased the rent. The business would generate a profit if I eliminated the receptionist, but then there would be nobody apart from myself actually working inside the business. That was not something I was prepared to do. It was an inexpensive way to expand in the co-working business. I would inherit all the furniture, all the equipment. It was an instant revenue stream. As is, the business represented too much risk. There was no way I would sign a 5 year lease complete with personal guarantees when I had no guarantee that the tenants would stay with me at a higher monthly rate. So I decided to decline the opportunity. In the latest co-working news, WeWork competitor RocketSpace is pulling the plug on its operations. RocketSpace is a San Francisco-based coworking startup founded in 2011. If RocketSpace files for bankruptcy, it will join another San Francisco coworking company called Sandbox Suites, which filed for Chapter 11 bankruptcy reorganization in April. The prices at Sandbox are pretty attractive if you’re a tenant. An office with two desks costs $1,000 per month. That includes 10 hours of free use of a meeting room each month. I’m talking about an office in San Francisco or in Silicon Valley. That’s incredibly cheap. The problem with these co-working businesses is that the labor costs are high for the number of tenants. A co-working space doesn’t really function properly with zero staff, and the front office staff doesn’t offer enough perceived value for the tenants that the customers would be willing to pay a premium for it. None of these companies have a profitable business model. I couldn’t even make the numbers work with zero capital investment, taking over an existing business.

Arithmetic By Politicians Dec 09, 2019

Show notes

On today’s show we are talking about elementary school arithmetic. It seems to me that elected officials should be able to perform third or fourth grade arithmetic. Multiplication and division would be a bonus, but we will settle for addition and subtraction.

Amazon announced last week that it had leased about 335,000 SF of office space in the Hudson Yards project on Manhattan’s west side. Hudson Yards is the project that was built on the old rail yards that bordered the shipping piers along the Hudson River. That was back in the day when shipping came directly into Manhattan. Today, most shipping commerce comes into much larger container ship terminals in Newark NJ. The Hudson Yards project was the brainchild of the Trump Organization and was more than 20 years in the making. The space will house some 1,500 employees. This despite the earlier Amazon announcement to pull out of locating the so called HQ2, satellite headquarters in Long Island City.

The original plan would have brought 25,000 direct jobs and nearly double that number in pull-through employment.

In response to the Amazon announcement, senator Mike Gianaris issued a press release on Friday declaring victory over Amazon. He said,

“Amazon is coming to New York, just as they always planned. Fortunately, we dodged a $3 billion bullet by not agreeing to their subsidy shakedown earlier this year. Now, we must enact reforms to our economic development programs to ensure no company can seek to take advantage of the public again.”

Since Amazon’s decision to leave New York in February, Senator Gianaris introduced legislation to ban secrecy clauses in economic development agreements, de-link state opportunity zone tax breaks from the federal tax code.

I don’t have a political axe to grind in any of this. I do have a strong opinion that arithmetic has no political affiliation. One plus one equals two. 25,000 jobs is a lot larger than 1,500.

A tax reduction is not the same as a government grant. In order for Amazon to benefit from the reduction, they would have to pay taxes, more taxes than NYC and NY state are collecting today.

The addition of 1,500 jobs is positive. But it’s really a loss of 23,500 jobs, instead of a loss of 25,000 jobs. The loss of 25,000 jobs was entirely the work of a few politicians actively doing the unfathomable.

New York has lost considerable population and considerable tax revenue in the past few years. One million people have fled New York City and the tri-state area—which encompasses New Jersey, Connecticut and Long Island—in the last nine years. According to Bloomberg, almost 300 people are moving out of the area per day.

When politicians make patently false statements in order to aid their narrative, they erode the political system as a whole.

Perhaps senator Gianaris would not mind a system whereby his income would be reduced every time he utters falsehoods. He probably would declare that consequence to be a victory too. He could use the same math that argued Amazon was fleecing the taxpayers of NY.

Reduction of revenue for the state of NY and NYC is hard for the city to tolerate. NYC has gone through considerable resurgence since the 1970’s and 1980’s when the city was on the verge of bankruptcy. They could not repair the crumbling infrastructure. The had 1.3M people on welfare at that time. After Mayor Giuliani took office, that number was reduced to 500,000. Nearly 800,000 people went back to work under Mayor Giuliani.

The fact is that business leaders know how to do math. The issue is not just with Amazon. NY has sent a signal to the business community that it is no longer open for business. When the most basic arithmetic is distorted to reflect a particular narrative, every business leader can see it for what it is.

Kathy Fettke Dec 08, 2019

Show notes

Kathy Fettke is the host of the Real Wealth Podcast, and co-CEO of The Real Wealth Network. On today's show we're talking about market dynamics and how to position the portfolio for the current and next economic cycle.

Special Guest, Dr. Jeff Anzalone Dec 07, 2019

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Dr. Jeff Anzalone specializes in helping doctors and dentists navigate the complex world of main street investments. In this episode we discuss some of the challenges unique to these investors making good investment decisions.

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