The Real Estate Espresso Podcast

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Why We Work Doesn't Work Sep 27, 2019

Show notes

Barely a week ago, Adam Neumann was sitting atop the most valuable startup in the U.S. and getting ready for a blockbuster initial public offering.

Now he’s out of a job.

Back in April of 2018 I dedicated an episode to WeWork and the problems that I saw with their business model. I currently run a shared office rental business consisting of 5 offices. There is no comparison between what I’m doing and WeWork. They are operating on a much larger scale. But for someone who is actually in the same business, I understand the risks and pitfalls of what WeWork is doing, including staffing, master lease agreements, and how to position different product offers in the space.

I’m coming to you live from NYC where WeWork has their largest presence and 55 WeWork locations in Manhattan alone. If you want to rent a dedicated office in NY, it will cost you about $1,100 a month. A dedicated desk will run about $750, and a hot desk will be able $500 a month. All pretty reasonable prices. I think these low prices are both the reason for its widespread adoption, and one of the causes at the root of its financial problems.

The biggest problem with the WeWork business model is that they have signed multi-year master lease agreements and their customers only have a 30 day obligation. The buildings that are owned outright have long term debt. Again, their customers only are on the hook for 30 days.

But here’s the kicker. As if these risks are not enough, the company has never turned a profit. The S1 filing for the IPO was done back in August. A study of their S1 shows that not only were they losing money, they were also losing money from operations. That means that the startup costs for expansion of the business were not the only reason the company was losing money.

The company was losing money in their day to day operations. If they stopped their rabid expansion immediately and spent nothing on growth, they would still be bleeding red ink from operations. They brought in $1.8B in revenue. For every dollar they brought in, they spent $2. So their very survival is predicated on the assumption that they continue to get cash infusions until some point in the future when they might someday, who knows, turn a profit.

Their principal funder was Softbank, the Japanese cell phone carrier who opened an aggressive fund several years ago that was being managed by the founder’s son. But in the past week, the governance at Softbank seems to have stepped in and put a stop to the craziness.

Particularly egregious was the lavish spending by the founder on things that bring zero shareholder value. This included lavish parties, a private jet, and many other expenses.

How is it, that these situations that seem so obvious take months or even years to play out?

Now it looks like JP Morgan and Goldman Sachs are in discussions with the company to lend about $3B, and the company will need to tap the private markets for a couple of hundred million in additional equity. Given that equity investors just took a 66% haircut on the valuation, I personally think this is going to be a difficult sell. This is a $3B loan to keep the company afloat. It’s not to grow the company to profitability. So far, the larger the company has grown, the faster the losses have multiplied.

As a minimum, the new leadership will need to demonstrate to investors that they can manage the company’s finances. That’s going to mean significant headcount reductions and a steep cost cutting program.

I personally can’t imagine myself speaking to investors with a straight face and proposing a money losing proposition. Yes, there can be periods of negative cash flow during the construction and lease-up of a project. That’s different. But this company hasn’t turned a profit since its founding and the founders have sucked out hundreds of millions of dollars to fund their lavish lifestyle. It's the shareholders money!

The Balance Of Trade. Importing And Exporting Culture Sep 26, 2019

Show notes

The US is very concerned these days with the balance of trade. But the US has successfully exported one thing more than any other country on earth. It has exported elements of its culture world-wide. I’ve traveled all over the world and heard American music. I’ll never forget the day I was in Dusseldorf Germany. In the central square was a guy with blond hair, a guitar and a cowboy hat. He had the leather vest, the glasses, everything. He was singing one John Denver tune after another. He looked and sounded exactly like John Denver. Except he didn’t speak a word of English. I’ve heard American music in small family run restaurants in Japan and Taiwan. American fashion has been exported to all corners of the globe. It started in the 1960’s with denim jeans.

The latest thing to be exported to China is American design in senior living, of course, adapted to the unique needs of the Chinese market. Even the concept of senior living communities, whether they be independent living, assisted living, or skilled nursing, the concept originated in the US. If you look through most parts of Europe, Asia, the Middle East, multi-generational housing is the norm. Kids take care of aging parents. In particular, single income households made this the norm. As the societal changes have taken place first in North America, then Europe and now increasingly in Asia, most households are dual income households. There isn’t the flexibility for one member of the family nucleus to remain at home and care for aging parents. The entire senior housing industry owes its existence to the shift from single income to dual income households. We now take senior housing for granted as part of the societal norm in North America. But it’s relatively new elsewhere. For example, the cost of a paid full-time in-house care-giver is very high in North America. Enabling a senior citizen to remain in their own home with help is by far the preferred solution. But when the labor cost is high, it makes senior housing seem like a relative bargain, even though this too can be expensive compared with just renting an apartment.

Several premier US architecture firms are taking part in exporting the senior living concept around the world.

The more ambitious Chinese senior communities are giant resort-style campuses, connected by a centralized, amenity-rich building offering near-seamless integration between interiors and exteriors.

Los Angeles-based architecture firm Steinberg Hart is another active firm in the Chinese market. The firm has designed over 10.6 million square feet of senior housing in China since opening an office in Shanghai in 2000.

But not everything American is the way to go. When we spend time in Europe we love the community feel that is at the heart of virtually every town in Europe regardless of size. People live, work, dine and shop in walkable neighborhoods. I love the feel of these communities. It exists in the smallest villages of a few hundred people, or in cities of millions. In response to this, many new development projects in North America have embraced the mixed use concept with planned retail, residential, hospitality, office and dining all within a walkable distance. The most famous of these trend setting communities was Santana Row in San Jose California. The success of that project spawned numerous projects around North America that attempted to recreate that town center feeling. Today you see town center projects like this in communities like Plano Texas, West Palm Beach Florida, and more recently in my home town of Ottawa Canada. They lack the centuries of history around a medieval town square. But they are often able to recreate the vibrancy and sense of community that many sterile American cities have lost.

This blending of culture is the result of globalization, but not in the sense of trade. It’s the result of the exchange of ideas.

US Short Term Repo Rates Spike Sep 25, 2019

Show notes

What is a Repo Rate and why did it jump to over 5% in just one day? The newspaper headlines were stating that the last time this happened the economy was in 2008 and was on the brink of collapse. The implication being that perhaps the economy is much weaker than the government is telling us. In my research, there is a much simpler explanation. Listen to today's show.

Why Would I Care Where India's Prime Minister Visited? Sep 24, 2019

Show notes

Coming to you live from NYC where we have the UN General Assembly in session. Today is the official first day of debate. According to UN rules, the debate is to last 9 days, although in recent years, they’ve managed to wrap things up usually in about 7 days.

It’s a crazy time to be in NYC. There is intense security everywhere. Traffic is gridlocked. There are private security firms guarding entire floors in the hotels that are housing visiting delegations. Hotels are incredibly expensive. Restaurants need to be booked well in advance.

There are lots of stories catching headlines, everything from protection of our environment to sustainable development.

This year brings new challenges overshadowing the international dialog. We read stories in the news, we see images on television. They’re a world away and it’s hard sometimes to connect the dots.

The central part of any economic development involves energy. Overshadowing the talks this year is the nuclear negotiation with Iran, and the bombing of Saudi oil production facilities that both UK and the US intelligence have connected directly with Iran. Earlier this year, President Trump seemed ready to try a negotiated approach to dialog with Iran. These drone strikes have cut Saudi Arabia’s oil production in half, representing about 5% of the global production of oil overnight. Iran has also re-started enriching weapons grade materials in contravention of their nuclear treaty. These signs of aggression from Iran are attracting widespread condemnation in the West.

As India’s economy has grown, so too has their appetite for energy. There is a clear and direct linkage between economic activity and energy consumption. For every unit of economic output, there is consumption of an equivalent unit of energy. India traditionally has been a major buyer of Oil from Iran.

If you want to see what is happening in the world economy, have a look at what is happening in the energy sector. That’s where the real stuff is happening.

Prime Minister Modi of India was in Houston this past weekend. This is not a traditional place for an Indian Prime Minister to visit while he is in the US for the UN General Assembly. In fact, Houston is really the center piece of his visit. In addition to a rally that he held for a packed house of 50,000 attendees, he visited with Houston based oil and gas companies. One of those companies is Houston based Tellurian. Tellurian just signed a $7.5B pact with India’s Petronet. The agreement was signed in the presence of Prime Minister Modi. Under this agreement, Petronet will initially spend $2.5 billion for an 18% equity stake in the $28 billion Driftwood LNG terminal. India will have the right to purchase 5 million tons of gas per year under this agreement. To put this in perspective, the US exported 22 million tons of LNG last year. So the deal with India is a big deal.

This is a real estate podcast. Why on earth would I be talking about natural gas? It turns out that I have 4 real estate projects within a 20 minute drive of the future site of the Driftwood LNG facility. When there is economic development on this scale, the people who work there need housing, they need retail, they need hospitals, they need storage, they need workforce housing. They need everything.

As a real estate investor, choosing where to invest is influenced by a number of factors. Some people like to invest close to where they live. If you happen to live in an area where the numbers are compelling for now. But the second you step outside that tiny radius around where you live, why would you go anywhere less than excellent? Why would you choose just good, or decent?

When we look to see what is happening at the UN General Assembly, we want to see what deals are being struck outside the UN headquarters.

AMA - Emotional Support Pets Sep 23, 2019

Show notes

Today is another Ask Me Anything episode.

Mike asks,

I love the podcast. Quick and packed with good info.

I have around 75 single family rental houses and recently it seems that people are applying more and more with emotional support animals. Apparently I can't say that I do not allow pets in my rental if they have an emotional support animal. Also, it's my understanding that they don't even have to tell me they have a pet, and they can just bring an animal into the house when they wish and claim that it is an emotional support animal. I have done quite a bit of research on this and am concerned with my lack of rights as the property owner. It seems as if I can't charge any pet fees or pet deposits as well. I can't really even ask any questions related to the animal at all once its in the house. I know its been a problem for airlines and college campuses and seems its increasingly become one for us.

I would love to hear your thoughts on this! Thanks again for a great podcast!

Mike this is a great question.

There are multiple sources of tenant damage that can happen. Pets for sure can be a source of damage. But they’re only one of several possible sources. Some of the literature I’ve read on the topic suggests that pets are nowhere near the top of the list in terms of sources of damage to a property.

The number one cause of property damage in terms of cost is children. There’s no way you would tell a tenant that they can’t have children on the property. That would violate every landlord tenant rule anywhere in existence.

The second highest cost in terms of damage is smoke damage from smokers. The reason is that a coat of paint won’t solve the problem. In the case of chain smokers, I’ve experienced having to put multiple barrier coats of sealing primer, and then finally two coats of finish paint. The smell infiltrates the carpets, and I’ve had to replace carpets. I’ve also had to replace laminate flooring that had absorbed a smell.

Pet damage usually falls into one of three categories:

Pet waste. If a cat or a dog urinates on a carpet, carpet cleaner is often not enough to solve the problem. It can soak into the subfloor and can often require cutting out the subfloor and replacement of the boards. While the scope of that kind of fix can seem large, the actual cost is not really that high.
Scratches on doorways and hardwood floors. Here too, the cost of these repairs is not usually that high. While the damage is very visible, the damage is usually confined to a few small areas. In my experience these repairs are much less than the spills that children can cause repeatedly.
Landscaping. Some pet owners have a bad habit of letting their pet out into a fenced back yard to do their business. After a couple of years these yards look like a mine field of dead grass and craters where pets have been digging. The effort to repair a yard and re-do a lawn can be considerable.

As part of your lease negotiation, you should definitely detail a schedule of costs for damage repairs, regardless of the cause. Some tenants with pets will simply choose to go elsewhere.

Make sure you’ve taken thorough photos and send copies of the photos of the property condition as part of your move-in inspection with the tenant. These photos must include details of windows, doors, doorframes, screens on windows, kitchen appliances, blinds, carpet condition and so on. These photos will be your best defence when it comes time for the tenant to vacate. You can make an argument that they were delivered an apartment in pristine condition and that the damage experienced represents more than normal wear and tear.

My personal opinion is that pets have earned an unfair reputation for property damage compared with some of the other leading causes. They usually don’t do as much damage to a property as the urban legends would have you believe.

Special Guest, Mayor Jim Watson Sep 22, 2019

Show notes

Today's episode is an excerpt of a Q&A session with Mayor Jim Watson. We grapple with questions on affordable housing and short term housing.

Speaking with Chuck Sutherland at The Real Estate Experts Summit Sep 21, 2019

Show notes

This episode is an excerpt of my conversation on The Real Estate Experts Summit where we're discussing my origin story and some of the fundamentals that I believe should underpin every investment strategy.

Oh Bernie, We Need To Chat. Sep 20, 2019

Show notes

If you listen to some of the election rhetoric coming out of the most left leaning candidates, you might be alarmed. And you should be.

I don’t have any party affiliation. I don’t even get to vote in the US election. I’m not a US citizen.

I’ve read through Bernie Sander’s election platform to understand what the core items that are being proposed. I don’t want someone else’s interpretation or spin. I wanted to read the document first hand and make my own assessment.

If you’re going to be opinionated, I encourage you to form your own opinions. Sure it’s easier and less effort to adopt someone else’s opinion. After all, they’ve gone through the effort to form an opinion.

There are a lot of elements and it’s hard to determine which parts he would ultimately be successful in implementing. Politicians rarely get the chance to fully implement their agenda.

Bernie's entire platform contains too many items to cover in a 5 minute podcast. Of particular interest to real estate investors are some of the items related to housing.

He says in his platform and I quote:

“In America today, corrupt real estate developers are gentrifying neighborhoods and forcing working families out of the homes and apartments where they have lived their entire lives and replacing them with fancy condominiums and hotels that only the very rich can afford.”

He then goes on to say several paragraphs later..

If we are serious about addressing the affordable housing crisis, we need to build millions of apartments and homes throughout the country that will remain affordable in perpetuity to prevent displacement and serve future generations. And when we do that, we will create millions of good-paying jobs in the process.

These are in no particular order.

Invest $1.48 trillion over 10 years in the National Affordable Housing Trust Fund to build, rehabilitate, and preserve the 7.4 million quality, affordable and accessible housing units necessary to eliminate the affordable housing gap, which will remain affordable in perpetuity. Units constructed with this funding will be eligible to be located in mixed-income developments.

Use federal preemption laws to ensure these new units are not segregated or excluded by local zoning ordinances.

Invest an additional $400 billion to build 2 million mixed-income social housing units to be administered through the National Affordable Housing Trust Fund, which will help desegregate and integrate communities.

Bernie proposed a 25 percent "House Flipping tax" that would be levied against people who sell a non-owner occupied property at a profit within five years of purchase.

OK. There’s a lot to discuss in his platform. Way more than we could realistically cover on today’s show.

Here’s the thing. Property pricing follows the laws of supply and demand. When a property is listed for sale on the market, there is nothing compelling a buyer to pay the asking price. It is being offered for sale at that price. If there is no demand at a given price, then those properties don’t sell, they don’t rent and they remain vacant.

When someone who makes it their business to renovate homes and put them back into the market, they’re improving the housing stock. They’re taking the risk that there will be demand at a profitable price point. They’re taking properties that in many cases were not in livable condition.

The only solution would be to demolish them and start again. If a 25% flipping tax were to be instituted, I can predict with great certainty that historic buildings in low income areas would not be repaired. I’ve personally played a role in salvaging some beautiful buildings.

Saying that it’s the fault of the flippers that we don’t have affordable housing is a failure to understand the cause and effect relationships that are at play in our markets. Reducing the price of Tylenol won’t eradicate head-aches.

The Fed Cuts Interest Rates Again Sep 19, 2019

Show notes

In this special bonus episode, I'm answering the question - "What does the quarter point cut in interest rates mean for your lending rates?"

The Myth of Real Estate Sep 19, 2019

Show notes

Today’s show was inspired by a number of emails I’ve received over the past month. I’ll get to that in a minute. In reality, today’s show is about the myth of real estate. There is a Giant myth and it’s perpetuated by the people who promote the free evening intro to real estate investing workshop and the weekend bootcamp for $199. That myth is of passive income. Become a real estate investor and you’ll never work another day in your life.

Last month I was a guest on the Rich Dad Radio Show with Robert and Kim Kiyosaki. On that show we talked about senior housing as one of the best investment asset classes. Robert and Kim are great people and they’ve managed to put together a great deal with a senior living operator. Robert and Kim are pure investors, and they also run an active business. Their active business is education. They write and sell books and they have speaking engagements. They manage a portfolio of investments of about 8,000 multi-family apartments. They are hard working people.

They also happen to have mastered the art of maximizing their assets. For example, they have a parcel of land on Camelback Road in Scottsdale. It’s a prime location that had a fitness club on it. Then one of the new fancy fitness clubs opened with two swimming pools and everything was bigger and better. Their fitness club could not compete. They could have chosen to improve the fitness center, but that would not have been the right choice for Robert and Kim at this stage in their lives and careers. Instead, they negotiated a 99 year ground lease with the builder and operator of a senior assisted living business. Smart move. They get to maximize the value of their land and the investment appears as a passive investment to Robert and Kim.

Since the show aired, I’ve been inundated with offers for land to build assisted living projects around the country. The email is usually something like this. Hey Victor, I loved your episode with Robert and Kim. I have an idea for building an assisted living project on this parcel of land that’s near my house. Would you be interested in discussing this opportunity further?

I’m flattered that they appreciated the conversation with Robert and Kim. I’m flattered that they would love to work with me.

But here’s the thing. Imagine if I came to you and said. Hey, I’ve got a piece of land that I think would be great for a restaurant. I can point you to the land, and you worry about the restaurant, building the building, paving the parking lot, hiring the executive chef, hiring the staff, hiring the guys to valet park the cars, the marketing, the supply chain for fresh ingredients. We could be partners.

The land is perhaps expensive, but clearly contributes a very small percentage to the success of a restaurant. The same is true for assisted living. Nobody would ever mistake a restaurant business for a real estate business.

Assisted living is also a service business, just like the restaurant business. It has a real estate component, but the real estate is a small fraction of the value creation. It’s first and foremost an active business. It’s a service business. Yes, the business might get structured so that it looks like a piece of real estate for the purpose of having a tax advantageous structure. But it’s not a passive business.

Yes, you can invest passively in an active business. But don’t confuse being an active real estate project sponsor with being a passive investor. They’re vastly different.

Many businesses have a real estate component to them, but that doesn’t make it a real estate business per se. A restaurant isn’t a real estate business. A hotel isn’t a real estate business, and an assisted living and memory care business isn’t a real estate play either. They all reside in a piece of real estate, and there is definitely a real estate component to those businesses.

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