The Real Estate Espresso Podcast

On today’s show we are asking the question, “Why do we need smaller banks?” After all, other countries seem to be dominated by a smaller number of very large banks. Why not rely on big banks and get rid of all the small banks altogether? In the wake of the great financial crisis that started in 2007 and 2008, lending in real estate virtually dried up. Part of the reason that prices fell so much is that the only buyers left in the market were cash buyers. In a market with a surplus of sellers and zero lending, the number of buyers evaporated. It was not a real estate crisis at all. It was a lending crisis that cascaded and became a real estate crisis. In those days I was building new apartments in Philadelphia with my partners. These were smaller buildings, student housing, duplexes, triplexes, 10 unit buildings and so on. There was no way that we would have walked into Wells Fargo or Bank of America and asked for a commercial real estate loan. The policies being set by these lenders were national in nature and the same criteria applied regardless of location. There was no room for local special situations. No lenders would even talk to us, except about four local lenders. These were smaller regional banks with about a dozen branches. At first the terms seemed very difficult. In fact, we went down the financing path with one lender and at the end of 90 days, the lender declined the loan. We started a second time with another lenders and this time after 60 days, the lender declined the loan. The third lender offered a 6% interest rate and a 20 year amortization with a five year term and a pre-payment penalty that would start at 5% in year 1 of the loan, 4% in year 2, 3% in year three and so on. That small bank was Meridian Bank. Today Meridian Bank is in five states and they’re still a small regional bank. The loan terms were not great. We were left with little residual cash flow at the end of each month. That first loan was a blanket commercial loan across four buildings. In those days, the availability of a loan was more important than the rate or the terms. We were able to return capital to our investors and ultimately we held those buildings for a decade and eventually sold them at a handsome profit. At the time, we grumbled over the loan terms. Today my partners and I are very grateful to Meridian Bank for affording us the opportunity to get any financing when nobody else would. As real estate investors, we depend upon lenders who have intimate knowledge of the local market. Having a major bank swallow up a small bank will force assimilation. The new parent companies don’t have a history of expanding their product offering to include the newly acquired banks in their offering. The products become homogenized. If you fit within the neat and tidy box of an hourly employee buying a single family home, with three years of income history you are a potential client. ------------------- Host: Victor Menasce email: podcast@victorjm.com

On today’s show we’re taking another look at what is happening in banking and at some of the risks that are inherent. The leaders at SVB made a strategic error. They failed to hedge their interest rate portfolio. After years of low interest rate policy and continued guidance from the Federal Reserve of another two years of low interest rates, the bank felt confident in buying long term bonds. These long bonds made up 89% of their securities portfolio, which ultimately left the bank in an illiquid situation where they could not convert bonds to cash without a financial impact. Last week the bank declared a $2B loss on the sale of securities. But In total, the value of their securities portfolio was down $17B on paper if they had to liquidate it all today. Over the weekend, the Fed put an emergency tool in place to help similarly affected banks, regardless of size. If a lender has a bond that is in their “hold to maturity” category on their balance sheet, the Fed will allow the bank to borrow against that collateral at full face value. Under the current rules, the banks are allowed to treat US treasuries as good as cash when calculating their reserves on deposit. Clearly a long bond that is trading at a discount in the market is not the same as cash as the folks at SVB found out. It’s too bad that it’s too late for SVB. The Fed’s actions over the weekend should be enough to restore the confidence in the banking system and prevent another similar run on mid-sized banks. In aggregate, the entire US banking system is sitting on a huge pile of bonds that have fallen in value at a time when the Federal Reserve is reducing its balance sheet. It is an issue that isn’t just concentrated in one or two banks: The FDIC has said that across all banks, there were about $620 billion in unrealized losses as of the end of last year. That number has likely increased since the start of the year. So the big question on everyone’s mind is, “Is the banking system safe?” The answer is, “We don’t know”. If we see depositors withdrawing cash on a large scale, the banking system could still fail, even with the measures introduced by the Fed this past weekend. The logical mind says that the Fed has backstopped the banks and there should be no further concern. But we have continued to see panic buying of Treasuries and T-Bills. The yield on the 6m TBill fell by 50 basis points on Monday morning and the 1 year TBill fell 63 basis points. The buying frenzy continued throughout the day on Monday. So much for logic prevailing. It seems that depositors are responding emotionally and pulling cash out of the bank and putting excess cash in short term Tbills. Back in 2008, the toxic debt was subprime loans that were of low quality. This time, the toxic debt is supposedly the highest quality US Treasuries. If SVB is in trouble, then so is everyone else. If the Fed thinks they can wallpaper over it, they are extremely naive. --------------- Host: Victor Menasce email: podcast@victorjm.com

On today show we’re taking a deeper look at the Silicon Valley Bank failure that occurred on Friday of last week. This spectacular bang failure has been making headlines and I am not going to merely repeat the types of things you might be reading on the front page of the Wall Street Journal. That would not be adding any value to you. I’m going to go out on a limb and state categorically that the federal reserve indeed accidentally engineered the failure of Silicon Valley Bank. That might sound like a bold statement. We all know what happened. The bank failed in spectacular fashion in what seemed like 48 hours. Clearly the Banks leader ship understood the gravity of the situation in the weeks leading up to the failure. It is alleged that the CEO sold shares in the weeks leading up to the collapse. But that’s a discussion for another day. As of the close of business on Thursday, a little more than 20 billion of the 175 billion still on deposit at the bank, were FDIC insured. Warnings from VCs to their clients is what caused the run on the bank. So the question is how many other banks are carrying assets that in the open marketplace are clearly worth far less than book value? If depositors were to withdraw funds on a moderate scale, and start putting them into US T-bills or German bonds or some other higher quality paper, how many other banks would suffer the same fee to Silicon Valley Bank? Last June when we met with Danielle DiMartino Booth in person at the Investor summit on send she said some thing which I remember to this day. She said the federal reserve will continue to raise interest rates until something breaks. We just did not know what would break. Well now we do. The member banks that on the federal reserve are likely to be the biggest casualties of the banks rapid increase in interest rates. I predict that on Monday morning, one of the consequences of the Silicon Valley Bank failure will be a complete freeze of new loan origination’s nationwide. Businesses with more than $250,000 in bank balances will move their excess funds into 60 day T-bills. We are going to see a panic wave of buying on Monday and the yield for the 60 day T-bills is going to fall. We have already seen panic buying in Asian markets overnight. So it’s not hard to predict the human behaviour. --------- Host: Victor Menasce email: podcast@victorjm.com

Marco Santarelli is based in Laguna Beach California. From there he manages portfolios of turnkey rentals across more than 20 markets in the US. On today's show we are talking about the current market conditions. To connect with Marco, visit noradarealestate.com. ---------------- Host: Victor Menasce email: podcast@victorjm.com

Richard Canfield is based in British Columbia and specializes in a concept called "Infinite Banking". This involves using funds borrowed from an insurance policy to help fund your real estate projects. He has a white paper that can be downloaded at 7steps.ca which outlines the steps in the infinite banking concept. --------------- Host: Victor Menasce email: podcast@victorjm.com

This short segment is an invitation to an upcoming webinar scheduled for Wednesday, March 15 at 6PM Pacific Time, 9PM Eastern. Our team at Y Street Capital has been investing and developing storage product for some time.  Webinar Invitation Link:  https://bit.ly/YSC_StorageFundWebinar_RegisterHere We have a number of new storage projects in the pipeline and launching a fund just seemed to make sense. Storage is a wonderful and recession resistant asset class that performs well in any economic conditions. The storage industry has attracted a lot of attention in recent years and larger institutional players are entering the market. That means the storage industry is changing. Most primary markets are saturated and over-supplied. Even with all the institutional investment, the industry is still 75% dominated by smaller mom and pop operators. The opportunity is located in secondary markets and in specific vertical segments within storage. For example, boat and RV storage is vastly under-supplied in many markets. If you’d like to learn more, sign up for the Webinar using the link in show notes. Even if you can’t make the live session due to a schedule conflict, we will be recording the session. Registering will give you access to the recording. This opportunity is not for everyone. Investment is limited to accredited investors, residing in the US and would be by prospectus only in compliance with US SEC regulations. Whether you invest or not, attending the webinar will educated you on the opportunity that exists in storage and more importantly, where the industry is heading. Again, the link to register is in the show notes and we look forward to talking with you live on Wednesday March 15. ---------------- Host: Victor Menasce email: podcast@victorjm.com

Today I had a realization. Amidst all of the confusion, all of a sudden the economic picture came clear. I was driving in the car this morning and a certain calm came over me. I’ve been wondering for weeks why there is conflicting economic data and I was unable to make sense out of it. I know what you’re thinking, Victor you need to get a life. When a moment of clarity about the economy is exciting to you , you need therapy. So without any apologies, I can hardly contain my excitement. We are hearing that the US economy is strong, that the economy in Europe is unexpectedly strong. Even in Canada the economy is strong. Employment is strong and we have 50 year low unemployment. But there is one thing I know about the economy. I treat it like a law of physics. We all learned about Newton’s second law of physics back in high school. An object at rest will stay at rest and an object in motion will remain in motion. This speaks to the law of conservation of momentum. We don’t have a corresponding law in economics, but I think the world needs it. That law simply stated is For every unit of economic output, there is an equivalent unit of energy consumed somewhere in the world. ------------- Host: Victor Menasce email: podcast@victorjm.com

On today’s show we are talking about the fallout of Chairman Powell’s testimony to the House Financial Services Committee on Wednesday and the corresponding Senate committee on Tuesday. In his remarks, he reiterated that the Fed sees raising rates further in response to the unexpectedly strong employment, GDP and inflation numbers. On Tuesday, he said the central bank would consider raising the federal funds rate by a half-percentage-point later this month, leading investors to anticipate the larger rate rise. All of this analysis is based on the famous Phillips Curve that forms the basis of so much of Fed policy. Every time the Phillips curve is shown to have fundamental flaws, they tweak the model to try and take some new factor into account. But the same fundamental flaws exist. The basic premise that a tight labor market automatically puts too much negotiating power in the hands of employees is at the core of the financial model. But if we go back through history there is example after example where a tight labor market did not result in inflation. The conclusions drawn by Fed officials using the Phillips curve each and every time has been shown to be incorrect. ------------- Host: Victor Menasce email: podcast@victorjm.com

On today’s show we are looking at where companies are making major investments. This is happening at time when economic uncertainty and higher cost of capital would suggest that it is not a great time to make major investments in new plant or equipment. There are two main drivers for investment in new manufacturing in today’s environment. Expansion of capacity for new and emerging technologies Global Security of Supply In my opinion, these two reasons driving investment in new manufacturing. On today’s show we are going to look at six new factories planned in the United States to see why these factories are being built.

On today’s show we are talking about the theory behind economic cycles and how the theory completely fails to take into account the reality of our world. If you want to learn more about projects that we have underway at Y Street Capital, visit https://ystreetcapital.com/investors/ -------------- Host: Victor Menasce email: podcast@victorjm.com