The Real Estate Espresso Podcast

Today's show was recorded live at the 20th annual Investor Summit on Sand on June 13 at the Mahogany Bay Village Hilton in Belize.  ----------------- Host: Victor Menasce email: podcast@victorjm.com

Gene Trowbridge is based in Southern California, and practices securities law across the US. He specializes in helping syndicators produce compliant offerings when real estate investors work with money partners. On today's show Gene talks about the most common rookie mistakes that are rampant in the industry. To connect with Gene, visit trowbridgelawgroup.com or call him directly at 949-855-8399.  ----------------- Host: Victor Menasce email: podcast@victorjm.com

On today’s show we’re talking about cost segregation, accelerated depreciation and ultimately paying taxes. First of all, I’m not an accountant, and this show is not intended to be tax advice in any way. Always seek your own tax advice. Most investors know that you can record a depreciation expense to recognize the wear and tear on your property. While this is not an actual cash outlay, it can be used to deduct against income and reduce the amount of tax owing. But as a general rule, the depreciation on your building will be calculated over 27.5 years. Land doesn’t depreciate, so you can only depreciate the improvements. But not all things wear out at the same rate. It’s often a good idea to look at depreciating your property in its constituent parts. For example, you kitchen appliances have a different lifespan compared with the paved driveway. The electronic security system has a different life from the security fence. The key to accelerating the depreciation for those items having a shorter life is something called cost segregation. This is an accounting and an engineering exercise that allows you to break your property apart into its individual pieces and depreciate each of these pieces on their own schedule. If it sounds like a lot of work, well, you would be correct. --------------- Host: Victor Menasce email: podcast@victorjm.com

On today’s show we are talking about the changes that are happening in residential real estate. What I’m about to share with you on today’s show is a stratification of the market into three main segments. Now what I’m sharing is not a scientific study. It’s the result of observation. The observation has raised questions. I’m going to share a thesis that might explain what we are seeing in the market. What I’m seeing from conversations with investors and developers is a stratification of the market. There are entry level homes. These are the homes purchased by first time buyers. The category of home could be a condo in a dense urban environment, a townhouse, a semi-detached, or a small suburban bungalow. The next level up are mid range houses having a two car garage and usually four bedrooms. Above that are the luxury homes. What we are seeing is that sales remain brisk at the top of the market. Those who are sitting on a lot of cash are not fundamentally going to have their lifestyle affected by an economic cycle. They’re probably paying all cash for the property, and are not really affected by rising interest rates. At the bottom of the market, sales also remain brisk. There are those who fear being priced out of the market. So they are buying whatever they can in order not to miss out on home ownership. We are seeing the greatest pause in the middle market. These are the people who would make a move to a more expensive property as a want, but not a need. It’s purely aspirational. They don’t need a bigger place. Their existing home is meeting their needs. Perhaps they have a growing family and could use an extra bedroom or space for one more vehicle. But they can still make their existing property work. We have seen sales in this middle segment drop significantly in the past month. Home builders that I speak with are seeing dramatic reductions in traffic at their sales centres in June. June is usually a peak month for new home sales. One volume building I spoke with is experiencing an 80% decline in traffic at their sales center. Deliveries won’t be until the following year, but many buyers are taking a wait and see approach. New homes won’t rate lock for permanent financing until they’re within 30 days of closing. Buyers are not willing to take the interest rate risk that far out in time if they don’t need to move. Many buyers will need to see a period of interest rate stability before making a blind commitment that could create financial stress. ---------------- Host: Victor Menasce email: podcast@victorjm.com

On today’s show we are talking about creating value with land. You’ve all heard the platitude: Location, location, location. Land value is definitely determined by location. But even more important than location is entitlement. When we look at land we are most concerned with three factors in addition to the location. Zoning Topography Soil condition Access to utilities ----------------- Host: Victor Menasce email: podcast@victorjm.com

On today’s show we’re breaking down specifically how the low interest rate environment has translated into inflated asset prices in the stock market. Unless you’re deeply immersed in the system, it may not be obvious how and why that relationship has happened. We’re going to connect the dots for you so that you understand how compensation structures are design in most public companies, and how those structures are being manipulated to maximize compensation for directors and officers at the expense of investors. Let’s imagine that you are the CEO or CFO of a public company. You negotiated bonuses and restricted share grants that reward the officers of the company for improving the profitability of the company for shareholders. The key metric is the earnings per share. In the good old days, company executives focused on growth of revenue and growth of earnings as the pathway to maximizing earnings per share. But remember, we’re maximizing earnings per share. There are two ways to increase that metric. One is to increase the earnings. The second is to reduce the number of shares in circulation. If there are fewer shares in existence, then by definition, the earnings per share went up. Of course by now, since the start of the year we are seeing that it takes more than share buybacks to sustain growth of share prices. Meanwhile these companies are now saddled with a lot more debt that they will need to find a way to pay back from future earnings. When we say that so much of the money printed over the past two years went straight into wall street, this is what we’re talking about.

On today’s show we’re going to break down the lending market into its constituent components and examine each of them independently. The lender is the loan originator who underwrites the loan. The loan servicer is the one who collects the interest. The Investor set an interest rate at which they’re willing to lend money and its up to the loan originator to find a borrower with the correct risk profile that meets the risk tolerance of the investor. Investors in the bond market are also lenders. So when a bank lends money to a borrower, they have to be mindful of the bond buyer who is ultimately going to securitize the debt. Back in the old days, banks would take in deposits and depending on the amount held in deposit, the bank would lend accordingly. Over the past 20 years, we’ve seen an increasing amount of shadow banking. This is where banks sell their debt in bond offerings to the commercial mortgage backed securities market. This takes those loans off the bank’s balance sheet and allows the bank to originate more loans. Banks make money on the differential between the interest collected on their loan portfolio and the interest paid to depositors, multiplied by the bank’s leverage. So for example if a bank charges 5% interest, and they pay 1% interest to their depositors, they collect 5% interest, multiplied by the bank leverage. If they must maintain 10% in reserve, then they collect 9 x 5% = 45%, and they pay out 1%, for a net profit of 44% of the funds on deposit. ‘ It sounds like a good gig and it is. But the banks ultimately want to get these loans off their balance sheet so they can originate more loans. Why? Because banks get paid an origination fee, in addition to the interest rate. If they sign a 30 year loan, then those funds don’t become available for lending again until the loan matures. That means the bank gets to collect their origination fee once every 30 years. But if they sell the loan into a secondary market, they can put that exact same money to work again and collect a new origination fee in addition to the interest on the loan. Private lenders are different from banks in that they don’t have leverage. They can only lend out money that they have in their immediate possession. These lenders lend to private equity firms, private mortgage investment corporations, and they purchase bonds. Private loan originators want to keep their loans recirculating as well. The originator gets to keep the origination fee, and the loan interest gets paid to the investors in the mortgage fund. If the loan term is too long, then the originator stops collecting fees and eventually goes out of business. So private lenders like the shorter loan terms to they can continue collecting fees. Here too, the interest rate is determined by the risk premium that is being attached to the borrower by the lender. I believe we are about to experience another liquidity crisis in the US and elsewhere in the world. If you are unconvinced, then ask yourself this simple question. If the currency is being devalued at a rate of 8.6% per year, would you be willing to lend money to a borrower at 5%? No? How about 6%? How about 7%? Still no? How high would interest rates need to be for you to lend funds to a low risk borrower on a low risk project? You have probably figured out by now that the private lenders and investors are in search of higher yield in order to compensate for the high rate of inflation. So if private lenders are not injecting liquidity into the market, then the only lender left is the lender of last resort and that is the central bank.

On today's show, Rod and I are talking about the market inflection point we are experiencing. Rod is also hosting a three day bootcamp in Denver at the end of July. To learn more about this three day event, visit rodindenver.com ------------------- Host: Victor Menasce email: podcast@victorjm.com

On today's show we're talking about how to navigate the current economic uncertainty. George puts forth some risk reduction ideas that are pure gold. Listen to what he has to say.  ------------------- Host: Victor Menasce email: podcast@victorjm.com

Our book this month is called “Fed up” by Danielle DiMartino Booth. Danielle worked at the federal reserve bank of Dallas for nine years where she ascended to the inner sanctum of those tasked with crafting Fed policy. Last month we reviewed Ben Bernanke’s newest book, “21st Century Monetary Policy “. The contrast between these two books that deal roughly with the same historic timeframe is dramatic. It was clear when I read Ben Bernanke’s book that there was some revision of history at play to better match Mr. Bernanke’s narrative. Some of those revisions were laid bare in Danielle’s book. ----------------- Host: Victor Menasce email: podcast@victorjm.com