The Real Estate Espresso Podcast

Thanks for all your valuable insight into real estate investing through the Real Estate Espresso podcast. I was curious your thoughts about investing in an apartment building right now. Do you think it’s a strategic time to buy since there seems to be low demand for living in an apartment with the recent pandemic subsequently lowering an apartment building’s value therefore getting a better deal? It is so difficult  finding a single-family property that you can justify buying as an investor because they are so expensive right now. Since single-family properties have a high comparative market analysis driving up value, do  large multi family properties have a low income value right now? I am assuming that people will slowly begin to return to apartments and with credit being so cheap and possibly having little demand for apartments it might be a formula for a good investment. What are your thoughts? Thanks! Allan, This is a great question. I’m going to reframe the question somewhat to make a couple of distinctions. As worded, your question is a little too general. In some ways it seems like you’re asking if there are bargains to be found in the apartment market. Part of your question is focused on choosing between investing in apartments versus single family homes for rentals. I don’t view the tradeoff as a yield related tradeoff. They’re fundamentally different products. Real Estate always is hyperlocal. It is true that there is a high vacancy rate in high rise apartments in New York, San Francisco, Seattle, and Toronto. These situations are temporary in some cases, and point to a problem in others. Determining whether the investment conditions are favourable depends on three main factors. The local submarket conditions The local boots on the ground team you have performing your project management and property management The specifics of the deal. Your question is an over-simplification of the issues which need to be looked at in a more holistic manner. If you pick a market like NW Austin or Downtown Nashville which are undergoing significant growth, then one set of market dynamics are at play. Demand has exceeded supply by a wide margin and home affordability is an issue. This is creating increased demand for rental product. Eventually, supply may catch up to meet the demand, and could possibly surpass the demand. A deep analysis of the local submarkets is essential to determine the current supply / demand situation and to forecast what is possible in the 5-10 year horizon in terms of supply and demand. There is no question that there is a lot of institutional money chasing too few opportunities which is creating demand for well managed stabilized product. Investors in search of yield have bid up the prices for these stabilized apartment complexes. Over time, the high quality assets have been snapped up and prices have increased for lower quality assets as money went in search of yield. I personally would not invest in markets with shrinking population. That was true pre-pandemic and it’s still true today. If you do choose to invest in a market like, say NYC or Chicago, be aware that you’re making a bet about market trends reversing direction from the past several years. Chicago has lost population consistently over the past five years for reasons that could be considered underlying and systemic. There are issues with crime, high taxes, anemic employment growth, all of which have contributed to people leaving the city in search of greater opportunity. Our criteria has hardly changed at all over the past 5 years. What has changed are the underlying market conditions. Some areas have become more favourable for investment, and others have become less favourable for investment.

Michael from Ottawa asks, I heard that lumber distributors are stocking pile of wood to keep prices high. Isn't that illegal? That would be artificial scarcity. Then what is the difference between artificial scarcity vs price fixing? Michael this is a great question. The notion of illegal price fixing has been uncovered in various industries from time to time. If it were happening, it would be hard to detect and would require a deep investigation of the type that probably only the FBI or the Justice department could undertake. I spoke with a number of industry insiders and I think I have figured out what is most likely happening. I’m hearing consistent feedback from multiple sources which leads me to believe that the major source of demand is not only for current new construction projects, but also to secure future supply. This is best explained by segmenting the supply chain into various elements. End buyers who buy product only on the day that they need it. End Buyers who pre-purchase materials and warehouse the materials themselves End buyers who write long term contracts to effectively pre-purchase materials and secure future supply when they need it. There is no question in my mind that many of the major builders are doing everything they can to secure future supply of materials. I’m going to quote from a letter that was published by the CEO of a Texas based Matheus Lumber to all of its customers at the end of last week. "As of today, mills cannot keep up with North American demand for forest products. With housing hitting 1.739 million starts in March, there is simply not enough supply to meet the demand. Additional capacity plans for the mills will probably not happen fast enough and prices will continue upward pressure. Mills are currently 45-90 days out and other items even longer. In addition, we are continuing to see 30 days or more in shipping delays for materials ordered. The mills are struggling to find transportation for the material that is already sold. Furthermore, the massive demand is causing the mills to raise prices by the day and/or hour. Prices have now exceeded anything thought possible, with no immediate relief in sight. The Engineered Wood Products are the scarcest among all wood products. Due to allocations by the producers, there is essentially no open market Engineered Wood Products for immediate sale. Some of the major Engineered Wood producers are now only quoting projects that ship after January of 2022. What the CEO of Matheus Lumber is saying echos what I’ve been hearing from other people that I’ve spoken with. I’m hearing many new construction home deliveries that are delayed by several months due to material shortages. If you’re a builder, material shortages impact far more than just deliveries. It means that you have employees sitting idle. In my view the acute shortage we are seeing is real to a degree and it has been made artificially worse by a few companies with deep pockets buying up whatever supply exists in order to secure their supply. That has left the retail market and the small players to fight over the few scraps that are left over. I’m also hearing noises that the US is going to reduce tariffs on Canadian lumber from the current 20% to 9% in order to reduce the cost of lumber and to stimulate more sales coming from Canada to the US. Traditionally, Canadian lumber makes up about 30% of the US supply of softwood lumber for new home construction. I’m personally not seeing any signs of inventory manipulation to result in price fixing. I’m seeing an industry scrambling to meet demand. I’m seeing transportation issues, and I’m seeing large inventory purchasing in order to secure supply.

As vaccination rates rise and Covid-19 cases fall in the U.S., more employers are calling workers back to the office. There’s just one problem: many don’t want to return. There are clearly other areas like Canada, Italy and France that are still firmly within the grip of the pandemic. But eventually, the same reductions in infection rates that are being seen in the UK and the US will spread to other parts of the world. A survey by management consulting firm McKinsey & Co. found only 37% of workers prefer a full-time return to on-site work at the office. That represents a steep drop from the pre-Covid-19 era, when 62% of workers preferred an on-site model. With 30% of employees surveyed saying they are likely to change jobs if required to return to the office on a permanent basis, return-to-work strategy has high stakes for businesses – particularly in the tight market for talent. Some employees have legal protections to refuse to return, such as medical conditions, while others just don’t want to. The pandemic has clearly had an impact on employees mental health. In the US, 56% of employees surveyed reported feeling at least somewhat burned out and at least 27% of employees reported a high degree of burnout. Burnout is especially pronounced for people feeling anxious due to a lack of organizational communication. For some organizations, the onsite environment is truly the best where in-person collaboration results in a more productive environment. During the pandemic, some organizations spent less time in meetings, and certainly less time commuting when forced to work in a virtual environment. In many cases, individual productivity went up. If your organization is considering a wholesale return to the office environment, you may face some unexpected challenges. The McKinsey survey had some fascinating insights. In describing the hybrid model of the future, more than half of government and corporate workers report that they would like to work from home at least three days a week once the pandemic is over. Across geographies, US employees are the most interested in having access to remote work, with nearly a third saying they would like to work remotely full time. With many employers seeing resistance, many are choosing a hybrid approach that can accommodate the challenges employees may have with returning, such as a lack of child care options. It’s also important for talent attraction and retention. Many employees will expect more flexibility moving forward, and it’s likely to be part of hiring negotiations. So what does all of this mean for the office market? There is no doubt that demand of office space is going to continue to fall. I’ve been in direct discussions with the owners of buildings that have seen significant drops in leased space. The number of listings for subleased space has hit an all-time high. Subleases are being offered at fire-sale prices which will ultimately put downward pressure on the leasing rates for new office space that hits the market.

Tom Laune is a rare financial advisor. He advises people to invest in real estate, and also to use Life Insurance policies as a means of leverage for investing. To learn more, vist stressfreeplanning.com. There are a bunch of resources that explain the various strategies and there is a way to contact Tom on his website.

Alicia Jarrett is based in Melbourne Australia and invests in the USA. On today's show we're talking about how to manage people at a distance. To connect with Alicia or to learn more, visit landscouts.com. She can be reached directly at alicia@landscouts.com

You’ve no doubt heard the stories of people struggling to make ends meet in an inflationary environment. You’ve heard of hyperinflation in places like Argentina. This is a place where inflation is currently averaging 42.6% per year. Inflation in Argentina has been running between 25% and 52% over the past 5 years. Venezuela’s inflation is currently running at 3000%. Prices are rising so fast, that quotes for services are only valid for less than an hour. Prices are increasing at a rate of about 1% per hour in order to maintain pace with the devaluation of the Bolivar. When you are in an inflationary environment, prices change fast. People become conditioned to the idea that prices are constantly changing. They know that they can never get ahead really. All they can hope to do is tread water. But this raises the question of what are things worth? We’ve grown accustomed to knowing what things cost, when our reference point is dollars. But separating the notion of price and value is sometimes a little difficult when the price changes frequently. Has the value of a clay brick changed from one week to the next? Not really. Has the value of a 2x4 piece of lumber changed from one day to the next? Not really. Has the value of a chicken for dinner gone up? Not really. It contains the same amount of calories as it did last week. But we’re increasingly seeing prices change quickly. So quickly in fact that suppliers are often willing to quote a price for only a short period of time. Lumber quotes are only valid for half a day. Chicken prices have surged nearly 100% in the past year. Lumber is up by a factor of 5.5 times. Fuel prices are up since the beginning of the year. This is largely due to a fall in domestic production. Higher energy prices definitely have a ripple effect through the economy. But a gallon of gas is not worth any more today than it was six months ago. It may cost more dollars to purchase, but it’s no more valuable than it was six months ago. In my home city of Ottawa Canada, the price of a single detached residential home has gone up an average of 42.3% since this time last year. Let’s have that number sink in for a moment. 42.3% price increase for a single family home since this time last year. Will this price stick for the long term? Is this the new normal? That means that prices have increased by $221,000 in the past year. That comes to a price increase of $605 per day, or a price increase of $25 per hour. When you consider that a work day is 8 hours a day, 5 days a week, the price increase comes to $105 for every hour of the work week. Most working people don’t earn $105 an hour. Even if you did earn that much, you would have to put 100% of your income towards paying only for the price increase. As a real estate property owner, you look at these asset price increases and feel good. But as someone who is servicing increasing debt levels if you're buying in the current market conditions, the prospect can seem daunting. It’s all good until interest rates rise just enough to make the affordability of that massive mortgage loan problematic. In the world of commercial real estate investing, these rapid increases in prices tend to favour landlords. Higher housing prices make it more difficult for tenants to transition from renting to home ownership. But when everything is going up in price the key question is whether rents will increase fast enough to keep ahead of increasing expenses. Prepare to live in a world of very fluid pricing, and try to figure out what that means for the prices you’re going to set in your business.

On today’s show we are talking about another form of situational awareness. When you buy a property in a neighborhood it’s pretty common to drive up and down the streets and look around. Are people leaving trash on the front lawn? Are there broken down cars in the lane way? Are people taking care of their property? That’s one form of situational awareness. We live in a physical world. But that form of situational awareness is a bit like looking in the rear view mirror. What if you could look at a property and see into the future? Well it turns out that you can. When I look at a neighborhood, I want to see who owns each property and what zoning applications have been filed. Let’s imagine that you drive down the street and you see homes, one after another. There is nothing particularly remarkable to see. Some driveways have kids bikes. Some driveways have a basketball net. You might conclude that young families live here. But a search of title might tell you something that is not readily visible to the naked eye. You might discover that one group of houses are owned by the local housing authority. The people living there are receiving some form of social assistance. There is nothing wrong with that of course. But if you were making assumptions about how property values in the area would appreciate, your assumptions might be incorrect. If you found a group of properties that were all owned by the same company, that might point to future development of those properties. If you found a property where the ownership had 5 names on title, you might research the ownership further. When did the property change hands? Was there a death in the family? Ownership by multiple next of kin is rarely a stable situation. Chances are high that the property could appear on the market for sale in the near future. You’ve probably heard investigative reporters use words like “Follow the money and you will understand the motives”. This can be true when you’re looking at property as well. When you look at the chain of title on properties in the area you get to ask questions. Questions like, Why did that commercial property change hands five times in the past three years? Why did that property change hands for $10? Clearly it didn’t change hands for $10. What’s the real story behind what happened? Why is there e mortgage recorded on a property that is clearly above the market value of the property? I wonder what’s happening here? Why did this property have three mortgages recorded on title in less than a year? Who are the lenders? Are the lenders traditional banks or private citizens? That tells you something about what might be happening on a property. You see none of this is visible by driving down the street. A recent search of neighbouring properties uncovered that one of our neighbours could be considered a really good neighbor. The owner of this property has not initiated a zoning application, nor have they done anything to the property. But this particular owner has a reputation for development. Could new development next door add value to our property?

Using historic data to predict the future seems to be getting more and more difficult. It used to be the case that you could rely on recent history as a predictor of near term demand. But that’s become increasingly difficult. On today’s show we’re talking about a new phenomenon that has become so common there is actually a phrase that is used to describe it. We’re talking about revenge spending. Revenge spending is not a new term. It’s often associated with a spending spree that happens when a member of a couple is mad at their partner. This podcast is not about marital troubles. We’re not talking about that kind of revenge spending. The kind of revenge spending that is trending in 2021 is pandemic revenge spending. This is the feeling that somehow we have missed out on treating ourselves for the past year. That somehow the universe owes us something. We’ve put up with no celebrations, no dining out, no concerts, no vacations by the beach, no new clothing and so on. People have the urge to go out and splurge on themselves, almost as a reward for being locked down over the past year. Revenge spending is going to take many different forms. People are spending money on luxuries, but not just in North America. All over the world. For many this is going to mean vacation travel in the second half of the year. So instead of just revenge spending, it’s going to be revenge travel. I’m talking with many people who have their finger on the mouse button, just waiting to purchase their airfare. I also know several who had travel booked for the Spring and have cancelled their plans. It’s still a little too soon in a number of locations to travel. Some countries have stated that they’re willing to accept tourists who are fully vaccinated. But even the global cruise industry is still on life support. In 2019, that industry brought in $57B in revenue and served 29.7M passengers. That’s a lot of vacations that are seeking alternate forms of vacation this year, and possibly into next. It’s going to be some time before the global cruise industry recovers to pre-pandemic levels. The pandemic has caused a number of people to rethink their priorities. Some have quit their jobs. Others have separated from their spouse after being locked up for a year with them. Some have decided to start a new business. One thing that we can easily predict is that the velocity of change in 2021 will be unlike any other year in recent memory. Supply chain shortages are testing the whole notion of supply elasticity of demand. Prices are being bid up across the board. This is true in real estate as well. We are continuing to see white hot market conditions in multiple markets. I have not moved to control as much land in a single time period as I have since the emergence from the pandemic began. The recovery is exposing those who are out of position. The examples are everywhere. The car rental companies had to reduce the size of their fleets in order to survive. Now they have a shortage of cars on holiday weekends. Business travel has not returned, and the demand is coming from the leisure sector. But here too, the demand is changing week by week. The emergence from the pandemic slowdown will be chaotic and exhilarating. It will also be frustrating for those who are out of position. It will be downright dangerous for those who forecast the spike in short term demand to continue. Revenge spending is an isolated event and not a long term trend.

On today’s show we’re talking about putting information where people are looking. Gary Vaynerchuk is the CEO of Vaynermedia, a NYC digital marketing firm. Gary is one of these guys that has the notion of attention deeply ingrained in his being. He tells the story of how when he was a young boy he would run a bunch of lemonade stands. The lemonade stands were operated by older kids. Gary would post signs for the lemonade stands on trees and sign posts. Then he would sit by the side of the road and watch the eyes of motorists to see if they posted signs were catching the attention passing motorists. This is understanding the basics of attention at its most basic level. The fact is, we are overloaded with marketers trying to vie for our attention. So we tune the vast majority of it out. If you as an investor, a sponsor, or a developer want to connect with potential investors, you want to be paying attention to where people are looking. On February 22 of this year Magnify Money which is a wholly owned subsidiary of Lending Tree published a paper based on some market research they had conducted with their clients. There are a number of fascinating findings in this report. Nearly 6 in 10 investors 40 or younger are members of investment communities or forums, such as Reddit or a group of like-minded investor friends. YouTube is the top source for investing information among young investors, with 41% turning to the site in the past month. 22% of Gen Z investors say they were younger than 18 when they started investing, versus 8% of millennial investors. In fact, 40% of Gen Z investors say they were encouraged by their parents to begin investing, which backs the earlier start. Only 36% of young investors plan to use that money for retirement. Instead, 35% will primarily use those returns to make additional investments, while 19% will use the money to pay for a major purchase like a home or a car. As an investor, you might be thinking that having a YouTube channel is not the best way to reach your potential investors. You might be thinking that TikTok is an app for sharing short dance videos. But the fact is, a significant portion of the investing public are turning to these sources for information. Now you might decide that your ideal client is not a Tiktok user. But you should remember that Tiktok as 689 million active users on a monthly basis. That may seem like a small number when compared with Facebook’s 2.7B users or Youtube’s 2B users. That doesn’t mean you should ignore those other platforms. But 689 million users is a significant potential audience. You might be thinking that your investors are likely not millennials, and perhaps not even Get Z. There are not that many accredited investors in that age group. We’re really talking about targeting less than 1% of the population. But if you’re speaking to 1% of 689 million people, that’s still nearly an audience of 7 million people. Perhaps you want to be more selective and speak to the top 0.1%, that’s still an audience of 700,000 people. The key is to find the way to connect with people who are out there looking for you. This particular study provides new insights that were not part of the conventional wisdom when it comes to investment education.

On today’s show we’re talking about three of the spreadsheet, the most common mistakes I see investors make. The first is the dreaded rule of thumb mistake. Somewhere along the way, a real estate trainer provided some rules of thumb about what things should cost. In particular, we’re talking about expense ratios. The logic goes something like this. In a multi-family apartment building, you should allocate about 45% of your revenue to expenses. Well folks, I’m here to tell you that this approach to analyzing your apartment complex is just plain inaccurate. In fact it’s so inaccurate that it’s not even useful as a tool for quick math. I’ve seen the exact same product with the same management company experience two dramatically different expense ratios. In one city, the expense ratio was 31% and in the other it was 42%. The rents were basically the same. The difference was in property taxes and insurance. One city had much higher property taxes which accounted for a massive difference in the total operating expenses for essentially the same product. So rules of thumb don’t work. The only exception to that would be if you had another similar building in the same area with a good bit of operating history. In that case, you can borrow actual expense numbers as an estimate from a similar property in the same area. But you’re not blindly multiplying by a percentage. In that case you’re using real data as a point of reference. Expenses tend not to care how much you’re getting in rent. If you have a lot of common area, you’re going to need to spend money on energy to provide lighting and climate control for those common areas. How old is the building? How much will you need to spend on maintenance? How high is your tenant turnover? The higher your turnover, the more you’re going to spend on unit turns. When a water heater decides that it has reached end of life, it doesn’t care whether you’re getting $700 a month in rent or $3,000 a month in rent. It’s going to cost the same to replace the water heater. But clearly as a percentage of rent, the cost of maintenance is going to be much higher. I’ve then seen investors take this flawed assumption and build a financial house of cards on top of it. There are three deadly sins when it comes to underwriting a deal. Excel will give you beautiful reports and charts and graphs. That creates an aura of legitimacy that far outstrips the integrity of the underlying data. Push the rents above the market. Nothing too aggressive, maybe just $50 a month above market. I’ve seen so many investors delude themselves using this approach. Use the aforementioned expense estimates. The cap rate assumption. The market cap rate is often used to determine the value of a property. But since cap rates these days are so low, even a small change in cap rate can result in a large change in value. I would have valued a new property in that C class location at about a 6% or 6.5% cap rate. But this investor chose to underwrite the value based on a 4.5% cap rate. That 2% difference in cap rate may not sound like that big a difference. But in reality, we’re talking about a 32% difference in value. Simply by choosing a lower cap rate, this investor had inflated the value of his proposed property by 32%. This particular investor had accepted another investor’s pro-forma as a good model without digging deeply into the numbers. It turns out that his expense ratio was below 20% which is unrealistic. When you layer the other sins on top, you find that the cumulative error is a whopping 76% overestimation of the value of the property. But Excel is perfectly willing to dutifully perform the math and show glowing numbers. In short, proper underwriting requires a deep analysis of all the variables that make up the income and expenses for a project. There is no shortcut.