The Real Estate Espresso Podcast

While the world was distracted by a crippling pandemic, major economic shifts were underway and the headlines totally missed it. Changes that affect the course of history happen slowly at first, then all of a sudden. I believe we’re in one of those phases again, right now as we speak. The last time this happened was 1971. We’re still bearing the fallout of the damage that Richard Nixon did to the United States back in 1971 when he took the US dollar off the gold standard. I remember those days even though I was just a child. I was eight years old. We used to listen to a half hour news radio show every evening during dinner time at my house. I remember the news vividly. I watched the news conference when Nixon made the announcement. I remember the OPEC oil embargo of the US. Naturally, the narrative on the news made the oil rich nations of the middle east to be the enemy. It was those nasty greedy oil Barrons in Saudi Arabia that were responsible for the long lines at the gas station, the unprecedented prices for a gallon of gasoline. When in fact, the oil Barrons were quite right to be upset at the notion that they were being paid less for their oil with the illusion that the price remained the same. What followed was a period of inflation, unlike what had been seen in the US in recent memory. Inflation was out of control. It started with oil, then spread to other commodities. Eventually the price increases trickled through the economy and spread to include rent, transportation, food, and eventually wages. It was a time of labour strife, of unions going on strike to protest declining purchasing power and the demand for higher wages. There were strikes at car manufacturers, the post office, at airlines, the railways, the longshoremen unloading cargo ships. The culprits were the big bad corporations who were exploiting their workers. Or were they? Perhaps the erosion of the purchasing power of their wage was really to blame. But since the government wasn’t paying the majority of pay checks in those days, you could only look to your employer for a raise, not the government. So here we are in 2021, with commodity prices shooting up and yet inflation is still below the 2% target. But wheat prices are up 33% of last year. Oil prices are triple what they were at this time last year. Copper prices are up 72.4% over this time last year. Lumber is up 260%. Corn prices are up 80% over last year. Real Estate prices for residential homes are up 16% nationwide. Yet somehow inflation is worryingly low, below 2%. Somehow there is either a disconnect, or the effect has yet to trickle through the system. China is America’s largest trading partner. The tone of the talks this past week in Anchorage Alaska between the US and China have made it clear that China is taking the dominant role in the discussions. OK. So what does this have to do with real estate? If you’re a real estate investor and you’re trying to underwrite deals based on flat market assumptions about inflation, it’s getting more and more difficult to create a financial model that reflects the reality we are now experiencing. If prices are up, will rents follow suit? Transportation costs are up dramatically. The balance of trade can be clearly seen in the cost of transportation. Shipping a container from California to Shanghai cost $445. But that same shipping contained coming from China to Long Beach California costs over $3,000, and if you want to ship to the US East Coast, add another $700. The question is how long until China no longer accepts the devaluing US dollar as a means of payment? When that happens, you will see a rapid drop in value of the US dollar. When that happens, you want to be holding real estate and as few dollars as humanly possible.

Collins asks.  I’m purchasing eight acres of Wetlands. Many people do not know the difference between Flood Zones and Wetlands... which limits the amount of people with whom one can discuss options. The entire site is designated as wetlands. I have an approved permit from the Army Corps of Engineers for a fill pad and building, but NOT a city approved building permit.  I would have to apply for and receive a Wetland Development permit from the City. The city requires a 2:1 mitigation ratio (i.e. 2 square feet of mitigation credit for each 1 square foot of wetland filled…).  The city also requires undisturbed wetland areas to remain in a natural wetland state, so the yard surrounding the proposed building will have to be natural. This means no topsoil and sod is allowed for a manicured lawn, and the only plants or landscaping allowed have to be wetland species plants and trees, no invasive species or non-native wetland landscaping that are typical in a normal, suburban yard landscape. What are some creative ways to use or leverage wetlands? Perhaps borrow against the land as collateral? Or dig in for the long haul and seek mitigations in order to develop? Collins, This is a great question. The question of land value is one that varies widely based on the designation of the land. In my experience, land increases in monetary value only when it has development potential. Land that is zoned rural or agricultural, or environmentally protected is worth very little. You could have the exact same land zoned for residential that sells for $800,000 an acre. That exact same land zoned agricultural or environmentally protected might be valued at $4,000 an acre. We’re talking a 20x increase in value. Wetland mitigation is a designation worth getting for a property. You are correct that in some cases, a property with a wetland designation doesn’t necessarily mean it’s not suitable for development. For example, it could mean that the water table is buried only to a shallow depth beneath the surface. If it’s wet, it could affect the geotechnical stability of the soil It might mean driving piles down 40 feet or until you hit bedrock before in order to create a stable substrate to build a structure on top. A conventional cement foundation may not work in a wetland situation. So your cost of construction could be higher. The range of Wetland mitigations vary widely. At one end of the spectrum, you simply write a check to the relevant authority and they give you a certificate of mitigation. That form of mitigation is called compensatory mitigation. If you’re going to be negatively affecting a wetland, then the state may want some money in exchange to protect other wetland. Generally, mitigation obligations are not assessed on an acre for acre basis. Unavoidable net losses to wetland ecological value resulting from a project are quantified as habitat units using the appropriate Wetland Value Assessment (WVA) model. You can trade these habitat units resulting from a monetary mitigation action to equal the habitat units lost. At the other end of the spectrum, you could spend a ton of money and resources and get absolutely nowhere. Creating a mitigation bank is a complicated high-risk, high-return venture that requires a high-level of specialized expertise. At the very least, you will need to enlist the help of several highly qualified, experienced consultants to navigate the multi-step process. Another option to create value would be to develop a portion of the property and then donate a portion permanently to conservation using a conservation easement. The tax benefit of the conservation easement could be substantial since the value of the land for tax purposes might be assessed at its highest and best use, rather than its value as a wetland.

Kyle Wilson is best known as the President of Jim Rohn International. He has worked with so many of the world's top personal development thought leaders including Zig Ziglar, Brian Tracy, Mark Victor Hansen, Les Brown, Dennis Waitley, to name just a few. On today's show we're talking about how to build a long standing relationship with your customers without "selling them". Kyle is best known for saying that he never uses a marketing tactic that violates a principle.  To learn more, visit kylewilson.com. If you send Kyle an email to info@kylewilson.com, he will send you a copy of one of his most recent books, "The Success Habits of Super Achievers". Let him know that you heard him on the Real Estate Espresso Podcast.

Jas Takhar is one of Canada's top 1% brokers. He manages a large team in Toronto. On today's show we're talking about the market cycle and how investors should be looking at the dynamics in one of North America's fastest growing cities. 

On today’s show we’re talking about a losing bid. Any time you lose a bid on a property, there is a natural reaction to second guess your offer. Did we offer too little or was the winner out of their mind? It happened to us this week. There were a total of 8 offers on this property in a good location. We calculated our offer price based on a reasonable set of zoning assumptions and a reasonable balancing of risk. A day after losing the bid, we spoke with the winning bidder to understand why they had bid nearly $900,000 more than our offer price. It came down to assumptions on the entitled density. If we could only get a low density approved, we would earn zero profit at the price the winner offered. But if he was right, even his offer price was still a bargain purchase price. It all comes down to what you believe the planning commission and ultimately city council will approve in that location. After careful deliberation, and the opportunity to do due diligence, we made an even higher offer to buy the contract from the winning bidder. So not only did we offer to pay $900,000 more than our original offer, we put a premium to compensate the winning bidder for their efforts. We may have got it wrong, or maybe we were right. But now we will have the time to perform the proper due diligence and determine the true potential for the property, and therefore its value. So why would we offer an even higher bid on the same property after having lost the bid? As long as the project ultimately meets our financial metrics, it really doesn’t matter that we’re paying a bit more. Would I prefer to pay less? Of course. The unfortunate thing about auction environments is that the winner almost always ends up paying more than if they were the only bidder. The question is whether auction fever takes over and the winner ends up paying too much. We are pretty disciplined investors and make sure that we don’t take needless risks. So now that we have the property under contract, the key is to determine the viability of the project during the due diligence period. The fact is, we don’t know if the project is truly viable yet. We will need to take the time over the next several weeks and truly determine the envelope of this project. We will run multiple different scenarios. What happens if we get a density of 4 units per acre, or 6 units per acre or how about 12 units per acre. Each one of these scenarios is a completely different product with a different market positioning. But now that we have it under contract, we have the control to make good decisions. Do we feel bad that we’re paying even more? Not at all. We’re constantly learning. What makes this project safe is the notion that land in the core of the city is fully developed. The city is one of the fastest growing cities in North America. It’s certainly within the top 10 fastest growing cities. The inventory is low, and the product we’re aiming to develop will continue to be in high demand, even if market conditions soften. Typically when there is a downturn in real estate, it affects the most expensive end of the market first. This particular property has multiple exit strategies. So we feel safe in developing a few hundred units of new residential housing. We’re still buying the land in a hot area at under $3.50 per square foot. The process of development can a little messy and unpredictable at times. You are literally dealing with a blank canvas. It takes multiple iterations of a design concept to arrive at something that truly fits in every respect. It has to fit the area in terms of features, price point, amenities. It’s truly a creative process that is an art form.

On today’s show we’re going to look at one of the largest barriers to housing affordability. But before we do, we’re going back to basic principles. We’re going to start with the law of supply and demand. If demand goes up and supply goes down, then it follows that prices will rise until a new equilibrium is reached. That’s exactly what we’ve seen over the past year. But in areas of highest prices, we have seen that the acute shortage is not of construction materials, nor has it been the ability to construct, but it’s been the cost of land. But it’s not just land that is expensive, but low density is expensive. Some communities have tried over the years to maintain their sense of community by restricting zoning. Property values have risen accordingly. Let’s look at the Township of Southold on Long Island. This is an area near the North-east fork at the far east end of Long Island. The community is extremely wealthy. Properties are expensive, and the community is decidedly anti development. According to the Township’s own zoning guide, land use within the Township has not changed much in the past decade. But here is the one statistic that fully describes the story. There are only a little more than 13,800 homes in the entire community. That’s a density of 1.27 units per acre in the residential zones. That’s extremely low density. The community has averaged only 30 new construction building permits per year over the past decade. It means that prices have risen to the point where people who live in the area could not actually afford to buy into the area. If they sell their home, they would have to leave. They can’t afford to stay. This situation describes so many communities across North America. But it’s not that Southold lacks land. On the contrary. They have plenty of it. Their zoning specifically is designed to be exclusionary. By artificially creating scarcity, these communities create an aura of exclusivity and therefore they keep the values of property high. Lack of affordable housing is a problem, yes. It’s mentioned in their 58 page zoning guide. But it could be argued that the lack of affordable housing is not really a problem, it’s a feature. Under the recently announced 3.1T Biden infrastructure bill, hidden deep within the pages is a provision to make housing more affordable. The proposed program of at least $5 billion would offer grants to cities and towns that relax restrictions on new construction. This initiative was reported this week in the Wall Street Journal. It’s interesting because it’s attacking the issue of affordability at one of the root causes of the problem. Many of the constraints on development are entirely artificial. It’s not that there is not sufficient land available. It’s that local governments are not allowing you to build projects that would result in affordable housing. They do this by limiting density. The Biden administration said in a fact sheet that the program would award “flexible and attractive funding to jurisdictions that take concrete steps to eliminate such needless barriers to producing affordable housing.” The White House won’t penalize cities if they don’t want to participate, according to some administration officials. Earlier this year I reported that some towns like Minneapolis have taken steps to relax their zoning code and allow for higher density in order to bring more affordable housing into nice areas. The link between value and entitlement has never been more clear.

Today’s question comes from Jeremy. He asks, I’m looking to develop a residential subdivision that is close to a naval air force base. There are plenty of houses all around the subject property. Could the airport affect what gets built on the property? Jeremy this is a great question. The regions around airports are all subject to elevated noise levels. The good news is that modern civilian aircraft have got a lot quieter as more fuel efficient aircraft have replaced the early jet engines of decades past. Newer aircraft use a turbo-fan high bypass engine that relies on the turbine to rotate a fan, rather than simply using the thrust of the tent engine combustion to propel the aircraft. But airports that are close to residential areas regularly get complaints from the general public. The airport authority don’t like getting complaints, so instead they restrict what can be built near the airport so that they don’t get complaints. The aviation authority in most countries have a set of standards that they use to both measure and enforce noise coming from an airport. The FAA has a measure of noise called Community Noise Equivalent Level (CNEL) and a second measure called the Day Night Average Sound Level (DNL) On a map these noise contours show the measurements as you get further from the airport. Some airports that are close to residential areas like John Wayne airport in Orange County have even gone so far as to restrict flight departure and arrival times so as not to disturb the neighborhood. No flight will depart John Wayne before 7AM, and they also need to use noise abatement procedures. That means taking off at a steep angle of attack until the aircraft reaches the boundary of the airport property, then throttling back and using a slower rate of climb. There is a close interplay between the operation at the airport and the surrounding community. Now a naval air force station will have a lot of jets which are very noisy. They often depart in tandem, and they will go supersonic causing sonic boom which is loud enough to drown out conversations inside a home of office building. Strange as it may sound, the airport authority may have jurisdiction over what gets built in the area surrounding the airport. They may prohibit development within certain noise contours. They may also impose additional requirements on the construction. For example, if you are allowed to build, you might be required to provide additional sound insulation. That could include triple glazed windows instead of double glazed windows. I spent several weeks evaluating a waterfront property a few years ago that was close to an airport. The way the map was drawn showed the airport exclusion zone roughly coinciding with the edge of the river. Nobody could tell us whether the inside of the line, the outside edge of the line, or the center of the line represented the edge of the exclusion zone. It would take months for the airport authority to rule on any development. They would not even offer an opinion unless a full application was submitted to the airport authority. That meant spending a lot of money on design and engineering only to be told no you can’t build in that location. So in our case we didn’t buy the property, even though it looked extremely desirable. The last time we looked, that land was still for sale 4 years later. I’m guessing we made the right decision. There are noise and vibration engineers, which is a branch of mechanical engineering. There are a subset of that specialty who specialize in airports. These are the folks you need to consult in making a determination whether your property is buildable or not. The city will generally grant your zoning permit which could give you a false sense of security that you have all the entitlements you need to build a home in that location.

On today’s show I’m going to share a rather unscientific observation. It’s not based on a statistical sample size of any significance. But the data is first hand and for that reason, I’m paying attention to it. A lot has been written about the pain of retail in the past year. There’s lots of office vacancy that has opened up as well. Many are wondering if the workplace of the future has been altered forever by the pandemic. I’ve seen many retail vacancies almost everywhere I look. We’re talking the typical main street locations. Businesses that have held the same location for 40 years have closed. However, I’ve had numerous conversations with commercial property owners in recent weeks. My own commercial space is now fully leased, even if the monthly rate isn’t the highest. We have one tenant who is still struggling financially. But overall, the situation is manageable. The surprising part is that we are starting to get unsolicited interest from prospective tenants for commercial storefronts. This is after having extremely little interest for nearly a year. Another commercial owner that I spoke with had four retail vacancies for much of the past year. Three out of the four spaces now have new leases signed. That’s a remarkable change compared with only a few months ago. Despite the economic pain, economies are looking past the pandemic. Let’s look at two completely different markets to see if there are some clues. We’re going to compare Austin Texas and Las Vegas Nevada. The biggest economic driver in Austin Texas is the tech industry. There is extensive growth in the tech sector from major tech employers including Amazon, Apple, Facebook, Tesla, Oracle and Qualcomm to name just a few. Come corporate relocations from California have accelerated the growth of the Austin market. These are high value jobs that have been resilient in during the pandemic. In 2020, about 1.2M SF were added to the supply in the market. Vacancy increased from 4.2% to 4.9%. Much of the new growth was in outlying areas as the city continues to expand its boundaries in all directions. Asking rents continued to push upwards at $22.06 per SF, and increase of 0.5% compared with the previous year. Single tenant properties performed the best. Rents in the central business district fell as much as 20%. This area experienced the largest loss in business as workers stayed home during the pandemic. Las Vegas on the other hand is heavily dependent on tourism and gaming. Both industries were decimated by the pandemic. Las Vegas has one of the highest rates of unemployment in the nation. Retail vacancy increased from 7.2% to 7.6% over the past year. Most of that increase was the result of new product entering the market. Nearly 700,000 SF were added to the market in 2020 and an expected 702,000 SF or new retail is expected to hit the market in 2021, or about 0.7% growth of the total. Less than half of the new supply is expected to be absorbed this year. So perhaps it’s no surprise that location matters more than anything else. In the case of retail, properties that are close to where people live performed the best. Those properties in new and expanding areas performed better than those linked to office workers. But you didn’t need a pandemic to know that downtown retail has performed poorly compared with the suburbs. That trend has been playing itself out for more than a decade. There is no question that trends in retail are changing. Some retail space is functionally obsolete. Anyone buying older retail sites has to consider one of two possible plays. Purchasing at such a low price that you can make money by renting at rates well below the rest of the market. Redeveloping the property to a higher and best use.

On today’s show we’re talking about the difficult topic of how to account for what has happened in the past year during the pandemic. Now I want to be clear, I’m not an accountant, and I don’t play one on a podcast. The questions raised on today’s show are for you to discuss with your accountant and make a determination for your specific circumstance on how to treat the situation. So here we go. If you’re a commercial landlord, you probably had tenants that could not pay their full lease amount. Their business might have been forced to close in order to stop the spread of the pandemic. With no revenue coming in the door, the tenant would have been looking for a reduction in rent. As a landlord, you had a few choices. To start with, your lease probably did not have any pandemic provisions in it. A reduction in lease payments, or a forgiveness in lease payments was probably not contemplated in the lease. These concessions are taking various forms and include reduced rent (cash payment forgiveness) or possibly deferral of rent payments. But if a lease modification was not properly undertaken, what is the proper accounting treatment? Do you report the full rental income on your income statement and then carry the outstanding amount as an accounts receivable? What if you never get paid? When is the income written off from the balance sheet? What if circumstances arise that are beyond the control of the parties of the contract, such as a force majeure clause, or the laws in the jurisdiction governing the lease may create an enforceable right when a concession is legally required? If a lease agreement provides these rights and obligations, then the concession may not be considered a lease modification. If the lease makes no mentions of a concession, then the concession is likely a lease modification. If you’re a residential landlord and your tenant has not paid, but still owes you rent, how are you supposed to account for the rent? You have a moratorium on evictions and have limited remedies to get your tenants to pay up. The tenants still owe you the back rent. It has not been forgiven. How are you supposed to account for it? Do you treat the unpaid rent as an accounts payable with no reduction in income? Do you reduce the income and treat the rent as if it was variable? Could you end up paying income tax on income you never actually received? What if there was a foreclosure involved on the property? A foreclosure is treated the same as a sale of property. Capital gain or loss may be triggered upon such sale and, in certain instances, taxpayers may also realize income from forgiveness on certain mortgage debt. Exclusions of income created in a foreclosure may be available to taxpayers but the specific facts should be first reviewed and all tax implications considered. What if the lease was cancelled? How will that be treated by the tax authority?  It’s not necessarily obvious. You need to check. If your tenant left behind improvements, there could be tax consequences. Whenever a lease is terminated, whether early or at the end of a lease, a landlord generally becomes the owner of improvements which were made to such leased space during the lease. Did the landlord receive a benefit or income from acquiring new property that it didn’t have before the tenant terminated the lease? You might be deemed to have received a taxable benefit, and not actually have the income to pay the tax on this benefit. But what if the landlord paid for the improvements and was recovering the improvements over the life of the lease? How will the improvements be treated in that circumstance? Are the unamortized improvements written off? There are so many questions. The rules are complex and vary by jurisdiction. You can’t simply guess at what should make sense.

David Kafka is the Remax broker in Belize, specializing in helping foreigners who want to own property in Belize. On today's show we're talking about what it's like to own property there and how the economy has survived the pandemic. You can learn more or connect with David at 1stChoiceBelize.com