The Real Estate Espresso Podcast

David in central valley California asks Hi Victor. I'm looking to develop a build to rent community of apartment sized single family homes. This will go from un- entitled vacant land all the way through to the sale of the built homes. My question is at what point are the impact fees paid. Is it while performing the horizontal land improvements and utility hookups? Or is it during vertical construction? Thank you! David, This is a great question. For the listeners at home, let’s take a minute to describe impact fees or what in some places are called development charges. These are fees that are charged to developers for the benefit of having the opportunity to make a profit from the expansion of a community. These fees are only assessed on new units that are added to a community. For example, if you demolish a house and replace the house with a new single family home, you would not pay any impact fee because you are not adding any density to the community. If instead you replace the single family home with a duplex, then you would pay an impact fee on the one additional unit and no fee for the existing unit you are replacing. Impact fees pay for the municipal infrastructure that makes it possible for you to build your property. We’re talking about the roads, water infrastructure, sewers, schools, parks, public transit, community centres, expansion of policing and so on. These fees vary widely from one community to the next, and they can vary widely within a community. Some cities have zero impact fees. Impact fees are extremely common throughout California where you live. I read a recent paper on the state of impact fees in the Central Valley in California where you live. I put a link to the study in the show notes. This 84 page report was authored in 2019 and gives a pretty good overview of the issues surrounding development impact fees in the Central Valley. It specifically studied 10 municipalities in the Central Valley. https://www.hcd.ca.gov/policy-research/plans-reports/docs/impact-fee-study.pdf Only a little over a quarter of the communities actually published the studies that were used to assess the impact fees. This lack of transparency makes it difficult to determine whether the assessment of impact fees is fair. The schedule of fees was also not readily available in many of the communities. When you finally do get hold of the schedule, determining which payment applies to you can be incredibly confusing. Often the preliminary feedback and estimate from the planning department doesn’t match the final assessment of fees. The net result is that many developers have a hard time predicting the correct fee structure for their financial pro forma. In the absence of an accurate number, the only prudent thing to do is to estimate high and hope that the real impact fee comes in below your estimate. But there is also a chance that the project becomes unattractive with a high estimate for the impact fees. You might end up talking yourself out of a project simply because the municipal government is doing a poor job of being transparent about their development charges. This is an excellent question and unfortunately it’s an area that is full of complexity and potential land mines. There is no quick or easy answer to your question. Hopefully this discussion helps you navigate through the maze and ask relevant questions from the decision makers who can answer the specific questions pertaining to a particular property and proposed development.

Today's show is one of the most important shows on investment strategy you'll hear this year. 

On today's show we're talking with my good friend Steff Boldrini from San Francisco about how to structure a construction loan for a new construction project. 

On today’s show we we are taking a deep look at the book called “This is Marketing” by Seth Godin For the longest time there has been confusion between the various words that surround the topic. What is selling? What is advertising? What is marketing? So many of the manipulations that we have accepted as normal we now almost universally reject as ineffective. My friend Kyle Wilson says it well when he says “Don’t use a tactic that violates a principle.” It doesn’t make any sense to make a key and then run around looking for a lock to open. The only productive solution is to find a lock and then fashion a key. It’s easier to make products and services for the customers you seek to serve than it is to find customers for your products and services. Marketing is the generous act of helping someone solve a problem. Their problem. It’s a chance to change the culture for the better. Marketing involves very little in the way of shouting, hustling, or coercion. It’s a chance to serve, instead. So many people think that marketing is about getting the word out. That’s one of the last steps in the process. It starts with creating change that solves a problem. When that change defines the culture, then you have the ingredients for marketing. If you want to make change, begin by making culture. Begin by organizing a tightly knit group. Begin by getting people in sync. Culture beats strategy—so much that culture is strategy. This is marketing by Seth Godin creates a new definition of marketing by turning the industry on its head. You see Seth has tried almost every method known to man. A few have worked, and most have failed. In some cases, the product succeeded despite the money wasted on advertising that nobody saw. He won’t give you a step-by-step step formula. Instead the book is a compass that keeps you grounded in timeless principles that honour the relationship of trust between you and the people who you seek to serve.

It’s hard to believe that 2020 is almost in the history books, the year that seemed to bring one surprise after another. The news media are filled with retrospectives on this most unusual of years, 2020. They’re bringing you stories that got the most air time over the past year. What was it that defined 2020? For some it was the pandemic. For others it was the protests against social injustice that gripped many communities around the world. Some will state with great fervour that the Presidential election combined with the pandemic that was the defining event of 2020. Yes, all of those things happened. There was economic carnage. There were massive job losses on a scale we have not witnessed in history. If your family lost a loved one, or if you lost someone you know to Covid-19, this year 2020 will be forever etched in your memory. As you conduct your retrospective on the year, don’t look to the news media to interpret the year for you. It was your year, nobody else. The only year that counts was your year. The purpose of conducting a retrospective is for you to learn and grow from it. If you spent the year watching youtube videos waiting for the pandemic to be over, then chances are you’re not listening to this podcast. That’s not the culture here, and I suspect not for any of our listeners. I’ve discovered something extremely important in life and I’d like to share it with you. It’s a perspective on living that has almost nothing to do with what actually happens. For some people, 2020 was a year of financial hardship. For others the exact same circumstance was a test of resourcefulness. As I conduct my retrospective on 2020, I’m seeing accomplishments that I’m proud of, and others that didn’t go my way. For many people, 2020 was a year of adjustment. They didn’t have a routine for working from home. They were not accustomed to holding meetings using video conferencing. For us, 2020 was a year of adjustment. It was stressful, simply because there was a wide gap between the expectations we had going into the year, and the reality on the ground. We had to accept the current reality was not going to meet our expectations. We experienced delays on virtually every project. We experienced higher than expected expenses. We experienced drops in revenue in some areas of the business. We experienced two hurricanes only 5 weeks apart. We also experienced new opportunities that were not present at the beginning of the year. We had zoom meetings for family gatherings. We got to experience moments over zoom that would never have happened any other way. Our regular monthly real estate meetups went online as well. While the quality of the relationship building suffered, going online enabled us to bring guests from all over the world would not have travelled all the way to Ottawa Canada for a 45 minute speech. Our regular masterminds went from being a conference call to a zoom meeting and we had much more engagement. Conducting a retrospective is a little like mining for gold. You have to sift through a few tons of rock in order to extract a few ounces of gold. The gold we’re looking for are the lessons that are buried deep within the thousands of memories in 2020. The art is in extracting the gold and letting go of the tons of rock and tailings from the mining process that will only weigh you down. The tailings are those feelings of regret, of shame. You did what you did. You didn’t do what you didn’t do. You can’t change it. You can only learn from it and aim to do better in the future. As I look to 2021, my resolve is to strengthen three habits. This year, my sleep has been thrown off, my morning routine is not where I want it to be, and my exercise has suffered. This is my focus in 2021.

What does it mean when restaurants close? What does it mean when restaurants close for real estate investors? On today’s show we’re going to take a deeper look at the restaurant industry. This year, 76 restaurants closed in Dallas, never to return. It’s common for some restaurants to fail even in a strong economy. But this year was different. Several estimates from earlier this year suggest that 10% of restaurants closed permanently in Q2 of this year. OpenTable is the company that makes it easy for you to book a restaurant table online. So not only are they convenient, they’re a great source of real industry data. They maintain data for each city in which they operate, each state, each country and even globally. So far this year, the number of seated diners in 2020 is down 58.4% on a global basis. Seated diners are down 60.39% so far this year in the USA, and 60.98% in Canada. Diners ate 49.38% fewer seated meals in the UK this year. Some of the business was offset by take-out business for which we don’t have an accurate global statistic. Needless to say, there are few businesses that can survive a 60% decline in business. If people aren’t reserving tables, then servers are not needed. Dishwashers are not needed. Bartenders are not needed. In California, table reservations are down 65.6%. In Illinois, table reservations are down 70%, and in New York  state they’re down a whopping 75%. The data for NYC is down an astonishing 83% for the year. It goes without saying that the PPP assistance that came at the end of March, consisting of 10 weeks of payroll is not sufficient to cover a drop in revenue of 83%. Most of these businesses will have fixed costs that are simply too high for the small amount of government assistance to cover. The restaurant needs to negotiate with the landlord. The landlord in turn needs to negotiate with their creditors. For many businesses, deferring the rent isn’t enough to save the business. If all the money is ultimately owed to the landlord, it might take a restaurant 10 years to make up that back rent out of excess cash flow from the business when dining returns to normal. The owner might simply choose to throw in the towel and determine that they don’t want to spend the next decade working for their landlord and essentially making no money. It might be easier to shut down and start again with something new when the time is right. So when all these properties are vacant, a new restaurant opening has a lot of negotiating leverage to demand rent concessions. The landlord faces the difficult choice of lowering their price to the point of tolerable pain or experiencing prolonged vacancy which incurs even greater financial pain. When a new restaurant faces so much choice in good locations, complete with a modern kitchen already in place, they can negotiate exceptional lease terms. Restaurant statistics over the past week which includes Christmas Day showed a global average of 61% decline in tables reservations for the last week of December compared with the same period in 2019. The US Average was 62.25% down and Canada is 74.5% down compared with the same period last year. In my opinion, we’re not going to see a recovery in the restaurant industry until the Spring. Until that time, I don’t see many people making significant investments in the traditional seated dining food service industry. The big question is how many businesses will be left standing in 3 months time.

Wall Street and Main Street have had different philosophies for a long time when it comes to investing. Wall Street’s focus is securitizing the underlying businesses. They’ve created so many derivative products that create financial leverage. This is a packaging and re-packaging of investment vehicles into increasingly large opaque homogenized pools of assets. What’s insane to me are the valuations being attached to these companies. I’ve long held that wall street valuations are far too high for the underlying assets. If a property is trading at, say, a 6% cap rate. If all the properties being held by that company are trading at a 6% cap rate, and the company is only in the business of holding assets like this, then how could the company be trading at 50x earnings, or the equivalent of a 2% cap rate? Yes, I understand that leverage can increase the yield. But leverage also increases the risk. That risk is already built into the cap rate for the property. How can a company be worth more than its underlying assets? We saw crazy valuations in the early 2000’s with the collateralized debt obligations. These were nothing more than packaging of pools of mortgage loans into a new financial instrument that could be sold. It had the effect of moving the debt off the bank’s balance sheet and allowing banks to loan even more money. The opaque nature of those debt obligations nearly collapsed the global financial system. It all worked fine as long as the default rate on those debt obligations remained low. When things blew up in 2008, the fragile nature of these paper assets became apparent. Wall Street seems to be at it again. The latest is a major push by Goldman Sachs to get into real estate, and the commercial sale leaseback game in particular. A unit of Goldman Sachs just purchased Oak Street Real Estate Capital for an estimated $2B. Sale leasebacks are a way for some companies to strengthen their balance sheets. The buyer purchases the commercial real estate from an active business who in turn take the cash and pay down debt. Instead, the business pays rent rather than servicing the debt. In some cases, it’s a way for companies that have paid down the debt to raise cash without borrowing funds. It’s a game that makes it all seem like a massive shell game where very little of value is being added to the equation. For the buyer of a sale leaseback asset, the key is in understanding the business health of the selling company. If we look at the makeup of the Oak Street portfolio, they’re about 35% retail, 50% industrial and 15% office. That’s not a bad asset mix as long as their exposure on the retail side is not at the higher risk end of the spectrum. Wall Street firms have to be seeing the crazy multiples in the market and are going in search of yield. While so much of Wall Street is focused on arbitrage of paper assets, the underlying fundamentals eventually rule the day. Another player in the sale leaseback space is Realty Income Inc. This REIT has 16.4B of assets in their portfolio. Their largest shareholders include various Vanguard funds and Blackrock. Together, these two own about 22% of the REIT. This REIT is trading at 51 x trailing 12 months earnings. Another REIT in the space is VEREIT. They’re trading at 31.55 x earnings. No doubt you’re going to hear about the risk in real estate investing when you see the prices of these stocks fall. Understand that the value of the underlying real estate is disconnected from the valuation of the companies that own them. This is no different than owning Tesla stock or Netflix stock where the market price is disconnected from the financial performance of the underlying business. I’m glad that I’m firmly grounded on main street and not playing the Wall Street game.

Ravi in Philadelphia asks I am a loyal listener to your podcast and greatly appreciate all the content that you provide. I was given an opportunity to invest in college student housing in Valdosta, Georgia adjacent to the state affiliated University. Numbers looked reasonably good, but as always I look at these things with a skeptical eye. My question to you is what are your feelings regarding student housing as an asset class? I do invest in multifamily apartment buildings but student housing is an area that I have not had much experience with. This particular asset has about 230 units and is mainly for students of that university. My concern is that this asset class may be a bit risky during this time since there has been significant upheaval with regards to the pandemic. Although the parents cosign the leases, this  does not insulate from any risks related to schools being closed and these students not paying. I would love to hear your opinion on this. As always, I value your input as I feel you are very well balanced and provide a very analytical point of view. Thank you as always for your contributions to the community. Ravi, thank you for the kind words. This is a great question. I’ve owned student housing since 2011 and generally speaking I love the asset class. However, in the past three years, my perspective on the long term outlook for student housing has changed. The pandemic and the upheaval of 2020 has merely accelerated a trend that was already underway. The problem with student housing is that it is facing multiple headwinds at the same time. The first is demographic. The number of university age teens is expected to decline over the next decade. This is based on the number of births in the US. Births peaked in the late 1980’s and have declined ever since. This is the so-called echo-boom generation. Not surprisingly, university enrolment peaked in 2011. This was a combination of the economic downturn that happened in the wake of the 2008 financial crisis and the peak number of births that occurred around 1990. This would lead to peak university enrolment about 20 years later. Let’s talk about the shift to online education. Even before the pandemic, a number of universities had increased the percentage of classes being offered online. If you look at many of the major universities, they have all increased the online programs. The University of Texas at Arlington, a campus of 52,000 students held 52% of its classes online in 2019. They were well prepared for the dislocation of 2020 when they were forced to increase that percentage to a much higher number. Generally speaking, we are seeing demand for student housing dropping each year. When supply exceeds demand, you will see prices fall for monthly rent. Let’s look at your specific case in Valdosta. This is a small campus. It grew from about 5,000 students to over 9,000 students at the peak. From 2011 to 2015, student enrolment fell by 17% and the President of the University reduced the number of lecture staff on contract by 35. According to articles I read, many in the community started to question to long term viability of that specific campus. Remember, Valdosta is one of 26 institutions that make up the University System of the State of Georgia. If there were to be shrinkage of enrolment, it stands to reason that the smaller campuses would be eliminated. There would be an effort to consolidate and focus investment on the larger campuses. I’ve not done a complete due diligence on the specifics of your deal. But when I look at the overall market for student housing on a national basis, and then more specifically in the Valdosta location, I’m not seeing the market conditions that would screaming for me to invest. I’m seeing considerable risk on the downside and not much potential on the upside.

Chay Lapin is a specialist in the Delaware Statutory Trust. On today's show we learned that this structure has gained popularity when working with investors looking to shelter capital gains under section 1031.  You can connect with Chay at kpi1031.com where you can learn more about the DST, its limitations, and how it can benefit investors.

Savannah Arroyo is based in Los Angeles, California where she still works full time as a registered nurse. Over the past several years she has developed a multi-family portfolio focused on deep value-add projects. She has been syndicating deals with her husband and has gained a considerable following as the "Net Worth Nurse". You can connect with Savannah at https://thenetworthnurse.com