The Real Estate Espresso Podcast

On today’s show we’re talking about the impact of the election. Let’s ask a simple question. As a landlord, do you screen your tenants based on political party affiliation? I already know the answer. Of course you don’t. That would be just as illegal as discriminating on the basis of gender, or skin color or religious beliefs. You can’t paint an entire state a single color. California has a reputation of being staunchly liberal. But they passed a politically conservative proposition 22 that would exempt Uber and Lyft drivers from be classified as employees. This is sure to create a new legal minefield in the years to come as more businesses seek exemptions from the law enacted last year that classified contract workers in the gig economy as full-time employees with all of the rights and obligations of full-time employment. With 64% of the polls reporting as of the morning after the election, Joe Biden had received 65.2% of the popular vote in California. That leaves 1/3 of the California population having voted for Donald Trump. 65.2% of voters in Oklahoma voted for Donald Trump and 1/3 having voted for Joe Biden. The rhetoric about civil war is ridiculous. There is no enemy. They’re your neighbor, or your son, your cousin, maybe your spouse or mother or father. The tragedy is that whoever wins, there will be roughly half the country disappointed in the outcome. You may not agree with their opinion, but you must defend their right to have their opinion no matter what. That’s the essence of a free society. But even a free society needs to have limits. Remove all the rules and you risk chaos and anarchy. The state of Oregon became the first state in the nation to decriminalize the possession of all illegal drugs. Oregon’s Measure 110 makes possession of any controlled substance, including heroin, cocaine or methamphetamines, a violation punishable by a maximum fine of $100 or a completed health assessment. The emphasis in the election coverage seems to focus on the executive branch. But the true governance of the country is the result of all three branches of government. It requires the Congress, the Senate and the White House. As of this writing, the Democrats have retained control of the Congress, the Senate votes are not fully counted yet, and the White House is leaning heavily in Joe Biden’s favor, but still not counted. The Senate race has not fully been decided. It looks likely that the Senate be retained by the Republicans, which means four more years of legislative gridlock. Colorado voted on whether to allow the release of thousands of wolves into the wild. The wolves were native to the area until hunting brought them to the brink of extinction. It’s looking like my pre-election prediction is going to be pretty accurate. There will be more printing of money. There will be more legislative gridlock. The early signs are that legal challenges are underway in two states and a recount is going to happen in at least one state. This could be another election where the outcome is decided by the courts. The silver lining is that there has not been election violence so far.

The Securities and Exchange Commission issued new regulations today that affect real estate investors and exempt offerings. The full news release can be found at https://www.sec.gov/news/press-release/2020-276

On today's show, I'm going on record to predict the outcome of the US election. Check it out. 

Today’s question comes from Richard in Ottawa, Canada. Rich asks, With materials costing more and labour being harder to get, wouldn’t it make sense that high end/newer homes property values will go up over the next 12-18 months? Doesn’t less supply = higher demand? Rich this is a great question. Supply and demand are independent variables. Less supply doesn’t actually mean higher demand. We’re concerned with the balance of these two independent variables. More supply than demand and prices will fall. More demand than supply and prices will increase. You are correct in pointing out that construction costs have increased. There are two reasons for that. We have experienced supply chain disruptions which have affected materials prices. There is a shortage of labor Paradoxically, the labor shortage exists at a time when we also have millions of people unemployed. When the pandemic hit we actually saw labor prices drop to more historic levels as people in construction saw projects being put on hold. If you peel back your question to the most fundamental, it seems like you’re really asking whether making an investment in a particular segment will be a safe investment in the newt 18 months. It’s a little like asking to predict the future. None of us really know. Economists try to understand the current market conditions and construct a model for how the economy functions. If that model is accurate it can be useful for predicting the near future as long as the major variables don’t change. Therein lies the difficulty. We have a lot of variables that could be easily described as headwinds or tailwinds. The direction of the economy and the local market conditions will be the sum of all those headwinds and tailwinds to see what the net result will be. 1) Because of the pandemic, most people who might consider moving have put those plans on hold. They’re staying put. That has taken supply of homes for sale and for rent off the market. 2) The low interest rate environment has definitely been a tailwind. 3) We have seen prices increase across many markets in North America. The national average is 11%. But this isn’t uniform at all. Some cities like Nashville and Austin continue to experience population growth. Let’s look at the headwinds. We have millions of people unemployed. We have political gridlock in Washington and we have a minority government in Canada where the threat of the government falling is increasingly likely. We have businesses failing all over the place. We have oil prices falling which means billions of dollars in write downs in the energy sector of the economy. We have between 8-9% of the residential mortgages in the US in some form of distress. We have millions of tenants who are behind on their rent payments. In our own province of Ontario, we have a backlog of over 80,000 eviction motions in front of the landlord tenant tribunal. These properties have not hit the market yet. They represent a shadow inventory of sorts that will eventually appear on the market in distressed condition. Travel is restricted due to the pandemic, and therefore immigration is well below historic levels. That too is a headwind. People are dying in large numbers as a result of Covid-19. The US has seen nearly 0.25M deaths. When people die, that brings more inventory into the market increasing supply. That’s another headwind, albeit a small one compared to the others. Finally, the US Federal election is likely to bring an environment that will not favour the housing market. So we’re trying to make sense out of all these variables and predicted how they will all play out.  There are a lot of variables and the outcome is highly uncertain. Remember, back in 1929, the economy was booming. Everything looked rosy and optimistic, until it didn’t.

Our book this month is called “Leaders Eat Last” by Simon Sinek. Simon shot to fame in the wake of his first TED Talk in 2010 entitled “How Great Leaders Inspire Action”. His second TED Talk in 2014 was called “Why Good Leaders Make You Feel Safe”. It’s no surprise this our book this month is also on leadership. The foreword was written by Lieutenant General George Flynn of the US Marine Corps. The opening paragraph of the Foreword says "I know of no case study in history that describes an organization that has been managed out of a crisis. Every single one was led. Yet a good number of our educational institutions and training programs today are focused not on developing great leaders but on training effective managers." This one opening paragraphs sums up the essence of the book. In the book, Simon emphasizes the humanity of relations as being essential to leadership. In the book, Simon emphasizes the humanity of relations as being essential to leadership. Every single employee is someone’s son or someone’s daughter. “It is we, the companies, who are now responsible for these precious lives,” To see money as subordinate to people and not the other way around is fundamental to creating a culture in which the people naturally pull together to advance the business. If they don't feel safe in the organization, they turn their energy inwards to fighting internal battles instead of focusing on the threats to the business from the outside.  As organizations scale, we start to abstract and no longer see people as human.  We are now customers, shareholders, employees, avatars, online profiles, screen names, e-mail addresses and expenses to be tracked. The human being really has gone virtual. Now more than ever, we are trying to work and live, be productive and happy, in a world in which we are strangers to those around us. The problem is, abstraction can be more than bad for our economy . . . it can be quite deadly. The more abstract people become, the more capable we are of doing them harm. The Titanic carried as many lifeboats as was required by the law, which was sixteen. The problem was, the Titanic was four times larger than the largest legal classification of ships of the day. The Oceanic Steam Navigation Company, the Titanic’s owner, adhered to the outdated regulation (in fact, they actually added four more inflatable rafts). Unfortunately, as we all know, on April 14, 1912, just four days after leaving port on its maiden voyage, the Titanic struck an iceberg far from any shoreline. There were not enough lifeboats for everyone and more than 1,500 of the 2,224 passengers and crew on board died as a result. A ship four times bigger than the largest classification carried only a quarter of the lifeboats they actually needed. In fact, additional space was added aboard the deck of the Titanic in expectation of a “lifeboats for all” requirement. But lifeboats were expensive. They require maintenance and could affect a ship’s stability, so executives at the Oceanic Steam Navigation Company decided not to add the lifeboats until the regulation said they had to. Though there were not enough lifeboats for all the passengers on board the Titanic, the company was in full compliance with applicable rules.

Adrian Panozzo has scaled his business over the span of ten years using the BRRR (Buy, Renovate, Rent, Refinance, Repeat) strategy by concentrating on a smaller multi-family properties. During this time he was a full time police officer in Toronto.  His investment market of Hamilton Ontario has a history as an industrial city with steel production, transportation and logistics at the core of the city's economy. This strategy could be transported to virtually any market in North America. To connect with Adrian, you can email him at  executiveproperties@rogers.com

Risk Management is one of those topics that seems dry and esoteric to some. It’s a subset of project management. But risk is one of those things that is ever-present, depending on how you plan your projects. On today’s show we’re going to look at a deep dive on one specific risk that actually came true. But before we talk about that specific story, let’s define what we mean by a risk. A risk is something that could happen that is outside your plan. If you’ve already planned for it, then by definition it can’t be a risk. When we talk about risk we divide risk into likelihood and impact, and then we categorize the impact according to the type of risk that it represents. It might be a cost risk, or a time risk, or perhaps it could impact the quality of the finished product. There are a number of categories that could apply to any given risk. Again if you want to learn more about this, send me an email to risk@victorjm.com and I’ll send you a link to the webinar on risk management. So here is the story. My partners and I are building a campus of residential assisted living and memory care homes in Lake Charles Louisiana. If you’ve been following the news over the past couple of months, you’ll know that this market has been hammered not by one, but by two major hurricanes in the span of 6 weeks. This market sustained an incredible amount of damage. Fortunately, our construction project suffered virtually zero damage from both hurricanes. We did suffer delays from the storms. With the extreme amount of rain, the site drained well. But the community was without electricity for 36 days and we could not find housing for the construction crews to actually come back into the local market to work on the construction of the buildings. In the end, the workers brought RV’s and are staying at an RV Park that we own in order to make progress on the construction. The demand for roofing materials and roofing labor meant that our roofing contractor refused to honor their contract. Our assessment is that they would rather get a higher rate for emergency roof repair work compared with the price they had quoted us for the new construction roofing. The impact of the hurricanes was twofold. The first was in a delay in the project. The delay was caused by lack of labor to do the work. The second is the lack of materials which could cause more delay and an increase in project cost. When the demand for roofing materials shot up, you simply could not source the desired product at any price, and the pricing for inferior product jumped locally as demand far exceeded the available supply. That meant looking further afield for both labor and materials. Just because roofing materials are expensive and in short supply along the gulf coast. As you are listening to this, Southeast Louisiana and Mississippi just got hammered by yet another hurricane, Hurricane Zeta on Wednesday of this week. While New Orleans is three hours away from Lake Charles, we now have a category 2 hurricane that ripped a lot of roofs in the New Orleans and Biloxi Mississippi markets, putting even more pressure on demand for roofing labor and materials. There is very little we can do to recover the six weeks that were lost. But we can prevent even more delay due to the shortage of roofing labor and the shortage of roofing materials. We can also protect the project from a cost increase by sourcing the materials from another location. All of this can be mitigated by replanning this part of the project and by taking all these new factors into account. We can limit the impact of these storms in both cost and time based on replanning this aspect of the project to treat the risks not as a risk, but as a certainty of having occurred. Once the risk is embedded in the plan, it’s no longer a risk by definition.

On today’s show we are talking about the fall in prices. There is a wide range of opinion on where real estate prices are heading in the next 12 months. Prices have continued to rise during the pandemic despite massive job losses, economic contraction, and falling revenues. The long predicted fall in prices is now just starting to become visible. My family lived in NYC for about 25 years. My aunt and uncle lived on fifth avenue and 72nd street overlooking Central Park. That part of fifth avenue is residential because it’s overlooking Central Park. So the shopping street is one block east on Madison Avenue. A group of three properties recently came on the market back in August. They’re located on Madison Avenue and 70th street. But before we talk about those properties, let me complete the picture of this neighborhood. Manhattan has many different areas. This is one of the most expensive areas, but not the most expensive area. It’s not Billionaires row which can be found about 12 blocks south on 59 th street. This is maybe the second or third most expensive areas in the city. After my aunt and uncle died, their apartment was sold to Keith Richards from the Rolling Stones. Prices in this area have averaged over $6,000 per SF for much of the past decade. In the last couple of years, prices have risen to over $7,000 per square foot and in some cases even flirted with $8,000 per square foot. Not surprisingly, prices for retail space one block away have tracked these sky high prices. Prices in the area for commercial space peaked about six years ago when another building six blocks away sold for a massive $7,589 per SF. Now this most recent sale on Madison and 70th was at a price of $1,340 per SF. This is a drop of over 83% compared with prices 6 years ago. Now I know what you are thinking, $1,340 per SF is still a very big number. Some of you are having a hard time considering that to be a bargain. When I saw the story of this property cross my desk, I saw something in the story that most people probably missed. Most are shocked by the drop in price. I saw the fact that there were 20 offers on the property. This was an auction environment. To the other 19 buyers, this property was worth even less, probably much less. When you have 20 offers, you are still in that auction environment. In an auction, the buyer almost always ends up paying too much. I regularly speak with investors who keep telling me that they are having a hard time finding deals. My message to them is consistent. The smart money is being patient. The smart money didn’t win the bidding war for this distressed property on Madison Avenue, even with a deep discount to the local market. These distressed properties are not appearing because of the freeze that governments have tried to impose on the markets. The industry has used the term shadow inventory in the past to describe properties that have not appeared on the market. But we don’t quite have a shadow inventory yet. I’m going to define a new term which I’m calling the invisible inventory. That invisible inventory will first transition to the shadow inventory before it transitions to the the real market inventory of distressed properties. So be patient folks, the wave is coming. We are seeing just the tip of the iceberg.

The day of reckoning for residential tenants is coming and it’s just around the corner. Governments all over are left scrambling trying to handle the expiration of the moratorium on evictions. But just as the day of reckoning is looming for tenants who are behind on their rent, some politicians are working behind the scenes to protect tenants who have been impacted by the pandemic. Still others are using the pandemic as a pretext to over-reach and actively penalize landlords. In my home city of Ottawa Canada one City Councilor put a motion in front of city council’s  Community and Protective Services Committee. Motions recommended by the committee eventually go in front of city council for a vote. The wording of the motion called on the province to ban all residential rental evictions, except in case of threats to public safety, until the COVID-19 pandemic is effectively contained. At the end of a long meeting, the committee carried that motion. If this motion were in fact to be approved by city council, this means: · If there is an agreement to terminate the lease, the tenant doesn’t actually need to leave and can stay as long as they like with no fear of eviction. · If a tenant sends the landlord a notice to terminate the lease, they don’t actually need to leave when they said they were going to, and they would have no fear of eviction. · If a tenant exercises bad behaviour and is disturbing the peace, they can’t be evicted. · If a tenant simply refuses to pay rent with no demonstrable financial hardship, they can’t be evicted. Since none of those reasons have anything to do with the pandemic and the economic impact resulting from the pandemic, why would government have the right to eliminate one of the few remedies at a landlords disposal? One of the lawyers who represents the landlord community called that city councilor and convinced them to change the wording of the motion to make it better balanced for landlords. The original wording was so broad and encompassing that it went far beyond protecting tenants from the pandemic. But here’s where the story took a turn. The city councilor agreed that the suggested wording changes were an improvement. But then later in the day changed their mind and reversed their support for the revised wording changes. Here is where I started to lose faith in at least one person who was elected to a position of power to make decisions. The argument is that housing is a basic human right. In a city where the winter temperatures drop to -40 degrees, I agree with that notion completely. Housing is a basic human right. But there is a difference between saying housing is a human right, and specifically targeting business owners to guarantee that human right. Food is a human right too. I don’t see government stepping in and telling the grocery store owner that they have to allow anyone who comes into the store to steal as much as they like with no consequence. I don’t see governments telling the car manufacturers that basic transportation is essential to life in our society and therefore they must let anyone who walks in and needs a car to help themselves to a car they like on the lot. I don’t see governments telling the lawyers that since justice is a human right, lawyers must allow their clients not to pay their legal bills. This distorted motion is going to be voted at City Council within the next day. I have no idea which way the vote is going to go.  I hope that the remainder of city council will know how dangerous this motion is and defeat it. So why am I telling you this? I can guarantee that similar discussions are underway at virtually every city council and town council in the world. It’s your job to get in contact with your local politicians and educate them on the alternative solutions

On today’s show we’re talking about hunting versus farming. Hunters go out in the morning, they catch their prey. They cook a big meal and they eat for a day, maybe longer. But the work of producing the food magically happened somewhere else. The same is true for fishermen. They catch their prey, but they don’t nurture it or do any of the hard work over a longer period of time to actually produce the food. They simply go out and catch it. They might lure it in and trap it. They might happen across it and tackle it to the ground. Hunters are transactional. They are opportunists. Farmers on the other hand work in harmony with nature. They know that you can’t grow anything anywhere. There are certain locations that are better suited to one type of crop versus another. You’re not going to grow rice in the rain forest. You’re not going to get Maple Syrup in the desert. If you want to make great tomatoes, you’re looking for a unique combination of soil composition, rainfall, sunshine.  There is a season for planting. There is a season for weeding. There is a season for harvesting. You wouldn’t dream of planting seeds as the weather gets colder in the fall. You wouldn’t dream of harvesting in May in the Northern hemisphere. There is a season for everything. By now, you’re probably wondering what this has to do with real estate investing. There are hunters and farmers in real estate investing as well. You know the hunters. They’re the ones who have the business cards that say “We Buy Houses”. They’re looking for deals below market value. They’re going to flip the contract to another buyer for an assignment fee. They’re very transactional. They eat for a day, or maybe a week. But then they have to go do it all over again. There’s nothing wrong with being a hunter. Just understand that hunting is an earned income. It requires you to get up off the sofa and go out into the wild and hunt your prey. If you don’t hunt, you don’t eat. There are farmers in real estate investing as well. They might be involved in new construction. Farmers are long term landlords.  Farmers focus on value creation over a long period of time. Farmers invest in properties years before they expect to harvest. Well, real estate investing has seasons as well. There are seasons for planting, and there are seasons for harvesting. That doesn’t mean that you need to sit idle when the seasons are changing. Right now I believe we are in a season for harvesting. You could also be looking past the current season and be planting for harvest in 5-7 years from now. But if your goal is to work the earth like crazy, slam the seeds into the ground, water every hour and hope to harvest in a few weeks, you’re probably going to be disappointed. Farming doesn’t work that way. We know that better opportunities are just around the corner. Waiting can be incredibly frustrating. It seems like inaction. Waiting feels like analysis paralysis. You would never tell a farmer to get off their butt and get out into the field and start planting new seeds in the autumn. It doesn’t make any sense. The seasons are clear. When I speak with established investors and developers who understand the economic cycle, they’re very clear on the seasons as well. You can start a project that will complete in another two years or even five years. But a project that is projected to complete in the next 6 months is incredibly risky. You stand the chance of being caught out of step with the seasons. Even hunters need to pay attention to the seasons. There is a hunting season. You don’t hunt for deer in March. There is a season for hunting as well. You can still undertake projects in today’s environment. You just need to be mindful of being in harmony with the season.