The Real Estate Espresso Podcast

Today’s show is another AMA episode.  Today’s question comes from Saadya in NYC. “I’m looking to conduct my first commercial deal. What is the most important thing to look for in that first project?” Well Saadya, this is a great question. When it comes to having a successful project, there are three main factors to consider. 1) The submarket 2) The people involved 3) The deal specifics You’re based in Brooklyn. The NY area is highly transient. It’s such an expensive market that people tend not to stay for long unless they really have to. It takes a strong consistent income stream to justify the cost of living. I know of so many people that live in NYC for just a short period of time. Real Estate is hyper local. I would recommend you choose a location that is experiencing population growth and job growth behind it. I would stay away from areas that are losing population. I like Philadelphia which is not too far from where you’re located. I would stay away from the expensive bedroom communities North of NY and in Connecticut. The taxes are too high, despite the fact that many people from NYC have moved to those communities this year during the pandemic. I don’t believe the growth in those communities will be sustained. I would choose a community that had strong growth prior to the pandemic, and then that growth continued or accelerated during the pandemic. 2) I’m fond of saying that a good deal badly managed is no deal. So the key is to make sure that you recruit the best quality people into your team. There are a shocking number of poor quality people in this industry, and a few outright crooks. 3) The deal itself. This is where most rookie investors start. They make it all about the deal. Let’s be clear, on your first few deals you will make some mistakes. It’s super important that those first few deals have next to no downside risk and lots of upside. You will need that to act as a cushion against the inevitable mistakes that will happen. So you’re looking for a deal that is off market. Even in today’s environment we have a lot of money chasing deals. It’s still an auction environment. You don’t want to be bidding against other more experienced investors who might be willing to pay more. You almost always end up paying too much in that environment. You want to find those special cases where there is a problem to be solved. It might be an estate sale where the property is physically distressed or financially distressed in a good area with strong fundamentals. It might involve rescuing a property that is in pre-foreclosure. You would have the opportunity to be solving a problem for a family that is in a difficult spot.  The moratorium on evictions and foreclosures is masking the depth of distress that is just beneath the surface. These business and real estate failures will create a re-pricing of assets in the near future. I can’t tell you exactly when that will happen. It could be in the next 90 days if government continues to gridlock on any decision making. It might be longer, perhaps 6-9 months away. But the tidal wave of distress is coming. It might involve a property that must be sold because of a divorce, or a discord between family members. That represents an opportunity to step in a save a family member from financial ruin. A friend of mine calls that doing good, and doing well at the same time.

This year is creating a number of precedent setting situations. The Senior Housing industry is under extreme financial pressure these days. Prior to the pandemic they were experiencing dropping occupancy as more and more new supply entered the market, faster than demographics could support increased demand. Some markets have experienced occupancies in the 80’s and 70’s. The most over-built market in the US right now is San Antonio Texas where occupancies were averaging in the low 80’. Then the covid-19 pandemic hit. The combination of a tight labor pool and falling occupancy are the main pressures senior housing operators currently face, and those pressures are not going away anytime soon. Staff who are concerned about workplace safety and contracting Covid-19 are demanding higher pay. The increase in expenses, combined with falling occupancy and price concessions has hampered providers’ ability to raise rates. That’s resulting in NOI erosion and margin pressure. On today’s show we’re talking about the impact of the moratorium on evictions on senior housing. Senior housing is partly a residential situation, but it’s primarily a service business. To be clear, we’re talking about the private pay, premium end of the market. In those properties, the real estate component represents maybe 20% of the cost of delivering the service in most cases. Labor typically accounts for about 60% of operating expenses, and providers are facing major workforce pressures at the moment. Of course the pandemic itself has increased operating costs for assisted living and skilled nursing operators as additional protocols have come into play. If a resident stops paying, the question is “What is an operator to do?” Does the operator put a claim on the estate of the senior citizen? Do they seek a court order to garnish social security payments? Do they seek a court order for capital encroachment if the senior has any savings? Do they evict? The image of an eviction of an elderly person with multiple infirmities is horrifying to say the least. It may be too early to determine what the law means for residents of senior housing communities across California and similar rules across the nation, but those in private-pay senior housing should be studying its details. We have a situation where there are millions of people unemployed. It’s often the adult children of seniors in assisted living who pay the bill. The seniors themselves are already on fixed incomes. Overall, the California law gives tenants broad protections from evictions, The new law provides eviction protections through January 31, 2025, but in order to be protected you must (1) return the declaration of COVID-19-related financial distress hardship declaration within 15 days after receiving any eviction notice, and (2) pay 25 percent of each month you could not pay from September 1, 2020 through January 31, 2021 by January 31, 2021. This raises a number of legal questions regarding how services are delivered in senior housing. Should there be a residential lease for the accommodation portion, followed by a separate contract for health care services? What is classified as rent perhaps should be brought into alignment with the actual cost allocation between rent and services. Considering that the average stay in assisted living could be in the range of 24-36 months, the idea that residents could choose not to pay their fees for 17 months and then only be required to pay 25% in order to extend the eviction moratorium for another 4 years. It would then require the senior living operator to sue the estate in order to get paid.

We’ve been hearing for months how interest rates are going down and how the Federal Reserve is going to maintain rates at near zero levels until well into 2022. That all sounds like good news for real estate investors who are looking to borrow funds at the lowest possible interest rates. As we’re talked about before, the interest rate charged by the banks is often tied to one of two benchmark rates. Shorter term loans and variable rate loans are usually tied to a short term benchmark like LIBOR which is the London Interbank Overnight Rate. Permanent financing is usually tied to the yield on the 10 year US Treasury Bill. When the Congress enacted legislation back in March to protect the US economy that involved a massive amount of printing of money. The total in new spending was $2.3T dollars. Most of that money was issued in the form of Treasury Notes having a short term of one year or less. As those notes become due, they are being repriced as longer term debt which carries with it a less frequent need for renewal. Over the past 80 days, the yield on the 10 year treasury has gone from 0.52% to 0.79%. That increase in almost 1/3 of a percentage point translates into interest rates for permanent financing that are 1/3 of a percentage point higher. There are three scenarios to consider. 1) A Republican sweep of the White House and both chambers of government 2) A split of the chambers of Government. It may not actually matter as much who wins the White House. 3) A Democratic sweep of the White House and both chambers of government. Let’s look at all three of these scenarios. According to the polls, a Trump victory in the White House is looking less likely. It’s highly unlikely that Republicans would win all three. Whether Joe Biden or Donald Trump is the next President, both will continue printing money. The big question is how much. The second scenario with a split between the House and the Senate will result in legislative gridlock. We’ve seen that in the past 7 months with no new money being pledged to recover from the pandemic. The level of acrimony between the parties has become the new normal in government. The third case, involving a Democratic sweep of the White House and both chambers  of government has the potential to unleash an unprecedented level of spending. It’s that third scenario that has the markets worried. We are already seeing signs of inflation even though it’s being downplayed by politicians. Inflation is the hidden tax that most people can’t isolate. When a can of tomatoes at the grocery store goes up by $0.50 most people blame the grocery store for the price increase. They rarely put the blame on the Secretary of the Treasury, or the Chairman of the Federal Reserve, or their representative in Congress. When those trillions of dollars get printed, the debt goes somewhere. So far, the US has been able to export the debt over the past 30 years. China’s central bank and Saudi Arabia have been willing buyers of all that debt. But the willingness of those countries to fund US deficits seems to be evaporating. For now, we’re in the middle of a global pandemic. All economies are suffering. When asked the question about which currency to buy, there doesn’t seem to be a stronger currency emerging. The Euro is in bad shape, the Yen is hopelessly over-leveraged, and international investors are not about to put their trust in the Chinese Central government. As we get closer to the election, and even after the election whoever wins we can expect the yield for 10 year Treasuries to go up. You have a small window in which to lock in historically low interest rates. Even if the Fed keeps rates low, I believe Treasury yields will go up, and therefore interest rates for investors.

Commercial brokerage house CBRE conducted a survey of CBRE investment and valuation professionals in the last two weeks of August. One of the top items that I saw in that survey was the word risk. As we’ve talked about several time recently, risk has become top of mind for most investors this year. There are a number of sentiments in the survey that are worth noting. We’ll start by talking about investment market conditions. Survey respondents report that a disconnect between buyer and seller expectations has emerged, with more than 60% of buyers looking for discounts from pre-pandemic prices versus 9% of sellers willing to offer them. One-third of survey respondents were underwriting with the same rental income assumptions as in Q1, with the remaining two-thirds adopting more conservative assumptions. Half of those with unchanged underwriting assumptions were in the industrial sector. CBRE professionals indicate that investors are placing greater importance on certain investment criteria than before the pandemic, particularly tenant credit quality (cited by 85% of respondents), length of remaining lease term (64%) and building occupancy (64%). Roughly two-thirds of survey respondents believe that investment activity will recover to pre-pandemic levels within one year. But that sentiment varies widely by asset class. Let’s dig into the details. When asked how it will take for market conditions to return to pre-pandemic levels, the answer varied widely by asset class. In the office asset class, 72% of respondents said it would take more than 12 months for offices in the central business districts. For offices in suburban settings, 48% said it would be more than one year, versus 52% who said it would take less than a year. In the retail sector, 58% of respondents said it would take more than one year for market conditions to recover to pre-pandemic levels. In multi-family 84% said it would take under a year and 45% said it would take less than 6 months. Industrial seems to have hardly skipped a beat during the pandemic. When asked about the factors influencing investment decisions, respondents said that three new factors loom large when looking at new investments. 1) Building occupancy 2) Length of time remaining on leases 3) Credit worthiness of the tenants These factors seem much more important than in the past. There is no question that the business outlook is considerably more negative, especially in office and retail.

On today’s show we’re talking about chaos. This year has been anything but orderly. The handling of the pandemic by governments all over the world has been met with raging opinions across the board. There are those who believe governments are not doing enough to keep us safe. There are others who believe the entire response to the pandemic is overblown. In order to effect the best decisions the right things need to happen, and they need to happen the right way. You will never please everyone. But if the rules appear arbitrary and inconsistent, that very fact will reduce faith in the rules and reduce compliance with the rules. The level of frustration in the population stems from the seeming contradictions in public policy. It’s difficult to reconcile those contradictions. There was the time when public officials told the population that masks were a bad idea. That guidance made no sense. It was not honest, and anyone with a shred of intelligence knew it. Now masks are mandatory in many places, but not all places. A full scale lock down of the population was seen by many as being heavy-handed. Taking a walk in the forest, distanced from others was not putting anyone at risk of either spreading nor contracting Covid-19. But for a time, it was against regulations in many states, towns and nations. It’s pretty clear that we are entering a second wave outbreak of Covid-19. But our governments are acting in an inconsistent way. My own provincial government closed down restaurants, gyms, and strip clubs this weekend for at least the next month. But they kept schools and universities open. This defies logic. In response to the restaurant closure, I know of several people who chose to go out for dinner in a restaurant for one last “hurrah” before the restaurant closures. If it’s not safe to go in a restaurant on Saturday, then it’s probably not safe of Friday night either. If smart educated people are defying logic, then they’re not believing what government is saying to them. We’ve been seeing that the majority of new cases in younger people. Yet, we’re doing nothing to reduce social contact in younger people. In our school system student in 4thgrade need to wear masks. Students in 3rd grade or younger need to wear masks. I know of one teacher who teaches a split class where half the students are in third grade and half and in fourth grade. Half the students are wearing masks and the other half are not. In Europe, there is a patchwork of regulations that are difficult to understand, and again seem to defy logic. The loosening of restrictions this summer helped Europe’s economy and partly saved the tourism season that is critical in countries such as Italy and Spain. But it also contributed to a sizable jump in the number of infections. Countries such as the U.K., France and Spain are now logging confirmed infections close to or above last spring’s numbers. Restricting arrivals from outside Europe isn’t an effective containment method when you have a rampant pandemic like we are seeing right now in most of Europe. Travel restrictions from abroad work in places like New Zealand and Australia where the case counts are extremely low and they have effectively kept Covid-19 out of the country. But when you have a full-on pandemic and you can travel freely within the EU, the logic makes no sense. If you’re confused by now, you’re probably getting the idea that governments are having a hard time getting their arms around making decisions. I follow Dr. Chris Martenson and Adam Taggart at Peak Prosperity. They have a very solid science based video series on Youtube that is published regularly with the latest on what has been learned. I also follow the work of Dr. John Campbell in England who has done a great job of curating the scientific and medical studies on the pandemic.

Phillip Vincent is the principal at MomsHouse.com where they specialize in helping families transition the elderly from their single family home to assisted living. During those moments, the families are experiencing a complex web of problems and Phillip's focus is on solving their problems. You can learn more and connect with Phillip at momshouse.com.

Valerie Malone is the principal at Quill Decor where she specializes in interior design for short term rental properties. Her clients are all across North America, even though she is based in Cambridge in the UK. On today's show we're talking about the design  elements that make for a winning short term rental property. You can connect with Valerie at quilldecor.com.  

One of the consequences of 2020 is that taxes are going to change in the coming year. I’m going on record as predicting that regardless who wins the Federal election in November, taxes are going to change. I know that I’m not saying anything terribly earth shattering. I suspect you all expect that. Tom Wheelright is one of the most well known accountants on the conference circuit. He’s one of Robert Kiyosaki’s Rich Dad Advisors and I love the degree to which he explains the tax code. Some people think of the tax code as a way for governments to extract money from the population. There are two ways you can look at a tax rate. You can look at it in absolute terms as a percentage, or you can look at the rates relative to what they were last year. Did the rate go up or down and by how much? Often politicians tend to focus on revenue collection, but they ignore the side effect which can be difficult to predict. But Tom has a secondary definition which I find equally useful. The tax code can be seen as a series of incentives. In that secondary definition Tom makes it clear that you’re not taxed on how much money you earn. You’re taxed on how you receive that money. Structure matters more than dollars in this instance. If you receive money as employment income, versus interest income, versus active business income,  versus capital gains they all get different tax treatment. The most favorable tax treatment can be considered an incentive to adopt the most favorable structure. This is something that governments sometimes forget. All levels of government collect tax. Some tax consumption. Some tax property ownership. Some tax income. There are taxes everywhere. Most cities calculate the amount of property tax owing based on a tax rate which is multiplied against the assessed value of the property. The tax rate can vary by area depending on the type of property and the costs associated with the infrastructure in that area. For example, some areas with new schools or higher water costs may have a higher tax rate. Some rural areas that don’t have water supply or trash collection may have a lower tax rate. In my home city, the tax rate averages about 1.07%. The city of Vancouver which is one of the most desirable and beautiful cities in the world has a tax rate of 0.26%. Houston Texas has one of the higher tax rates in the country at an average of 2.09%. But Texas has one of the lowest state income tax rates. Illinois has a high state tax rate and the second highest property taxes in the country. California has relatively low property tax rates at 0.76%, placing them in the lowest third of state property taxes. But they have the highest state income tax rates. The state that created the largest incentive for people to leave was New Jersey. They have the 6th highest state income tax rate, and the highest property tax rate in the nation. When you look at Florida’s average property tax rate placing it 26th among states in the Union, combined with a zero personal state income tax rate, is it any wonder that you hear so many New York, and New Jersey accents in Florida? The incentive was for people to move to Florida. Think of Taxes as merely incentives, and make your decisions accordingly.

On today’s show we’re talking about the top 4 causes of erosion of our scarcest resource. Whether we’re talking personally or more broadly, the scarcest resource is time. Time wasters are the among the most tragic of outcomes. After all, that’s all we have is time. Time is the great equalizer. Many of those who have managed to amass wealth have learned to manage their time better than others. They use their wealth and their time together in concert to create leverage. They spend money to save time. They invest time and money together to multiply their business and life objectives. But there are things that happen in life that can derail focus and cause massive amounts of time to slip by. On today’s show we’re going to focus on the top three causes of time erosion. 1) Low Value Activities. There are so many activities that make up part of daily life. Some people spend time mowing their lawn. That’s minimum wage work. If your time is worth $10 or $15 an hour, then by all means you should mow your own lawn. But if you aspire to more, then you should delegate that work to others who can do it for less than your time is worth. I rarely go shopping these days. I try to order almost everything I can online. It might be for pickup at the grocery store. 2) Emotional Disruption When people get uncomfortable, they often seek distractions in order to manage their emotional state. Some people spend time on social media. Some turn to alcohol, or watching TV, computer gaming or any of a number of distractions. There is a massive difference between idle time wasting and regeneration. Regeneration is an important and vital activity. Time wasting has little regenerative quality to it. 3) Health A health issue can cause a massive disruption in one’s life. This could something as simple as a common cold which can sap you of energy to a more serious situation. My sister recently had a bout of appendicitis. I’m happy to say that the surgery and treatment she received post-op has been successful. She fully on the mend. That single event has taken her offline for a minimum of three weeks. The last health issue I had was back in high school when I too suffered with intestinal issues that caused me to miss about 3 weeks of school. Today here in 2020, even a mild symptom that matches the Covid-19 description is cause for self-isolating for a minimum of 14 days. If you test positive for SARS Cov 2 you’re going to be infectious for a period and could lose 4) Conflict Conflict can sap you of energy and focus. I know that whenever my wife and I have a disagreement, which doesn’t happen often, I have witnessed 3-4 hours just vanish into thin air. We’ve both got much better are coming back from those hardened positions and resolving conflict more quickly. But conflict comes in all shapes and sizes. If you’re party to a lawsuit, that process can drag for months or years. The amount of lost time and energy in dealing with a lawsuit can be astronomical. Right now, there is nothing more important for society than dealing with the Covid-19 pandemic and the impact to the health of people and the health of the economy. But the US is in the middle of an election cycle. The last time there was consensus and collaboration among lawmakers was in the early Spring when the Cares act was signed into law on March 27. The past six months have seen nothing new to help the economy. In fact, the White House reported today that they’re not even going to try and get consensus on helping the people until after the election. That’s another month wasted. In the meantime, the economy is suffering, people are losing their jobs, businesses that can’t make it in the current environment are closing permanently. The most important thing you can do with your time is manage your time, energy and health.

On today’s show we’re talking about the materials cycle. Construction costs are influenced by the cost of materials. These commodities vary due to short term supply and demand fluctuations. Last year, the industry was buzzing about the rising cost of steel due to the trade negotiations with China. A lot of the steel used in US construction is sourced in China these days and the tariffs on imports meant that Chinese steel would be more expensive. The price of US Steel went up to match the higher price of Chinese steel. It seems that every time a major hurricane makes landfall in the US, there is a spike in the price of lumber. These storms create extreme demand for construction materials, especially in the Southern States. The ripple effect is felt through-out North America. We saw this after Hurricane Harvey soaked Houston. We saw it when Hurricane Laura smashed through Southwest Louisiana last month. I have friends who have been grumbling that prices for plywood have tripled since earlier this year. I even saw 2x4 lumber priced at nearly $8 per stud last week. I’ve never seen lumber studs priced that high. I’m going to introduce you to the metric for lumber commodity futures. Lumber commodity prices are measured in USD per 1000 board feet. Over the past 25 years, these prices have fluctuated in a range between $200 per 1000 board feet to $400 per board feet. As recently as March of this year, prices were below $300. By 14th September of this year prices hit an all time high of $984 per 1000 board feet. Two days later, by the 16th of the month, prices had fallen nearly $380 to $600 per 1000 board feet. Lumber futures prices fell 3% just today in the time it took me to record this podcast episode. The question is twofold: 1) What is the right price for planning purposes if you have a new project that you’re undertaking? 2) How do you plan your project to take advantage of the most advantageous pricing. When prices spike, it’s because of a short-term supply demand imbalance. The choke point in the system are the lumber saw-mills. There is actually a surplus of trees. The past three decades saw more acreage planted than at any time in history. Many of these investments were made by those seeking a recession resistant investment. Trees grow by about 15% per year, regardless what the economy is doing. As many sawmills sought greater efficiency and lower cost over the past decade, many smaller sawmills closed down. The result was a significant reduction in sawmill capacity across the industry. That sawmill capacity was better tuned to the average demand and resulted in better profit margins for the sawmill companies. This reduction in capacity also exposed the industry to greater price volatility for finished products. That’s exactly what we’re seeing right now. If you’re a developer, rehabber or builder who relies upon price stability in order to make your margins, how do you plan your projects? This comes down to an exercise in risk mitigation. If you know you’re going to use lumber in the next year, and your cost of borrowing funds is, say, 5%. You can store lumber for up to a year for a very low cost. If you can get your lumber at a price that meets your budget, you should consider locking in at that price, or pre-purchasing the materials and storing them yourself in order to guarantee that security of supply. If you failed to do that, then waiting a few weeks might be the smartest thing to do. In any industry that is sensitive to commodity prices, you need to pay close attention and manage your supply chain accordingly. Southwest Airlines was the most profitable airline in the US for nearly a decade simply because they had done a better job of securing long term fuel contracts at a price that made sense for them.