The Real Estate Espresso Podcast

Paul Hopfensperger has swum the English Channel three times. I can't tell you how difficult this achievement has been. Today's story is such an inspiration. Paul is so humble and you're going to love this conversation.  Enjoy...

On today’s show we’re talking about how feedback delays affect speed of decision making. Today’s show is an explanation of how control systems operate. We’re going to start with a pretty simple control system that most of us are familiar with. Imagine you’re behind the steering wheel of a car. In fact, some of you are probably in your car as you’re listening to this. When you turn the wheel to the left, the car goes left. Turn the wheel right, and the car performs as expected. The delay between turning the steering wheel and the effect on the direction of the car is pretty short. It’s well under one second. It feels pretty instantaneous. Imagine for a moment that instead of that instant response, there was a two second delay. You turn the steering wheel, and two full seconds go by. one one thousand, two one thousand, and then the car starts its turn. Think about how much more difficult it would be to make driving decisions if there was just a two second delay. Now extend that delay to 10 seconds. How much more difficult would it be if there was a 10 second delay between making the decision to turn the car and you starting to see the effect of your decision. Hopefully you’re getting the idea. I’d like you to keep that idea in the back of your mind. We’re going to apply that same concept to the control system that is steering our economy. Specifically, the impact of government decisions to increase or relax social isolation regulations. This is another control system, just like steering a car. If you turn the wheel to the right, you have more social isolation, you reduce the spread of the disease. If you turn the wheel to the left you have less social isolation, the disease spreads more quickly. The government is monitoring data coming from the testing that’s happening all over the country. They are seeing the number of reported cases increasing. They’re looking at the number of people being admitted to hospital. All of this data is being used to make a decision on how strict an isolation policy is required to stop the spread of the pandemic. So the question is, do they need to impose a stricter social isolation policy? The economic damage that results from a complete shutdown is extremely painful and there is not consensus among the population that a full lockdown is warranted. So let’s figure out how government officials can even hope to make a decision before seeing the effect of that decision. The incubation period of Covid-19 is averaging about  7.7 days. That’s the amount of time between someone contracting the disease and the onset of symptoms. If you get tested, you will get your results in about 4 days. You’re now at 11 days. It takes a while for symptoms to worsen. So you’re at another 10-12 days before being admitted to hospital and then another few days before being admitted to intensive care. On average, we’re at three weeks from infection until someone ends up in hospital. The average hospital stay for Covid 19 is 23 days. So let’s add this all up. We’re looking at an average of 44 days from the time someone catches the disease until they get released from hospital or they die. So in order for a trend to establish itself, you need to wait nearly double the delay before you have a visible trend resulting from the decision. That’s a total of 88 days for government to gather enough data before they make a second decision. So let’s say that on day 1, they see case numbers creeping up to unacceptable levels. Government officials make a decision to turn right to shut down the economy. It’s going to take another 44 days for the first effect of that decision to show up.  Based on these simple facts, it’s no wonder that governments are over-steering in their attempts to control the pandemic. It would be impossible not to. Once they make a decision to increase social isolation, their next decision is at least 88 days away.

On today’s show we’re talking about the true costs of borrowing. Borrowers often look at the interest rate when it comes to figuring out the cost of borrowing. On today’s show we’re going to look at the hidden costs associated with signing a new loan. Loans come in all shapes and sizes. Most of them come with some form of up-front fees. These fees can be inclusive of disbursements. In other cases, these direct costs associated with the loan are added to the up front fees. These fees include a lender fee. On top of the the lender might charge you for preparation of the loan documents. In that case, the lender’s legal fees are passed on directly to the borrower. If the lender wants additional title insurance, you’re going to pay for that too. The latest fee in the US for some insured loans include the Adverse Market Refinance Fee. This fee is an additional 0.5% of the loan amount and is added to the upfront fees. This new fee was announced back in August and was supposed to be effective September 1. But an outcry from borrowers pushed the effective date of the new fee until December 1. A survey of a few mortgage brokers suggests that the additional fee might be added to the upfront closing costs, or in some cases, the lender will aim to recoup the fee by adding it to the interest rate over the term of the loan. The fee is ultimately charged by Fannie Mae to the lender and it’s up to the lender to collect the fee however they choose to do so. So the bank may choose instead to spread the fee over a 5 year term and increase the interest rate by 0.1% to cover the additional fee. That fee sounds painful, but it pales in comparison to some of the back end fees that can be assessed for early termination of the loan. It’s pretty common to have a sliding scale termination fee if you refinance before the end of the term of the loan. For example, if you have a 7 year loan you might have a termination fee of 5% of the loan principal if you terminate in the first year of the loan. That would drop to 4% in year 2, 3% in year 3 and drop to zero by year 5 of the loan. If you’re going to sign a new loan that is going to be at a lower rate than your existing financing, you want to look at the total difference in cost. Let’s say that you have an origination fee of 1% for the new loan, and let’s say that you’re terminating your existing loan early and have a 2% pre-payment penalty to pay. You’re now looking at 3% in up front fees. In order for that new loan to make sense, the interest rate would need to drop sufficiently to result in a meaningful saving. But you also need to look at it from a cash flow perspective. The lender fees need to be paid up front. So let’s imagine for a moment that you’re looking at a $1M loan. Those 3% in fees come to $30,000 that you need to fund at loan closing. If you don’t have that much available in cash, you’re going to have a hard time closing the refinance. You might have done the analysis which shows that over 5 years, a 2% annual savings in interest on a $1M loan would save you $100,000, minus the transaction fees of $30,000 for a total savings of $70,000. But you still need to come up with the $30,000 + additional closing fees in cash. Remember that in today’s environment some lenders are looking for borrowers to escrow larger amounts for maintenance reserves and for interest reserves than in the past. This is all part of a more conservative underwriting environment. So you might be facing a larger cash infusion for the refinance than you might have previously considered. We are in one of the lowest interest rate environments ever. But to take advantage of it, you may need to pay careful attention to the entire capital structure and ensure you don’t fall short.

On today’s show we’re talking about getting access to high value market data for free. I’m a big believer in getting access to market data and using that data to make decisions. I also believe that independently developed market studies are essential to make sure you’re not deluding yourself. Whenever there is a new commercial project undertaken, you can bet that there is going to be a third party market study. These studies are both expensive and time consuming. Before you take a project through the entire process of entitlement and a capital raise, you will want to commission a market study. But before you commit significant resources to a project, it might be nice to get a hold of an existing study that would help you understand the dynamics of the market. That kind of early look at the market can save you a lot of time and money by allowing you to validate and refine your product concept.   On today’s show I’m going to give you a shortcut. We know that work performed by government bodies carries with it a requirement for transparency. That doesn’t mean that governments publish all of the work they do. In fact they don’t publish that much. But you can often get a hold of information from government bodies through a formal access to information request. Almost all levels of government have a formal access to information process. So if you’re looking for market studies that can cost anywhere from about $5,000 to $50,000 to produce, you might just find that the information you’re looking for already exists and can be secured by simply asking the relevant government department to send it to you. Now a market study and an appraisal are not the same thing. But they often can contain the same information. I recently made a request to a government department for a market study in the industrial sector. They responded that they didn’t have the specific market study I was looking for. However, they did have an appraisal for several comparable properties in the area. Would I like to see a copy of the appraisal instead? Clearly the answer was yes. The appraisal was a 54 page document that was jam packed with sufficient market data to meet my needs at the start of a project. It showed more information than I was expecting. It showed annual absorption of square footage by neighborhood within the city. It showed total inventory and vacancy by neighborhood. It showed average rent per square foot by neighborhood. What did this document cost me? It cost a single email and about 10 days, and a follow-up email. The appraisal was a little more than a year old. Would I ultimately commission my own market study? Of course. But to get a project validated and to help refine a product concept, that document was more than sufficient.

Technology is testing the boundaries of new business models, and the pandemic is creating sufficient disruption to accelerate the adoption of these new business models. I had dinner delivered to my house last week from a restaurant. The restaurant is only about a 2 minute drive from my house, but having dinner delivered during an evening when I had a packed schedule was incredibly convenient. A new startup company is hoping to become the Uber of evictions and post-eviction cleaning. There are approximately 4.5 million homes in the US in some form of financial distress. One startup is treating the dire situation as a moneymaking opportunity for gig workers. The company, Civvl is recruiting freelancers to sign up as eviction crews for landlords and lenders, calling it the “FASTEST GROWING MONEY MAKING GIG DUE TO COVID-19.” Civvl is a company that started its online presence back in May of this year is hiring gig workers in all 50 states. Their website says that they’re accepting new gig workers in all 50 states and Canada. But when I attempted to register on their site, it was not capable of accepting a Canadian address. While there is a large scale moratorium on evictions, some evictions that do not fall under the moratorium are happening. The company aims to provide services in 4 separate areas: 1) Process Serving 2) Foreclosure and eviction clean-outs 3) Property Inspection 4) Eviction Standby and assistance The system basically aims to match landlords and lenders with process servers and cleaning crews who would be involved with the eviction process. The agents would not be responsible themselves for the eviction of tenants or the eviction of occupants in the event of a foreclosure. At the heart of the system is an iPhone or Android App that agents have running on their phone. When a new gig comes into the system in a geographic area, potential agents are notified of an incoming gig and then they have an opportunity to snag the gig. Pricing is negotiated between the user of the service and the agents who take the gig. I’m personally not ready to hire an unknown gig worker to serve legal documents. Yes, that will probably be less expensive than hiring a professional process server. But if the service doesn’t follow the process to the letter of the law, the landlord or the lender runs the risk of having the service being invalidated. In that situation you would believe that the notice was served, when in fact you would not be in compliance. Hiring someone from an app to complete an eviction clean-out would probably be an ideal service as long as there is enough resource available at a decent price in order to hire reliably. This is something that I would be inclined to use as a lender or as a landlord. I read through the company’s 28 page agent agreement that any gig worker would have to sign prior to becoming part of their network. I don’t know whether Civvl is ultimately going to be a good service or not. But we are living in a time of innovation and there is no doubt that new business models will emerge for services. I’m not here to offer advice. But rather this is an idea and information that you can keep on your radar.

There is a black knight at the black jack table. At first this statement might seem a little obscure. But stay with me on it and you’ll see it. If you’ve been listening to this show for a while, you’ll know that I’m a big believer in economic fundamentals. I’m a believer that 1+1=2 and the math needs to balance at the end of the day. I have this strange belief that in order for an investment to return a profit, the company needs to generate positive net income. For an investment to go up in value, that income needs to increase. If the income drops, so too does the value of the company. The power of the purse is vested with the federal reserve. This year the Fed made a commitment in March to deploy hundreds of billions of dollars to prop up the economy. The Fed promised to buy corporate bonds and exchange traded funds that invest in portfolios of corporate debt. The Fed can’t buy the debt of individual companies. But they can buy funds. The central bank tapped BlackRock to help advise it and buy the bonds and funds on its behalf, though the central bank retained ultimate authority over what to purchase. So while they met the letter of the law to ensure they’re in compliance, they’re certainly not living up to the spirit of the law. I’ve said this before, if you went to Las Vegas to play a game of black jack and one player at the table had the ability to add cards to the deck at will, some thugs would take that player out back and break their knees. But that’s exactly what the Fed is doing. They’re printing money and using that funny money to skew the card game in the favor of whoever they designate should be the beneficiary. The Federal Reserve had budgeted up to $750 billion for these asset purchases. In the end, the thaw in markets meant the Fed only spent about $13 billion of the $750 billion it had designated for corporate-bond and ETF buying. The positive signal sent by the Fed was enough to bring capital back into the market. Investors believed that the Fed would buy all this toxic equity and provide an effective backstop to investors from losing money. Whether that was true or not is immaterial. The fact is, investors believed it to be true and that was enough to have money pour back into equities. For the past three weeks we’ve seen an 8% pullback in stock valuations, including a 3% drop just today. But the problem is that none of these valuations are connected with the profit producing capacity of these companies. The folks at Blackrock have amassed another $57 billion in new investment during the past quarter and how have 7.3 trillion dollars worth of assets under management. Just because everyone is piling into the stock market without regard for company fundamentals doesn’t mean you should do it.

Jonathan Tuttle is based in Chicago Illinois where he invests in mobile home parks nation wide. On today's show we're talking about mobile home park investing and gaining insight into how that market is evolving. You can reach Jonathan at midwestparkcapitalfund.com

Mike Simmons is from Try Michigan. Today's conversation is all about how to scale your business from a solo-preneur to a larger business.  You can connect with Mike at mikesimmons.com

Today is another AMA episode (ask me anything)  Ryan asks: "I live in Los Angeles and have been working on my education and networking to break into the Commercial Multifamily Investing space (particularly in Arizona); however I do have an opportunity to possibly break into ground up development of built to rent units here in Los Angeles. A buddy of mine who develops (completed 24 units, 6 units and currently raising capital for 33 units in decent areas such as West LA, Hancock Park) is willing to let me tag along on his projects to learn while being a passive investor. Any advice on which path to choose (B & C class MF in AZ vs. ground up build to rent here in Los Angeles, CA)? I am leaning towards MF in AZ given the business friendly atmosphere there, but it's hard not being in the market." Ryan this is a great question. You’ve presented your question as one of two choices. Either new construction in Los Angeles, or B & C Class in Arizona. For reasons that I’ll go into in a minute, I probably would not choose either of the two asset classes you’ve presented. I’d like to encourage you to consider additional alternatives. In fact, I’d suggest that before you commit to a single project, you get clear on the type of project that is going to meet your investment criteria. In my world, an investment needs to follow the laws of supply and demand. That means I want to be in a market with growing population, growing employment, and a shortage of supply for housing. Los Angeles lost population in 2018, 2019, and it has lost population in 2020. In fact, LA ranked fourth in the nation in terms of population loss in 2018. All other things being equal, that means that prices will drop for both rentals and purchases. The problem with rentals in an expensive market like Los Angeles is that the cost to deliver a finished product is quite high compared with the net income you can generate. In addition, many submarkets are rent controlled. That means that the properties often don’t meet their potential because the rents are being artificially held down. I’m not a fan of C-class properties in Arizona. I’ve owned investment property in both Maricopa County and Pinal County. The problem with C-class is that the income strength is not there. If you’re renting property to people who don’t have stable income, then your investment is at risk every month. If they’re relying on government subsidies, you’re renting to people who are broke. They’re not going to take good care of your property. I’ve never lost money in A-Class properties. But I have lost money in C-class. You will find that C-class properties tend to have more than their share of surprises and unplanned maintenance. In terms of meeting your investment criteria, it’s important to get clear on what constitutes a good investment for you. I can’t decide that for you, I can only share what my investment criteria are. 1) I’m looking for projects that generate 30% net profit margin within 12-24 months. That means I’m buying at enough of a discount that I can generate that 30% margin after all expenses and interest carrying costs. We’re at a unique cross-roads in history. This is an exceptional time to start in investing. We are on the cusp of a repeat of 2008 all over again. Except this time it is happening in slow motion. We know it is coming. We can prepare. The moratorium on evictions, and the moratorium on foreclosures are both holding the market in a form of financial hibernation. I would hate to see you jump into the market a few months too soon in what amounts to the absolute top of the market, only to have a huge number of distressed properties hit the market all at once. When that happens, even with low interest rates, the laws of supply and demand dictate that we will see a precipitous drop in prices in some markets.

On today’s show we’re talking about the latest guidance from the Federal Reserve regarding interest rates. Yesterday the Fed announced the result of their latest committee meeting. They reaffirmed their guidance on maintaining interest rates low for the next 18 months, and then they extended that guidance by another year until the end of 2023. The Fed talked about the role for monetary policy which simply describes interest rates. The Fed has made it clear that simply lowering interest rates won’t do much to further stimulate the economy. Whether interest rates are 2% or 0% isn’t going to all of a sudden get people to run out and make new investments in The Fed chairman also spoke about fiscal policy. This is controlled by the Treasury department’s spending of money to stimulate the economy. Naturally the Fed has a hand in this as well because the treasury is empty and any spending requires the treasury to come back to the Fed with cap in hand asking the Fed to print more money. Right now, political wrangling has created a stalemate whereby the losers are those who are in need of financial help. The politics of an election have come ahead of helping a crippled economy. After nearly a month with little congressional progress on a renewed assistance package, the economy is in peril from lack of government action. So interest rates are at historic lows. What do you do with that information? What decisions should you be making knowing that interest rates are going to remain low for some time to come? As I see it, low interest rates may possibly reduce your income if you’re in the business of lending money.  But if you rely on debt to fund the growth of your business, then you have a series of decisions to make. 1) The best think you can do in this environment is reprice existing debt into a lower interest rate vehicle with as long a horizon as possible. When you borrow money in an inflationary environment, you are basically shorting the dollar. You banking on those future dollars being worth less than today’s dollars. If your interest rate is, say 2%, and let’s say that inflation is running at 3%, then the debt is being devalued at a faster rate than what you’re paying in interest. The money is essentially free at that point. I believe we are at the cusp of free money for that reason. But even more important than shorting the dollar, refinancing the debt into a lower interest rate facility gives you stronger cash flow and makes your business more resilient to economic shocks. We are not out of the woods yet with the pandemic and all the economic side effects. Lowering the cost of your debt is just plain responsibility. 2) It’s tempting to go and secure additional debt to grow your business. After all, the debt is so cheap, it’s tempting to go get as much capital as possible to take advantage of the low interest rate environment. But here is where you need to think carefully. What is the purpose of the debt? Is it to provide a cash buffer for the business? Is it to fund a growth in the business that is based on verifiable sustained demand? Is the growth speculative? In today’s environment of uncertainty, you want to be establishing clear criteria for how you make investments. When are you going to make incremental investments? Have you established a high bar for making investment decisions? Investments are made within a context. That context makes a number of assumptions. For example, in 2010 the context was a distressed market where assets could be purchased for 30-40 cents on the dollar. Today’s context isn’t fully known or understood. For that reason, my guidance is that new projects need to be undertaken very carefully. New debt should first be used to reprice existing debt and improve cash flow.