The Real Estate Espresso Podcast

In June of 2019, the Securities and Exchange Commission issued a draft working paper in which they solicited feedback on a possible change to the definition of an accredited investor. The idea was to increase the number of investors who would be eligible for making main street investments. Over the span of several months, the SEC collected input from the investment community. Thousands of people send comments on the proposal, including yours truly. Yesterday, the SEC announced the new definitions. I’m going to quote directly from their press release. You can read the full press release here.  "The Securities and Exchange Commission today adopted amendments to the “accredited investor” definition, one of the principal tests for determining who is eligible to participate in our private capital markets.  Historically, individual investors who do not meet specific income or net worth tests, regardless of their financial sophistication, have been denied the opportunity to invest in our multifaceted and vast private markets.  The amendments update and improve the definition to more effectively identify institutional and individual investors that have the knowledge and expertise to participate in those markets." The details of the new definitions are contained in the accredited investor definition in Rule 501(a): add a new category to the definition that permits natural persons to qualify as accredited investors based on certain professional certifications, designations or credentials or other credentials issued by an accredited educational institution, which the Commission may designate from time to time by order.  In conjunction with the adoption of the amendments, the Commission designated by order holders in good standing of the Series 7, Series 65, and Series 82 licenses as qualifying natural persons.  This approach provides the Commission with flexibility to reevaluate or add certifications, designations, or credentials in the future.  Members of the public may wish to propose for the Commission’s consideration additional certifications, designations or credentials that satisfy the attributes set out in the new rule; include as accredited investors, with respect to investments in a private fund, natural persons who are “knowledgeable employees” of the fund; clarify that limited liability companies with $5 million in assets may be accredited investors and add SEC- and state-registered investment advisers, exempt reporting advisers, and rural business investment companies (RBICs) to the list of entities that may qualify; add a new category for any entity, including Indian tribes, governmental bodies, funds, and entities organized under the laws of foreign countries, that own “investments,” as defined in Rule 2a51-1(b) under the Investment Company Act, in excess of $5 million and that was not formed for the specific purpose of investing in the securities offered; add “family offices” with at least $5 million in assets under management and their “family clients,” as each term is defined under the Investment Advisers Act; and add the term “spousal equivalent” to the accredited investor definition, so that spousal equivalents may pool their finances for the purpose of qualifying as accredited investors. So what does this mean for syndicators? It’s too early to say exactly. We are waiting on guidance from our own securities lawyers on how to interpret the new changes. We’ll do another episode in the near future once we have some legal opinions to share on the topic. From my perspective, this is a welcome change that will become effective 60 days from now.

On today’s show we’re bringing you an up to the minute update on the major hurricane that slammed into the Gulf Coast overnight. We’re talking about a major category 4 storm called hurricane Laura. About half a million people were evacuated from the low lying coastal area. Some people I spoke with drove as far as Austin Texas, 5 hours away in order to find a hotel room. We have several projects in SW Louisiana. So what was happening in Lake Charles is of direct personal interest. We have staff, residents, suppliers, lawyers, accountants in the market that we speak with on a daily basis. The short time available for preparing for the storm illustrated where we had weaknesses in our emergency preparedness. For example, in the future we will have a checklist for protecting key pieces of equipment, and records. When the staff closed down the office, we can only hope that they took the appropriate precautions. Some things will have been done well and others, perhaps not. We will certainly do a lessons learned and put some process into emergency preparation. But the important part is that we will carry that beyond our Lake Charles team into the other geographies. Some of those areas also have tropical storm threats. We knew there would be major power outages across the region and we took additional precautions by disconnecting the power to our buildings and powering down the water treatment plants and sewage treatment plants. These systems will be restarted in an orderly manner when power is restored following the storm. The national hurricane center published a map showing the impact of the storm surge, even 30 miles inland from the coast. That forecast predicted widespread flooding across several hundred miles of coastline, and up to 30 miles inland. If you stayed in the Lake Charles area, you’re getting wet. Now that the storm has passed, we know that the major impact was from the wind and that the storm surge was much less than predicted. Overnight we had reports of downed trees, of many broken electrical utility poles and downed power lines. We saw many broken windows and lots of debris scattered through the streets. One of the things that makes these storms so damaging is that the wind changes direction. Once the eye of the storm passes over you, many structures have been weakened or compromised. Then the backside of the storm brings back the hurricane force winds from the opposite direction and that’s when the real damage happens. You have a weakened structure that can’t handle being hit a second time from the other side. Whenever there is a major storm, people dig out their insurance policies and start reading policies, if they even have the full wording of the policies at all. Most of the time when we buy insurance, the insurance broker sends a one page quote with a signature line at the bottom. We always ask for the full policy and we’re often met with surprised reaction. What that tells me is that most people don’t really know what their insurance coverage is. Many policies have exclusions or limitations for named storms. Certainly Hurricane Laura would meet the definition of a named storm. Most policies have limitations on their coverage for water damage. They make a distinction between wind damage and water damage. If your building was damaged by wind and then water got into the building because of the wind damage, that would be covered under wind damage. But if the water came up from below, either because of a storm surge or because of a sewer backup, then that would be covered under a flood insurance policy. The insurers make a distinction on where the water came from when it comes to insuring that risk. As far as we know, all of our staff complied with the mandatory evacuation orders and will be fully ready to get to work on the cleanup in the coming days.

On today’s show we’re talking about what is happening in the world of hospitality. The American Hotel and Lodging Association is an organization that represents the hotel industry in North America. The AHLA reports that since the public health issue began escalating in mid-February in the U.S., hotels have already lost more than $46 billion in room revenue. This figure is devastating with hotels currently on pace to lose up to $400 million in room revenue per day based on current occupancy rates and revenue trends. Earlier this year I attended a virtual conference of hotel owners. In that conference, the owners talked about their forecast for the remainder of the year and the measures they had taken to protect the solvency of their businesses. Most hotel owners had assumed occupancy of 50% for the year, and had assumed that they needed enough cash to survive until September. Well, here we are in the last week of August. Last week, financial analytics firm TREPP issued a report on the delinquency rate in hospitality industry for those hotels that have debt in the CMBS market. The numbers are somewhat shocking. To be clear, we’re talking about hotels that have CMBS loans. We have no reason to expect that hotels with other forms of debt would intrinsically be in better or worse shape. They should be about the same, but we don’t have hard data on that aspect. The report highlighted 10 metro areas across the united states. The New York area had about $1.5B in delinquent loans representing 53 hotels and 39% of the market. Second was Chicago with $976M in delinquent loans spread across 28 hotels representing 54% of the hotels in market being delinquent. Houston has $664M of delinquent loans across 40 hotels representing 66% of the market. As a point of comparison, the delinquency rate in December of 2019 prior to the pandemic was 1.34%. The overall lodging delinquency rate increased to 2.71% in April and to 19.13% in May. The percentage of loans that are 30 or more days delinquent is 23.4% as of July 2020. This is the highest percentage on record. We have about $20.4B in hotel loans that are delinquent 30 days or more. At the height of the post 2008 financial crisis, there were $13.5B in delinquent hotel loans. We have a serious economic crisis underway and governments the world over are busy fighting over votes. This is like re-arranging the deck chairs on the Titanic while the ship is sinking. I was invited to attend a webinar tonight to discuss the investment opportunity for a new construction hotel in San Antonio. The numbers in the projection were glowing. It’s as if they forgot there is a pandemic underway. They’re assuming it’s all over by the time the hotel is built and that travel patterns return quickly to pre-pandemic levels. That’s far from assured. Why? Because the airlines are shrinking their businesses as well. If there is less air travel, then there is less demand for hotel rooms. The question is, why would an investor who wants to invest in hotels put money into a new hotel, when they can probably buy any one of several thousand distressed hotels for pennies on the dollar. For those who truly understand the dynamics of the new travel industry, there will be opportunity to make some spectacular investments. But this will require some guts and some well placed bets before the outcome is obvious.

My friends Jarrrett and Raja are magicians. They live in Las Vegas and they’ve had a magic show at the Stratosphere Hotel. They’ve been semi-finalists on America’s Got Talent. They’ve been featured frequently on the TV Show Masters of Illusion. They’ve even appeared on the TV Show Shark Tank. I’m sorry to disappoint you that when the canvas booth goes up in flames and the girl disappears from the booth and appears seconds later across the room floating in a water tank that’s inside a Grand piano, it’s not magic. It’s an illusion. Well folks, magic doesn’t happen in real estate either. I get so many questions from listeners that follow the same theme. I see real estate listings from brokers that assume magic happens. When I say magic, I truly mean magic. Let’s imagine that you were running a retail store. Customers come into the store. They buy your product at the retail price and you purchased the inventory at a wholesale price. Your profit quite simply is the retail price, minus the wholesale price, right? No, of course not. You have to pay rent on the space for the store, and you have to hire cashiers to take payment, and inventory managers to manage the inventory levels and purchasing of new inventory. You have to spend on marketing and advertising. All of that costs real money. If you don’t account for the actual management of the business in your business plan, then you’re relying on work getting done by magic. I really want to banish the term passive income from the dictionary because it doesn’t exist. All of these businesses are active businesses. There was a question from Joe who is evaluating a 20 unit mobile home park. The mobile home park is at 80% occupancy and has $59,000 in gross income. After expenses, the park nets about $37,000 a year in net income. The 20 unit park is on an 8 acre property. At a purchase price of $375,000, Joe is wondering if this is a good deal. The problem with this deal is that it assumes that magic is happening. If you don’t have a person dedicated to managing the business, then nobody is managing the business. A 20 unit park is not large enough to hire a dedicated manager. So that means hiring a part-time manager, and a part time maintenance person. That’s a problem. If you finance $300,000 of the purchase at 5% interest, you’re looking at an additional $24,000 in debt service. So the cash flow is now $13,000. That assumes that nothing goes wrong, that you don’t lose another tenant, that the septic system doesn’t need repairs, or that the water well doesn’t face contamination from an agricultural source. So often, I see these financial projections put together based on a snapshot of recent performance. But the problem is that these snapshots are incomplete. There are categories of work that attract real expense. The projection of $37,000 in profit and a 10% cap rate is a pure fantasy. There is no money allocated in the expenses for cutting the grass on 8 acres. That amount of landscaping will cost nearly $1,000 a month if the grass is cut weekly. The point here is not to dig into the weeds on this particular deal, but to frame the problem. Last week, I visited a historic manor inn. The Inn is in a wonderful location. It’s a perfect venue for hosting weddings. It has been beautifully decorated and the rooms would attract a high nightly rate during peak season. It’s a perfect setting for corporate retreats. What’s the problem? It only has 11 guest rooms. It’s too small to be economically viable. Unless the operator lives onsite or nearby and acts as an owner/operator, the economics don’t work. This is the problem with projects that are too small. They rely on real work happening that isn’t allocated in the operating budget. When something happens for free in a business, that’s magic. We all know that magic doesn’t really exist. It’s just an illusion. There is a sleight of hand happening.

Today is another AMA Episode (Ask Me Anything).  Paul asks: "I have been acquiring gold/silver since December of last year. Outside of a small physical holdings possession what do you recommend for storage for a larger portion of your holdings? I have heard Russel Gray talk about holding gold/silver and then borrowing against it to buy real estate. I love the idea but my search hasn’t found a trusted institution to do this? I believe you have mentioned in your Podcast you have bought from your bank. Would you be open to sharing your thought on how to find a custodian to store and borrow from your own precious collateral?" Paul, this is a great question. In fact there are a couple of questions wrapped up in this question. Let’s take a step back and talk about the purpose of holding physical gold. Of course, the amount of gold that you hold will ultimately influence your decision on where to store it. Gold is a store of wealth. It’s money, one of the only true forms of money. Although the government would like to have you believe that it’s not. It used to be of course. When you buy gold, there are many forms you can buy gold. Most people buy gold certificates. We don’t recommend it. Just because most people do it, doesn’t mean it’s the best thing to do. When you buy gold certificates, you’re buying a futures contract on gold at the spot price for gold. But the biggest problem with certificates is that you’re only holding a piece of paper. The piece of paper is essentially an IOU. This is not different than holding US dollars which are an IOU. It is subject to counterparty risk. The IOU is only as good as the company providing the IOU. The 2008 financial crisis showed us how even a legendary name like Lehman Brothers with over 150 years of history could leave an investor exposed. I’m personally a fan of holding the real metal. So when you buy gold, the question is where to buy it from? There have been a few isolated cases of counterfeit gold being sold on the open market. So you need to buy from a reputable dealer. Generally, these dealers buy directly from the mint, or from a distributor who buys from the mint. I like holding gold at private security companies where the records of who holds the safe deposit box is kept private. Your second question is where to store gold that his being held as collateral? You have a few choices. You can allow the lender to hold your collateral if you trust them. It’s more common to have collateral held by a third party who is in a fiduciary role where the functioning of that trustee is documented in a trust agreement. There are trust companies that can act as the trustee for precisely that purpose. They charge a fee for that custodial role and you need to decide if that fee is worth the additional security of having the collateral being held by the trustee. Sometimes the trustee can be an individual like a lawyer, if you are confident in that person fulfilling their role as trustee. After all, lawyers do have trust accounts where they hold money on behalf of their clients. This is conceptually no different. Let’s say that you want to invest in real estate. You might have some gold and you don’t want to sell the gold. Clearly you’re going to pay a higher interest rate to borrow funds with no security. You can use the real estate as collateral for a portion of the loan. But the remainder, the equity is the more expensive money to find. What if you could borrow money against your gold to fund the equity portion of the purchase?

Ari Rastegar specializes in upgrading and repositioning multi-family apartments to A-Class finishes at discounted prices in secondary markets. He's based in Austin Texas which is on the cusp of becoming the 10th largest metro in the US. You can reach Ari at https://rastegarproperty.com/.

Today's show is an excerpt of a conversation with George from earlier this week. George taught negotiation in the law school at NYU for over 20 years.  The outline of his course formed the basis of his best selling book on negotiation, which was published in 17 languages by John Wiley and Sons. On today's show, we're looking at a real life case study on how to negotiate the purchase of a property. George provides his perspective based on his years and hundreds of transactions in which he was a principal negotiator. Today's show is filled with pure gold. Enjoy...

On today’s show we’re talking about a new policy that positively affects owners of short term rental properties. As of August 20, 2020, Airbnb announced a global ban on all parties and events at Airbnb listings, including a cap on occupancy at 16. This party ban applies to all future bookings on Airbnb, and it will remain in effect indefinitely, until further notice. Today’s show is an excerpt of an interview that I had with a news reporter for CBC Radio and TV in Montreal on the topic of AirBnB’s new policy.

On today’s show we’re going to take a brief history lesson for the year 2020. We saw the first outbreaks of the pandemic in China, followed by countries where the infection had spread. These included Korea, Italy, Japan, Spain and France. Soon after followed Switzerland, Belgium, Sweden, the US and Canada. For much of the Winter and early Spring, North America was about 3 weeks behind what was happening in Europe. Critics in North America tended to dismiss what was happening in Italy as something that was specific to Italy. It won’t happen here in the US or Canada because Italy has an older population. It won’t happen in Canada because there is less population density. It won’t happen in the midwest of the US because there is already social distancing built into the way people live. Yet, there is a trend in almost every conversation...and that is the person agrees that the pandemic is a problem, but it won’t be a problem here. Why? There’s always a reason, until they’re wrong. At the other end of the spectrum, there are those who say there was no need for a large scale lockdown. The number of cases didn’t explode in their community and the damage to the economy was needless. So here we are again, with a near doubling of new cases in France and Spain in a very short time period. Many European countries have implemented new travel restrictions based on the increased number of new infections. Spanish authorities have flagged social gatherings—in nightclubs and among family and friends—as the primary source of infection. In France, high-risk workplaces and medical facilities have been the top sites for disease clusters. I was reflecting on those situations when I used to catch a cold. So far this year, I have not caught a cold. The last cold I caught was in July of 2019 when I attended a wedding. I haven’t had one since. Before the pandemic, I rarely used to catch a cold. If I did, it was because my children brought it home from school. Sometimes I would catch a cold from attending a conference, or perhaps someone seated nearby on an aircraft was coughing and sneezing. Catching a cold required contact with those who are infected. I know I’m not telling you anything earth shattering. So now, we have schools going back into session. Some schools have already started holding in person classes. We have differing protocols from one school board to the next. Some schools are requiring children to wear masks. Others have established plastic partitions in the classroom. Others are reducing class time to three days a week. Some have chosen a mix of hybrid online and classroom teaching. Some schools have reduced the number of subjects being taught at a time. The hope is that by concentrating the full year math course into a full-day 6 week period, the amount of social interaction will be reduced. These measures might help. But it’s fair to say that we are heading for another wave of increased covid-19 infection. Where this will hit, and when, or how broadly is anyone’s guess. Just like in the Spring of this year, we looked to Europe to see our future. I’m going on record, right here, right now as predicting that we will see another wave of infections. Those businesses that rely upon social gathering or movement of people will take another hit. That means a further setback for travel, hospitality, food and beverage, car rentals, and live entertainment. Some geographic areas have the core of their economy built on tourism. I’m thinking of places like Las Vegas, Orlando, many islands in the Caribbean, coastal beach towns. These sectors of the economy are going to be hit again. If you want to see your future, look ahead to Europe.

On today’s show we’re talking about what it takes to increase profitability or reduce the cash burn rate in the pandemic environment. Many businesses have taken advantage of the government programs that have provided emergency funding. But the indications are that emergency government funding is going to reduce or come to an end over the coming months. Now is the time for businesses to tighten their belts and focus on expense reduction before those subsidies expire. The biggest expenses for most businesses are debt service, taxes, employee salaries and other fixed costs like contracts. At a time when businesses are being tested for resiliency, this is the time to focus on improving profitability. That means a combination of tactics and strategy. Strategy is all about improving revenue, new marketing, new sources of income. These approaches can have a big impact on business performance. But when you focus all of your attention on the strategy, these changes sometimes take longer. There is also something to be said for working on the short term tactical. If you have suffered a loss of revenue during the pandemic, you are probably dealing with a drop in cash flow, or even negative cash flow. That means focusing on expense reduction. It’s amazing how much a company can accumulate in terms of discretionary expense over a period of time. Expenses that made perfect sense on the day they were approved, might be of lesser value a year later. Subscriptions are one of the biggest culprits. Now sometimes these expenses are small, which is why they’re allowed to linger, month after month. I’ll give you a good example. My company hosts its mail with Google using their business applications suite. Each email account costs $6 per month. For the quality of service, Google delivers a tremendous amount of value for $6. But there are two items that make a big impact on the profitability of a real estate project. Lowering interest costs Lower property tax costs Many cities are under pressure to cover revenues lost during the pandemic. They’re not allowed to borrow funds to cover operating expenses. As a result, you can expect significant property tax increases. There are two ways that cities increase taxes. The first is by increasing the tax rate charged against the assessed value of a property. The second way is by increasing the assessed value. The tax rate is something that is debated at city council and passed into municipal law. But the property assessment valuation is a hidden tax increase. If they deem that your property went up in value by 10%, well then your taxes just went up by 10%. The responsibility rests with you as the property owner to contest the valuation increase and maintain a lower valuation for tax purposes. Large developers that I know maintain a full-time position for the sole purpose of contesting property tax valuations. On a large portfolio, the savings more than pay for the salary for that person, and still result in a net tax saving to the owner. So you want to be contesting your property value assessment and making arguments that your property has been unfairly assessed. The second big saving comes in lowering your debt service. That can come in several different ways. You can refinance over a longer amortization period. This will go a long way towards reducing your monthly principal and interest costs. We are in an era of historically low interest rates. These rates are projected to persist for the next couple of years based on guidance from the Federal Reserve, and numerous other G20 central banks around the world. If you have high interest bridge loans, you want to negotiate better loan terms with your existing lenders, or replace those loans with lower cost debt.