The Real Estate Espresso Podcast

On today’s show we’re talking about Freedom of Speech and what it means to be neutral. The year was 1889 and Almon Strowger was the local undertaker in Kansas City Missouri. Clients would call the operator and ask to be connected with the undertaker. The operator was called Mabel. They were all called Mabel. In those days, the operator would patch you through by pulling a wire out of the console and connecting the call manually to the destination. The problem is that one of the operators was married to the other competing undertaker in town and Almon Strowger was losing business to his competition because, in his opinion, the operator was giving calls intended for him to the competition, her husband. So Almon Strowger invented the first mechanical electrical phone switching system that would allow users of the phone system to dial the number of the destination and the connection would be made with no human intervention and no bias. The machine was truly neutral and would connect the parties following the commands of the person dialing the number. The Stronger Step By Step Exchange was eventually sold all over the world and became the dominant phone system around the world for close to 70 years. The system was eventually replaced by a digital exchange invented at Bell Laboratories and at Bell Northern Research. These systems maintained the neutrality inherent in the initial system devised by Almon Strowger. If you called Fedex, you were sure that you would be connected with Fedex and not UPS or DHL. So that’s the concept of neutrality, and the phone network solved that about 130 years ago Now let’s talk about freedom of speech and we’ll come back to talking about Strowger later on. So exactly what does Freedom of Speech mean? Most Western democracies have some form of Freedom of Speech enshrined in the constitution. That’s true in the US, Canada, the UK, most of Europe and so on. So what exactly does that mean? It means that you can’t be persecuted for what you think or what you say. There are limits on those freedoms. You’re not free to harm others through your speech. For example, you can’t frivolously yell “Fire” in the middle of a crowded movie theatre. You can’t make defamatory statements which aim to damage the reputation of another person or company. You literally have the right to stand on a soap box in a public place and make a speech. In the good old days, that might have been on the Boston Commons, or perhaps in Central Park in NYC, or on the Mall in Washington DC. Today, that means on the Internet, perhaps on social media, or who knows, a podcast. The makers of social media platforms are the modern day manufacturers of the soap box. The manufacturer of the soap box clearly can’t be held responsible for what someone standing on the soap box says. They merely cut some wood and screwed it together to form a box. Arguably, social media is private property, not public. The use agreement between users of the platform and the owners of the platform is between a company and the user. This is clearly a legal gray zone. Something said on social media is not truly public, but in many ways it is public. There are so many messages being put out on social media. How is a piece of software supposed to figure out what’s a legitimate use of the platform and what is in violation of the use standards. The amount of fake news is astounding. This week, the CEO’s of Amazon, Apple, Facebook and Google appeared before congress to answer questions about the amount of power and influence they wield to shape public opinion. They are the modern day Mabel. By curating what’s displayed on the platform, they’re filtering out what you get to see. When that happens, then free speech gets suppressed, neutrality is gone and Mabel is back in control of how calls get routed to the undertaker, and how propaganda gets presented to the voting population.

As students prepare to go back to school, the question on the minds of many student housing operators is “Has a university education changed forever?” Universities in the US represent about 20 million students, faculty and staff. That’s almost the same as the population of Chile in South America or Romania in Europe. those planning to reopen campus to students have different ideas about how best to do that. Duke University announced Sunday that it would limit campus housing to mainly first-year students and sophomores, rather than bringing back juniors and seniors as well. Stanford University will alternate groups of students by class year for each 10-week academic quarter; Harvard University plans to allow mainly just first-year undergraduates on its Cambridge, Mass., campus. The neighboring Massachusetts Institute of Technology campus is hosting mainly seniors. Cornell currently plans to return students to its Ithaca, N.Y., campus, with a mix of face-to-face and online classes. The University of California, Berkeley announced last week that fall classes would begin online, and said face-to-face instruction won’t start until the Bay Area’s Covid-19 resurgence is reversed. At Temple University in Philadelphia they are going to be making changes at the individual course level. They plan a return to campus in the fall. Some will be In-person classes: These are the typical, traditional classroom or seminar-style classes, but they will take place in rooms adjusted to allow for each student and the instructor to maintain six feet of distance from each other. Hybrid classes: These classes will blend in-person and online learning in an effort to reduce the number of students on campus and in classrooms at once. Online classes: These classes will be conducted fully online. I know of several students who elected to take a year off. They didn’t want their university experience to be compromised because of the constraints being imposed by the pandemic. There is a perception that watching a video online is a lower value experience than an in person experience. If you’re a student and you were expecting to pay a huge sum of money, possibly going into debt to sit at home and attend classes by video conference, there’s a good chance you’re going to think twice about making that investment in that way. Now if you’re in a faculty like medicine on dentistry, many of those classes can’t be taught in an online format. You’re not likely to take a year off from medical school waiting for the pandemic to pass. The folks at UT had already transitioned 52% of the classes at their Arlington campus to having an online option prior to the pandemic. They too will have a mixture of on campus classes, hybrid classes and fully online classes. Some of the hybrid classes will conduct the lectures fully online, but hold the labs in the lab with smaller lab numbers and increasing the times available for the labs. One thing is clear, the attendance on campus this year will be lower than in past years. If you’re a student housing owner or operator, you have to be thinking about three questions: How will I get through the 2020/2021 academic school year? What will university life look like after the pandemic? How long will we be living with the pandemic? If there is going to be long term vacancy in student housing this year, how will the monthly income be affected? Not just will you be one of the unlucky ones experiencing a vacancy, but will operators vying for a smaller student population drop prices in order to attract tenants? Student housing operators are accustomed to renting by the bedroom and they typically get a premium over a market rate rental.

On today’s show we’re talking about the discipline of making decisions based on the numbers. In the past couple of weeks I went through a process of underwriting a property that is a rare property. We’re talking about a property at 316 Water Street. As you might have guessed by the name, the property is on a body of water. This was a distressed property that was a bank power of sale. In my home market prices have shot up significantly in the past year. The average price is up 14% in the past year. The largest price increase has been at the bottom of the market. We’re seen prices at the bottom of the market up more than 25% in some cases.  A detached home of any description is selling above $650,000.  Imagine my surprise when my wife came across a distressed property, a little bit outside the city that was listed for $219,000. Even rural properties are being priced similarly to properties in the city. There is just no inventory. Not only was this property at a good price, it was actually on 3/4 of an acre on a beautiful body of water with a permanently deeded conservation area across the river. The area on the far side would never be developed. Immediately in front of the house the water is quite shallow and you would never have powerboats nearby. Fishermen would come within a few houses with their trawling motors but again, they’re pretty quiet. The property had a row of mature trees at the water’s edge. The house was about 15 feet above the river and very safe from the risk of flooding. At first the house looked like it could be an opportunity for a flip. Valuations for a single family home on the water we’re accustomed to building in higher volume. So while some of the trades would be competitive with volume pricing, we also knew that trades like plumbing and electrical would be more expensive. The biggest variable was in determining the scope of work. With a bank power of sale, the property is being sold as-is, whereis with no warranties of any kind. So if there was any doubt about a particular part of the property, we had to assume a rebuild. The bank gave us a week to complete our due diligence. A total of 20 trades would be required to complete this project, not much different than constructing a new house. We felt that if we could keep the renovation and repairs below $200,000 we would have a very viable project. A house on the water would sell easily for $600,000. As time went on, we started to put our budget together, it was looking increasingly like the project would exceed the original idea of getting it done for under $200,000. The house had a lot of problems. This would be a full gut of the property down to the bare timbers. It would mean a new roof, new flooring, new plumbing and electrical infrastructure, new HVAC, new exterior siding, new windows, a new attached garage. It would need a new water well and a new septic system. As a rural property, there is no municipal infrastructure. There was a condemned addition on the house. The separate garage structure was also condemned. The chimney was condemned. The house was sagging in places, but overall, the house was pretty robust. The walls were over 12” thick. There was considerable moisture in the basement, and the basement had not been cleaned from the dog breeding operation that had been underway. Entering the house safely required special breathing apparatus with N95 filters. We considered demolishing the house and building a new house with a better orientation facing the water. Both my wife and I were captivated by the allure of buying a waterfront property for considerably less than the going rate in the market.  Our heart said yes, and the numbers said no.

Ben from Oklahoma City asks We are looking at building a residential assisted living center consisting of 12 residential care homes. What are your tips on mapping supply and demand for the market. Our current approach is googling and building a list and talking with folks that are already in the assisted living industry for the market.  Do you usually commission a 3rd party to do a market study? What are your criteria for hiring and finding someone to complete that study? Thanks! Ben, this is a great question. You are focusing on residential assisted is very smart. The assisted living market is part of a continuum of care that starts with independent living with a very light amount of services at one end of the spectrum and skilled nursing at the other end of the spectrum. Assisted living fits somewhere in the middle. The first step is to get your own market intelligence. That consists of talking with lots of people in the local market. You want to find out which banks have funded the local projects. This is done by simply searching title and seeing who has the mortgage recorded on title. You can then talk to those banks and get their assessment of the local market conditions. Next we talk to people who operate the local facilities, including staff. Do they like their job? How long have they worked in their current job? Is there high staff turnover? You and your wife should visit all of the possible competitor facilities in the market as a secret shopper. You can interview each facility under the guise of looking for a place for a family member who is getting older and will need a place soon. When you do, find out the current occupancy of all the competitors. But most important, make an assessment of their strengths and weaknesses. If the market were to become saturated and oversupplied, you need to know what it will take to compete to win and get more than your fair share of the market. Then to answer your question directly. Yes, we always commission a third party market study. This is done for every major project. Some accounting firms and brokerages have consulting divisions that specialize in market studies. In the assisted living world, there are also consultants that have industry recognition. You perform a market study for three different purposes. Make sure you’re not deluding yourself into thinking that you have a viable project. It’s easy to get project fever and become emotionally attached to a project. Your lender may require it. If you’re raising capital from investors, it’s a good practice from two points of view. You can show your investors that you’re taking their investment seriously. The market study is part of your fiduciary responsibility to them. The market study which shows demand for your product can be part of your communication with your investors as to why the project might be a good investment. The market study is going to look at other elements. They’re going to examine the demand and the ability to afford your product. So they will look at the number of people in the age demographic. But they will also match the age demographic with the income of the kids. Because often, the funding for the assisted living stay is coming from the next generation. If the parents don’t have the money, maybe the kids do. So you will get a comprehensive picture of the market. The market study will look at the capture rates for independent living as a leading indicator of what the capture rate might be for assisted living a few years down the road. They will also look at the capture rate for assisted living and compare that with industry averages for a healthy market.

Jyoti is an analyst with Trepp in New York City, specializing in commercial mortgage backed securities. On today's show Jyoti gives a basic tutorial on the CMBS market and how it operates. If you want to learn more, reach out to her at info@trepp.com.

George is a repeat guest on the show. He's best known for his role as Executive Vice President in the Trump Organization. He's the best selling author of two books on real estate and negotiation. He taught at the law school at NYU for over twenty years. In business for over 60 years. At 92 years of age, one of the wisest men I know. On today's show George discusses the current market conditions, the moratorium on evictions and foreclosures and what to do about it.

On today’s show we’re talking about your frame of reference. The price of silver has gone up 28% in a little over two weeks. But we’ve been saying for a long time that silver is undervalued relative to gold. Two months ago gold was trading at 115 times the price of silver. In historic terms, that’s a nearly record breaking ratio. Either gold was over valued or silver was undervalued. Through much of history the ratio between gold and silver has been hovering in a range between 50 and 70. Sometimes it would go outside that ratio. For example, in the period from April 2010 to May 2011, the ratio dropped from 65 to 30 before rebounding back to 60 a year later. When silver was trading at such a discount, buying more silver seemed like the obvious thing to do. Markets are truly inefficient. Even markets with high degrees of liquidity and millions of participants can get off balance for a period of time. If you’ve been listening to this podcast for a while then you’ll know that I’m not a huge fan of the Wall Street Casino. While the price of silver has nearly doubled since March of this year, that may be an illusion. That’s because your frame of reference is dollars. Frame of reference is extremely important. Some people measure their wealth in terms of dollars. Others may choose to measure their wealth in ounces of silver and gold. You see, you might be standing still as you’re listening to this podcast. Or you might be seated at your desk. If you’re in your car on the freeway, you might be driving 60 miles an hour. But of course none of those are correct. You’re on the edge of the earth that is spinning at about 460 meters per second or about 1,000 miles an hour. It doesn’t feel like you’re traveling that fast, because of your frame of reference. It turns out that 1,000 miles an hour isn’t quite right either. You see the earth is spinning around the sun at a speed of about 30 km per second or about 67,000 miles an hour. It all depends on your point of reference. Some people choose to keep dollars as the point of reference. But dollars are constantly in motion. They’re continually declining in value. Dollars are not money, they’re merely currency. In order for something to be considered money it must perform two vital functions. It must serve as a means of exchange and as a store of value. Dollars are a very effective means of exchange, but not a very good store of value. So far, we’ve been successful in exporting our inflation. When you go to Walmart and buy a pair of shoes that were made in China, or perhaps an electronic gadget, the supplier to Walmart gets paid in US dollars. That supplier has no real use for US dollars so they go to their local bank who exchanges the dollars for Remnimbi. China’s central bank ends up with a surplus of dollars. So they go in search of assets they can buy with US dollars. For years, they’ve been buy US Treasury bills. It’s the perfect solution. The trade deficit with China results in China buying the surplus debt of the US Government. All those extra dollars in circulation get taken out of the economy in the West and end up buying the excess government debt. It’s a system that works perfectly until it doesn’t. When you put dollars in the bank , you’re  exposed to counter party risk. If the bank goes bust, then you don’t have any money, you merely have a claim on money that is actually the bank’s money that you have put on deposit with the bank. When you hold the physical metal in your hand. There is no counter party, and therefore there is no counter party risk. So back to the frame of reference. My analysis is pretty simple: the more money that central banks print, and the more debt that governments take on, the more valuable gold and silver will become. Said another way, : the more money that central banks print, and the more debt that governments take on  the less valuable the currency will be.

On today’s show we’re taking a look at what’s happening in the housing market and make sense out of some pretty confusing data. Last week we reported that lumber prices have increased to record levels, driven by outdoor construction projects at restaurants, the low inventory in homes for sale, and numerous home improvement projects are driving demand for building materials. On a recent project that I’m building, I’m receiving quotes of 5-6 weeks delivery for wood siding that normally should be a two week delivery item. Construction trades for large projects in my market are booked for the next 18 months. We just had a builder in Utah decline a very attractive land purchase that had been previously committed. When that happens, it’s usually because they’re worried about making a financial commitment to building houses. In this case, they declined because they’re so busy with existing construction jobs that they don’t have the capacity to even start those jobs in the foreseeable future. The headlines read that housing sales volumes for existing houses jumped 20.7% in the past month. Driving sales are apartment renters seeking more space, young families moving to the suburbs, and wealthy city dwellers looking for second homes, brokers and economists say. At the same time, the supply of houses for sale remains low, with the pandemic making potential sellers cautious about letting people tour their homes. The demand for houses is there. To put this in perspective, home sales are still down 11% compared with this time last year, which was a slow year by many measures. So arguably the market has the ability to support a higher level of activity without being considered overheated. Home sales had been in a two-year rut heading into 2020, weighed down by perennially tight supply and historically high home prices. Even solid U.S. economic growth and low unemployment couldn’t get sales moving back in 2019. That seems like a lifetime ago. Homes typically go under contract a month or two before the sale closes, so the June sales data largely reflect purchase decisions made in April or May when we were still in a stricter lockdown environment. Some agents and brokers I’ve spoken with are optimistic that the usual spring demand has been pushed to the summer, and that momentum is building. The spring is normally the busiest season for home sales, as buyers with children want to move into new homes before the school year starts. My take it that the market is being constrained on the supply side. People are not moving in the same numbers that we’ve seen in historical years. That’s reduced the supply of houses coming on the market. We often see this happen when prices rise. People want to move but don’t because they can’t find anywhere to move to. They bought their house a decade ago at a good price, maybe $150,000 or $200,000. Their home has increased in value and now would command a sale price of, say $500,000. But the seller is still living in a house that they paid $200,000 for. If they buy something new, they’re looking at prices starting at $500,000. Yes, they have a lot more equity to work with. But they often don’t see the purpose behind getting a larger mortgage and buying a house with a larger price tag. They’ll move because they’re forced to move for employment or a life event, but not for a change of scenery. I’m currently in negotiation with a home owner whose name is Andy for a property that’s on the edge of a larger development site. Andy and his wife bought their house for $350,000. Prices in the neighborhood have skyrocketed to more than $1.2M. They don't want to pay that much for a new house.  So they’re deciding not to sell and stay where they are. That’s another house that will not go on the market this year.

On today’s show we’re taking a look at what’s happening in population migration. Over the past 20 years population growth among secondary and tertiary markets has outpaced that of the country’s large primary metros. A new report from Marcus and Millichap shines a spotlight on a trend that has been accelerated by the events of this year. Over the past two decades total population growth was 70 percent higher in secondary and tertiary metros than in gateway cities. Since 2014 that ratio has climbed to over 200 percent. In my opinion, the number one driver that has enabled growth in secondary and tertiary markets has been the installation of fiber infrastructure for communications. When you have a fiber connection to your home or office, you have communication speeds that are among the best in the world regardless of your location. Speed of electronic connection is on par with the importance of physical presence. The fact is, you will always need to meet with people who are more than driving distance away. There will always be people who are more than flying distance away. Even before the pandemic, I was routinely spending hours each day in video conference meetings. The pandemic has merely accelerated a trend that was already underway. In my opinion, the Marcus Millichap report is over-simplifying the trend. They mention that New York and Chicago have lost about 600,000 population in the past 5 years. But high taxation and difficulty of doing business have played a major role in that trend. The beneficiaries have been cities in lower tax environments. These include the primary markets like DFW, Atlanta and Houston, and the secondary markets like Austin, Nashville, Charlotte. 

On today’s show we’re talking about how the Pandemic is going to shape the near future for real estate investors. Our entire economy situation, both in the US, Canada and much of Europe is based entirely on the printing of money by central banks. Our entire economic system is fully dependent on the free flow of low cost debt. Every major sector of the economy has a financing plan associated with it. Virtually every facet of every family of every business is being supported by debt, and now government subsidies. Let’s look at debt for a moment. Of course there are two types of debt, there is good debt and bad debt. Good debt is the kind that is paid off by an income producing asset. Bad debt is consumer debt that is strictly to pay for luxuries that people can’t afford to buy today. Some economies are more highly debt dependent than others. For example, I walked into an electronics shop in the downtown area of Cancun Mexico, that is outside the tourist zone. The prices for most items were not listed. The only price listed was the bi-weekly payment if you financed that particular gadget. I saw the same thing at the supermarket. You could buy a motorcycle at the supermarket. The price listed was not the purchase price, but the bi-weekly payment. People were being socially conditioned to judge affordability based on how much of their bi-weekly paycheck they could allocate to that luxury. The same thing happens of course in the US, Canada and Europe, only to a lesser degree. When you go to the car dealership, the sticker price displayed on the vehicle is often the cost of a lease payment. We can’t shut of the credit markets without creating economic collapse. But we have to acknowledge that we are way too dependent on credit for things that really should not be financed. Our society has a planning horizon of two weeks. That sounds harsh. But there’s an element of truth to it. The real question as to what will happen as a result of the pandemic rests on two fundamental questions: 1) When will the stimulus money stop? 2) When will the confidence in the currency collapse? The US has largely exhausted the payroll protection program funds. They extended the period of time that payroll funds can be used. But they haven’t allocated any additional funds to the program or allowed borrowers to get access to more than 2.5 months worth of payroll. We are now 5 months into the pandemic. The number of people collecting unemployment benefits started to decline in June but is now growing again. The pandemic unemployment benefits in the US are set to expire at the end of July in less than ten days. There are still more than 32 million people collecting unemployment benefits between the regular state run programs, and the pandemic programs. Turning off the taps to relief money would create mass riots. Deciding new benefits  will be government's task in the next week.  The next question is whether to give the money to households or to employers. In Canada, the emergency relief benefit being paid to businesses has been extended until the end of the year. I had a conversation with a restaurant owner yesterday who share that 75% of his payroll if being covered by government funding. In April, at the peak of the shutdown, he thought his business was over. Today, he has opened up seating for 150 outdoors. He’s doing a robust take-out business, and the tables are busy and he’s making more money today than in his best months prior to the pandemic. When the subsidy disappears, he will need to reduce his staff by 50%. As real estate investors, our income comes from our tenants. Our tenants get their rent money from their job, or lately from an unemployment benefit. As investors we need to acknowledge the uncertainty that depends entirely on what governments will decide in the coming week regarding further stimulus money.