The Real Estate Espresso Podcast

On today’s show we’re talking about some leading indicators that might predict what will happen in the housing market 3-6 months from now. As we all know, there is a moratorium on evictions and foreclosures in most areas right now. In the US, the moratorium on evictions was extended again until at least the end of August. The big debate is whether we will face a period of real estate asset deflation before we experience large scale inflation. Let’s look at the drivers that might be affecting the real estate markets. The big question is what will happen in the credit markets. We have a 13.3% unemployment rate in the US and 13.7 percent unemployment rate in Canada.  For now, unemployment benefits remain in place. But they won’t remain in place indefinitely. When they start to disappear we will start to see defaults in consumer credit, automotive credit, and eventually in mortgage credit. But here is where the numbers get interesting. Only 15.9% of loans in forebearance made payments in June. That’s down from 28% in May and 46% in April. These forebearance agreements are finite in duration. The question is what happens six months from now. More than 100 million auto loans and student loans have had missed payments since the start of the pandemic. As of the end of May, 4.3M real estate loans were in default, and increase of 723,000 from the month before. More than 8% of US mortgages were past due or in foreclosure. That compares with a normal mortgage default rate of 0.42%. There are now 4.3 million homeowners past due on their mortgages or in active foreclosure – including those in forbearance who have missed scheduled payments as part of their plans – up from 2 million at the end of March. On a percentage basis, there are now 7.76% of homes in the US in a distressed situation. But the fact is, almost none of these are on the market, thanks to the moratorium on foreclosures. As the amount of government bailout money dries up, the number of distressed homeowners will only increase. Over the span of 5 years from 2008 to 2013, a total of 10 million people lost their homes in what was at the time the biggest distressed home market in history. We have lots of people with traditionally good paying jobs that have experienced significant income disruption. We’re talking about airline pilots, dentists, dental hygienists, hotel staff, flight attendants, fire fighters, police officers, physiotherapists. The list goes on and on. Airline pilots and flight attendants are obviously impacted by the pandemic. City employees like fire fighters and police officers is less obvious. The problem is that cities are forced to balance their budgets and most have experienced a 25% loss in revenue during the pandemic. As we reported last week, Nashville just passed a 34% property tax increase in order to try and make up the shortfall. Whether that truly solves their problem remains to be seen. Other cities have been forced to reduce staff significantly. There are a few hotspots where the delinquency rate is much higher. Mississippi, Louisiana, New York, New Jersey, and Florida all have delinquency rates above 10.5%. Mississippi is close to 13% delinquency. You can expect that there will eventually be a sharp increase in distressed inventory working its way through the system. At what point will the bailout money dry up? We are in an election year in the US and neither Republicans nor Democrats want to be seen as abandoning the population in a moment of need While all the traditional real estate market indicators point to a strong real estate market in many cities including low inventory, low interest rates, rising prices, multiple offers. These conditions may be artificial and could be hiding a much different underlying condition.

On today’s show we’re looking at some of the leading indicators to predict what might happen in the housing market three to six months from now. We’re currently in the middle of a moratorium on both evictions and foreclosures. Let’s talk about rentals first. We will talk about foreclosures on Tuesday. The moratorium on evictions doesn’t mean that tenants don’t need to pay rent anymore. It simply removes one of the remedies that landlords have in the case where tenants don’t pay their rent. In most states and provinces, there is a landlord tenant tribunal that deals with disputes between tenants and landlords. In Ontario where I live, the current landlord tenant board has a backlog of more than 80,000 cases. The tribunal is not handling eviction cases, except in severe cases where safety is threatened. But a little known remedy within the tribunal system is to get the tribunal to render a judgement on arrears. The judgement simply states whether the tenant owes the money to the landlord or not. The landlord still can’t evict, but armed with the judgement, can take other collection actions. You see if the landlord can demonstrate that the tenant still has the means to pay, and is using Covid-19 as an excuse not to pay, they could likely win a judgement in their favor. I’m going to cover two cases. The first case involved a student tenancy where 4 tenants had entered into the standard industry lease, the terms of which bind all tenants on a “joint and several” basis. Prior to the lease commencement date, 2 of the 4 tenants informed the landlord that due to COVID-19 and the prospect of on-line classes, they would not require the tenancy and would not be moving in. Two tenants agreed to honour the lease and paid rent for the commencement of the tenancy. The defaulting tenants took the position that the application should be dismissed since they never moved into the unit: they were not “in possession” In the second case, a tenant proposed to vacate without proper notice on the basis of his fear that the risk of COVID-19 in a multi-res building was very high and he wished to move his family into a lower risk environment. The tenant stopped paying rent and, since L9 applications don’t require advance notice, the landlord immediately applied to the LTB for judgment for arrears. In an ARREARS  application, the LTB’s only function is to determine whether there are rent arrears; furthermore, in contrast to eviction applications where the LTB has a discretion to delay or deny eviction and force the landlord into a repayment plan for arrears, in an ARREARS  application there is no “overriding discretion” to refuse or delay a remedy, the only issue is whether rent is owing. In its analysis, the LTB Member stated: "With respect to the health risks arising out of Covid 19, I am sympathetic to the fear this pandemic has placed on everyday living practices. However, once I have made a finding that the rent for May 2020 is owing, I do not have the jurisdiction to tell a Landlord that he must forfeit rent that is validly owing.” Now I’m not a lawyer, and the law varies widely from one jurisdiction to another. You definitely need to seek your own legal advice and examine the facts that are specific to your case. These two cases illustrate that there might be other remedies apart from eviction. Don’t just assume that a moratorium on evictions means that landlords are stripped of any tools to enforce a duly signed rental contract. As cases like these become more highly publicized, you may start to see greater compliance. The fact that Ontario has a pending eviction case affecting about 4.7% of all rental properties in the province. The real number could be much higher. You see some landlords will not have even filed paperwork if they believe the application will be denied. Check out your local remedies. 

Rich Danby hails from my home city of Ottawa Canada and can be reached at rich@richdanby.com. On today’s show we are talking about how most goals for 2020 were impacted by the pandemic and what to do instead. How can you set goals in an environment of such uncertainty? 

George is a repeat guest on the show. On today's show we're hearing George's take on the economic recovery and on negotiation with China. Fascinating perspective.

Vacation bookings usually happen months in advance. Employees book the time off work. They buy the airline tickets far in advance to get the best prices. Of course this year is different. But people still want a get-away, perhaps even more than ever. The perception is that it’s not safe to board an aircraft, that a cruise is risky. In fact, the cruise industry is largely shut down, and the airline industry is operating at about 20% of its capacity. Most of the air travel is essential travel and it’s short to medium haul in nature. Air travel has all kinds of restrictions. You will be expected to wear a mask for the duration of the flight. Meal and drink service has been cancelled and this becomes impractical on a 13 hour flight to Asia or even a 9 hour flight to Europe. People have decided to vacation close to home. That means driving distance. We are now in peak summer season and listings for most vacation properties show that they’re fully booked until the end of August. The exception to this is in areas where there is a lot of condo’s like at ski resorts; there tends to be a lot of availability at ski resorts. The perception is that it’s more difficult to social distance in a condo than in a standalone cottage or lakefront home. The other place where vacation rentals are easily found is in areas where government mandated travel restrictions are still in force. We also find that boat and RV rentals are almost fully booked for the entire summer. The only ones available are the result of last-minute cancellations because of international travel restrictions. Those with long standing reservations seem to have hung on until the last minute to see if travel was going to be possible. Some vacation markets rely heavily on air travel to fill the rooms in a market. Those areas are definitely going to experience higher vacancy during peak season and lower nightly rates. For example, we have a portfolio of vacation rentals in the Rocky Mountains near Banff Alberta. The local driving distance population centers of Calgary and Edmonton will provide a strong source of demand. But they won’t make up for the plane loads of tourists from Japan, China, and Korea that regularly frequented the area in years past. Instead of the usual $650 per night rate, we’re seeing strong occupancy at a more modest but acceptable $250 per night rate. Markets along the eastern seaboard like the Jersey Shore, and the Carolinas are seeing strong occupancy. Hotel occupancy in Myrtle Beach is close to pre-pandemic levels according to hotel data analytics company STR Global. Urban vacations are not as popular these days with social distancing still an important criteria for many families. For example, hotel occupancies in NYC have risen from the lockdown low of 9% to a current occupancy of about 40%. Nightly rates in NYC have dropped from an average of $250 per night to about $125 per night. But since NYC was a hotbed of Covid-19 outbreaks, it’s probably not at the top of the vacation destinations this summer. Some areas are opening up to tourists, subject to a negative Covid-19 test result that is less than 72 hours old. Some tourists have entered Canada by car and told the border agents that they were driving to Alaska which is allowed. But it seems some of them have been found stopping in Banff National Park. If a visitor drives straight through to Alaska with only minimal stops for fuel and food, that is permitted. If a visitor stays in a hotel, then they’re required to quarantine for 14 days at a designated quarantine location.

Much has been written in recently years about the retail apocalypse. Earlier this year we shared the mind numbing statistics of retail store closures that amounted to over 10,000 retail stores in the US in 2019. The pandemic clearly hasn’t helped most retail establishments. On today’s show we’re taking a closer look at what is happening in retail. These days, my email in inundated with listing offers for retail real estate. They aren’t bargains for the most part. I’m seeing  pharmacy locations, banks, fast food establishments, convenience stores, has stations, and automotive service shops like muffler and tire shops. The list is long and varied. These for sale listings are not bargains. I recently saw an offering for a 21,000 SF multi-tenant property that houses four large restaurants. The asking price is at $588 per square foot. This is well above replacement cost. Remember, these restaurants have been closed for quite some time and the metrics for restaurant dining post pandemic have not been established. It would be very hard for this investor to pay that kind of top dollar with the risk that is inherent in four new restaurants as tenants. Simon Properties is the largest shopping mall owner in the US. In the past four years, Simon has acquired three of its tenants. Now they’re in discussion with Brookfield Property Partners to potentially acquire JC Penney. JC Penny is an anchor tenant in several of Simon’s shopping malls. When a mall loses its anchor tenants, the mall usually dies. You see our credit system isn’t designed to handle an economic downturn. There is so much debt in the system that businesses can’t survive a drop in revenue. The businesses have borrowed money to fund their inventory. They’ve borrowed money to advance funds for their accounts receivable. They’ve borrowed money to pay for equipment, or perhaps the equipment is leased. Either way, the fixed costs of these retail businesses are high and these businesses are not resilient to economic fluctuations. The problem is further compounded by the fact that the mall owner can’t survive a long period of economic vacancy. As a commercial landlord, I frequently face questions from tenants looking for rent concessions to help them with revenue fluctuations.  The massage therapy office that rents from us needs rent relief. The clothing store needs rent relief. We know that some stores will close as a result of the pandemic. Some stores simply won’t survive. Here’s the scenario that I believe we will face in the world of retail. Retail space will get repriced, on a massive scale. There will be lots of pain along the way. Even those retail owners with firm leases will find themselves negotiating rent concessions on a large scale. Let’s imagine that we have a 20% reduction in retail floor space as a result of the combination of the pandemic and the ongoing trend of local retail sales being replaced by online sales. There might have been already a 10% vacancy rate in the market. Add another 20% and you’re near 30% vacancy. So now some of those properties go into default on their loans and the buildings are sold at a fire sale price, say, 50% off their construction cost in a foreclosure auction. The new buyer owns these buildings at 50% of their replacement cost. They can charge a lower rent compared with the competition and still make a healthy rate of return. New tenants will flock to the newly available space that is priced 1/3 less than the comparable market. Tenants in existing spaces will renegotiate their leases. They will argue that the move to less expensive space is necessary for business survival. The existing landlord faces a difficult choice. The landlord either offers a rent concession, or they lose the existing tenant and revenue goes to zero. It’s a lose lose scenario for the landlord.

On today’s show we’re talking about the merits of two different approaches for raising capital. It’s a bit like asking which is better, Ketchup or Mustard? Some people like ketchup, some like mustard, and some like both. The two funding models are the blind fund and the syndication for each project. Some syndicators have a preference for raising capital for each new project. Each project stands on its own and investors who qualify to invest in these exempt market offerings make the decision to invest in each offering independently. They diversify their investments by investing in multiple different projects. Each project sits in its own separate entity and there is no chance of a problem in one property cascading and affecting any other property. There is a veritable fire-wall between each property. This structure is ideal for many investors since it allows investors to make individual choices on which project they want to invest in. The blind fund model requires a stream of similar investment over a period of time that matches the life of the fund. The benefit of a fund is that you raise the money into the fund at the beginning. Once you have access to the funds, you can execute quickly on deals. You don’t have to worry about being too aggressive when placing an offer. You know that you’ll be able to close since you already have all the funds you need to get the deal done. In today’s environment, if you’re going to be in the market for distressed deals when they become available, you will want to have the cash on hand before you even place the offer. There will be competition for the best deals and they will go to the ones with the strongest track record for closing. If you’re going to raise a fund, your investors are going to want to see a track record. Some investors will not invest in a company’s first fund. It’s not hard to see the paradox that this logic creates. When you have a fund, there is an expectation that the fund will be generating returns for the investors. Between the date the fund closes and the money being put to work, the investment capital is sitting in the fund manager’s bank account and earning zero. All the while, the investors are expecting a return on investment. It’s possible to raise too much money into a fund. If you can’t put the money to work, you might feel artificial pressure to accept a deal that doesn’t meet your standards because a deal that delivers 2% less than your target is still better than zero. In a fund, you’re restricted to a stream of investment deals that meet a similar criteria. They might be multi-family apartment complexes in Arizona. Or perhaps you might do a fund that specializes in mobile home parks. You could have a fund that invests in assisted living projects, or hotels. But if you’re a new fund manager, how do you create a new fund with no track record? In our business, we actually have both. We have raised a fund, and we have also raised capital for individual projects. Both have merits. But you also have to remember that a single project creates an aura of exclusivity, whereas a fund suggests that it’s open to all comers who qualify for the investment. It comes down to knowing your investors. The investor who invests in a single project may not be the same investor who would invest in a fund. Funds tend to be a little more opaque than single projects. Some hands-on investors will want the higher degree of transparency and reporting that is associated with a single project.

Today's show is a real life story of a negotiation between Sally and Mark. It's about how negotiating leverage is the key to getting a successful deal done. 

This question is from Meg in Westchester NY. I listen to your podcasts regularly.  I find them thoughtful and provoking and love that you get to the point in the short amount of time. We are residential investors and primarily design and build new single family homes in Westchester NY.   We have a very savvy group of buyers.  With that, one aspect we have come to understand is that our buyers want functionality and flexibility in their homes and we strive to provide designs that accommodate this. I was perplexed on your recent podcast when you were discussing how designers should consider supplying 2 offices and 1 bedroom in new apartments as opposed to 3 bedrooms.  Maybe that can be an innovative marketing strategy but I don’t see why you wouldn’t want to ensure that all three rooms can be used as a bedroom or office. With the codes as they are, for a room to be a bedroom you have to have an egress window (or sprinklers) but not so for an office.  So why not make sure you have the rooms set up so they can be used for either and let a buyer or renter determine what is best?  We often end up choosing at least 1 bedroom that we label as bedroom/office to imply this flexibility.  It is usually a smaller sized bedroom but very nice size office. I was confused by your suggestion and was hoping to hear a bit more from you to clarify. Thank you again for providing such insightful and current information on your podcast.  It isn’t easy to find helpful real estate information without gimmicks . Meg, thank you for a great question. I love the Westchester area. My family is originally from NYC and I used to have a cousin who lived on Mamaroneck Blvd in White Plains. For the listeners at home, the Westchester area is a bedroom community for NYC and there are a lot of professionals, who live in Westchester and commute into Manhattan. Meg you are correct that the building code has specific requirements for a room to classified as a bedroom. If you could meet all the necessary requirements for both a bedroom and an office, then naturally it would make sense to do so. Designers of a bedroom tend to think about the size of room required for a bedroom. You need to support either a single or double bed, a night table, a dresser, and maybe a bookcase. They don’t think through the requirements for an office, or if they do it’s an afterthought. If you were designing a room to be used as an office, you would be paying close attention to how the office would be designed. What styles of desks could be used in the room? Would the design be on a wall, or in the middle of the room? Would the desk be facing a window? Where would the door be placed? Where would the filing cabinet, the printer and the scanner be located? Where would the electrical outlets be located?, and the hardwired data connections? If there was to be a wireless access point in the room, where would it be mounted? If the office was going to host regular video conferences, how would the lighting be optimized to provide a good video image? Will the lighting support a full day of computer work, or will there be glare on the computer screen during the afternoon hours? You see it’s one thing to build a bedroom with a single electrical outlet every 12 feet of linear wall space as required by the electrical code. Its quite another to think through the placement of people and equipment to create a viable work flow. Would the flow be different if the client uses a sit-down desk versus a standup desk? You see there are lots of three bedroom houses. There are very few one bedroom, two office houses.  The person who needs two offices that are truly designed to be offices will pay extra to fulfill that need.

Robert is the best selling business author of all time and the author if Rich Dad, Poor Dad.  He's the host of the Rich Dad Radio Show and you can find out more about him at Richdad.com.