The Real Estate Espresso Podcast

On today’s show we’re talking about the flexibility of being a real estate investor. When I had a job and was short of money, I needed to wait until the next paycheck. If I really wanted to increase my income, I had to wait until I got a raise, or perhaps a promotion. I could take initiative as an employee and my employer would be appreciative of the extra effort. Somewhere down the road, I might get a raise or a promotion. Someone else was in control of that process. There was no direct connection between my effort, the creation of value, and the financial compensation for that extra effort. After all, that’s the difference between being an employee and an entrepreneur. Then about 10 years ago I made the switch from being an employee to a full-time real estate investor and developer. Let’s be clear, my income took a hit. I had saved a bunch of money hoping that my business would take off before my savings ran out. Somewhere along the way, I came to the realization that each of the projects by themselves could generate some income. Some projects ran into delays and the income I was expecting from those projects didn’t materialize. At those moments it was tempting to go back and get a job with a steady 6 figure income. But somewhere along the way, I realized that I could truly generate income at will. It could be the result of taking on a new project. If I needed an extra $5,000 I could host a workshop that would deliver something of value to people in my network. It could be a class on underwriting rental apartment projects. Perhaps I could say yes to the numerous offers of consulting engagements. Maybe I could flip another house, or wholesale a contract. I could generate income at will. So here we are in the year 2020. Tens of millions of people are out of a job. But the vast majority of them are waiting on the sidelines, waiting for someone to hire them, waiting for someone to discover their hidden talents. That process involves sending out resumes to hundreds of places, hoping that your resume gets on a short list and maybe you’re invited for an interview. I’ve been that hiring manager many times. When I post a job these days, I will usually get 50 applicants within a day or so. Of those, maybe four or five are a good fit and worth calling in for an interview. There have been times when I had to review 600 resumes in a single resume review session. When there are that many to review, you really don’t have more than about 5 seconds to spend with each one. I feel bad for all those folks who took the time to send out their resume. We can’t practically response to all of them. For those who are looking to generate income, there’s an awful lot of waiting involved. Let’s contrast that with the world of entrepreneurship. In my world, income involves solving problems. If that sounds abstract, let me make it clear. You might be walking down the street and notice that a house has tall grass. You could walk up to the house, ring the doorbell and tell the homeowner that you couldn’t help but notice their grass hadn’t been cut in a while. Would you like me to take care of that for you? I would solve that problem for only $30. Some might say no, but I believe you wouldn’t need to visit too many houses before you had $30 in your pocket. Maybe this example is a little too trivial. After all, you’re not going to go and start mowing people’s lawns. Maybe your expertise is in project management. You might walk up to a real estate investor who is overwhelmed with flip properties and offer to solve the project management problem for them. You see the secret to generating income at will is based on the power of using your senses and your curiosity to notice problems that need to be solved.

On today’s show we’re talking about what’s happening in the industrial and logistics market. Last week, commercial brokerage house CBRE held a detailed webinar on what’s happening in the logistics market. There were over 1,200 attendees on the call. We’re going to summarize the perspectives on the industrial market. How has federal stimulus impacted the economy? The stimulus has gone a long way toward smoothing over the impact of the pandemic. We are going to have a very negative year in 2020, down 6%. 2021 is expected to be a rebound of nearly 6% in GDP. We’re looking at two lost years of economic growth. Much like the residential home market which has seen large drops in volume during the pandemic, Industrial transaction volume has been down by 2/3. The main reason for that is price discovery. Buyers and sellers haven’t figured out where pricing should be in the current market. The capital market for the sale of industrial assets has been fairly steady throughout the pandemic. When buyers and sellers come together, the cash is there to get deals done. The top tier for investments are industrial and multi-family. The small number of rental defaults has shown a lot of stability in the multi-family market. The top assets in industrial are for big box, cold storage. Lease rates are holding strong and increasing in some markets. Sublease space is largely occupied space. Some companies are trying to temporarily downsize space requirements on an opportunistic basis. They’re not looking to sell space, but are hoping to cover costs within existing facilities by subdividing space. Construction dropped by about 30 million square feet in the current quarter. But at the end of Q1, there were more than 300 million SF of space under construction. That’s an all time high.  Pre-leasing is in the 30% range for that space. Record low vacancy of 4.5% across the industrial market. Compared with 2008, the market had 7.5% vacancy and very quickly moved into an oversupplied scenario. Ground-breakings have dropped in the most recent quarter and is expected to create a drop for new supply in a year. The biggest demand driver is e-commerce. Amazon is by far the largest driver. Retail sales are expected to grow to 39% of the all retail over the next several years. Final mile logistics is the biggest area of change. Walmart and Target are extremely effective omni-channels with instore pickup. Some independent third party fulfillment centers are coming into the market to provide omni-channel logisitics fulfillment and last mile inventory. There are very few distressed properties appearing in industrial. Those that are appearing on the market are typically owner-occupied properties where the seller needs liquidity elsewhere in their business. In fact, this mirrors what I’m seeing as well. A friend of mine was looking at a manufacturing company with a weak balance sheet that was looking to do a sale lease-back of the factory. Amazon is the elephant in the industry. The company has grown from adding 25 million square feet of space per year, to more than 50 million square feet of new capacity per year. Amazon has grown from 70 to 255 operational delivery locations.  In the coming year, Amazon has 45 new sites. They are mostly non sortable fulfillment centers.  The sortable facilities are multi-story facilities. The sortable facilities ae more efficient because they have air conditioned space.  Market rent is attributed to usable square footage. But the expenses are lower.

On today’s show we’re taking a look at the economic recovery. Some sectors will bounce back, and others will take a long time. In real estate, we’re seeing some encouraging data during the month of May for several asset classes. In the broad economy, the US lost about 30 million jobs in March and April. Canada lost about 3 million jobs. But in the month of May we’ve started to see the beginning of a recovery. The US added about 2.8 million jobs in May, excluding farm employment. Canada added about 290,000 jobs in the same time period. May saw about 10% of the jobs lost in March and April return. This is encouraging. Frankly, I was expecting that the wave of bankruptcies would create permanent damage to the economy.. Construction registered the strongest improvement among goods-producing industries with an increase of 464,000 jobs, or almost half the number lost in April. Despite the coronavirus shutdowns, house prices continued to rise, and some real-estate brokers and economists say they see signs that demand for new homes has started to rise in recent weeks. In fact, om May, we’ve seen demand for new homes surge 21% compared with the same period last year. Mortgage applications for home purchases in the week ended May 29 also rose for the seventh straight week, up 5.3% from a week earlier and 17% from a year earlier, according to the Mortgage Bankers Association. Several real estate brokers I spoke with in the past week are seeing a flurry of activity. One broker said that she sees a busy summer ahead with a large number of new listings coming in the second half of June. It’s as if the traditional Spring market is happening anyway, but just a couple of months delayed. Those who wanted to move in 2020, are going to move anyway unless they lost their job. Many markets are still experiencing a shortage of supply and rising prices. In my home market, detached homes at the entry level of the market show the lowest inventory. Homes in this category are usually selling on the first day of listing with multiple offers. So far during the pandemic, we’re seeing a 6.1% price increase compared with the same period last year. Let’s be clear, this is a couple of weeks of data. It doesn’t define a trend. If this is a wave of pent up demand, that wave could subside later in the year. If we have a second wave of the pandemic, we could see a significant slowdown in the fall and winter.

Last week Neal and I talked about the state of the capital markets. On today's show we're talking about which asset classes are hurting in the current environment, and which ones will thrive. 

Colin Douthit is a property manager from Kansas City Missouri. On today's show we're talking about how to manage during this period of uncertainty, lost income, and disruption. You can reach Colin at atlaspropertymanagement.com. 

On today’s show we’re talking about the great ideological debate about help, government help. Our economy has suffered the largest fall in activity in recorded history. All of this is in the name of saving lives. Economic suffering is preferable to death. I’ve heard many articulate that some death is acceptable as long as it’s someone else’s death. There are over 40 million people in the US newly unemployed as a result of the pandemic. It’s not clear how many have been re-hired. There’s more than 7 million in Canada who have received some form of assistance. The payroll protection program kept a number of people employed at businesses that were forced to shut down. Now that these government dollars have been largely exhausted, it’s not clear whether these people will be kept on the payroll. A study by Forbes in 2019 found that 78% of workers were living paycheck to paycheck. That is to say they had essentially zero financial buffer. A more recent study by Nielsen showed that 74% of all employees were living paycheck to paycheck. The fact is, there is no good solution. We have a pandemic on our hands. The art is in finding the least worst solution. governments have tried to protect the public from the pandemic by imposing restrictions on movement, which has obviously hurt the economy. They’ve tried to compensate with financial assistance. So here we are, four months into a pandemic and three months into a steep economic downturn. The political appetite for opening the government coffers and showering the population with cash seems to be waning. But those three quarters of the population who were living paycheck to paycheck, are still living paycheck to paycheck. They haven’t magically amassed a war chest of cash in the past few months. Some people believe that we just need to re-open the economy and let the economy take care of itself. Some believe that government help breeds dependence. Some believe that people are hurting and they need government help and they need it now. Some believe that as our economy changes and many repetitive jobs are being replaced by a piece of hardware we need a universal basic income to provide for our population. Well guess what? If you go looking, you’ll find multiple examples to support all of these arguments. They’re all valid, but not universally true. More importantly, I’m seeing people expend tremendous amounts of energy and time talking about what someone else should do. The government should do something. Big business should step in and help. The landlord should give the tenants a break. You see economic activity is not the result of money being dumped into the economy. It’s the result of money circulating in the economy. If the government gives me a check for $1,000 and I put $800 towards rent and I spend the rest on groceries, that money isn’t doing much for the economy. If instead I come across a problem that needs to be solved, and people are willing to spend money to solve it, then I have an opportunity to generate income. If it’s a big problem and I’ll need help, then I can hire people and put them to work on solving that problem too. Now that’s starting to feel like economic activity, and money circulating through the economy. After all, isn’t that one of the fundamentals of business? In fact, it’s more acutely true today than at any other time in history. While some people are at home watching movies, I’m busier than I’ve been in a long time. We still have a number of active projects. We still are attracting investment. Using your personal sense of agency is the key to getting the economy going again, but only for things that are needed now.

On today’s show Matt asks, I have been invited to come into a new construction project for an 8 unit apartment building as an investor. The hard construction cost is $1.2M and the total value of the project is about $1.8M after lease-up. We should be able to return the majority of the equity on refinance. The investor who wants out made an initial investment of $250,000 and has been with the project since inception until now. They are asking for $310,000 for their 50% share of the project. The project qualifies for a 10 year tax abatement. I’m hearing that construction costs are falling and am wondering if we should find a lower cost general contractor to complete the project. I’m going to need to raise money from investors for the equity participation in the project which is proving difficult in today’s environment. Some of my investors are dentists who have been hit hard by the pandemic. Any thoughts on the project and the investment? Matt, This is a great question. There is no question that raising money in today’s environment is more difficult than it was even 6 months ago. Some investors are sitting on their cash waiting for deeply distressed bargains to appear on the market. I’m familiar with the location of your project and I think you should be conservative in your underwriting for the investment. Assume that rents will be lower than the current projections. There has been a lot of new construction in the area and the numbers of unemployed will put downward pressure on rents. Assume that rents fall 10% compared with today for a building that will complete a year from now. If the numbers still work, then pull the trigger. I understand that the current partner in the project wants to get bought out. They also want a profit, which is perfectly fair for value creation. But the value hasn’t been created yet because the project isn’t complete. I would make a counter-offer to the current investor that they can get their initial capital back immediately. The profit portion would deferred until a later milestone in the project. It could be paid when the building hits break-even leasing, or perhaps when the building achieves its certificate of occupancy. It doesn’t make sense that a partner cash out of a project and expect to collect a profit before the project itself generates a profit. I think you can make a compelling argument that the partner’s profit be deferred until the project is complete. If the investor objects that their profit isn’t secured, you can offer one of several solutions. You could offer a shareholder pledge. This would put shares of the company in trust and they would automatically transfer to the investor in the event that you default on your commitment to pay the profit at the agreed point in time. You could also secure their profit on title with a mortgage. This mortgage would need to be approved by your construction lender, or it would be an un-recorded mortgage, only to be recorded in the event of default. You also asked about getting a new bid on the project. We’ve seen labour costs reduced in several markets. This is the result of millions of unemployed people across the country. We believe that putting people to work who have no work is an awesome thing to do. But you need to be careful as well. Most problems in projects are the result of making a bad hire. Since you’re not local to the investment, your risk is higher of problems not being caught in a timely manner. That means you need a lot more formal process in place for management of construction funds, construction materials, and quality control. Don’t just hire a new general contractor because they gave you a low bid for the project. We’ve done lots of shows on the perils of the hiring the wrong contractor.

Could your well managed city be going bankrupt? You see the federal government has the right to invent currency out of thin air. They can just print it. In modern day terms, that means changing a number in an account to say that you now have more money. The US Federal Reserve does this in the US. The Bank of England is responsible for this act of magic, and the Bank of Canada has the official right to perform this sleight of hand without going to jail. But let’s talk about what a city is. A city is not constitutionally enshrined. It only exists, usually as a corporation, enacted by the state or provincial legislature in which it resides. The bylaws of the corporation are determined at the state or provincial level and they define the decision making power of the city council around how local regulations can be enacted and they define the rules around the collecting and spending of money. You see, many cities were only allowed to borrow money for very specific purposes. I’m aware of a lot of cities that can only borrow money for capital projects. They’re barred by law, from borrowing money to fund operating expenses. That seems like a prudent bit of fiscal management. A city that borrows money to fund day to day operations is heading for bankruptcy at some point. Since the start of the pandemic, many cities have experienced shortfalls in revenue. A review of several cities showed that they were carrying little more than 40 days of cash burn in the form of liquidity. Under the current circumstances, that may not be enough. Many cities collect about ¼ of their revenue in the form of service fees and user charges. Since the start of the pandemic, these revenues have fallen to nearly zero. In addition, cities have seen a significant drop in tax revenue collected. Tax revenues account for about 50%-70% of a city’s total revenue. Many cities have responded with significant workforce reductions. They’ve cut non-essential services like libraries, swimming pools, recreation facilities and so on. They’ve maintained essential services like police, fire and various emergency services. They’ve deferred maintenance where possible. But at a certain point, there are no more discretionary services to cut. First responders are key to protecting life and safety in our society. So what happens when a city declares bankruptcy? First of all, unlike a corporate bankruptcy, there will be no liquidation. In the US, a city bankruptcy is governed by Chapter 9. A judge will be appointed to oversee the spending of monies and the rebalancing of the budget. There will be no free pass that allows the city to abdicate responsibilities for providing municipal services. The City still has the obligation to get its fiscal house in order. It still have to balance the budget. It still has to settle with the claimants. The city still has to pay its legal bills, and the city still has to deal with its unfunded liabilities. When there's a label put across a city or a county that says, you're in bankruptcy, it equates in the minds of the public to dysfunction. You couldn't manage your own business, so you end up in bankruptcy. The lasting legacy of a bankruptcy is that the city is not a place to invest. It discourages people from moving there. It discourages the creation of jobs. It’s assumed that the place is economically depressed. Jobs start to leave permanently. Then real estate prices start to fall. They fall because jobs are leaving The inevitable cutting of essential services means reduced safety for residents who live there. You might see an increase in crime, in vandalism. You might see an increase in desperation within the population. Even some of the best managed cities could stumble into bankruptcy. In these uncertain times, a review of a city’s financial state should be part of the required due diligence for a new project.

On today’s show we’re talking about running a virtual organization. For many the idea of working from home is new. It comes with its own benefits and drawbacks. When you get in your car and transition from home to the office, your mind shifts. You get into work mode. On the drive to work, most people spend their drive time going over the plan and priorities for their day. By the time they’re in the chair with a cup of coffee close at hand, they’re ready to tackle what the day has in store for them. The office has structure, systems, and processes. If you need something, you swing by a co-worker’s desk and ask them for help. If you need to call a meeting, the conference room at the end of the hall can solve problems and create a collaborative environment. The face to face communication means that you can read body language. New people in the organization need particular hand-holding and training. A study published by MIT in 2006 showed that the probability of communication in an office setting dropped dramatically the further people are apart. By the time people are 160 – 200 feet apart, they don’t communicate at all. So here we are in June of 2020, a global pandemic has forced millions of people to work from home. The good news is, you’re saving all that commute time twice a day. You’re saving gas. You don’t have to get dressed up. You can be in comfortable clothing. You can work when you want to.Together with all that flexibility comes the dark side. The dark side is full of distractions. The garden that needs to be watered, or that unfinished home improvement project. It would be really nice for the deck outside to have some sun shade so you can conduct conference calls from your back yard. Before long, you’re working until 11PM at night. The work day and the family day get blended together. After a few weeks, you come to the realization that your life has no structure. You used to be so disciplined. What I’ve discovered is that no matter where you work, the systems and processes for managing your day should remain the same. But if you’re working outside the office, you need an extra discipline. That also means creating streamlined connections with people, and you need to create and maintain structures that work. That means starting your day consistently, and ending your day consistently. If you have zero commute time, then have a virtual commute. This is a ritual task that marks the start and end of your work day. It might be as simple as closing the door to your office. Even before the outbreak, most of my teams have been thousands of miles from me. Conference calls, video conferences, and screen sharing have been normal for more than 20 years. Most of my team were on different time zones. They were in France, or India or Israel. It didn’t matter. Within our core team, we use a walkie talkie application called Voxer. It’s a push to talk system. There are quite a few out there. We use Voxer, but there are many others to choose from.  No time wasted calling someone on the phone, waiting for the phone to ring, waiting for them not to answer, listening to the voicemail greeting, and then finally leaving them a message that usually they don’t even listen to. Sometimes we hold and entire conversation over the span of a couple of hours, just by messaging back and forth using voxer. It’s a private direct connection, faster than sending a text message. You can even perform group chats using the same software. The key is to treat your team as if they’re with you all the time, the same as when you’re in the office.

Our book this month comes from one of the master story tellers of our time. The book is called “Ask: The Bridge From Your Dreams To Your Destiny”, by Mark Victor Hansen and his wife Crystal Dwyer Hansen. Mark was a guest on the show two weeks ago. He’s known for being the best selling author of all time with over 500 million books sold, many of them part of the Chicken Soup series. Mark and Crystal believe that asking is the key to getting anything you want in life. But you need to know how to ask, and you need to know who to ask. There are three people you can ask. 1) Yourself 2) Others 3) God When children are young, they ask all kinds of questions. There is no filter. The questions just flow, one after another. But somehow as we age, asking questions doesn’t seem to be socially acceptable. How many people die inside at age 25 and then spend the rest of their lives trapped in a prison of their own making. Mark and Crystal have discovered that there are 7 principal Roadblocks to Asking: 1) Unworthiness / Insecurity 2) Naivete 3) Doubt 4) Excuses 5) Fear 6) Pattern Paralysis 7) Disconnection The power to unlocking the path to your destiny is found by asking. It starts by asking better questions. What you focus on becomes amplified. It becomes your target. If you’re focused on the negative, then negative will be emphasized in your life. For example, if you ask “Will I go bankrupt?” will take you on a different trajectory than asking “How much wealth will you accumulate?” They tell the story of Mitsy Purdue. Mitsy was the daughter of the founder of Sheraton Hotels. She had been struggling with failure for much of her life. The fear of failure was preventing her from moving forward, from achieving her goals. Then one day, she reframed what it meant to fail. At first, failure was defined as having been denied a request, of being turned down. But then she realized that when she got turned down, she wasn’t failing. She was paying her dues. The only failure was in not trying. Failure was in giving up. That simple reframe of failure changed the trajectory of her life. She tells the story of how she met her second husband Frank Purdue. She was cultivating rice in California and hosting radio and TV shows. Frank was at the other end of the country raising chickens. The speed and certainty of their union was the result of  asking clear questions.