The Real Estate Espresso Podcast

On today's show George and I discuss the current climate for borrowing funds. His stance surprised me a bit. Check it out. 

Neal Bawa is a Silicon Valley based syndicator, and educator specializing in multi-family asset classes. On today's show we're talking about the state of the capital markets and where investing is heading in multi-family apartments.  You can reach Neal at http://multifamilyu.com.  

On today’s show we’re talking about stranded assets. These are assets that can’t be used at all. In some cases they’re merely under-utilized assets. You can find deeply discounted assets in today’s market. But only if you train yourself to look for them. Underpriced assets have a substantial sunk cost in them. The old school way of doing this was to go to the weekend garage sales and buy items of high value for pennies and re-sell them on Ebay for a higher price. The problem with this approach is that it requires a lot of time, the dollar values are low, and therefore the profit potential is low even if the percentage gains are high. Buying gym equipment or bicycles will net you a few tens of dollars every time you stop in someone’s driveway. These opportunities exploit inefficiencies in the market for used items. But I want you to think bigger. Think restaurants, hotels, boats, trucks, cars, ships. Sometimes, the assets are not physical. It could be a list of customers, or a handful of high quality relationships. You see the value of a business is based on the quality of its customers. If you want to do better business, then find better customers. The headlines over the past several weeks have focused on the tens of millions of people who have lost their jobs. That’s a tragedy by itself. There’s been almost no mention of the tens of millions of customers who have lost their favourite restaurant, their favourite clothing store, the ice cream stand next to the barber shop. Oh and the barber shop is gone too. Who is out there serving those millions of clients who have been separated from the businesses they have been loyal to all these years. the hidden assets which are less tangible could likely be purchased for zero dollars and nothing more than a royalty. The good-will that has been built over the years between restaurants and diners, between florists and funeral directors, between health food stores and those with dietary restrictions has real value. Let’s look at back at the people who have been laid off. There are millions of front line workers, some of the bottom income earners in any business that have been impacted the most. At the other end of the spectrum there are very senior people, those with immense technical and business know-how. These are the high six figure earners that the businesses could not afford to retain. Most importantly, these folks have immense connections. They have incredible relationships. These folks are probably not getting hired into another company in a comparable role anytime soon. They have a lifestyle and cost structure to match their previous salary.  The relationships they have, could be the seed of a business transformation for those businesses that know how to leverage them. Many of these laid off workers are sales people who are used to working on commission. They’re used to getting paid for performance. They know that money doesn’t flow until something gets sold. Maybe a re-energized top notch sales team that costs you nothing to hire and only makes you money could help your business. These are all assets that you can find at a garage sale. These are assets that are hard to connect with the right buyer. Because the right buyer is unlikely to stumble across them by randomly wandering around.

On today’s show we’re going to make an important distinction between two words that are often used interchangeably but have vastly different meanings. The two words are “pain” and “damage”. If you hit your thumb with a hammer by accident, you will experience pain. In fact, the pain will be so acute that you can think of little else for the next few minutes. Eventually the throbbing subsides and you can get on with your day. I know the weekend handymen are cringing as I’m describing this. I know you can clearly visualize the last time this happened and the mere mention of it immediately takes you back to that moment when the hammer slid sideways off the nail and made contact with your thumb. No doubt you were in pain. But if you hit it really hard and you actually break a bone, then the impact is much longer lasting. You might have done enough damage that the impact could be permanent. The context of today’s discussion is not your thumb, but the economy. There’s no doubt that individuals and companies the world over are experiencing economic pain. The bigger question is, where in the economy are we experiencing damage? When Hertz Rent a Car has next to no clients for two months, they’re experiencing economic pain. When they’re forced to seek creditor protection using bankruptcy laws, they’re experiencing economic damage. Some companies manage to convince a bankruptcy judge to restructure some debt and then re-emerge from bankruptcy as a viable business. This takes time. It results in a shrinking organization. In other cases, the bankruptcy judge will argue that the business is too far gone to ever recover and will be forced into liquidation. At that point, the damage is permanent. Now you may not have the ability to singlehandedly save Hertz. But companies don’t need to be over-leveraged like Hertz in order to experience damage. I’m going to tell you the story of a restaurant named Stonefaced Dolly’s. This restaurant has been a fixture in little Italy for a few decades. It’s a family owned restaurant and multiple generations of the family are involved. The problem is that the founder of the company is now 75 years of age. They have three locations. The owner is tired. He doesn’t have the energy to restart the business when the economy re-opens. He believes that re-opening is going to involve some heavy lifting and he simply doesn’t have the emotional fortitude to go through that at 75 years of age. He is not alone. I’ve spoken with three restaurant owners in the past few weeks. All of them are thinking of throwing in the towel. They’re not bankrupt. They’re not in extreme pain. They’re just tired. But when these businesses which have no succession plan, no sale plan, and no viable path to re-opening, they just die. This folks is the very definition of a bargain. When a significant percentage of restaurants close because they can’t see a way back, those that remain will eventually have an incredible amount of business coming their way. That may not happen in a month, or maybe even six months. Economic pain is becoming economic damage. That damage is occurring for a variety of reasons. In some cases, the businesses were carrying too much debt to survive the current market conditions. In some cases, their competitor got a bail-out check and they didn’t. But in some cases, the owner is just tired. The opportunities to find viable businesses for pennies on the dollar are becoming apparent even now in the early days of this pandemic.

Love the show. I could use your advice. Last August I acquired a property in a tax auction at a bargain price in a class c neighborhood in a different state than where I live. This was my first venture into rehabbing a property and figured this might be a good way to learn with a fair amount of cushion for mistakes. I found a contractor on Craigslist who was willing to work in this address (several were not). Work got underway quickly. Flooring, painting, kitchen updates and other misc repairs were all needed based on pictures the contractor sent over. He estimated about 20k worth of work. That seemed reasonable and he pulled permits and work got underway quickly. As work progressed bigger problems arose. Contracts were drawn up for each project successively. He would call me at least weekly with updates to what was doing, supplies that were needed and different things that code inspectors wanted to see updated. Every time I thought everything in the house was finally ready something else would be found. This all culminated in me finally growing very suspicious. I called the code office to find out where things stood and was devastated to learn they had never stepped foot inside the house. Moreover all the permits had been pulled in MY name without my knowledge. I had an investigator walk through the property and send more detailed pictures and the place is a mess. He did 85% of the siding work but cropped pictures of the final job and big chunk of the back of the property is unfinished. Lumber and materials are lying all over the job site. Between materials and labor and dumpster fees I have now put in about 2x what the property is worth fully renovated and really have nothing to show for it. Many of the materials I bought appear to be missing. This is a big hit for me. Is there anything I can do? At the very least maybe I can get a tax write off? I am obviously rethinking real estate altogether as an investment choice. JP, This unfortunately is all too common a situation. I’d like to zero in on a couple of things that you said. You’re talking about rethinking real estate investing. I’ve got bad news for you. What you’ve been doing is not real estate investing. You put yourself into the house rehabilitation business. That’s an active business that’s pretty similar to the construction business. You got into the construction business without even knowing it. Your construction business had no quality control because nobody was staffed to fill the position. If that position had been staffed, there would have been no surprises. I understand how painful this is right now. But if you stop, you’re going to lose 100% of your investment. If you have debt on the property, you’re going to be on the hook for that too. There are only three viable paths from here. 1) Fire sale the property as is and take a substantial loss 2) Bring in a partner with additional capital to complete the renovation and then sell the completed property at a loss. This may be a smaller loss than a fire sale scenario. 3) Complete the project, and rent out the property as a long term hold income property. You told me in a subsequent email that you’re looking at a total investment of about $125,000 and a monthly income of about $1,400. That means you’re collecting about 1.1% of the property value in rent each month. That’s a good percentage. It has the potential to carry the expenses of the property and pay down the debt. You will want to get a low interest rate permanent financing structure in place at the highest possible loan to value ratio. If there is still work to be done to complete the project, the ownership of the building permit isn’t a problem per se. In fact, in this instance it gives you the freedom to fire your contractor and you can hire someone else without having the original contractor transfer the permit.

Duane asks, Just curious. Have you ever come across something that looks like a great opportunity, but was way beyond your capabilities? Duane, This is a great question. The short answer is yes. That’s the only way to grow. But the further you are from your proven capabilities, the lower your chances of success are going to be. So if you know going into the venture that your chances of failure are real, you want to make sure that: 1) You’re bringing the best people with the most relevant expertise onto your team to improve your chances of success 2) You want to limit the risk on the downside. So if you fail, the cost to you personally will be acceptable, and more importantly It takes courage to do something that is unknown. After all, you might fail. Failure has all kinds of negative connotations in our culture. When you fail, you’re a failure. Even worse, you’re a loser. On the other hand, if you’re a scientist running an experiment, then somehow experimentation is elevated to a higher stature. An experiment, by definition will have an unknown outcome. It may not be your desired outcome, but it will have an outcome and the main purpose of an experiment is to learn. Therefore, an experiment can never really fail. So the question is how do you undertake projects that can be a little bit of an experiment? I’ve done this several times in my career. For example, in the world of technology, the year was 2003. IBM had a division that designed and manufactured microprocessors. I had been at Tundra Semiconductor developing system controller chips that worked with the IBM microprocessors. So I had the crazy idea of going out to raise the money and build the management team to buy that division of IBM. I had never raised $250,000,000 in one shot before. I had not run a business of that size before. I didn’t have the brand name to go down to Wall Street and raise the money. I started with an idea. The first person I called was someone who had been general manager of a similar business. He had sold processors into Apple. He ran an automotive microprocessor business and counted Mercedes, General Motors, BMW, VW, and Toyota among his customers. His name is Brian Wilkie. The venture was my idea. But I hired Brian to be my boss. I contacted the CEO of another chip manufacturing company. She had previously run that division inside IBM and reported directly to the executive who had responsibility for that business. She became one of my advisors. I brought another 5 people on board with similar pedigree. Brian and I went down to NYC and met with Credit Suisse First Boston’s private equity group. We met with Citicorp Ventures who in that year had been very aggressive about investing in technology buyouts. As a result of these relationships, our pitch to IBM matched almost exactly what IBM was looking for in a partner. IBM entered into exclusive negotiation with us. We spent 3 weeks at IBM headquarters, negotiating 19 agreements around the clock. IBM wanted to close the transaction before March 31, 2004. A week before closing, the IBM management team delivered some bad news from one of the customers. That spooked our banker who asked for additional time to complete their due diligence. At that point, the senior executive in IBM said that he needed the asset sale in the quarter to compensate for a loss elsewhere in the division. He was a on notice from the CFO that he should not deliver a negative surprise to Wall Street. The asset sale was required to prevent that embarrassment. At that point, IBM invited a California company called AMCC to bid on the business. Literally at the stroke of midnight, AMCC offered $100,000,000 more than us and scooped the business out from underneath us. We were devastated.

I'm trying to narrow down to 1-2 focus markets for buy-and-hold SFR/small multi-family investments. I've come down to the following options and am curious about any feedback: 1. Huntsville, AL 2. Memphis, TN (high crime) 3. Charlotte, NC 4. Omaha, NE (steady but not super growth oriented) 5. Columbus, OH 6. Atlanta, GA (already overheated market) I like all of these markets from a population / job growth perspective and affordability as a new investor. I'm curious about any major positives / negatives about these markets I might be missing - high crime, new employers, high poverty levels, etc. Kerry, This is a great question. I’m a believer in the laws of supply and demand. But it’s more than just demand that matters. I’m talking about demand and ability to pay. The current job market turmoil puts a big question mark around ability to pay. For now, millions of people are collecting unemployment benefits. But it’s unclear how long those benefits will be in place. At some point, the weakness in the job market will cascade into the financial markets, which may precipitate a shortage of lending. The last time we saw this was 2008. The cause was different, but the effect is likely to be the same. There are several considerations you want to examine. 1) The partnership and the team. 2) The city. Is it attracting jobs. 3) The micro-market. Real Estate is always hyper local. Some neighborhoods maintain value while others don’t. 4) The asset class 5) The deal structure. How much debt is on the property. Personally, I like Huntsville because it has a strong jobs story with the auto sector having selected Huntsville for manufacturing. There is a history of technical expertise in both radio and military R&D centers. The drawback, is that the rent per square foot in the market is low, averaging at about $1.10. While there is a shortage of rental housing, there doesn’t seem to be much upward pressure on rental rates, which is keeping new supply from coming into the market. I personally would stay away from Memphis. It’s a tough market and you need expert property management to make money in Memphis. I know several investors who own property in Memphis, and it’s got more risk than I’m comfortable with. Charlotte NC is a growing city and has attracted a several financial institutions. It’s emerging as a banking center in the South. It’s not very high priced, but overall it has good fundamentals. It’s hard to say what the impact of the current economic downturn will be on Charlotte. I simply haven’t researched it. Charlotte is definitely worth a closer look. I don’t have an opinion on Omaha. I simply haven’t researched that market. Columbus Ohio is likely to suffer from its higher than average exposure to retail in the current economic conditions. Columbus is also a financial and insurance center in the middle of the country. Overall, Columbus has been one of the fastest growing cities in the country for a number of years now. It’s definitely worth a closer look. Atlanta is also a growing city. But like any city it has a lot of areas. Some that I would not consider investing in, and others that are growing. But before choosing a city, I would focus on finding a team to work with. Having the right people on your team, is more important than choosing the city. I would also be patient about investing right now. There will be opportunities to buy properties at a deep discount to the market. This will take some time. We currently have a moratorium on foreclosures. That will eventually be lifted. Much like the period following the 2008 recession, the opportunities took years to materialize. The best years for finding deals were 2010 and 2011. It took a while for the deals to show up, and I believe that will be the case this time around too

On today's show we're talking about developing resort properties using RV's and mobile homes with Shane Melanson. You can reach Shane at shanemelanson.com.

Dr. Tom Burns is the co-founder and partner at Presario Ventures, specializing in new construction apartments. He is also the author of the upcoming book "Why Doctors Don't Get Rich." You can connect with Tom and get a copy of his book at richdoctor.com.

On today’s show we’re talking about the merits and pitfalls of just accepting a contractor’s bid. When you’re experienced in construction, you get a feel for what items should cost for both materials and labor. But there are two distinct markets, the retail market and the developer or contractor market. In the retail market, there are businesses out there charging what I consider to be outrageous prices for what amounts to basic commodity construction. Yes, quality matters. But I often find that in the retail market you get amateurs charging more than the most skilled trades people. These are the crooks. Frankly, they’re out there and you can run into them often. I have a job under construction right now where the entire crew didn’t show up to work yesterday. Why? Because one of the members of the team has a family member with a health issue. Because one person couldn’t work today, an entire team of three people didn’t show up. This crew was in fact the lowest bidder. To be honest, the number they quoted was lower than I expected. So I wasn’t surprised or upset when they discovered that they underbid the job. I fully expected to pay more. I feel badly that the subcontractor has a family member with a health issue. He’s absolutely doing the right thing by being with his family. Somehow, I’ll have to find a way to maintain the schedule with alternate labor. Otherwise the delays will cascade.  I knew I was accepting a low ball bid and that there was risk of problems. The first bid that I received was from someone who said they could do the work in a week and at a competitive price. But in the end, they quoted 4 times the price of the low bid, and fully three times what I considered to be a fair price. I made them aware that I was a developer and we discussed per square foot rates. Somehow between that conversation and the paper quote, something got lost in translation. Clearly they didn’t get the job. I had another subcontractor quote me a price that was double what it should have been. I worked out the hourly rate and concluded that they would be charging me $125 per hour for what amounts to unskilled work. I reminded the subcontractor that I was a developer and that I had a volume of business in the pipeline. He offered that if I paid cash, I could save the sales tax. At that point, I knew I couldn’t hire his company. But I decided to see where the negotiation would go. I offered that if he gave a really good price on this project, I would give him early visibility of new projects in the pipeline. So he offered me a 4% discount. Needless to say, they didn’t get the job. I had another contractor inflate the square footage in the scope of work on another part of this job. He argued that he needed to add 10% to the area because there could be wasted material. I completely agreed with the additional material allowance. There is always material wasted because the cuts result in odd remnants that can’t be used. But there should not be 10% wasted labor. The labour component of square footage is the actual square footage. The funny thing is that these attempts at cheating the customer aren’t even sophisticated. They are plain as day. Perhaps these subcontractors think that customers don’t know how to perform basic arithmetic. I found one subcontractor selling materials from second subcontractor with an additional markup on the original supplier’s price. Folks, the path to saving tens of thousands, or in some cases millions of dollars is found in being curious, asking lots of questions, and checking the math against known benchmarks.