The Real Estate Espresso Podcast

Jeff Love is a real estate lawyer with Gibbs Giden in Southern California. This is one of the most difficult environments for real estate investors in recent years. Our conversation centered around how to form strong partnerships. You can reach Jeff at jlove@gibbsgiden.com

We are in an unprecedented situation economically. Because of that, we might conclude that there is no playbook for dealing with a crisis of this type. The question is, can we learn anything from the handling of past economic downturns and is there anything that we can apply from that past experience? I sat in on a conference call with the senior leadership from real estate firm Marcus and Millichap late last week that attempts to address this question. Of course we are all in uncharted territory, so it’s impossible for anyone to say they have all the answers. Clearly if any did make such a claim, they’d be delusional. 2008-2010 saw a contraction of the economy of 4% over an 18 month period. This time around we’re seeing a 29% contraction in the economy in a matter of a few weeks. This number could degrade further as the impact of the health crisis deepens. Now we have a relatively healthy financial system compared with 2007. Companies are highly leveraged, but corporate balance sheets have been pretty strong compared with history. If we compare this current situation to 2007, the banks only had $44B in reserves in 2007. Today the banks are sitting on $1.7 T in reserves. They were vastly undercapitalized in 2007. Back in 2007, household debt was at 100% of GDP. Today, household debt is at 74% of GDP. Back in 2007, the economic damage was caused by major cracks in the financial system, whereas today it’s being caused by a health crisis. The concern of course is primarily for the health and wellbeing of the population. The secondary concern is on the economic damage potentially spilling over, causing massive loss of jobs, large scale corporate bankruptcies, and that in turn could destabilize the global financial system. The news media today are portraying the economic numbers with a combination of surprise, shock and horror. That’s partly their job to sensationalize the outcomes. But really there’s not a lot of surprise to me that the lockdown is damaging to the economy. The folks at Marcus and Millichap created an economic model that uses a number of baseline expectations. They based their model on the folks at Moody’s Analytics. Frankly, what the folks at Marcus and Millichap have presented seems to me to be a nearly best case scenario. Yes, the US banks are much better capitalized. The US banks reserves have never been stronger. Simon Black and Peter Schiff had a conversation about the state of our global debt situation. That discussion centered on the massive amount of debt that is being created, and the lack of equity to support that debt. On a global basis, we have about $250T of debt. The banks don’t own all of that debt, but the banks are an integral part of the system and if their customers feel the pain as a result of bond defaults, the banks are not immune. The banks are only sitting on somewhere between 7.5T - 10T of Bank capital. That puts bank equity at about 3% of the global debt. If we saw a destruction of only 3% of bank’s debt, the banks would be technically 100% insolvent. The question is, would a 30% decline in GDP as the folks at Moody’s have surmised be enough to wipe out 3% of bank debt on a global basis? We are about to enter a period of economic stagnation combined with one of the most inflationary periods in the past century. We’ve seen pockets of hyper-inflation throughout history in South America in the 1980’s, most recently in Zimbabwe and Venezuela, in Weimar Germany after the Great depression, and of course in the good ol US of A during the American Revolution. The result has been the same each and every time. Every time has seen an economic collapse and a large scale destruction of savings, and a corresponding destruction of debt.

We’re one week into the month of April. Landlords across the globe have been bracing themselves for a fall in rent collections in April. After talking with a number of investors over the past several days, some preliminary numbers are coming in. I spoke with a landlord in Texas who owns about 3,000 units. Their portfolio contains a mix of both B-class and C-class properties. Overall, collections are running between 75%-78% of potential after the first week of April. The numbers are definitely down compared with a month ago. In a normal month, collections would be well into the 80’s and in many cases approaching 90% after the end of the first week of each month. There is a small difference in collection between B-class and C-class. The numbers are slightly better in the B-class properties. Management has spoken with every family. They’re seeing a large number of new leases being signed, even in this environment. Some markets like Houston and San Antonio have a high annual turnover rate. The landlords I spoke with are seeing higher than expected tenant retention. That means, tenants that had previously given 60 days notice to vacate have changed their mind and signed a new lease. The National Multifamily Housing Council (NMHC) found a 12-percentage point decrease in the share of apartment households that paid rent through April 5, in the first review of the effect of the COVID-19 outbreak on rent payments. The Tracker found 69 percent of households had paid their rent by April 5; this compares to 81 percent that had paid by March 5, 2020, and 82 percent that had paid by the same time last year. The NMHC data takes data from several property management sources including realpage, Yardi, Entrata, Resman and MRI. There is a belief, propagated by many in the tenant advocacy groups that tenants are no longer required to pay their rent. They point to the moratorium on evictions that have been publicized. The fact is, there are several levels of government involved which results in a patchwork of regulations. There can be rules imposed at the federal level, the state or provincial level, or at the local level. In some cases, there may be more than one regulation providing conflicting rules. Understanding which rule takes precedence will require that you get local legal advice in your home market. For example in the US, the federal disaster relief CARES Act, included a 120-day moratorium on evictions, late fees and other penalties, starting on March 27, the date the legislation was signed.  This moratorium  applies to all properties with a federally insured mortgage (Fannie Mae, Freddie Mac, FHA, HUD, VA) and properties participating in a covered housing program, such as the Section 8 voucher program, rural housing voucher program, the Low-Income Housing Tax Credit. Covered property owners also may evict or charge late fees to any resident. This moratorium applies to ANY resident who fails to pay their rent, not just those whose incomes have been disrupted by COVID-19.  Unfortunately, the way it is written, that currently means the moratorium also applies to residents who simply choose not to pay their rent On the commercial side, we’re seeing a very real problem with collections. It depends highly on whether the business has been forced to close its doors. We have some businesses that are unable to perform their business online. Their revenue has gone to zero. Our commercial rent collections are currently running at 50% of leased space. We expect that number might drop even lower in the coming months.  Overall, the impact to residential rents seems to be less than many had feared. It’s also reasonable to expect that the rent collections will be lower in May than in April. As you think about that, keep your lines of communication open with your tenants.

On today’s show, we’re talking about what you can do if you have a short term rental? Short term rentals, like hotels, and most of the hospitality industry are suffering deeply in this era of social isolation. You might be used to a high nightly rate, similar to what hotels are accustomed to getting. On average, this revenue stream is higher than the traditional monthly unfurnished lease. Today, very few people are traveling to take vacations. Only essential travel is being permitted. That means that unless you have a medical reason for travel, or perhaps repatriation to your home country, there is no reason to travel. Upon return from outside the country, all citizens must undergo a mandatory 14 day quarantine. A quarantine in the same home together with others who have not traveled defeats the purpose. Here’s the problem. The hotels are closed. Many communities have instituted rules that restrict short term rentals to only happening in owner occupied properties. For example, you might have a spare bedroom, or maybe an inlaw suite. Where would someone who must quarantine stay? Where would someone who has potentially been exposed to Covid-19 stay? Locally, health care workers who are on the front line of the Covid-19 pandemic need a place to call home temporarily, without putting their families at risk. To that end, the folks at AirBnB are looking to help provide accommodations for health care workers who need a temporary place to stay. They have agreed to waive their fees for the first 100,000 bookings that match health care workers with a place to stay. Hosts can put their homes into the program, either a full price, at a reduced price, and in many cases for free. The thinking is that any revenue is better than the alternative. The people at AirBnb have put together a comprehensive cleaning checklist for your cleaning staff. They’ve also assembled a recommended list of amenities that might be difficult for guests to source during this time of social lockdown. This includes all the basics that someone might need for daily living. There needs to be enough towels, linens, pillows, for each guest. The kitchen needs to be properly equipped with plates and glasses, cookware; everything you might need for cooking should be on hand. Make sure there is ample supply of paper products. When it comes to cleaning, make sure your guests know about your enhanced cleaning routine. Guests will want to know about all of the additional steps you’re taking to reduce the spread of infection. So it’s a good idea to mention your enhanced cleaning routine in your listing description. Now is not the time to be trying to squeeze every last dollar out of every booking. It’s the time to get anyone to stay at your property, even at a reduced rent to try and cover your expenses. Another use of vacation homes is to protect more vulnerable family members. Let’s say that you have a family member working at a grocery store. They’re interacting with the public on a daily basis. They’re definitely at higher risk of coming into contact with the disease by virtue of being exposed to more people during the pandemic. Let’s say you have someone else in the home who is elderly, or perhaps immune compromised, you want to make sure that the vulnerable family member and the at-risk family member don’t cross paths during this pandemic. Isolating vulnerable family members in a second location can be a very practical way of protecting them. All of these uses for Short Term Rentals can fulfill very real needs during this time of social need.

Folks, I’m an optimist. Those who know me would classify me as a solid optimist. But in the past few days, there has been a deluge of news that, quite frankly is heavily biased toward the negative. Let me be clear, I’m not here to propagate fear. But I think you ought to know what is possibly in our immediate future. Armed with that information, you can take steps to protect yourself and your family. So here we go. Over the past several days, the folks at Moody’s Analytics who provide the bond ratings for much of the debt that is issued in the world have been performing a lot of modelling and analysis on the current market situation. The latest projection from Moody’s is that if the shutdown of the economy persists another two months, the fall in gross domestic product is estimated at 75%. That would be the largest drop in economic output in global history. All of it having occurred in less than three months. The impact of the shutdown is coming into focus with each passing day. So far, supply chains for food remain largely intact, but this is unlikely to last. We know for example that Vietnam had banned the export of rice. That country is one of the top three producers of rice in the world. The US no longer maintains a grain reserve. You can expect that there will be rice shortages in the west later this year. Much of our food harvesting in Canada and the US is performed by migrant labor, much of it coming from Latin America. Some estimates put the number of agricultural migrant workers in the US at about 3 million people. In an era of social isolation and international travel restrictions, what will happen to food production? This isn’t just an issue in one country. Covid-19 is a global pandemic. On Sunday evening, the folks at Wells Fargo announced that the loan window had closed for its customers wanting to apply for the SBA Paycheck Protection Program, only a day after it opened. The bank said that it had exhausted the $10B it had capacity to lend for the SBA PPP. Now I have no doubt that the government will realize that it needs to do much more than it has so far. In fact the Federal Reserve announced on Monday that they were going to facilitate more lending to small businesses through the SBA program. A massive decline in economic output on the scale of 30-75% will require the government to step in and replace that money in some fashion. If cash runs out in households across globe, and commerce becomes inefficient or impossible, we can only expect that a bartering system will eventually take over and a brand new underground economy will flourish. But even before that happens I expect that we will start to see social unrest as people become desperate. Governments have been slow to react to this pandemic. Here too, they are way behind the curve. Two months of payroll help for small businesses is not going to be enough. It’s not even close. This evening, my own city extended its official state of emergency until the end of June. That’s a full 3.5 months. Those of you who know me, know that I’m someone who has a high degree of personal initiative. I don’t wait for permission to do the right thing. This year is going to be a test of emotional fortitude for billions of people around the world. I’m going to be taking additional steps to prepare for a deeper economic stress. I can say with all honesty that I don’t know exactly what that’s going to be. But it will be something. I told my wife tonight that we were going to be alright. We both acknowledged that this period is stressful. We are going to be alright for three reasons. We’re in better financial shape than the bulk of the population. We’re generous and will help others during this time of difficulty. We have each other.

On today’s show we are talking about why our governments policies in the aftermath of 2008 is making this economic downturn so much more painful than it needs to be. This all falls into the category of a self inflicted wound. I’m going to share some data with you from the federal reserve bank of St. Louis. But before I do let’s talk about the different types of expenses that a business or individuals can incur. Broadly speaking, there are two types of expenses: fixed costs and variable costs. If my business is a bakery, then an ingredient like flour is a variable cost. A fixed cost would be something like rent or a loan payment. Irrespective of the number of loafs of bread, those costs don’t change. The cost of labour is also a fixed expense in the short term. Yes, you can reduce the size of your workforce, but that comes at a price that goes beyond just the cost of paying severance. There is a human, social and emotional price to be paid for both employers and employees. The problem with debt is that it keeps accumulating with the passage of time. Some debt that is government backed can be deferred through government intervention. But most commercial debt is not government backed. Large commercial projects are funded by insurance companies, but commercial lenders who have issued commercial mortgage backed securities that are sold in the bond market. A bank that is regulated by the federal government can implement temporary rules based on changes in legislation. But a bond that is held by private investors has no provision to implement a forbearance agreement. There is no mechanism to provide a 90 day payment holiday. Debt involves bringing future money into the present. That only makes sense if you’re going to have more money in the future, measured in the same dollars so that inflation doesn’t skew the picture and accidentally make the picture look different than it really is. What you find is that our nominal gross domestic product before inflation adjustment has been growing at about 4.5% over the past number of years. The real GDP number, adjusted for inflation is about 2%. But the growth of debt across the United States has been growing at about 9% s year over the same time period. When the growth of those two numbers diverge, you can never catch up. This will eventually blow up. We had the opportunity for debt to implode in 2008. Governments elected not to allow that to happen by issuing even more debt. It seems that since debt is the problem, then more debt is going to be the solution. Unless the financial system totally collapses this time around, we’re going to be issuing more debt. The only question is who is going to carry that debt on their balance sheet. Will it be individuals, businesses, or the government? We have a global medical condition and the goal is not to harm the economy, but to put the economy into a medically induced coma. The question is, how do we come out of the economic coma? Does the economy bounce back? Does it take years to limp back to health? The path to economic recovery depends on how governments choose to respond to the economic damage. You could give the money to the company that employs the people on the condition that they keep people employed. That way, the employees are never separated from the company they work for. The other approach is to pay people unemployment benefits. But as soon as employees are separated from their employers, the path to economic recovery requires people to be re-hired. That’s a higher barrier than simply reopening the doors. This is the time for you to get in touch with your elected officials and educate them on how to structure the bailout so as to enable the fastest restart of the economy. We already have tens of millions of people out of work in the past two weeks. It may be too late already.

Chris Prefontaine is a repeat guest on the show. His no bank strategy is zero risk and very appropriate for a down market. You can learn more from SmartRealEstateCoach.com Fascinating conversation. You won't want to miss this one.

Billy Keels is a US Real Estate Investor, living in Barcelona Spain. On today's show he gives a first hand, boots on the ground perspective of what's happening with the Covid-19 outbreak in one of Europe's hot spots of the outbreak. 

Today is another AMA episode that is Ask Me Anything. I’m not going to attribute this question to any one listener because I've had several people reach out to me and ask the same question. The question is, “Do I think the stock market has hit bottom, or is there more downside risk?”

As real estate investors we all have projects at various phases in the pipeline. Projects that are completed, those that are in construction, and those that are still under contract. The impact of the current global circumstance on each of these will be different. It’s clear that the scope of the economic impact is going to extend beyond a few months. Governments are only now starting to come to terms with this stark reality and setting more realistic expectations with the general public. For example, the City of Toronto told its residents to expect another 12 weeks of lockdown. At this stage we are focusing on only two things. Protecting our investors and ensuring that our existing projects remain healthy Ensuring that our family remains safe and our household well supplied for the long haul. For many of us, the focus has shifted to the basics of human living. That means making sure you are maintaining focus on keeping your family safe. Trips to the grocery store that in December were taken for granted, now are a process involving risk and immediate detox as soon as you leave the store. Nearly nothing is as it was. We have responsibilities to our investors, to our stakeholders, to our partners and to our families. You response to the current market conditions will very widely depending on your circumstance. If you are a landlord, you’re concerned with whether tenants will pay rent on the first of the month. Many jurisdictions have put a moratorium on evictions which creates the incentive in many people’s minds that they no longer need to pay rent. Even some tenants who are receiving unemployment benefits may choose to capitalize on the moratorium on evictions and not pay their rent. Our vacation rental business in the Rockie Mountains is currently 100% vacant. Our lender has offered a 3 month mortgage payment holiday. We have also brought additional capital into the business to further protect the business from possible collapse. At this stage we have about 7 months of cash reserves. That may not be enough and we may have to do even more to ultimately protect the business and our investors capital. So far today we had are down about $6,000 in retail rent collections compared with last month, but we don’t have a full report. We’re completely sympathetic to the plight of businesses that have been forced to close due to the pandemic. The fact is, very few retail clients will pay rent. This will become a huge issue for commercial landlords in the coming months. Eventually this will cascade and become a huge issue for commercial lenders. Banks are getting a bailout package, but many commercial buildings have non-bank lenders including private lenders, insurance companies, and commercial mortgage backed security lenders. Deal sponsors who have tried to close deals in the past two weeks have reported that lenders have pulled out in some cases. In other cases, they’ve changed the terms of the deal and asked for substantial additional cash reserves. One investor I spoke with yesterday had a deal fall apart when the lender required and additional $750,000 in capital at the closing table. These stories are becoming routine. If you have a closing coming up, now is the time to seek extensions from the other side. You can expect that there will be delays and that the delays will be extensive. These negotiations require a recognition by the parties that a third party that is not part of the transaction is the cause of the delay. Then there is the entire question of what valuations will look like when the market emerges from this pandemic. I expect that many more deals will get canceled or renegotiated. For the time being, in our business we’re focusing on execution of projects, protecting our projects and by extension our investors, and taking care of our families.