The Real Estate Espresso Podcast

On today’s show we’re talking about the fallout from last week’s stock market correction. Investors hate uncertainty. Whenever there is uncertainty investors go running for the hills. This is why investors finally woke up to the earnings warnings that have been resounding through the back alleys of Wall Street in the past 10 days. Is the drop in corporate earnings going to represent a V shaped blip, or will it be more of a U shaped business impact? Will this viral outbreak last until the Spring and then disappear much like SARS did in 2003? Or can we expect this virus to circulate around the globe multiple times including mutations of the strain? Will the supply chain disruption result in a weak Q1 and a roaring Q2? Will the drop in travel result in airline and travel industry bankruptcies? As real estate investors it’s easy to be complacent and say that real estate is unaffected. Tenants still need a place to live. They’re still going to pay their rent and we haven’t seen any job losses being announced on a large scale. At least not yet. We keep hearing that investors have a lot of cash sitting on the sidelines. In the past week, we’ve had the markets fall by about 12%. The losses total 6 trillion dollars in just five trading sessions. How many day traders were undisciplined and didn’t close out their positions at the end of the day? How many day traders will have their margin accounts called in? How many investors left their cash in the market and were waiting on the right real estate transaction before cashing out of the market and using their gain to invest in a qualified opportunity zone investment? Exactly who was impacted by the loss of wealth? The bottom 50% of the population in terms of net worth are likely not to be impacted at all by the stock market correction. They have very little in the way of holdings. Where they are at risk depends on the where the pension plans had funds invested. If you’ve been listening to this show for a while, you’ll know that I’ve been advocating getting out of the stock market for some time. The valuations haven’t made any sense. But here’s where its going to start to hurt for real estate investors. If your traditional sources of capital have been impacted by the stock market correction, they may be feeling conservative at the moment. They may be saying that it’s not a good time to make investments and would rather wait a few months to see what is going to happen in the market before making any commitments. Remember investors hate uncertainty. They may be asking questions like “How will the coronavirus outbreak impact real estate markets?” It’s a difficult question to answer. How many people will wait for the quarantine orders to subside before making a decision to buy a larger home, or invest in a multi-family apartment complex? You may find that investors who had committed funds to a syndication all of a sudden pull back and decide to wait it out. I know of at least three investors where this has happened. The good news for real estate investors is that the yield on the 10 year treasury has dropped even further in the past week. Interest rates on permanent financing is index to the 10 year treasury yield which means it could be an excellent time to rate lock into permanent financing or refinance into a lower interest rate. There’s no question that the rates of infection are going to multiply. I took an hour this weekend and created a mathematical model for the spread of the corona virus. If the current rates of infection remain unchanged and quarantines prove ineffective, we can expect that much of the global population will be impacted within the next 90 days. If you’re raising capital in today’s uncertain environment, it would be a good idea to communicate with your investors and ensure they’re still on board.

Our book this month is Prosper!: How To Prepare for the Future and Create a World Worth Inheriting written by my good friends Chris Martenson and Adam Taggart. They run Peak Prosperity, and organization dedicated to helping people live a rich and sustainable life. Their book Prosper! is a companion to The Crash Course. It shows the way that our society is living in a way that is destined to break down. Arguably crises like the one the world is facing right now with the Covid 19 outbreak is an excellent case study. In the book Prosper, Chris and Adam outline many of the things that can happen in a moment of crisis. In fact, we’re seeing these scenes play out in many communities all over the world. We’re seeing lines to enter the grocery store in Korea, in Milan, and in Aukland New Zealand which just reported its first case of the Corona Virus. In the book Prosper, Chris and Adam outline the steps you can take to build a resilient life. This isn’t just a single thing. We live in a world where black swan events do happen. They’re rare, but they happen. We’ve had two World Wars in the past century. We’ve had several major economic recessions including a decade long depression. We’ve had terrorist attacks and natural disasters. In the past twenty years we’ve had four outbreaks of highly infectious disease that have threatened our health care systems and killed tens of thousands. Any one of these types of events can have a profound impact on our daily life if we’re not prepared. Now I’m not talking about building a concrete bunker 100 feet below your house and stocking a year worth of food and water. That’s for the doomsday prep community. We’re talking about investing in 8 forms of capital that will prepare you well in the event of a crisis. If the crisis never happens, it will give you a richer life. Financial Capital Living Capital Material Capital Knowledge Capital Emotional and Spiritual Capital Social Capital Cultural Capital Time Capital I found the book prosper to be a real wake-up call and it has helped me bring focus to what’s important. With this current global crisis, I’ve been following Chris and Adam’s recommendations and I have to tell you I feel very secure knowing that I have prepared a deep pantry with several months of food. If the supermarkets were to be emptied tomorrow, there are definitely some things we would miss like fresh vegetables. But we would survive without any worry whatsoever. There’s a comfort that comes from knowing that the grocery store could close for a month or more and I’d be fine. I could be quarantined for 30 or 60 days and be very comfortable. If you haven’t been following Chris’s daily updates on YouTube, I really urge you to look them up. They reveal a perspective that is not being shared widely in the mainstream media. But I can tell you that everything he shares is well researched and has no agenda apart from keeping you informed.

Adam Carswell is with Concordia Realty, specializing in anchored shopping centers. His story is how someone with little experience came into the world of commercial investing by adding value to the business.  Adam can be reached at carswell.io.  

David from Anchorage in Alaska asks 1. AirBnB was founded in 2008 at the height of the Great Recession. In the past 12 years, the travel and leisure sectors of the economy have exploded. There have been various dips in the economy, but the modern short term rental market has not been tested against a major downturn. Hotels and resorts have historically taken a large hit during economic decline, but do vacation rentals get lumped in with hotels or do they offer a cheaper alternative and continue steady? 2. Markets set aside. The Vacation Rental season is almost upon us in Alaska. Unless you’ve just come back from off the grid, you likely have heard that a COVID-19 “pandemic” is also almost upon us. As a STR owner myself, I am curious. There is no historical precedence for modern STR's and platforms like AirBnB during a "crisis" event. How will the escalation of COVID-19 affect the STR market? Will it affect an AirBnB IPO in 2020? David, That’s a great question. The obvious answer is it depends. There’s clearly a linkage between travel and hospitality. A portion of the short term rental market is made up of medium term stays. Some estimates put the proportion at about 20%. I received this number from an employee at AirBnB directly back in November. Of course this number varies by market. You need to look at how people arrive at the destination. How many arrive by air, how many by car and so on. For example for your market, I don’t expect that many people are going to be driving to Alaska compared with those who fly. The Corona Virus is clearly having a massive impact on air travel. We own several short term rental properties in the Rockie Mountains near some major ski resorts and a national park. A high percentage of the traffic to our properties comes from within driving distance. But if air travel is reduced and occupancy falls in hotels, we can expect prices to fall across the breadth of the market, including short term rentals. We won’t see as high a nightly rate as we might have seen in past seasons. Short term rentals cater to a different market than hotels. While there is some overlap, the reduction in air traffic will have a significant impact. In our market we routinely see plane loads of tourists from China and Japan in the summer months. During the peak season we see essentially full occupancy and nightly rates that are over $600 a night. Air traffic from Asia is down by 90% at the moment. If that continues into the peak summer months, it will be a problem. We’ve seen that vacancy in the short term rental market doesn’t hit the market uniformly. Properties with the best reviews and the highest ratings get a disproportionate number of nightly stays. Even during low season, many of our properties have seen very high occupancy, far above the market average. By offering a superior product, competitively priced you can get more than your share of occupancy. The vacancy will tend to go to the junk in the market. Active daily management of pricing is essential to keeping units full. We are at a moment when history is being made. We don’t know what the outcome will be. Be prepared for a bumpy ride in the short term rental market this holiday season. Finally, to answer the last part of your question. Whether AirBnB will delay its IPO remains to be seen. I have no inside information. A downturn in the hospitality industry could easily create unfavourable conditions for an IPO. When hotel stocks and airline stocks are falling, it will be hard for AirBnB to convince investors that they're different.

Today’s show is a personal story of why I canceled a trip to Italy today. I was scheduled to fly to Italy today to attend a wedding in Rome. It’s a study of what can happen in times when there is a major civil disruption like the one caused by the current Covid-19 pandemic. Italy is working hard to get the outbreak under control. Italy’s health care system is pretty strong by global standards. But it’s not perfect. The number of cases continues to escalate with 51 new cases reported in the past 24 hours. Each one of these 51 new cases could have spread the virus to others. The average number of people infected by a carrier is estimated to be around 3. Each person infected, transmits the disease to three others. You can do the math. Unless the number of those subsequently infected can be brought below 1, the disease will continue to spread. In some cases, there are a few super-spreaders. There was the case of a woman in Korea who infected nearly 100 people at her church. That single carrier was largely responsible for the large scale outbreak in Korea. The lengthy asymptomatic incubation period is the greatest risk overall. People are spreading the disease who don’t know they have it. When you couple that with the cases where people are not being tested, and some number of tests that give erroneous results, we have the makings of a disease that will continue to multiply quickly. I have many reasons to go to Italy this weekend. It was going to be a quick 3 day trip. It would be wonderful to see my cousins. I have an aunt who is 94 years old and experiencing some health issues. Any time you have the chance to spend quality time with someone in their 90’s, take it. When a member of the family get’s married, you can’t ask them to reschedule it. You can’t say, I’ll catch you on the next one. You either participate, or not. So far, the region surrounding Rome has reported only 3 cases of Corona Virus. The vast majority of cases are in the North surrounding Milan. I also have family in Milan as well and I’m concerned for them. One of my family members is in her 90’s and not in great health. I have no doubt that they’ll be able to stay out of circulation for a period of time. But grocery store shelves have already been emptied. Getting food and basic supplies will be an issue in the near future. This is a warning to those who are not prepared for how quickly a situation can change. Grocery stores can be well stocked one day, and then two days later be completely emptied. It’s easy to rationalize that I’m going to be in a small group of people. It’s not a huge wedding, about 100 people. My risk is low. But still, people would be traveling from all over the world to attend. Who will be on the planes and trains of those 100 people attending the wedding? I have no idea who is catering the food. Several of the meals are scheduled for restaurants in central Rome. This area is frequented by tourists from all over the world on a daily basis. I have no doubt that my direct flight to Rome would be pretty safe. There are no known cases of the disease in my community. What I can’t be certain of is the return flight. We’ve seen travel bans being instituted from parts of Italy. It would be problematic for me to be stuck in Europe in a quarantine situation, or unable to return home because flights are cancelled all of a sudden. Even back here at home, preparations are important. We have no known cases in our city yet. We’ve been stocking up on food. As of now we easily have a month of non-perishable food in our pantry. My local Home Depot is now completely out of N95 surgical masks. I purchased 3 out of the last remaining box. Walmart is out of hand sanitizer in the city. My wife bought the last two bottles after checking the inventory across a city of 1.4 million people. Check the inventory in your pantry and go shopping for at least a month of essentials.

A new report was presented at a conference of global central bankers last week in New York that has multiple authors including several of the top economists.  The report advocates that central banks act early and aggressively when confronting a downturn. These crisis-era stimulus tools follow monetary policy. That is to say, the Fed, or any central bank tries to create stimulus in the economy by making money less expensive to borrow. We’re talking printing money, negative interest rates and forward guidance telling the markets that money will remain cheap. The idea is that if money is cheap, borrowers will use it to expand production, to hire people, and to make investments in growth of the business. On the consumer side, low interest rates make it attractive for consumers to buy now using credit instead of saving up the money to buy things when they can truly afford them. Today we are facing a crisis caused by the corona virus outbreak. If the impact is prolonged and travel becomes severely curtailed, we could start to see airline bankruptcies, hotel bankruptcies, and tour operators going out of business. We are seeing supply chain disruptions where the impact is not even fully understood. How this will ultimately impact businesses remains to be seen. We are already seeing companies unable to ship products because of component shortages. Making money cheaper to borrow won’t help. Federal Reserve Chairman Jerome Powell said recently that the Fed will fight the next recession aggressively with quantitative easing. That’s code for printing money. What will be needed in this instance is fiscal stimulus. But not just any form of fiscal stimulus. Typically when governments try to stimulate the economy they get busy building roads and bridges. That too would be completely useless as a remedy to today’s economic slowdown. Now is where government needs to step in and say to businesses affected by the corona virus outbreak, “here’s how government is going to help you directly”. So far none of the affected countries are making any meaningful statements about how they intend to protect their citizens from economic harm caused by the outbreak. Monetary stimulus will do nothing. It will require fiscal stimulus in the form of low interest loans or outright grants to affected businesses. Governments are way behind the curve in taking steps to contain the outbreak of the virus and they’re also way behind the curve in taking steps to protect the economy. So what’s the message in all this? Make sure you have taken the necessary steps to conserve cash in your business, take a defensive posture and be ready to rescue troubled assets when the time comes.

On today’s show we are talking about stock market valuations and how Wall Street justifies these high valuations. A year ago the Dow Jones Industrial average was trading at an average of 18.17 x earnings. Value investors the world over were fretting about how such a high valuation could be justified. As of Friday, the Dow was trading at 22.56 x earnings. First of all, let’s unpack what that means. The Price To Earnings Multiple is a measure of how expensive an investment is. In absolute terms it means that you would have to hold a stock on the Dow for 22.5 years for a company to earn back the investment an investor has made in the company. Let’s look at a low growth company like Consolidated Edison which provides regulated electricity, gas and steam to customers primarily in the NY area. Because they’re in a regulated industry, their ability to grow is limited by the utilities commission setting the rates that can be charged. Revenue grew by 0.1% last quarter. In the past year, Con Ed saw their net earnings shrink by 10.9%. Well Con Ed is trading today at 22 x earnings. This is a stock that should trade at a lower multiple. Historically, low growth stocks like this have traded at lower multiples like 10-12 times earnings. They’re stable year over year. I predict that we’re going to see a return to fundamentals in the near future. This is going to start with the more aggressively priced companies and then will spill over to the broader market. Today we still have a situation where the majority of trades in the market are computer program trades and not actual legitimate investor activity. We also have a large percentage of the investor market now investing in ETF’s, funds that track the market indexes. Let’s look at a stock like Apple or Google. These have traditionally been considered high growth stocks. We’ve been dealing with the Corona Virus outbreak for more than a month and the markets have shrugged it off and pushed valuations to all-time highs. Clearly investors have been disconnected from what is happening on the ground. We now have Apple issuing guidance that their first quarter will be impacted by supply chain issues. As of Monday’s opening bell, the shares were down 8% for the week and down 6.6% over the weekend. It doesn’t make sense that Apple trades at a premium to the market. The market multiples for Con Ed don’t make sense either. I’ve talked about 2 companies at opposite ends of the business spectrum. I believe that my argument applies to all the companies that occupy the space between these two companies. I believe that we will see a precipitous drop in the market averages as analysts come to grips with the true impact of the Corona Virus outbreak on the global economy. So far in the past week, we’ve seen a 4% drop in the S&P 500. Many have pointed to the stock market shrugging off the concerns about Corona Virus as a reason not to worry. Let me remind you of the irrational exuberance of the .com bubble in the late 1990’s. I lived through those days in the tech sector and was part of a company that had just gone public in the run-up to the .com crash. Markets have a way of being very wise in hindsight, but not so forward looking. Whether in good times or bad, but overwhelmingly when valuations are historically high I believe it is prudent to take a more defensive posture and invest in hard assets. Apple lost nearly 8% of its value in a few short days. Hard assets don’t typically exhibit that kind of volatility.

We are in the middle of a black swan event. We have a serious global health risk. The scope and magnitude of the impact is yet to be understood. Unfortunately, we have seen bureaucrats with zero understanding of scientific information making decisions that have put entire countries at risk. For example, the US State Department over-ruled other government departments and put 11 infected passengers from the Diamond Princess in the same aircraft as other passengers who had tested negative for the virus. The corona virus outbreak, also known as Covid-19 is what I would call a black swan event. The idea of a black swan was coined by  Nissam Taleb. It’s a metaphor used to describe an event that is so rare it is thought not to exist.  We typically can only see a black swan in hindsight. The collapse of financial markets in 2008 was a black swan event. A hurricane hitting a major populated area can be a black swan event. The terrorist attack on the world trade centre on Sept 11, 2001 was a black swan event. What will be the economic cascade of this situation? We tend to discuss counter-party risk as a financial issue between holders of assets and liabilities. There is another form of counter party risk that we rarely talk about. That is in the global supply chain. We don’t understand the complex web of linkages that make up the global supply chain. Economic activity can be disrupted by a drop in demand, or by a drop in supply. We have nearly 3/4 of a billion people in China on lockdown. This will clearly impact both demand and supply. When Japan experienced the Fukushima nuclear power plant failure, there was a single factory that supplied a critical component for batteries used all over the world. That single factory’s inability to supply for a period of time meant global disruption in the cell phone market. That was a single factory. Right now we have a situation where 50% of the containership traffic from China has been halted. Even if the products are on the pier ready to depart for North America or Europe, there is no way to get the products to market. Understand, each one of these container ships are capable of carrying more than 20,000 containers. That’s right, 20,000 20 foot containers. That’s the equivalent of 10,000 trucks on the highway for each ship. There are over 96 of these ships plying the ocean waters right now and a large number of them are stuck in port. We are going to experience supply chain disruptions on a scale we have not seen since the Great Depression. If companies can’t deliver their products, they can’t collect revenue. It doesn’t matter if there is demand. They simply can’t deliver because they can’t get the product to market. All it takes is a critical component to be missing in the manufacturing process. Some companies will be able to survive a number of weeks, or perhaps even a few months with their current inventory. In the world of Just-In-Time manufacturing, the most efficient companies focus on minimizing that inventory. Ironically, it’s the most efficient companies in the world that will experience the most acute pain in their supply chain. Finding an alternate sources of supply for a product is never quick, nor easy. Component substitutions and supplier substitutions take months or longer to implement. We have a number of companies that have massive corporate debt, much of it in the way of bonds. A large number of companies will have a very hard time withstanding a precipitous drop in business lasting more than a few months. The debt obligations of those companies assumes that growth will continue without interruption. I’m predicting a wave of corporate debt defaults over the next 90 days as a direct result of the supply chain disruptions. Those defaults will have a cascade effect due to counter-party risk on the paper.

Bob started his career in professional hockey where he played in the US and internationally. His brother played 15 years for the Montreal Canadians. Then after a start in real estate investing, he moved into the world of managing real estate projects with the help of virtual assistants. Today, he manages a team of virtual assistants based in the Philippines.  Real Estate Virtual Assistants is a company specially designed to supply virtual assistants to North American real estate clients, based in the Philippines. You can reach Bob at revaglobal.com

Bruce Firestone has been developing real estate for many years. He is best know for his role in creating a National Hockey League expansion franchise and creating the Ottawa Senators NHL team from an idea. Today's conversation in packed with powerful lessons on overcoming adversity.