The Real Estate Espresso Podcast

On today’s show we’re talking about value engineering your finished product. It’s hard to believe that a little bit of software makes it possible to save a bunch of money in the communications infrastructure for your projects. Today’s property has so many connections. There is water, sewer, electricity, telephone, Cable TV, internet, natural gas. When you are supplying services to a multi-family apartment or assisted living project, every single one of these services costs money. In fact, it’s common to have two water mains, one for the household use, and a second higher capacity water supply for the sprinkler system. These days, a modern building will be pre-wired with cable for telephone, internet, and Cable TV. It might even be pre-wired for the security system and for surveillance security cameras. We just recently went through an exercise where our general contractor missed a critical item in the scope of work. They agreed to absorb the cost of the error. But nevertheless it became clear that the designers had specified a lot of wiring in the buildings. We decided to undertake a significant cost reduction in the wiring of the project in order to save money. But the real question is whether we would experience any loss of capability or quality. We’re not willing to compromise on the quality of service. At the end of the day, the residents want their service and they want it to work reliably with great performance. The want to be able to make phone calls, watch TV, and access any internet based service. How that’s accomplished is immaterial. Traditionally all three of those services had their own separate infrastructure. Today, the technology makes it possible to put all three services on top of the basic internet service. It was an easy decision to eliminate the legacy telephone wiring. These days, even in the event of a power outage, the need for a hard wired telephone is virtually non-existent. So many people have wireless cellular phones that a hardwired phone is no longer needed. The second cost saving comes from eliminating the Cable TV wiring. There is no need for Cable TV. Virtually every market has a TV service provider offering a digital set top box that can be connected via Ethernet or WiFi. Now I know what you’re thinking. A wired connection is going to be a better connection than a wireless connection. WiFi connections are prone to interference. Wireless technology has changed dramatically over the past decade. The older legacy WiFi technology used the 2.4 GHz spectrum. That region of the airwaves is unlicensed and you can literally have all kinds of interference showing up in that radio band. You can have garage door openers, microwave ovens, cordless telephones, and yes, lots of other WiFi access points. If you’re in a sense urban environment like NYC, it’s common to see the radio signal of 40-50 other wireless networks. All that interference can make for a very unreliable connection. The newer wireless technology uses the 5 GHz spectrum. As you go up in frequency, the shorter the distance the signal will carry. That’s both good and bad. It’s good because it means that you will experience less interference. It also means that your own radio signal won’t go as far. You may be required to install multiple wireless access points in order to get decent wireless coverage within your desired coverage area. As an example, we’ve designed a system that will use five access points in order to provide coverage for a 9,000 square foot home. The reason for having five access points is to have each one operate in a difference frequency band within the 5GHz spectrum. This means that each region of the home will be very close to the base station. We've replaced the legacy wiring with bundles of 24 optical fibers per building. This ensures expansion capacity for decades to come.  

On today’s show we are talking about a proposed change to the accredited investor definition by the SEC. The effect of the change would be to make more private investment options available to individual investors who have a level of financial education and sophistication. The purpose of today’s show is to open the topic for you to investigate further. I’m not a lawyer, and I’m definitely not a securities lawyer and my role is not to provide legal advice of any kind. The proposal would expand the number of people allowed to invest in private securities offerings.  Currently, people who may invest in those markets, known as accredited investors, must have the financial resources to withstand big losses: either $1 million in net assets, not counting their home, or at least $200,000 in annual income. The SEC proposal, which was approved by a vote of 3-2, would allow investors with certain qualifications, such as an entry-level stockbroker’s license, to sidestep the income and wealth thresholds The SEC’s rules which were enacted in 1933 were born out of a Depression-era mandate to protect Main Street investors from the vagaries of financial markets. If you go back to the 1920’s, the irrational exuberance of the markets was littered with fraudulent public offerings. Companies with no underlying business issued public offerings and cheated investors out of their life savings. The SEC estimates that $2.9 trillion was raised through private channels in 2018, versus $1.4 trillion in registered offerings. The fact is, the vast majority of private offerings today that are filed with the SEC are under Regulation D, part 506. Under a 506 offering, there is 506B which allows up to 35 non-accredited investors and an unlimited number of accredited investors. However, under 506B, solicitation is not permitted. Under 506c, offerings are only open to accredited investors who must demonstrate that they meet the accredited investor criteria. Offerings under 506c are permitted to be advertised and do not require the pre-existing relationship that is part of the 506b rules. The proposal is outlined in a 153 page document that you can download and read from the SEC website. There is also a mechanism and a 60 day period for collecting comments from the public, and this too can be done on the SEC website. The methods for submitting comments are outlined on the second page of the SEC proposal. Just in case you’re thinking that 153 pages is a lot to wade through, I suppose it is. But on each page, there are substantial footnotes. Some pages consist of about 25% actual text and 75% footnotes. Unless you intend to go through all the footnotes and references, it’s actually not too bad a document to read through. The proposal includes Adding “family offices” with at least $5 million in assets under management and their “family clients,” as each term is defined under the Advisers Act; The proposal also includes Add the term “spousal equivalent” to the accredited investor definition, so that spousal equivalents may pool their finances for the purpose of qualifying as accredited investors; If and when these changes might be implemented is anybody’s guess. They could be amended between now and then. Even once enacted in law, they could be further refined by policies governing the implementation of the new rules. In the coming years, we can look forward to the possibility of an expanded definition for accredited investor that could make a larger number of investors eligible for the accredited investor definition. That, in turn could make the 506c offering an even more effective tool for syndicators and project sponsors to raise capital for real estate projects and other business ventures.

Owen Barrett from San Diego is a specialist in energy management. On today's show we're talking about the economics of solar power for multi-family apartment and commercial real estate projects. He can be reached at valueaddsolar.com.  

I take several days each year to get clear on my goals and to set quarterly goals. This is such a vital exercise. On today's show I'm talking with my friend Rich Danby about goal setting in front of a live studio audience. 

This question comes from Kyle. I am considering a new construction MF project. My business partner is a home builder and general contractor. Through my research on MF syndication it sounds like the majority of these deals follow the same cycle: - Value Add Building - Refinance once units are rehabbed to market value - Payback investors with refi money When it comes to new construction how does your deal cycle compare? Thank you Kyle for a great question. In many ways you are correct in drawing a parallel between development and a value add deal. Conceptually, they are exactly the same. But where they differ is in the details, and its in the numerous details that the traps can lie. When it comes to development, there are just a lot of moving parts and any one of them can trip you up. Like a value add, the goal is the same, to add value, in fact to create enough value that you can refinance the project and recover your initial investment for a long term hold with little to no cash tied up in the project. In your classic value add project, you perform light remodeling, you add washers and dryers to the apartments, you improve the amenities, and you increase the rent accordingly. When you move into the world of development, there are just so many moving parts. You may have to hire the engineers to design your site and prove to the city that you are not adding more runoff to the stormwater management system. You may be required to perform a traffic study to prove the existing road infrastructure can handle the increase in traffic. You may have to perform a shadow study to prove that your building won’t cast a shadow on the neighbours property. You will need to make sure the water, sewer, and utility infrastructure has the capacity to handle your project. Will you be limited by storm water management? Will you be limited by soil stability and the strength of the soil to support the weight of the building? Will the city allow you to get a curb cut to access the property in your desired location? Will the proximity to other properties limit your choice of building materials? Will you be required to use fire rated doors and windows? Unless you know the answers to these questions and more, you can be facing substantial cost increases that will completely catch you by surprise. Apart from quite a few details that can trip you up, it’s exactly the same as a value add project. Having people on your team who know how to navigate these complexities is key to having a successful development project. The second area of risk is in construction. Hiring an established general contractor who does large projects is essential. If you’re hiring the smaller GC’s, the ones that I call “2 guys and pickup truck”, your risk of having corners cut and failing inspections goes way up. You might pay a tiny bit more for a more established contractor, but your risk of cost over-runs goes way down. It’s also important to hire a GC who has experience in multi-family. The subcontractors who work on multi-family are completely different. The project management of the subcontractors is completely different from other forms of construction. We don’t have time to go into all those details on today’s show, but you must hire a GC who specializes in multi-family construction. Finally, you want to hire an attorney to negotiate your construction contract, but not just any attorney. You want someone who has experience negotiating and litigating these types of contracts. These contracts can be filled with landmines and you need a specialist who can spot and correct the risks.

I’m coming to you live on location from Key Biscayne Florida. One of the most beautiful places to visit in the US are the Florida Keys. The waterfront homes in the keys are a dream to me. Many of them are built up on stilts to protect them from the storm surge of the occasional hurricane. This strip of islands stretches all the way from Miami to Key West. From the very first Key, called Virginia key, down the Rickenbacker causeway towards Key Biscayne. Further south, Key Largo. The entire drive through the keys stretches for 118 miles or about 190 km. The state has a rule that the island chain has to be able to get everyone out 24 hours before a hurricane hits. And there’s just one road out. So there’s a limit to how many people are allowed to live in the Keys. Hurricane Irma in 2017 did considerable damage to properties on the keys. Overall in Monroe County, 27,649 homes experienced some degree of damage, including 1,179 homes being destroyed, 2,977 homes receiving major damage, and 5,361 suffering minor damage. Starting in 2023, no new building permits will be issued in the Florida Keys, a stipulation of a 1970s state mandate aimed at controlling development in the environmentally sensitive archipelago and ensuring timely evacuation of tourists and residents in the path of hurricanes. Because the Keys were designated an area of critical state concern, development there is regulated by a law called the Rate of Growth Ordinance, known as ROGO, which requires property owners to go through a myriad of steps that can take decades before they can build. Many of the thousands of people who have not built on their land haven’t done so because they are mired in the ROGO process. The question is, will the renovation of an existing property be allowed? As long as the density is not being increased, will the county allow an existing property to be redeveloped, to be improved? This has not been made clear. As a real estate investor, this kind of situation is precisely what I look for. I love to see situations where there is a supply demand imbalance. In this case, there is a constraint being applied on the supply side. When these types of conditions exist, the downside risk to property value is reduced. The demand for homes in the keys appears robust. The Keys have already survived a devastating category 4 storm. That has not deterred people from wanting to live there, from owning their own piece of paradise.

On today’s show we’re talking about what’s happening in France. I spend several months a year in France and I used to manage a team of 110 people in France for several years. I understand a little about French culture, and it’s very different than we’re accustomed to in North America. Unlike in the US and Canada, the business environment in France is highly dominated by labour unions. In fact, any enterprise having more than 50 employees must have a works council. That is a union. Unions in France are incredibly militant. When I was managing a team of microprocessor designers, professional electrical engineers, I was surprised to see them on strike one day, picketing in front of the building and being interviewed by the evening news TV show. The retirement age in France is 62. That compares with 65 in North America, and 67 in some other European countries. The math is pretty simple. Demographics says that entitlement programs in most countries are under-funded when you fast forward only a few years into the future. Mr. Macron wants to consolidate the country’s 42 different pension plans—each with varying retirement ages and benefits—into one universal system. Many civil servants, including teachers and rail workers, worry they could lose some of the advantages they enjoy under the current system. The contentious proposal includes a system of bonuses and penalties to incentivize people to work until age 64, two years beyond the legal age of retirement of 62 years. Unions reacted by calling on workers to hit the streets. Workers are taking to the streets in droves virtually paralyzing the country. The latest estimate from the French Interior Ministry is that over 800,000 people participated directly in the protests. Even towns like Toulouse that have a strong manufacturing base with companies like Airbus manufacturing aircraft are seeing tens of thousands of protesters clogging the streets, bridges, and central squares. The largest protest in Paris was estimated at 65,000 people and turned violent at times. The French are incredibly militant when it comes to protecting their social programs, regardless whether the math adds up or not. There is a feeling that somebody will take care of it. If I have a pension that’s been promised to me, then it’s not my problem. Somebody owes me my money. There is a sense of entitlement that is so deeply ingrained in the culture that anything that threatens any aspect of the an entitlement program is enough to bring people out into the streets in force. But you need to understand why this is the case. The work environment in France does not favour entrepreneurship. If you’re an employee in France, if you work for a company for one year plus one day, you are entitled to two years of severance if they fire you. In an environment where it’s very difficult to fire people, its also very difficult for people to get hired. So it has the effect of reducing mobility. When someone has a job, has an income stream, they become incredibly protective of it because their choices are perceived to be extremely limited. The loss of job, the loss of benefits, the loss of even one day of vacation per year is enough to trigger protests. But just in case you think this is a France only issue, don’t be fooled. We have seen organized labour movements have a larger voice in the US than at any time since the 1980’s. We’ve seen more strikes by teachers, auto workers, and hotel workers than in decades. Public sentiment is much more favourable toward unions where they have a 64% favourable view in eye of the public according to a poll by the Gallup organization. That’s the highest it’s been in half a century. I’ve long maintained that if you want to see your future, have a look at what is happening in Europe.

On today’s show we’re talking about the war on short term rentals. Communities around North America have been establishing new regulations designed to reduce the number and scope of short term rentals in their communities. Many communities are facing a shortage of affordable housing and the perception exists that homes are being removed from the rental market and put into the more lucrative short term rental market, putting an even greater strain on housing affordability. By making these investment properties illegal, the hope is that many of these rental properties would be returned to the long term rental market, or sold outright into the owner occupied market. A widely accepted definition of a short term rental is one where you rent to the same person for less than 30 days. Many cities have put restrictions on short term rentals and limited them to owner occupied properties. So if you have a spare bedroom in your principal residence, you can rent it out. Some cities have introduced licensing as a way of regulating the industry and keeping tabs on which properties are in the short term rental market. On today’s show we’re looking at some of the activity across several cities in North America. The City of Vancouver says its efforts to regulate short-term rental units and bring more long-term rental options back into the pricey housing market are working. Active short-term listings are down to around 5,000, compared to more than 6,600 before the regulations took full effect last September, the city said. More than 2,000 unauthorized units that were taken offline have not been re-listed. In Austin, whether renting out an entire home, an apartment or a bedroom for a single day or all 365 days of the year, local law requires the owner to register and license the property as a short-term rental with the city. The city counts 2,500 licensed units throughout the city; however, a third-party firm working with the city has reported over 10,000 properties advertising as a short-term rentals. The City of Nashville is undergoing tremendous growth with about 120 people a day moving into the city. This is putting a strain on housing supply and on housing affordability. They implement new regulations at the city level, which were then subsequently blocked at the state level. One year after state lawmakers blocked the city’s plan to phase out non-owner-occupied short-term rentals by 2021, Metro Nashville officials are revisiting not only where rentals can operate through their zoning ordinance, but they also increased the annual permit fee by more than 600%. In San Francisco, new rules governing short term rentals were implemented a couple of years ago. Any home rented out in San Francisco for less than 30 days must be registered with the city, and someone must live there at least 275 nights per year. An NBC News report suggests that about 45 percent of short-term rental applications are now being denied for what appear to be false residency claims, in which the applicants falsely state they are the “primary resident” of the home, which is a requirement for all short-term rentals. If you’re noticing a trend here, that’s no accident. Cities around North America are actively trying to remove short term rentals from residential zones, and they’re making sure that they don’t lose hotel tax in the process. If you’re contemplating making an investment in short term rentals, you definitely want to know that the city has completed their regulatory process. If not, you’re taking a huge risk of the rules changing after you’ve made a significant investment.

On today’s show we’re talking about opinions. The nice part about opinions is that there is no shortage of them. The world is unlikely to run out of them any time soon. Last week we reported on the podcast that Fannie Mae had published their housing confidence metrics showing a very high consumer confidence index as it relates to housing. A new report published by CCN paints a far more pessimistic view of the market. The report referenced new guidance from Home Depot which has lowered its guidance on both revenue and earnings for 2020. They cite several factors for the lower guidance. There is an acute shortage of homes at the entry level of the market. Homes in this category are those priced below $200,000. The housing market is also experiencing a shortage of mid-tier homes, that is, those priced between $200,000 and $750,000. The author draws the conclusions that the shortage of supply combined with a possible future increase in interest rates could cause the housing market bubble to burst in 2020. The author went on to say, “In all, the U.S. housing market is suffering from a lack of supply. This could prove to be its undoing next year as buyers are likely to be priced out of the market if mortgage rates continue to tick up. Americans are already under duress, as evident from four straight months of declining consumer confidence.” When I read things like this, I sometimes find it hard to make sense of the logic. So I read the article 4 times. Each time, I tried to follow the chain of logic that would lead to the outcome the author is claiming. Yes, the consumer confidence has fallen for four straight months. It fell from a high of 135 to 125.5. In the past month the index fell from 126.1 to 125.5. A measure of 100 is considered neutral. While it is true that consumer confidence has fallen slightly, it is still considered well into positive territory and is consistent with what the folks at Fannie Mae reported last week. The author says “Consumer confidence is also low” which is an outright misrepresentation of the data. I’m sorry, consumer confidence is not low, it has dipped slightly, but remains incredibly high, well above historic averages. For contrast, consumer confidence hit a low mark of 60 back in 2013 and didn’t reach 100 until mid-way through 2016. The author of the report seems stuck on pushing a particular narrative and is quoting numbers that actually contradict his conclusions. It’s almost like they’re asking the reader not be confused by the facts. When there is a shortage of supply and an excess of demand, it has the effect of pushing prices up. That’s exactly what we’ve seen. The shortage is driven by population growth and by the millennial generation finally getting into home ownership. The number of new homes constructed is not keeping pace with population growth. Where we are starting to see bargains is in the upper segment of the market. These larger homes are selling at a relative discount to the market on a per square foot basis. We call this price compression.  Unless the demand evaporates, we can expect continued upward pressure on housing prices at the bottom of the market. We are seeing prices fall in areas where people are moving out. So did Home Depot lower its guidance? What does it really mean, and what is driving it? Could it be that a smaller number of homes on the market would in fact reduce the revenue at Home Depot as the author suggests? I read the entire transcript of their investor conference. The author has it wrong. In my view the author of the article has an agenda. They’re trying to paint a picture that the real estate markets have some downside risk. I get that. I have no problem with having that point of view. If the author wanted to hi light the downside risks, there’s ample data they can find to make that argument. There’s no need to make stuff up.

On today's show, I'm talking with George about how to maintain liquidity in your business. Having cash on hand is vital for dealing with the unexpected. I love George's practical wisdom and common sense approach.