The Real Estate Espresso Podcast

We just spent 3 intensive days on the beach in Mexico working on goal setting for 2020. It was not exactly on the beach. We set up our conference table inside a straw hut called a palapa that was situated at the end of a pier out over the water. The pier was surrounded by schools of fish, needle fish, barracuda. It was a pretty magical and inspiring place to do this kind of deep work where there was a panoramic view of the beach to one side and the ocean stretching to the horizon You can’t improve something you are not measuring. The business world is filled with performance metrics. Revenue, profitability, efficiency, return on investment, gross profit margin, inventory turns, cash flow, vacancy, delinquency rate, accounts receivable aging. The list goes on and on. We establish these measures to improve business performance. It’s said that anything which is actively measured has a general tendency to improve. The simple act of measuring brings focus and attention to that metric. Sometimes businesses get off track by focusing on the wrong measures. You only need to look at companies like Sears, Macy’s and General Electric to see examples of companies that did a great job of optimizing the wrong metrics. Today’s show is about setting expectations, not so much with others, but with yourself. How often we as humans latch on to measures that we use to define our own sense of self worth. For some people their sense of worth is attached to their career, perhaps their title. A lawyer who needs to make partner before the age of 40. For some it’s the house they live in, the car they drive. How much money they have in their bank account. There are so many metrics that we unconsciously track on a daily and weekly basis. Some people measure their weight, the number of hours they sleep, the number of steps taken each day, the number of likes on a social media post, the miles per gallon they get in their car, the percentage increase in their stock portfolio in the past year, the value of their home. How many people wished you happy birthday on Facebook? How much did your spouse spend on your birthday gift? How big a discount did you get when you went shopping for holiday gifts? Think about it. In each one of these measures, there is an entire story wrapped up in what a good number means. More importantly, there’s an opportunity to feel bad about yourself if the number isn’t what you hope it to be. What does a number actually mean? And who decided what a good number or a bad number means? Do any of these measures have any real meaning that reflects truly upon your worth as a human being? How many people measure the quality of the time spent with their children, the hours spent hugging a loved one, the time spent laughing per day? So often people lose their way by focusing on measures that are not truly in alignment with the core values that will bring fulfillment. In the same way that companies can go bankrupt by optimizing the wrong measures, individuals can become emotionally bankrupt by focusing on the wrong measures. Sometimes things get measured simply because they’re easy to measure, not because that measurement is truly important to improving my life. The fuel efficiency of my car is not going to fundamentally change the quality of my life for better or for worse. But it is easy to measure. So many people find themselves climbing the ladder of success only to find when they get to the top that they leaned the ladder against the wrong wall. I’m going to be taking three days in the next week to complete the work on my goals for 2020 and beyond. But before I can start working on my goals, I need to get clear on my values, what’s important to me. Once I have that clarity, setting the goals becomes obvious.

Kevin from California asks, I currently live in California and would like to know which other states are good for investments within the next 5-10 years and why? Kevin, This is a great question. The first thing to remember is that real estate is hyper local. We will come back to discussing the hyper local aspect of investing in a minute. The direct answer to your question. Generally speaking I’m looking for areas where there is influx of jobs, and influx of population. That increase in demand in the presence of modest supply means that we should experience increasing prices with all other things been equal. I like to pay attention to demographic trends. I like low tax states where both residents and corporations pay a minimum of tax. I also like states where there is a demonstrated flow of both jobs and population. This means places like Texas, North Carolina, Florida, Nevada, Arizona, and Alabama. You want to choose places where there is an already an established flow of migration. But in each of these states there are locations that are not suitable. So if you choose a state like, say, Florida, there are local areas that are great investments, and others that aren’t. I might be much more interest in Fort Myers than, say, Ocala. There is a clear migration flow to certain locations in Florida from cities in the North East like New York and Boston to communities like Boca Raton, Jupiter, West Palm Beach. There is a clear migration flow from California to Texas, Nevada, and Arizona.  In fact, Some 660 companies moved 765 facilities out of California in the past two years, and Dallas-Fort Worth has been the beneficiary of many of the relocations, according to a recently published report. Discount brokerage Schwab is among the latest announcements. The company has already moved several hundred roles from its San Francisco location to Dallas. The latest announcement will move about 400 jobs to Dallas to be housed in a new campus being built in Westlake Texas. Even Uber is moving it headquarters to Dallas from the SF Bay area. One of the culprits that is often cited is the increasing regulation that is making it difficult to do business in California. One of the latest is a law in California that was passed in September that requires companies to hire workers as employees, not independent contractors, with some exceptions. The law is intended to give basic labor rights and benefits to hundreds of thousands of California workers now classified as independent contractors. This is a major shift that fundamentally alters how businesses conduct themselves. So you want to pay close attention to the specific moves that are taking place. You want to look at the migration of several hundred jobs to a specific office location and then draw a circle of a few miles around that office and see what the dynamics are within that radius. You want to see where the shortage is. There might be a surplus of 3-4 bedroom residential properties and a shortage of one and two bedroom properties. You also want to look at asset class. Maybe the shortage is in single family residential, perhaps apartments, or maybe self storage. There are other dynamics affect the value of property. Specifically the distance from a major airport affects property values significantly. The further you get from a major airport, the more prices drop generally. If you look along the Gulf coast, you would find that properties in towns like Englewood are very inexpensive, including waterfront properties. These towns also lack major industry. As you get closer to an airport heading North to Sarasota, prices increase. Higher prices are not something to shy away from. They’re a reflection of higher demand. Even in those higher priced markets, there are opportunities to acquire bargains and create tremendous value. Again, these moves are subject to the local supply and demand balance.

On today’s show we’re looking at why prices for real estate in Australia fell by 8.4% in the past two years and we’re answering the question as to whether what happened in Australia could happen elsewhere in the near future. Australia’s median house price dropped 8.4% between July 2017 and May 2019. With only a handful of larger price dips during the late 1800s, the slump surpassed the recession of the 1990s and 2008 financial crisis, making it the worst ever recorded in recent decades. markets in Sydney and Melbourne were hit the hardest during the downturn, which lasted from mid 2017 until earlier this year, with an average price drop of 22.5% in Sydney and 32.1% in Melbourne. Following a boom that peaked in mid-2017, prices began to fall due to tighter lending conditions, low buyer confidence and changes to Chinese investor loan limits. The government launched a Banking Royal Commission inquiry into lending practices, which commenced in late 2017 and concluded earlier this year, resulting in a crackdown on lending practices by big banks in Australia. This government-led inquiry, triggered by reports of misconduct by certain Australian banks, was a major reason house prices began to fall.  Much like the 2008 crisis, the downturn in Australia was the result of significantly reduced availability of credit in the market. At the same time, demand from Chinese buyers, Australia’s largest offshore property investors, also slowed in 2017 and 2018. We’ve seen the same dynamic in the US and Canada. China’s government has imposed tighter capital controls, making it harder for residents to move money out of their own economy. There is still money coming into the market from China, but the numbers are down significantly. Chinese buyers have a cap of A$50,000 (US$33,903) they can take outside the country. Much like the 2008 downturn in the US, the availability of credit is more important than the interest rate. When financing is hard to come by, the balance between buyers and sellers changes dramatically. If the only buyers are cash buyers, sellers will drop their price in order to sell. Proof that the problem is a credit problem rather than a real estate problem is the fact that since May, lending has opened up and prices in Sydney and Melbourne have risen almost 6% in both those markets since May. It’s fair to say that the issues in Australia were unique to that country. But it goes to show that something as simple as an investigation into banking practices can, at least temporarily crater the real estate values in an entire nation. So the question is, could we see a credit crunch again in the US, in Europe, or in Canada? If so, what could be the cause? We often think about the levels of sovereign debt that so many countries around the world have signed up to. This includes every major economy in the world. We’re talking about the US, China, Japan, the UK, Canada, Italy, and yes, even Switzerland. So far the problem in Australia was limited to a regulatory issue. There was no domino effect. There was limited counter party risk. You might be wondering, what is counter party risk again? Well, I’m glad you asked. Counter Party risk happens when an asset on my balance sheet appears as a liability on your balance sheet. If you fail to pay me, then I’m at risk of defaulting on my obligations to the liabilities on my balance sheet and the dominos start to fall. Clearly the political will does not exist for any one country to trigger the next financial crisis. The point is that this time the problem was localized to Australia. No dominos fell, except in Australia. Once the dominos start to fall, there is almost no stopping it from happening.

Welcome to December. This is the last month in the current decade. Hard to believe that the 2010’s are almost over. Today is the book of the month episode. On the first day of each month we review the book of the month. In order to be considered for a book of the month the book has to meet a very simple criteria. It has to be impactful enough that it will change your life or your perspective on the world. Whether it does or not is entirely up to you. You might read the book and comment on what a great book it was. But if you don’t internalize the book and make a part of you, you’re missing the point. The author of this month’s book is none other than Malcolm Gladwell. He has written several other ground breaking books including Outliers, Blink, David and Goliath, The Tipping Point, and What the Dog Saw. Each of these books would have easily met the book of the month criteria. Malcolm Gladwell is also host of the Revisionist History Podcast in which he goes back through history and looks at something that happened and examines underneath the covers. At heart, Malcolm Gladwell is a journalist. He’s a Canadian from Toronto and currently lives in NYC where he writes for the New Yorker Magazine. Our book this month is called Talking with Strangers. Like his previous books, Gladwell takes real life stories and tries to dig beneath the covers to find insights, to find common threads of new learnings and to illuminate the blind spots that are hidden in plain sight. The premise of the book is that communication happens easily with people whom we are familiar with, whom we understand The authors examples are diverse. The book is framed around the story of a woman from Chicago who moved to a small town in West Texas to restart her life in a new setting. She had secured a new job, and on her first day in town was stopped by a police officer for a questionable traffic stop. The sequence of events that unfolded found this innocent woman being dragged from her car, handcuffed and brought into custody, and eventually dead three days later in a jail cell, never having committed a crime of any sort. The author looks at how we process communication. A case study of the TV sitcom “Friends” showed that viewers of the show were able to follow the story line of the show with the audio completely turned off simply by watching the body language and facial expressions of the actors on the show. The accuracy of the interpretation was incredibly high. It shows that many of us rely upon these cue far more than we know. But this is a TV show and the actors are paid to do a great job of acting.  In the real world, a smile isn’t always a signal of happiness. There are those people who make up a small percentage of the population who have learned to disconnect their emotions from their body language. Some go on to become criminal masterminds like Bernie Madoff. Others go on to become championship poker players. It is full of case studies that individually can lead you astray. Taken together they reframe the way you will look at interactions. Malcolm Gladwell isn’t shy about confronting difficult topics. He chronicles the case study of the negotiations between Prime Minister Neville Chamberlain of the UK and Adolf Hitler in 1938. Chamberlain’s negotiations with Hitler are widely regarded as one of the great follies of the second world war. Chamberlain fell under Hitler’s spell. He was outmaneuvered at the bargaining table. He misread Hitler’s intentions. In the book Gladwell argues that something is very wrong with the tools and strategies we use to make sense of people we don't know. The idea of the book of the month is to change your life or change the way you see the world. Talking with Strangers by Malcolm Gladwell will definitely deliver on both those promises.

Logan Freeman is based in Kansas City where he helps out of town investors with their portfolios large and small. 

Today's show is part 2 of a question from yesterday's show.  Anthony and Julia from Brooklyn ask. Hi Victor. I’ve been listening to your podcast for about a year now and appreciate what you’re doing!  I have my wife, who is an architect, listening in now too! We want to invest in other real estate but with two young boys we don’t have a lot of disposable income to work with. We own and live in a double duplex in Brooklyn. We bought in 2013 and after significant work and neighborhood development its has more than doubled in value. On our block alone there is a lot of studio and one bedroom apartment development going on.  We’d like to access some of the equity we have built up in our property.  We’ve been renting the lower unit short term for about 4 years, but that business is getting less attractive.  We are considering condominium conversion and selling half to capture money to buy other property or renting out both units and taking out a HELOC or do a Cash Out Refi. Ideally we’d like to hold because the neighborhood has a lot of growing yet to do.  Our interest rate seems kind of high at 4.875%. What are your opinions of Helocs vs Home Equity Loans for less experienced eager to grow investors? Thanks for taking the time and we look forward to learning more from your show! Anthony and Julia On yesterday’s show we talked about the differences between the types of debt offerings that could be used to invest in more income properties. On today’s show, we’re going to focus on what to do with the money when you have it. You’re probably thinking the same way that most DIY investors do, save up some money for a downpayment, put down 20% in equity, borrow 80% and add one more property to the portfolio. That’s definitely one way to do it, and in one sense there’s nothing wrong with it, depending on what your goals are. In this context I”m going to speak directly to your wife Julia. Julia, you’re an architect. My mom was the second woman in history to graduate in architecture from Cornell University back in 1945. She has her stamp on several landmark buildings in NYC. You entered university to get your degree in architecture, knowing that it would be a huge commitment of both time and money in order to get that degree enabling you to practice as an architect. You didn’t say to yourself, I want to be an architect, but it’s hard so I’ll take a small step and get a degree in drafting. Just like someone wanting to be a doctor doesn’t say, that’s hard so I’ll go to nursing school instead. So I want you both to look at your investment goals with a longer view. If you truly only want to own a handful of apartments in the NY market and you are willing to get there slowly over the next 20 years, then the approach you’re taking is perfectly fine. The number one mistake I see rookie investors make is to run their project with too little capital. You want to make sure that in addition to raising the money to purchase the property, you maintain a healthy reserve fund to handle any surprise that the market might throw at you. You might have a water heater fail, or an air-conditioner fail and all of a sudden you’re digging deep into your pocket for a capital repair that wasn’t in the budget. Spend time with other experienced investors in your area and learn from their mistakes, rather than going and making the rookie mistakes yourself. It’s much cheaper that way. Like I said, investing in small properties is a perfectly viable strategy, if that’s in line with your ultimate goal. But if you want to create a stream of residual income that can provide multi-generational wealth for you and your family, then you may want to think bigger. If you’re thinking bigger, then you may want to jump to the next level and skip the time wasted on small stuff.

This question is from Anthony and Julia in Brooklyn. Hi Victor. I’ve been listening to your podcast for about a year now and appreciate what you’re doing!  I have my wife, who is an architect, listening in now too! We want to invest in other real estate but with two young boys we don’t have a lot of disposable income to work with. We own and live in a double duplex in Brooklyn. We bought in 2013 and after significant work and neighborhood development its has more than doubled in value. On our block alone there is a lot of studio and one bedroom apartment development going on.  We’d like to access some of the equity we have built up in our property.  We’ve been renting the lower unit short term for about 4 years, but that business is getting less attractive.  We are considering condominium conversion and selling half to capture money to buy other property or renting out both units and taking out a HELOC or do a Cash Out Refi. Ideally we’d like to hold because the neighborhood has a lot of growing yet to do.  Our interest rate seems kind of high at 4.875%. What are your opinions of Helocs vs Home Equity Loans for less experienced eager to grow investors? Sorry for the sprawling question but I hope you can speak to some of these issues. Thanks for taking the time and we look forward to learning more from your show! Anthony and Julia Let’s look at the condo conversion option. While it’s certainly possible to do a condo conversion, it’s not very practical for such a small condo project. The overhead of managing a condo corporation for the rest of time quite frankly is hardly worth it for two units. The shared common elements between the two units can become a source of friction between unit holders. For a small property you’re better off keeping it all together and not subdividing it in my opinion. A sale of the lower unit that you don’t occupy would free up some equity, but it might also be considered a taxable event.  A refinance on the other hand isn’t a taxable event. It offers you a lot more flexibility in terms of what to buy, and when to buy it. Let’s start by describing the difference between a home equity loan and a home equity line of credit. A home equity loan would basically be a refinance of your existing two unit property. It would be for a fixed amount of money and rates these days a pretty good. You have a couple of choices in this. If you work with your existing lender, they may be willing to put a second loan on the property while maintaining the original loan. That way, there’s no pre-payment penalty for refinancing the old loan. The second choice is to replace your existing financing with a new loan up to the new loan amount. Remember, at this stage, the lender assumes that the path to repaying the loan is primarily from your employment income for both of you. They will generally give you credit for the rental income in the second unit, but they will typically want to see a 12 month lease. Short term rentals usually don’t fit with most bank’s lending model. The third choice is the home equity line of credit. The difference between the line of credit and the home equity loan is the way the funds are advanced, the way the interest is calculated and the way the loan is repaid. The loan is an amortized loan which means that the monthly payments include both principal and interest. A line of credit simply requires that the interest be paid monthly. If you’re using the equity in your home to buy another property you probably want to use the equity on an ongoing basis without being forced to repay it on a monthly basis. For that reason, the home equity line of credit might be a better fit. The home equity line of credit also has the advantage that you’re not paying interest on monies you don’t use.

On today’s show we’re talking about one of the latest disruptions to come into the retail industry. This is from the guy who brought us Uber, Travis Kalanick. His latest venture is called Cloudkitchens. The company is currently live in 3 markets, Los Angeles, San Francisco and Chicago. The idea behind cloud kitchens is to break apart the traditional food and beverage model associated with a bricks and mortar restaurant. The trend toward delivery meals is growing and is being serviced primarily from the traditional bricks and mortar restaurants. The vast majority of food delivery currently takes place in traditional brick and mortar restaurants, but these locations are not optimized for delivery. Today, online delivery is a high priced luxury product with a very poor experience. Everything about the restaurant experience is designed for walk-ins and reservations. And while delivery is an increasing percentage of the business, many operators are forced to trade-off the dine-in experience with a booming delivery business. Cloudkitchens has designed a commercial kitchen along a formula that allows for the basics and at the same time allows for customization of work flow. It’s a turnkey solution to opening new locations for those who want to be in the food and beverage business, with a focus towards building a delivery oriented brand. The delivery channels like ubereats, grubhub, doordash, each have their own platform. There’s a problem of integrating the data from each of these disparate channels into a single accounting system. Cloudkitchens has completed the integration so that audited financials are a breeze. The workflow in a restaurant is optimized towards the front of house dining experience. The workflow for a delivery model is completely different. When you are operating a restaurant kitchen with two competing workflows, you end up compromising both. Kitchens in a restaurant are built to support table capacity. You now have a full set of tables and now additional demands on the workflow for which the kitchen was never designed. This forces food operators to compromise on both the dine-in and delivery experience. When workflows operate above 80% of their capacity, queueing theory says that the delays grow exponentially. A simple example of that is rush hour traffic. When the number of cars exceed 80% of the designed capacity of a road, the delays multiply. The same thing happens in a kitchen. So what does this have to do with real estate? The traditional bricks and mortar restaurants are located in the most expensive commercial retail real estate. A commercial kitchen can be located in the least expensive industrial space, lowering the operating cost of being in the food business dramatically. So how is Cloudkitchens capitalized? Well, they recently secured a $400 million dollar round of financing from the Saudi Royal family. You might be wondering why on earth would Cloudkitchens need that much money as a startup? The technology component of their offer wouldn’t cost more than a couple of million dollars to develop from a software perspective. Even the marketing might stretch into a few tens of millions, but not much beyond that. Well, it turns out that CloudKitchens is a real estate company that provides smart kitchens for delivery-only restaurants. They provide infrastructure and software that enables food operators to open delivery-only locations with minimal capital expenditure and time. They enable food operators to get into business within weeks instead of months or longer in the traditional restaurant model. I know of several investors in the retail space who have argued that retail investments are safe as long as you are focused on businesses that cannot be satisfied by Amazon or other cloud based businesses. You can’t get your hair cut online. I see that the CloudKitchens model has the potential to upend prepared food.

Today’s show is a continuation on the topic of demographics. Yesterday, we talked about the reduction in mobility that has taken place over the past decade. The least mobile group of people are those above 65 years of age. The move less frequently than any other group. But eventually they move, usually because they have to. Either due to health or because they die, one way or another, they will eventually move. A number of communities have been built around the country specializing in retirees as the target client. When Sun City, a suburb of Phoenix Arizona opened on January 1, 1960, it was billed as the original retirement community. It was the first of its kind in America. On the weekend Sun City opened, cars were backed up for 2 miles as some 100,000 visitors waited to gawk at a village built specifically for adults over the age of 50. But the same demographics that propelled Sun City’s rise now pose an existential risk to this suburb as baby boomers age. More than a third of Sun City’s homes are expected to turn over by 2027 as seniors die, move in with their children or migrate to assisted living facilities. The big question looming in this neighborhood—and dozens of others like it around the country—is what happens to everything from home prices and to the local economy when so many homes post ‘For Sale’ signs around the same time? The very same tidal wave of people expected to enter senior housing, whether it’s independent living, assisted living, or skilled nursing means that same wave of folks are exiting their homes. This second but related tidal wave of homes will be hitting the market on the scale of the housing bubble in the mid-2000s. This time it won’t be driven by overbuilding, easy credit or irrational exuberance, but by an inevitable fact of life: the passing of the baby boomer generation. It’s estimated that one in eight owner-occupied homes in the U.S., or roughly nine million residences, are set to hit the market over the next 10 years as the baby boomers start to die in larger numbers. That is up from roughly 7 million homes in the prior decade. By 2037, one quarter of the U.S. for-sale housing stock, or roughly 21 million homes will be vacated by seniors. That is more than twice the number of new properties built during a 10-year period that spanned the last housing bubble. Most of these excess homes will be concentrated in traditional retirement communities in Arizona and Florida or parts of the Rust Belt that have been losing population for decades. A more modest infusion of new housing is expected in pricey coastal regions of New York or San Francisco where younger Americans are still flocking in large numbers. The Gen Xers, as a generation are a smaller in numbers than the boomer generation and more financially precarious. They have different preferences, posing a new kind of test for the housing market. They don’t necessarily want to live in the same types of homes that their parents did. One problem is that the bulk of the supply won’t necessarily be in places where these new buyers want to live. Gen Xers and the younger millennials have shown thus far they would rather be in cities or suburbs in major metropolitan areas that offer strong Wi-Fi and plenty of shops and restaurants within walking distance In case you think I’m being overly alarmist, you just need to look to Japan to see the impact of demographics on the housing market. With the aging population, Japan now has 11 million vacant apartments across the nation. This was in a place where real estate was once in such demand that people were signing multi-generational loans in order to afford the property. As you make investments, you definitely want to look at demographics in your local market and fast forward a few years to make sure you’re going be in a good spot when the elderly exit the market.

On today’s show we’re talking about where your future tenants are going to come from. Last week the US Census Bureau published new data on migration across the US. It shows some new trends that are quite frankly a reversal of some long term historic trends. If you think back to the time of your grandparents or great grandparents, they probably grew up in the family homestead community and they married and started their own family in the same community, probably the same neighborhood. My father’s family lived in the same community on an island for nearly 400 years. They were displaced by the Second World War. Were it not for that, my father probably would have ended up taking over his father’s Pharmacy and continued the family business. As modern transportation increased and mobility became easier, so too did migration of people. Migration, that is the percentage of people who move their primary residence has been increasing generally with each passing decade. That is, until now. In the latest census report, we’re seeing a reversal of migration trends in the past decade since the start of the Great Recession. But I don’t think you can blame this on the Recession itself. Because even as the economic recovery has taken hold, migration has continued to decline steadily across the US. If you have a brand new vacant apartment ready for someone to rent, or a recently renovated property for sale, people have to be willing to move in order for you to rent your apartment, or buy your house. If the mobility in the population is declining, it stands to reason that there will be fewer people looking to move into your property. So let’s look at the data. The Census Bureau looked at a data set of 263M people over 15 years of age. Of those, 238M didn’t move in the past year and about 25M people did move. That’s about 10.5% of the population. That sounds like a lot. But it’s a significant decline compared with the previous decade when In 1985, nearly 20 percent of Americans had changed their residence within the preceding 12 months, but by 2018, fewer than ten percent had. That’s the lowest level since 1948, when the Census Bureau first started tracking mobility. The largest group of movers by age are in the range of 15 to 24 years of age where 17% of people in that age range moved in the past year. This makes sense. College choice is a big driver of that need to move. The older you get, the less people move. Only 4% of those over 65 years of age moved in the past year. 11% of those between 25 and 64 years of age moved. Your inclination to move also depends on where you live. The lowest mobility part of the US is the NE where less than 8% moved in the past year. 10.73% moved in the midwest and 11.2% moved in the South and the West. Income also seems to be a factor. Those with no income had one of the highest inclinations to move with 11.55% of those people moving. The lowest percentage of movers were those having incomes above $100,000 with only 8.5% of those people moving. Only 3.7% of the people who moved in 2018 came from outside the country. Of those coming from abroad, men were more likely to move than women, with men making up 3.9% of those who moved compared with 3.4% who were women. 81% of people who moved stayed within the same state and 15.5% of those who moved went to another state. So if you’re looking for new tenants and you can target your product offer or your marketing message, it pays to take a closer look at the demographic information in the census data.