The Real Estate Espresso Podcast

On today’s show we’re talking about the race to the bottom. You have to admit, it’s hard to compete with “free”. There are numerous examples of products and services that used to cost money, that all of a sudden are “free”. If you were in business relying upon service revenue and one of your competitors up-ends the market by offering your service for free, what are you to do? Are you out of business? Earlier this year, Luxembourg decided to make its public transit 100% free. Luxembourg City, the capital of the small country, suffers from some of the worst traffic congestion in the world. It is home to about 110,000 people, but a further 400,000 commute into the city to work. A study suggested that drivers in the capital spent an average of 33 hours in traffic jams in 2016. While the country as a whole has 600,000 inhabitants, nearly 200,000 people living in France, Belgium and Germany cross the border every day to work in Luxembourg. Annual revenue from fares – 41M Euros – covers less than 10% of the network’s 491M-Euro operating costs. When you consider how much labour and expense is spent collecting money, counting, sorting, enforcing payment, it actually made sense to eliminate the fares. But think about the impact to the other forms of transportation. If you’re a taxi driver in Luxembourg, you’re probably unhappy about the new free alternative. Will taxis go out of business? Probably not, but free doesn’t help bring more business. If you’re in the online dating business like match.com, e-harmony, tinder or bumble, you were probably unhappy to hear that Facebook was going to enter the market with a free offering. The service has been live in 20 countries for a while and is now live in the US over the past few weeks. The service aims to put a dent in the $2.5B dating market that is aimed at the 200 million Facebook users in North America who identify as single. In other news, Charles Schwab began offering commission-free online trading for U.S. stocks, exchange-traded funds and options on October 7. Previously, each trade cost investors $4.95. Commission fees are charged by a brokerage when you buy or sell a stock, ETF or other type of investment product. So far, one area that has been defended strongly from “free” services is real estate commissions. The standard model of 6% commissions being split half way between the buyer and the seller side hasn’t budged in a few decades, even though much of what a realtor does has changed significantly. Finally, specialty news services, Cable TV, and subscription radio are struggling to survive in the era of YouTube, online news sources like Business Insider, and of course the entire podcast movement. I’ve had several people who want to start a podcast ask me how to monetize a podcast. The simple answer is that you don’t monetize a podcast, at least not directly. So the question is, why would anyone provide something for free? Why would a broker provide free brokering? Why would Facebook provide a free platform? So why would someone host a podcast for free? In the case of the podcast, it’s a fair exchange. I provide you with something valuable each day for free. My message will connect with some of you and some of you will want to reach out to me and propose doing business together. That doesn’t mean that every one will be a match, but a subset could be and that’s enough for me.  Some people view free as a race to the bottom. Some free offerings are just click bait. I view free as an opportunity to engage in a conversation and develop a relationship that may turn into something more in the future.

Pam in New Orleans asks: Harry Dent recently published a view that says “The Biggest Stock Market Bubble In History Set To Crash.” What are your thoughts on what Harry has to say? Pam, this is a great question. Harry Dent is an economist who specializes in using demographics to predict economic behaviour. He is also known for having some controversial views. All controversy aside, I agree mostly with Harry Dent’s perspective that the market is going to face some significant headwinds. If you think about what drives up prices in the stock market, it’s more buyers than sellers. Buyers of stock are people who are in the workforce who put some money aside and invest some of those savings in the stock market, the bond market or in real estate. People who are of retirement age take their life savings out of the stock market and put them into more fixed income securities and use the income to fund their retirement. When you look at the number of people in the workforce compared with the number of people in retirement, we see an inversion. When the baby boomers were all in the workforce, they were saving for retirement and investing in the stock market. With about half of the baby boomers now retired, and the remainder to retire over the next decade, that large generation will be pulling money out of retirement accounts and out of the stock market for the next 30 years. The generation of people who came behind the baby boomers, the so-called Generation X is a much smaller population who are still in the workforce. All other things being equal, we’ve gone from a period where there were more investors in the stock market to a period where there are now more people withdrawing form the stock market. All other things being equal, this redemption of funds form the stock market is putting downward pressure on the stock market. It’s hard to see that right now because we’ve just gone through a few years of asset price inflation in the stock market. The valuations we are seeing in the market don’t make sense on a fundamentals basis. We’ve seen insane valuations being attached to companies that are losing money. The examples are rampant from WeWork to Uber, Lyft, Tesla and Netflix. The valuation multiples being attached to these companies are decidedly in bubble territory. So at some point, when the markets wake up and sanity prevails, we can expect to see a dramatic drop in stock prices. I think we’re starting to see the tip of that iceberg with the failed IPO of WeWork. So when will this happen? I’m not sure about the timing. The difficult thing to predict is how much longer governments can inflate the bubble by printing more money. These hits of heroin (cash) being injected into the economy do have a stimulative effect (less and less), and they definitely inflate asset prices. The patient is now resistant to the drug. That’s why negative interest rates in Europe for over a decade have done nothing to stimulate the economy there. You want to get your money into assets that are an effective hedge and you want to do it before the precipitous fall in prices. Harry also predicted a precipitous fall in real estate prices. When he says that, I believe he is talking about residential real estate. There is no question that demand for 5 bedroom houses in the suburbs is falling. Demographics says that the demand isn’t there at those price points. So we will definitely see homes at the top end of the market fall in price, even as homes at the bottom end of the market increase in price. He did say that cash flow positive real estate is a good hedge (I agree). He said long bonds are a good hedge, but I don’t agree. Paper assets get devalued too much over the long haul. Savings get wiped out. Debt gets wiped out, and people on fixed income get wiped out. A destruction of wealth in the stock market will make less equity available for investment. 

On today’s show we’re coming to you live from Annapolis Maryland. Annapolis is the capital of the state of Maryland. It’s also the home of the US Naval Academy. This is where the US Navy trains its officers. It’s also home to the world’s largest in the water boat show. It’s an important town because it is a state capital. But it is a small town. Total population is only 39,000. It’s small because it is geographically constrained. On today’s show we’re going to do a small walking tour of Annapolis from a real estate perspective. This town is decidedly anti development. It’s a vey quaint seaside town with historic homes set on narrow streets with cobblestone sidewalks. Many of the narrow century old townhouses have a flag pole jutting out from the side of the house. You won’t have to go very far to be reminded which country you are in. Most of the streets are one way streets and many of them are dead end streets. They’re dead end streets because in Annapolis it’s common to run out of land and come across the Chesapeake Bay. The many inlets, rivers and coves make for a very intimate and extensive coastline. Many of the waterfront homes have a boat docked in front. The idyllic setting is one of the most picturesque coastal towns in all of North America. Real Estate is expensive here. Waterfront homes are priced usually between $2-3M. Development in Annapolis is difficult because any development that falls within what is called a critical area must be sent to the State of Maryland Critical Area Commission for the Chesapeake and Atlantic Coastal Bays prior to receiving local zoning approval, or a building permit. Generally speaking any property within 1000 feet of a waterway falls into the critical area overlay. In this zone, a whole bunch of extra rules come into play. Most of these rules are designed to protect the sensitive waterways of the Chesapeake and coastal regions. For example, there are vegetation requirements. There are restrictions on waste transfer. You are unlikely to get a septic system approved on a property in the critical area overlay. This is not an easy town to be a real estate investor. We saw an old townhouse in very poor condition. It had a public notice posted in the front window. The owner of the home was seeking to make improvements including new siding, new windows, and a small addition in the rear yard. The entire process had been opened up to public review. That home, is directly across the street from the courthouse and has been in distressed condition waiting for the application process to complete. A review of commercial listings in Annapolis shows only a single 5 unit building for sale. The next closest listing is a commercial property for sale in neighbouring Parole which is one exit away on the freeway. Annapolis is a difficult place to get anything approved. Residents are decidedly anti-development. This is why you see very few new structures in the town at all. Older structures are governed by the Annapolis Historic Preservation Commission which has final say on any changes to properties within the historic district. For example, the Annapolis Waterfront hotel recently wanted to update the Awnings, fence and landscaping. This too had go in front of the Historic Preservation Commission for comments and approval. We’re not even talking about any permanent structures. We’re talking about awnings, fence and landscaping. As you think about undertaking projects, pay close attention to the rules in your municipality.

Joe Quirk is President of the SeaSteading Institute. On today's show we're getting an update on the advancement of the technology of life on the high seas. Listen to this fascinating conversation.

Peter Conti is the author of "Commercial Real Estate For Dummies" and lives with his family in Annapolis Maryland. Six years ago, he survived a devastating motorcycle injury. As part of his rehabilitation, he walked the entire Appalachian trail from Georgia to Maine. Listen to this fascinating conversation with Peter Conti.

On today’s show we’re talking about another of the many distortions that exist in our world. I’ve been to Greece many times. I love the food. I love the weather. I love the islands, and the rich ancient history. My father was born on the island of Rhodes and he was born in a home inside the old walled city in Rhodes. The fortifications date back to the time of the Knights Hospitaler and were built in the 1300’s. My fathers house was built in the 1400’s. Prior to 1910 the island was under Turkish occupation. Then from 1910 until the end of the second world war it was under Italian occupation, before finally being returned to Greece after the war. I love going to Greece. But Greece is a chaotic place. The culture in Greece is one of rebellion. It’s common for traffic violations to happen directly in front of police officers with zero consequence. Greece also struggles to have strong enforcement of tax collection. The underground economy is alive and well. Not surprisingly, Greece is also mired in debt. One sovereign debt crisis after another has befallen the country. The country has struggled to pay its bills. The solution? Each and every time, its creditors have loaned it more money even though it was obvious that they didn’t have the political will to implement the austerity required to improve their balance sheet. But since a default was too distasteful for the creditors, it was easier to loan them more money and kick the can down the road. By the time the next crisis hits, hopefully the decision makers at the bank will be retired and it’s no longer their problem. This week, Greece entered the Negative Club. What is the negative club you ask? Greece sold debt offering less than 0% for the first time on Wednesday in the latest sign of how far investors will go in a hunt for returns amid a global slump in yields. The Greek government issued €487.5 million ($535.31 million) of three-month debt at a yield of minus-0.02%. At a previous auction for bills with similar maturity on Aug. 7, the rate was 0.095%. The move reflects a broader shift in European bond markets in recent years, with investors paying governments from Germany and Switzerland to Italy to hold their money as the European Central Bank cuts borrowing costs to bolster economic growth in the region. That also means investors are being forced to take on more risk to generate returns, with Greece long considered the final frontier. The nation, which emerged in August 2018 from an eight-year international bailout program following a prolonged debt crisis, has been welcomed back into the bond market with strong demand for its debt.  While the Greek government so far has issued only very short-term debt at a negative yield, other European governments are borrowing through longer-dated debt that pays no interest. Germany, for example, sold 30-year debt at a negative yield for the first time in August. The yield on the government debt has tracked improvements in the Greek economy, suggesting that debt holders are “not as worried" they’re going to lose money as they were in the past. So the question is would you be willing to lend money to the Greek Government for 90 days and make the bet that they won’t default in the next 90 days? But more importantly, would you be willing to lend money to the Greek Government at negative interest rates, even if it's for only 90 days? Perhaps purchasing a 90 day bond from the Bank of Canada at 1.75% would be a better bet. I know, I know, you would face costs associated with the foreign exchange that would negate any earnings. Europe is a family. Within every family, not all members are an equal credit risk. The very idea of lending money to my cousin who has a spending problem because I don’t know what else to do with my money seems a little crazy.

The idea behind today's episode came to me from one of our listeners. Hayden in Atlanta share some details on the topic of today's show. So thank you to Hayden for keeping your eyes open to what's happening in the marketplace. The latest of these is a new company called Why Hotel. Apartment developers often have a number of vacant units upon completion of the building. The developer ultimately wants to sell these as soon as possible. But these vacant units are costing them money each and every day. The developers are not in the nightly property management business. They don't want to put tenants into vacant units they intend to sell. They certainly don't want to be in the hotel business. It is far too labor-intensive. The folks at Why Hotel will partner with a developer to take a percentage of their vacant units and make them available in the short term rental market. Why hotel manages the furnishing of the units. They handle the nightly rentals, and they handle the day to day cleaning and management of the customer experience. The value proposition to the end customer is it that they get to stay in a brand-new luxury building with modern amenities. By establishing a brand and setting a high standard for quality of finishes, they address the very common customer objection over the wide variation of accommodation quality that you find on platforms like AirBnB and VRBO. Why Hotel solves a problem for the developer, by giving them a stream of income during a period where they have vacancy and holding costs. They solve a problem for the end customer by delivering a high quality finished product. So far the company has locations in Seattle Washington and Arlington Virginia. They have a third location schedule to open shortly in Virginia as well. So far why hotel is a small player. But it is a unique and innovative business model. The folks at Why Hotel are obviously making a capital investment in the furniture and fittings. The developer is contributing to vacant units on their side of the deal. The profits get split between the developer and why Hotel according to a formula that is negotiated between the two parties. The first property opened in the Inner Harbor area of Baltimore, the result of a partnership with Monument Realty for 158 of the building’s units. The 347-unit property offers a custom mural, apartments with private balconies, an outdoor rooftop pool, a rooftop lounge, game room, theater room, 5,000-sq.-ft. fitness center, and business center. Today, that property is no longer part of the hotel portfolio and has been fully leased. One of the criticisms of short term rentals is the increased traffic of hotel guests mixing in with permanent residents. Residents often raise concerns about security. Why hotel has full-time staff on site, just like a regular hotel. But these pop-up hotels also offer an additional benefit to residents. Permanent tenants of the building can have access to the hotel cleaning staff services at very reduced and competitive rates. If you have a building that is going to be leasing 20 or 30 units a month, the developer can be secure in reserving a portion of that inventory for a pop-up hotel. While each pop-up is expected to typically last between eight and 16 months, the company expects to remain active in a single market over a sustained period of time in multiple properties. On the podcast, we keep our eyes and ears open to innovative ideas. Again this one came to us from Hayden in Atlanta. Thank you Hayden. Perhaps this gives you ideas on other ways you can create a master lease agreement with an under-utilized asset to solve a business problem.

Governments all over the world have resorted to FIAT currencies that are no longer tied to the value of a hard asset. The word FIAT comes from Latin and simply means “by decree”. The fact is, both gold and silver have been money for centuries. It’s only in the last 50 years that the US stopped using Gold and Silver as the basis for money. For a while, it was illegal for US citizens to hold gold. There was a shortage of gold to fund the war effort around the second world war and the US government didn’t want to be competing with private citizens for access to gold reserves. Fortunately that ban was lifted and we can all buy gold coins or bullion. So what is gold worth today? It’s a little like asking how fast you’re going? It all depends on your point of reference. You might be standing perfectly still right now. But the earth is spinning on its axis and if you were standing on the equator, you would be traveling at a speed of roughly 1,000 miles per hour. But wait, the planet itself is rotating around the sun once a year. Maybe you’re really traveling at a much faster rate of 30 km per second or about 67,000 miles per hour. You get the idea. So what is the value of gold? It depends on your point of reference. Is the measure of value in US dollars, in Euros, in Chinese Remnimbi? Maybe when the price of gold is going up, it’s really the value of the currency that is going down. Perhaps you should be measuring your net worth not in dollars, but in ounces of gold? Why is it that both China and Russia are amassing gold at furious rate? In fact, China is growing its gold reserves at a rate that is equivalent to the annual global mining volume. Whatever gold is being pulled out of the ground today, China is buying virtually all of it. I know of a few contractors who have been working in the oil field in Saudi Arabia. They get their pay check in gold bars. So today the price of gold, as measured in US dollars has gone up by nearly 20% in just the past couple of months. Is that a reflection of the weakening of the global economies and an anticipation that governments will start printing more money again as the economies show signs of weakness? So why does the price of gold as measured in US dollars fluctuate so wildly? Should the price of gold not be more stable? In the end, gold is a hard asset with intrinsic value. It’s value should be very stable over time. It’s one of those references. So are other hard assets. That 11 unit apartment building we built last year will not change in value from week to week based on whether the President sent a controversial message on twitter or not. It’s still the same 11 unit building where a two bedroom apartment rents for $1,650 per month. It will be worth about the same in a year, plus a little bit of appraised value growth as our currency devalues. The rents will increase a bit, so will the expenses. In 10 years, it will still be the same 11 unit building, generating strong income and cash flow each and every month. We tend to think of our net worth in dollars. But what if we thought of our net worth in apartments, or in ounces of gold? What if we measured our net worth in acres of agricultural land, or number of beds of dementia care in assisted living? Each one of these offers a hard intrinsic value based on the underlying physical assets and value to the marketplace. The benefit of holding a hard asset is that devaluation of the currency has three effects. It wipes out purchasing power for those on fixed income. It wipes out savings, and it wipes out debt. You don’t typically borrow money at low interest rates to buy gold, although I suppose you could. It wouldn’t be terribly responsible because gold doesn’t generate positive cash flow.  But real estate can carry the debt service plus a bit and provides a highly effecting hedge on inflation.

On today’s show we’re talking about how to measure the financial merit of an investment. How do you compare two investments that pay the investor according to differing formulas? Some investments pay greater cash flow. Others have more aggressive loan principal pay down schedules. Others still are creating equity through forced appreciation. We’re not going to even touch the topic of risk, since that’s an entirely other subject. So how do you compare these dissimilar investments? Yesterday we talked about the equity multiple as a metric for evaluating the merits of an investment. It’s a simple metric to calculate and involves adding up all the cash flow from an investment and dividing by the initial investment. It has the major drawback that it neglects time. Getting a 3x equity multiple in one year is clearly a better investment than one that takes 50 years to achieve a 3x multiple. Perhaps a rate of return calculation would be more meaningful. But here too, there are multiple calculations that you can perform. The most comprehensive is the internal rate of return. The simplest investment to understand is a fixed income security. Think of a certificate of deposit with your bank. You put in $100. A year later the bank allows you to redeem the certificate and you get $103 back. The annualized rate of return is a simple 3%. The math to calculate the rate of return for that simple cash flow is about as simple as it gets. But if you have a real estate investment that is appreciating 2% per year, with 4:1 bank leverage, paying out a 5% preferred return, and has a one-time forced appreciation of 30% in value in year 2 of the investment which you predict to hold for 5 years. What’s the rate of return now? If your head is spinning, you’re probably not alone. Enter the Internal Rate of return metric. Calculating the internal rate of return involves quite a bit of complex math. It’s a time value of money calculation for a stream of cash flows over the life of the investment. Payments happening now are considered to be worth more than payments in the future. For the pure mathematicians in the audience, I’m not going to go into all the math that the internal rate of return calculation entails, nor the related net present value calculation. I can assure I’ve done all those calculations many times as part of my engineering degree. Fortunately, most spreadsheet programs including Google Sheets, Microsoft Excel, and Apple Numbers have a built in function that calculates the internal rate of return without requiring you to do a ton of math. The IRR function assumes that you have a stream of cash flows that occur on a regular schedule. So for example if you expect regular monthly payments from a project, the IRR function can handle that with no problem. The payment amount can vary each month, and as long as the time element remains regular. If you have a month with zero cash flow, that’s no problem. If you have a month of negative cash flow, that’s no problem. If you have a large lump sum payment upon the sale of an asset or a cash distribution in the middle as the result of a refinance, that’s no problem. The IRR function is one of the most powerful tools for measuring financial rates of return. In order to assist in that process, I’ve created a simple Excel tutorial which you can get for free. Simply send me an email to victor@victorjm.com with the word IRR, just three letters in the subject line. I’ll send you a copy of the Excel file and a short two minute youtube video that walks you through the Excel file.

I often have both investors and consulting clients ask me about various metrics contained in the executive summaries we prepare. In order to maximize the benefits, investors need to know how to effectively compare opportunities. That’s often easier said than done, because the entire concept of valuation is often highly subjective. So while it’s certainly possible to gauge the potential returns, security and performance of any given property, investors need to know how to use the right tools to do so. A lot of investors use the cap rate as a measure of the attractiveness of an opportunity. But the cap rate really only talks about the profit potential for a project, independent of how you might finance a project. Clearly the operating performance of an apartment complex at a 7% cap rate is not going to depend on the financing. But the rate of return to the investor will depend heavily on the financing structure. If we’re paying a 9% interest rate for debt versus a 4% interest rate, it makes a big difference. In order to capture that, we use two metrics. The Internal Rate of Return is the most often used metric. On today’s show we’re focusing on the equity multiple. In fact, along with Internal Rate of Return, we believe equity multiple is one of the most effective ways to compare the attractiveness of specific real estate investments. Here is what you need to know in order to effectively use this metric. Equity multiple is a metric that calculates the expected or achieved total return on an initial investment. It’s calculated by dividing the total dollars received by the total dollars invested. Equity multiple is an easy comparison tool because it provides a quick glimpse into the total profit investors can expect to earn on a particular investment, if successful. However, while equity multiple is important when analyzing deals, it is by no means a one-size-fits-all solution because it ignores one critical factor — time. To thoroughly evaluate a potential investment, investors should pair equity multiple with other industry metrics — particularly the Internal Rate of Return (IRR).