The Real Estate Espresso Podcast

Yes, today is my birthday and I’ve been thinking about what I might like for my birthday. We’re coming to you live on location in France.  If you’ve been wondering where you might want to retire, living the dream of owning a large, spectacular and historic building in many countries can often be somewhat difficult to realise. Not so, in France. Many people thinking about retirement consider selling the suburban home and finding a place in the warm south where they don’t have to shovel snow or deal with the impersonal nature of most big cities.  Almost every region om France has its share of imposing tower-topped chateaux dominating the landscape.  French chateaux for sale encompass all states of preservation. From windowless shells requiring total renovation, to those requiring light decoration, to immaculate 19th century bourgeois stately homes, the amount you will need to spend will depend on how much work you are willing to undertake. Being large properties, renovations can be very costly and time-consuming but need not be outside the budget of most serious buyers if planned correctly. Typically, to arrive at a habitable building you will need to spend around a total of around 500,000 Euros, whether you opt to renovate or buy an already renovated example.  That’s really quite a bargain if you think about it.  If your taste goes toward a little grander property, there is a lovely 33 bedroom chateau in the Aquitaine region of France that is currently operating as a 3 star hotel and restaurant business. It’s currently for sale for the relatively low price of 5.7M. It sits on a total of 49 acres, and the buildings have about 40,000 square feet of living space. A property like this, properly marketed could be the perfect venue for destination weddings.  If you’re on a bit of a budget, then perhaps the 8 bedroom chateau located just 35 minutes from Toulouse in the South of France might be more your style. It has 9,000 square feet of living space and is located on 43 acres of land.  If you want to keep things below $1M, then perhaps you would be interested in an 11 bedroom chateau in the Burgundy region of France, just near a town called Nevers just 2 hours from Paris and currently used as a home and full chateau rental business, this property is being sold fully furnished and would offer a great family home or an investment business currently generating 5,000 Euros per week as a full chateau rental, would also be an ideal luxury and themed bed and breakfast business.  If that’s too rich for you, then perhaps you might consider an 11 bedroom, 7 bath manor house in the Pyrenees Atlantique region. This is close to the Basque region which means you are close to skiing, and not far from Spain. You have the coast and the mountains all within a very short drive.  So I’m thinking about what I might like for my birthday. I can’t wait to see what my wife has bought me. 

Mike Lloyd is a specialist in business branding based in Silicon Valley. He started his career as a photographer and has translated that skill into having a broader impact. 

The changing face of retail means that retailers don’t need as large a footprint as before. As more and more business shifts online, delivery is often cheaper than prime real estate.  But secure delivery is still one of the friction points that is affecting the adoption of e-commerce in a lot of cases. The reports of stolen amazon packages from door-steps has caused some customers to avoid ordering items online. The solution? The Amazon locker. This is a locker bank like you might find at a train station for storing your luggage. But the boxes are generally much smaller. There are some boxes in the bank of lockers for large parcels, and a whole bunch of boxes for small parcels.  This past week, I saw a bank of these lockers in every major train station in Paris. These train stations are also major subway stops. So those who are on their way home can stop and pick up a package on their way home with complete confidence that their package has been securely delivered with no risk of theft, or problems with getting past building security.  Success in business is all about removing friction. My 94 year old aunt orders her groceries over the internet and they come delivered to her home.  This past week in Paris I used many of the hundreds of electric bikes and scooters that litter the city and can be picked up for 1 Euro plus 15 cents per minute. They travel 20 km per hour and you can use the bike lanes, and the bus lanes, even on a one way street. I was able to make multiple stops on my trips, something that would have been more difficult in a taxi or on the subway. In total, I spent less than a taxi and I had the flexibility of going where I wanted, when I wanted, without the investment or responsibility of owning a bike or scooter. It’s all about removing friction.   So these lockers solve a problem. They remove friction. They make receiving a parcel from Amazon easier than ever before. Amazon has even started putting lockers in Whole Foods stores which it now owns.  So why does this matter to a real estate audience? If you live in NYC, chances are that the door-man in your building will accept an Amazon order for you and keep it secure until you get home. But that’s a feature that’s unique to luxury buildings in major cities like NY. If you live in most other cities, the parcel will be left on your doorstep or in the lobby of your building. Hundreds or thousands of people could pass in front of your package before you lay hands on it. The problem is so common that there is a new term for it. If you are a victim of a stolen package, then a porch pirate was to blame. That’s right a porch pirate.  As more and more commerce shifts to online, the problem of package theft has been growing.  Business is all about solving problems. So the question is, could you as a real estate investor, solve a problem for your tenants, or perhaps solve a problem for Amazon? What if you own a multi-family apartment complex. Could you add a secure package drop off so that your tenants would be confident their parcels don’t go missing? If you have property across from a major public transit stop, would it make sense to rent a few square feet of space to Amazon so they can install a bank of lockers? If you own a drug store that also has a post office kiosk, would it make sense to rent a few square feet to Amazon? The purpose of today’s episode is to get you thinking, to get you to see opportunities that were not obvious before today. What if you have a store front in a strip mall that gets a lot of traffic, but for whatever reason that store front just isn’t renting.

All the major financial newspapers from the Wall Street Journal to The Financial Times are sounding the alarm bell on economic contraction at the moment. On today’s show we’re going to take a deeper look at what the numbers are telling us and see what it means for us as real estate investors.  Economic cycles are the result of expansion of supply capacity and building of inventory ahead of demand. That’s the general cause. These types of cycles happen in everything from semiconductors to automotive to housing. Suppliers expand their capacity and output in response to rising demand during an economic boom. All the suppliers do this at once hoping to gain market share during the expansion. But once that demand gets satisfied, there is excess capacity in the market and often excess inventory. But it takes a while for the suppliers to notice the excess supply. By the time they notice, it’s usually a problem. Inventories have grown to unsafe levels and businesses slam on the brakes to protect the very survival of the business. The latest news out of Europe is that Germany’s economy contracted by 0.1% in the second quarter and narrowly missed a contraction in the first quarter. Germany is the largest economy in Europe and is responsible for nearly 50% of the exports of all of Europe. There are 27 other countries and then there’s Germany. While this contraction isn’t huge. It’s barely a contraction at all, much of Germany’s output is export based, particularly in the automotive business. If we focus on manufacturing, Germany’s industrial output dropped 1.5 percent in June and is now down 5.2 percent year-on-year. This is a big shift. Investors hate uncertainty. At the moment we’ve got plenty. The outcome of the trade negotiations between China and the US is far from known. We have the possibility of a no-deal Brexit less than 90 days away. The implications of a no-deal Brexit on the economies of the UK and the rest of Europe are hard to determine.  Europe’s economy is highly dependent on exports. A global trade war could have a major impact on the European economy. Europe has twice the population of the USA and it’s economy is of a similar size to the US.  I know that very little of what is happening in the trade dispute is affecting my business directly. The only significant impact has been on the price of steel which has jumped 25% in the past year. But structural steel only makes up a small fraction of our construction costs. The net result is an increase in prices of less than 1% on our overall project costs. This is happening at a time when the market overall has seen strong rent growth, averaging 5.1% in the past year as reported recently by Freddie Mac.  The bigger question is what will happen in the broader economy. Will we start to see businesses contracting their investments? Will we start to see workforce reductions like we have seen in past economic downturns? For the moment, we continue to see what might be a soft landing. We are not seeing the kind of overheated market conditions in 2007 with bloated inventories across the board.  In select real estate markets like the SF Bay Area and San Diego we are now seeing a slowdown in foreign investment, and a slowdown in construction activity.  As real estate investors we need to pay attention to what’s happening in your local market in order to make sound investment decisions. From the news this week, we’re not making any changes and holding to our plans.

On today’s show we’re talking about a new report from Freddie Mac on the state of the multi-family market nationwide. But the purpose of today’s show isn’t just to share information. It’s about what you do with the information.  When you prepare a financial pro-forma for investors and lenders, the numbers you choose for that financial model should not be arbitrary. They should be based on widely accepted principles and practices. For example, no financial model should assume zero vacancy when the market vacancy is in fact much higher. Which number should you choose? Do you arbitrarily choose 10%, 5%, 8%. How do you justify your choice of that vacancy factor? On today’s show Freddie Mac’s economics team has issued some guidance that could be particularly useful in forecasting and modelling. The first thing we see is that despite the recent surge in new construction, there continues to be a modest shortage of housing on a national basis as household demand outpaces total supply.  We all know that national numbers are meaningless because real estate is a hyper local business. Within the average there can be a shortage in one market and a surplus in another. But still, on a national basis the folks at Freddie Mac are seeing continued demand. Total housing completions over the past three years have averaged 1.1 million housing units each year. During that same time, total households have increased on average 1.4 million each year. The second noteworthy item in their report was rent growth and occupancy. The federal government has been telling us that inflation is low, worryingly low in fact. But Freddie Mac is stating clearly that rents grew an average of 5.1% in 2018 and vacancy rates closed the year at 4.8%.  It is interesting to note that housing makes about about 40% of the consumer price index in most markets. The government Bureau of Labor and Statistics reported that inflation was 2.44% for 2018. But if rents increased by 5.1% and housing makes up 40% of the CPI, then what they’re saying is that the only thing that went up in price in 2018 was rent. Everything else remained flat. Something isn’t adding for me.  But here’s the thing that I found interesting in the report. Freddie is reporting that rent growth will remain healthy but at more modest levels compared with the robust growth seen in 2018. They are expecting rent growth of around 4% in 2019 and 3.6% in 2020.   Now here’s where things get interesting for me. When I’m modelling the rent growth for a project, I typically use a very conservative number, typically the rate of inflation. So if the CPI is 2%, I model 2% rent growth year over year for, say, a 10 year hold period of a project.  But now we have Freddie Mac clearly saying that rent growth was 5.1% in 2018, and will be 4% in 2019 and 3.6% in 2020. All those numbers are a long way from 2% that has been the conventional wisdom for a number of years.  Now the Freddie report did have some local data that I think is quite useful. They provided a forecast for local market vacancies and new construction starts for 47 markets. This gives a rough graphical view of whether vacancies will be trending upwards or downwards in a given market.  They also gave a view of rent growth compared with historical averages for those same 47 markets.  So what should you use when you model rent growth for the next few years? Should you use 2%, like the conventional wisdom? Should you use the Freddie Mac numbers averaged at, say 4%, and back up your assertion with the Freddie Mac report? The difference in valuation for a project between a 2% rental growth rate and 4% is dramatic.

Julien in Cambridge Mass asks, "Should I get a real estate appraisal or a comparative market analysis?" Julien, that’s a great question.  The simple answer is it depends on what you need it for. A comparable market analysis, or what is sometimes called a broker opinion of value is a quick and simple approximation of the market value of a property. However, it’s not of high enough quality for some purposes. Nor will it give you an accurate enough answer in all cases. Let’s look at the different types of appraisals that can be ordered. Depending on how you constrain the appraisal, you can get a dramatically different result. So it’s important to understand the details of what you are getting.  Generally speaking, appraisers determine the value of a property using one of three methods. Replacement Cost Comaparable Sales Multiples of net income The problem exists when the three methods don’t agree, which of the three do you select? Generally, the appraiser will choose the lowest of the three. But here too they need to apply judgement and discard the one that doesn’t apply.  The biggest problem in particular for commercial real estate is that in many cases there are no truly comparable properties in the same area. In those cases, a like for like comparison is truly impossible.  If your property is a 10 unit building, there may not be any other 10 unit buildings in the area. There might a 12 unit, a 16 unit, a 20 unit. So what do you compare? Do you compare price per unit? Do you compare price per square foot? Are the properties truly comparable meaning are they of a similar vintage with similar levels of finish and attracting a similar tenant base? If not, then they’re not true comps.  The appraiser will then look at replacement cost. They will look at the finishes of the building, and make a cost per square foot estimate construct the a new version of the same building today. Often times, buildings are trading below construction cost because they might have been built some number of years ago and the increase in value has not kept pace with the rising cost of new construction.  Finally, the third method is multiples of net income. This is where a property is valued on its ability to generate profit. That is, after all why we real estate investors are in this business altogether. The appraiser will look at what, say, B class apartment buildings are trading for in the area. It might be 6.5% cap rate. They will then analyze the financials for your building and determine the income and the expenses for the property based on a bank approved model for properties in the local area.  But here is where things get tricky. Not all appraisals are created equal. They’re not equal if they serve different purposes.  Imagine if a bank asks for an appraisal to value a property under fire sale conditions. What would this property sell for if the bank had to dump it and get its money in under 30 days? That would be a very different result than if the bank asked the appraiser to allow it to list for 6 months.  Sometimes the appraisal is to justify the purchase price for a lender who is about to lend against a property. In that case, the buyer may have got a real bargain. But the appraiser will likely list the purchase price as the appraised value even if the market value was higher than the purchase price. Why would they do that? You guessed it, the client for the appraisal was the bank, and that’s what the bank instructed the appraiser to do.  By now you’re probably getting the idea that the process of determining value is somewhat fluid. If that’s your conclusion, you’d be correct. 

Farhana asks, “Given the real estate prices in big cities are skyrocketing, which small city would consider investing?” Farhana, this is a great question. But before I answer the question directly, let’s ask another question. “Why would prices be skyrocketing?” The housing market is a free market. That is to say, prices are subject to the laws of supply and demand. Excess demand and prices rise. Excess supply and prices fall.  Furthermore, Is it actually true that prices are skyrocketing? First of all, Real estate is a business like any other business. That means that its about solving problems that real people have, that they’re willing to spend money to have solved. If housing is scarce and people have high paying jobs, then the price of housing gets bid up. You want to be able to solve those problems.  When cities are generating new jobs, once the unemployment is absorbed, new housing is needed. The tightest market for housing in the nation is the SF bay area. In the past couple of years that area has generated 3.5 jobs for every unit of housing created. This has resulted in longer commute times and even greater demand for housing in San Francisco itself. So are these markets skyrocketing? Well, they were for a while. Today, the price growth in a lot of these hot markets has levelled off and in some cases we are starting to see prices dip a little. But the fact remains, these markets are expensive. If your goal is to be a buy and hold investor, I would not recommend San Francisco, just to pick an example of an expensive market because the numbers don’t work. The underlying assumption in your question, is that expensive markets don’t work from a rate of return perspective. You have to spend too much money to acquire a property compared with the rent you can get in the market. It comes down to the ratio of net income to your total investment. In other words the capitalization rate.  So the question then becomes which markets make sense?

Today's show is recorded live in front of Notre Dame Cathedral which suffered a devastating fire back in April. Check it out. 

Several listeners have asked me what it's like living on board a boat. Today I'm taking you on a mini tour of the boat and what it's like living aboard.

On today’s show we’re talking about one of the other impacts of the 2008 recession. A decade later we are seeing a significant difference between the number of single family homes being built versus multi-family.  Multi-family is growing in share of new permits across the nation. But in select markets that already had a substantial footprint of multi-family, that growth has accelerated. So let’s go back to 2008. As the national housing market collapsed amidst the subprime mortgage crisis, new construction ground to a halt, with building permit issuance bottoming out at the lowest level ever recorded in 2009. At the peak, there were nearly 1.7M single family homes permitted in 2005. By 2011, that number had dropped to 418,000. If you were working in single family home construction 75% of the nation’s business evaporated. No surprise there were many business failures in that industry.  In the recovery years that followed, multi-family housing construction rebounded fairly quickly, driven by a trend toward urbanization that increased demand for housing in and around city centers. The number of multi-family units permitted surpassed its pre-recession peak in 2015 and has since maintained that pace. In a balanced market, a new housing unit should be built for every two new jobs that the economy adds. Markets that add more than two jobs-per-permit are considered to be undersupplied.  In Philadelphia, pre melt-down, the city was permitting about 15% of all units in the multi-family category. In the past decade, more than 45% of all units are multi-family. That statistic mirrors what I’m seeing on the ground in Philadelphia as well. Philly is one of the few coastal markets that is actually balanced. The job growth and housing growth have been pretty well balanced.  Since 2008, the San Francisco Bay Area has added 3.45 jobs for every new housing unit permitted, more than any other large metro in the nation. Furthermore, when we zoom in to the county level, we find that this housing is not being built in the same locations where jobs are being created. In fact, many smaller metros throughout the country are actually building more new housing than needed based on local job growth. As the knowledge jobs of the modern economy cluster in a shrinking set of “superstar cities,” job growth has lagged in many other parts of the country. In these regions, it seems that struggles with housing affordability may have more to do with household income than with housing supply.  Even some major cities like Dallas, Charlotte, and Atlanta and Phoenix are adding enough units according to employment metrics. This analysis of course neglects migration due to retirement.  Pay close attention to permit activity. That will give you visibility of the market conditions 2-3 years from now when those units are in the market.