The Real Estate Espresso Podcast

On today’s show we are going to reveal information that could dramatically alter your rental marketing. This is all about knowing your customer. You wouldn’t advertise pencils to someone searching for a fountain pen. If you know what your customer is looking for, connecting them with the right product is relatively easy. Sending the right message to the customer who is looking for what you have to offer has a 36 times greater chance of success than blind random advertising. The vast majority of paper flyers that come in the mail at my house are wasted. They’re all promoting things that I’m not interested in. And if there was something of interest, it’s so buried in the noise of things I’m not interested in, I’m not willing to go through the effort to check and see if its there. Website Apartment List recently published something called the Renter Migration Report. This report analyzes millions of searches to see where users are preparing to move. So why does that matter? If you have apartments for rent, and you are competing with all the other apartments in the market for attention from prospective tenants, you are stuck in the sea of sameness. You are in the same pond as everybody else. But what if you knew that for whatever reason, 7% of people moving to your city are coming from New york, and 5% are coming from Washington, and a similar number from Miami, that’s useful information. How is it useful you might ask? In today’s world of digital advertising, users compete for ad placement with the search engines, whether it’s with Google, Yahoo, Facebook, or Bing. All these search engines treat the process like an auction.  Now imagine if you were, say, in Atlanta and you are competing for ad placement for apartments for rent. You would pay a lot to have that keyword search present your advertisement. In the world of pay per click advertising, you bid for each keyword that you want to present an ad for. Let’s say for example your keywords are Atlanta Apartments for Rent. You select your audience to be people in the Atlanta and surrounding area. You usually exclude everywhere else. There’s no reason for people in the Philippines, Russia or in India to be presented with an advertisement for Atlanta Apartments for Rent. It doesn’t make any sense and it would be a waste of money. Conventional wisdom is to exclude those advertisements from outside the local geography.  In the Atlanta area, there are hundreds or even thousands competing locally for those precious keywords.  But if you knew that 7% of the people moving into Atlanta came from New York, then it would make sense to present an advertisement to New Yorkers for Atlanta Apartments for Rent, when that search term appears. Instead of paying a really high price for those keywords, you would pay mere pennies per click. Why because there aren’t a lot of people bidding for those keywords in the New York market. New Yorkers expect to see ads for other New York apartments for rent, not Atlanta. There’s very little competition for those Atlanta keywords in New York, so they are very inexpensive.  You can use this information to better optimize your ad campaigns.  Advertising that is targeted at a specific customer is always more effective than random ads that don’t speak to a specific individual.  You wouldn’t present an ad to locals from Atlanta that says “Escape the snow” in this beautiful swimming pool. But it makes complete sense to present that to a New Yorker looking to relocate to Atlanta. 

On today’s show we’re talking about what to do when subcontractors are too busy. The front end of a project contains the most uncertainty. This is when you are perpetually in waiting mode. Waiting for engineering drawings, waiting for permits, waiting for lenders, waiting for inspectors, waiting for quotes, waiting, waiting, waiting.  The process that was supposed to take only a few months. Just when you think everything is ready, one of your chosen subcontractors says that they’ve taken other work and can’t do your job after all.  What are your options? Accept a higher priced bid? Restart the bidding process all over again?  In today’s market conditions, many subcontractors are busy beyond their capacity. The folks who are good are busy. The ones who aren’t busy don’t meet your quality criteria. They’re not the ones you want. These are the ones who will accept the work and then not deliver. They’re the ones where materials will go missing.  It’s easy at moments like this to feel trapped. Your general contractor has certain subs that they prefer to work with. Do you defer to your GC and accept anything they recommend? Do you search for another GC? At the end of the day, it’s difficult to over-rule your GC, because as soon as you do, they start to shift responsibility for decisions to you, and that’s not what you want.  You’ve negotiated a guaranteed maximum price contract with your GC, but that contract won’t be firm until the construction loan is funded and the contract is signed. Until then, it’s merely a draft. The draft is based on quotes that were valid for 30 days and more than 30 days have passed since the quotes were submitted. The subcontractors put a time limit on these quotes for a number of reasons.  They know that material prices can change. A severe weather event like a hurricane can cause a local material shortage that can cause prices to jump. The current trade negotiations with China have caused material prices to fluctuate.  They know that delays can happen. They know that new projects can show up. They don’t want to have to keep their crew in a holding pattern for months until your project is ready to break ground.  Unless you are large enough that you have complete control over your subcontractors, or can maintain some of the highest value subcontractors in-house, you are always going to be negotiating both pricing and schedule with subcontractors. When you’re bidding a project, the key item is price. But when you’re finally in construction, the key item is schedule. 

On today’s show we are talking about the importance of checking an often overlooked item when purchasing a property.  The question is, does the structure have all the required permits? Did it ever get a building permit? Were all the permits ever closed out? When you consider making improvements or additions to your home, it can be tempting to try and skirt the permit process. In some cities and towns, the cost and hassle of getting a permit can seem unnecessary, especially if you are handy and like to do the work yourself.  Some buyers don’t do the proper due diligence and confirm that the permits were issued and property closed. This can significantly affect the marketability of a property.  The financial motivation for many homeowners to avoid permits is the re-assessment of property value that would result. Nearly every city and town in America collects taxes bases upon the assessed value of a home. Assessed value is calculated by looking at the size and characteristics of property. What is the gross living area? How many bedrooms does it have? How many bathrooms? These are all factors in determining an appropriate assessed value. Guess what happens when the tax assessor knows about the luxurious new finished basement with home theater, wet bar, home gym and beautiful bath you just added. If you guessed your taxes are going up, then you would be right. Homeowners can save thousands of dollars over the course of owning a home when permits are not pulled. When selling a home, this becomes very problematic. If and when the town or city finds out about it, the new owner is the one who will bear the brunt of the increased taxes. So how do you know if you need to pull a permit?  The simple answer is to call your local building department and review the scope of work with them. They will let you know what requires a permit. Generally speaking, anything involving safety will require a permit. This includes electrical work, plumbing work, or anything structural, or anything that will significantly alter a property. Simple repair work should not require a permit.   Many homeowners who are undertaking a renovation will start the process with good intentions and apply for a permit. It’s often the case that they forget to call the city for a final inspection to close out the permit.  This can create a liability for you. For example, if you are performing electrical upgrades and don’t complete the final electrical inspection, you can bet that your insurance company will argue that the unauthorized and incomplete electrical work was to blame for your insurance claim, and therefore the insurer is exempt from paying the claim.   One of the most famous examples is the Sagrada Familia cathedral in barcelona. This famous Cathedral is still under construction after 137 years. This landmark gets about 4.5 million visitors a year. It’s a breathtaking work of art. Back in the day, the year was 1882, the then designer of the Cathedral was Antony Gaudi. Gaudi’s architecture is all over Barcelona, famous for his unique style. At the time, he asked the city for permission to build the church.   But the city can’t find anywhere in its records that Gaudi was ever given a response to his request to build the church. The initial permit fee imposed by the city included penalties and interest dating back 137 years. Needless to say, the price tag was enormous. That was eventually negotiated down to $4.5 million Euros, still a huge price to pay.   One of the other risks of not pulling permits is getting sued later on down the road by the buyer who purchases your home. Unfortunately, we live in a litigious society. When you don’t pull a permit, and something tragic happens years down the road, who do you think they are going to come after?

As real estate investors we are very familiar with the difference between good debt and bad debt. Good debt is debt that is used to purchase income producing assets. Bad debt is merely for consumption. That’s the debt that is used to buy everything from your car to your home renovation.  A recent story in the Wall Street Journal illustrates how bad things have become, with bad debt. Families across the country are going deep into consumer debt to maintain a middle class lifestyle, even if they can’t afford it. Cars, College, homes, medical care have all gone up in price over the past two decades, while incomes have not changed very much at all in that time frame. Increasingly, consumers are turning to credit to fill the gap.  Student debt has ballooned to $1.5 trillion last year, taking second place behind mortgages. Automotive debt has increase 40% in the past decade, adjusted for inflation and is now at 1.3 trillion. Alarmingly, the default rate on automotive debt is way up. Unsecured personal loans are up.  The simplest and easier form of consumer debt is the household refinance. Many people are continuing to bury consumer borrowing in their residential mortgage.  Inflation is an average. As always with an average, some items rise faster than inflation, and others rise slower than inflation. Wages are up 135% in the past 3 decades neglecting inflation. When you take the government reported numbers for inflation into account, incomes have not moved. College tuitions have increase 540% in the same time period, without adjusting for inflation. Health care costs are up 276% over that time period. The middle class is shrinking, and they don’t know it.  The Trump administration is reducing how much home equity mortgage borrowers can withdraw through cash-out refinances.   Starting Sept. 1, the Federal Housing Administration will limit the money available for cash-out refinance activity to 80% of the home’s value or less. Previously, borrowers could take out up to 85% of the property’s equity. The new loan amount limit is in line with the limits already in place at Fannie Mae and Freddie Mac.

Al Williamson is based in Sacramento California where he has focused on medium term rentals. This strategy is filling a gap in the market between short term rentals, hotel rooms, and long term rentals. Very smart approach. Check it out. 

Pete Barrow is based in Indianapolis Indiana where he maintains a high volume business in wholesaling and redeveloping single family homes. Some real nuggets in this conversation. 

The Fed lowered interest rates for the first time in a decade citing lower global economic activity.

Ray Dalio is the founder and co-chairman of Bridgewater Associates, which, over the last forty years, has become the largest and best performing hedge fund in the world. Dalio has appeared on the  Time 100 list of the most influential people in the world as well as the Bloomberg Markets list of the 50 most influential people. The first part of the book reads like a biography. It outlines the events that shaped this thinking including both his failures and his successes.  In the second part of the book, the author gets into the stuff that's incredibly important, but difficult to implement. In short, he provides a roadmap and tools (via algorithmic means) to accomplish anything you want in life. There's a ton of substance, definition, & practicality on how to action your objectives. He has a five-step process to achieve what you want out of life, and it couldn't be more understandable and reasonable. The tricky part for most people (in my humble opinion) is finding a goal or objective that they can focus and remain passionate about for an extended period. If that's not your problem, then Mr. Dalio's advice in the second part of the book is significantly profound. In the third section of the book, the author teaches you how to build the mastermind group/organization that's going to achieve the goals/mission you outlined in the second part of the book. The knowledge and thought that went into these 300 pages of the book are quite impressive. In short, the reader needs to get the culture right, get the people right, and then build and evolve the protocols that run the organization at a fundamental level. There's so much granularity behind those core concepts that it'll keep you busy trying to absorb everything. This book is not an easy read. It requires deep thinking. It's perfect for a summer holiday read when you have the time to integrate the lessons into your own life.

Today’s show is inspired by a conversation that I had with an investor about a project that they were undertaking.   The situation should never have happened and that is the purpose of today’s episode. The construction budget was based on a quote from a contractor, but unfortunately it was riddled with problems and the investor didn’t see it. As soon as I looked at the numbers, it was obvious that the budget would never work in the real world. I was able to see it instantly and the investor didn’t. I don’t have any special super powers. A few simple calculations immediately showed the problems. The goal of these calculations is to quickly answer a simple question: “Do these numbers make sense?” The first thing I look at is the allowance for interest reserves in the project. I start with the loan amount and calculate the interest for the construction period, and then make a guess at how long it might take to lease the property followed by how long it might take to complete the refinance into permanent financing. I then compare the interest that would be due over that entire time period and compare to what is in the budget. In this particular instance, it looked to me like the budget took the time for construction into account, but not the period for leasing or refinance. I would even add a buffer to that of 50%. So the interest reserve in the budget needed to triple compared with the amount in the budget.  Next I look at the allowance for appliances. You can easily drive down to your nearest Best Buy and price our an appliance package for a single apartment. Choose items on sale and you will get s pretty good estimate. We are usually talking about 6-7 appliances. A good estimate is somewhere between $3500-$4000 for a class A apartment. In this particular instance, the budget was a little over $2000 per apartment. It was easy to see that the estimate was not close to where it should be.  Hardwood flooring costs about $3 per square foot to purchase the material and about $2.50 to install in large quantities. You are looking at about $$5.50 per square foot for hardwood. Ceramic tile starts at $1.00 per square foot and cost about $3.50 per square foot for installation. The cheapest tile will cost $4.50 per square foot installed. I usually budget $2.00 for square foot for the material which brings me total cost to $5.50 per square foot. It means that the price for ceramic versus hardwood is virtually the same and in this instance I didn’t have the breakdown of the different flooring types. Vinyl plank flooring is less expensive and can be done for about $2.50 installed on the best day ever.  My friend had received a budget allowance of slightly above &1.00 per square foot installed. If doesn’t require a huge skill to see that there is no flooring on the planet that would fit within that budget number. The estimate was off by anywhere from 250%-550%.  These are simple rules of thumb. But they can quickly show when a budget has problems.  Being in this business requires a high degree of diligence every step along the way. 

Jonathan from Arlington Virginia asks, The Fed signals of an imminent rate cut made me eager to consider how I can take advantage of reduced rates through additional real estate purchases and other business acquisitions. Then, the announcement from Deutsche Bank that 18,000 employees will be let go stunned me. The two seem eerily (albeit tangentially) connected - I can’t ignore the timing. Should one be bullish toward leveraging  cheap debt to buy sensible assets with the real possibility of another financial crisis around the corner? Pursuing these acquisitions now can seize access to capital that likely won’t be available in tighter times, but the risk of holding such highly leveraged assets is intimidating. Jonathan, this is a great question. My reading of the situation is a little different. I’m not saying that Deutsche Bank is the only major bank that is struggling, but the company had ambitions to compete in the world of investment banking along with Goldman Sachs and JP Morgan Chase. They made substantial investments to grow those operations to compete with the Wall Street heavyweights. This is an area of the business that earns a lot of its money on the basis of corporate financings, bond issuance, brokering mergers and acquisitions, and initial public offerings. The trading desk for stocks, bonds, commodities, and currencies is also included in this business unit. The number of large corporate transactions have reduced significantly in recent years, even though the bond market remains highly active in terms of new offerings. This division turned a profit last year, but had lost money every other year since 2014. Most of the volume of the trading desks is increasingly being done by computer with no human intervention. You simply don’t need as many people to execute the trades as you once did. While the volume of trades is up, this is a misleading statistic. The number of computer trades is up, while those initiated by paying clients is down.  The bank hasn’t disclosed where all of the 18,000 layoffs will occur. But they have said that their brokerage and investment banking business will be among the heaviest hit areas. The company has about 9,275 employees in North America, most of them in the NewYork area, and about 800 in Cary North Carolina.  About 150 software developers in the Cary North Carolina office have already received their layoff notices. Investment banking is not at all like general business banking or personal banking. Investment banking relies upon large commissions. I’ve seen these negotiated down to 1.5% in some cases. This too has an impact on profits at the investment banks. The cuts are not limited to Deutsche Bank. Goldman Sachs, Citi Group, BMO, and in fact most of the European banks have announced substantial headcount cuts at their trading desks. Citigroup has announced a cut of 10% of their equity trading desk, and large numbers at their bond trading desk.  There is no question that the business of banking is changing across the board. The number of reasons for me to physically enter a bank branch continues to decline. I can now perform the majority of transactions from a web client or an app on my phone. I can now even make deposits using the camera on my cell phone which is integrated with the bank app. The one thing that kept me going to visit the branch every month will eventually disappear entirely. Banks across the country are reducing headcount and closing lower volume branches.  Borrowing money is not just about interest rates. A number of lenders have become more conservative in terms of underwriting rules and have tightened their lending criteria, even if money is cheap. They too are worried about making investments late in the business cycle. Continue to take advantage of the low interest rate environment and secure debt under the best terms, for as long as you can.