The Real Estate Espresso Podcast

On today’s show we’re talking about how to make sense of confusing market trends. These days there is no shortage of contradictory data.  I’m continually reminded that real estate is hyper-local. The news media reports the averages, the macro trends across the nation, across a continent, and even globally. Somehow the news media is attempting to connect the dots and warn you that a slower growth in manufacturing in China will translate into a loss of jobs in your home town, or that a higher price of oil will mean fewer home sales in  Some local real estate markets are bucking the trends. It is completely possible to have cities that are at different stages in the cycle.  In Silicon Valley, we’ve seen inventory of homes on the market increase 132% in a very short time period. The main factor is that the number of buyers entering the market in silicon valley seem to have vanished. There simply aren’t as many buyers.  We’re seeing the same in Dallas, Seattle, Portland. We’re seeing dramatically higher inventory and homes are taking a lot longer to sell. Prices have levelled off and are either flat or slightly down in many major US cities. In my home city of Ottawa Canada, we’re seeing the opposite. Inventories have dropped to the lowest level I can remember. We have just over 2 months of inventory on the market for both single family homes and condominiums. I can remember just two years ago when we had 10 months of inventory in the condo market.  In some areas of the city, the inventory is even lower. The number of days on market has fallen by 24% for single family homes and by 48% for condos.  Prices increased 7.7% year over year and inventory is down 25%. When I talk with friends who are brokers, they speak about how difficult it is for a buyer agent to close a deal under $500,000. There are multiple offers and homes often sell above asking price. Some buyer agents are getting burnt out. Some agents are worried about the traditional uptick in market volume in the spring. The current market inventory is at 2.2 months. But when you consider the traditional increase in sales during the Spring, we can expect an even more acute shortage.   So when a market diverges from the norm, there can be two explanations. The market is truly a market unto itself and is not influenced that much by outside forces. The market follows the macro market trends but is merely delayed. Some secondary markets attract investment when the primary markets get overheated. We often see a lag between a hot submarket and a neighbouring submarket. Buyers say, well, if I can’t afford to live here, why don’t I look another 5 minutes down the road.  If I can’t afford to live in NY, why don’t I look at New Jersey, or Philadelphia. If I can’t afford to live in Palo Alto, why don’t I look in Freemont.  Some cities like Ottawa and Washington DC as capital cities tend to live in an economic bubble. So much of the local economy is dominated by government spending that they’re somewhat insulated from broader market forces. In the last downturn in the wake of the 2008 financial crisis, real estate prices in Washington DC only fell 19% from the top of the market in 2007 to the bottom of the market in July 2010 before rebounding by 14% in only a few months later that year. By comparison, prices in Phoenix Arizona fell by 67% in the last downturn and took almost a decade to rebound to prior levels. So please folks, stop listening to the macro housing data and using that infer meaning to your real estate decisions.  Real Estate is hyper local. Prices changes are highly linked to mobility of people. If people don’t move very much, prices don’t change much. If people move in or out of the market easily, you can expect prices to move a lot.

David from Seattle asks.  Within the realm of private placements, how should investors think about investing in a fund vs in a project? Funds pool money and share the risk across multiples projects. However, funds further separate investors from the actual assets and deals. For example, a passive investor can't choose which individual project the fund may take on down the road, and it may be overburdensome for the investor to review the financial details of each project, if the fund shares those information at all.  Given these complexities and layers of abstraction in a fund, it seems to me that one should generally only invest in funds managed by people they are most comfortable with (such as by seeing them perform in a single project before). Would love to hear your thought on this. David, this is a great question. It’s one that we grapple with ourselves.  There can be multiple reasons to form a fund. One idea is diversification. The second is scale. Both could bring you greater safety.  Diversification would span multiple asset classes and multiple geographies. I believe that sophisticated investors don’t want a fund manager to manage their diversification for them. It becomes incredibly difficult to figure out how a fund is going to perform if its diversified. An exchange traded fund is an example of a fund that embraces diversification. By tracking the S&P 500 index, you are by definition embracing diversity. You have zero ability to perform due diligence on the underlying assets. They’re all in the fund whether you like it or not. Not only that, they’ve put the whole thing in a blender and made a pureed soup out of it. I do not embrace this approach.  I believe that investors want a fund manager to be the best at what they’re good at within a narrow field of specialty. You still want your fund to be resilient. If you’re in a medical office building fund, you only want medical office buildings, and you want them to follow a proven formula. If you’re in a self storage fund, then you want only self storage and you want that fund to invest in a manner that follows a proven formula. The resilience can come from scale. A single family home as a rental property is less resilient than a multi-family apartment building. If you have a vacancy in the home, you go from 100% occupancy to 100% vacancy in an instant. If you’re in a 100 unit building, then a single vacancy produces a very manageable 1% vacancy. There is resilience in scale. A lot of investors who invest in funds believe that you should not invest in fund #1 with a company. They would rather you invest in fund 2, 3 or 4. That creates a startup problem.   Rather than starting with a brand new fund from a blank sheet of paper, we’re considering forming the fund out of existing investments in the portfolio. The fund unit holders would come largely from the existing investors in individual projects. The advantage for investors in this scenario is to create a bit of diversification compared with just a single project. Even if you design all of your projects to offer a similar rate of return, there will be variation. A fund helps bring greater scale and more stability to the overall financial picture. From the sponsor’s perspective, a fund can be beneficial because it puts the resources at your fingertips to go and get some great deals. There’s no delay in raising funds for a project. The downside is that the fund comes with an expectation of a rate of return. If you are holding onto money that hasn’t been put to work yet, it is earning zero, and the investors still have an expectation of a rate of return. Funds that are too large run into the problem of having to deploy funds simply to put the money to work.  I believe the same criteria should apply when you consider investing in a fund versus a single project. A fund is more difficult to evaluate.

On a public show such as this, there is a tendency to focus on the positive, to highlight successes, to inspire you the listener to greater heights. On today’s show we’re talking about one of the darker sides of being in business. But as Jim Collins, the author of Good to Great says, you must confront the brutal facts. That’s what we’re going to do today. Earlier today I got a phone call from another investor. He's a good friend and we’ve known each other many years. He’s a good person with strong values and strong ethics. The story he told was so sad. Sad because it happened to him. Sad because it’s happened to me. Sad because nearly everyone I know who has been in business for a while has a similar story.  On today’s show we’re talking about what to do when you face a theft in your business. Often the victim is a high profile individual. A few weeks ago I was speaking with a high profile author and he was describing the times when he was a victim of theft. A month ago I was speaking with a high profile jeweller. The jeweller was the victim of employee theft. When the employee was confronted, their response was “You didn’t seem like you needed the money, and I did, so I took it.” My friend had hired a general contractor. The contractor asked for draws on the construction in advance of the work being done. The contractor had lots of good reasons why the funds should be advanced before the schedule said they were needed. Inconsistencies started to appear between the story being told by the contractor and the facts on the ground. When everything was eventually laid bare, it was clear that the contractor had in his words “borrowed funds” and in the end far more than the borrowed funds were missing.  The subcontractors had not been paid, and the jobs had been under-bid. The net result is a project with a contractual commitment that cannot be fulfilled and then there are stolen funds on top of the situation.  I’ve encountered a very similar situation several years ago. The crooks who do this are very adept at establishing trust and using a fabricated web of evidence to create that trust and support their stories.  I’m sorry for my friend. I feel for what he is going through. While what happened is not his fault, he still is responsible. That’s where the painful part hits home. You can do everything right, and if someone on your team does something wrong, you’re still responsible, even if you’re not at fault.  Every employee at Boeing is sharing responsibility for two jets that crashed, even though the actual fault probably lies with only a handful of people who made a hasty decision.  When you put diligence in the context of approving an aircraft’s control software, the standards are pretty clear. But what about hiring a general contractor? The stakes aren’t as high. Or are they? You don’t need a crook in your midst. Innocent mistakes can be as dangerous. We all make mistakes. I certainly do. They’re embarrassing. They’re painful, and they’re a necessary part of learning. Mistakes are not to be avoided altogether. The only true way to avoid mistakes is to do nothing at all. Mistakes are to be expected. They are there to learn from and to be caught and corrected before the consequences are catastrophic. 

Robert and I sat down on the balcony of his suite on the Investor Summit at Sea for a conversation about his new book "Fake"  which launches on his birthday April 8.  

On today's show, special guest Ed Griffin joins me to talk about what it means to swallow the red pill. For those of you fans of the movie "The Matrix", you'll know exactly what we're talking about. For the rest of you, watch the movie.  We held a private screening of "The Matrix" on board The Investor Summit at Sea and then had a group discussion about what the movie meant in the context of the time in which the movie was launched, and more importantly today.   The upcoming Red Pill Expo is designed to lay bare the truth to many things that are in fact illusions in our day to day lives. Check it out at redpillexpo.net and put it on your calendar for June 7-9 in Hartford, Connecticut. . 

On today’s show we’re talking about demographics and the senior housing market. The baby boomers began turning 65 years of age in 2011. Today the oldest baby boomer is 72 years old. By 2029 the remainder will also reach age 65 and account for more than 20% of the total population. By 2050 the population of senior citizens is estimated to equal 88 million people nearly double the current population of 49 million.  Much of the new capacity in senior housing has been billed in anticipation of this massive future growth. But that growth will not hit assisted living and skilled nursing for at least another decade. The near term growth area is in independent living. One of the primary drivers for senior housing the aging population is longer life expectancy. in the 1970s the average life expectancy was 80.2 years of age buy 2018-expectancy hey Snell 85 1/2 years of age. It’s also estimated that one in 4 will live to be 90 years of age and one in 10 will live past 95 years of age A report issued last week by Fannie Mae’s research team takes a broad summary view of the senior housing across the nation. Generally speaking, nationwide occupancy in assisted living peaked back in 2015 at 89% occupancy. Since that time, there has been a lot of new product injected into the market causing average occupancies to fall to about 85%. In spite of the low occupancies, we continue to see year over year rent increases of about 3% per year.  The report notes that occupancy is falling marginally across the nation, driven largely by the amount of new product that entered the market last year. Thankfully, the amount of new supply is also slowing. The number of new starts this year declined by 21% in Q4. This shows that the market has gotten a little ahead of itself. Much of the new capacity has been built in anticipation of our aging population. The silver lining in this is the absorption rates have reached record levels in 2018 with nearly 14,000 units being absorbed during the year. That’s a 34% increase in absorption compared with the prior quarter. So if absorption rates hold steady or continue their upward trend, we can expect occupancies in AL to increase into the high 80’s and eventually into the 90’s, depending on the rate of new construction in the future.  The most troubled segment in senior housing is the skilled nursing sector. One of the nations largest operators is Five Star based in Newton Mass. The company operates with 213 senior living communities it owns or leases and 70 it manages across 32 states.  Skilled nursing occupancy dropped again this year and rests at 78%. The skilled nursing segment has lost market share to the newer assisted living and memory care model, which offers a lower cost alternative for many clients who have enough of the basic human functions to qualify for assisted living.  We know that demand is going to double over the next 15 years. So operators are clearly trying to position themselves to win, even if it means suffering a little bit of short term pain with lower occupancies.  

The UK is past the deadline for leaving the EU with no deal that has been accepted by the British parliament.  The entire Brexit situation is incredibly complex. Prime minister may has set a new deadline for leaving the European Union by May 22. If the departure is delayed beyond that date, Britain would need to participate in the upcoming elections for the European Parliament. The prime ministers proposal in front of the British Parliament have defeated three times. However she survived a vote of non-confidence. Her latest effort to negotiate a new deal involves a coalition with the opposition Labour Party which favours a stronger customs and economic union with the European continent. It’s a pretty high risk move by the prime minister. She is essentially looking to form a consensus that ignores her own conservative political party. The entire question period in parliament was a loud raucous chaotic experience punctuated by numerous interruptions by the speaker of the house calling for order. Members of the house would stand as a way of requesting to speak, waiting to be recognized by the speaker of the house. Some of the comments and questions for the prime minister were directly related to the matter at hand. Other matters seemed to drop into the middle of the discussion out of left field. One member of the house of commons asked for the prime minister’s support in furthering recognition and training for members of parliament regarding autism. Another member of Parliament requested the prime minister support for improved handicap accessibility at a local train station.  The entire process seems like one where everybody’s talking all at once, but nobody’s listening. I very much doubt that anyone‘s opinions were swayed by anything that was said in Parliament today.  When we talk about Brexit there are five principal areas that we can examine  Single market Courts of justice  Customs union Immigration and border protection  Financial benefits, financial support and funding for EU institutions  Proponents of a hard Brexit would see all of those areas severed from the eu.  Proponents of a soft break want a continued customs union, and a single market, but full autonomous control over justice, borders and funding. It’s as if they want all of the benefits but none of the responsibilities of being part of the European Union. While it may be possible to gain a new consensus among the parties in the UK, it’s not obvious that the rest of Europe would agree to such an arrangement. Agreeing to a proposal like this would be synonymous with the death of the European Union. You would see other countries demanding the benefits but not the obligations of being part of the union.  The current deadline to leave the EU is April 12. Any extension requires unanimous agreement by all 27 member nations. That’s not assured. If the April 12 deadline passes with no deal and no extension, then the prospect exists that the UK leaves with no transition period and get treated just like any other country that’s outside the EU. It would be the same as Vietnam or Thailand. There would be tariffs in place on goods, there would be restrictions on the movement of people. Licenses that were valid across the EU would cease to be valid. The level of economic and social disruption that could result is staggering.  You might be thinking that the UK is a distant land. You might have visited the UK and strolled through the grounds of Windsor Castle, but if there are problems there, they really do affect you. Think again. We live in a single global village. No country is an island unto itself. No country is fully self sufficient.  

On today’s show we’re talking about how a remodel can destroy the value of a property. The TV Reno Shows are sometimes bringing people into the remodelling business that only see one thing. They say, I can make this house nicer too. They become inspired to replicate what they see on TV. They believe they have a design sensibility. Of course, everyone thinks they have good taste and believe that they can make some money improving a house and putting it for sale.  On today’s show we’re going to look at a case study where the value of a house that was destroyed by a renovation.  The home is located in Arlington Texas, exactly one block from the University of Texas campus. It had been owner occupied since it was built. It had changed hands a few times over its life, but basically it was the same house built in 1940. It appears to have been updated in the 1970’s, and again most recently immediately before it was put on the market. The owner put about $50,000 worth of improvements to the property immediately before putting it on the market. They assumed that the property would be purchased by another owner occupant. After all, they lived happily in that home for many years.  Naturally, the home owner hoped and expected that they would gain more than their added investment in the way of a higher sale price. The failure of this renovation was in a fundamental assumption. It’s as if they failed to notice that the university next door had grown from 22,000 students to 51,000 students in the past decade. They had failed to pay attention to how other properties a couple of blocks away that used to house single family homes, are now part of the university campus. They failed to notice that other properties had been assembled into larger parcels and a dozen or more student housing residences were built where perhaps a couple of families used to live. The failure was in assuming the buyer would be another family, just like them.  The real buyer would have been a guy like me, someone who would have talked to the planning department at the city and conceived of a new use for the property taking into consideration the new needs of the local marketplace. I had conversations with the planning department to determine the allowable density, and the parking requirements. I had my eye on the neighbor's property as well. The two properties put together would give access to a larger parcel from two sides and make it easier to design the parking for the desired number of units.  On this show we talk often about the difference between content and context. The problem was not with the content of the homeowners renovation. It was with the context of the sale. The seller failed to recognize who the ideal buyer would be. The owner probably spent a lot of time selecting the perfect materials for the renovation. I feel sad for him because it was a wasted effort.    An improvement isn’t an improvement if it misses the target.

On today’s show we’re examining the idea of seeing over the horizon.  The horizon is the distance that you can see before the curvature of the earth obscures what is just a bit further away.  Generally speaking For an observer standing on the ground with h = 2 metres (6 ft 7 in), the horizon is at a distance of 5 kilometres (3.1 mi). You can’t see over the horizon. But that’s not the only horizon that exists. We as humans construct many artificial horizons. There are horizons in time. There are financial horizons. There are career horizons.  There are horizons in the game of chess. Some chess players only think one move ahead.  World class grandmasters can see anywhere from 15-20 moves ahead.  It is said that Garry Kasparov knew he had lost a game 11 moves before he was ultimately defeated. The horizon for Garry Kasparov is substantially further than for most other chess players.  You may know some people who only plan a few days ahead. That is their planning horizon. The real horizon is what is within our line of sight. If you’re lying on the beach you may be able to see only a few hundred yards or meters. Someone standing upright at a height of 6 feet or a couple of meters, they can see about 3 miles or 5 km. But for an observer standing on a hill or tower 100 feet (30 m) above sea level, the horizon is at a distance of 12.2 miles (19.6 km). How hard is it to find that higher vantage point so you can see further? Often all it takes is a conscious decision to seek out that higher vantage point so you can see further.  Often all it takes is a decision to plan further into the future. There is no real obstacle. Yes, you may have to make some assumptions about how the future will unfold, but these can often be reasonable assumptions.  But then there are people who seem to have the ability to see around corners. Do they have supernatural powers?  Not really. What they have is experience. They can draw upon a history book of past projects that have similar metrics in terms of cost, schedule, resource requirements, and risks. They have relationships with experts, mentors and consultants that they can draw upon to help double check their assumptions. Each one of these steps creates a higher vantage point enabling you to see further, to extend the horizon, and to ultimately see past the horizon. 

This month’s book is a 600 page classic called “The Creature From Jekyll Island”. The subtitle is “A Second Look at the Federal Reserve”, by G. Edward Griffin. The subtitle really tells the story of what the book is about.  The fact is, very few people really know what the federal reserve is. Most think it is an arm of the US government. The fact is the Federal Reserve Bank is neither federal, nor has any reserves.  If you’re going to be a player in this game called business and you care at all about money. Then you might want to invest some time into learning about what money is, where it comes from, and what some of the rules are that govern our financial system. If you’re playing a game and you don’t know the rules, well then, you probably won’t win the game. In fact, you might get crushed.  I know what you’re thinking. “I know everything I need to know about money”. How complicated can it be? How will knowing a bit of history help me with my money problems today? I’ve had the pleasure of getting to know the author G. Edward Griffin over the past several years. He’s one of the gentlest of gentlemen you could ever meet. He has been a documentary film maker for much of his life.  This story begins late at nigh in a New Jersey railway station in 1910. The trains at that time consisted of coach cars immediately behind the locomotive which belched out massive quantities of thick black smoke that would infiltrate the guest accommodations through the unseen cracks. After that was the dining car, and then after that were the sleeping cars with the hard upper and lower bunks that made up the better class of service. At the very back of the train was a private car that was a 5 star rail car with the finest in furnishings and mahogany paneling. The name Aldrich was stencilled on the side of the car. Aldrich was senator Nelson Aldrich from Rhode Island. Aboard this last car were 7 men who represented about one fourth of the wealth of the entire world at the time. Nelson Aldrich was chairman of the national monetary commission, a business associate of JP Morgan and father in law of John D Rockefeller Jr. Some of the others aboard the train were: Abraham Piatt Andrew - Assistant Secretary of the US Treasury Frank Vanderlip - President of the National City Bank of NY Henry Davison - Senior Partner at JP Morgan Charles Norton - President of JP Morgans First National Bank of NY Benjamin Strong - head of JP Morgan’s banker trust  Paul Warburg - a representative of the Rothschild banking dynasty in England and France. His brother was Max Warburg who was head of the Warburg banking consortium in Germany and the Netherlands. This clandestine trip to Jeckyll Island in Georgia was for the purpose of creating a new solution to the banking system’s problems, but this time owned and controlled by the banks, and legally sanctioned by the US government.  The genesis of the book was a quest to create a documentary on the origins of the Federal Reserve. As Ed Griffin researched the works of prior authors, he became more fascinated with the topic. This culminated in Ed making his own trip to Jekyll Island in Georgia. There is a small museum on Jeckyll island where you can visit and see some of the original documents that date back to 1910. It was here that the uncomfortable truth was laid bare. The story of the history of the Federal Reserve is an unpopular one, because its uncomfortable. But unless you know that what we call money isn’t actually money, you won’t understand the rules of how to play the game.