The Real Estate Espresso Podcast

On today’s show Patrick asks “How important is making site visits prior to purchasing a property?” The simple answer is “It depends”. Certainly, you need to get a lot of information about a property before you buy. Some of it requires a site visit. That doesn’t mean it has to be you to go to the property. But you do need the information one way or another.  When I perform due diligence on a property, I’m looking for a few important things.  I want to know what is around it. If the value of a property is determined by location location location, then you want to learn as much as you can about the area surrounding the property. You need to evaluate the context of the property. You can have 1000 pictures of the subject property, but still know nothing about the value of the property because you haven’t seen what is around it.  I want to see the amenities in the area. What is the traffic like? How easy is it to get on the freeway from the subject property? How close is good quality shopping? If the closest Whole Foods is 20 miles away, then that might color your decision.  I want to look at the subject property and properties immediately surrounding the subject property for evidence of erosion or standing water.  I want to look at the zoning map and the municipal plan overlay. The properties next to me might be zoned according to their current use, but if the city has designated them for another use, I would want to know that. Is the city going to widen a major road and take a 20 foot or 40 foot strip from my property at some point in the future? You might think I’m exaggerating. But I’m not. I’m currently building two project where the city has taken and additional 40 feet of land from all the properties on the street and added it to the road allowance. This will enable the city to widen the road when it feels the need arises. Instead of having 851 feet of land depth from the road, I have 811 feet of depth. It definitely has an impact on the project. I’m going to want the environmental phase 1 survey. That survey will require a site visit. But it doesn’t have to be me. The site visit will be performed by the consultant who performs the survey. If I don’t feel like getting on an airplane, and visiting a property, then I’ll find somebody local who is willing to perform a live video conference walking tour of the property and the area. I record the video, and by being connected to the live video, I’m able to direct the camera to anything I want to take a deeper look at. So far, everything I’ve talked about is outside the building. If the property has a structure on it, you will definitely want to get a detailed view of key items. What is the finished product that you have in mind? How easy will it be to transform the existing structure into that new finished product? If the property has a basement and you wan to develop the basement, you need to take a detailed look at the supporting columns, the vertical clearances, and the routing of utilities to determine the scope of work. You will want to know the capacity of the electrical panel and find out if there is expansion room for what you want to accomplish. Adding a few breakers is a very manageable scope. Replacing the entire electrical main wiring and replacing the panel with a larger one might not be. Again, you don’t need to visit the property yourself. But you do need answers to the key questions.  The key is to have clarity on your due diligence checklist. Some items will require documentation. Some will require consultants. Some will require conversations with neighbours, local politicians, people in the planning department at the city.  It all starts with a vision for the finished product, and developing a detailed due diligence checklist before you step away from your desk.

Today’s show is a fascinating story about industry insiders who are challenging the state of the banking industry.  Last week I published an episode called "Not worth a Continental". If you have not listened to that episode, I suggest you stop today’s show and go listen to that earlier episode first. Today’s show will make so much more sense if you do. The players in the story are James McAndrews, former research director for the New York Federal Reserve Bank., And the Federal Reserve itself on the other side of the table. The Wall Street Journal reported on Friday that The Federal Reserve is pushing back against a new private bank that is suing the central bank for access to its services.  The New York Fed filed a motion last Friday in U.S. federal court asking the court to dismiss a lawsuit filed against it last August by TNB USA Inc., a private bank formed in 2017 by James McAndrews, the New York Fed’s former research director.  TNB, is a bank chartered in Connecticut, and they sued the New York Fed for taking no action on its request for an interest-bearing account at the central bank like those that member banks have, and which are necessary to obtain Fed services.  Under its business model, TNB would accept deposits from large investors and park the money on the Fed’s books to earn interest.  The Fed would pay TNB the same rate it pays banks on the money, called excess reserves, they hold at the central bank. TNB would pay a slightly lower rate of interest to its depositors, pocketing the difference while still enabling its depositors to earn more than they might at a conventional bank.  The interesting part here is that TNB’s model isn’t novel at all. It’s called arbitrage, and its been at the foundation of the banking industry since the beginning of banking. Loan money at a higher rate, and give deposit interest to depositors at a lower rate. The real issue is that the Fed is loaning money to member banks and then taking back the excess reserves as deposits.  TNB is a private bank and not a Fed member bank. Therefore it doesn’t automatically get to take advantage of all the same privileges that member banks do. It’s a closed club. It took an industry insider, James McAndrews to expose the issue and to try and take advantage of the system that was put in place. Think about it. If you could put money on deposit with the Fed, and earn virtually the same rate of interest as you would with US Treasury bills with the zero risk of the Fed defaulting, would you make that investment as a place to park cash? If you put your money at Wells Fargo or Bank of America, you’re going to get 1.44% on your money and you’re locked into to a certificate of deposit. For something even more restrictive, you can get 2.3% at one of the major banks. But imagine if you could get 2.5% and park your money at the Fed and have full liquidity? The point of today’s episode is that there are multiple sets of rule books. If you’re going to be playing the game of finance, recognize that context is very important. It determines which set of rules will apply to you. If you change your context, you can change the game you’re playing altogether. Most people aren’t playing the game because they don’t know the rules.

When I was 10 years old, I made my first investment. I didn’t know it at the time. Apparently I had $10,000 kicking around that my grandmother had put in my account. My uncle who owned a seat on the NY Stock exchange was an aggressive trader and a very wealthy man. He lived on 5th Avenue next to the Italian consulate overlooking Central Park. It was as good an address as you could possibly have in the financial center of the world. He would actively trade all day long. He would trade stocks in Asia after dinner, and he would get up early in the morning and catch the end of the trading day in Hong Kong. He had a 4 hour break before the opening bell on Wall Street. He was the expert when it came to investing. So my mother asked his advice when it came to making the first investment for her 10 year old son.  My uncle suggest that we buy two mining companies that traded on the Vancouver Stock exchange. Mountain State Resources Exploration and another small cap mining company. I’ve long since even forgotten the name of the company.  My uncle said that both companies had made some solid discoveries in the world of mining. The two companies were expected to merge. As a result, he predicted that the value of both companies would multiply.  Well, you might have guessed it by now, the merger never happened. Both companies went broke, and my $10,000 evaporated. I was 10 years old and my life savings to that point in time evaporated. But, none of this is the reason I’m telling you this story.  There were several powerful lessons in that story. Do I wish I still had those $10,000? Of course. Had I invested them myself, I expect that I would have multiplied them many times over. What you get when you don’t get what you want is an education. So all I have to show for those $10,000 is an education.  So what was the lesson? Listen to find out.

Mark and Tami Kenney are multi-family investors. In a few short years they have acquired about 4,500 units of multi-family apartments together with their partners. It's enabled them to abandon the corporate life, and focus on their passion. Join me for a great conversation about how to make the transition from small projects to larger multi-family apartment investing.

Michael Flight is a principal at Concordia Realty from the Chicago suburb of Oak Brook. He specializes in shopping center investing nationwide. Just because retail is going through major changes, doesn't mean there isn't opportunity. Join me for this immensely educational conversation about investing in shopping centers. You can reach Mike at www.concordiarealty.com

In late-18th-century America, something of minimal value was often described as being “Not worth a Continental,” which referred to the Continental Dollar, the American currency at the time of the American Revolution. The continental was paper money. It had occurred to the colonists that, as their revolution was costing quite a bit to maintain, they could go into “temporary” debt to finance the war. Pretty soon it became clear that the debt could not be repaid. The printing of paper banknotes resulted in inflation. The solution? Print more of them. Further devaluation of the continental motivated the colonists to print more… then more… then still more. The Continental became worthless, either for trade or for repayment of debt. The new country, the United States, then did something quite unusual. In its new Constitution, it created a clause to assure that this would never happen again. Under Article I, Section 10, the states were not permitted to “coin Money; emit Bills of Credit; [or] make any Thing but gold and silver Coin a Tender in Payment of Debts.” This week, Federal Reserve Chairman Jerome Powell testified in front of the Senate Banking Committee in its semi-annual Report on monetary policy. In that discourse, Chairman Powell described one of the debates inside the Federal Reserve. The question was whether the 2% target for inflation was a maximum or an average. It was felt that during times of economic weakness, prices would not rise as fast, and therefore there could be some relaxation on the inflation target during times of economic boom such as we are experiencing now. This would average out over time.  It’s interesting that this particular statement didn’t invite any discussion with the committee members.  There seems to be a misconception among law makers that inflation is the increase of prices, when in fact, the increase of prices is actually the symptom of inflation. The real inflation is the inflation of the money supply. Every time a government prints money, there is inflation. When there is more money available, then people become more willing to pay more for goods and services. The increase in prices is the consequence of too much money in the system. Lord knows we’ve been pumping money into the system over the past 10 years like never before. Quantitative easing was the new buzzword for printing money. We went through 3 rounds of quantitative easing over the past decade. The fact is, much of the money never made it into the broader economy. It was held within the banking system to restore profitability to banks that otherwise would have needed to earn their profits the old fashioned way.  Before the financial crisis, the fed balance sheet represented about 6% of GDP. Most of the demand for funds was for currency, and a small amount for reserves. After the financial crisis, the Fed balance sheet grew to about 25% of GDP. Most of that was to fund demands for reserves at banks, and the Fed also purchased assets. Assets is code for the Fed purchasing long term government debt. So when the US government borrowed money to bail out the financial system, the Fed printed the money, and the government issued bonds which the Fed purchased and earned interest on. Pretty good gig. Banks made 237B in profits last year, some of which came from cash reserves given to banks using printed money by the Fed. The excess reserves held by the banks above their statutory requirements were in turn loaned back to the Fed and the banks earned interest on those excess reserves. Wait, what? The loan had zero risk, and was basically a license to print money for the banks.  So here’s the bottom line. Inflation is a phenomenon of having too much money in the system. It causes prices to rise, albeit not uniformly. If you’re going to be playing the finance game, it makes sense to know the rules of the game.

Today’s show is a personal story. We are all part of this journey called life. The daily struggles are universal. Managing time, energy, diet, exercise, finances, commitments, friendships, cleaning up messes and mistakes. Finding the time, and creating the space to live out your dreams. I’m a pretty driven individual. If you’ve been listening to the podcast you probably have that sense by now.   On today’s show I want to share with you something deeply personal about how I start my day each day.  I’ve discovered that some days are better than others. Some are more productive than others. There are a number of factors that can come into play which affect the quality of my day.  Sleep is high on the list. Sometimes I sleep really well, and other nights I don’t. There doesn’t seem to be a consistent pattern.  My mindset in the morning is consistently the best indication of what kind of day I will have.  This morning was one of those when I woke up at 5:00. I had got to bed late and it took me a long time to fall asleep. I was really tired, my mind was already racing with thoughts about the day ahead and the insurmountable todo list. I was tired and I was anxious. My wife was still sound asleep next to me and I didn’t want to wake her. So I put earphones on and listened to several podcast episodes including Hal Elrod, author of the Miracle Morning. By the time my wife was stirring, I was full of energy, determination and focus on the one thing that would be my focus for the day. And then I slipped into the best part of my morning routine. I rolled over, gave my wife a hug for several minutes. We then put on the recording of our guided meditation. We both lay in bed, side by side, holding hands, while we did our meditation together. I gave her a kiss on the back of her neck and thanked her for being my best friend.  We then got out of bed and continued with our morning routine. 

On today’s episode we are going to slow things down. Often in this fast-paced world, with a short attention span we only see a very small snapshots what is really happening. When you turn on the television news you will see a nine second segment of the Federal Reserve Chairman‘s testimony in front of the US congressional committee. We are talking nine seconds out of a two hour hearing. There is no way that any nine second snapshot taken at random in those two hours can be an accurate representation of the full two hours. So today I want to introduce a concept that is not new in the world of cinematography. It might be a first on a real estate podcast however. On a podcast we don’t have the benefit of visual aids. So I want you to close your eyes and imagine a beautiful scene of a mountain panorama. There’s a big blue sky. there are the snow capped peaks. There is a Valley down below. To start with we’re looking at a single panoramic image a single snapshot in time. Now we’re going to do an upgrade and technology and go to live motion video. Whether the video is shot at 30 frames per second, or 60 frames per second very little changes from one minute to the next. After about 20 seconds, we’re starting to get bored. Your attention is starting to wander and you were easily distracted. But imagine for a moment if the cinematographer left the camera in place for several months and shot one frame every 10 minutes. By animating those individual images into a time lapse sequence over a longer period of time you see the movement of the clouds. you see the change of color from Dawn through mid day, until dusk. You see the change of the seasons. You see the weather storms come through and attack the mountain peaks with great fury. A time lapse sequence gives you a completely different perspective than a still image, or a live stream video.  Find let’s photography was invented by Louis Schwartzberg. As it turns out, he did not set out to develop time lapse photography. When he was just starting out early in his career, he did not have a lot of money. He wanted to capture high quality images. By shooting a single frame every 20 minutes, he could make a four minute roll of film last a lot longer. Little did he know he was going to invent an entirely new way of looking at the world. If time I photography can be more effective at helping you see a flower open from a close bud to a full-blown blossom, or the morning sunrise on the beach, what else can this technique be applied to?

Today’s episode is another AMA episode.  Today's question comes from BJ in Raleigh North Carolina. He sent me quite a detailed package of information that is far too much to cover in a single episode. However, I will summarize his project and give my initial reaction based on the information provided. BJ is looking to assemble five different parcels of land into a single large development site for a multi family apartment complex. His question relates to how he should best negotiate with the five independent landowners, hoping to make the land part of the equity contribution to the deal. Presumably that would reduce the amount of capital required and would have the benefit of allowing the landowners to participate in the future value creation of the apartment complex.  First of all, congratulations BJ for having the guts to consider a project of this size. Larger projects have the benefit of providing enough value and enough cash flow in order to afford all of the necessary skills you need to pull it off. Having said that, large projects also represent more risk. Larger projects come with larger problems. While there are many aspects of this project that I could provide comments on, I’m going to zero in on three items. Undertaking a project of this size requires that you have the right experience team working with you. You can still be one of the principals of the project, but you need to bring in people with significant development experience building multi family apartment complexes as partners in the project.  If the success of the project requires all five landowners to agree to similar terms in order for the project to be successful, your chances of success start to drop very very quickly. Complexity, is the enemy of any project. The land assembly process can be lengthy, and the negotiation can be difficult. Sometimes, it is simpler to raise the money and buy the landowners out. However, you only want to do that once you are assured that you will be given the entitlements that you require. You want to negotiate a deal with the landowners whereby you offer a lower price today that is a reflection of the as-is market value for the land, or a higher price once the entitlements have been granted. Land that is entitled for an apartment project is worth substantially more than land which is being used for agriculture. By keeping the negotiations with each of the sellers simple and straightforward, you increase your chances of success. Also want to look at the minimum land assembly required for your project to be viable. That may not require all five parcels of land. You might be able to get away with only three parcels. Yes it will be a smaller project, but it will also be simpler. The third area that I noticed in the information you provided is the construction budget. I am currently building a project of similar size and scope in another state. However, construction costs in North Carolina will not differ materially from other locations in the south. When I look at your construction budget, it seems quite low to me. If you under estimate the cost of construction, you are setting yourself up for failure. The definition of success or failure of any project often has little to do with the actual cost of the project. It has more to do with the expectations that were set at the beginning. If you set the expectation of too low a construction cost, you are almost certain to fail. My third piece of feedback on the construction cost is easily solved with my first piece of feedback which is to make sure you get some experienced apartment constructors involved as part of your core team.

On today’s episode we are talking about the laws of economics and how they apply to the world of investing.  As real estate investors, we make choices about where to invest, when to invest, what us a class to invest in, and the positioning of the product in the marketplace. When you perform due diligence on a particular opportunity there are always three elements to look at in detail.  The team. The overall market  The specific deal.  One of the realities of our modern world is that nothing ever stays the same. You’ll either be in a period of growth, or a period of decline. That is true of companies. That is true of cities. That is also true of individuals. Often, the period of growth or decline can be self reinforcing. What I mean by that is growth attracts growth. decline attracts decline. During periods of decline, people tend to run the other way. Whenever you have a self reinforcing function, it has the effect of accelerating. That is why you see companies experience financial difficulty slowly at first and then all of a sudden they’re in bankruptcy. Cities can experience the same phenomenon. Most cities are incorporated. It’s a special type of corporation that gets its power from the province or state in which it resides. Cities are not enshrined in the constitution. Municipal governments get their power usually from an act of the state or provincial legislature. So why is all of this important? The financial health of any municipality is determined by a number of complex factors. Most cities get the bulk of their revenue from property taxes. In an environment of rising property values, property taxes increase in proportion to the value of the property. As long as there is an influx of population, and an influx of jobs. We will tend to see rising prices for real estate and rising tax revenues If people are leaving the market, and prices are falling then local government revenues will fall unless the city raises the tax rates. This is politically unpopular, and therefore politicians are reluctant to use that approach. The other major variables are on the expenditure site. Cities spend most of their money maintaining the infrastructure of the city, paying local welfare checks, education, and funding other entitlement programs like pensions for those city workers who used to be in the police department, the fire department, or one of the numerous municipal bureaucracies. It’s no secret that the number of people retiring has accelerated to an unprecedented level. We can expect about 10,000 baby boomers to be entering retirement across North America every day for the next 15 years.  So what happens when a city can no longer afford to meet its pension obligations? At first they start to cut back on discretionary spending. Next they start to defer maintenance on critical infrastructure including roads, water, sewer, and public parks. Then they cut back on the number of teachers in the schools. We see class-size is increasing. When that trick stop working the city has no choice but to declare bankruptcy. We have seen it in Detroit which owed $18.5B in debt. We have seen it in Stockton California. Even Jefferson county Alabama had to seek bankruptcy protection with 4 billion in debt. The 36 cities across the United States that have declared bankruptcy are just the tip of the iceberg. So my question to you was a simple one. When you make an investment decision to invest in any municipality, are you taking a close look at that city’s upcoming pension liabilities? Are you paying attention to their ability to fund those liabilities?