The Real Estate Espresso Podcast

On today’s episode, we are discussing what it’s like to work with an architect on a new development project. Few people understand the myriad of constraints that have to be balanced when developing a new building. Justin Greenleaf is one of the principals at the architecture firm of Greenleaf Lawson based in New Orlean, Louisiana. Join me for this insightful conversation. 

Limor Markman is a Toronto based real estate educator and host of the national TV show The Fortunate Future. She's one of those folks flying around the country hosting weekend workshops for new investors. Unlike many educators, she's still an active investor. On today's show we pull back the curtain on what it means to be a real estate trainer. 

Today’s episode is the book of the month book review. In order to be considered for a book of the month the book has to meet a very simple criteria. It has to be impactful enough that it will change your life or your perspective on the world. Whether it does or not is entirely up to you. You might read the book and comment on what a great book it was. But if you don’t internalize the book and make a part of you, you’re missing the point. The book selection this month is certainly worthy of meeting the book of the month criteria. Many people go through life looking for answers. But before you can look for answers you need to be looking for better questions. Our book this month is “The one thing” by Gary Keller.  Gary Keller is the founder of the Keller Williams real estate empire. He began this brokerage and grew it systematically organically into the dominant and largest brand in real estate brokerage in the world.  The ONE Thing has made more than 400 appearances on national bestseller lists, including #1 Wall Street Journal, NewYork Times, and USA Today. It won 12 book awards, has been translated into 30 languages. Unless you have been living under a rock, you have probably heard of the title. I’m certain that many of you have read it.  So why would I be selecting the one thing for the book of the month?  I read the book about 4 years ago. It had a big impression on me at the time. Fast forward to 2019 and the memory of the book and its lessons have faded. I need this book every bit as much today as I did in 2014 when I read it for the first time.

On today’s show we are talking about a new rule under the generally accepted accounting principles that could profoundly affect the way commercial real estate leases are written in the future. If you’re a property owner where your commercial tenants sign multi-year leases, you need to pay close attention.  There is a new rule under GAAP that requires companies to disclose long term lease obligations on their financial statements. For all leases with terms of more than 12 months, the revised standard requires a right-to-use asset to be added to the asset section of the balance sheet and the present value of the related lease obligations to be included as liabilities.  So let’s say you have just signed a 10 year lease with lease payments of $100,000 a month, of which there are, say 9 years remaining. You would be required to add a right of use asset on your balance sheet in the value of 9 x 1.2M or 10.8M. You would also have a liability added to your balance sheet in the amount of $10.8M. Next month that liability would be 10.7M, 10.6M and so on as you draw down the residual balance of the lease. You might argue that there is no change really since the you’re adding an asset and a liability to the balance sheet and they fully offset each other.  However, not everyone looks at liabilities the same way. These changes could make lessees appear significantly more leveraged and cause unprepared entities to violate their loan covenants. Remember, just because the generally excepted accounting principles have changed, doesn’t mean that banks and lenders are going to change their underwriting rules to accommodate the changes in GAAP. Many bank underwriting rules compare the loan amount to the total liabilities. If these long term liabilities now appear on the company balance sheet, it can change the way a bank looks at a borrower.

This week Berkshire Hathaway published their investor newsletter. It’s widely read and many people look to the newsletter for clues on how to invest. Warren Buffett and Charlie Munger are legendary in their sustained performance. The company has been conservative and continues to build cash reserves. They haven’t made a major acquisition in nearly 3 years. The part that I noticed in the newsletter has nothing to do with investing, but instead on financial reporting. With the latest changes in GAAP rules, it will become increasingly difficult for investors to make sense of what is happening with a company. In 2018, Berkshire Hathaway reported 24.8B in operating earnings, a 3B non cash loss from its interest in Kraft Heinz, a $2.8B cash gain on the sale of assets, and a $20.6B loss from a reduction in unrealized capital gains. The net result of all those items is a report of only $4B in net income, down from $44.94B a year earlier. So here’s the problem, the company reported a record in terms of operating earnings, but rather dismal results against GAAP earnings.  A new GAAP rule requires the company to include the a reduction in unrealized capital gains as part of their earnings. Both Warren Buffett and Charlie Munger, believe that rule is silly. They argue that the new rule would produce wild swings in their bottom line. Let’s look at their quarterly results during 2018. In the first and fourth quarters, they reported GAAP losses of $1.1 billion and $25.4 billion respectively. In the second and third quarters, they reported profits of $12 billion and $18.5 billion. In complete contrast to these gyrations, the many businesses that Berkshire owns delivered consistent and satisfactory operating earnings in all quarters. For the year, those earnings exceeded their 2016 high of $17.6 billion by 41%.   What is Warren Buffet’s advice? Focus on operating earnings, paying little attention to gains or losses of any variety. So here’s the problem. Investor shave long since had a hard time making sense of corporate financials. The emphasis has been on operating earnings for a long time. But a complete set of financials requires a look at the income statement and the balance sheet. If you ignore the balance sheet, you can hide an awful lot of really important facts about the company in balance sheet transactions. When you add another layer of noise on top of the accounting to include unrealized gains or losses, it makes the balance sheet virtually impossible to use as a tool. I know why the accounting profession has added this rule. Many companies have avoided making prudent transactions in order to avoid declaring losses. This will force an additional level of transparency. But the quarterly report will cease to be a meaningful trend indicator when you consider the level of stock market volatility. The financial statements will be valid for only a few hours. After that, they will cease to be a meaningful representation of what is happening at a company.  We live in an era of fake news. We have now entered an era of fake financials.

About a decade ago a Brazilian private equity firm called 3G Gapital made waves in the US when it spent billions to buy Americas most notable food brands including Kraft, Heinz, Burger King, Oscar Mayer and Budweiser.  Following the acquisitions the new owners relentlessly cut costs including mass layoffs to create greater efficiency and profitability. The companies single minded ability to improve profit margin‘s through cost cutting sent ripples throughout the entire food industry. A decade later 3G‘s strategy appears to have failed. Earlier this week craft Heinz wrote down the value of its Kraft an Oscar Meyer brands and other assets by $15.4 billion and disclosed an investigation by the federal securities and exchange commission into their accounting practices. In after hours trading shares fell nearly 28%. While they were paying attention to the expense line and the bottom line, they failed to pay attention to what it might take to grow the top line revenue. During that time consumer tastes have changed. Consumers are seeking healthier alternatives, more organic food, and many younger consumers have shifted away from beer towards drinking cocktails. Through a series of acquisitions 3G bought its way into the beer market and owns 40% of the volume of beer consumed in the United States. They completely missed the microbrewery threat to their business. Maintaining a healthy business requires adapting your product offer to your customers tastes. Real estate is a business like any other business. It is the same as selling beer, and ketchup, and hotdogs. Even in housing customer tastes do change over time. If you fail to invest in developing product that is going to be at the forefront of customer demand this year and next year, you will find yourself on the slow road to obsolescence. Putting a fresh coat of paint on that 1950s bungalow is just like putting a new label on the can of Budweiser. For the loyal consumer of Budweiser, the new label maybe eye-catching. But if your customers have shifted to craft beers or cocktails, the new label won’t do it. You will be playing catch-up in the market at best, or possibly bankrupt at worst.  So what do today’s tenants want? They want certain amenities in a rental property, or an office building.  Your customers don’t want 6 inch floor tiles. They want large rectangular 12 x 24 floor tiles. They don’t want laminate counters. They want natural stone like granite or a semi synthetic stone like quartz.  They don’t want ornate colonial style trim on the windows and doors. They want clean lines that are crisp and modern.  They may tolerate the old stuff, but that doesn’t mean they want it. I will tolerate Heinz Ketchup, but my taste has shifted towards other brands that have more vinegar and less sugar. You see the folks at Heinz never asked me. I had been buying Heinz ketchup for years. But then one day, my taste changed. I wanted a more natural ketchup. I never gave them the feedback. There was no way for them to know I had stopped buying Heinz. The folks at Heinz were busy looking internally for ways to save money. They eliminated single sided printing to save paper. They cut the corporate jet that the Heinz family used to use. Profits were growing, so everything looked good. All of a sudden they woke up one day and discovered that Victor and thousands like me had stopped buying Ketchup and Oscar Meyer hot dogs.

On today’s episode we’re talking about how you can prevent the next violent social revolution. History has seen its share of violent uprisings.  The French revolution which began in 1789 was not just a single event this was a protracted period of a people that lasted over 10 years. The causes of the French revolution or complex and still debated amongst historians. The French revolution took place after a seven-year war and the American Revolution. The French government was deeply in debt. it attempted it’s financial status through some pretty unpopular taxation’s games. Years of worsening living conditions for the general population combined with several years of bad harvests inflamed popular resentment of the privileges enjoyed by the establishment and the Aristocracy.  The American Revolution was a Revolt that took place also over an extended period of time. It started in 1765 and ended in 1783. I believe we are witnessing a moment in history right now that is not that different from the early days of the French revolution. The yellow vest movement has brought hundreds of thousands of protesters into the streets all over France for 15 weeks in a row. The five star movement in Italy which was elected to lead the current governing coalition had its roots roots in a similar Anti establishment popular uprising. Increasingly a disenfranchised segment of the population is looking to government to solve the problem. There is no question that there are millions of honest hard-working people who are struggling to create and maintain a minimum living standard. I believe that lack of financial education is one of the major causes of financial hardship, and what will emerge as social unrest. Even in the United States there are political movements afoot that could be enormously destabilizing. One of the best examples is Alexandria Ocasio Cortez who was recently elected to the US Congress. She was a very vocal opponent of Amazon creating jobs and investing in the New York area. When the population is angry and politicians get elected who don’t have the most basic understanding of grade 3 level arithmetic, the outcome can be extremely dangerous. The newly elected Congress woman does not understand the difference between a tax reduction and a tax credit.  Most of us would agree that there’s a big difference between a gift card and a discount. You can’t spend a discount but you can spend the gift card. Amazon was given a discount not a gift card. When politicians who don’t understand the difference between a gift card and a discount further confused and in rage the public , The results can be highly unpredictable. Arguments get made and they are completely irrational and have no basis in actual fact. Whether the lie is intentional or simply naïve, both are equally dangerous. This is where the importance of financial education comes into play. Every single one of us shares a burden of responsibility for ensuring not only that our children become financially educated, but also those members of our society who are most Disconnected from understanding how money and our financial system works. If we fail the educator society on how money works, more and more members of our society will continue to look up in the sky with arms outstretched waiting for the giant piggy bank in the sky to shower money up on them. If the piggy bank doesn’t produce enough, they will band together and smash the piggy bank in a violent uprising. If you don’t believe me, take a deeper look at what’s happening in France right now. These are not just the usual protests in the center of Paris or in other major cities like Lyon. These protests are occurring even in small villages and towns all over the country.

Today's episode is a real life case study recorded live at the Real Estate Guys, "Secrets of Successful Syndication" conference in Dallas Texas. This project started like many of our projects with a clear plan and solid market data to support the thesis for the project. Everything changed when the city announced a plan to expropriate 1344 properties in the area, including the land for this project.

Today's episode is about a purchase that ended in a lawsuit. This story is packed with suspense, uncertainty, stress, and wisdom. Check it out.

On today's episode we are talking about the major considerations when designing a new development site.  Developers often look at a site from the perspective of how many units of finished product you can place on the parcel of land. This is an area that is fraught with complications. I can tell you from first-hand experience that the number one constraint on virtually every project is road access and parking. It is relatively easy to increase density by going vertical. However every time you do so, The density is going to gobble up more land for parking. Whether you're building an apartment complex, or a small residential subdivision, or even an office complex, parking and driveway requirements will dictate the design of the overall project.