The Real Estate Espresso Podcast

On today’s show we examine what it means to be an investor. An investor is very distinct from a business operator, and distinct from a business owner, different than a broker, and different than a trader. An investor is truly passive. They don’t work for their money. They put their money to work for them.  An investor isn’t a gambler, nor are they a speculator. Those folks are called gamblers and speculators.  The return on investment for an investor is based on the creation of value. That happens when you invest in a business, that business generates profit, and returns value to investors in the form of cash flow and increased valuation. In a liquid market, some of the value can be realized in the form of an exit, that is a sale. Trading isn’t investing. Trading shares is the same as trading tomatoes at a farmers market, or trading baseball cards at a baseball card convention. You’re buying assets at a lower price and selling at a higher price. The profit is made in the arbitrage. Imagine if you went into the farmers market and decided you were going to invest in tomatoes. Sounds like a strange thing to say and it is. There’s no way you could be investing in tomatoes in that environment. You could be trading tomatoes. That is not Investing. Let me be clear there’s nothing wrong with trading. Trading is perfectly fine. Only problem arises when you confuse trading and investing. If you think you’re investing and you’re really trading, you might be surprised by the outcome.

On today show we are talking about functional obsolescence. So what exactly is functional obsolescence? Those old 1950’s houses with the small kitchen that you can touch both walls when you stretch your arms out fully. You can put in new cupboards and appliances, but you will still have a tiny 1950’s kitchen. The functional flow of the home won’t match the needs of today’s modern family where the kitchen is the hub of virtually any home. Economic obsolescence is when the functional obsolescence is curable, but not practically curable due to the cost of making the changes compared with the cost of outright replacement.  Incurable obsolescence is when there is something about a property that simply cannot be fixed without a complete reconstruction. These are things like ceiling height. A modern office building simply won’t do well with an 8 foot ceiling height.

The US is building the most expensive wall in history. But it's not the one on the front page of every newspaper.  The proposed wall along the US Mexico border an expensive undertaking. The proposed budget allocation is a little under $6B. That’s a lot of money. In context, it represents less than 0.1% of total federal government spending. Spread over two years, it’s less than 0.05% of total federal government spending. It is a rounding error on a rounding error. When you consider the nearly 3.7M government contractors who haven’t been paid for nearly a month, the government has saved more than 21 billion by not paying those contractors in the past month.  Clearly the fight isn’t about money. Whether the wall gets built or not is largely immaterial.  The real wall that has already been built is inside the country. It’s the wall of political division, of hardened ideological positions. It’s the wall that exists when it becomes impossible to separate the message from the messenger.  If you represent my ideological adversary, my response to you will not be conditioned by what you say, but who you represent in the narrative that’s going on in my head.  In that world you might say something that I actually agree with, I’m going to disagree with you simply because you said it. In a world like that, there is no dialog, there is no listening. There is only confirmation bias, and distortion There is really only one way to destroy that wall. It involves listening. But before you can listen, you need to know all of the different forms of listening. You might think there is really only one form of listening. You’re either listening or you’re not. But in fact there are 8 forms of listening. 1. Ignoring listening You can talk all you want but nothing gets in. I am not interested in your problems, your requests, or your pleas. Don't talk to me I'm a cold brick wall. 2. Partial listening I'm listening as I do another task. I'm distracted. I may mumble a reply or absently nod my head.  3. Selective listening Selective listening involves listening for particular things and ignoring other parts of the conversation. We hear what we want to hear and pay little attention to or ignore parts of the conversation which we don't want to hear 4. Know it all listening As you try to tell me your story, I'm already filling in the blanks or offering your solutions. I know what the problem is and I have the solution. Stop talking already so you can go fix your problem and I can get on with the rest of my day. I've stopped listening and I'm thinking about what I'm going to say back to you. 5. Pretend listening I pretend to listen but have not intention of actually doing anything you say. I do not actually take in anything that you say. Are you finished yet? 6. Active listening I am engaged on our conversation. I paraphrase your words back to you and ask relevant questions. Some people think that active listening is the highest form of listening. It’s actually not.  7. Empathic listening I listen to go beyond sympathy for the speaker. I'm trying to truly understand how you are feeling, how you experience the world and events that unfold around you. Empathic listening means I’m willing to take a few steps in your shoes. It helps people feel heard and can be a corner stone to positive relationships. 8. Focused listening I'm listening to you and I want to make sure you are being understood. I want you to feel understood by me. I truly internalize and understand your words. I'm not offering any advice or solutions just fully listening.

On today’s show we’re talking about the news. I’m finding that in many cases the news isn’t really news. It’s not new enough to be news and it’s not old enough to be history. So what is it? It’s almost stuck in no-mans land. A lot of people, including investors rely on the news media to figure out what is going on in the marketplace. There’s no doubt that there is a lot of good content out there in the news. But there are a few problems with that process. As I’ve been working on the podcast for about a year now, I’ve noticed a few things: 1) The major news outlets can’t afford to focus on local. The audience is too small. The business side of journalism has changed so much that increasingly news outlets need to focus on a much larger audience. The best example of that is Jeff Bezos purchase of the Washington Post. He has used his knowledge of the internet to transform that newspaper from a local Washington print publication to a national online publication with over 12,000 pieces of new content per day. But the problem with appealing to a wide audience is that you end up quoting national statistics. As you know, real estate isn’t a national business. Its a local business. In fact its a hyper-local business. What’s happening in Pocatello Idaho is irrelevant in Chicago or Nashville. These outlets resort to reporting things that frankly is so diluted that it adds very little value. A story about interest rates which affects everyone nationally is about all they can truly report on that is of broad interest. I’ve now come to understand why the Wall Street Journal has such a dismal real estate section. But here’s the key. When I notice something specific in a local market, I’ll report it. While rent control in NY may not apply in Phoenix Arizona, there are political voices all over the country that agree with what is happening in New York. It’s local and specific, but it’s also universal. But you the listener have to connect the dots and determine if it applies. 2) In the process of creating the content, I have my finger on the pulse of what is going on in the marketplace. It doesn’t work for me to simply quote USA Today or the Globe and Mail on the podcast. I would not adding much real value if I did that. I’ve discovered that I’m seeing real trends by talking to other investors. I’m able to figure out what is happening in the market before it gets reported in the news.  This was illustrated very clearly with two episodes in the recent past. On January 4th I put out an episode on the impact that student debt is having on delaying home buying for the current generation of university graduates. This week, the Federal Reserve came out with a statement that also reported the same phenomenon.  In the past month I reported that one title agency in silicon valley had seen an 80% drop in closings in a month. That’s a huge shift in transaction volume in a very short time period. On Friday, the Wall Street Journal published a story that homes for sale inventories have risen dramatically in a number of markets across the country. In San Jose California, for sale inventories increased 131% in a month. My reaction to that story was “Of course. I saw that coming a full 4 weeks before it appeared in the news." I saw the student debt issue long before the Federal reserve came out with their report which was widely covered in the news.  The reason I’m telling you all this is because I’m not doing anything special except paying attention. If you’re a serious investor and you are in the flow of what’s happening in the marketplace, you don’t need to rely on the news to draw conclusions. You can rely on your own senses.   You will see things more clearly and sooner if you just trust your own eye sight and your own ears.  More importantly, you will see with greater clarity than any news outlet can give you. 

Deann O'Donovan is the CEO of AHP Servicing, a Chicago based company that specializes in rescuing distressed loans. The company is crowd funded and combines a unique business model and an innovative funding model. You're going to love this episode.

This episode was recorded live as part of a keynote address to a real estate investment club in Lancaster, PA. An audience member asked a great question on how to become a developer, and a followup question on how to create the track record to attract investment capital whether it is debt or equity.  Two great questions. Check it out.

On today’s show we’re talking about some of the excellent global research performed by accounting firm Price Waterhouse Coopers. Two days ago we talk about the worst asset class in the PWC survey, that is retail. Yesterday we talked about Warehousing and Fulfillment which are at the top of the PWC survey. Today we’re talking about senior housing. This is an area where my company is making major investments this year. The senior housing and care sector is still generating buzz, and frankly has been for several years. Who is investing in senior housing? PWC reported that debt providers set aside generous annual allocations. This is consistent with my findings as well. Virtually every lender I speak with mentions that they have a strong interest in senior housing. Nearly 60 percent of the three largest health care REITs’ investments are in senior housing. This year has seen a lot of new capacity. A wide 16-percentage-point difference exists between occupancy rates for the most occupied senior housing market (San Jose at 95 percent) and the least occupied (San Antonio at 78.6 percent). Much of the excess capacity has been built in Sun Belt cities like Phoenix, and parts of Florida. But this over supply is mostly in primary markets. Some secondary markets and tertiary markets have been largely ignored and are facing acute shortages.  We talk about senior housing as if it is a real estate play. It’s actually a service business with a real estate component. From an expense standpoint, the number one expense is staffing. In that sense senior housing looks more like a hotel than, say, an apartment building.  The second major challenge in senior housing is labor. Increasingly, operators are reporting labor shortages in all occupations, ranging from care managers to executive directors. In the last year, average hourly earnings rose 2.7 percent—up from 2.5 percent on average in 2017.  The key in senior housing in senior housing is attracting and retaining talent. Wages are part of the equation, but even more important are working conditions. That’s where we believe our senior housing model is superior not only for residents, but also for staff.  There’s no question that many of the major players have built new capacity ahead of the demand. Much of this new capacity has been in primary markets.  Taken in its entirety, it is a time for a cautious near-term approach in the senior housing sector. Currently, some operators face challenging market conditions since supply has outpaced demand. Operators and investors who underwrote deals with 90 percent or 95 percent stabilized occupancy rates a few years ago are facing pressures as they open into markets with 85 percent or lower occupancy rates. In a time of rising expense pressures, where average hourly earnings for assisted living operators are increasing at a 5 percent annual clip, achieving NOI expectations may be difficult. In fact, there was recently a highly visible bankruptcy of an operator in the San Antonio market. Many in the industry were surprised. Frankly I was not. Some of these new complexes are taking years to fill.  You’ve heard me beating the drum of the supply and demand, supply and demand. It’s crazy to me the number of people that only seem to analyze the demand side of the equation when making investment decisions. That’s very dangerous. On the other hand, investors who have partnered with solid operators located in strong markets are seeing outsized investment returns. Take a look at senior housing, but do so cautiously.

On today’s show we’re talking about some of the excellent global research performed by accounting firm Price Waterhouse Coopers. They recently published their latest prediction reports for a number of geographies around the world.  Yesterday we talked about the worst asset class in the PWC survey, that is retail. Today we’re going to the opposite end of the spectrum. It’s really a story about changes in the retail environment. Where there are changes, there are winners and losers. Retail’s loss is a win for warehousing and fulfilment.

On today’s show we’re talking about some of the excellent global research performed by accounting firm Price Waterhouse Coopers. They recently published their latest prediction reports for a number of geographies around the world.  The data reflects the views of individuals who completed surveys or were interviewed as a part of the research process. The data comes from 1630 people who responded to the survey or were interviewed individually. Over the next several days we’re going to pull out a few significant items that are worth noting from this 108 page report. The top areas for investment according to the PWC report are: Warehousing Fulfillment Workforce housing Senior Housing Midscale hotels Medical office I find it comforting that my company is currently investing in 4 out of the 6 areas listed as the top asset classes for 2019.  We will talk more about these other asset classes on future episodes. Today we’re going to zero in on the worst asset class on the list. Heading up the worst asset classes are virtually all forms of retail, with suburban malls and big box stores at the worst end of the list. The buzzword in retail is Experiential retail.  “You will see a lot more experiential retail. You need to give people a reason to go to a retail location.” So what is experiential retail? It combines an element of retail and entertainment.   A great example of that is  "House of Vans" in London. It certainly lives up to the company motto of being “off the wall”. Vans is a maker of athletic shoes that target the skateboarder market. House of Vans is a location where art, music, BMX, street culture and fashion converge, you can find almost everything you can imagine across the 30,000 square feet building. There’s a cinema, café, live music venue and art gallery, the bottom floor holds the most unique feature of the building; the concrete skateboarding bowl, mini ramp and street course. While some retail experts are claiming that experiential retail is the future, I don’t buy it. There’s no question that a few retailers will transform the buyer experience through innovations. That will no doubt help that specific retailer. It will do almost nothing to help The owner of retail real estate. The price per square foot you can get in rent as a retail landlord is a function of supply and demand. it’s very simple. If there is too much supply and not enough demand, prices will fall. Many businesses that have traditionally used a large format to carry local inventory are shrinking their foot prints.  When you extract the direct holding cost of the inventory, the cost of the real estate to house the real estate is a significant cost. By using warehouse space instead of retail space to store that inventory, retailers can experience the compounded savings of the higher storage density and the lower cost per square foot. Together the real estate component can be 50 x cheaper. That’s why e-commerce companies like Amazon can beat retailers with even higher shipping costs. They’re real estate costs are a fraction of the retailers.  That’s why I believe there will be a surplus of retail real estate for decades to come. When you obey the laws of supply and demand, the market will tell you what’s going to happen. 

I personally don’t have a political affiliation. Politics in both Canada and the US have become increasingly polarized in recent years. If you’re like me, where I’m fiscally conservative, and socially liberal on some items, but not all, there’s no political party that speaks directly to me. In fact, I would propose that most people don’t agree 100% with either of the political extremes.  One topic I’m particularly passionate about and you’ve heard me speak repeatedly is the topic of rent control. It’s not because I’m a landlord. It’s because history has proven time and again that rent controls don’t work. They don’t produce the desired results. Rent controls treat the symptom, not the root cause.  If properties are not affordable, it’s because the free market balance of supply and demand has pushed prices up.  Gov. Cuomo in New York delivered a blow to both landlords and tenants on last week by pledging an end to vacancy decontrol, a 24-year-old policy that has removed 150,000 apartments from rent regulations in NY state. Tenants will be celebrating, but only for a short time. The problem is that governments can’t compel investors to make investments where they will lose money.  But the entire state government — including the Senate and governor’s office — are now in Democratic hands, with newly elected progressives pushing for much stronger tenant protections. Cuomo responded “yes” when asked on WNYC radio whether he would sign a law to abolish vacancy decontrol if it passes the Legislature. He said “One of the big pieces in an affordable-housing program is going to be a reform of the rent regulations. It doesn’t provide additional units of affordability to the extent we need. I still believe in production and supply. But reforming the rent-regulation system, especially vacancy decontrol, can make a major difference.” Vacancy decontrol was implemented under GOP then-Gov. George Pataki. At the time, Republicans sympathetic to landlords had leverage by threatening not to renew the entire rent-stabilization law, which was expiring. Here is the story of a property located in mid-town Manhattan. It’s a 6-plex in the Murray Hill neighborhood on the east side. I took a close look at this property last week. This neighborhood is one of the more expensive areas in Manhattan. Here are the particulars on the property. It’s a 6 unit building. The building is fully occupied and the apartments rent at $1,136 per unit per month. This is an area where apartments routinely rent for over $4,000 per month. The asking price for the property was $4.5M. There is no way to justify the purchase of the property as an income property. The numbers don’t make any sense. The listing was being promoted as a development site with significant air rights above it. That means that someone could theoretically go vertical, or buy one of the neighbouring properties and combine it with this property. That might create a large enough floor plate to build an actual apartment building with some scale. On its own, it made no sense as an income property, and it barely made sense as a development site. If that property sells for anywhere near the $4.5M asking price, it will be redeveloped into a condo building, and those affordable units will disappear from the market forever.  I was in New York last week speaking with lenders and hedge fund managers. I heard about several rental property  transactions scheduled to close in the next 60 days were cancelled by the lender. The lenders are not willing to put money at risk when the math doesn’t work. We know that under rent control, assets degrade in value. The lenders I spoke with don’t want any part of that.  Government can’t mandate banks to approve a loan that is too risky. If there isn’t financing for these income properties, they will get redeveloped. There is really no choice for a property owner.