On today's show I'm answering questions on capital raising because it's not easy to raise funds if you've never done it. 

Today's talk was recorded live in Lancaster Pennsylvania. We're talking about the laws of supply and demand. 

Today we're talking about the Inflation Deflator.  The rate of inflation in the US, Canada, Europe and much of the industrialized world is reported by each respective central government. These statistics follow a methodology that is publicized, but highly complex and rather difficult to understand. The measure of price inflation is the consumer price index. In the good old days, the statisticians followed a simple process of comparing the price of a basket of goods over time.  Over the years, governments have made small tweaks to the inflation adjustment.  We’re being told today that inflation is very low, in fact worryingly low. Governments in Europe, the US and Canada have set a 2% target for inflation. But I’m not sure that governments are being fully truthful with the numbers they’re reporting. I’ll give you an example. Most educated people would agree that there is a link between the price of energy and the cost of goods. From December 1 until today, the price of oil has gone up 39% in the past 5 months. Shockingly, the US Bureau of Labor and Statistics reported that inflation in Q1 was a stunning 0.9%. This past week, I paid $6 for a bunch of celery. Yes, we are in the middle of spring. This is not the time to be harvesting celery. So it’s being shipped from a long way away. Much of our produce during these months comes from Mexico and South America.  So the price of energy is a significant component of much of what we consume. So how is it that items like celery can cost $6 and yet the inflation index is running at 0.9%. It turns out there are numerous adjustments that the government applies. The first is the so-called seasonal adjustment. If prices are expected to fluctuate with the seasons, then those seasonal fluctuations are removed from the inflation number.  Since many government costs like social security, hourly wages of government workers are tied to the rate of inflation, a lower reported rate of inflation means the government saves a ton of money The measurement of gross domestic product is based on adding up all the economic activity in the economy and comparing it to the previous period. If the number is higher, then the economy is said to have grown. But in the presence of inflation, we would need to subtract the rate of inflation from the measurement of GDP. Otherwise we would have a false GDP measurement. So we take the nominal GDP measurement, subtract inflation, and we get the real GDP measurement. But if the inflation is understated, then the real GDP is overstated. Governments like to report economic growth. It’s one of the measures that they use to show the voting population how great a job they’re doing.   There are several more adjustments applied by the statisticians in addition to the seasonal effects. The second is something called substitution. This is based on the concept that if the price of a Lexus goes up, consumers will switch to a cheaper Toyota. The third is the concept of imputation. This is where there is no actual economic activity. So the Bureau of Labor and Statistics assigns a value to the contribution to the economy, even though no money changed hands. The largest and most questionable of these measures is the concept of imputed rent. If you own your own home and do not rent, the government adds in the value of the rent that you should have paid if you were renting. The fourth sleight of hand is in fact weighting. This is where they determine how much of the CPI should be attributed to each part of the household expenditures. Today, healthcare makes up about 8% of the consumer price index. But healthcare actually makes up closer to 18% of the US economy. The final and most outrageous adjustment is hedonics. These are the arbitrary price adjustments the government make to suit their rationale. 

Today’s episode is another AMA episode. That is ask me anything.   Dominic asks While I am new into real estate investing, I do have prior business experience. I am primarily interested in passive investing, for now, with a main interest being multifamily projects. With that in mind, your podcast “Money without a clue” really struck a chord with me. I have been listening to fundraising conference calls, reviewing the operating agreements, and so forth. I go through my due diligence checklist and my personal investment criteria. If things look promising, I ask questions to clarify any outstanding issues. I am new, so this process takes me a few hours, and ideally I like to sleep on it before I wire $100k. But what do you do when there are so many gamblers at the table who are apparently not doing any due diligence? Much like the lady you mentioned in your podcast. It seems that many deals that I’m seeing are subscribed before the conference call is held. On the basis of a few lines of information and no specifics. At any rate, I thought I would reach out and ask your take on this. Perhaps the same question has occurred to other listeners. Dominic, thank you for an excellent question.  It is true that there is a lot of money sitting on the sidelines these days. That money often gets deployed quickly when a good opportunity comes along. What you will probably discover is that the people who move quickly on opportunities like the one you described are not in fact gamblers, although there could always be a few hiding in their midst. I suspect that what you are seeing are people who have made repeat investments with the same deal sponsors.  I know from my own inner circle of investors that once we have returned capital to investors several times, they get to know us. They understand how we underwrite our projects. They have seen our legal agreements before and have completed due diligence on us as a team.  I know that if I’m looking to raise money quickly, I’m going to call people who have invested with us in the past. I’m going to see if there is a fit between our near term requirements and the funds they have available. It’s pretty common for me to raise funds in a couple of days in that type of situation.  But if I’m working with a new investor, it could take much longer. When I say new, I don’t mean that they’re necessarily a rookie, they’re just new to us. They haven’t invested with us before. In that situation, I will suggest that the investor put in the minimum investment, or in some cases I’ll suggest an amount that is even below the minimum investment, simply to start the relationship building process. I consider an investment of this type to be a get acquainted round of investment. Even with a large investor I often suggest a small initial investment to get acquainted with one another. I as a sponsor will have qualified the investor on the first engagement and the process for making subsequent investments is much faster. Both the investor and the sponsor of the project know what to expect.  If you’re having trouble getting into a deal, my suggestion is that you speak with sponsors who look like they might be a good fit for you. They may not have an open opportunity right at this moment. Ask to see their last representative deal and ask to go through a partial due diligence with them so that you could be ready for an upcoming project when it becomes available. You will have qualified them, and they will have qualified you. You can do all the reference checks you need to in the un-rushed comfort of a no-deal situation. 

The book of the month this month is "The Miracle Morning” by Hal Elrod.  Hal is a human enigma. He’s the cat with 9 lives. When he was 20 years old, he barely survived a car crash that should have left him crippled for life, and with permanent brain damage. After six minutes with no pulse, he was brought back to life, evacuated by helicopter to the hospital. After six days in a coma he awoke to his new reality in hospital. He would be crippled for life. Instead, he made a decision to control his emotional state. From that launch pad, he was able to reprogram his life narrative and physically, mentally, emotionally, and financially put his life back together.  So much of life’s success has nothing to do with what actually happens to us. Our perception of what it means is completely of our own creation. Hal is living proof of that.  We are all born with many things in common. One of them is the innate desire to grow, to improve our lives and ourselves.  Hal figured out while he was lying in the hospital bed staring at the ceiling, that he alone could control his mental state, not his circumstance. He knew that he had a steep setback to overcome. If he was going to truly overcome his predicament, it would take an extraordinary series of steps. One simple change was unlikely to be enough to have a measurable impact. So he made a decision to combine the best practices of several practices into a single intense explosion of activity to start his day.  His doctors thought he was delusional. He was not supposed to be able to walk again. Only weeks after his accident, he started taking the steps that would ultimately regain full physical ability.  Years later after writing the book, Hal suffered another major setback. He recently was diagnosed with a life threatening form of cancer and only given a few weeks to live. Here again, Hal dug deep into his archive of knowledge about how to control his mental state. He combined a healthy lifestyle, the cocktail of drugs the oncology threw at him, and the practices of the Miracle Morning. Hal should not be alive today.  At one point in his career, Hal faced near financial ruin. Strangely, he found that experience more difficult and more isolating than his real near death experiences. There is really something to managing your emotional state.  Hal made the decision not to focus on loss, on the bad things. He decided to focus 100% on making the best of what he had. He could not change the past. He could only move forward, and he dedicated his life to fulfilling his potential. The book is based on the core principles. You are just as worthy, deserving and capable of creating and sustaining health, wealth, happiness, love and success in your life as anybody else on earth In order for you to stop settling for less than you deserve, you must dedicate time each day to becoming the person you need to be, one who is qualified and capable of consistently attracting, creating and sustaining the levels of success you want. How you wake up each day and your morning routine dramatically affects your levels of success in every single area of your life.  Simply by changing the way you wake up in the morning you can transform any area of your life faster than you thought possible. 

Today’s show is about how a bad appraisal can adversely affect your business.  Appraisers determine the value of your property in the eyes of a lender and they help the lender independently justify the loan to their loan committee and to the bank regulators. This independence prevents the kind of loan manipulation that unfortunately became far too commonplace in the 1970’s and 1980’s.  The banks have the right to choose their appraiser independently, and the borrower is not to influence the appraisal process. There is a significant incentive for the borrower to get a high number for their appraised value. The higher the number, then perhaps the more the bank may be willing to lend. If the appraised value is artificially high, then the bank ends up taking on much more risk. Appraisers use three principal methods to value a property. These methods are: Replacement cost Multiples of net income Comparable sales Generally speaking, the appraiser needs to apply their professional judgement on which of the three methods to give the greatest weight to. If the property is unique and there are no comparable sales, then they may have to rely on one of the other methods. If the property has no income yet, then the income multiples method doesn’t apply. If the property consists of vacant land, then the construction cost won’t apply. On today’s show, we’re going to focus on what to do when the appraiser for your lender gives a value that is far from what you believe the true value of the property to be. There can be several reasons why the appraiser comes to a surprising conclusion. In 2017, many cities started accepting carriage houses as legal accessory dwelling units. These separate buildings would be treated the same as an in-law suite located in a residential home. Here too, there were few if any examples in the market, and appraisers struggled with how to value them. They had no comps. None of the appraisers I spoke with were willing to blaze a trail and take the personal risk of setting price precedents in the market.  In another case, an appraiser valued a parcel of land as if it was agricultural land, instead of valuing it with the improvements that had been approved by city council. It happens that sometimes you get a bad appraisal. It first happened to me back in 2012. The result was that instead of a refinance taking 3 months, it ultimately took 9 months and three separate lenders to complete the transaction. Bad appraisals were at the root of the issue in each dead-end loan application.  So what can you do to prevent a bad appraisal? As a property owner, you don’t get the opportunity to direct the appraiser. They have to do their work independently.  However, I believe it is perfectly fair to show the lender your analysis at the start of the project. To show the lender you’ve done your homework and that you have a good understanding of the market. Include all of the relevant data in your executive summary that forms part of your loan request. Not all real estate transactions are advertised on the MLS. Private sales which are transacted outside of the public eye are no less real. They too should count when considering the landscape of transactions considered in the market analysis. You can include all those off-market transactions that you might be aware of that the appraiser is unlikely to find because they’re not advertised.  The impact of a bad appraisal can be significant delays. It can put a borrower in the impossible situation of having to seek an emergency extension of a loan while they complete a refinance. Show the lender your analysis and it may increase the chances of a fair and accurate appraisal.

Today’s show was inspired by something that happened recently. I was at a party and I met someone who said they knew who I was, but I didn’t know them. That happens often when you speak frequently as I do. She was asking me about the projects we have underway. She was telling me about the ideas she had for flipping houses in our local market, something she had never done before. The ideas she was suggesting sounded risky to me. The path to success is filled with land mines and she really would need to work with someone who has a lot of experience and help her avoid the many pitfalls along the path. At that point she offered to invest passively with me in some of my projects. Now I don’t know if she would even qualify to invest in our projects. That’s not the point of the story. The point is that it was clear to me that she had not developed a clear idea of what constitutes a good investment. The idea that she would part with large sums of money without having that clear criteria is the part I found disturbing. Sadly, I encounter this situation very very frequently. So on today’s show we are talking about the importance of developing a clear investment criteria. Making an investment decision requires discipline. It requires a formal due diligence process. I see of people making insanely rash and poor investment decisions all the time. Frankly it’s hard to stand by and watch it happen.  Due diligence requires a separate focus on three areas. These are: The local market conditions  The people running the project  The specifics of the deal itself.  The idea here is that you develop your own due diligence checklist. The step that most people miss in that exercise is to have some clear pass/fail criteria for each of the checklist items.  I look at the overall supply and demand situation to confirm that the market conditions are truly favorable for investment. If there is much more supply than demand, it’s going to be difficult to create value in the market. Business is all about solving real problems. If there is excess supply, whether it is because people are leaving or it has become overbuilt, the outcome is the same. If there is an excess of supply, there’s no reason to invest. When it comes to the team, I look deeply at the people who are sponsoring the project. I look at their track record. I want to see projects that have experienced adverse situations to see how the team handled those situations. The deal itself also has to meet very specific criteria. My own due diligence checklist consists of about 60 items. Your list doesn’t need to be excessive. But I believe a due diligence list of between 40 - 60 meaningful questions is about right.  The questions should be categorized by grouping. Within each subset list some questions can allow for some grayscale in the answers. Others will require a black or white binary pass or fail answer. If you color code the answers to the checklist you will be able to see in a couple of pages whether the deal is going to work or not. You will see if there are a few solvable problems, or if there are too many problem areas to overcome. If the problems are confined to a few areas. You may be able to have a meaningful negotiation with the deal sponsor. Maybe an additional piece of collateral, or an additional process step can eliminate a risk item. Ask other more experienced investors to review your checklist and provide both ideas and input.  It will take several iterations to develop a checklist that you feel truly confident in. You may refine that checklist over a period of months or years. That doesn’t mean you should wait until the checklist is perfect before you make an investment. But the simple act of having a checklist and a defined process for making decisions will put you ahead of the vast majority of investors. 

Patrick Francey is CEO and Managing Partner of The Real Estate Investment Network. He can be reached at reincanada.com. 

Matthew Sullivan is the CEO of QuantmRE.com, a firm that specializes in a different form of financing for property owners. Chances are that you've not heard of this business model before. It's a fascinating twist on how to take advantage of the equity in a property.

We tend to think of most investors as rational beings who think through each situation and look for the best economic solution for a given investment.  But if that were true, there would be very few good deals on the market. There must be something else in play.  The root cause of good deals is a human emotion called pain. There are two types of pain. There is acute pain. This is the kind of pain that results when you hit your thumb with a hammer by accident. In that moment, the throbbing pain in your thumb is all you can think about. Your child asking for an ice cream cone won’t get your attention. The phone ringing won’t get your attention. Your entire world is your thumb.  That’s acute pain.  The second kind of pain is chronic pain. This is when you have a pebble in your shoe. It’s annoying. You might limp a little or rotate your ankle a certain way to avoid the pain. But it’s not bad enough to consume you. It’s not even bad enough to get your focused attention.  Chronic pain is not usually enough to cause people to take action.  So what does this have to do with real estate? One of the fundamental human needs is for certainty. If a human is experiencing financial stress, they are probably experiencing uncertainty along with it. They might be able to pay the bills this week, but what about next month? What if there’s an emergency? Will they have the funds to cope with an emergency, even a small one?  That feeds directly into their decision making process.  Let’s look at a purely fictitious example. Let’s say Fred owns a couple of rental properties. His wife is undergoing medical tests and may have to take an extended medical leave of absence depending on the outcome of those tests. He has a decent amount of equity in the rental properties, but they have not been producing a lot of cash flow. In fact, he recently had to replace the water heater in one home, and the air conditioner in another. Then Fred gets the news that a tenant is going to be moving out. That’s going to mean spending more money on paint, cleaning, carpet replacement and dealing with at least a month of vacancy. Fred is feeling financial stress.  Fred decides that he’s going to sell one of the homes. We think that investors make rational decisions that are based on maximizing investment returns. But in Fred’s case, his return on investment isn’t even on his radar. His over-riding concern is bringing certainty to the situation. That’s more important to him at that moment than maximizing his return. He is experiencing acute emotional pain. That pain isn’t real. The origin of that pain is his own mind. He doesn’t know what’s going to happen. His wife might be fine. He might find a tenant quickly who is looking for a home in a great location. But Fred is consumed with fear. His mind is projecting into the future all the things that could go wrong and he is experiencing them very vividly as if they are happening right now.  Fred probably won’t even evaluate a spectrum of solutions to his financial predicament. He could refinance one of the properties. But he doesn’t know how much more equity he can pull from the property. He’s pretty sure he can get some, but will it be enough? He is likely to pick the first solution that will restore financial certainty to his life.  The marketplace is full of vultures who are waiting to pounce all over guys like Fred and take advantage of them. They’ll play mind games with them and further exploit Fred’s fragile emotional state to get a lower purchase price. Fred is what the vultures call a motivated seller.  Make sure you are sitting on some cash and have the ability to maintain financial certainty for yourself, and have the ability to restore financial certainty for someone else should they need it.

Last week I was in Toronto and my meeting was right downtown. Hotels were incredibly expensive, and the hotel where my meeting was being held was advertising rooms for $600 per night. So rather than stay near the airport and fighting rush hour traffic, I decided to look at short term rentals. I came across a listing for a penthouse apartment that was only two blocks from my meeting in the downtown. Better still, it was only $78 per night. The chances of finding a comparable hotel offer were pretty slim. So I jumped on it and seconds later I had a firm reservation. When I received the information about the accommodations, there were very strict instructions to enter the building only through the parking garage, and not to interact with the building’s concierge staff. Under no circumstances should I mention Air BnB. The key was located in the laneway behind the building in a lock box. The instructions for locating the key were pretty clear. There was nothing saying explicitly that I was in a prohibited short term rental. But I suspect that I was. I am an owner of short term rentals. I do this as a business. So staying in another short term rental was interesting from the perspective of someone who is in the business. This particular unit did not live up to the standards of what we provide our guests. The unit was clean and everything was in working order. I have no complaints. But the apartment was minimally furnished. The quality of the furniture was minimal. The apartment had not been painted since construction and had the original builder’s white paint on the walls. There were no decorations or art work. It looked very bare. Definitely not the kind of product we would offer our guests. But the location was amazing and the price was right. Short term rentals have been controversial in many cities. In Toronto, there are new rules that govern short term rentals. But the city has said they’re not going to enforce them until late into 2019, and only after the next consultation hearing which is scheduled for August. The owners who claim a right to rent to whoever they want often do not realize that they are not just renting out their unit.  They are, in effect, renting out the common elements and all of the shared facilities.  The other occupants now have to share the lobby, pool, sauna and gym with strangers and have to deal with increased traffic in their garage. The guests are not informed of the condominium rules and by-laws, and they often impose an additional burden on the rest of the building residents. They are less invested and less concerned about the security and comfort of the rest of the occupants.  After all, they view your home as a hotel. One building in Toronto sends a legal letter to owners who violate the rules of the condominium corporation. According to the bylaws of that building, the condo board has the right to charge the owner for the legal cost of preparing each letter. This can amount to $500 - $600 per letter. Some home owners simply choose to pay for the cost of the letter and keep doing what they’re doing.  All of my short term rentals are zoned for short term rentals. They are in buildings that embrace short term rentals, and they fully comply with all the rules for short term rentals. There’s no grey zone, no bending of the rules, and no breaking of the rules. If you’re going to be in business on a sustained basis and you’re truly a professional, how could you imagine to do anything otherwise?

On Monday the Social Security Administration issued their annual report. This story was relegated to a back page of the paper. Somehow the one and only story that’s going to affect every person in the country was less important than the optics of Mike Pence’s tax returns, which ultimately affects nobody directly.  This 270 page report lists a number of issues. I’m going to read directly from the report and expand on some of its findings and what it means to us as real estate investors.  When social security was brought into being by Congress on August 14, 1935 and then president Roosevelt signed it into law. At that time there were 13 people in the workforce for every one person who would ultimately collect on social security benefits.  The average life expectancy in the US was 60 years of age in 1935. Today average life expectancy is 78 years of age. Today there are 2.8 people in the workforce for every person collected social security benefits. Over the next decade, the number of workers to beneficiaries is expected to decline from 2.8 today to 2.3. We will have fewer people contributing and more people collecting, a lot more.  Together Social security and medicare accounts for 45% of US Federal Government Spending. Interest on the federal government debt accounts for 13% of spending, and military accounts for 17% of total spending.  Last year 63 million people received social security benefits. 47 million retired workers and dependents of retired workers, 6 million survivors of deceased workers, and 10 million disabled workers and dependents of disabled workers. We have known for some time that social security is running out of money. It’s been reported for years. It’s not a surprise . It’s simple demographics. But by law, the social security administration is limited in how it can invest its approximately 3 trillion dollars in reserves. That nest egg is expected to be depleted over the next 15 years to zero. The interest it earns on that 3 trillion dollars is a measly 2.8%. The only investment approved by the social security legislation is for the administration to invest in US treasuries. That’s right, the only permitted investment is US government debt. Let me get this straight. The US government prints money, then pays interest to itself on the money it printed in order to help fund its obligations. Does anyone else see a problem with this logic? As investors, I expect that virtually everyone listening to this podcast knows how to consistently earn more than 2.8% on their money. The private sector knows how to do this with a high degree of confidence.  So let’s look at the options available to the government. I don’t envy those in government. They really don’t have a lot of great choices, regardless of who is elected.  They can increase taxes. They can lie about inflation, by under-reporting the real rate of inflation and thereby reduce the actual cost of living adjustments. That means that as time goes on, the revenue increases with the real rate of inflation and payouts are indexed to the reported rate of inflation which is less. That’s a way of reducing benefits without changing any existing rules. Or they can do the politically unpopular thing and explicitly reduce benefits. They could do this by raising the age of eligibility as has been done in many European countries, or by reducing the actual amount paid out. They could redirect revenue from other sources into social security. Finally, they could change how they invest the remaining 3T dollars and hope for a higher rate of return on their money.  That’s about it. There aren’t really many choices left.  Politicians are still 15 years away from the system being completely 100% bankrupt.  I predict they will kick the can down the road again.

Virtually everything we buy emits sulphur to get it to the destination.  On today’s show we’re talking about a major shift in shipping that is not capturing major headlines, but will have a significant and measurable economic impact on global trade. 90% of the world’s trade is carried by ship. So anything that affects shipping is going to have an impact on the global economy.  One of the least regulated and dirtiest fuels has been the fuel used by cargo ships around the world. New global environmental regulations are requiring ships to use low sulphur fuel and ships are being forced to reduce their emissions starting Jan 1, 2020. Low sulphur fuel is more expensive than the predecessor bunker fuels.  Most bunker fuel burned on ships is derived from the left overs, from the ”residue" that remains after all of the more valuable light fuels such as gasoline and diesel have been removed from crude oil in a refinery. The tighter pollution rules by the International Maritime Organization, called IMO 2020, are set to take effect Jan. 1, 2020, resulting in the sulphur content limit of "bunker" fuel on ships dropping from 3.5 per cent to just 0.5 per cent. That means ships will have to either switch to alternative fuels, which could include marine gas oil, liquefied natural gas or biofuels, or install scrubbers to remove sulphur from exhaust gas. It is estimated he emissions mandate taking effect at the start of 2020 will affect at least 60,000 vessels and cost the industry up to $50 billion, according to shipping industry insiders. Cargo owners expect a significant jump in freight rates, which over the past five years have been hovering below break-even levels for vessel operators as a result of a glut of ships in the water and numerous price wars. “If the extra costs related to low-sulphur fuel go to shipping companies and end there, it would result in bankruptcies,” according to Soren Skou,  CEO of Moller-Maersk A/S, the world’s biggest container ship operator. Shipping executives expect to pay 25% to 40% more than they pay for bunker because of the higher cost for producing the fuel and setting up new distribution sites.  Be prepared for economic impact that will be either reflected in higher shipping costs, and ultimately higher prices at the checkout. 

This weekend I spent a couple of hours in a flight simulator. My sister is the chief pilot for a major executive jet manufacturer.   Together we practiced take-offs, landings, ground taxi, instrument landings, avoiding thunder storms, low ceiling conditions, cross-winds, and engine fires. I’m talking one of those $20M machines that is cheaper than the $80 million dollar aircraft it imitates. It sits in one of those large bays with a 60 foot ceiling. Every aspect of the aircraft’s cockpit has been replicated. The outdoor view of the windscreen was incredibly realistic. The avionics, the seats, the power systems, the air vents, the communications systems, the landing gear. Everything was made to feel and sound like the real aircraft. When you lower the landing gear, the sound of the wind rushing past the the open wheel bay is clearly audible in the cockpit, just like on the real aircraft. The entire simulator is on 3 axis hydraulics and is capable of replicating most of the physical aircraft attitudes.  When you taxi on the ground and the turn is too radical, you feel the forces and the skidding of the nose wheel.  If there is a rut on the runway, you feel it in the shaking of the entire simulator. When you make mistakes, the systems on the aircraft. When my son simulated a landing with an engine failure, the hard landing was physically jarring, just like a hard landing on a real aircraft.  Pilots use simulation to replicate test conditions that are not easily found in the real world. If you are training and practicing how to land with a nose gear failure, the simulator is the perfect tool. Using the real aircraft would be difficult, unsafe, and incredibly expensive.   The learning process requires us to make mistakes. That’s how we learn.  I was on a final approach and my sister advised me to pull up. Her direction put me above the glide slope. It was her mistake, but it could have been mine. We reset the simulation about 4 miles back and re-ran the landing sequence. When I had control of the aircraft, I was routinely making small mistakes in controlling the aircraft. But I was able to correct them easily and the consequence of these mistakes was that I made fewer and fewer of them as I improved.  Flying a plane is full of metaphors for real life.  On the investor summit at sea, we had a group of about 40 people playing the game Cash Flow together, under the direction of Robert Kiyosaki, the inventor of the game. Cash Flow is a simulation.  It gives you the chance to make offers on properties, to borrow funds, to sell assets, to spend money on luxuries, all the things that are present in real life. In the game, errors in accounting cause delays in the game, just like in real life. In the simulation, the increase in interest rates can cause financial hardship, just like in real life.  In the game, some people thought the idea was to compete against the others, more like in the game monopoly. They were going to do it all by themselves. Others had the idea to collaborate and help each other. Just like in real life, whatever beliefs you have at home show up in the game as behaviours, and they show up in business. How often do we run simulations in our own business to train ourselves? I see rookie investors go out and randomly buy a property. There is little in the way of guidance. It reminds me a lot of jumping into the cockpit of a live aircraft with little to no instruction, and hoping for the best. 

Peter Schiff is a well known author, economics commentator, fund manager, and radio host. His show, the Peter Schiff Show is consistently among the top business and economics shows. He's a frequent guest commentator on TV. He's the principal at schiffgold.com and now lives in Puerto Rico with his wife Lauren and his two children. 

Brad Smotherman specializes in notes and creative financing. His take on how to use creative financing to generate revenue streams out of properties that are in financial distress is utterly fascinating. You will definitely want to pay close attention to what Brad has to say. You can reach Brad at bradsmotherman.com.

How would you like the government has your home ownership partner? This week the Canadian government announced a new program that as far as I know is the first of its kind in the world. The measure would make it easier for first time home buyers with household incomes less than $120,000 per year to buy a home. But in this case, the government would register a lien against the equity in the home, and not just the debt.  Under the program, the buyer would bring a 5% downpayment in the form of equity. This is the same as the ratio loan currently offered by our federally owned mortgage insurer. The Incentive would allow eligible first-time home buyers who have the minimum down payment for an insured mortgage to apply to finance a portion of their home purchase through a shared equity mortgage with Canada Mortgage and Housing Corporation (CMHC). It is expected that approximately 100,000 first-time home buyers would be able to benefit from the Incentive over the next three years. Since no ongoing payments would be required with the Incentive, Canadian families would have lower monthly mortgage payments. For example, if a borrower purchases a new $400,000 home with a 5 per cent down payment and a 10 per cent CMHC shared equity mortgage ($40,000), the borrower’s total mortgage size would be reduced from $380,000 to $340,000, reducing the borrower’s monthly mortgage costs by as much as $228 per month. Terms and conditions for the First-Time Home Buyer Incentive would be released by CMHC. CMHC would offer qualified first-time home buyers a 10 per cent shared equity mortgage for a newly constructed home or a 5 per cent shared equity mortgage for an existing home. This larger shared equity mortgage for newly constructed homes could help encourage the home construction needed to address some of the housing supply shortages in Canada, particularly in our largest cities. The terms of the announcement are not completely clear. From what I understand, Functionally, it's more like an almost interest-free loan — one where the repayment plan doesn't require any payback until years in the future. The Government budget document is far from clear on how much the buyer would owe; is it the same dollar amount the CMHC provided up front, or does the bill go up based on how much the house has appreciated in value?  Government officials say details of the plan will be hashed out in the coming months. I really don’t know how I would feel about having the government own a portion of my home. In my case, I am not eligible for this program because I’m not a first time home buyer. 

David from Seattle asks. Your recent episodes on the Fed and the worrying size of their balance sheet are timely but also quite unnerving. Given the potential strong inflationary pressure in the coming years, two popular hard assets come to mind: gold and real estate. In terms of cash flow, gold bars generally don't cash flow, whereas apartments can cashflow very well. Moreover, fixed rate mortgage carried by most real estate also works for the owner under high inflation. On the other hand, physical gold is free of counter party risk, whereas real estate might have some limited counter party risk (e.g. from the mortgage). Which one is "better" in hedging against inflation? How should investors think about their asset allocation between gold and real estate as we head into inflation or even stagflation?  I like how you've addressed gold and real estate in depth separately in many other episodes. I know quite a few investors have this gold vs real estate debate, and hence the question. David, that’s a great question. I’m left feeling like it’s a little like asking which is better for you Broccoli or Tofu. The truth is you need both vegetables and protein. It’s not really a choice between one or the other. Rather it’s a question of proportion.  You are correct in stating that gold has no counter party risk. For those who don’t know or don’t remember what counter party risk is. If I loan you money, that loan shows up as a liability on your balance sheet and as an asset on my balance sheet. However, it remains as an asset as long as you repay. That asset is said to carry counterparty risk. The reason the financial system nearly collapsed in 2008 was because of counter party risk. Holding the physical metal has no counterparty risk. If you hold gold certificates, you are holding a claim on gold. That claim is subject to counterparty risk.  In terms of creating long term wealth, real estate is an effective hedge against inflation. As you pointed out in your question. I firmly believe that governments are under-reporting inflation. Not only are there multiple reasons for them to do so, there is ample evidence that they are in fact under-reporting inflation.  We don’t typically leverage our ownership of precious metals. Whereas real estate is much better suited to leverage. Here too, the leverage must be responsible. Too much leverage would expose you to financial risk. But generally speaking, with income producing assets, leverage can be your friend. Inflation increases rents. Inflation pumps up asset prices.

On today’s show we’re talking about a strategy for creating value in expensive markets. In some of the most expensive cities in North America, cities are increasingly charging development fees or impact fees for new construction. These fees pay for paving new roads, for the cost of expanding water, sewer and public transit infrastructure. The rationale is that urban expansion costs money long before the new properties are completed and contributing to the expanded property tax base. So development charges, levied against the developers makes sure that the cost of these expansions are covered by those who stand to profit the most from the growth. In these expensive markets it can sometime be difficult to make the numbers work for new construction. When you add the cost of the development charges, a new home can be extremely expensive compared with resale homes in the marketplace. This is particularly true for the smaller player who doesn’t have the economies of scale of a larger builder. The methods to make money in these conditions requires much more creativity than a simple flip project.  The first strategy is the increase density with accessory dwelling units, sometimes called in-law suites. This might be a basement apartment, or sometimes a carriage house if your local zoning allows for a separate building on the property that takes its utilities from the main house.   But remember, the development charges only apply to an increase in density. If the property had a single family home on it, and the finished product is still a single family home, then no development charges apply. You haven’t increased the density.  Some single story ranch bungalows simply don’t have the flexibility to be transformed into a modern home that the market would embrace. Many investors consider a complete tear-down and rebuild if the existing home is functionally obsolete. There is a middle ground solution that can save a lot of cost and still deliver a new home. That is the so-called pop-top. This is where you cut off the roof, demolish the interior and utilize the existing foundation and footprint of the home as a basis for a new two-story home.  You get to re-use the foundation which saves about $40-50k off the cost of construction. By re-using the utilities coming to the home, you save about $20k-30k in utility servicing costs. Compared with new construction, the savings of the foundations and utilities can generate considerable profit for the home builder.  The ground floor layout will be completely redesigned. You can create large open spaces that are consistent with a new home of today’s vintage. The structural supporting walls, columns and beams for the upper level can be easily incorporated at this time. The second level will house the bedrooms and bathrooms.

Today’s show is focused on the consequences of the shrinking middle class. If you go back to the 1960’s and 1970’s it was possible for a single income family with blue collar employment to join the ranks of the middle class. Today, the number of two income families has grown and families are finding it harder than ever to make ends meet. The shrinking middle class has enormous economic and social consequences. It’s has given rise to a new wave of socialism as the average person feels like they’re getting the short end of the stick.  The Organization for Economic Cooperation and Development defines the middle class as comprising households with incomes between 75% and 200% of the median. Across member nations, the proportion of the population who are in the category has fallen over the last 30 years, from 64% to 61%. Today the middle class makes up 50% of the population.  That definition of middle class doesn’t really tell the full story. It neglects family size and local cost of living. The fact is there has been an continual erosion of our purchasing power over the years. Those on fixed incomes are the ones who are losing the most. We can learn a lot from history. We are facing a growing class warfare where those with less blame those with more for their situation and for exploitation.  I don’t believe that entrepreneurs are to blame for the plight of those who are struggling. Entrepreneurs and business owners struggle too. The vast majority of them suffer setbacks on a regular basis. Only a few manage to rise above water to build sustainable businesses and sustained wealth. The problem with the tax the rich approach is that it works to a point. Once you reach a threshold of pain, the ultra-rich have the financial means and the incentive to organize their affairs in a manner that legally minimizes their tax liability.  Many will simply relocate to a lower tax jurisdiction.  There is no question that people who have succeeded in business have attracted envy, admiration, and most importantly jealousy. It’s that jealousy, combined with the genuine hardship that many families are experiencing that has fuelled the latest round of anti-rich sentiment. Increasingly, newly elected left leaning politicians want wealth taxes, dramatically higher income taxes, corporate taxes, surtaxes, and so on.  The amount of economic activity has been a larger contributor to tax revenue than the actual tax rate. As individual investors we don’t control the political climate, nor do we control the tax rules.  Entrepreneurs generate economic activity, they give people employment, they create better living spaces for families to grow and thrive, and they should be rewarded for taking those risks along the way.  The tax code does not tax you on your income, it taxes you on the manner in which you receive your income. Pay close attention to not only your income, but how it comes to you. Be prepared for lots of changes to the tax rules in the coming years as governments become increasingly desperate and creative for ways to pull more revenue.

Today is another Ask Me Anything episode. Robin from Ottawa asks. “How do you build relationships with high net worth individuals? In your book Magnetic Capital, this is one of the primary factors you touch upon. Let's say you meet an individual at an event and exchanged cards/contact information, what are the next steps?“ Robin, This is a great question. It’s one that I get frequently. In fact, if I do an updated edition of Magnetic Capital, I will certainly dedicate an entire chapter to answering that question.  Let’s go back to the fundamentals of raising capital that are clearly outlined in my book Magnetic Capital. Relationship Trust Results Compelling Opportunity Alignment  If you don’t have a perfect fit between the goals for the money and the goals for your project, it’s not going to work.  The main thing to remember about high net worth people is that they are people too. They have different perspectives and different values because of their circumstances. They recognize that their most valuable resource is not money, but time. As a result, high net worth people tend to be much more time conscious than the average person. They don’t want to develop relationships with people who want them just for their money. They don’t want to be used.  They also don’t want to waste time with people who can’t help them with their mission.   High net worth people are slow to develop relationships. High net worth people know how to make money. They know how hard it is, and they don’t want to have to go back and do the hard work to make it back. As a result, they are much more focused on safety and preservation of capital. You will face a lot of scrutiny and due diligence from high net worth people. These relationships take time to develop and do not happen quickly.  In terms of how I build these relationships, it comes down to one simple characteristic. I approach high net worth people as peers. I approach them with confidence and with humility. I work quickly to establish rapport with them by showing them that I understand their world, but not in a presumptive way. That’s a subtle but important distinction.  One thing that helps me in that regard is that I’m incredibly well traveled. I’ve been to a lot of places in the world and chances are good that I can start up a conversation about somewhere we’ve both explored. That’s a pretty safe bet. I do my research and find out as much as I can about a person before I meet them. We probably know some people in common.  People who don’t have money look at the ultra-wealthy as having it made, as if they don’t have a single care in the world. Nothing could be further from the truth. They too are constantly learning, evolving, developing, figuring things out. The ultra-wealthy circulate in a community that spills opportunity at every turn. These people are inundated with opportunity. If they don’t focus, they will become time and energy bankrupt due to 1000 inquiries. They have to become very good at saying no. It’s a matter of survival. The key to breaking through that barrier is to show that you’re mindful of their time and energy management challenge. If you have a phone call with them, keep it to 10-15 minutes, no more. Communicate in a way that pierces through the noise and gets to the heart of the matter. It won’t be rude. They will respect you for it. You’re speaking their language. That doesn’t mean skipping steps in the relationship building process. That’s creepy. It means communicating in a concise and insightful way. 

Today's conversation is a lunchtime discussion about how to negotiate development projects and some ideas on how development deals can be structured.  Enjoy...

Brien Lundin is the publisher of The Gold Newsletter, the foremost publication and oldest on precious metals. He's also the promoter of the New Orleans Investment Conference, the longest running investment conference in North America, now in its 45th year. Today we're talking about interest rate policy, government printing of money (quantitative easing), and the demand for gold on a global basis.

Today’s show is my perspective on the college admission scandal that has been grabbing headlines across the US. At the center of the scandal is a Rick Singer, a former Canadian football League player who has more recently been in the speaking circuit and working as a college admissions consultant. Fifty people, including 33 parents, were charged last month for their alleged roles in a scam by which California college-admissions consultant William “Rick” Singer said he helped get their children into selective schools either by creating fake athletic profiles and bribing coaches to list the students as recruited athletes, or boosting their ACT or SAT scores by having someone fix their wrong answers.  Here’s the problem with the whole story. Who was really harmed by all of this? Some people say that the students who legitimately should have been accepted to these elite schools are the ones who were harmed.  I have a different view. The parents who engaged in this deceit have hurt their own children. I believe that children learn by modelling the behaviour they witness. Rather than teach their kids to work for their accomplishments, the parents are leaving the field open for their kids to create several unhelpful interpretations. You can take a shortcut in life when things don’t work out the way you want them to. The parents don’t have faith in their child to succeed on their own. The kids could spend their entire lives thinking they’re a screw up and will never measure up. The optics of graduating from an elite school is more important to the parent’s ego than the substance of living a happy and fulfilled life. At that point the kids stop being human. They become an object for the purpose of satisfying the parent’s ego.  There is so much about this story that is screwed up on so many levels.  A university education is a valuable step in many people’s lives. But it’s not everything. In fact, numerous studies have shown that graduating near the top of the class from a smaller lesser known school results in better life outcomes than graduating in the bottom half of the class from an elite school.  It comes down to reinforcing beliefs. If you are doing well in high-school, you might represent the top few percent in your class. When you get accepted at Harvard, you might be at the bottom of your class and still represent the top 0.1% of the global student population in terms of academic achievement. But if you spend 4 or 6 or 9 years at the bottom of your class, the message is you’re a screwup. When kids are in their formative years, developing self reinforcing patterns of high self esteem is incredibly important to constructive life outcomes.  Let’s frame this story in a larger context. In 2017, Kessler international published a study based on a survey of 300 students. The survey found: 86 percent claimed they cheated in school. 54 percent indicated that cheating was OK. Some said it it is necessary to stay competitive. 97 percent of admitted cheaters say they have never been caught. 76 percent copied word for word someone else's assignments.. 12 percent indicated they would never cheat because of ethics. 42 percent said they purchased custom term papers, essays and thesis online. There is something wrong with our culture that places more emphasis on the appearance of credentials than the substance of actual education. The education is the real knowledge, wisdom, perspective, and resilience that comes from integrating experience gained on the journey of life. 

On today’s show we are asking the question is flipping a legitimate form of real estate investing? A lot of people enter the world of real estate investing because they are drawn by the lure of mailbox money. They are drawn by this thing called passive income.   Well folks, money comes in one of three ways. Earned income Residual Income Capital Gains Most of the wealth in the world has been created through a combination of #2 or #3. The simple test of whether what you’re doing is earned income is to ask a simple question: "If you took two months vacation, would the business come to a stop?"  If the answer is yes, then you’ve just purchased a job. It might be a job with greater freedom than being chained to a desk. But it’s a job nevertheless.  It gets confusing because sometimes a job requires investment of capital to do the job. Just because it requires investment doesn’t make it the same as investing. It’s the presence of that active component that makes it more like a job.  I know a number of professional volume flippers. They perform anywhere from 20 to 1,000 homes per year. Once you put some scale behind it and it becomes a self sustaining business, there is dedicated staff in each of the key roles. You have acquisitions specialists, construction managers, sales people, a legal team. At that point the business owner can step away from the business and the business will continue to run itself. The cash generated by that business falls into the category of residual income. But it’s business income, not passive investment income. The properties are held for as short a time period as possible. The profits are unlikely to be considered capital gains.  So is flipping investing? My answer to that question is no. It’s a business, like any other active business that produces a product. It’s the same as a bakery, or a business that manufactures children’s toys. It takes in raw materials and manufactures a new product which gets sold. That product happens to involve real estate and buildings. The raw materials consist of an existing property that is in some level of distress. You add new materials, some design sensibility and transform as property that was less desirable into one that the market really wants.  You need money to fund the inventory for the manufacturing business. If you’re baking muffins, you need to buy flour and yeast and all the other ingredients. If you’re product is toys, you may need to invest in the manufacturing capacity, and purchase the raw materials. Flipping houses is exactly the same. It’s more like a manufacturing business than an investing business. Yes, the numbers are bigger because the sale price is not under $10, the sale price is in the hundreds of thousands. It’s a high price low volume business. An effective bakery would probably be a low price high volume business. 

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. 

Jonny asks: "I invest in single family rentals in several different US markets. Most are midwestern conservative and stable environments with steadily growing populations and economies - there's modest appreciation, but solid and dependable cash flow. The outlier is Chicago. I enjoy the very strong cash flow I receive from Section 8 tenants, but the impending pension crisis presents a precarious situation in the future. Chicago's pension situation looks abysmal with a future reckoning not far away. While I see this down the road and pause with concern, I also know that there are few states and municipalities without a pension dilemma. The perenial question "Compared To What?" comes to mind. Also, even if there is a pension crisis that becomes fully actualized, people will still fundamentally need housing. Is this a matter investors do need to consider regarding long term buy and hold strategies or is Chicken Little saying the sky is falling?" Jonny, that is a great question. My response is based on my personal experience and you should take my response as a point of view , or an opinion, not as the gospel. With that disclaimer, here goes. One of my cardinal rules is to invest in growing markets. I like influx of jobs and influx of population. Both Chicago and the State of Illinois have lost population in the last several years. Illinois lost 115,000 population last year. That means that both the state and the city are experiencing a falling tax base. Cities like Chicago are struggling with meeting the obligations of their entitlement programs, whether they be public housing, pensions, education, infrastructure maintenance, or public transit, all of these aspects can place huge demands for money on the city. The City of Chicago has been so desperate for cash, that they sold their parking meter business to a private company. The private company paid a little over $2 billion for the right to collect parking revenue in the city of Chicago for the next 20 years. Shortly thereafter, parking rates in Chicago skyrocketed. Anyone with basic math skills figured out that the city did a bad deal and that the buyer of the parking meter business is on the path to tremendous riches. I had some section 8 tenants in my properties in Chicago. The Chicago Housing Authority does pay a premium over market rent to landlords who except tenants with CHA vouchers. However, while these numbers look great on a spreadsheet, the extra $150 per month in rent did not cover the higher costs associated with meeting the extra ordinary demands made by CHA inspectors, nor to cover the much higher property maintenance and property damage costs incurred by many section 8 tenants. We had experiences that should never happen. We had tenants who would smash the electrical cover plates on the outlets and then lodge a complaint with the housing authority that we were not properly maintaining the property. The Housing Authority with then fine us one month rent and refused to pay rent until the repairs were made. So we would lose $1,500 in rent because the tenant intentionally damaged about five dollars worth of electrical cover plates. That was one of many situations that made no sense whatsoever. The tenant did not benefit financially from this action. It was purely destructive action and we could not find any financial gain for any of the parties. When cities are strapped for cash, they experience deferred maintenance. People don’t like to move into cities with crumbling infrastructure. Its not just about pensions. It's about how the city will manage itself financially, and will people leave as a result.

We’ve all heard about the benefits of diversification. Don’t put all your eggs in one basket. You might have heard a family member preach about it. On the other hand, if your eggs are in one basket and guarded really well, then you will have a greater amount of control over your investments. I had an in depth conversation with an investor this week who had made the decision to diversify his holdings across nine assets, many of them in separate geographies. All of a sudden, within a short period of time, several of them were under-performing at the same time. Diversification was supposed to protect him against that.  I’m a big believer in diversification, but only as a secondary strategy. It’s lower priority than making sure you have a critical mass of assets under the watchful eye of a competent management team.  Another investor I know well purchased multiples properties at the peak of the downturn. They were all bargains. But here too, they were spread across multiple markets. It wasn’t long before all five properties were performing poorly. Eventually it took hurricane Sandy to hit NYC and Atlantic City to create a success. The city was so impacted by the hurricane that suddenly her property which was undamaged, became in high demand. By comparison, I’ve always believed in concentration of assets until you achieve optimum performance. The key item in the success of a property is not the property. It’s the management of the property. All too often I see investors focus on the physical asset. I can tell you from first hand experience that my worst investment experiences were bargains that were mismanaged. Management quality trumps asset price almost every time. If you own rental property, even if you have it professionally managed, you will need to get the attention of your property manager. The relationship you have with your property manager is a critically important relationship. I like to talk with my property managers every week, sometimes multiple times per week. But if you only have one or two units with that property manager, that frequency of communication will be burdensome for the property manager. They will look at you like you’re a nuisance.  I believe that the ideal ratio of units to property managers is somewhere between 75:1 and 150:1. It’s somewhere in that range, depending on the type of asset. If you have 75 units with a property manager, then it’s perfectly acceptable and appropriate to speak with them once a week. You can focus your energies and your attention on that single property management relationship. 75 units starts to look like critical mass. Once you grow beyond a single multi-family property with a large number of units, you can then consider diversifying.  If you look at much of the real wealth that has been created in the world, there has been very little diversification. The Zuckerberg family is firmly focused on Facebook. If they had divided their time and attention between Facebook, real estate, oil and gas, and restaurants, they would be nowhere close to having accomplished what they have.  Diversification is important, but it’s a distant second in importance to having the business properly managed.  

Last week the federal Reserve announced its interest rate guidance for the current period and for the remainder of the year. Back in December the federal Reserve increased short term interest rates by 1/4 of one Percent. At the same time chairman Powell also forecast three rate increases for 2019. In a stunning reversal, the federal Reserve is holding rates steady and is forecasting no further increases in 2019. Last week the Bank of Canada also announced that it was holding rates steady.  The European Central Bank also has kept rates study at essentially zero or negative interest rates.  All of this is against a backdrop of slowing economic activity on a global basis. The growth forecast of the US economy has been revised to 1.75% to 2% this year, down from the last estimate of 2019 growth at 2.25%.   Central bankers have been using interest rate policy to engineer the so-called soft landing. Briefly raising interest rates would prevent the economy from overheating. It would also give the central bank a tool with which to stimulate the economy should it slow down.  Europe has lost the ammunition to stimulate the economy. By maintaining rates low, they have nowhere to go. Printing money is the only tool they have left. They’re going to try it, but it hasn’t worked so far. I see no reason for it to work now.   Here in North America, all of this is good news for real estate developers. One of the biggest risks that we face as developers is the uncertainty of interest rates once a construction project is completed. However, a period of interest rate stability makes it much easier to budget and model in the future. Construction projects are typically funded by construction loans only during the construction phase. Upon completion of leasing, the projects are typically refinanced into permanent fully amortized loans. Without knowing what interest rates will be in 18 months time when the project completes, it is difficult to forecast the operating model for the project with permanent financing. Now is the time to take advantage of these low rates and lock into permanent financing for as long as you can. 

Today’s episode is the story that started for me back in 1974. For two years in a row in 1974 in 1975 I visited Caracas Venezuela. I was 11 years old and I was struck by the huge contrasts in the city of Caracas.  The city is in the centre of a valley surrounded virtually on all sides by tall steep hills.  In the centre of the valley floor was a bustling modern city with freeways, and tall modern buildings. Surrounding the city lining the Steep hill sides were thousands and thousands of makeshift shelters where the poorest people were living in absolutely horrible conditions.  Our family became friends with an older couple who lived in Caracas and we traveled with them on several trips over the subsequent years. One of the frequent topics of conversation at that time was the inevitable social, economic and political unrest that would likely result if the economic disparity in the society was not properly addressed.  Fast forward to today and Venezuela is in economic collapse. The gross domestic product has fallen by more than 60% in real terms. The government has been trying to solve its financial problems by printing money. Inflation has been replaced by hyperinflation. In January of 2019 alone, inflation was 345%.  Today a school teacher earns enough money in one month to afford a carton of eggs and 2 litres of milk. About 3M people have left the country. Those who have left are sending money back to family members who have remained in the country. On average, the Wall Street Journal is estimating that the average money going back to family members is about $80 per month. But those funds are in US dollars which is rapidly becoming the black market currency of choice.  It took 45 years for the economic collapse to happen. We foresaw saw it back in 1974. Venezuela was a relatively vibrant country with lots of natural resources.  It’s really easy to be complacent and dismiss Venezuela or Zimbabwe as distant lands with their own issues.  Zimbabwe was previously Rhodesia. My family lived in Rhodesia before things became politically unstable there. We need to be students of history. Every time a country has debased its currency, it has ended in disaster. It happened to the Roman Empire. It happened in Germany. It happened in the United States prior to the signature of the US constitution.  It has happened in Zimbabwe, Argentina, and now in Venezuela. The headwaters of those disasters look just like the conditions in the US, Canada, and the European Union.  I don’t know if we have 45 years until the runaway train of inflation and economic contraction happens here in North America. 

The more you know about your potential customers, the better you can target your offer to the needs of your customers.  People make a number of life decisions that alter their demand for housing. Housing is so much more than a dry roof over your head. Children grow up and move out on their own. Some will move to be walking distance from a university. Maybe they lose their employment and move back home. The decision to get married and start a family. Sometimes its the decision to end a relationship. People sometimes move due to the loss of a loved one. They move to experience a different climate. They move to experience a different culture. They move to escape persecution. They move for employment. They could move because of a health reason. They sometimes move to create a fresh start. They may move to care for an ailing family member. They could move to be closer to friends. They could move to be closer to the action. Maybe to be closer to recreation. They could move to get away from the pace of the city. They might move to save money. Some will move to create the home of their dreams. They might move to make room for a growing family. They might move to start a garden. They might move because they’re tired of caring for a garden. They might move to have a home that can be left vacant during periods of extended travel.  Every one of these reasons could bring housing requirements unique to the reason for moving.  The averages are a fog that make it impossible to see what is really happening at a tangible granular level. If you’re looking at a 5% vacancy rate in the market, that number could obscure what is happening in each of these specific market segments.  You have no idea whether there is a shortage of housing within walking distance of the university if you’re stuck in market averages? You don’t know whether there is a surplus of 3 and 4 bedroom units and a shortage of 1’s and 2’s.  The more you know about the needs of your clients, the better you can market to them. Someone with health problems might not be able to navigate steps and would prefer a single story home. The averages tell you nothing about homes with stairs.  If you’re looking at cancelling your commercial office lease and working form a home office to save money, you may need a larger home. The averages tell you very little about the suitability of a property for a specific customer.  When you understand who your target customer is, you can better package your final product. The features of the finished product can be tailored to meet the needs of your customer. If your target is families with aging parents, a separate accessory suite might be the perfect feature. The market might have 5% average market vacancy, but absolutely zero inventory for properties with accessory suites.  Averages are for businesses that don’t care to know their customers. When you go to the average grocery store for average customers and buy a head of lettuce, they know how many lettuce they sell per day on average. They know how many cases of Coke they sell each day. These are completely anonymous transactions They don’t know who is buying it.  But when you go to whole foods and you give your amazon prime number for a discount, they know that if you bought a head of kale lettuce, you’re probably going to buy tofu. They know that you won’t buy a Coke, and they know where you live. That’s a level of detailed knowledge about the customer that few other businesses have, and it’s the reason why Amazon continues to grow so quickly and virtually dominate every segment they choose to enter. They dominate because they know their customers so much better. 

Todays' episode is a discussion on whether to build versus buy.

Sep is a multifamily real estate investor who has made an unusual transition from multifamily to portfolios of single family homes. When I first heard about the transition, I was a little skeptical. But the rationale for the shift makes sense and is sound.  Sep has dealt first hand with the difficulties of managing economically challenged properties in rough neighborhoods. That learning has shaped his current investment choices. Many investors have made the same mistakes in some form. I love his willingness to share his mistakes so that all of us can learn from them. 

I’m coming to you on location from the 17th annual investor summit at sea. This annual event is like no other. Every night, I’m seated with a new group of investors at my dinner table. One of the frequent questions that I ask people at my table is “What are your goals?” The typical story goes something like this. They have a full-time job. They like what I do, but I’m ready to change careers in favour of something with passive income. So They’ve started buying a few rental properties. They haven’t figured out how to scale up beyond a few properties. Each of the properties are a lot more work than they anticipated. They don’t have the investment capital to buy a larger multi-family project by themselves.   In talking with a number of people at length over an extended period of time I’ve noticed a few trends. I can broadly put the investors on board the summit at sea into four major categories.  there are the beginner to intermediate investors who are still working as employees in their day job and moonlighting with a small rental portfolio, trying to figure out how to transition from their current life to one where passive income has replaced their employment income. There are investors who have decided to become the full-time operator of the business. They have traded their day jobs for the role of a small business owner. They have recognize that owning a portfolio of properties is not a passive endeavor. It takes a lot of work. They have reached the limits of scalability not only based on capital but based on time. They’re still on the hamster wheel, running faster than ever before with a larger number of the small projects. Number three there are full-time investors and developers who have decided to focus on larger projects. He’s larger projects or afford the possibility of hiring dedicated full-time staff in all of the critical roles that are necessary to operate the business on a daily basis. The focus of time and energy goes into managing the project but not the day-to-day operations. The time and energy is put into growth of the portfolio. Once the projects are complete and they are on auto pilot the dedicated staff manage the daily operations with little to no intervention from the business owner. If at some point in the future I decide to take my foot off the gas and either slow down or stop growing the portfolio, it will be a flow of residual and passive income. My role as the business owner focuses on making sure the right people are in the right roles. I’m focused on building the organization. This is not that different from a senior role in corporate America. The fourth and final group have figured out that managing all these projects is a ton of work. We have decided to focus their time and energy on selecting a handful of high-quality operators who they trust the building management portfolio. And that you to invest passively in private syndications. These are the same types of projects and investments that large family offices of the wealthy and ultra wealthy invest in. 

Back in November, Californians voted on a proposition to eliminate the current state wide rent control legislation that was enacted in 1995. California’s rent-control regime is governed by a state law called the Costa-Hawkins Rental Housing Act. It prevents cities and counties from imposing rent control on single-family homes or apartments built after 1995, among other prohibitions. The law also froze rent control rules in cities such as Los Angeles that had policies before Costa-Hawkins was implemented. By repealing Costa Hawkins, it would leave the field wide open for individual cities to implement their own rent control rules.  The defeat of the proposition by a vote of 60% in which voters rejected the initiative and landlords spent $100-million-plus in a campaign to sway public opinion.  The state government is trying again with a new set of measures aimed at weakening the Costa Hawkins rules. About 9.5 million renters — more than half of California’s tenant population — are burdened by high rents, spending at least 30% of their income on housing costs, according to a UC Berkeley Study. The authors of the study are recommending rent control again, at the same time they acknowledge it will not solve the problem of inadequate supply. 

I'm coming to you live from The Investor Summit at Sea. This is an event like no other. It's here that you have the opportunity to learn from some of the biggest brains on the planet. 

On today’s show I want to share a perspective on the world of investing. My mother started an investment holding company back in 1976. She had a portfolio of investments, largely in the stock market. When my mother passed away in 1981, I was 18 years old, I had the task of taking over that investment holding company.  At the time, the conventional wisdom was that you could routinely earn an average return of 10-11 percent. In my world, as a relatively young investor, our target was to invest in primarily high dividend yield stocks like utility companies. They would deliver about an 8% rate of return on their dividends and another 2-3% in long term appreciation. These stable high yield stocks were the so-called granny stocks of the day. We chose these because at the time, my father who would be retiring in the coming 2-3 years would be reliant on the income from the stock portfolio for his retirement income. My sister and I would ultimately become the capital beneficiaries of the portfolio, but my father was the to be the income beneficiary. I was effectively managing a small pension fund for my father as the sole benficary. The market conditions enabled a solid investment strategy at the time. The large pension funds that are responsible for police departments, fire departments, schools boards, public sector employees have had very similar investment objectives as part of their charter.  But the problem is that in the last decade, ever since the 2008 financial crisis, the rates of return experienced by pension funds have been approximately half of what they were in the 1980’s and 1990’s. They’ve been averaging around 5% for the past decade. You don’t need to be a financial wizard to understand that this is a ticking time bomb.  When I talk about stock market yields, I’m not talking about the price of Apple, Facebook, Amazon or Alibaba. Those stocks are not the mainstay of pension funds. They are too volatile and they don’t offer the kind of capital protection that responsible pension fund managers require.  So now if yields in the stock market are falling, investors are going in search of yield elsewhere. In the world of real estate, I can tell you that I would never undertake a project for only a 5% annualized yield. That’s far too risky.  But if you’re coming from the world of public stock investing, and you’re seeing the types of returns that are possible in real estate, you’re probably getting excited. We’ve seen a lot of investors attracted by the stability and the kind of appreciation that is possible through the combination of forced appreciation and leverage. These new entrants have been bidding up the prices for real estate, because by comparison, the stock market alternative is too volatile and less attractive. That’s made it harder for the professional real estate investors like you and I who are not willing to pay too much for an asset. 

This question has been asked so many times by audience members, I'm not going to attribute it to a single person. It's a great question, and the answer is highly situation dependent.  I’ve experienced situations where raising money has been easy, and other times when it has been very time consuming.  The main issue is whether the venture is going to be appealing to the sources of debt financing and the sources of equity financing you are talking to. It’s easy when you get a quick yes. It’s hard when you get a lot of no’s. It means that you need to figure out what is the reason why you’re being declined. Are you talking to the wrong people, or is there something fundamentally wrong with your offer? I strongly believe that if you have a compelling opportunity, your job is to find the money and most importantly make sure you create that perfect fit between the goals for the money and the goals for the project. If you don’t have that perfect alignment, then raising the money is going to be extremely difficult.  For example, sometimes you need to match the type of money to the phase of the project. The cheapest money for permanent financing will almost always be bank debt. The risk premium attached to the debt is a function of risk.  If you’re undertaking a construction project. You might be better off working with a lender who specializes in construction financing. You will pay more for that money in the short term. Once the project is leased and stabilized with an income history, you can then refinance and get very low cost permanent financing on a 25 year, 35 year, or perhaps even 40 year term. But you may not qualify for that financing during the construction phase.  If on the other hand, you look for a conventional lender to fund both the construction and the permanent financing, you will pay a premium because of the added risk, and that higher risk premium might carry forward for the life of the project. You will pay less during the construction phase, but more during the entire life cycle of the project.  Sometimes packaging the investment to have the best possible characteristics during each phase of the project can make the difference between difficult and easy.  Sometimes you may find that you need additional balance sheet strength in order to get a large loan. In that case, you may need to bring a partner into the project with a very strong balance sheet in order to co-sign on the loan. In that case, you’re going to be giving up some equity share in order to secure the debt. That’s different than raising equity money in exchange for an equity share. It’s a fallacy to think that a project is hard to finance, assuming you haven’t made any major mistakes that would make the project broadly unattractive. If a large established developer could do it easily, then so could you. The only difference between them and you is that they have established better relationships than you. They may have more financial capital but they also have greater relationship capital. Relationship capital is the value of their relationships. If an established developer were to lose all their money, it would not take very long for them to make a substantial amount of it back. The reason for that is that they have the relationships.  If you’re like many, you have experienced some success in raising money. But perhaps you have some relationships, but have exhausted the capacity of your existing ecosystem. So you may need to expand your Network of relationships. This means getting out and building relationships that you won’t need next week, but perhaps in 6-12 months, or beyond. 

Quentin D'Souza is a Toronto based investor who runs one of the local Real Estate Investment clubs there. You can reach Quentin at durhamrei.com.  One of his specialties is legal secondary units. These in-law suites are a great way to multiply the revenue and increase the overall value of a property for minimal investment. It's particularly attractive in a high priced markets like Toronto.