Your morning shot of what's new in the world of real estate investing. Daily real estate investment outlook from investor, syndicator, developer and author Victor J. Menasce, so that you can compress timeframes as a real estate investor or developer. Weekday shows are 5 minutes of high energy, high impact awesomeness. The weekend edition consists of interviews with notable guests including Robert Kiyosaki, Robert Helms, Peter Schiff, Chris Martenson, Mark Victor Hansen, George Ross, Ed Griffin, Dr. Doug Duncan, and many more.
Water Water Everywhere
On today’s show we’re talking about water.
We’re all attracted to water features on a property. A lake, a pond, a canal, a river. All these water features make a property more interesting than a flat area of grass. In addition to the visual appeal, water brings a positive environmental benefit to a property. It provides a refuge for nature, for birds, fish, frogs, insects, and all kinds of vegetation that you may not otherwise find in an open field.
But if you have water on your property, chances are that you don’t own it. The question of ownership of water dates back to riparian water rights. This is an area of law that varies widely from one jurisdiction to another. Generally speaking, the law has been created and interpreted by the courts in response to conflicts between competing legal systems.
There are too many cases to cover on today’s show, but I’ll give you an example from the state of Texas. You’re going to need to perform your own research and due diligence in the location you own property.
The basic idea when it comes to water is the presumption that mother nature was perfect in how the natural environment was created. When we start putting buildings, paving surfaces we start interfering with how the water flows when it rains, and we start interfering with how water is absorbed into the soil.
When we’re talking about water we need to be clear on what kind of water we are talking about, is it ground water or surface water. Generally speaking, Texas groundwater belongs to the landowner. Groundwater is governed by the rule of capture, which grants landowners the right to capture the water beneath their property. The landowners do not own the water but have a right only to pump and capture whatever water is available, regardless of the effects of that pumping on neighbors underground water supply.
Surface water on the other hand is much more complex. It depends on how the surface water is situated. If it is flowing, then the water is owned by the state. If that flowing waterway is a named waterway, then the flow of that waterway might be managed by the Army Corps of Engineers. Altering the bank of the waterway or having water flow into or out of that waterway would require approval from the Army Corps of Engineers.
Surface water in Texas follows two sets of rules, Riparian rights, or Prior Appropriation. The riparian doctrine is based on English common law. The rules in most states and Canadian provinces follow the English Riparian rights. These court-developed rules are used in deciding cases that involve water use conflicts. The basic concept is that private water rights are tied to the ownership of land bordering a natural river or stream. Water rights are controlled by land ownership.
Riparian landowners have a right to use the water, provided that the use is reasonable in relation to the needs of all other riparian owners. Riparian owners retain the right to use water so long as they own the land adjacent to the water.
In the days of the wild west, when land was being explored, the much drier states had much less water. People used water whenever they could find it, regardless who owned the land. In the absence of any rules, people simply took water from streams and used it; that is, they appropriated it. When this practice became legalized, it became known as the Doctrine of Prior Appropriation.
In some communities, you are allowed to capture rain water. In others, you are not. Finally, many communities will require you to manage your stormwater runoff so as to not harm your neighbors. They may required you to build a stormwater detention pond to provide more controlled runoff during storm events that bring large amounts of rainfall. This is one area where you can’t simply apply what you believe is common sense.
AMA - Luxury Home Sales
AMA - Anu from San Diego asks:
In the current SF real estate boom (last 6 months), the most growth has happened in the luxury end of the market. A new report from Redfin confirms this trend over the past year.
1. I would like to know your opinion on why this has happened.
2. Do you think this is a temporary phenomenon or is it here to stay?
Anu this is a great question.
The pandemic has hurt the economy in numerous ways. But the pain has not been uniform. Those who have been most impacted by the business shutdowns have been those hourly paid workers.
Those at the top of the economic ladder have continued to do well in 2020, even if some of the gains might be argued to be an illusion. The fall in the stock market it Q2 was overtaken by a run up in the market in Q3 and Q4. That has given people more confidence. Some recognized that the profits could evaporate and chose to redeploy the cash into property
The low interest rate environment, combined with the forward interest rate guidance for the next three years has created incentive for homeowners to borrow even more money than ever before. It’s clear that the Fed intends to keep interest rates low for at least the next few years.
But remember, when we’re talking about the luxury segment of the market, we’re talking about the top 5% of the properties in a market by price.
The analysis that Redfin performed in the article you referenced broke down their analysis into 5 segments.. There are three equal-sized tiers based on Redfin Estimates of the market values as of Dec. 15, 2020, as well as tiers for the bottom 5% and top 5% of the market. The top 5% of the market by price is considered “luxury” for the purposes of this report, while the bottom 5% is titled “most affordable.
These luxury properties still make up a small percentage of the market, and they’re still taking longer to sell than properties in the middle and lower end of the market. When people make a decision to purchase their homestead property, they’re looking with a longer time horizon. They’re looking past the pandemic. It might have been a purchase that was planned in the future, but merely accelerated.
The increase in land costs and the increase in construction cost has caused some builders to focus on the upper end of the market. Those builders found a combination of robust market demand drive by low interest rates, and better profit margins. You see builders make most of their profit on upgrades and custom finishes. These buyers are willing to spend more.
Some buyers took the opportunity that the pandemic afforded to invest in personal projects. The lockdown in the spring created extra time while the world figured out how to work from home. Some people took on home renovation projects, perhaps a backyard space like a deck or a pool. Others chose to design a new house. We’re seeing that reflected in the numbers.
It’s tempting to look at short term trends in the market and extrapolate those trends into the future. In a stable boring market where nothing changes from one month to the next, you might be able to project into the future a little bit.
It’s a little like trying to make sense out of the spike in toilet paper sales in Q2 of 2020. Store shelves were emptied of toilet paper. Did the population start using the bathroom at an accelerated rate? Did the population grow all of a sudden therefore driving demand for more toilet paper? Of course the answer is no. Over the long term, toilet paper consumption will revert to the average consumption, despite short term decisions to buy sooner than needed.
I expect the same will be true in the luxury property segment. It appears like a large increase, but in reality, the numbers are small and it doesn’t take a large shift in absolute numbers to materially affect the percentages.
The Short Term Rental Trap
On today’s show we’re talking about one of the traps that the market might be luring investors with.
When you make an investment in real property, this is often majority funded by permanent financing, usually amortized over a long time like 20-30 years. But if the market window for your demand is short term, then you’re at risk of making a bad investment.
I’m hearing reports that cottages and other similar vacation properties are already fully booked for next summer. Some investors I’ve spoken with have indicated a desire to purchase a vacation property and rent it out when not in use. They point to the strong demand as the rationale for the investment.
The fact is we don’t know what the demand will look like in a year or two, or five.
We know that global travel is down 90% due to the pandemic. People who are desperate for a getaway are booking accommodations within driving distance of home that allow for them to remain socially isolated.
In a pandemic environment, this all makes perfect sense. Even our own short term rental portfolio has continued to experience strong demand well into the coming year.
But we expect that the pandemic will eventually come to an end. It won’t be in the next few months. It will take much of 2021 before enough of the population is immunized for these restrictions on social activities to eliminated.
Israel stands alone in the world as having the most aggressive roll-out of vaccination of any nation. They have already immunized 20% of the population and expect to complete the entire population over 16 years of age before the end of March.
The roll-out in the US, Canada, Europe, is looking like it will be well into the 4th quarter before the majority of the population is immunized. It could be even longer. I’m expecting 2021 to look an awful lot like 2020 in terms of travel and leisure.
Cruise ships probably won’t be sailing anytime in 2021. If they do, it will be later in the year. In 2019, the cruise industry had nearly 30 million passengers, the majority of them from North America. There are all these tourists who are looking for a different vacation this year.
But eventually, many will return to cruise ships, to beach resorts in the islands, to the bus tour through Asia, to the luxury cottages in the middle of a game reserve in Africa or Australia. All of these experiences are off-limits for many because of the higher risk of infection that comes with international travel.
So what happens to all those cottages that are fully booked this year when people return to traveling? What will bookings look like in 2022 and 2023 and beyond?
I think back to the lean years at resorts that built excess capacity. Many of those condo units sat empty for much of the year. In retrospect turned out to be very poor investments. Yes, they look great again in 2020 and perhaps in 2021. But if it took a black swan event like a global pandemic to make your investment viable, is that really a good strategy?
If you currently own a vacation property and you want to make a small incremental investment in maximize the revenue for that property, I say go for it. Maybe you want to upgrade the furniture and the interior finishes so you can command a higher price in the market. That’s a good move.
But if you’re an investor looking to make a major investment with a 25 or 30 year commitment, how do you know if the demand for your product is going to be there in a year from now, or five? After all, just as quickly as conditions changed this year, they could change again next year.
I would go back to the market conditions of 2017 and 2018 as a better indicator of what the market demand might look like in the post covid environment. You want to use market analysis tools like Alltherooms or AirDNA to determine both demand and pricing for your local market before you make an investment.
On today’s show we’re talking about the notion of valuation or what is sometimes called price discovery.
I was 13 years old when I got my first taste of price discovery. In Istanbul Turkey there is the largest covered bazaar that comprises over 61 streets and over 4,000 vendors. The vendor was trying to sell me a metal sword and a negotiation ensued. I was a rookie at this, but my father knew the game and by the end of a 5 minute negotiation we settled on a price that was about 1/3 of the original asking price. The seller was grumbling the whole time as he wrapped up my purchase. I left his shop confident that I had just got a great deal. As I reflect back on it now, how much was that souvenir really worth? It’s worth what I paid for it. Did I pay too much? Did I get a great deal? I have truly no idea.
There is the story of Honus Wagner played in major league baseball for 21 seasons, most of that for the Pittsburg Pirates. He was one the first five players to be inducted into the National Baseball Hall of Fame in 1936.
On October 31 of last year, one of 50 Wagner baseball cards sold for $1.4M dollars. It’s not the most expensive version of that card to ever sell. The most expensive one sold for $3.25M. The scarcity is part of what drives the notion of value. If there were 1,000 of these cards, they would be worth much less. It’s because there are only 50 remaining in existence that drives the notion of value. Maybe the baseball card worth 2.5 cents, the cost of the paper and ink to print it?
When you buy shares in a public company, you’re buying a fraction of a company, that presumably has the ability through its active ongoing business to generate a profit for its owners. As a shareholder, you’re an owner. You would think that the value of a business is somehow tied to its ability to generate a profit. A business that generates a lot of profit should be worth more than a business that generates very little profit.
Tesla Stock is currently trading at 1,667 times earnings. That means that if Tesla remained at the same level of profitability, it would take 1,667 years to earn your initial investment back, and that’s assuming of course that the company paid out 100% of its earnings in dividends to investors. At that point, I’m starting to wonder which is a better deal, Tesla stock or the baseball card?
The notion of value has become distorted.
A single family home in an expensive neighborhood is worth $1M because we all agree that it’s worth that much.
This is what is called price discovery. If a house on the street sells for $100,000 more, now all of a sudden everyone on the street thinks their house is worth $100,000 more.
But the world of real estate investing is different than the world of residential home ownership. It might seem to the uninitiated that they’re similar. But they’re quite different.
You see if an apartment rents for $1,500 a month, that rent check clears every month. If you have a 100 unit building, then you have 1,200 transactions that closed over the past 12 months. There is no speculation about what the apartments will rent for. There is hard data. So when it comes to valuation, if rental properties are valuing at a 6% cap rate, then you can easily determine what a property is worth. You have lots of data from hundreds and hundreds actual transactions that settled each and every month.
So what is a piece of real estate worth? Is it merely the result of negotiation, or perhaps the real estate business that is wrapped around the property is worth a multiple of its net income, its ability to generate a profit.
AMA - How To Write A Book
Today is another AMA episode (ask me anything). Karla asks:
Your book “Magnetic Capital” in my opinion is a quality , easy to follow book. Would you please share your own process to write, market and publish your book? Any highs and lows from lessons learned in the process that you can recommend?
Have a successful year.
Karla, This is a great question.
There are undoubtedly numerous ways to write a book, but I’ll share with you my process. When I say this, I’m confining the discussion to non-fiction books. The process for fiction books is somewhat different. It all starts with intention. Some people write a book as a vanity project. For some it’s a large expensive business card. For some it is a real contribution to the world to advance the art and science in a particular area. You really want to get clear on why you are writing a book. It starts with asking a few simple questions,
“Who are you writing the book for?”
“Why does the world need this book?”
“Why are you the one to write this book?”
Do you seek publisher or to self publish?
In the case of Magnetic Capital, I saw many people who wanted to grow as real estate investors who were lacking the skill in raising capital. Some were trying to raise money and having terrible results. So the book was written for the investor who was looking to grow beyond their own capital, but most importantly, those who were looking to grow beyond the initial stages of leveraging other people’s money. Some people start out by performing a joint venture or two and then get stuck.
Most of the books written on the topic tended to be academic in nature and lacked a practical approach to understanding the psychology of raising capital. It seemed like people were out there trying to violate laws of nature, violate laws of human respect, and certainly violate securities laws.
So I saw a gap in the marketplace.
So let’s talk about how to outline a book. In my case, I took a stack of blank 8.5x11 sheets of paper and brainstormed the chapter titles. I put one chapter title on each page. Some chapter titles didn’t make sense and I threw those away. I then spread out all of the pages on my dining room table so that I could see the big picture for the structure of the book. I could easily move the sheets around so that the sequence of the chapters made sense. I then took each sheet and wrote down 3-5 major points that would need to be covered in each chapter.
I then decided which chapters would need real life examples to support the points being made in the chapters.
Some books require a lot of research. I’m thinking of authors like Malcolm Gladwell or Jim Collins. In those cases, you might be facing a couple of years of work prior to writing the book. In my case, the book was already inside me and just needed to come out on paper.
The mechanics of writing the book was extremely straightforward. I would write every day. Some days I would sit at the computer and write a few pages each day. In the case of Magnetic Capital, the first draft of the entire book was written in under a month, followed by a few weeks of editing.
The publishing process has two choices, working with a publisher or self publishing. If you’re going to work with a publisher, the industry has changed. In fact, the work is pretty much all going to fall to you unless you already have a huge brand name with a massive following. Before you can even engage with a literary agent you’re going to need to prepare a book proposal. What they call a book proposal is really a detailed marketing plan when you look at all the headings. There are several templates out there on the internet from various literary agents. I chose to self-publish my book using Amazon as the platform. It was easy to do and there are lots of good resources out there that can guide you on the particulars.
Bryan Miller is a musician, composer, a musician to the film industry in Hollywood, and a real estate investor. You can learn more about Bryan and his strategies at capitalstackinvestments.com.
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