07 Jan / 2019
Wow! What a year? Hang on to your hat because 2019 is going to continue the wild ride! People ask me all the time, “what about the interest rate increase?” For the most part, I tell them commercial real estate doesn’t get affected the same way as residential. That is true, but the hidden lie is that it is still an impact. We’ve seen a 15% increase in rates in a year – that’s a lot! It affects people’s sentiments – makes them pause.
The other cocktail conversation is of course, “What about the stock market? – Ouch”. To which I also reply, “I’m in commercial real estate – it really doesn’t affect me.” Again, a bit of a white lie. Besides affecting people’s 401Ks and sentiment it often affects the money people were holding to put down on a commercial property purchase or to start or expand their business. This is true trickle down economics.
I will say that I am less concerned about rates then I am about the Fed running the debt off the balance sheet. If interest rates are rising because of stronger economic growth (which is what the Fed chief tells us), then real estate demand will also likely grow. But, if the stock market tumbles like it has recently, when we take 6 billion off the balance sheet, what happens when we take the remaining 3 trillion off? In the meantime, we have 9 trillion of corporate debt which is double that of a decade ago – as rates rise the squeeze is on.
So, where are we? I will tell you that we are in the battle between “stag” and “flation”. You see the recent rise in rates causing the stock market dip also took care of the fear of “flation” and now we have to wait and see if the fear of unwinding of QE (Quantitative Easing i.e., Debt) causes “stag”.
With the economy seemingly running on all cylinders and companies struggling to hire enough workers, it might be difficult to find time to take stock and examine your new year strategies and efficiencies. Yet now, as we move through the late stages of the business cycle, it’s more important than ever to do so. Here are 3 things to consider at this stage in the cycle;
- If you are thinking of selling your property or business in the next 5 to 7 years, consider selling sooner. Now is an opportune time to maximize value.
- In your business, your personal life and your property – streamline your cash flow. Invest now in the tech and time to digitize your life and your assets.
- Reduce risk on your balance sheet. Just like the Fed is doing (take some chips off the table).
As many of you will remember, for years we produced The Gold Report which was our look and advice for the year ahead. As in recent years, we have found it more efficient to give you links to a couple of the best reports in the industry;
I also strongly encourage you to attend a presentation of The Emerging Trends in Real Estate 2019 by Mitch Roschelle. It will be at USD on February 6 from 7 AM to 10 AM. I’ve attended many of Mitch’s presentations and find him to be entertaining and massively educational. Here is a link to register.
So, they teach you in sales school to always have a “call to action”. So here it is, “If you or someone you know is thinking of selling (buying is OK too) and/or would like to know the value of their property, have them call or email me.”
In the meantime, I am going to try to be like a duck (or a frog) and stay calm on the surface but paddle like crazy underneath. Hope you enjoy the story …
In the Pail
Two frogs left the safety of their swamp one day and ventured into a nearby farm to explore. Soon they found themselves in a dairy, where they found a large milk pail. Hopping into the pail, they found it was half filled with fresh cream.
The two little frogs were absolutely thrilled. They had never tasted anything so delicious! Soon their bellies were full. Feeling sleepy, they decided it was time to leave – and that’s when they realized they were in trouble.
They’d had no trouble hopping in. but how were they going to get out? The inside of the pail was too slippery to climb. And because they couldn’t reach the bottom and there was nothing for them to step on for traction, hopping to safety was out of the question, too. They were trapped.
Frantic, they began thrashing about, their feet scrabbling for a foothold on the elusive, slippery curve of the pail’s side.
Finally, one frog cried out, “it’s no use. We’re doomed!”
“No,” the other frog gasped, “we can’t give up. When we were tadpoles, could we have dreamed that some day we would emerge from the water and hop about on land? Swim on, brother, and pray for a miracle!”
But the first frog only eyed his brother sadly. “There are no miracles in the life of a frog,” he groaned. “Farewell.” And he sank slowly out of sight.
The second frog refused to give up. He continued paddling in the same tiny circle, over and over, hoping against hope for a miracle. An hour later, he was still paddling in his futile little circle. He no longer even knew why. His brother’s dying words clutched at his thoughts as fatigue tugged at his tiny muscles. “Was my brother, right?” he thought desperately. “Are there no miracles in the life of a frog? Finally, he could swim no more. With a whimper of anguish, he stopped paddling and let go, ready to face his fate…
Yet to his surprise, unlike his brother, the second frog did not sink. In fact, he stayed right where he was, as if suspended in midair. He stretched out a foot tentatively-and felt it touch something solid. He heaved a big sigh, said a silent farewell to his poor departed brother frog, then scrambled up onto the top of the big lump of butter he had just churned, hopped out of the pail and off toward his home in the swamp.
The Slight Edge by Jeff Olson
04 Dec / 2018
Happy Holidays! In today’s fast-paced, tech driven world it is often hard to get our nose out of a screen and just plain be thankful for all that’s around us. I was thinking back to the early days of caller ID and why we would “op out” because we didn’t want people to know who was calling, now we won’t answer unless we know who is calling. When I was a kid, our parents worried about all the cheap stuff that was being sold that said, “Made in Japan” now we worry about “Made in China.” Will our kids worry when it says, “Made in Space?”
With our economy running on all cylinders and companies struggling to hire enough workers, it might be difficult to find time to both be thankful and to examine financial strategies and efficiencies. Yet now as we move through the late stages of the business cycle, it’s more important than ever to do so. Remember that if companies do not have access to enough labor than they must invest in capital (which in this case is productivity tools or technology).
In the meantime, interest rates continue to rise and put a damper on the stock market and the whole economy. The tight labor market has also caused wage growth but not enough to offset the rising rates. Rising household income contributed $11,000 to consumer house-buying power. Alas, the rise of rates from 3.99% to 4.6% over the last year reduced that house-buying power by nearly $30,000.
However, all these strong economic reports belie a potential shift of the pendulum. In the San Diego area, the rate of job growth has slowed. Employment in July rose 1.5% over the previous 12 months, however that is down from a 3.6% increase in July of 2015.
With a growing number of employees working from home and 96% of people shopping online, protecting your commercial property is more important today than ever before. Keeping commercial tenants is becoming increasingly difficult, as more and more move to an online profile. What can you do? Two things that seem particularly relevant during this Holiday season are:
- Create an experience: shopping online is purely transactional. There is no experience other than graphics and clicks. People will leave their homes for the purpose of a memorable experience that gives them value beyond the price of the transaction.
- Create community and belonging: provide a meaningful community experience and a sense of belonging. In the future, a building will garner a greater price if it has a brand around a shared local experience with deepening connections with neighbors all done with enabling technology (signs, tweets and texts, Instagram, etc.).
At this time of year, we would like to thank our community of clients, vendors, fellow brokers and associates. We know it takes a village to be successful in this market and we thank you for being in ours.
We know we are only here for a short time, but we don’t act like we know that. You will not have unlimited opportunities to do your work so do it now. There will come a time when you can no longer express your love, so express it now. There will come a time when all of your possessions are just stuff, and when all of your plans and excuses are just air. Your moment is now.
God bless and Happy Holidays…I hope you enjoy the story.
Isn’t it amazing how God works through technology in our lives! On a Saturday night just before Christmas, this pastor was working late, and decided to call his wife before he left for home.
It was about 10:00 pm, but his wife didn’t answer the phone. The pastor let the phone ring many times. He thought it was odd that she didn’t answer but decided to wrap up a few things and try again in a few minutes.
When he tried again, she answered right away! He asked her why she hadn’t answered before, and she said that t hadn’t run at their house. They brushed it off as a fluke and went on their merry ways.
The following Monday, the pastor received a call at the church office, which was the phone that he’d used that Saturday night. The man that he spoke with wanted to know why he’d called on Saturday night.
The pastor couldn’t figure out what the man was talking about. Then the man said, “It rang and rang, but I didn’t answer.” The pastor remembered the mishap and apologized for disturbing him, explaining that he’d intended to call his wife.
The man said, “That’s OK. Let me tell you my story. You see, I was planning to commit suicide on Saturday night, but before I did, I prayed, ‘God if you’re there, and you don’t want me to do this, give me a sign now.’ At that point my phone started to ring. I looked at the caller ID, and it said, ‘Almighty God.’ I was afraid to answer!”
The reason it showed on the man’s caller ID that the call came from “Almighty God” is because the church that the pastor attended is called Almighty God Tabernacle!!
May the Blessing of the Holidays be yours!
CDC Commercial Inc.
Don, Candy, Nick, Matt & Cheryl
06 Nov / 2018
“Beer is proof that God loves us and wants us to be happy.” – Ben Franklin
I think it’s funny that we live in a time where our President has never had a beer and our newest Justice “loves beer” and we live in a region where craft beer adds over a billion to our economy (we even nickname Highway 78 “the Hop Highway.”). I also think it’s funny that Ben Franklin wanted the turkey to be our National Bird (Happy Thanksgiving BTW). Could you imagine 50 years ago if they had announced “Houston, The Turkey has landed” instead of “Houston, The Eagle has landed.” I am just glad we kept the turkey as our sacrificial bird.
I think we have a lot in common with our forefathers (and founding fathers). We may have landed on the moon 50 years ago, but the space race is back on and in the next 50 years we are likely to see colonists appear again in our vocabulary. The early colonists wanted less government and lower taxes. In a few days, we will all have the opportunity to benefit from the fruits of their labors as we head to the ballot box. Even though I understand Facebook has created a “war room” to cut down on the fake news, might I suggest that you source your education from more reliable sources. Never fear, however, separating fact from fiction (or gossip) has been with us from the beginning of time.
I try to stay apolitical but as far as real estate goes all I can tell you is that rent control (prop 10) is a slippery slope and never good for real estate. I can also forewarn you that split roll tax (lifting prop 13 exemption for commercial property) is coming to the ballot in 2019. This will be a real property and business killer and a cost increase to all consumers as the increase in property taxes is passed from owner to tenant to consumer.
It is nowhere on the ballot yet, but I have heard rumblings of the idea of a “vacancy tax.” Somehow residents and local governments think owners (and their brokers) will fill empty spaces faster if they are being taxed on the vacant space (as if loss of rent is not enough!).
While still on taxes, one thing we all need to understand better is QBI (Qualified Business Income). The IRS and the Accountants are still scrambling on the details. I can guarantee we all need to understand this section and maximize it to your benefit for lower taxes.
I know I have discussed this before, but I attended an ADA Seminar and the reality is that although you are not required by law to have a CASp report you really, really need one for your property and/or your business. To put it another way, you are going to get sued and when you do it will cost you 10X as much if you don’t have the report and a plan. Here is a link to the slide deck from my class. I also highly recommend the presentor Greg Izor (email: firstname.lastname@example.org phone: 760.489.5892) if you need a report. When you do the report, please let us know and give us a copy (we are required to disclose to tenants and buyers). You also need to give to tenants when they renew their leases (if you are a tenant, this is the time to negotiate conformance).
Has anyone noticed that rates are rising? The stock and bond markets sure have. Here are some of my observations:
- Why does the Fed only work in quarter points? When rates are at 1% and you go up a quarter point, it is a much bigger impact than when they are at 5% so their tool gets blunter the more, they need it. I vote for 1/8 and 1/16 cuts and bumps to send gentler messages.
- As interest rates go up the cost to service the deficit (pay back loan thru treasuries) costs us more (our Nation’s debt is on a variable rate loan!). This means we either cut expenses or we get inflation.
- Positive leverage (where cap rates are higher than borrowing rates) is disappearing. This means cap rates must rise or inflation is rising so fast you will pay more for your loan because the rents and property are going up faster than the extra payment.
- In the field, we are starting to see the impact. Mortgage companies are laying off, subleasing or consolidating. Escrow companies are doing the same. Home builder futures are down a bit. Lenders are slowing down development loans. The good news in this low unemployment rate market, workers are finding other work.
Well I hope that you all remain blessed and thankful as you enjoy your turkey and beer this year. And I hope that you exercise your right to vote and don’t fall for all the fake news and gossip and most of all I hope you enjoy the story…
The Original Facebook
Early politicians required feedback from the public to determine what the people considered important.
Since there were no telephones, TV’s or radios (or Facebook), the politicians sent their assistants to local taverns, pubs and bars.
They were told to ‘go sip some Ale and listen to people’s conversations and political concerns.
Many assistants were dispatched at different times. ‘You go sip here’ and ‘You go sip there.’
The two words ‘go sip’ were eventually combined when referring to the local opinion and thus we have the term ‘gossip.’
01 Oct / 2018
At the end of the year, my youngest son will be completing his MBA. Of course, I was quick to remind him what B.S. stands for (you know…bull stuff) and that an M.S. is more of the same and of course a P.H.D is piled higher and deeper. Whether students are finishing their post graduate work or beginning middle school, back to school season is here. Although they may grimace when they hear “back to school” they won’t regret pursuing a higher education as they compete for well-paying jobs in the future. Today’s millennials are the most educated generation in American history. Student debt though can be a burden but the cost of not going is higher. An average 50-year-old with a college degree will earn about $46,500 more annually than an average person with just a high school degree according to Brookings Institute. In short, higher education leads to higher income, leading to higher likelihood of home ownership which in turn drives our overall economy.
As an aside, while still on the topic of education, you have heard of “helicopter parents” (those that hover about doing everything for their children). My wife (who does college counseling) tells me that now we have “lawn mower parents.” These are the parents who mow down anything in their child’s way that would be uncomfortable for them to experience.
First, let me tell you that things are doing well, business is good (no I am not tired of winning yet). But, I do always worry about what will cause things to change and when will it happen. When real estate outperforms for too long – when appreciation returns far exceed net income (rent) growth and when short-term returns are far better than long-term returns it usually means that the market is overpriced, and it will correct.
While I can’t tell you how happy I am to see unemployment at all-time lows and GDP growing and inflation low and consumer confidence high, I am trying to look for cracks in the foundation. As mentioned above I worry about student debt, but I am far more concerned about automotive debt and pension obligations.
First, new car sales are flattening because of rising prices. However, used car sales have risen. Overall sales are down 6%. But why are sub-prime auto loan delinquencies at a 22-year high? There is over 1.1 trillion in auto debt outstanding. In 2007/2008 Greenspan started raising rates after years of low rates. Soon after, subprime loans started blowing up and it trickled over into chaos.
Problem #2 – There are big unfunded pension obligations because of the way that the Federal pension laws were written. When pensions were first started, employers balked at having to make mandatory payments to a pension fund, because they might have a bad year or years and wouldn’t be able to make the payment. So that’s when it was written into law that payments didn’t have to be made, with the UNREALISTIC expectation that employers would then make up any shortfall when times were good. There was no limit on how big the shortfall could be, there was no repercussions for it, AND it didn’t have to be posted to a balance sheet as a recorded liability. So…guess what happened. About 99% of all pensions in the U.S. have big unfunded obligations. There is a big push to have those unfunded liabilities recorded on the balance sheet, but it’s going to have a huge impact on financial statements and could even force some corporations and municipalities in BK.
On that subject, you have legacy retailers like Sears who have more retirees in their pension plan (+/- 100,000) than they do employees (+/-85,000). When you see Sears sell off it’s crown jewels like Craftsman and Stanley Black & Decker for 900 million you have to realize they must contribute about $250 million of that to its pension plans.
So back to education for a minute. More specifically, Debt Service Coverage Ratio (DSCR). We often hear what kind of loan to value (LTV) can I get or what percentage down do I need down? When in fact most all lenders are looking at DSCR.
DSCR = Net Operating Income/Debt Service (full loan payment that may be interest-only or amortizing). Basically, it is the amount of income (plus cushion) you have to pay the loan.
Of course, the obvious use of this ratio is monitoring the risk of potential default. A low DSCR (close to 1.0x) means the property’s net income is barley sufficient to cover loan payments.
But it’s important to note that DSCR isn’t purely a performance monitoring metric. It’s a measure that will affect the underwriting of your loan and can determine how well a borrower is able to finance their asset.
When acquiring a property, a low cap rate and a high DSCR requirement can shrink your loan proceeds. I think this is best shown in examples. Loan quotes shown here are for illustrative purposes only.
You’re buying a stabilized retail asset in San Diego, where such properties trade at very low cap rates.
If Purchase Price $10,000,000 and NOI = $425,000 then Cap Rate = 4.25
You’re able to get two competitive loan quotes for the deal, and you’re most concerned about maximizing leverage. At first thought, you’re excited about a loan from Big Bank #1, because you know they can go up to 80% LTV while staying non-recourse.
But in San Diego, that’s not the case.
|Goliath National Bank||4.5% fixed||7 years||1.1x||30 years|
|Big Bank #1||4.5% fixed||7 years||1.2x||30 years|
In order to cover a 1.2x DSCR with Big Bank #1, the max proceeds they can reach would be around $4\5.6 million, an LTV of 56%, a far cry from the max 80% you hear about. Given the $425K NOI, the property would need to trade at a much higher cap rate to reach 80% leverage.
The other lender, Goliath National Bank, would be higher leverage (up to ~62.5% LTV), purely based on their lower standard for debt service coverage.
There are a few strategies for managing your DSCR risk.
- Buy value-add – if you can “increase the cap rate” on a property you own, and then refinance, the equity you’ve built up on the property should help you reach higher loan proceeds.
- Buy at higher cap rates – this may mean hunting for properties in markets that are more advantageous for buyers’ Higher risk, higher reward, higher cap rates.
- Use lower leverage- more equity is required, but you’re building in a larger margin of safety from a default.
- Find the right lender – in San Diego County, to achieve higher leverage you need to use a bank or credit union that understands the local market, and tailors their lending programs appropriately.
Hopefully, this month’s letter was very educational and not to full of B.S. I hope you enjoy the story…and continue your education…
Manure: An interesting fact
In the 16th and 17th centuries, everything for export had to be transported by ship. It was also before the invention of commercial fertilizers, so large shipments of manure were quite common.
It was shipped dry, because in dry form it weighed a lot less than when wet, but once water (at sea) hit it, not only did it become heavier, but the process of fermentation began again, of which a by-product is methane gas. As the stuff was stored below decks in bundles you can see what could (and did) happen. Methane began to build up below decks and the first time someone came below at night with a lantern, BOOOOM!
Several ships were destroyed in this manner before it was determined just what was happening.
After that, the bundles of manure were always stamped with the instruction, “Stow high in transit” on them, which meant for the sailors to stow it high enough off the lower decks so that any water that came into the hold would not touch this “volatile” cargo and start the production of methane.
Thus, evolved the term…the acronym for “Stow High In Transit.” (You can figure it out.) It was stamped on all the bundles. So, it’s really not a swear word which has come down through the centuries and is in use to this very day.
I did not know the true history of this word.
I always thought it was a golfing term.
01 Sep / 2018
Well, my birthday came and went again, and I still can’t figure out how I got over the hill without getting to the top! But I have found a way to increase my fitness quotient without working any harder yet still impressing all my friends and family. I have officially renamed “the John” to “the Jim”. It sounds so much better when I tell people I go to the Jim every morning!
I am very concerned that our society is grappling with what is truth and what is not. It has infected our politics, our media, the stock market and I am afraid maybe the real estate market as well. If you don’t understand what the market is saying, then you are not listening closely enough.
Ten years ago, the Fed was pushing on the string trying to get rates down low enough to kick start the economy – no luck. Now, with the economy humming the Fed is again walking the tight rope pushing rates up to slow down but not stop the growth. I guess you call it Quantitative Tightening (or QT vs QE). Remember when we were saying that there was cap rate “compression” because interest rates were so low that cap rates were pushed lower. Well with rates on the rise shall we call it “decompression”? In scuba diving when you rise from lows you stop along the way to equalize the inert gases in your blood stream (otherwise your blood literally boils). Same thing happens as the economy and rates rise and we get rid of the FEDS “inert gas” also known as QE or liquidity. However, as in scuba diving if you go up to quickly, you get decompression sickness also known as “the bends.” In our economy, the bends are called a recession.
In the commercial real estate market, we have a similar problem. As rates rise, cap rates do too. This is because investors can now get higher and safer returns from CD’s, Bonds, and stocks so there becomes less demand causing cap rates to rise (you know – supply and demand). Cap rates rise, and price goes down. So, this is what it looks like as the economy gets better, but you lose value. The only way you can make up for this is increased rents (or lower expenses).
So, is it time to sell? Yes. No. Maybe. Yes, if you bought low and want to sell high, pay your taxes and do something else with your money. Yes, if you have a lot of debt and a drop-in value of 10% – 20% would wipe out most of or all of your equity. No, if you have long term stable tenants with room to raise rent over time and fixed rate financing in place. Maybe? – well there are lots of maybe reasons and that is why you need to call us to discuss.
Similarly, the housing market must see wage growth to keep up with the accelerated housing prices that have been occurring over recent years. Hourly earnings are up 2.7% but still behind the pre-2008 pace in the low 3’s. Wage pressure will come from low unemployment (down to 3.7% in San Diego from 6% in 2008) but just as importantly from the labor participation rate. We are at 82.1% but need to get over the pre-recession high at 83.2%.
In the meantime, Southern California home sales hit the brakes in June falling to the lowest reading in four years. Furthermore, pending home sales stepped back in July and have been falling for seven straight months. The biggest part of the problem is lack of availability of “affordable” housing. Sales below $500K dropped 21%, while deals over $500K only dropped 3%. This was due to lack of supply not demand. Higher rates will not make this problem any better (I’m starting to feel my blood boil).
So, this leads to my biggest worry, more people moving out than moving in – that is a recipe for commercial real estate value decreases. According to the U.S. Census Bureau, more than 42,000 San Diego residents left the area for the Inland Empire from 2000-2015, 9000 left for Phoenix.
San Diego only grew by 0.6 percent last year which is below the national average of 0.7 percent and lower than San Diego’s historic average of 1 percent. Almost all the growth was births over death. The strongest in-migration was people making over $100K (duh—they’re the only ones who can afford to live here). So, will San Diego be a castle on the hill with its work force commuting in from Riverside County and or across the Mexican border?
Another negative cloud on the horizon…the foreclosure rate rose for the first time in 36 months. On the positive front that 3.7% unemployment rate was highlighted by strength across all sectors since 10 years ago – Happy Labor Day!
- Healthcare up 34,900 jobs
- Tourism/Hospitality up 29,100 jobs
- Government up 25,800 jobs
- Science & Technology up 17,500 jobs
- Management up 5,800 jobs
One other thing that is up in San Diego is telecommuting. Up almost 200% in the last 10 years. Carlsbad based, Global Workplace Analytics estimates that 65,000 San Diegans now work at least half of their hours from home.
I was out driving the market the other day and I couldn’t help but notice the number of church’s that have changed their names to things like, The Well, The Place, The Sanctuary, etc… I give them an “A+” for rebranding but the product is still the same as it has been for 2000+ years (which I think is a good thing). However, I look at McDonalds, Starbucks or In-N-Out and you see them adjust and refreshen but as in my opening paragraph, changing the name does not change the truth. Just look at IHOP…I mean IHOB.
At CDC Commercial, we aren’t planning on changing our name, we plan to keep telling you the truth and we try to remember that the market is ever changing, and the truth often seems illusive…hope you enjoy the story
A woman was waiting at an airport one night, with several long hours before her flight. She hunted for a book in the airport shops, bought a bag of cookies and found a place to drop.
She was engrossed in her book but happened to see, that the man sitting beside her, as bold as could be. . .grabbed a cookie or two from the bag in between, which she tried to ignore to avoid a scene.
So, she munched the cookies and watched the clock, as the gutsy cookie thief diminished her stock. She was getting more irritated as the minutes ticked by, thinking, “If I wasn’t so nice, I would blacken his eye.”
With each cookie she took, he took one too, when only one was left, she wondered what he would do. With a smile on his face, and a nervous laugh, he took the last cookie and broke it in half.
He offered her half, as he ate the other, she snatched it from him and thought… oooh, brother. This guy has some nerve and he’s also rude, why he didn’t even show any gratitude!
She had never known when she had been so galled and sighed with relief when her flight was called. She gathered her belongings and headed to the gate, refusing to look back at the thieving ingrate.
She boarded the plane, and sank in her seat, then she sought her book, which was almost complete. As she reached in her baggage, she gasped with surprise, there was her bag of cookies, in front of her eyes.
If mine are here, she moaned in despair, the others were his, and he tried to share. Too late to apologize, she realized with grief, that she was the rude one, the ingrate, the thief.
01 Aug / 2018
I have come to realize that both our bodies and our properties are aging and sometimes a meaningful disruption comes along and we need to be smart and flexible to stay in the game. While on the subject of medical, talk about a niche that is undergoing a dramatic change. This change is also flowing through to real estate. Instead of the old model of one large delivery point – a hospital – the new model is “healthcare everywhere.” Technology enabled care will increase efficiencies and drive changes in the design of space – be it retail, clinic, acute care or for the home. It ranges from Amazon delivering your prescription to Uber delivering you to the hospital (ambulance traffic has plummeted in most cities). Big data access and Artificial Intelligence is making diagnosis easier (symptoms can be compared to millions of other cases) and now medicine is getting predictive. Soon you will get an email telling you to come in because you have a 90% chance of having a problem within 90 days. Or now at Heal.com, you can just schedule the doctor to come to you (I remember as a kid, doctors used to make house-calls. It seems to be coming full circle). In the medical office world, I am now seeing executive suites starting to popup, so Doctors can have offices in multiple cities or states for several days a week.
In the last 10 years we have seen the rise of open office plans. These are large open offices with table tops and sofa’s strewn throughout. The idea is everyone working on their laptops and collaborating as if they are in their living room or kitchen table. This concept was born out of companies like Facebook renting old warehouses and throwing up banquet tables and couches as an affordable office option. I don’t know if it was cool to be in an open office or working for Facebook. However, now everyone is looking to open their office plan and put more people in less square feet. This is all well and good but there are some pitfalls.
First of all, when you get more employees in the same space (I call it expansion in place), it results in a lot of hidden costs (parking, HVAC load, wear and tear). As this trend grows you will start seeing more control exercised over parking spaces and fees for parking. We will also see caps on the number of employees and overage charges for excess employees. Jeff Eales, Senior VP of Asset Management at Bircher Anderson Realty Management (and reader of my monthly letter) wrote a great article on this subject for Commercial Investment Real Estate and created a great spreadsheet to assess the cost of extra occupants in the building.
Just when you think you are ready to make the adjustment to open office (you know get a laptop and a hoodie and some earbuds and work on the couch), a new study from Harvard has found that open offices don’t live up to all the hype. Open office took off because of the idea of increased interactions and collaboration. When in fact, the Harvard study has found that employees spend 73% less time in face-to-face interactions. However, email and messaging shot up by over 67% (so you text the guy on the couch next to you). Open office tries to drive collaboration, but it often comes at the expense of focus and concentration. When it is hard to focus, stress and errors increase. As in personal health, getting the balance right “is paramount.”
When you are on fire you are taught to “stop, drop and roll.” Well when you own your property in an LLC or Partnership and want to do a 1031 exchange, you need to learn to do a “drop & swap.”
When a partnership is selling property and some, but not all, of the partners want to do an exchange, it creates complications for the exchange. A basic rule of exchanges is that the taxpayer who disposes of the relinquished property must be the same taxpayer that acquired the replacement property. If the partnership sells the relinquished property, then the partnership, and not an individual partner, must buy the replacement property. In addition, Section 1031 does not apply to an exchange of partnership interests, so a partner cannot dispose of his partnership interest as relinquished property in an exchange.
If the partners don’t want to keep the partnership intact, one solution to this problem is the drop and swap, where the partnership is dissolved, the property is deeded down to the individual partners as tenants-in-common, and then each individual partner can choose to either cash out and pay the taxes or trade into a replacement property.
The benefits of a drop and swap are that the individual owners now each own a real estate interest that can be traded into other real estate. In addition, because of partnership tax rules, the transfer of the partnership property down to the partners should be a tax-free transfer (be sure to speak with your tax advisers.
29 Jun / 2018
“Computers are useless. They can only give you answers.” – Pablo Picasso
Happy 4th of July to all! Boy when our founders signed the constitution do you think they could have imagined where we are at now? Of course, life changes and evolves. Who would have thought that the mechanical pencil company, “Sharp” would now be a giant electronic and TV manufacturer? Who would have thought that an online book seller (Amazon) would become the dominant retailer they are? What can we expect in the future from the like of Uber, Google, and Facebook. A few clues to ponder – Walmart Stores has dropped “stores” from it name. Microsoft has added AI (artificial intelligence) to its name and Google has dropped “don’t be evil” from its long-time motto (and the first thing they did is lie and say the didn’t change it. – Gizmodo 5/18/18).
The heck with “Fake News,” it looks like we might be moving forward in a “post truth” world. According to the infamously secretive Bilderberg elite (about 120-150 of the worlds political elite, industry, finance, academia and media), the most pressing issues in global affairs are:
- Populism in Europe
- The inequality challenge
- The future of work
- Artificial intelligence
- The U.S. before midterms
- Free trade
- S. world leadership
- Quantum computing
- Saudi Arabia and Iran
- The “post-truth” world
- Current events
Well since I said I was going to write about it last month and seeing the Bilderberg elite list has it at #4, I guess it is important to address Artificial Intelligence (AI). Most of us grew up hearing that jobs will be replaced by robots. Well that time is here, and it is going to affect our jobs, our real estate and our bank accounts. Forty-seven percent of U.S. jobs could be automated in the next two decades. There is an 83% chance that workers earning less than $20/hour will have their jobs replaced in the next 5 years. Those in the $40/hour range face a 31% chance of having their jobs taken over by machine. Clearly, robots are coming!
Imagine what it might look like to a commercial real estate broker. You go to a website and type in your size, space requirements and financial and location parameters. Moments later a recommendation list and map are produced along with a virtual tour of each site. Market intelligence tells you what terms and incentives to expect (free rent, cpi, cap, etc.), you put in your bid along with an upload of your financial info, credit check and an intelligent assistant checks out your Linkedin and Facebook profile, Uber ride history and determines you have only a 2% chance of not fulfilling your obligation. It also determines that your business should grow to need more space in 3 years, but the space next door will be expiring then. It asks if you would like to pay now for an option or “buy it now” to lock in the space. You are asked if you need insurance, utilities transferred to your name, movers arranged. With all of the boxes checked, you summon your driverless Uber to take you to the golf course for some exercise.
Adapting to change is going to require us to understand how man-machine partnerships are going to evolve. HUMAN + MACHINE = FUSION SKILLS (or in Star Trek – Cyborg!). I like the quote, “AI – use it or be used by it.” If you would like an in-depth dive into the effects AI will have on commercial real estate, I highly recommend the following YouTube video.
If you don’t have time, here are the 17 real estate work flows in the crosshairs of AI;
|· Asset performance|
On average, it costs about $60,000 to replace a departing employee. Furthermore, it takes 3-6 months to get a new employee up to speed. Knowledge transfer of a departing employee is a difficult and typically not well documented process. How do you transfer experience, context and interpersonal relationships? I used to say, “I wish I could clone myself” so I could get twice as much done. Businesses are now looking at ways to use AI to clone you so as to retain a departing employee’s knowledge and experience and allow a new employee to come up to speed almost instantly (or completely replace said employee!). If you don’t think that’s realistic (and if you need an AI friend), check out Replika in the app store. You can upload text messages, social media posts and create you own chat bot who will text with you any time and not judge – plus your chat bot can stay around after you die and text with your friends and family…hmmm…
On the National front, I continue to worry a bit about the yield curve and the message it is sending (It is about where it was in 2007). Locally, inventory is continuing to absorb, new buyers are upgrading old buildings, rents are rising. I also notice more construction cranes in the sky (usually a sign of prosperity).
Well as real estate values rise, and you enjoy family pictures around the barbeque this 4th, just remember some things change, some things evolve but if you don’t want to pay an arm and a leg we’re here to help you with your real estate needs. Hope you enjoy the story…
In George Washington’s days, there were not cameras. One’s image was either sculpted or painted. Some paintings of George Washington showed him standing behind a desk with one arm behind his back while others showed both legs and both arms. Prices charged by painters were not based on how many people were to be painted, but by how many limbs were to be painted. Arms and legs are “limbs,” therefore painting them would cost the buyer more. Hence the expression, ‘Okay, but it’ll cost you an arm and a leg.’ (Artists know hands and arms are more difficult to paint).
04 Jun / 2018
Well I am going to keep this month’s letter short since I am writing it from my balcony over-looking the blue green waters of the Pacific Ocean and Maui coastline. First it never ceases to amaze me how technology allows me to stay in touch with calls, emails, electronic files, etc…. (on the other hand, I know what you’re thinking “Geez get a life, you’re on vacation!). So, this is the conundrum of modern life (or what is now being termed “the gig economy” – after the idea of getting paid one deal at a time – or “one gig at a time” or what’s your next “gig”). Although, this might be a new concept, that is how I have been getting paid for the last 33 years! Of course, by the time you are reading this I will already be home working like a dog again.
Speaking of dogs, it never gets easier but one of our two family dogs passed after 14 years. It is never fun, but a replacement goes a long way to filling the void (pictured at top). While still on the subject of pets, you may want to give some consideration to your rules, leases, employee handbooks, etc. with regards to pets. The service animals have been around for a long time but there has been an explosion of “support animals” (from Dogs to Peacocks). In addition, dogs have grown to almost human standards in terms of their access to planes, trains and automobiles, not to mention stores, offices, hotels and theaters. Don’t get me wrong, I love my dogs, but I recently toured a space where a tenant wouldn’t lease because she has allergies and the suite next door had two dogs in their office. On the other hand, my daughter works at Petco Corporate and they have nearly as many dogs as they do employees wandering the halls (complete with two dogs parks!) Linked below is a great article by Brian Adkins at KTS Law on pets in the workplace. If you haven’t already, this is a good time to address this growing issue.
Regardless of which side of the fence (sorry for the pun) you are politically, finding contractors (Gig workers) has gotten tougher – everyone is busy. Finding workers in the Trades (plumbing, painting, electrical etc… has gotten difficult and more expensive. At the global level, economists are saying there is slower global growth rate and higher rates are leading to stagnation. However, at the street level what I see is Goldilocks on steroids – not too hot, not too cold and plenty of activity to go around. However, it does make my head turn a bit when I start hearing the old phrase, “but it’s different this time.” One thing I think is different is that rate increases are felt much quicker and therefore won’t travel as high or as quickly as say in the ’70s’. Back then you had a fixed rate home loan and you paid cash for your car. Today, a simple rate bump affects millions of businesses and tens of millions of consumers right away because we have so much financed. That leads me to my greatest concern – High debt companies. These companies have been living at the trough of government sponsored low interest rates and when the uptick is felt they will cut jobs, space and overhead quickly. I think in the meantime, we are looking pretty good until 2019 or 2020.
One other early warning sign that has just come onto my radar in the last month. Appraisals seem to be coming in higher than I expect. Now consider that I am an optimist and want to value a property at the highest price I can get it sold for. But in the last month, I have seen 3 – 4 appraisals that were much higher than I would value the property for. In all of the cases they had used poor comps or had projected rents higher than the market for the subject building. I don’t know if this was because they were busy, incompetent or overly optimistic, but it is of concern.
Well I was going to write about artificial intelligence and its future effect on commercial real estate… but I think it is time to go play in the surf and curl up like a dog in the sun. BTW in dog beers… I only had one!
A Dogs Purpose (from a 6-year-old)
Being a veterinarian, I have been called to examine a 10-year-old Irish wolfhound name Belker. The dog’s owners, Ron, his wife, Lisa, and their little boy, Shane, were all very attached to Belker.
I examined Belker and found he was dying of cancer.
I told the family we couldn’t do anything for Belker and offered to perform the euthanasia procedure for the old dog in their home.
As we made arrangements, Ron and Lisa told me they thought it would be good for six-year-old Shane to observe the procedure. They felt as though Shane might learn something from the experience.
The next day, I felt the familiar catching my throat as Belker’s family surrounded him. Shane seemed so calm, petting the old dog for the last time, that, I wondered if he understood what was going on.
Within a few minutes, Belker slipped peacefully away.
The little boys seem to except Belker’s transition without any difficulty or confusion. We sat together for a while after Belker’s death, wondering aloud about the sad fact that animal lives are shorter than human lives. Shane, who had been listening quietly, piped up, “I know why.”
Startled, we all turn to him. What came out of his mouth next stunned me. I’d never heard a more comforting explanation.
He said, “People are born so that they can learn how to live a good life — like loving everybody all the time and being nice, right?”
The six-year-old continued, “Well, dogs already know how to do that, so they don’t have to stay as long.”
Remember, if a dog was the teacher, you would learn things like:
- When loved ones come home, always run to greet them
- Never pass up the opportunity to go for a joyride
- Allow the experience of fresh air and the wind in your face to be pure ecstasy
- Take naps
- Stretch before rising
- Run, romp, and play daily
- Thrive on attention and let people touch you
- Avoid biting when a simple growl will do
- On warm days, stop to lie on your back on the grass
- On hot days, drink lots of water and lie under a shady tree
- When you’re happy, dance around and wag your entire body
- Delight in the simple joy of a long walk
- Eat with gusto and enthusiasm
- Stop when you have had enough
- Never pretend to be something you’re not
- If what you want lies buried, dig until you find it
- When someone is having a bad day, be silent, sit close by and nuzzle them gently
- Be always grateful for each new day
Enjoy Every Moment of Every Day!
01 May / 2018
“Brokers, who having no stock of their own, set up and trade with that of other men , buying here, and selling there, and commonly abusing both sides to make out a little paltry gain.”
~From Samuel Johnson’s “a Dictionary of the English Language”, 1755.
I prefer to think of the brokerage business like that of a virtuoso of the deal! Well as I write this the 10-year Treasury has touched the 3% mark for the first time since 2014. The 30-year fixed rate mortgage hit 4.46% also a high point. Consensus is that the 30-year fixed mortgage will reach 5% by the end of the year. Some perspective however, the historical average for the 30-year fixed rate mortgage is about 8%, so rates are still low by historical standards. The primary reason mortgage rates are rising is a healthy and growing economy. However, income levels must keep growing to offset rising rates (that means wages and rents).
The USD economic index set a record high for the third month in a row in March, indicating positive growth in the local economy through at least the end of 2018. The report does warn, however, we face a long run problem of shrinking employment due to improved technology. The key as always, is whether the technology changes will lead to new opportunities as it has in the past.
Computers are performing detailed image processing on x-rays, text mining of legal documents. IBM touts Watson, we all talk to Siri or Alexa, but AI is now even being used to read leases. An application called Dilligen can scan hundreds of lease and CC&R’s and tell you if there are any use conflicts or who needs to be notified in case of certain events. AI is starting to be used in locational decision making, in valuations and appraisal. You might also check out www.commonareas.com to help manage your property. It is an amazing way to track all the work and tenants at your property. In fact, we are even using an AI mining product that allows us to generate an amazing history and projection of rent, value and comparables of most properties on the market. Let us know if you would be interest in an evaluation of your property or one you might want to buy.
One area that San Diego ranks high in (not in a good way) but that might change with technology (can you say self-driving cars) is traffic. San Diego was 45th out of 1360 cities in 38 counties. According to the study, San Diegans spent 48 hours in peak traffic congestion last year. Ten percent of our driving time in 2017 was spent in traffic jams!
In the swamp also known as Washington D.C. you will be glad to know that IREM (Institute of Real Estate Management) is hard at work advocating for seven major issues affecting the industry and maybe with a developer as President we will get some traction. Their agenda is;
- ADA lawsuit reform. IREM supports legislation to create “notice and cure” provisions within ADA to allow owners of businesses and property to rectify violations before facing costly lawsuits.
- Federally Assisted Housing. Federally assisted housing puts people into homes. HUD contracts with private owners to fund the difference between rent and 30% of tenant’s income.
- Rent Control. IREM urges elected officials at all levels of government to oppose rent control as being counterproductive to all segments of society and the well-being of the nation.
- Medical and recreational marijuana. The conflict between federal, state and local law creates a complicated situation for real estate owners, users and lenders.
- Flood insurance. The National Flood Insurance Program (NFIP) provides affordable insurance for those that need it. IREM supports reform and continued funding.
- Data Security. Property owners and managers collect and maintain huge amounts of sensitive data (it’s not just Facebook!) including social security numbers, account numbers and financial records putting them at risk from cyber criminals. There is a fine line between establishing standards and creating onerous legislation on property owners and managers.
- Online sales tax. This is a hot topic in the news lately. IREM supports creating a level playing field but opposes a “federal sales tax on internet purchases.” Instead it supports states collecting sales tax at the state and local level.
So, what can we do? Gene Simmons (yes, rocker with the Band KISS) said, “whether you are left or right the bad guys still hate us.” Former Speaker of the House Newt Gingrich says, “we need a national theory of succeeding in education and the economy. An unhealthy, uneducated and unproductive America will not sustain a global national security system and may not even be able to defend itself. Specifically, to be successful over the next 20 years, we must develop national security theories for:
- Shrinking and eventually eliminating Radical Islamic supremacism as an ideology capable of recruiting soldiers willing to engage in terrorism.
- Creating an American response to the Russian model of hybrid warfare which operates with the same capabilities.
- Developing systems, strategies, and structures for sustaining continuous competition with China and Russia.
- Being prepared for constant change across every career, institution, and system brought about by emerging technologies (this includes your real estate).
- Constantly communicating with Americans and allies to help people understand that mastering the scale and pace of change will be the key to success (this also includes your real estate).
This is a daunting agenda, but we need to face the music and look for a virtuoso (we hope that’s us for your real estate)…hope you like the story.
Music and Perception
In Washington, D.C., at a Metro Station, on a cold January morning in 2007, this man with a violin played six Bach pieces for about 45 minutes. During that time, approximately 2,000 people went through the station, most of them on their way to work. After about 3 minutes, a middle-aged man noticed that there was a musician playing. He slowed his pace and stopped for a few seconds, and then he hurried on to meet his schedule.
About 4 minutes later:
At 6 minutes:
A young man leaned against the wall to listen to him, then looked at his watch and started to walk again.
After 1 hour:
He finished playing and silence took over. No one noticed, and no one applauded. There was no recognition at all.
No one knew this, but the violinist was Joshua Bell, one of the greatest musicians in the world… He played one of the most intricate pieces ever written, with a violin worth $3.5 million dollars. Two days before, Joshua Bell sold-out a theater in Boston where the seats averaged $100 each to sit and listen to him play the same music.
This is a true story. Joshua Bell, playing incognito in the D.C. Metro Station, was organized by the Washington Post as part of a social experiment about perception, taste and people’s priorities. This experiment raised several questions:
*In a common-place environment, at an inappropriate hour, do we perceive beauty?
*If so, do we stop to appreciate it?
*Do we recognize talent in an unexpected context? One possible conclusion reached from this experiment could be this:
If we do not have a moment to stop and listen to one of the best musicians in the world, playing some of the finest music ever written, with one of the most beautiful instruments ever made. How many other things are we missing as we rush through life?
Enjoy life NOW… it has an expiration date!
02 Apr / 2018
“The difference between death and taxes is death doesn’t get worse every time Congress meets.” ~ Will Rogers
Isn’t it appropriate that the month we pay taxes starts with April Fool’s day and finishes with the cries of May Day (traditional International Workers Day)! Adlai Stevenson said in a campaign speech, “I offer my opponents a bargain: if they will stop telling lies about us, I will stop telling the truth about them.” (History might not repeat itself, but it sure does rhyme). In today’s world of “Russia, Russia, Russia” and #DeleteFacebook, I think it is important to be a little reflective. Of course, we should seek to shut down Russian influence as much as possible, without losing perspective. But we aren’t divided because of Russia; we are divided because we have genuine deeply held differences. The fault, to the extent there is one, isn’t with the bots, but with ourselves.
The shuffling among new technologies and potential business responses (and yes that includes commercial real estate) is what sets the page for social change. No one believed that self-driving cars would ever be viable, let alone at the verge of commercialization. Computers will soon be able to perform detailed image processing on x-rays, text mine legal materials and turn out fault-free analysis of tax forms by breaking these dauntingly complex cognitive tasks into smaller and smaller task units. Whether it is the #metoo movement or an episode of House of Cards, your taxes or the future of AI it is all about “Control.” So how do you “control” your commercial real estate (especially in the event of an inevitable real estate downturn)? Times are good, but they won’t last forever. Now is the time to take advantage of what’s left of the good times. Money is still relatively cheap, vacancies are low, and rents are rising. For some, it is time to offload assets that are not strong enough to weather the storm. For others who are confident their properties will hold up long term, here are some beneficial tips:
- Negotiate Long-Term Leases. During downturns when vacancies are up, having long term tenants and steady cash flow is important.
- Pursue Rehabs and Upgrades. Be sure your property is in tip-top condition. When times are slower you want to remain the most attractive spot on the block. Doing this while capital is available and cheap is the best approach.
- Embrace Technology. Look at Tech solutions to make your property more efficient and nimble. New sprinkler box timers connect to WiFi, so they turn off automatically when rain is in the forecast plus you can control your system from your cell phone.
Speaking of technology, I recently read about a new technology that may soon make WiFi obsolete. It is called LiFi and it uses LED lightbulbs to transfer data. It boasts speeds up to 1000 times faster than WiFi. Now that is light speed!
For you to remain in control of your real estate and be light years ahead, it is important to know the fundamentals of how you make money – and optimize it.
- Cash Flow – Income after expenses and depreciation shelter.
- Loan Paydown – it doesn’t look like much, but it adds up to a lot over time.
- Appreciation – appreciation come from rent increases or cap rates going down (buyers accepting less return). Leverage (loan) super charges that appreciation. A 3% rent increase on a $100,000 property that you own for cash is 3% but if you have a 50% loan that is $3000 on a $50,000 investment or a 6% return., on an 80% loan that is 15%! – just remember it cuts both ways when things go south.
Whether we own a skyscraper on Wall Street or a duplex on Main Street, the basic principle of income property remains essentially unchanged. We expect to collect money, mainly in the form of rent, and we expect to spend money to pay for the operating expenses and the loans against the property. When we’re done for the year, we hope to have a surplus and to keep the tax collector from getting too large a chunk of it. Perhaps someday our prudent management and careful upkeep will combine with a healthy real estate market to allow us to sell the property at a profit and wise tax advice will keep some of that profit in our bank account.
So Happy Tax month, may the tax man taketh less, and you have more in all ways of your life. Hope you enjoy the story…
The local bar was so sure that its bartender was the strongest man around that they offered a standing $1,000 bet. The bartender would squeeze a lemon until all the juice ran into a glass and hand the lemon to a patron. Anyone who could squeeze one more drop of juice out would win the money.
Many people had tried…over time: weightlifters, longshoremen, etc., but nobody could do it.
One day, this scrawny little fellow came into the bar, wearing thick glasses and a polyester suit, and said in a small voice, “I’d like to try the bet.”
After the laughter had died down the bartender said “OK”; grabbed the lemon; and squeezed away. Then he handed the wrinkled remains of the rind to the little fellow. But the crowd’s laughter turned to total silence…as the man clenched his little fist around the lemon…and six drops fell into the glass.
As the crowd cheered, the bartender paid the $1,000 and ask the little man, “What do you do for a living? Are you a lumberjack, a weightlifter, or what?”
The little fellow quietly replied, “I work for the IRS.”