01 Jul 2019
The tune of the National Anthem was originally used as an English drinking song called “To Anacreon in Heaven.” Cheers…and Happy 4th of July!
U.S. economic growth depends heavily on the performance of individual states. California, for instance, in 2017 was the fifth largest economy in the world, boasting a GDP larger than that of the U.K., France, and India according to Wallet Hub.
Although nationally our inflation rate seems to be tame, San Diego has risen by 3.8% over the last 12 months and a full 1 percent over the last two months. This is largely due to an increase in the cost of gasoline. And that is before the 5.6 cents per gallon gas tax hitting today (July 1, 2019). If you believe that reported inflation doesn’t accurately reflect real inflation, you might want to visit; http://www.chapwoodindex.com/.
Good news! San Diego’s unemployment rate logged in at 2.8%, the lowest rate in a decade.
Although the next two trends are affecting residential real estate, I think they are noteworthy and could easily be seen in the commercial realm.
Just when you think things in Los Angeles could be any more dysfunctional, they take the cake again! The City Council has proposed a new tax on property owners for leaving a home vacant.
LeaseLock a new Fintech company is offering a new technology that would eliminate security deposits for multifamily rentals. It decreases move-in costs and accelerates the leasing cycle which increases occupancy rates. Think of it as an electronic surety bond.
Trade dispute tensions, a slowing global and U.S. economy and rising tension in the Middle East have caused a flight to treasuries and a drop-in rate. The Fed has signaled possible rate cuts. All this bodes well for commercial real estate and financing. First, if you didn’t refinance before now might be a good time to do so. To give you an idea as to rates here’s a quick snip of a recent quote:
$1mm + staring at:
5 year fixed – 4.5%
7 year fixed – 4.6%
10 year fixed – 4.7%
Up to 75% LTV
With rates remaining low, it’s still a good time to look at acquisition. However, the reason for investing now shouldn’t be because of FOMO (Fear Of Missing Out). Money mistakes are a fact of life. According to a recent survey, 78% of Americans confessed to making a least one financial gaffe. These are always bad, but in a commercial real estate deal, this could easily cost millions of dollars. Here is a list of common mistakes and some strategies to sidestep them.
- Insist on a margin of Safety – in other words, don’t buy at fair market value but instead expect things to not live up to expectations.
- This time is NEVER different – the four most dangerous words in investing are “this time is different.” When you hear those four magic words – get out!
- Don’t go it alone – you probably got your money from being smart and exerting some special skills. When you buy real estate have a team to help with; real estate law, taxes, insurance, leasing, and property management.
- Don’t invest in something you don’t understand – don’t be at the mercy of your advisors. Fully understand the concept of your investment and be confident you are investing wisely.
- Be leery of leverage – leverage is a two-edged sword; it increases your returns and it increases your risk.
- Understand the local market – get the local newspaper or newsfeed. (I met a medical building investor who bought next to a hospital that was closing!). Know the local price per square foot comparisons, cap rates, commercial construction activity, zoning regulations, and economic growth. Have a local broker who knows and can help with that (Hint hint).
With #6 above in mind, I would like to re-introduce “Nick’s Numbers.”
Hello all, I would like to take a section of the monthly letter each month and give you some current data about a specific city or other trends that I think you may find informative and/or educational. This month, I will start with a summary overview of Escondido’s retail, office, and industrial property categories. ~ Nick
Please give me a call or email me if you would like more in-depth info on Escondido or other San Diego and North County sub-markets (Nick Zech, 858-232-2100, firstname.lastname@example.org).
I hope you all have a great 4th of July and enjoy beautiful San Diego. You can quiz your friends around the BBQ to see who is a real San Diegan . . .
YOU KNOW YOU’RE FROM SAN DIEGO WHEN;
- You can correctly pronounce Tierrasanta, La Jolla, Rancho Penasquitos, San Ysidro, Otay Mesa, Jamul, and El Cajon, and know where they are.
- There are four distinct seasons: Summer, Not Quite Summer, Almost Summer, and oh, hey look its summer again.
- Your house is worth more than some small countries.
- You know what MB, OB, and PB stand for.
- Every street name is either in Spanish or Spanish related, and you’re surprised when other areas don’t have this.
- You see weather forecasts for four different climate zones in the same county and aren’t remotely surprised.
- You remember going to “The Cross” on Mt. Helix for Easter services. 60 degrees is COLD!
- You’ve tailgated at Qualcomm Stadium, and for bonus points, also tailgated when it was Jack Murphy Stadium.
- You know that “charge!” doesn’t refer to a credit card.
- You remember going downtown via Federal Blvd. before Hwy 94 was built.
- You remember when Hwy 94 was 2 lanes in each direction.
- You still call it the Del Mar Fair.
- You say, “I’m going to the track” and people know what you’re talking about.
- You remember when Lemon Grove, La Mesa, and Spring Valley were “in the sticks.”
- You understand what May-gray and June-gloom mean.
- There’s a North County, South County, and an East County but no Central County.
- You know what “the merge” is and will plan your entire day around not being on it during rush hour.
- You know the difference between Clairmont Mesa, Kearny Mesa, and Mira Mesa.
- You’ve gone to Sea World on a warm day and sat in the first few rows at the Shamu Show to get cooled off.
- You’ve been delayed at the Border Checkpoints on the 5, the 8 and the 15.
- Your house doesn’t have or need air conditioning unless you live in the East County.
- No matter what the weather is, there is always someone walking around in a t-shirt, shorts, and flip flops.
- You’ve been to the desert, the mountains, and the beach all in one day.
- You know that Santee and Lakeside are where the “cowboys” live.
- You hate tourists and their bad driving. (But you don’t know how to drive in the rain.) 26. You’ve gone to the Zoo just to hang out.
- You have family or friends that have moved to Arizona, Nevada, Utah or Colorado.
- You know what the “Santa Anas” are and that they have nothing to do with the city of Santa Ana.
- You know what “real Mexican food” tastes like.
- You remember when “Mission Valley” was cow pastures (Oh… to have bought land then!)
- You remember when Lemon Grove had “the cows.”
03 Jun 2019
Hard to believe but 10 years ago, Walter Cronkite, Paul Harvey and Michael Jackson all died. Equally hard to believe, 10 years ago Nick Zech joined CDC Commercial – Happy Anniversary Nick!
Who would have thought back 23 years ago with four kids under the age of seven and naming the company after Candy, Don, and Children that one would grow up and be willing to work for me (far less do it for the last 10 years!)!
Well, one thing that has grown over that time is San Diego’s population. The Census Bureau reports that 2010 to 2018 San Diego County grew nearly 250,000 people! That’s 3,343,364 people in the County making us the fifth most populous county in the nation. As I always say, the key to rising real estate values is more people moving in than moving out.
One downside to all the people moving in is gridlock… Gridlock is when vehicles block a network of intersecting streets, bringing traffic in all directions to a complete standstill. I am very concerned that we might be entering this phase in the real estate market, the stock market, interest rates, and the political landscape.
First, the real estate market. We are experiencing buyers and tenants who are unwilling to pay higher and higher prices and owners unwilling to sell properties because “there is nowhere to go with the money.” Market vacancies are very slim so many tenants are finding no space in their size requirement or space is not in the location they desire. Furthermore, they are shocked at the cost to build new and the reality that it could take 18-24 months to be ready. Gridlock.
Interest rates recently were raised, and the Fed signaled more to come. The markets skidded and careened about until the Fed took their foot off the brake and announced no foreseeable plan to raise them again in the near future… Hmm…like a game of chicken – or Gridlock. With the election machine gearing up you can expect the Fed to try to stay on the sideline as best as they can!
The trade war has the market in a knot. Tariffs affect markets more than Main Street. But eventually, bad markets lead to bad economies. Tariffs is a war we need to win but we appear to be shaking in our boots (after all, 75% of our shoes do come from China.).
The political world is in gridlock and will only get worse through the upcoming election season. It used to be you could tune in to Walter Cronkite and get an idea of what was happening. Today, it depends on which network you tune in – to learn your truth.
Back to San Diego real estate for a minute. The restaurant business is in a big squeeze. Rents are rising, insurance is up, wages have skyrocketed, and the cost of goods has gone up. To a degree, we are all seeing it on the pass-thru – $16 to $20 for a sandwich, drink, and chips! Although San Diego is still giving out more food & beverage licenses each year, the rate of increase has dropped dramatically (from increases in the 1,000’s annually to only 300 or so yearly over the last 3 years).
Housing starts are a good gauge of the future of the real estate market. Every recession since 1960 has been prefaced by a double-digit decline in housing starts – March 2019 – down 16.99% YOY! Robert Campbell’s real estate timing letter flashed a sell signal January of this year for San Diego.
Breaking news – GDP was up 3.1% this last quarter. That is .1% higher than expected and .1% less than the previous quarter . . . Hmmm . . . is that bad news, good news or gridlock?
In case you are confused by all of the political jargon, geopolitics and big business on all the networks and social media, perhaps, as Paul Harvey would say, you will enjoy “the rest of the story” …
Cows and Geopolitics
Feudalism: You have two cows. The lord of the manor takes some of the milk. And all the cream.
Pure Socialism: You have two cows. The government takes them and puts them in a barn with everyone else’s cows. You must take care of all the cows. The government gives you as much milk as you need.
Socialism: You have two cows. The government takes one of your cows and gives it to your neighbor. You’re both forced to join a cooperative where you must teach your neighbor how to take care of his cow.
Bureaucratic Socialism: You have two cows. The government takes them and puts them in a barn with everyone else’s cows. They are cared for by ex-chicken farmers. You must take care of the chickens the government took from the chicken farmers. The government gives you as much milk and as many eggs as its regulations say you should need.
Fascism: You have two cows. The government takes both, hires you to take care of them, and sells you the milk.
Pure Communism: You have two cows. Your neighbors help you take care of them, and you all share the milk.
Russian Communism: You have two cows. You must take care of them, but the government takes all the milk.
Communism: You have two cows. The government seizes both and provides you with milk. You wait in line for your share of the milk, but it’s so long that the milk is sour by the time you get it.
Dictatorship: You have two cows. The government takes both and shoots you.
Militarism: You have two cows. The government takes both and drafts you.
Pure Democracy: You have two cows. Your neighbors decide who gets the milk.
Representative Democracy: You have two cows. Your neighbors pick someone to tell you who gets the milk.
American Democracy: The government promises to give you two cows if you vote for it. After the election, the president is impeached for speculating in cow futures. The press dubs the affair “Cowgate.” The cows are set free.
Democracy, Democrat-style: You have two cows. Your neighbor has none. You feel guilty for being so successful. You vote politicians into office who tax your cows, which forces you to sell one to pay the tax. The politicians use the tax money to buy a cow for your neighbor. You feel good. Barbra Streisand sings for you.
Democracy, Republican-style: You have two cows. Your neighbor has none. You move to a better neighborhood.
Indian Democracy: You have two cows. You worship them.
British Democracy: You have two cows. You feed them sheep brains and they go mad. The government gives you compensation for your diseased cows, compensation for your lost income, and a grant not to use your fields for anything else. And tells the public not to worry.
Bureaucracy: You have two cows. At first, the government regulates what you can feed them and when you can milk them. Then it pays you not to milk them. After that, it takes both, shoots one, milks the other, and pours the milk down the drain. Then it requires you to fill out forms accounting for the missing cows.
Anarchy: You have two cows. Either you sell the milk at a fair price or your neighbors try to kill you and take the cows.
Capitalism: You have two cows. You lay one off and force the other to produce the milk of four cows. You are surprised when she drops dead.
Hong Kong Capitalism (alias Enron Capitalism): You have two cows. You sell three of them to your publicly-listed company, using letters of credit opened by your brother-in-law at the bank, then execute a debt/equity swap with an associated general offer so that you get all four cows back, with a tax deduction for keeping five cows.
The milk rights of six cows are transferred via a Panamanian intermediary to a Cayman Islands company secretly owned by the majority shareholder, who sells the rights to all seven cows’ milk back to the listed company.
The annual report says that the company owns eight cows, with an option on one more. Meanwhile, you kill the two cows because the Feng Shui is bad.
Totalitarianism: You have two cows. The government takes them and denies they ever existed. Milk is banned.
Counterculturalism: Wow, dude, there’s like . . . these two cows, man. You have got to have some of this milk.
Surrealism: You have two giraffes. The government requires you to take harmonica lessons.
01 May 2019
“You’re always going to have critics and naysayers and people that are going to tell you that you won’t, that you can’t, that you shouldn’t. Most of those people are the people that didn’t, that wouldn’t, that couldn’t.” ~ Tim Tebow
I have been fortunate to have been on several trips this month for business and pleasure and I am pleased to report that our national bird, “The Prosperity Crane” (more commonly known as a construction crane) has been prevalent everywhere. I was also pleased to read that the United States has more millionaires than Sweden or Portugal have total population!
One of my trips took me to Washington, D.C., where I was amazed, on one hand, what a fortress the town was and yet realizing just how fragile democracy is. It was thrilling to visit the museums, but I was disappointed by the focus on the exceptions, not on the exceptionalism of our country, it’s people and their accomplishments.
Speaking of exceptional. In February, the Department of Commerce reported that for the first time, online purchases took up a larger percentage of all sales of general merchandise than brick and mortar stores (General merchandise excludes cars, parts, food, beverages, and restaurants). The “retail apocalypse” is on. Fifteen thousand stores have closed since 2017 and 75,000 more are expected by 2026 according to UBS analysts. American consumers show no sign of slowing their online purchases with the average U.S. household spending 50% more online than they did a year ago.
However, there is no substitute for creativity. IKEA recently sent our newspaper ads that if you pee on, will show if you are pregnant and thereby qualify for a 20% discount on baby things – I haven’t figured out how you redeem the coupon though. We recently used Walmart’s grocery pickup service and were very impressed. We had a family reunion trip and had ordered our groceries online. We drove the rental car up and they loaded up the weekend’s groceries and we were on our way to the condo. Slick!
As happy as I am about the “Prosperity Cranes” and the economy chugging forward, I thought it was worth sharing a case study of a deal that we did so you could fully appreciate how long the “process” can sometimes take just to get you that little fast food place on the corner.
Twenty-five years ago, this city determined that drive-thrus were passé and shouldn’t be in their newly determined urban core.
Twenty years later (2012) a 5,000 SF sit down restaurant in that core closed because of changes in people’s eating habits (more food to go) high cost of labor and utilities. The team at CDC went to work and we found four replacement tenants and had four offers within 30 days. One from a mattress company, one from a franchisee of another sit-down restaurant and two different offers from national fast food restaurants with drive-thrus. The fast food offers were the highest but both required drive-thrus (40-60%) of their business. The LOI was negotiated within 30 days and the lease took another 60-90 days. Of course, the lease was contingent upon getting a business license, approved building plans and of course a drive-thru (there was a bank with a drive-thru next door and 12-15 others on the same street). The selected tenant was a “hot” chain that consumers and cities alike were clamoring for. The tenant had a team of architects, designers, and consultants. They met with community leaders, city staff and city officials. They were told the city liked their business (business friendly) but the area didn’t allow drive-thrus and perhaps they could just get by without one. The tenant explained that wasn’t possible. After six months it was determined that a general plan amendment could be made, a change to the zoning code and perhaps some kind of conditional use permit. This process, of course, could take 18 months or so. This, of course, was all on top of a demolition permit, grading permit and construction drawings and building permit. Finally, it was determined that the CC&R’s of the shopping center needed to be modified so those needed to be signed off by four different parcel owners in the project (each with their own concerns or wants). This process took 3-6 months to negotiate.
It was determined that environmental studies and traffic impact reports needed to be done – add 12 more months.
After six months of staff review, the project was scheduled to the planning commission who recommended approval to the city council. This approval scheduling and cycle took another four months.
With the drive-thru approved (after 50 months!), the deal became “non-contingent” and CDC was paid the first half of its commission! With the drive-thru approved, the city wrapped up its review of the demo permit and construction drawings – 3-4 months. Plans were put out to bid and contractors were selected – 3-4 months and construction begins, and the tenant began paying rent. Now, the irony – at the groundbreaking ceremony, all the city officials gathered and extolled their business-friendly city. Meanwhile, the tenant will employ 80 full and part-time workers and CDC got paid the second half of their commission – 6 years after negotiating the lease!
I can’t wait for our next deal! (I mean, I really can’t afford to wait that long!)
Thankfully all deals don’t take that long. But you can see how easily the ship known as our economy can be sunk. Hope you enjoy the story…
Most people don’t know that in 1912, Hellmann’s mayonnaise was manufactured in England.
In fact, the Titanic was carrying 12,000 jars of the condiment scheduled for delivery in Vera Cruz, Mexico, which was to have been the next port of call for the great ship after it stops in New York. This would have been the largest single shipment of mayonnaise ever delivered to Mexico. But as we know, the great ship did not make it to New York. The ship hit an iceberg and sank, and the cargo was lost forever.
The people of Mexico, who were crazy about mayonnaise, and were eagerly awaiting its delivery, were disconsolate at the loss. Their anguish was so great they declared a National Day of Mourning, which they still observe today.
The National Day of Mourning occurs each year on May 5th and is known, of course, as Sinko de Mayo.
08 Apr 2019
“The difference between death and taxes is death doesn’t get worse every time Congress meets.” – Will Rogers
April Fool’s Day also called All Fool’s Day, dates back to 1582 when France changed from the Julian calendar to the Gregorian calendar. People who were slow to adapt or get the news that the new year had moved to January 1st were celebrating the last week of March through April 1st became the butt of jokes and hoaxes.
However, the original “fake news” started in 1973 when Joseph Stalin created the first Disinformation Office. The idea was to provide false information with the intent to deceive public opinion. Stalin would say, “Flood the people with false info so they won’t know or believe the truth.”
True to the Will Rogers quote above, our state legislature has been hard at work. The sheer volume of new laws is staggering! In total, 1016 new laws will take effect in California in 2019. Amongst those, only milk and water will be published as beverage options on kid’s menus in sit down restaurants. Obesity is an epidemic, but I am not sure this solves the problem. Similarly, restaurants will no longer automatically offer you plastic straws when you order a drink. We’ll save the environment but sicken society by putting our mouths on questionably clean glasses.
I can’t say that I have reviewed the over 1000 new laws but the folks at Kimball, Tirey & St. John LLP have, and I have culled their list for laws affecting commercial real estate that are worthy of your review and understanding;
AB 2173 Commercial Property: Abandoned Personal Property: This bill increased the threshold amount for personal property abandoned in a commercial property to the great of (1) $2,500 or (2) one month’s rent. This bill does not change existing law with regard to the valuation of residential abandoned property. An article with information about the abandoned personal property in commercial property is available at https://www.kts-law.com/abandoned-personal-property-left-by-a-former-commercial-tenant/.
AB 2343 Calculations of 3-Day Notices and Summons: This bill amends Code of Civil Procedure Sections 1161 and 1167 to extend the waiting period for summons and some notices, effective September 1, 2019.
California Landlord/Tenant Law previously allowed weekends and holidays to count towards the three (3) day notice period but prohibited a notice from expiring on a weekend or holiday. Code of Civil Procedure §1167 has been amended to specifically exclude “Saturdays and Sundays and other judicial holidays” when calculating the notice period for notices to pay rent or quit or notices to perform covenant or quit. It does not exclude these days when calculating expiration periods for 30, and 60-day termination notices and notices to quit based on unauthorized assignment, subletting, nuisance, and waste.
AB 2847 Abandoned Commercial Property: creates new law regarding abandoned commercial property. Previously, the law specified that rent had to be unpaid for 14 days before a Notice of Belief of Abandonment could be served on the tenant. Effective July 16, 2018, new California Civil Code §1951.35 changes the 14-day period to the time period specified in the lease for the landlord to declare a rent default (if the lease is silent, it is a 3-day period. Leases sometimes provide for other time periods, such as 3 business days, 5 days or 10 days). AB 2847 also slightly modified the residential Notice of Belief of Abandonment form.
SB 745 Water-Conserving Plumbing Fixture Replacement (2014): Originally passed in 2014, and codified in Civil Code §1101.5, it requires water-conserving plumbing fixtures to be installed in property constructed before January 1, 1994. To be compliant, plumbing fixtures may not use more than the following amounts of water:
- Toilets – 1.6 gallons per flush
- Urinals – 1 gallon per flush
- Shower heads – 2.5 gallons per minute
- Interior faucets -2.2 gallons per minute
Beginning on January 1, 2014, noncompliant plumbing in multifamily and commercial property were required to be replaced in certain situations.
By January 1, 2019, multifamily and commercial properties must be in full compliance. An article with information about water-conserving plumbing fixtures required in California is available at https://www.kts-law.com/water-conserving-plumbing-fixtures-required-in-california/.
SB 1397 Automated External Defibrillators: Health and Safety Code §19300 previously required automated external defibrillators (AED) be installed in properties constructed on or after January 1, 2017. The law will now require that specific residential and commercial properties built before January 1, 2017, to install automated external defibrillators if the structure is modified, renovated or tenant improved, as specified, on or after January 1, 2020. An article about AEDs in commercial properties is available at https://www.kts-law.com/aed-devices-in-commercial-properties/.
Proposition 65: Proposition 65 requires businesses with 10 or more employees to provide warnings when they cause significant exposure to specific chemicals. Proposition 65 requires disclosures by employers who have 10 or more employees and who may expose their employees or the public to specific listed chemicals. There are more than 850 chemicals listed. Some of the environmental hazards are contained in items common in commercial, such as building materials, cleaning materials, car exhaust, and tobacco smoke.
For some time, landlords have been uncertain about how to comply with their Proposition 65 obligations. “Clear and reasonable” warnings must be given. Generally, in an effort to comply with Proposition 65, landlords have posted signage on their properties. Some also have also included Proposition 65 warnings in their leases. For more information about the new Proposition 65 warnings, see https://www.p65warnings.ca.gov/new-proposition-65-warnings .
I told you there were a lot of laws!
Well, we are at the stage of having a lot of good news and a lot of bad news going on. The good news is we had a great year and made money last year, the bad news is we paid a lot of taxes. The good news is we paid less than we would have under the previous year’s rates.
In February, the economy added a meager 20,000 jobs, well below the 180,000 expected. But the number of employed Americans – 156,959,000 has never been higher. The unemployment rate has dropped to 3.8 percent from January’s 4.0 percent.
The Fannie Mae Home Purchasing Sentiment Index (a measure of the current mood of the market) was 83.5 – a 3 year low and well below the May 2018 reading of 92.3 – a seven-year high. This is typically a sign of a reversal in the housing market.
In the leasing market, we are having a tough time finding the space tenants are looking for and at the same time we are finding some tenants getting conservative/cautious about their plans (shortening lease term, etc.). We have also seen multiple mortgage and escrow companies close or downsize.
I will say I am very concerned about the inversion of the yield curve. This is a pretty strong predictor of a recession. However, waiting for a recession is not a good investment strategy.
I still hold that we are in a lull window with some things tearing forward and some pulling back. At this point, it might be a soft landing or better yet a touch and go.
Finally, with the Mueller report out and election season kicking off, expect more talk and less action out of Washington.
Well, with all the information already disseminated I thought you would just like a little more as your story…
- In general, men can read smaller print than women can, but women can hear much better than men.
- Coca-Cola was originally colored green.
- It is impossible to lick your elbows.
- The percentage of Africa that is wilderness:28% (now get this…) The percentage of North America that is wilderness: 38%.
- Each king in a deck of playing cards represents a great king from history: Spades-King David, Hearts – Charlemagne, Clubs – Alexander the Great, Diamonds – Julius Caesar.
- If a statue in the park of a person on a horse has both front legs in the air, that person died in battle. If the horse has one front leg in the air that person died as a result of wounds received in battle. If the horse has all four legs on the ground, that person died of natural causes.
- Hershey’s Kisses are called that because the machine that makes them looks like it’s kissing the conveyor belt.
- What day are there more collect calls made than any other day of the year? Father’s Day.
- What is the most ironic trivia fact about Mel Blanc (voice of Bugs Bunny)? He was allergic to carrots.
- What is an activity performed by 40% of all people at a party? Snooping in your medicine cabinet.
- In Shakespeare’s time, mattresses were secured on bed frames by ropes. When you pulled on the ropes the mattress tightened, making the bed firmer to sleep on. Hence the phrase “goodnight, sleep tight”.
- It was the accepted practice in Babylon 4,000 years ago that for a month after the wedding, the bride’s father would supply his son-in-law with all the mead he could drink. Mead is a honey beer and because their calendar was lunar based, this period was called the honey month we know today as the honeymoon.
- In English pubs, the ale is ordered by pints and quarts. So, in old England, when customers got unruly, the innkeeper would yell at them mind their own pints and quarts and settle down. It’s where we get the phrase “mind your P’s and Q’s”
- Many years ago, in England, pub frequenters had a whistle baked into the rim or handle of their ceramic cups. When they needed a refill, they used the whistle to get some service. “Wet your whistle” is the phrase inspired by this practice.
01 Mar 2019
A Scot, a Muslim, a German and a Jew play golf and go to the bar afterward. They play, they talk, they laugh, they drink and become good friends… It’s not a joke. It’s what happens when you play golf!
I say this because I recently received an email from my golf club telling us that they would stop showing news on the TV’s and to refrain from political conversations on the course. I know this is just part and parcel of the times and that because of social media, one person in Podunk can do one thing weird or wrong and the rest of us assume that is the norm. I worry about our “social fabric.”
When I was growing up you were taught to get married before you have children and strive to stay married for their sake. Get the education you need for gainful employment, work hard and avoid illness. Go the extra mile for your employer or client. Be a patriot, ready to serve the country. Be neighborly, civic-minded and charitable. Avoid coarse language in public. Be respectful of authority. Eschew substance abuse and crime. Be civil.
Lest you think there is no hope for the future, I have to tell you that I was walking with our neighbor who has adopted kids from China and Africa. She told me that a question on her recent job application asked how she handled diversity? She replied, “she kicks them out of bed in the morning just like her other two kids!”
Well San Diego closed out 2018 with the lowest unemployment levels since 2000 (don’t expect your commute to be any easier any time in the near future!). San Diego remains attractive because of its high quality of life and broad pool of talented workers. I know this is hard to believe but it is a lower cost of living compared to other tech markets for most tech talent. The story of San Diego’s real estate market will continue to be about low unemployment and where the tech jobs in the nation are going.
With baseball season upon us, I will tell you I get asked all the time, “what inning are we in – when will this cycle be over?” I will tell you that I think we are in the 7th inning (yes you can take a little stretch). However, having coached a lot of baseball, it is not a 9-inning game like many presuppose. In fact, the longest major league game went 25 innings in 1984 with the White Sox beating the Brewers after 8 hours and 6 minutes! So, although we may be in the 7th inning, I think there are a lot of extra innings in our future.
I tried to figure out how to string all these thoughts together but finally decided that in our ADD society, I would just serve them up to you as bullet points for thought prompts;
- There are 7.3 billion toothbrushes in the world. There are 7.5 billion cell phones. The real cyber security threat in the world is in the palm of your hand.
- In 1995, we had 100% tariffs on Japanese cars.
- The Tech Disturbance and low oil prices are both anti-inflationary.
- We used to worry about people “photoshopping” pictures (you know – your head on someone else’s body). The new thing is “Dark Fake” and it is making fake video and fake voice of you. This is a frightening trend!
- New trend – having a building masseuse.
- Chinese home buyers in the US last year (2018) spent $30 billion on houses.
- There are 130 million books in publication. There are 7.5 million books on Amazon and 500 a day being added.
- 24 million passengers passed through Lindbergh Field last year which is the fifth straight record year. Passenger traffic is directly related to a local economies’ health.
I hope that in our highly conflicted social fabric that you always remember that people aren’t stupid – life is hard. And we’re here at CDC Commercial to help make it easier for you!
I hope you have a Happy St. Patrick’s Day! I hope that in the spirit of that, you enjoy the bagpipe story.
As a bagpiper, I play many gigs. Recently I was asked by a funeral director to play at a graveside service for a homeless man. He had no family or friends, so the service was to be at a pauper’s cemetery in the Irish backcountry.
As I was not familiar with the backwoods, I got lost and, being a typical man, I didn’t stop for directions.
I finally arrived an hour late and saw the funeral guy had evidently gone and the hearse was nowhere in sight. There were only the diggers and crew left and they were eating lunch.
I felt badly and apologized to the men for being late.
I went to the side of the grave and looked down and the vault lid was already in place. I didn’t know what else to do, so I started to play.
The workers put down their lunches and began to gather around. I played out my heart and soul for this man with no family and friends. I played like I’ve never played before for this homeless man.
And as I played “Amazing Grace”, the workers began to weep. They wept, I wept, we all wept together. When I finished, I packed up my bagpipes and started for my car. Though my head was hung low, my heart was full.
As I opened the door to my car, I heard one of the workers say, “I never seen anything like that before, and I’ve been putting in septic tanks for twenty years.”
01 Feb 2019
In 1929 in Chicago, gun men in the suspected employment of organized crime boss Al Capone murdered seven members of George “Bugs” Morin’s North Siders gang in a garage on North Clark Street. The so-called St. Valentines Day Massacre stirred a media storm centered on Capone and his illegal prohibition era activities and motivated Federal authorities to redouble their efforts to find evidence incriminating enough to take him off the streets. With that nugget in mind, Happy Valentine’s Day!
Back in the day the cops used to complain about the crooks getting away before they could get to the scene of the crime. Of course, that was when the cops were still on horseback and the crooks had the modern technology of a car. Thus, was born the get-away car and later, the cop car.
What about today’s electric cars. What impact will they have on our commercial real estate landscape? Gas stations? Auto repair shops? Charging stations? Hot Roders, tuners and Hobbyists? (Do you expect a dual electric distributed battery system with stick shift Corvette in your garage?) Will gas cars go the way of steam and horses? Do you still have doubts? Volvo has announced that it is going to electrify all of its cars by the end of 2019.
Besides electric cars, Artificial Intelligence (AI) is also getting a lot of hype. How will this impact our commercial real estate landscape? After the hype dies down, I see AI becoming a part of our lives just like combustion, electricity and the internet. Will we have an Alexa in the lobby to help people find a tenant’s suite instead of a directory. It could also be used to check the weather, order your lunch and call your Uber. What was once a lobby valet and only in the most luxurious of buildings can be had by all. The great concern about AI of course, is that it will lead to human unemployment and social strife. For now, AI appears to be creating more jobs than it is displacing. Manufacturing is expected to take the biggest hit – 1.8 million jobs (great we’ll bring home all of these manufacturing jobs and then automate them all and put everyone out of work!) The 2.3 million jobs expected to be created by AI are in the education, healthcare and public sector. We have seen robotic automation affecting banking (ATM and bank by phone), retail cashiers and warehouse workers but the next step is “augmenting” where technology works alongside human professionals assisting them with repetitive tasks while leaving them with the “final say.” Think Doctors, Lawyers, hmm… Real Estate Brokers (“Siri, write my monthly letter…”).
The other real estate product heading for major transition is the drug store. The new healthcare model is to become the “healthcare destination”. CVS recently acquired Aetna Insurance, Walgreens has partnered with Humana and Amazon has a joint venture with Berkshire Hathaway (Warren Buffet) and JP Morgan Chase. What can we expect? Amazon store in front and minute clinic in back? Alexa detecting that you have a cold or cough and delivering a pill pack? Will it be drug store as a C-Store or as your Doctor office? Or both? Healthcare is a $3.5 trillion industry. We must figure out how to corral the costs or our nation will go bankrupt. I am starting to see the green shoots of this now; automated blood pressure machines at the mall, Apple watches telling you that you have Afib, your dental hygienist checking your mouth and neck for early cancer signs, blood labs giving your results along with dietary guidelines to increase or decrease a particular blood count.
Agility is key to winning in the digital era. New business models and competition, extensive use of technology, and changing tenant and investor expectations are redefining the commercial real estate (CRE) industry. As investors increasingly favor newer business models and the tech-enabled ecosystem, companies in the commercial real estate industry will have to realign business priorities and adapt to new demands. The most agile will be the winners! (That would be us at CDC Commercial!)
San Diego’s economy remains solid. When the government finally figures out how to stay open. San Diego will be one of the markets that benefit most from the latest spending bill. Two of San Diego’s key economic engines (Defense and Health Care/Biotech) look to be even stronger in 2019. San Diego was a little slow/late getting into the current recovery so hopefully we have a little more runway left than other markets.
Speaking of runways, I hope you enjoy the story.
A story of two men:
STORY NUMBER ONE
Many years ago, Al Capone virtually owned Chicago. Capone wasn’t famous for anything heroic. He was notorious for enmeshing the windy city in everything from bootlegged booze and prostitution to murder. Capone had a lawyer nicknamed “Easy Eddie.” He was his lawyer for a good reason. Eddie was very good! In fact, Eddie’s skill at legal maneuvering kept Big Al out of jail for a long time. To show his appreciation, Capone paid him very well. Not only was the money big, but Eddie got special dividends.
For instance, he and his family occupied a fenced-in mansion with live-in help and all of the conveniences of the day. The estate was so large that it filled an entire Chicago City block. Eddie lived the high life of the Chicago mob and gave little consideration to the atrocity that went on around him. Eddie did have one soft spot, however. He had a son that he loved dearly. Eddie saw to it that his young son had the best of everything: clothes, cars and a good education. Nothing was withheld. Price was no object. And, despite his involvement with organized crime, Eddie even tried to teach him right from wrong.
Eddie wanted his son to be a better man than he was. Yet, with all his wealth and influence, there were two things he couldn’t give his son; that he couldn’t pass on a good name and a good example. One day, Easy Eddie reached a difficult decision. Easy Eddie wanted to rectify wrongs he had done. He decided he would go to the authorities and tell the truth about Al “Scarface” Capone, clean up his tarnished name and offer his son some semblance of integrity. To do this, he would have to testify against The Mob, and he knew that the cost would be great. So, he testified. Within the year, Easy Eddie’s life ended in a blaze of gunfire on a lonely Chicago Street. But in his eyes, he had given his son the greatest gift he had to offer, at the greatest price he would ever pay.
STORY NUMBER TWO
World War II produced many heroes. One such man was Lieutenant Commander Butch O’Hare. He was a fighter pilot assigned to the aircraft carrier Lexington in the South Pacific. Butch O’Hare demonstrated in real life, and when it counted most, the fighting skills he had mastered. The carrier Lexington had been assigned the dangerous task of penetrating enemy-held waters north of New Ireland. From there her planes were to make a strike at Japanese shipping in the harbor at Rabaul. Nine Japanese bombers were reported on the way to the Lexington. Six Wildcats, one of them piloted by Butch O’Hare, roared off the Lexington’s deck to stop them. O’Hare and his wingman spotted the V formation of bombers first and dived to try to head them off. The other F4F pilots were too far away to reach most of the enemy planes before they released their bombs. As if this weren’t bad enough, O’Hare’s wingman discovered his guns were jammed. He was forced to turn away. Butch O’Hare stood alone between the Lexington and the bombers. O’Hare didn’t hesitate. Full throttle, he roared into the enemy formation. While tracers from the concentrated fire of the nine bombers streaked around him, he took careful aim at the starboard engine of the last plane in the V and squeezed his trigger. Slugs from the Wildcats six .50-caliber guns ripped into the Japanese bomber’s wing and the engine literally jumped out of its mountings. The bomber spun crazily toward the sea as O’Hare’s guns tore up another enemy plane. Then he ducked to the other side of the formation and smashed the port engine of the last Japanese plane there. One by one he attacked the oncoming bombers until five had been downed. Commander Thach later reported that at one point he saw three of the bombers falling in flames at the same time. By now Thach and the other pilots had joined the fight. This was lucky because O’Hare was out of ammunition. The Wildcats took care of several more bombers and Lexington managed to evade the few bombs that were released. It was an amazing example of daring and shooting skill. Afterward Thach figured out that Butch O’Hare had used only sixty rounds of ammunition for each plane he destroyed. He had probably saved his ship.
This took place on February 20, 1942, and for that action Butch became the Navy’s first Ace of W.W.II, and the first Naval Aviator to win the Congressional Medal of Honor. A year later Butch was killed in aerial combat at the age of 29. His home town would not allow the memory of this WW II hero to fade, and today, O’Hare Airport in Chicago is named in tribute to the courage of this great man. So the next time you find yourself at O’Hare International, give some thought to visiting Butch’s memorial displaying his statue and his Medal of Honor. It’s located between Terminals 1 and 2.
SO, WHAT DO THESE TWO STORIES HAVE TO DO WITH EACH OTHER?
Butch O’Hare was Easy Eddie’s son.
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
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: email@example.com 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.