C'mon Lucky Sevens!

C’mon Lucky Sevens!

 I am typically not one given over to speculation and hyperbole.  I do not play the odds and I am no good at the casinos.  However, let me be among the first people to point to the coming downturn in investment grade commercial and apartment properties.  This has nothing to do with overbuilding as was the case in the 1980s or the drunken lending practices of the 2000s.  This is purely related to today’s low interest rate environment.

Consider the bond market for ease of comparison.  If you invest long term in low interest rate bonds, and then rates start to increase, the value of your bonds will decrease.  The same principal holds true for real estate capitalization rates and commercial properties. 

Let’s look at investment grade apartment complexes and office buildings as examples.  For Class A properties, you have average cap rates between 4.5% - 7.5%, give or take.  You also have had relatively little new construction over the past 5 years.  Now that the future is looking somewhat brighter, coupled with stagnant supply and low rates, you have a high demand and low cap rate environment for these properties.  As these properties are purchased, they are also typically financed to some degree with low interest rate debt that will have up to 10 year balloon payoff horizons.

Let’s now fast forward to the balloon payoff maturity dates.  In 10 years, I think it is reasonable to assume that interest rates may rise from 4.5% to 6%.  That is still a low rate.  However it is a 33% increase.  If cap rates increase by 33% as well, this will have a huge negative impact on property values.  In order to keep pace, net rents and income would need to increase by 33% in order to just maintain net property values.  That is not going to happen without some serious inflation.  So, when the mortgage note balloons, cap rates will be higher, property values will be lower, and the cost of replacement capital will be more expensive with less replacement debt available due to the lower property values.  Viola!  Another real estate downturn for opportunity funds to swoop in to purchase properties that may have trouble recapitalizing their debt. 

The term buy low and sell high never loses its meaning.  In today’s low interest and cap rate environment, I am concerned that too much institutional money is buying real estate too high for their own long term good.  But, then again, maybe I am wrong.  After all, some people never stop rolling sevens, right?

Until next time…

 

Keep kicking the dirt!

The Convenient Amnesia Rule

The Convenient Amnesia Rule

 When constructing an amenity for active adult communities, the rule of thumb is 15 – 20 sf of space per home.  Learn this rule and commit it to memory.  You will be quizzed on it later. 

When buying a home, amenity collateral is typically crystal clear on the amenities that are to be included in the community.  There are colored renderings of elevations and floor plans as well as a list of club services.  Remember, this amenity is usually planned on the rule of 15 – 20 sf of space per home (a reminder before the quiz). 

This rule is meant to provide an appropriate level of activities at a development expense that will allow for competitively priced homes.  Remember this.  More cost equals more expensive homes.

I bring your attention to these items to deal with what I call the Convenient Amnesia Rule due to Density.  This rule states that homebuyers forget what they bought as the community begins to grow.  As the community grows, so too does activity at the club.  This often causes residents to say the club is too small and needs to be expanded.  The growth of the community has caused them to forget that they received exactly what they were promised.  However, crowded clubs are not bad things.  Would you rather have a club that is quiet and empty?  Hopefully, the club execution and management will be done so well that there is energy and excitement throughout the club all day long.  What those people who complain about the crowds often forget is that if the club was larger, it would have cost more money to build and this additional cost would have needed to be passed along into the price of their home, possibly making their home too expensive for them to afford.  Also, a larger club would have a larger operating budget, possibly increasing HOA fees to a level that buyers cannot afford. 

Ok.  Quiz time! 

Question 1:  An appropriately sized club will help allow homes to be sold at a reasonable price if the club size is : A) 10 sf per home B) 15 – 20 sf home, or C) why are you asking, I don’t know what sf is anyway.

Question 2:  If the club is oversized, your annual HOA fees may:  A) be paid by the builder, B) be too high for you to afford, or C) I don’t care since I will never live in an active adult community regardless of how nice it is.

I hope you did not need to look at the paper next to you.  If you answered anything other than B to both questions, we need to talk.

Until next time…

 

Keep kicking the dirt!

 

 

When is a production builder not a production builder? Never!

When is a production builder not a production builder?  Never!

I wish I was an expert in human nature.  I wish I knew how to read people, understand what makes them tick and what makes them think that a production builder can and should act like a custom builder.  People will sign a contract for a production home and then, all of a sudden, feel that the floor plan and options offered are nothing more than a starting point for whatever changes they feel should be made to the home.  Oh, these poor misguided individuals.  I wish I understood them better.

They see the word production builder, they hear the word production builder, but they do not understand the word production builder.  Yes, you have guessed it.  I am going to explain the word production in the definition of production builder.

For a production builder (PB for short) to obtain the best pricing from their subcontractors, they have to make it as simple for their trades as possible.  That means that the subs need to know in advance what plans they are building, what options are being offered,  approximately how many homes per year the builder plans to build and what is the approximate construction cycle time.  This way, they know how to properly price their work, they know what to look for on selection sheets and they can appropriately staff their job sites. 

PBs also strive to make the job site as manageable as possible for their field managers.  When managing between 15 and 20 homes at a time, the field managers want to know that they are working off of standard plans and option sheets so that they can direct their subcontractors appropriately to make sure that what has been bought is what is being built.

PBs further work to make sure that their Design and Purchasing Departments can be effective by controlling the structural and design options offered.  This allows Purchasing to appropriately price out options up front so that the Designers can effectively work with customers during their design selection meetings.

Let’s now evaluate what happens to this well-oiled machine when a customer requests special items and forgets that they are dealing with a Production versus a Custom Builder.  Purchasing will not have priced their requested custom options up front so that Design has no idea what these items will cost or whether or not they are even feasible from a construction standpoint.  Construction may not end up with the correct plans to work from, increasing the risk of field mistakes being made by the subcontractors and causing delays and errors in the delivery of the home to the customer.  And the fuming customer will not understand how the builder could have made such a mistake with their custom changes.  It is true.  No good deed goes unpunished.

So, the next time you don’t understand why your PB can’t move a window two feet, or change the shower head from one wall to the other, take a minute to reflect on the unseen machinations that make up the construction process.  The more pebbles you throw into the machinery, the greater the risk of that machinery grinding to a very messy and painful halt.  I won’t even begin to explain in this blog what this can do to the warranty process.

Until next time…

Keep kicking the dirt!

 

Carve up the turkey, not the turkey farmer

Carve up the turkey, not the turkey farmer

How often have you driven through a development and thought about the things you would have done differently.  Or wondered what a developer was thinking.  Well, let me speak for the voiceless, those developers that do not have the benefit of sitting with you while you drive through their community.  Let me be their champion!

Let’s pretend together for a moment.  Assume that your unknown eccentric uncle just left you 500 prime residential acres and tens of millions of dollars to develop it.  You jump for joy and can’t imagine your good fortune.  Now what?  There are some barren acres, some wooded acres, some lakes and some wildlife.  You have a blank canvass.  Are you going to paint a masterpiece or are you going to finger paint?

It is a very complicated and involved process to develop land.  You want the development to be aesthetically pleasing and blend into the larger town and community.  You want tree lined streets, lakes, parks, good architecture, strong signage and landscaping.  You also want to make sure that the local government is on board with your vision and will approve your plans.  You need builders that will buy into your architectural guidelines and want to build in your community.  And, most of all, you actually want to make a profit doing it and not squander away all of your dearly departed uncle’s money.

Consider it like going to the grocery store to plan a large dinner with no idea how many people are coming or what they are willing to eat.  You also don’t know if you have enough money to buy all the food, you are not yet sure if you have enough kitchen space to prepare the meal and you wonder if your dining room will have enough seats for all of your guests.  Then, by the time the big evening comes, you have ended up making a fantastic meal with superb appetizers, main course and dessert.  You have also decorated your house to fit the theme of the dinner and paid particular attention to where everyone sits to maximize conversation.  Then, as you are basking in the glory of your accomplishment, you overhear conversation from some of your guests as to how they would have done things differently.

Before you run back to the kitchen for the butcher’s knife to feed those guests their own fingers, think back to the efforts of the developer that built the fabulous community where your home is located.  You now have some common stories to share with each other.  And, please, put the knives back in the drawer.

Until next time…

 

Keep kicking the dirt!

All that Glitters is not Gold, but it still Glitters for Me

All that Glitters is not Gold, but it still Glitters for Me

I often hear people wonder that if they perform renovations on their house if they will be able to recoup their investment.  While well meaning, this is not the right question to ask.  Think about this for a minute.  Are you more concerned with pleasing others or pleasing yourself?  While I commend anyone who puts the needs of others in front of themselves, I typically do not favor this conduct when determining the functionality and livability of your own home.

What would your home look like if all your energies were focused on having the greatest appeal to the general population.  After all, if you want to maximize value for the money you put into your home, wouldn’t you want to undertake projects that would appeal to the greatest universe of homebuyers.  In that case, you would most likely have beige walls, slightly darker large tile, maybe generic granite countertops and simple maple cabinets.  Awesome.  Your home is now the most boring house on the street!

I am not saying you should totally disregard value creation.  In other words, don’t undertake head scratching renovations that leave you thinking “I did what?” after the work is complete.  As I have mentioned in previous blogs, the best renovations are the ones that look like they have always been there.  However, you should focus the bulk of your efforts on making sure that your renovation expresses your own wants and desires.  Remember, it is your home, not some else’s home (at least not yet).  Undertake work that will make you happy, that will create a sense of peace for you.  Let’s be honest.  If you are in love with the result, how do you put a price on your own satisfaction?  So what if a future buyer does not share your taste.  It is your taste and it works for the way you live.  Let the others find that mind numbing combination of beige colors in someone else’s home.

Until next time…

Keep kicking the dirt!

To spend or nor to spend, that is the question

To spend or not to spend, that is the question

You have found a home plan that you love.  You have found a homesite that you cherish even more.  Now, to close the circle on your dream home, you need to select options.  However, you chose a home that was a bit larger than you had planned for and the lot premium with the killer view was also a bit over the top.  So, with more flies than cash swimming around in your wallet, you walk into the design center convinced that you can put off many of your design selections and just add them to the house later. 

STOP RIGHT THERE.  Think about this for a minute.  It is kind of like buying the Mercedes, but seeing if you can get cloth instead of leather with no sunroof or navigation.  You may have fallen in love with the floor plan and backyard view, but the reality is that you live inside of your home.  The bulk of your time will not be spend staring out the windows, but most likely sitting in your family room or kitchen.  Make sure the areas where you spend the bulk of your time live up to your quality and finish expectations.

I know what you are thinking.  I can either do some of the upgrade work myself or just contract with someone else to do it cheaper later.  This typically sounds good, but, in reality, is usually a bad idea.  First, let’s review the types of things you would normally consider putting off.  Crown moulding, interior paint, backsplash tile, laundry room cabinetry, exterior landscaping, a pool.  You get the idea.  It can be a long list.  I also understand that maximizing your design selections with the builder can really stretch your budget.  However, putting it off is many times an example of truly being pennywise and pound foolish.  First, working through the builder allows you to roll these options into your mortgage.  Spreading the cost of these options over thirty years at 4.5% is really an inexpensive way to pay for these items versus paying in full or putting the expense on your credit card.  Second, having the work done by the builder maintains all your home warranties.  If someone else comes in to do work after the fact and damages something in your home, the repair will not be the responsibility of the builder.  Also, if the work is not done right, getting the contractor back to complete repairs may be more difficult than working through the builder on a home warranty item.  Finally, when selecting finishes during the design process, you typically have a trained designer working with you – for free. 

I know that a home purchase can oftentimes prove to be a more expensive decision than you had originally planned.  However, once you make the decision to get what you want, don’t be afraid to truly go all in up front.  In the end, what you think may be a more expensive decision may instead truly be the move that saves you the most money while also providing the greatest long term satisfaction.

Until next time…

Keep kicking the dirt!

The Sky is not Falling

The Sky is not Falling

 Grab your favorite adult beverage, get comfortable and kick back.  This may take a while.  It appears that misinformation is being spread far and wide.  There is discussion that rising interest rates will be something akin to the great apocalypse and that the window of real estate recovery will slam shut, never to open again.

Fear not.  I am here to tell you that the sky will not fall, volcanos will not erupt and large winged creatures will not swoop down from the heavens to steal your children.  In fact, a rise in interest rates will be a result of positive economic change, not a reason for economic panic. 

 First, let’s understand the dynamics that keep interest rates low.  Low interest rates are typically associated with a struggling economy.  Low interest rates help to spur investment by keeping the cost of capital low, thereby increasing the opportunity for corporate borrowing and creating an environment for future industrial and economic growth.  This growth, in turn, results in increased hiring, lower unemployment and higher wages.  This is called a blueprint for prosperity. 

 As the economy improves, the demand for investment capital will increase, driving up the cost of borrowing, resulting in higher interest rates.  The key is to strike a balance where interest rates rise at a reasonable rate in response to economic demand.  If they rise too quickly, borrowing and capital investment will slow down and you run the risk of recession.  If they rise too fast, you have the flip side risk of inflation.  I am going to go out on a limb and assume that the governors of the Federal Reserve are smart enough to appropriately manage this process.

 In an improving economic environment, both home prices and interest rates will increase.   However, remember the phrase “A rising tide lifts all boats”.  An improving economy will also result in more jobs and higher wages, increasing your ability to pay more for a home.  Furthermore, if you will be selling a home, you will benefit by selling your home at a higher price as well.  In this environment, an increase in housing values does not mean that a real estate bubble has returned.  It means that economic strength has emerged and should be a reason for rejoicing.  The skies will be sunny, the birds will sing and your 401Ks should be well funded.

 So, next time you hear that interest rate increases will serve as a new death knell for housing, try not to get caught up in the hype.  Remember that housing prices currently remain relatively low.  Both home prices and the cost of borrowing can only go up at this point.  It is a sign of recovery.  Also, if you are buying a home as a long term investment and find that interest rates are rising above 5% or so, take a step back and look at the historic nature of interest rates.  A spike from today’s rates would still result in exceptionally low historic rates. 

It is now time for another adult beverage.  Pour a full glass and raise it in toast to the expectation of an economic recovery.

Until next time…

Keep kicking the dirt!