The Pursuit of Passive Income

The new cry from constituents and customers alike is for transparency. No more backroom deals or preferred treatment. The White House is being held to a new standard of transparency, Wall Street is being dragged into an era of transparency (abet kicking and screaming) and in the age of Google and communication at the speed of light, why not?

Shouldn’t we all understand why something happened or why it didn’t. Haven’t we outgrown the ambiguous answer of “Just because?” The world is asking why and how and how does it work and why did that happen and what caused it? We are learning that there is usually a simple, obvious and truthful answer, even if insiders try to make it complicated, cloudy and ambiguous.

Why isn’t the sales model in Real Estate transparent?

There are so many new tools available to the consumer. In many cases, the research we can do ourselves is better than the research the professionals in their respective fields can assemble. What’s more, we have a direct/integral role in the validity and source of the data. Generally we are not looking for data to support our position, or to close a sale, we are educating ourselves.

It’s part of the evolution of business and business culture. Travel Agents are rare today, but the good ones are very helpful for complicated travel plans. But if I just want the best deal on a flight to Vegas and hotel room that I can chose from a list of options, I’ll book it myself on one of dozens of online sites. I can do my own research on the best locations, rooms, itinerary and prices. As much we take that for granted, just 10 years ago, you couldn’t gain access to the booking systems and therefore the available options without being a member of the travel industry (A Travel Industry Professional).

Interested in buying and trading stocks, bonds, options and equity positions? Before online services, you called your stock broker and placed the trade. Today true day-traders and those with the time and patience can research positions and companies while reacting to streaming news and moment by moment to changes in the markets all from the comfort of their kitchen table. Of course, there are still positions not open to the general public like IPO’s, some forms of shorts and propriety stock class offerings. But, that’s all probably going to change.

Why is it that one needs to hire a Real Estate Agent to find, view and offer on real estate? Our we really so short sighted to think by restricting access to a “Listing Service” we are protecting the consumer? Does a confidentiality agreement protect the seller?  No, we are protecting the business model.

I’m going to step on some toes here, but this is the question consumers (buyers) and the sellers (mostly bank asset managers) are asking.

There’s no surprise we’ve seen the growth of the Auction market in Real Estate. HUD has done it for years for residential sales… generally HUD listing agents simply act as a concierge to assist HUD. Any buyer can find, research and in many states bid on homes themselves. Other lenders are starting to catch on too. Why manage 100 sales through 100 platforms with 100 different brokers when they can market all of their inventory themselves, on-line, see every offer, question and feel confident they reached as many possible buyers as they could. (Achieving the highest possible price.)

Nearly every Asset Manager has said the same thing to me in different ways..”We trust and need the local expertise of the local broker, but we just don’t trust the execution..”

Why are lenders selling their assets on auction sites? They want to be sure everyone had access to make an offer who is qualified to make an offer and they got the highest and best price. That’s why HUD does it. Transparency and accountability. All offers are submitted and managed through their on-line bidding site. It’s a blind, best price take all approach we all hoped the traditional sales process was supposed to be. (Ever wonder why the house or building you offered more for was purchased by another buyer at a lower price? Consumers do..)

The world is shrinking. We are all asking for the accountability and transparency that a free market should produce. If we don’t like that our roles are changing, it’s too late. They’ve already changed. (Gone the way of the wheel-right, cooper, mule skinner, lamp-lighter). Auctions are here to stay.

As always, open to your comments and suggestions.

John Kobierowski

Tough times breed new levels of desperate behavior. Not that landlords need more to worry about, but I just heard about a new trend in theft called “Travelers.” If you haven’t heard about these folks, you might be quick to fall victim. 

Spawned by the rash of people loosing homes to foreclosure and gutting the home of everything that isn’t nailed down (which for some reason is condoned as getting back at the big bad banks) we are now finding renters feel it’s ok to strip your rental home or apartments. 

Here’s how it works: A nice couple fills out application, pays a small move in fee (prorated rent, meager deposit) and they show up with a moving truck and move in. You’re staff is smiling because they just leased another unit - one less vacancy. 

Next month, that tenant doesn’t pay rent and the eviction process starts. The night before they are supposed to be in court, a moving truck shows up and they are gone. When your staff gets access to the unit you get a frantic call… “They took everything…” Your manager is telling you that the tenants left in the night with the cabinets, appliances, a/c unit, circuit breakers, sinks, light fixtures, toilets, garbage disposal, window coverings, everything. They got away with paying a few dollars to live in the unit for 45 days or more and left with $5,000 of the units interior. The police are too busy to follow up, and the “Traveler” has already sold everything on Craig’s list and left town. They are already on to their next victim.  

The scenario is worse for homeowners who find the house gutted and the copper gone, pool equipment cut out and the aluminium garage door missing (presumably sold for scrap metal).

The tenant is nearly untraceable, even if law enforcement would get involved (most see this as a civil issue).

This new trend is compounded by the growing transient nature of our residents and the active resale markets for materials via Crag’s list, Backpage.com and other free listing sites. No one questions where the cabinets came from or why they were able to purchase a full hvac system for a few hundred dollars cash. Scrap metal prices are at all time highs too.

I’ve heard from some property managers who have been hit on all their properties. Neighbors and neighboring tenants didn’t see anything out of the ordinary and assume their neighbor was just moving. Bank asset managers report that it’s becoming so prevalent that they have become accustomed to it “…if it’s not the previous owner gutting the home when they leave, or the neighbors gutting it when the home sits vacant, then it will be a Traveler that rips them off. 

If you are wondering why they call them Travelers, its because these thieves will hit property after property, each in a different state as they criss-cross the country. 

Beware of who you rent to and more aware of who you are buying used appliances from…

As always, open to your comments.

John

The “Buzz” among the politically charged today is centered around the Frank-Dodd Financial reform act. Over 2,000 pages in length, it contains only instructions to the regulatory agencies to create the policy - its a work in process and this seems to scare everyone.

What is clear is that we will see Fannie/Freddie and the other GSE’s scaled down and eliminated. The new rules put in place for loans to be securitized are going to be more stringent on private sector loans. 

-Real Down Payments of 20% (no secondary financing or carry-back)

-Higher credit scores

-Lower “Maximum” loan amounts. 

With just these changes, less than 36% of those who could have qualified for a loan today will qualify for a home loan after the new rules go into effect.

Pair this with the reality of a shrinking pool of first-time home buyers and lower consumer confidence in home ownership and we start to see a strong undercurrent of renters. 

Our markets in the southwest US (Phoenix, Tucson, Las Vegas, Reno, etc) have seen heavy adjustments in home values from the highs of 2005-2007, which should have lead to a buying frenzy. It didn’t because in these same markets, household income declined in-step with home values. Families buying power has declined which is creating a generation of renters.

Most surveys of the Phoenix apartment market report lower vacancy, increasing rents and lower concessions. Owners are experiencing a strong rental market.

Multifamily values have remained low mostly as a reflection of the distressed condition of the properties going to market. These buildings were cannibalization, and run on a shoestring while lenders pushed off foreclosures and owners struggled to run their failing assets. 

With the recent surge in acquisitions these buildings are bouncing back. We will soon see a new wave of properties hitting the market that are stabilized, clean, reset to today’s values and producing real (not Pro-forma) cashflow. 

We are returning to an investment market from the days of a trading market. 

I’m including a link to an interactive heat map from the Wall Street Journal on-line today, illustrating the states that will see the greatest changes to qualifying for a home loan. http://ow.ly/5qhAh 

It’s been a long dry-spell, but we are entering a market cycle where hard work will be rewarded with profit again.

As always, open to your comments and suggestions.

John Kobierowski

I have been spending most of my spare time meeting with and talking to owners and developers. I’m happy to report that most of the market seems to feel the market is turning for the better. I’ll elaborate on this in my next blog post. 

On another front, I read an article this past week about how the rest of the world is trimming their federal budgets. One startling bit of news was the dramatic cuts in public housing funding in the UK. The 2011-12 budget has been slashed by 60%. 

This is putting a tremendous amount of pressure on families who are in the UK’s subsidized housing system. Public apartments are closing and there are very few alternatives in the densely populated cities.

I mention this because the UK is not the only government forced to make hard cuts. Almost every country in Europe has been struggling to determine where to cut. 

Here on the other side of the pond we are approaching it in a different way. Yes, we are seeing some services cut, but HUD and HUD properties have not been tagged for the chopping block. We are are however certain that Fannie/Freddie/FHA and associated GSE’s will be trimmed and phased out ultimately. Even the mighty US postal service is changing. They are eliminating thousands of post office locations by not renewing their leases. 

I can’t help but wonder when we will see some of the US housing programs revamped or slimmed down. It might be a logical conclusion given the fact that cuts to defense, Medicare and other US entitlement programs seem to be the last cuts our citizens want to see. 

With an abundance of apartment vacancies, vacant foreclosed homes and growing REO portfolios, cuts to providing and subsidizing housing may be an easy cut here as well.

As Always. Open to your thoughts and comments. 

John

I really do enjoy the conversations I have daily with owners, developers and managers in our business. The frustrations, challenges and successes they experience each day reminds me how far we have come in running our properties. 

Today we have software systems (cloud based) that combine accounting, management, tenant records (contact management), documents and even maintenance records. No longer do we need to keep cabinets of files or any written documents. Tenants pay rent, view units, schedule repairs, and renew leases completely on-line. Regional and national offices have the same access to records as the on-site staff - no need to mail or fax or triple copy each department. So in some ways our jobs are becoming easier and our properties easier to manage. 

But with every advance comes new challenges. Our staff now needs to be trained on fair housing, litigation support, privacy screening, HUD regulations, company policy and so many new areas of potential litigation.

Arizona is in the midst of passing new legislation that will require our on-site managers to determine if a rental applicant is in the US legally before they can rent to them. We are already required to determine if a job applicant/employee and now if a vendor/subcontractor has legal status to be in in the country. 

This morning I was speaking with a friend who was pointing out the way the world has changed. As he said, twenty-five years ago, I decided who I wanted to rent to and it was my decision. Twenty years ago I was told who I had to rent to. Now I’m being told what happens if I rent to the wrong person. Problem is, I’m not allowed to even use my own judgment anymore - I can be sued and/or jailed for doing so. 

We joked about the old TV sitcom “Three’s company”, in which Jack Tripper had to pretend he was gay to share an apartment with two single women. The landlord would never have allowed the three of them to live together, even in the very free thinking time of the 1970’s and in a the free spirited town of San Diego. (which made for hours of fun dialog and humor)

But, putting aside well understood the horrors of discrimination for discussions sake, it’s interesting to understand today, that the Three’s Company landlord would have been in more trouble from federal and civil agencies for refusing to rent the apartment then he would have been from the neighborhood for harboring socially unacceptable behavior (co-habitation of single coeds). 

Is is safe to say that social pressure, virtue and common sense are being trumped by political correctness? 

I’ll give you another example. A few years ago I was marketing a large student housing property. The property had developed a population of primarily Indian students. The seasoned staff knew enough to ask specific questions of the applicants to understand what class/sect they were from in India, then placed them in areas of the property (floors, or sections) where renters were of the same sect. From the outsider’s perspective, this may have seemed like a discriminatory practice. From a common sense perspective it was genius. There were rarely conflicts and because the residents recognized the staff understood their culture, the property was always fully leased before the school year. 

I understand the need for regulations and enforcement of restrictions, but I clearly see a need for more common sense approach to their implementation. I don’t want my staff to take on the role of a customs agent, bouncer, detective, or document specialist. I just want them to treat our residents fairly and excercise good judgment.

As always, open to your thoughts and comments.

A friend told me that you never see the progress when you are knee deep in the process. I use this little pearl of wisdom to explain why some investors and owners are having a tough time seeing positive changes in the housing markets. 

We look for signs of change and benchmarks that are measurable. I’ll share a few that have been shared with me:

- You know when the market has topped out when brokers start buying their own listings. (The drug dealers shouldn’t smoke what they are selling example)

- You know when you hit the market bottom when prices have retreated to the pre-bubble lows. 

- You know when the market has peaked when your mailman starts lecturing you on his investment property portfolio.

I can remember selling lender owned buildings on the I-17 corridor in the early 1990’s for $5,000 per unit. I underwrote buildings in Texas for $4,000 per unit. But…that was 20 years ago. That was when gasoline was under $1.25 a gallon and you could  buy a pack of gum for $0.25. Adjusted to the current market prices for consumer items, wouldn’t a west Phoenix building selling at $11,000 per unit today be equal to that building selling at $5,000 per unit during the last recession? Have we lost perspective? Maybe. I seem to meet many investors that are convinced values can go lower and are waiting for the illusive bottom of the market to jump in. Maybe we’re there?

Here’s another benchmark I’ve been watching for: second generation defaults vs. second generation sales.

Second generation defaults defined as a home or property recently sold as a distressed sale that is again in default by the new buyer. The new buyer is now losing the property. 

Second Generation sales are defined as the resale of a building that had been sold at a profit after the initial flip/fix up sale. 

Both definitions explore the two sides of equity. Assets gaining enough equity that a profit is realized in the second sale or, in the case of the default, the asset is loosing equity so quickly, that the new owner can’t maintain it..

The bad news is that we are seeing Second Generation defaults in the single family home market in Arizona, Florida and Nevada. The good news, I’ve seen some second generation sales in Arizona, Nevada and Florida multifamily sales. 

These phenomenons can be synergistic. A wave of second generation defaults can lead to a “double dip recession”, while a market budding with second generation sales can lead to the growth of value and reinvestment. 

It’s too early to see which effect is gaining and interesting to see them simultaneously in certain markets.  

As always, open to your thoughts and comments.

John

With rising energy costs and soon to follow, rising restrictions I expect to see a lot more legislation passed to save energy. Personally, I’m all for it. However, there is a cost to the conversion and with the budget fight in Washington, don’t expect the folks who pass the restrictions to help fund the conversions.

The last 100 watt light bulbs will be pulled from the shelves in January 2012. You should still be able to buy 75 watt, 40 watt, and 25 watt ones, but the 100 watt ones will be obsolete. (I can see the eBay folks stocking up to sell them in a few years at a premium - like the folks who stocked up on “Old Coke” when the “New Coke” formula was released).

California lawmakers are just about to pass the most agressive alternative energy laws. If passed, California Public utilities will be required to produce one-third of their energy using alternative means- to be phased in over the next few years. Wow….is that even possible? 

I was an early adopter of the CFL bulbs at my properties. We soon learned that the reduced heat produced, significantly longer life and lower energy use made it worth the time to retrofit our fixtures. We also learned that our residents loved these bulbs so much, that they began to steal them. We went one step further, converting our fixtures to the cartridge style bulbs. 

I remember walking into one of my leasing offices with a ceiling dotted with 120 watt reflector bulbs in the middle of the summer. It was really hot and those 20+ bulbs were heating up the place even more. We replaced them with 13 watt CFL reflectors and then replaced/retrofitted all the exterior fixtures. The result was we cut our electric use by 30% and our maintenance staff rarely had to replace a bulb (they last for 10,000 hours). The clubhouse/leasing office was as bright, but noticeably cooler.

Our next step was to work on the water costs. Water is expensive in Phoenix…

We replaced our old toilets with 1.6 gallon ones, added better quality low-flow shower heads and replaced the valve stops for all fixtures with 1/4 turn ball valves. Next we split our water systems, adding a second city meter just for irrigation (is avoided charges for sewer on water that was used for the pool and landscaping).  Our savings were were over 40% - and some cities actually rebated us up to 1/2 the cost of the upgrades. 

We made our landscaper adjust the sprinklers to the minimum water needs of the property and quickly addressed the source of any puddles that formed - chnging broken heads and adjusting flow. 

It didn’t take long before we had our properties running better and with reduced maintenance.

If you own a master metered property, I would certainly suggest these changes plus adding your own interior fixtures that use only energy efficient bulbs. If residents buy their own fixtures, they won’t choose the ones that use less energy and produce less heat. 

It’s clear to me that if we are forcing our utility providers to find alternative sources of energy, it won’t be long before our properties, shopping centers and office buildings will be required to employ them too. 

As always,

Open to your comments and suggestions.

John

Is there really such thing as a “Bad” property? Can a good operator make the difference? Every property has it’s unique location, construction and functional differences. How much weight do you assign to the operator vs. the building in determining if it will be a star property? 

I have to admit I’ve sold some buildings with a long history of poor operations, through several management and ownership changes; it seemed like no one could get it right. I’ve also sold and owned great properties with a long history of good operations and the new owner then has horrible luck in matching the past operations. Is it the operator or the building to be blamed?

I’ve been pleasantly surprised to see the successes of first time operators who, as some would say, “don’t know any better,” turn around an historically poor operating property. Sometimes it’s as simple as their attitude, other times they have played to the building’s perceived faults (small units, transitional sub-market, student population, etc). Instead of fighting the building and forcing it into their operational mold, they work it’s strengths.

A few years ago I attended a luncheon where the keynote speaker was a former advisor to the White House on Latin Affairs. He challenged the audience (made up of mostly regional and national owners) to give some examples of what their Hispanic tenants want in a property. Then he listed what his group had learned through their surveys of traditionally strong Hispanic neighborhoods/communities. 

The audience listed things like having materials in both English and Spanish, having bi-lingual staff, etc. But the speaker went far beyond the basics. He explained how quickly the Hispanic population was growing in the US, how closely tied the families and communities were, the type of social activities they participated in and how they were slow to complain to outsiders. The colors that they would paint the buildings, what services they would appreciate, the office hours that worked better with their schedules, even flexibility in rent collection days due to their payroll periods. It was enlightening to hear how minor changes created a stronger property, decreased turnover and actually engaged the residents. 

In a market with so many housing choices, it may be smarter to understand the strengths of your asset, core tenants and the community that you are part of to gain market share. The fundamental premise of consumer marketing changed over 50 years ago when we realized we needed to figure out what the consumer wanted, cater to them and produce it rather than produce a product and figure out how to sell it to them. How can we we produce a product that the consumer wants? What does your core tenant group need? What makes your property more attractive, and conducive to their lifestyle?

Think outside of the box, otherwise you’re just another vacancy sign on the street…

As Always, open to your comments and suggestions.

John

The study of Urban Planning has always interested me. Examining population growth and migration from the Fertile Crescent to the growth of European cities, to Manifest Destiny in the US. People have migrated and congregated based on factors specific to the era. 

Since the industrial revolution we have seen a steady migration to the job centers. People have been following the jobs. It’s interesting to note in comparing our current recession to the Great Depression, we haven’t yet seen mass migrations of the workforce to any particular market. (Re: scenes from the movie The Grapes of Wrath, with lines of overloaded cars heading west.)

One observation by Mick Cornett, the current Mayor of Oklahoma City, who has been working to redesign his city; Mayor Cornett believes “… People used to follow jobs. In the future, jobs will follow people to where they want to live…” He has been trying to build a diverse, world class city to attract great people who will bring the jobs.

I think there may be something to this idea. In a world where companies can have virtual headquarters, organizations can be defined not by location but by association and we are at whole new levels of connectivity, why wouldn’t you choose to live where you feel is best?

Could this explain why the “Rust Belt” continues to rust? Were places like Detroit, Cleveland and Pittsburgh appealing to industry but less appealing to workers? 

If you could keep your job, but choose to live anywhere where would that be? 

Before you comment, think bigger. Think globally. With Broadband access, Saas/Saap systems, VOiP, international cell phone plans, international banking, social media, etc, you are only limited by your imagination. 

Part of that decision might be proximity to other family members, quality of primary education, access to world class healthcare, political and environmental safety/security and other factors that would be subjective. 

The Phoenix MSA experienced true net migration from those who have a choice. One of those groups are retirees. Though they spent their working years in cities where the work was located, when they retired and were no longer economically tied to that market, they chose to move to Phoenix. 

Given the more fluid nature of careers, people will choose to live where they want to live and the jobs will follow to those talent centers. Metropolitan Phoenix will appeal to many because of our relatively low cost of living, ample housing, newer infrastructure, expanding cultural attractions and quality of life. But, we are competing against other cities both here in the US and abroad which are quickly embracing the new workers (As evidenced by the two links I’ve attached to studies of the best places to live in the US and world).

http://www.kiplinger.com/magazine/archives/10-best-cities-2010-for-the-next-decade.html

http://www.smashinglists.com/10-best-places-to-live-in-2011-quality-of-living-index/

Though Phoenix is ranked 100th on the best places to live in the US (2010) we are now competing globally. Our ability to attract higher earning residents won’t just be tied to our ability to create industry anymore.  Our politicians and leaders so focused on job creation should also be concerned with making our cities more livable. 

As Always, open to your comments and suggestions..

John 

I’ve often talked about how the costs of operations continue to creep up over time. Every line item in our operating budget has increased while income/rents have moved in the opposite direction. This is one of the reasons some owners who don’t reassess their budgets and projections annually will find they are losing income and can’t explain why. 

What’s happening in Japan is beyond my words. A horrendous earthquake, followed by a tsunami, snow storms, food shortages, and what seems like an inevitable nuclear disaster. Those poor people.

Todays news in the US brought us the first wave of how this crisis is going to effect us in ways most of us wouldn’t have anticipated. As one of our largest trading partners (we are a net importer of Japanese Products) some US factories announced that they were slowing production or shutting down because they could not import key products necessary to their production that produced in Japan. 

The second growing wave of impact is the international backlash and concern for the safety of nuclear energy. Germany reversed it’s decision to extend the use of their plants, Switzerland actually shut down their plants (pending further review) and the planned development of several key plants in Texas are probably going to be stalled. All at a time when the world has been trying to reduce it’s dependence on fossil fuels. 

You might remember the utility cost run up of the early 2000’s. California electricity costs spiked. Arizona and other states power grids were pushed to their limits. Local utility companies scrambled to impose emergency rate increases. 

The lesson for many apartment building owners was that their commercial power costs were not regulated, therefore the higher costs were immediately passed along to users. Residential users rates are regulated by most states. 

I can remember owners of master metered properties who were almost driven out of business. I can also remember quite a few owners who shut down the use of their laundry rooms. The costs to operate them had grossly exceeded the income (because the property electric meter was a commercial account). 

The growing international backlash against nuclear power at a time when very few alternatives exist will put more and more pressure on fossil fuels worldwide. The costs to rebuild Japan will put further strains on the supply of fossil fuels. 

I fully expect to see sharp increases in the cost of energy. I fully expect these increases to effect us in ways we can’t possibly yet appreciate.  

Hoping for the best.

John