Apartments vs SFR & Trading vs Investing with Douglas J. Utberg
(3:12) Patrick (producer of the show) talks about average prices and rent control in San Francisco
(18:38) An example of a property in Little Rock, Arkansas
(24:40) Airbnb in San Francisco
(26:01) Introducing Doug Utberg
(27:16) Discussing a recent article from John Burns Real Estate Consulting about single-family homes vs. apartments
(36:29) The difficulties of managing an apartment building
(38:03) Trading vs. investing
(40:05) Trading vs. investing and the trade of the decade
(45:14) Three rules of investing for value
(48:08) Closing comments
My professional life started when I was delivering newspapers at 15 years of age, progressed through multiple jobs paying near minimum wage. This experience taught me the value of gaining a strong financial education to ensure that I would be able to lift myself up to higher opportunities in the future.
Upon completing my first year of college, I enlisted in the US Marine Corps Reserve. The experience of training in the Marines taught me the importance of a strong work ethic, and the ability to adapt and improvise during difficult situations. During my six years of service in the Marine Corps Reserve, I eventually earned the rank of Sergeant, and was assigned responsibility for a squad of fellow Marines. This taught me the importance of placing the team’s needs before your own when in a position of responsibility.
Later on, I graduated from Portland State University, earning a bachelor of science in Finance. Immediately afterward, I embarked on a brief career in the financial services industry, selling insurance products and mutual funds. During this experience, I discovered the extent to which the financial industry is driven by a desire for management fees and commissions. This experience inspired me to seek out both a different career path and to develop a way for people to learn the skills necessary for managing their own finances and investments so that they can escape the fees and commissions of the financial services industry.
It is at this point when I began my career at Intel Corporation, during which I was able to earn my MBA from George Fox University. While working at Intel, I was fortunate enough to gain a broad array of experience ranging between manufacturing, cost, inventory, software business analysis, open source business analysis, microprocessor pricing, long range planning, compute continuum, and leading the P&L team in building and implementing a new forecasting system. Each assignment during my career at Intel provided a unique opportunity to learn and develop.
In addition to my career working for an employer, I have also engaged in a broad variety of business and investing activities, ranging from the purchase and management of single plus multi-family investment real estate to stock market investing to building web-based businesses. My investment and business philosophy are both the same, with each centered around fundamentals and value. My personal and professional studies have repeatedly found that speculation is not a formula for consistent long-term success.
My experience has shown that the best way to succeed in both our career and our investments is to seek value in everything that you do.
ANNOUNCER: Welcome to Creating Wealth with Jason Hartman! During this program Jason is going to tell you some really exciting things that you probably haven’t thought of before, and a new slant on investing: fresh new approaches to America’s best investment that will enable you to create more wealth and happiness than you ever thought possible. Jason is a genuine, self-made multi-millionaire who not only talks the talk, but walks the walk. He’s been a successful investor for 20 years and currently owns properties in 11 states and 17 cities. This program will help you follow in Jason’s footsteps on the road to financial freedom. You really can do it! And now, here’s your host, Jason Hartman, with the complete solution for real estate investors.
JASON HARTMAN: Welcome to the Creating Wealth Show! This is your host, Jason Hartman, and this is episode #393! 393. We are getting up there. Today, our guest, Doug, who’s been on the show many times, will be talking with me about apartments vs. single-family homes, and trading vs. investing. And you know, this kind of blends pretty well. We’re gonna talk very specifically, and drill down very much, on real estate investing, or, as I like to say, income property investing, in this episode. But it really dovetails very well on that last couple of episodes, especially where we talked with Vitaliy about Warren Buffet and value investing. So, I think it ties in pretty well there. And I’ve actually got our producer, is going to join me for the intro portion today. And that is Patrick, coming to us from the Socialist Republic of San Francisco. Patrick, welcome. How are you?
PATRICK: I’m doing well, thank you. Good to be here.
JASON HARTMAN: Good. I hope you didn’t get mad at me for saying that.
PATRICK: Well, I actually live in the Haight-Ashbury, so I’m in the most liberal voting section of the most liberal city in the most liberal state, so I guess that could be a fair characterization.
JASON HARTMAN: That’s good. But, you know, the thing I really gotta tell you, Patrick, I really enjoyed our very first conversation, when I first met you, met you via Skype, I should say. We meet people virtually nowadays. And asked you about living in San Francisco. By the way, I should make the disclaimer, I love San Francisco. I’ve spent a lot of time there over the years. You don’t know this, but I had a couple of uncles that were very big in the bar and restaurant business up there. They were very successful. One, my late uncle Norman, his last bar was called Eddie Rickenbacker’s, and he passed away, and he basically gave that bar to some of his managers. And my other uncle, Jack, who owned a bunch of bars, some with him, one was the Balboa Café, which is pretty well known. He sold that several years ago. But, they owned a bunch of bars. And Jack owned one with Boz Scaggs, the musician. So, I spent a lot of time in San Francisco. I love it up there. It’s a great place. I just wouldn’t want to be a landlord there.
PATRICK: It’s a great place to be a tenant.
JASON HARTMAN: Yeah, it’s a great place to be a tenant. And that was really interesting, our first conversation, because I wanted to share this with the listeners, and your experience there, and talk about how it affects investing, and prospects for that, and all of that good stuff. So, you know, maybe first, Patrick, I’ll just ask you to kind of tell the listeners a little bit about—maybe about yourself, if you want, and about your rental situation. You’ve got a fantastic deal, and you know, you’re just right in the heart of San Francisco with a great location, been renting it for a long time. So, take it away.
Patrick (producer of the show) talks about average prices and rent control in San Francisco
PATRICK: I’ve been here in San Francisco since ’95, during all of the dot com days. And really, rent control is the equivalent of affordable housing in San Francisco. The majority of people that live in San Francisco are renters. So, there are more protections for renters here, which is very useful, because the median home price here is $1 million now, so it’s very difficult to be an owner in San Francisco unless you have a considerable amount of wealth.
JASON HARTMAN: What do you get for a million bucks? I mean, that’s so outrageously expensive. But you know, it’s obviously a very desirable place to live. Do you have any friends that are living in that sort of stereotypical median priced home?
PATRICK: No, and actually, the median priced home, there’s nothing glamorous about it at all. It’s a very average looking kind of home. And to get one of the Victorian, the old single-family Victorians here, you’re looking at about $2.5-3 million here in the Haight-Ashbury. But by being a renter, you can really get a good deal, and the great thing for me was, I was able to move from a one bedroom apartment to a two bedroom apartment back in 1998, and the rent was a lot at that point in time. It was $1800 a month. But right now, for June of 2014, the rent for a two bedroom two bathroom apartment is $4200 a month. That’s the average.
JASON HARTMAN: Okay, now, is that one rent controlled, by the way? I mean, can someone walk into that market today and get a rent controlled $4200 apartment and stick around and stay there for 10, 20 years, and then that’ll look cheap, eventually.
PATRICK: Absolutely. And that’s how it works. When you first rent in San Francisco, it’s whatever the market will bear. And then, your rent increases are controlled on a yearly basis by a percentage that’s set by the city supervisors. Which tends to be about anywhere between 1 and 2%.
JASON HARTMAN: So that’s the increase. That’s lower than even the stated inflation rate, much less the real inflation rate. That’s a great deal.
PATRICK: The great thing for me is, having moved into this apartment in ‘98, at $1800 a month, it’s now a little over $2000 a month, but still, it’s a lot less than what the $4200 a month average would be for people that are just moving into the market newly today.
JASON HARTMAN: Right, okay. So, I think what’s interesting here is to look at the dynamic of rent control, and how it impacts the market. And Patrick, you know, we had such a great conversation about that initially. Because, I had a couple new revelations that I really haven’t thought about in too much detail when we talked initially, and that is that #1, I would think that that really causes a lot of settling, and a lot of stagnation. In other words, someone like you, why would you ever move? If you move, you would have to be like, you can’t take that with you. Like, one of the things in California that’s sort of interesting, I’d almost make the comparison, is that there are some cases where you can take—if you own a home, you can take your prop 13 taxes, your property taxes, to another home. And forgive me, I cannot really remember how that works. But when I was in traditional real estate many years ago, I remember people would do that, and that would be a big thing they would think about, especially older people, you know, who want to move from one house to another, and move maybe from one part of Orange County to another, and take that prop 13 low tax rate with them, so their taxes wouldn’t really increase in any substantial way. And you can’t do that with rent control! You just gotta stay in that same place, right?
PATRICK: That’s true. And fortunately, San Francisco is a great place where you want to stay for a long period of time.
JASON HARTMAN: Right, but you might want to move around the city. Right, you might want to move to Pacific Heights, or—well, those are really expensive areas. But you know, you might want to move to the Marina district or something. I don’t know. To a different area. Or stay in Haight-Ashbury, and move to a different home. Maybe a bigger or smaller house, right?
PATRICK: I’m very lucky in that I live right across the street from a park, Buena Vista Park, and so my entire field of view is green.
JASON HARTMAN: Wow.
PATRICK: And so, I have absolutely no desire to try to—you know, true, there are a lot of awesome views to be had, living in San Francisco. And I’m perfectly happy with the one I have. And you can always get a better view, but again, rent control really kind of does make it so that you don’t move around as much. Fortunately I’m in a place where I’m able to enjoy where I live.
JASON HARTMAN: I appreciate that, I’m just trying to talk about the broader market though, you know? Because I think that pretty big implications for the economy. I mean, think about it; when someone moves, they spend money. You know? They buy new furniture, they redecorate, they hire movers, it’s expensive to move. It’s a hassle, too. And you know, moving sort of creates like a velocity of money, if you will, in a real estate market. And so, people—like, your neighbors, and your friends, and the people you know there, they’re probably pretty long-term people, right? They just kind of stay in one place, I assume.
PATRICK: The vast majority of people—I’m in a multi-unit building, and the vast majority of people here are only here for a year or two. There are a couple of people in our building that have been here for 10+ years, but very few who have been here in the 20+ range. Most people are actually just passing through. One, two, three years tops.
JASON HARTMAN: And so, where do they go? Who are they? Are they like Silicon Valley people that make a zillion dollars and then move on? Or, what kind of people are they that are moving?
PATRICK: You get the tech people coming through. The Google Bus network—
JASON HARTMAN: Yeah, I was gonna ask about the Google Bus. That’s on my list.
PATRICK: It’s totally distorting property values around San Francisco, because it’s creating hotspots wherever their shuttle bus stops are. So, the Google employees are moving in and driving up cost.
JASON HARTMAN: Isn’t that mind-boggling? Literally Google Bus—I mean, people are picketing the Google Buses, and all of this kind of stuff. Now, why did they need those buses? I mean, what was the thing? Like, in Palo Alto, it was—or, Mountain View, it was just—I mean, it’s not more expensive there than it is in the city. Or their employees just wanted to live in the city?
PATRICK: That’s right. The employees want to live in the city. You know, most of Silicon Valley, Mountain View, Palo Alto—
JASON HARTMAN: It’s suburbia.
PATRICK: Right, exactly. And it’s about 30 miles south of the city. But now we’re seeing, in the past five, seven years, northward migration of tech workers not wanting to live just in Palo Alto, but they want to live in San Francisco. And so, there are networks of corporate shuttle buses, you know, various companies have them. Apple, Google, Genentech, you name it. And so, there’s many more employees looking for places to live, and to rent and buy in San Francisco, and it’s distorting values in the spots where these shuttle buses stop.
JASON HARTMAN: Wow, that’s just amazing. I mean, like, what, within a two block radius? Three block radius of the shuttle bus? Is that how it works?
PATRICK: Pretty much, yeah.
JASON HARTMAN: Wow, unbelievable. I mean, when did Google start that program? About two years ago?
PATRICK: Google Buses, that sounds about right. Maybe two, four years ago. It’s only recently become a political hot button, because they were using public bus stops for their private usage, so there was discussion of using public resources by private companies, etcetera.
JASON HARTMAN: Yeah, wow. Quite interesting. Very, very interesting. Okay, so, back to your own situation a little bit, let’s just analyze that if we can for the listeners. You started paying I think $1800 a month rent, back in what, 1995?
PATRICK: $1800 in 1998.
JASON HARTMAN: In 1998. Okay, so that was—boy, that was just at the big ramp up of the dot com boom, it turned into a bubble and a bust, obviously. Now, what is it, you know, 15 years later? No, more than 15 years later. So, it’s 17 years later, or something, and you’re paying $2000?
PATRICK: About—well, about $2100.
JASON HARTMAN: Okay. And, $2100—do you pay your own utilities?
PATRICK: I do, yes.
JASON HARTMAN: Okay. And—just, describe your place for us, if you would. How many square feet is it, how many bedrooms, how much is it worth, do you know how much it’s worth?
PATRICK: It’s a two bedroom two bath. I’m not sure what the actual square footage is. I know that the monthly average now is $4200 a month. But—
JASON HARTMAN: What do you think it’s worth, though? I mean, would that property, if it were to go up for sale today, would it sell for a million dollars? Is it a million dollar median price home?
PATRICK: The whole Victorian home that has about 12-15 units in it?
JASON HARTMAN: No, it would have to be just your unit, because we can’t evaluate that any other way. We’re only evaluating your unit that produced $2000 a month for the landlord, or $2100 a month. You know, what would that go for? You know, what—like, if you’ve looked around, what would a two bedroom two bath place about your size, in a comparable location, what do you think it would go for?
PATRICK: I would guess $1-1.5 million.
JASON HARTMAN: Okay, $1-1.5 million. So, here is the analysis. On typical California—I mean, we’re not talking about San Francisco here. But typical California rent to value ratio is about a 0.3 or a 0.35. Meaning, that a $1 million property, if you were to rent a $1 million property in, say, Irvine, California, south of you, okay, south of LA. About 40 miles south of LA, where I used to live. You would probably pay about $3500 a month for that property. In San Francisco, it’s even better or worse, depending on which side of the coin you’re on. If you’re an owner, it’s terrible, because a $1.1-1.5 million property here, let’s just, whip out the calculator, and let’s go $1.5 million, okay? And if we go 0.35 that would be, $5250 per month. So, that’s what that property would generate in a typical California scenario. But, again, as you well know, from editing the shows—I love it when—I know that my podcast editor is the person who really listens to my shows. And as you know, from me talking before on the prior episodes, we like to see people get 1% per month. So, if it’s $1.1 million, we would hope that a $1.1 million portfolio of properties, which might be 11 $100,000 single-family homes, hopefully in diverse markets, that they would rent for $1000 a month each, or in the aggregate, $11,000 per month. If it’s $1.5 million invested in real estate, we would expect that investor would get somewhere in the ball park of $15,000 per month. So, you really see how living in your unit in San Francisco, you have totally arbitraged the market. I mean, you’ve just—you’ve got yourself a great deal. And it’s interesting what you said before, because you said that back in 1998, $1800 a month for that place really was a stretch for you. I think you told me that either off air or—
JASON HARTMAN: Yeah. So, that was a big stretch. But, really in a way, it’s kind of an investment. Because the way a first-time buyer looks at a home, and I remember in selling real estate when I first got into the business at the ripe old age of 19 years old, I was selling houses to entry-level buyers, and investors who would buy these really tacky fixer-upper government repo properties. That was kind of my specialty; to sell HUD and VA repos. In San Francisco you don’t even know what this is. Okay? Because it’s not even in the ballpark. I would go out and maybe, in some areas occasionally in Orange County, but mostly in the Inland Empire in Riverside and San Bernardino Counties; I would be selling these little cheap houses. I remember the very first house I ever sold was in Anaheim, California, and it was $92,000. And I think it was on Raymond Avenue, if I remember correctly. You know, you always remember your first one. And, I remember the psychology, Patrick, of people that were looking. They would always agonize, because they could always rent something a little nicer than what they could afford to buy. Buying was always a stretch in monthly expenses and down payment, and it was always a little bit of a step back in lifestyle. But the idea was, it was for the greater good. It was for the future, you know? It was mostly a better deal to own a home, and build some equity, and get in the game, if you will. And really, with a rent-controlled apartment, people kind of go through, there’s a similar psychology. You make a stretch, maybe you’re spending more than you think you can afford, but ultimately, in a strange kind of way, it becomes an investment, because that lease that you have has real value to you. To replace that lease today would cost $4200, probably, and if it was on the open market, it should be $5200. It’s a pretty interesting dynamic. You said that people usually come in and they go in, you know, two or three years, they’re kind of passing through, as you put it. But, the people that have been in a rent-controlled place for 8, 10, 12 years, I mean, they’re not going anywhere, right?
PATRICK: Absolutely not.
JASON HARTMAN: They just stay put. Now, did they ever say to you, or do you ever have these thoughts yourself, that you know, gosh, you kind of wish you could have a different option, or you know, maybe you want a bigger place, or you know, try something different for a while? I mean, you’re pretty kind of stuck, in a way, because you just don’t want to give that up, right?
PATRICK: It’s true, but I’m lucky, in that I like where I am a great deal.
JASON HARTMAN: Yeah.
PATRICK: So, that really does kind of offset that a bit. Because, I am where I want to be. Yes, I could move, but, my current position is such that I like where I live, I like the neighborhood, I like that there’s a park right across the street, I like that when I look out my window it’s all green, it doesn’t look like I live in a big huge city. And there are intangibles to that. I mean, I’ve lived practically almost 20 years under the same roof here in San Francisco, and that’s just not the case for most people.
JASON HARTMAN: Tell us about your landlord. I mean, you would seem like your landlord would be just dying to have you move! Because they could bump the rent up! Now, the rule is, they can bump the rent up to the market rate of maybe $4200 or so, right? When you move?
PATRICK: Absolutely. Whatever the market will bear once I move out.
JASON HARTMAN: In rent-controlled apartments, and situations like that, in New York, Santa Monica, San Francisco, I have heard many times of stories where landlords will kind of try to make life a little bit miserable for their tenants. They won’t be attentive, they’ll make noise, they’ll just—they’ll just want them to move. It’s like, please move! You know? Do you even get that vibe at all?
PATRICK: No, not at all. Actually, I’ve been pretty lucky. We certainly hear stories around the city about landlords that behave badly towards their tenants. And there’s also a lot trying to convert units—to take units off the rental market, and convert them into the tenants in common, and things along those lines. Our landlord would rather have a 20 year tenant that pays rent consistently than someone who just comes in and doesn’t pay, or—
An example of a property in Little Rock, Arkansas
JASON HARTMAN: You really have an incentive to be a good tenant, and maintain a nice relationship, because you’ve got such a good situation. So, well, I want to give you a comparison, and give our listeners a comparison here quick before we get to our guest. As the listeners know, and as you know, Patrick, we have a property tour coming up. A Creating Wealth in Today’s Economy Seminar, and a property tour the next day, and that’s in Little Rock, Arkansas, Bill Clinton’s hometown. This property—I’ll just give one example of many. Our listeners can go to www.jasonhartman.com and click on the properties section to see pro formas on all of these. But here’s an example. This property is only $78,900, okay, and in San Francisco you’d just add at least one zero to that, if not more. And the projected rent on it is $895 a month. It’s got a brand new roof, a new HVAC system, and so, you see there, if you bought 10 of these, you would still be lower than the median priced home in San Francisco. And you would get $895 in rent, times 10, that’d be almost $9000 a month in rental income. That would still only be $780,000. It’s an amazing shocking difference.
And this is why investors—one of my pseudo-famous quotes is, invest in places that make sense, so you can afford to live in places that don’t make any sense, okay? And a place that doesn’t make any sense to live in, from a financial perspective—except in your case—is San Francisco, for example. Or Newport Beach. Or Santa Monica. Or any of these places with beautiful coastline, and nice areas, and great opportunities like that. Or New York City. It doesn’t make any sense to live there either. From a financial perspective. But that’s what you can do. You can arbitrage this. So, if someone in San Francisco—and we have many clients in Silicon Valley and San Francisco that are investing through us. Many clients with Google, Apple, you know, all the big name companies there. We totally appreciate their business, and it’s great that they recognize this. Because if they live in, say, San Francisco, and they’ve got some money to do some stuff with, it doesn’t make any sense to go and buy things in San Francisco, because you just can’t get any good ratios. The overall return on investment on this is projected at 45% annually.
And the cash on cash return—now what that means is that even if the property drops in value, even if you buy it for $79,000, okay, and then the next day, it becomes worth a dollar, okay? The value doesn’t matter. As long as you maintain that same income to expense ratio, you will get 14% annually, cash on cash. The overall return that I mentioned includes all the other multidimensional aspects of real estate investment. So, it includes appreciation, and all the other factors. Okay? Tax benefits, etcetera. But just cash on cash, which is the really simple metric—14% annually. And, let’s take another thing into account. Let’s say it only goes half as well as projected. Well, then 7% annually. Which is about 7-14 times better than you’re gonna get in the bank, okay? So, and you know, the stock market, who knows. That’s all debatable. Invest in places that make sense, so you can afford to live in places that don’t make sense. And that is really one of the big things that we always like to point out. So, I hope our listeners will join us for our Creating Wealth in Today’s Economy Seminar, and our property tour, where we’ll actually look at these properties in good old Little Rock, Arkansas. Again, this is a boring place. It’s a place that never makes the headlines.
If Bill Clinton wasn’t from Little Rock, probably nobody would have ever heard of it. But it’s a really nice, clean city, where you get nice, stable, not in the news, rental properties, that just make sense from day one. They’re inexpensive, they’re low-risk, and it’s a great thing. So, that tour is late September; go to www.jasonhartman.com, click on events to register for that one, and we will look forward to seeing you there. Patrick, any other thoughts on San Francisco, or rent control, or things like that? You know, one of the things we didn’t talk about, that I think is important to notice, and I’m sure because the numbers aren’t very good for investors or landlords in San Francisco, it’s not in their favor, I would assume there’s just a huge shortage in supply. I would assume that there aren’t very many new investors coming into that market thinking, gosh, I want to be a landlord in San Francisco, you know? I mean, supply is really tight there, right?
PATRICK: It’s super constricted, and it’s one of the biggest and most contentious political issues that the mayor has faced for multiple election cycles, has been the lack of supply and the lack of affordable housing. San Francisco had—you know, we’re a peninsula, so there’s limitations; you can’t just build out. You can’t sprawl out, because there’s an ocean there.
JASON HARTMAN: What is it, seven square miles or something? Yeah.
PATRICK: Yeah, it’s seven miles by seven miles, or as they like to say, forty nine square miles surrounded by reality. That’s the joke.
JASON HARTMAN: I love it.
PATRICK: While there is new supply coming down the pipeline being constructed—for example, there is a new high rise on Market Street, right by the Twitter headquarters, and it’s not even done being constructed yet. And it’s already 100% sold. By Twitter. Twitter has already bought up all of the stock for themselves. And so, here’s this new housing that’s never even going to hit the open market because it’s already presold.
JASON HARTMAN: Wow. And so, those are condos, then, I assume?
PATRICK: That’s correct.
JASON HARTMAN: Yeah, yeah. Is there a gray market, or a black market, for rental housing? I mean, those always develop in rent-controlled cities where you’ve got people doing stuff under the table. And then, of course you have—and I know someone personally who did this, a friend of mine who had a rent-controlled place in San Francisco that he never gave up. He moved to Southern California—well, he moved to Chicago first, then he moved to Southern California, and he still had a lease on a place there that his friends leased from him. And of course, if his landlord ever found out, he would not be able to do that. Obviously, because you can’t sublease. But, do you know anything about a black or gray market there?
Airbnb in San Francisco
PATRICK: Airbnb is huge here in San Francisco, in terms of both sides. In terms of tenants renting out a spare bedroom, and also in terms of landlords using Airbnb because they can get a higher rate per day, daily rate, from renting out just short-term rentals via Airbnb, and they’ve been getting into some degree of trouble with that, because it takes, you know, rental stock away from the market.
JASON HARTMAN: Hoteliers, of course, hate Airbnb, because they represent competition. What else happens? You know, is the city wanting to shut Airbnb down and outlaw it there because it sort of bypasses the rent control market?
PATRICK: They actually just recently signed an agreement with the city so that Airbnb will now start paying a hotel tax to the city of San Francisco.
JASON HARTMAN: So now the city’s happy.
PATRICK: That’s right.
JASON HARTMAN: Oh, interesting. It’s just crazy. But, no gray market? Like, have you ever heard of people finding a landlord, and saying, hey, choose me as your tenant, and I’ll pay you under the table a little extra, or something?
PATRICK: I haven’t heard that.
JASON HARTMAN: Good stuff. Well hey, thank you so much for sharing this with us. We really appreciate it. That was a very interesting discussion.
PATRICK: My pleasure. It’s good to be here, thank you.
JASON HARTMAN: All right. Well, we’ll go to our guest, and that is Doug, and we’ll talk about trading vs. investing, and apartments vs. single-family.
Introducing Doug Utberg
JASON HARTMAN: Welcome to the show, everybody. I’m here with Doug today, and we are talking about a couple of really important things you’re gonna want to hear. We’re gonna talk about trading vs. investing, and maybe we’ll even get into the trade of the decade, which we talked about at a Meet the Masters event a few years ago. We’re also gonna talk about pull vs. push appreciation, and the age-old question of, what is the better investment: Apartments or single-family homes? We’ll kind of dive into a few of these issues. But first let me apologize; I am outdoors, and I know there may be a tad bit of background noise. I’m trying to overcome my perfectionistic tendencies, and it’s good enough, so I hope you’ll agree with me that it’s good enough, because we’re not in the studio today. Sometimes we’re out mobile, and when the idea strikes, and the opportunity’s there, you ought to just record a show. So that’s what we’re doing. Hey Doug, welcome. How are you?
DOUG UTBERG: I’m doing well, Jason. Although I would recommend that you should go with the Microsoft standard of 85% of good enough.
JASON HARTMAN: Oh, okay. The thing I always complained about over the years when I was a Microsoft user—I’ve converted to Apple, and I found paradise. I know you’re still using a PC. I feel sorry for you. But the thing I always complained about is, Bill Gates would force us all to buy the next version before he fixes the last version! And I just thought that was really quite wrong. So Doug, let’s talk about this recent article from John Burns Real Estate Consulting. Our listeners know, we had John on the show before, and he’s got some great information. But this is really startling, how single-family rental homes are increasing dramatically as a percentage of total rentals. And I think this shows a preference in the marketplace, and the demand being met, to some extent too, for single-family homes over apartments. Talk about some of your thoughts about this article.
Discussing a recent article from John Burns Real Estate Consulting about single-family homes vs. apartments
DOUG UTBERG: If you take a look at the chart that’s in John’s article, in 2005, just under 31% of all of the homes that were available for rent, or all the units that were available for rent, were single-families. Whereas the estimate for 2013 is just over 35%. So, that’s roughly a 15% gain in the proportion of single-family homes as a percentage of total rentals. What’s really interesting is, when you think about this on the backdrop of what the market’s been like since 2005. Because there were basically no new single-family homes built for all of 2009, all of 2010, and at least half of 2011.
JASON HARTMAN: We’ve gotta be clear though, Doug. When you say there were none built, of course you’re using that as a figure of speech. There were some built, but compared to the building boom pre-financial crisis, it was negligible.
DOUG UTBERG: Yeah, I’m using hyperbole that is just barely supported by facts, much like politicians.
JASON HARTMAN: Okay, good. At least you admit it.
DOUG UTBERG: The thing that’s interesting is that during this whole time, there have still been apartment units being built, but even during that stall from 2009 to 2010, the rate of single-family homes as rentals stayed roughly flat, but otherwise for that whole time period, single-family homes have been increasing as a proportion of total rentals. And I think, like you said, this is showing that there’s a structural preference in the market for single-family homes. And what’s been happening is that, you know, of course a lot of people know lately that a lot of the houses that have been bought out of foreclosure, have been purchased by investors.
Those investors have been turning those into rentals, and those rentals have been slowly displacing apartments, because people have a natural tendency towards single-family homes. This sort of segues really nicely into our conversation of single-family vs. multi-family investing. Because one of the things to think about when you’re an investor is that there’s two forms of value. One is cash flow and one is appreciation. Those are your main factors. As a multi-family investor, the only way you can get appreciation is by what I call push appreciation. So, multi-family properties are valued based on a multiple of their cash flow. So, for example, capitalization rate of 10 would mean that you’re valued at 10 times your annual net operating income, or annual cash flow. And so, the only way that you can make the value of that property go up, is to push up the cash flow, either by cutting expenses, raising rents, or something else.
Alternatively, with single-family houses, their price is based on market comparables. In a lot of cases what will happen is, when the market value of single-family homes goes down, then the capitalization rate will go up, but then when people start moving into the area and buying more homes, it pushes the price up, but the rents don’t go up in unison. What you end up with with single-family homes is almost like a call option. Which I know that to a lot of people, the notion of a call option is a little confusing. So, in the financial world, and the world of options, a call option gives you the right to sell something at a certain price. For example, say I buy a call option on Microsoft to buy it at a certain price. Say that I buy an option of Microsoft at its current market price, and it goes up $10. I get to keep that whole $10, but the amount I paid for that option was much less than if I bought that stock outright. Similarly, if you own a single-family house, you have your cost of capital locked in, but if the local area suddenly becomes very desirable, that market value can start to shoot up, can go up that hockey stick chart, but the rental value will almost certainly stay flat. That’s the issue you run into with multi-families; is that, if your market suddenly gets hot, rents don’t go up a hockey stick. Rents go up a slow, plodding slope. Anybody who has rental properties knows that rents never go up as fast as you think they should.
JASON HARTMAN: That’s absolutely true. Because, when I talk in the Creating Wealth Boot Camp, when I talk about the three dimensions of real estate, and of course there are more than three. I talk about the main three. When things become really illogical and frothy and bubbly in a market, that’s where single-family home investors can profit dramatically. I love that it’s illogical like that. It’s great that there is just not much rhyme or reason. And the rents do flatten. Sometimes they decline in those markets. Because everybody’s buying instead of renting.
DOUG UTBERG: The single-family home economics are just so different from the apartment economics. Because as you said, one of the things—for example, one of the things that killed apartment owners in 2000, 2001, and especially 2008, 2009, was that the interest rates dropped, and so, a bunch of people that used to be renting apartments—now they’ve gone out and bought houses. That killed apartment owners, but that enriched everybody who owned single families. Because all the people who stopped renting and started buying, they moved out of apartments and into single-families, or out of a single-family rental, into a single-family owner-occupied. If you own that single-family, all those people who are buying those owner-occupied properties, they’re pushing up the market value of your property every time they log another transaction. But that doesn’t happen with multi-families, because nobody buys an apartment unit. Nobody wants to own an apartment unit. People want to live there for just long enough to save up enough money to buy a house.
JASON HARTMAN: We should say to the listeners that a lot of the stuff we’re talking about here applies to retail properties, industrial properties, and office properties the same way. Because they’re all sold on income, rather than being sold on illogical things. Like, scarcity mentality, and ridiculously low interest rates, and silly monetary policy, and whether it be Janet Yellen, who I’m sure is gonna be guilty of it during her tenure, or Greenspan was the most guilty of anybody. And Bernanke, too. Of putting the economy on Steroids, and juicing it to get their result, their short-term result for their tenure. And lot of residential investors profit from that quite dramatically.
DOUG UTBERG: Another way of saying that is, let the legendary investor Jim Rogers—one of his aphorisms was to buy panic and sell euphoria. And as he says, single-family housing is frequently illogical, and if you sell into that euphoria, you can do very well. Similarly, if you buy into that panic, you can also do very well. For example, with apartments, and with the multi-families, whether they be those office complexes, or apartments, or retail, or even the light industrial, what happens is, you don’t get those irrational swings. You know, you don’t really get those chances to really time the market like you do with single-families. The reason being, I’ve seen listings for an office complex that was, say, 10% occupied, that had—where the cash flow was just atrocious. The listing was still for pretty close to replacement cost. Whereas on the other hand, at the bottom of the financial crisis, when you were picking up foreclosures, they were being sold at less than half of construction costs. Prices and panic on housing gets ridiculously low. And then, when everything gets frothy, whenever you get bubbles, the prices go ridiculously high, and those swings just don’t happen. You don’t have that chance to really ride the huge cycles like you do in the single-family houses. Now, on the other hand, if you’re an idiot, you can lose money in single-family houses much more quickly as well. But the best remedy to that is to just not be stupid.
JASON HARTMAN: And the way to not be stupid is to just invest for cash flow, and to invest for income, rather than trying to invest in cyclical markets where you have those big swings. In the markets that have the big swings, you’ll never get the cash flow to work. It just never, ever works.
DOUG UTBERG: What investing for cash flow does, is it puts you in a position where you can benefit from the swing. Because anybody who tells you that they know where the market’s going, is lying. The best anyone can possibly do, is to have an edge where they have a slightly better than average chance of knowing where the market’s going, meaning that nearly half the time they’ll still be wrong. Or they can make a slightly better than average rate of return. Meaning that nearly half of the time they’re still going to lose money. What investing for cash flow does, is it lets you be wrong for a really long time without losing your shirt.
JASON HARTMAN: Right. That’s a great way to put it. It lets you ride the storm. So, you don’t have to be a market timer. Which is something that I’ve just never seen anybody successfully do it.
DOUG UTBERG: I’ve seen a lot of people talk about it.
JASON HARTMAN: Yeah, I’ve gotten lucky a lot of times, but it wasn’t genius, it was just luck.
DOUG UTBERG: Timing the market has always been easier to talk about than it has been to actually do.
The difficulties of managing an apartment building
JASON HARTMAN: Great cocktail party discussion. You know, the other thing I want to say, and we did a show several episodes ago where I talked about single-family vs. apartment buildings, and look it, I’ve owned both. I own both now. And I like both. However, one of the things that a lot of investors just don’t really understand, is how much more complex it is to manage an apartment complex. Because, just think about what happens. When you put a bunch of people together, and they are neighbors, and they have music they can play, and dogs that do things, and they have parties, you’ve gotta basically run a business. It’s like you’re running a hotel. You’ve gotta keep all the guests happy all the time. And then, they do this other thing, Doug. They form little mutinies. They do things like, start talking to each other, and they form little internet groups, and they go on Yelp and write negative things about your apartment building, and your apartment building is on Yelp, just like any business, right? Just like the restaurant, or the chiropractor, or whatever. Your apartment building’s there too, okay? And you really have to manage a reputation for your building. When you have single-family homes, you don’t have to do this kind of thing.
DOUG UTBERG: One of the things that I liked was, if you wanted to go large scale with a single-family home, the best way to do that is to work on buying out a whole neighborhood. Because then you can still get the economies of scale, but you don’t have to deal with a lot of the ancillary issues that are associated with a multi-family property.
Trading vs. investing
JASON HARTMAN: And that’s something I’ve talked to some of our larger clients about, who are building their portfolios. And something I’m gonna talk about more on the show in the future, of ways that you can basically buy and form little monopolies on neighborhoods. And if you do this in about three cities, you’re also well diversified at the same time. So, for larger investors, stay tuned. We’ll talk about that some more. So Doug, this is kind of a good segue. Let’s talk about trading vs. investing for just a moment. And do you want to talk about—I think it’s fair to ask for revisiting the trade of the decade that we announced four years ago. Before we talk about trading vs. investing, and before we dive into the trade of the decade that was announced four years ago, I just want to make sure we point out some of the specific numbers from John Burns, because we opened with that. And these numbers are pretty astounding, really. In 2005, single-family homes as a percentage of total rentals was 30.8%. And by 2013, that was 35.3%. That’s a pretty big increase, statistically, in just eight years.
DOUG UTBERG: Most certainly is, Jason. Eight short years, the proportion has increased by about 15% increase over those eight years. And if you think about that, that is relative to the total amount of rental units outstanding.
JASON HARTMAN: Right. So, what you mean there is that there’s more housing stock. It’s like looking at statistics based on a per capita basis. There’s a larger stock of housing, so not only has it increased 8% based on the overall supply, but if you kept the supply steady the way you might think of adjusting for inflation in real dollars versus nominal dollars; so in 2005 houses—that’d be a fair way to say it—what would that look like in 2013? It’d probably be, I don’t know, 41%, right?
DOUG UTBERG: If you’re gonna try to keep your units of measure constant. Because the one thing to consider is that your total housing stock has been growing for this total time period. So that means, in order for the proportion of single-families to go up from 31 to 45%, that the growth rate of single-family rentals is gonna have to be significantly higher than the growth rate of your overall rentals.
JASON HARTMAN: Yeah, sure.
DOUG UTBERG: Because it’s increasing as a proportion of the total.
Trading vs. investing and the trade of the decade
JASON HARTMAN: People just want single-family homes. That’s the American dream, you know? The American dream—whenever you see that idyllic image of the American dream, it’s never somebody living in an apartment building, you know? Let’s talk about trading vs. investing, and the trade of the decade, for just a moment, if we can.
DOUG UTBERG: A few years ago, we announced what we called our trade of the decade. The whole I idea behind this was that at the time, everybody was worried about when interest rates were going to go up. That’s a really valid concern, because interest rates have been basically ridiculously low for quite a while now. What we said was that the real trade of the decade, that we’re still in the midst of right now, is to continue purchasing reasonable cash flow rental properties while rates are low, but once rates shift, to go from purchasing on credit to purchasing with cash. Because what happens is, when interest rates go up, then that means your payment to purchase a house is also going to go up, so that’s going to put pressure on the pricing for houses. So that now, of course, all the people who own these properties are gonna say, oh my goodness, this is terrible, because all of the houses that I just bought on credit, the price is gonna go down.
Maybe it’s not quite as terrible as you think, though. Because think about what’s happening in the overall market that’s gonna be driving the price of your house down. What’s happening is, the cost of acquiring a new property is going up, so that drives the price down, but it also pushes more people out of owner-occupied houses and into rental houses. As we just saw from John Burns, there’s a structural preference in the market for single-family houses versus apartment units. So now what happens is, once interest rates go up, once you already have your—if you already have properties, now those properties, the price may go lower, but your rents will start going up, because there will be more people in the rental pool. And if you have cash, now what you’ll be able to do is you’ll be able to start—you’ll be able to keep buying properties at depressed overall prices for good cash flow ratios, and then, once interest rates come back down, you’ll be able to refinance and pull cash out of that property. So, the real thing to do with our trade of the decade idea, is to modulate your strategy for purchasing properties based on what happens with interest rates. The real bottom line takeaway is that there’s not likely to be a bad time to buy properties coming up in the future. The question’s going to be whether it’s a better time to buy on credit, or a better time to buy with cash.
JASON HARTMAN: It’s always a better time to buy with credit if you can mortgage the property. However, sometimes you can’t. So, when you can’t, that shouldn’t keep you from not buying, because the investment, compared to anything else, at least now, or in the last many years when we look at it, because it’s got multi-dimensional aspects—one of them is leverage, which is wonderful, if you can get it. Even if you take away the leverage, in the acronym IDEAL, the L is leverage, there are still other great factors. And you know, you’re still a great commodities investors, you’re still investing in something that has universal need, you still have the most tax-favored asset in America. But there’s still many reasons to do it, and if you look at it solely from a cash on cash return, anywhere over these last 10 years, if you’re in the sensible market buying the sensible property in the right segment of that market, you’re doing better than anything else. Maybe there are some little blips when gold would have outperformed you. Some little blips when the Dow or the S&P might have outperformed you. But overall, if you’re into something for three years, the real estate has been a better deal, even non-leveraged. Many times a much better deal.
DOUG UTBERG: I think that’s actually where the real trading vs. investing intersection comes in. Because the way that I think about trading vs. investing, is that an investor is looking to buy something that’s a good value, and hold it for a long time. That is the model for real estate. As you say, real estate investing. There’s a reason why we call it real estate investing, and not real estate trading.
JASON HARTMAN: Yeah, we don’t call it real estate trading. Thank you. There are stock market traders, there’s a lot of trading software for the stock market stuff. ETF traders. There’s Forex traders. Real estate traders are flippers.
DOUG UTBERG: The way that I like to juxtapose, say, financial markets and real estate, is that I think real estate is the world’s best investment market, and the world’s worst trading market. And I would put the financial markets as exactly the opposite. They are fantastic places to trade, and they’re just atrocious places to invest. With the financial markets, there’s a lot of ingrained volatility. Now, if you’re a trader, volatility is literally your lifeblood. You know, traders live because of volatility. Because what a trader does, is they intensely study the market to be able to anticipate which direction either a stock or a market or a currency or a country or a commodity is going, and then trade that direction profitably, and then take their profits, and then when the direction flips, to trade that other direction profitably. What investors try to do, is buy something that’s a good value and hold onto it for a really long time, until that full value is recognized. One of the best phrases I ever heard on value investing, I think it was—I forget which hedge fund manager said this, but there was three rules of investing for value. Rule #1 is that investing for value works. Rule #2 was that investing for value doesn’t always work in the short run. And rule #3 was that rule 2 is the reason why #1 was true. And so what that means is, if you are a value-based housing investor, there will be years when you will have been able to do better in something else. In gold, in stocks, in something. There will always be individual years where something—many times, lots of times, many other things will outperform investing in real estate. But over a really long time, what will happen is, if you have invested in good values, you will generate superior long run average return.
JASON HARTMAN: I agree if the real estate is unleveraged. However, if the real estate is sensible income property that we would recommend, produces income, that has cash flow, and it’s leveraged, nothing’s gonna outperform it. You’re gonna have to be totally lucky and buy Apple at $80 and see it go to $400 in a year. Then you’ll outperform it. But if it’s leveraged, it’s always gonna win. Pretty much. You know? If it’s unleveraged though, you’re absolutely right. And that’s what the stock market people, the Wall Street people, love to do, is they love to compare non-leveraged income property with stocks that are not multidimensional, like the real estate.
DOUG UTBERG: The way that most people are profitable as traders, is really to do leveraged trading. Is through trading in things like options, or on margin accounts. Now, the tradeoff to that is, it’s very volatile.
JASON HARTMAN: It’s very risky.
DOUG UTBERG: The volatility creates risks. You have to really know what you’re doing, otherwise you can get wiped out very easily. The advantage that real estate brings to most investors, is that it lets you use leverage without being as susceptible to volatility. Because if you’re investing for cash flow, then if your price varies, but you’re still producing cash flow, you’ll be able to ride out that volatility. Whereas the way that almost all market trading accounts work, is that your accounts are marked to market every day, and then what happens is, if your account ends up in a margin deficit, you can enter into a forced liquidation by your broker. But you don’t run into that situation frequently in real estate, because as long as the bank is getting paid on their loan, they don’t care how low the price of your house has gone.
JASON HARTMAN: And Doug, let me tell you something else. And remember, you’re outsourcing that debt to the tenants, so you’re not paying the loan anyway, and hopefully you have positive cash flow or at least break even. The other part of it is, even if the bank isn’t getting paid, sometimes they don’t care and don’t pay attention! We saw that over the last several years. They’ll let you keep not paying for three years sometimes. It’s mind-boggling. We’ve covered that on many prior episodes.
DOUG UTBERG: Gotta take your jabs at the banks whenever you get a chance.
JASON HARTMAN: The banksters. The criminal banksters. Who we’re glad are there, because we love borrowing their money to buy good income properties and good packaged commodities. Hey Doug, we gotta wrap up. Did you have a final thought you wanted to share? This has been very interesting and enlightening; it’s always great having you on the show. You’ve been on many times. But any final thoughts on this?
DOUG UTBERG: A final thought for all the trading junkies out there. Is that, you allude to it a little bit when you talk about packaged commodities. But another way you can think about purchasing a rental property, is think about it as a series of trades that you’re putting together. So, for example, when you take out a mortgage, you are going short the US dollar. In other words, you are trading against the value of the dollar. When you purchase the property, you are going long the value of the commodities. You are making a trade saying that you are placing a bet that the value of the commodities will go up.
JASON HARTMAN: Right.
DOUG UTBERG: You are purchasing a bond in the form of the rents, because the tenant is going to pay you income, and you’re also going long the value of your land. If you break it apart into the different trades, that’s where you see where the real value is coming from. Because the dollar over the long term is in a lot of trouble, whereas commodities and land value over the long term are likely going to be on an up trajectory. And the bond that you’re purchasing is a competitive bond—it’s a place to live bond, and the number of people who are going to want to purchase place to live bonds over time, is going to go up. Because the number of people who need a place to live is going up. There’s a structural preference in the market for single-family housing, and the number of people who can legitimately afford to purchase a house isn’t growing very quickly.
JASON HARTMAN: Very good points. I mean, Americans haven’t had a real raise in income in a couple of decades, depending on how you calculate it. So that is very true. And houses just keep getting more expensive. So, instead of being hurt by this, people, take advantage of it. Be on the winning side of this trade. The trade of the decade is, buy good, sensible income property. Be a buy and hold investor. Don’t be seduced by this siren song of the cocktail party conversation that’s gonna come up again, okay? At some point. It’s not really out there now. But it’s gonna come up in some other asset class. It’s gonna divert your attention. And the win always goes to those who are focused and consistent and persevere to just win the game. So, great talk on some of this. And Doug, I really enjoyed some of the trading analogies. So, if we’ve got some adrenaline trading junkies out there listening—which I’m sure we do, because they’ve called and emailed me before—they’ll appreciate that. So, I hope this moved the needle for you guys, and for the rest of you who already get it and buy into it—well, you know, that’s just more affirmation. So Doug, thanks so much for joining us. I appreciate it.
DOUG UTBERG: Thank you, Jason.
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