An in-depth look at the real estate market with Mike Madsen of RealSource Equities on The RealCrowd Podcast - The Fundamentals of Commercial Real Estate Investing.
Mike Madsen a Client Services representative since 2005, has participated in workshops around the nation in the National Association of Real Estate Investors, as well as analyzing multi-family properties and doing market due diligence for RealSource.
To help clients improve their retirement investments Mike and Jeremy Hanks formed RealSource Retirement Services.
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Adam Hooper - Hey listeners, Adam Hooper here, CEO and Co-Founder of RealCrowd. As we near our twentieth episode this year we wanted to give you guys an opportunity to have a Q and A session with Tyler and I. If you have anything you'd like us to discuss please send me an email direct to ahooper at realcrowd dot com If you want us to talk about what we've learned, where we've been or where we're going with the podcast or at RealCrowd, let us know and we'll record a quick session for ya. Happy Holidays and thanks again for listening. Hey Tyler.
Tyler Stewart - Hey Adam, how are you today?
Adam Hooper - I'm doing well, Tyler, what's on the docket today?
Tyler Stewart - Adam, today we have Mike Madsen, the head of the Econometrics team at RealSource Equities.
Adam Hooper - Yeah, he's been on the podcast before, had him on, gosh, that was earlier this year, wasn't it?
Tyler Stewart - Yeah.
Adam Hooper - Yeah, so we got him back. Think this is another two parter. Always just a ton of incredible information with Mike. We could talk to the guy for hours.
Tyler Stewart - Hours, yeah. Mike said they're tracking 225 different markets in the US right now and he shared that data with us, what's currently happening and also looking towards the future.
Adam Hooper - Yeah, we talked about a lot of stuff. Again as always, we talked about some of the tax issues, demographics, good markets, bad markets, where we're at in the cycle, timing, just a tremendous amount of good information in here.
Tyler Stewart - So much information. This is one, have your note pad ready and take notes as you go through or hit up our blog and download the transcript and take your time going through this one.
Adam Hooper - Yeah.
Tyler Stewart - There's a lot of information.
Adam Hooper - Good one, I think that's enough of us talking. As always, listeners out there, if you have any comments or feedback, please send us an email to podcast at realcrowd dot com and we always appreciate ratings, reviews on iTunes, SoundCloud, Google Play and with that, Tyler, let's get to it.
RealCrowd - This podcast is brought to you by RealCrowd, the leader in online real estate investing. Visit realcrowd.com to learn more about how we provide our members with direct access to commercial real estate investments. Don't forget to subscribe to the podcast on iTunes, Google Music or SoundCloud. RealCrowd, invest smarter.
Adam Hooper - Well Mike, thanks for joining us again today, glad to have you back on the show and I think the listeners had a really, really good time, a lot of great feedback from our first go with this. So we're excited to get an update and dig back in today.
Mike Madsen - Awesome, it's great to be back and it's been a good year for RealSource, we've really enjoyed getting to know more RealCrowd clients and investors and kind of get their take and we're excited for the next year as well. Things have gone well, obviously, for those of us are invested in multi-family or commercial real estate and ya know, the big question is what's next and so we're always talking about that and always analyzing it and looking forward to next year.
Adam Hooper - Before we get too deep into what's next, let's maybe do a bit of a recap, it was earlier this year that we had you on first time around, there was a bunch that we talked about so I don't know if we can rehash everything but what are something of the biggest changes that you've seen since maybe the later Q1 this year. How have you seen things change, what's on your radar now that might not have been back then and what's your kind of snapshot of today where we're at.
Mike Madsen - Things kind of happened the way we thought they were, we knew that demand was certainly going to increase as far as buying commercial real estate assets, in particular, apartment buildings and there's no doubt that the competitive buying market to acquire 200 unit plus units is a lot stronger than it was a year ago and it's a lot stronger than it was two years ago. That's a good thing and also, creates some challenges but overall we think it's indicating some additional upside in the equities market, the apartment market and we're feeling like we know how to navigate our capital and deal structure for what's ahead to not only preserve capital for clients but also achieve our returns and our goals. We're definitely finding that when we find a property that we're circling and under writing and feel really good about that there's a lot of other people that are trying to buy the same assets. It definitely changes the way that you target markets, it changes the way you underwrite properties and how much time you can spend on one asset when the goal is to go out there and acquire five to 10 properties a year. It definitely creates the challenge in the acquisition market, especially for RealSource where particularly kind of a picky buyer, we invest a lot of the money ourselves and with friends and family into each of these deals. We never want to do a bad deal, we never want to do an iffy deal, so we'd much rather pass on a deal than do something that we're not really feeling good about
Mike Madsen - and really excited about for our investors. That's definitely the biggest challenge out there, this year. Obviously, commercial real estate in the right markets has had a really good year, we've seen cap rates hold steady at decline in most places and definitely seeing the trend of more and more investors are confidently continuing to buy income property and expectations for economic growth and asset inflation are on the rise and so that's definitely going to change the buying market. Overall the good news is is that we're still in definitely the early innings of the macro cycle. We will stand by that in our target markets and I know that a lot of people are wondering is the market going to retreat, is it going to turn on us but all the indicators are there that the next four years are going to be just as good as the last four and have potential to go out for as far as the next decade. We're feeling good about the business we're in, for sure.
Adam Hooper - Good, I know you mentioned, we started that comment, you broke it down by size right, 200 plus units. Not necessarily by geography or market, primary, secondary, tertiary, are you seeing that breakout for, in competitive bid situations, more as a function in asset size in total deal size or are you seeing that kind of still market by market.
Mike Madsen - That's a good point and we're definitely seeing it by kind of asset size. Three years ago you could go to a secondary market and get a lot more attractive cap rate. There are plenty of markets out there that you could buy at a seven cap that today you could probably only buy at a six cap or five and a half cap. We've got to adjust there, we've noticed yield is been chasing these secondary markets and that's kind of already happened so now it's how do we adjust going forward and there's no doubt that if a two or 300 unit apartment, in a top 50 metro, hits the market that it's going to get a lot more attention than it did a few year ago and that's brought across a lot of different markets. It's not something we're seeing only in the gateway or primary markets. It's a good thing, it's a good sign for the industry, it's a good sign that people are confident in apartments, they're confident in that people need a place to live and that renter demand is increasing and especially in these kind of bigger cities as people move out of kind of more rural areas into more metropolitan areas looking for jobs and job growth.
Adam Hooper - Where do you see that competition coming from is it institutional investors, foreign investors, who's bringing that competition in these markets?
Mike Madsen - It really depends on the area, you've got some places, like Florida, that are heavy in foreign buyers, you've got other places, like Ohio, to where it's traditionally been more regional buyers but now you're starting to see more institutional buyers. Overall it's increasing with everybody, you've got more of your RealSource type companies out there chasing down deals and you also have the institutional funds which is also apart of foreign capital wanting to come to the US.
Adam Hooper - Now, of course when you have increased competition on the buy side that's going to naturally try to compress some yields on these deals. How is that or is that changing anything with your underwriting, is it changing how you're having to source capital, is it changing how you have to kind of reset expectations for that capital, what's going to be deliverable over the next four to 10 years, if it continues.
Mike Madsen - Absolutely and I think the further out you go the less that's an issue but there's no doubt that three years ago you could go out and get a lot higher returns than you can right now, that's just a natural process of more people chasing these assets but at the same time, investors expectations have calmed in the last two years, people have realized that we're not going to get 7% rent growth year after year, it's not sustainable, it's not something that's going to happen over and over. But the good news is people are more inline with reality as far as return expectations and kind of in our world, the underwriting process has changed a bit, everybody's having to underwrite and basically bake in interest rate rises into their underwriting and into their performas but at the same time, nobody's really pricing in increased growth that could happen. The markets are kind of, a lot of the capital markets are kind of in this wait and see mode and if we do get some things happening, if we do get tax reform, if we do get repatriation of funds hitting the US, we do get stimulated job growth. There's a huge potential upside but none of it's been priced into the values quite like it has in some of the other sectors so, that's the good news is everybody's underwriting, conservative growth but there's definitely a chance that there can be a lot more upside. If you look at the stock market and you see why that's going up and what's creating the increase there, it's a little bit more speculative,
Mike Madsen - it's a little more liquid, people can get in, people can get out but the commercial real estate market does not fluctuate as quickly as that does. I think it's good news for current owners because everybody's being really cautious and really conservative and at the same time there's some things that can happen that can really spur growth and really create better returns for everybody.
Adam Hooper - And now, you mentioned interest rate risk. As long as I can remember we've said they've got to go up, they got to go up, they got to go up. At some point they're going to go up right.
Mike Madsen - Yeah.
Adam Hooper - By how much and at what point does it become a material impact on returns, return expectations and underwriting.
Mike Madsen - That's the big question out there, there's definitely people out there that think the interest rate rise will be moderate and slow and there's other people out there that think that the market could take off and the interest rates once they go past like 3% that they'll jump to four pretty quick on the ten year. A lot of that is yet to be known but there's no doubt that the higher interest rates go the more stress it's going to put on the single family market. I believe we've talked about this in the past and I think it's really important for people to realize that if you're investing and playing in the single family market it's very different than commercial real estate. Your home, if you live in it and you have a mortgage it's really classified as a liability not an asset and the single family market is going to be a lot more sensitive to rising interest rates, which could really create different situations in different markets. The more overpriced, more expensive you think that the single family market is in a particular city kind of basing that on average housing cost verse average incomes, there's a few cities out there, a lot of them on the coast, that are kind of showing a red flag of hey, this is could be a heavy impact to single family real estate. However, at the same time, we've got to remember that commercial real estate in particular apartments, people are buying cash flow opportunity, they're buying future cash flow opportunity and it's priced out much different.
Mike Madsen - We'll see commercial real estate perform much more like the equities market, much more kind of like a stock market and I think initially, rising interest rates will actually be favorable to the performance of some of these assets.
Adam Hooper - We talked about that last time too, right, that's kind of a double edge sword from a owner of multi-family standpoint. A decrease in housing affordability or increase in single family pricing can actually create opportunity because again, people have to live somewhere, right. It's not good or bad necessarily, I guess it depends on which side of the coin your on Really from where home prices and if housing affordability is going.
Mike Madsen - Yeah, definitely. There's going to be less of an opportunity to make money with single family properties renting them out and creating an income property. I think people that are speculating that home prices are just going to continue to go up and up and up and up I think people need to be careful there. People definitely need a place to live but you can only afford so much of an interest rate when you qualify for a mortgage.
Adam Hooper - Yeah, the notion, I guess, I don't know, I think I'm on the tail end of the Millennial generation, maybe, I don't know, what am I 36 years old I guess. Our generation, the notion of maybe our parents generation, the baby boomers, right, the understanding that your home is one of your main generators of wealth, right, home prices always go up, that's always how it goes, you put your money in your house and you live there for 40 years and you pay off your mortgage and that's your nest egg. Boy is that not true for a lot of us anymore, right. Just that mentality, that way of thinking and attaching this prospect of wealth creation through your home isn't as given as it was just a generation prior.
Mike Madsen - Yeah, no doubt and obviously in the long term owning is better than renting and has been historically since the 30 year mortgage came to the industry but there's no doubt that we've seen a shift in change. We realized that back in 2008 and I think that people who expect home prices to just keep increasing, increasing, increasing are going to realize that they should've learned a few lessons back in 2008 and know that the affordability band can only stretch so far and I think apartment owners need to realize that the single family market can have a huge impact on any rental market. And that's something else we learned through the last downturn so, it's not necessarily a good idea to be in a market to where you think the single family market could take a correction. A 10% correction isn't going to have a big impact but if you're talking 30% correction then it's going to have an impact on multi-family, which is why RealSource has always focused on affordability these last few years, we've realized that there's certain single family markets out there that are way more at risk than others and we want to make sure that we're in a safe place, that we're protecting our investment and we're aware of what's going to happen.
Adam Hooper - And for our listeners out there who are single family home investors or owners, what are some early warning signs they can look for in a market?
Mike Madsen - Obviously the amount of time, the average number of days that a market, a house sits on the market is a key indicator, the other one would be watching the interest rates rise. If they start rising too fast, too soon that can be an indicator that things are going to slow down really fast. Definitely there's been a lot of discussion on some of this tax reform and how it'll hit some of these states like California, it could make owning a home a little bit less attractive, taxes could go up, property taxes could go up, it could create a less favorable business environment which could create some major migrations. If I was in California, I would definitely be watching to see what happens and you could see a lot of people trying to sell their single family homes if the tax reform goes through and depending on those details but it's key to remember that there's a survey that came in from LinkedIn not too long ago that people age 20 to 35, over a third of them or about one third of them have relocated cities just for a job and that trend will only magnify and only increase if we see some tax reform go through that creates basically a migration of people and businesses towards lower cost of living places, lower cost of doing business places. And that's good thing for RealSource and our business model because we have a almost a 30 year history of studying migration patterns, what makes businesses and people relocate, we feel like we're ahead of the curve there and now if the tax reform doesn't happen
Mike Madsen - or doesn't go through, it's not going to have a big negative impact on where we're positioned but at the same time it would be exciting to know that the gap between good market and a bad market in the US right now could widen and that's a good thing for us.
RealCrowd - Thanks again for listening to the RealCrowd podcast. If you like what you're hearing please visit realcrowd.com to learn more and subscribe at iTunes, Google Music and SoundCloud. RealCrowd, invest smarter.
Jack (RealCrowd User) - My name is Jack and I've been in the financial services industry for over 30 years. I've done six different deals and when I first started doing these deals I was looking for sort of core real estate cash flow, I wasn't looking for a lot of upside return, I wanted more immediate yield and so I went conservative to start and then as I've gone through I've just looked really at the quality of the sponsors first and foremost and their level of experience. Now I'm trying to mix in different types of properties, different geographies, I wanted some core plus and a little bit of development, so it's still pretty, in my view, a conservative portfolio. It's mostly focused on sponsors and then looking at the projections as far as how much of the return would come from current income and yield and how much of it would be based on appreciation and thinking through whether or not, how much risk there is and the appreciation being realized. It's really a portfolio approach for me, looking at different sponsors, different geographies, different property types and even different types of properties as far as core or core plus or development. Ya know, I'm looking for, I guess I would start with a certain level of return because my investments are primarily in equities and I look at the direct real estate investing through RealCrowd as being diversification play but I also want a pretty substantial return. I typically look for properties that have a yield of seven, eight, nine percent current income and then IRR that's in the mid to upper teens,
Jack (RealCrowd User) - low twenties, in some cases. I start with returns, I focus on sponsor, I look for property types that I don't have already invested in the portfolio and I guess finally I look at geography. Well, I think that diversification's important to any portfolio. I looked at a number of different crowd funding portals and I chose RealCrowd because I like the transparency, I like the fact that the sponsors pay a fee to be on the portal and that there's not built in fees for RealCrowd in the compensation structure of the deal cause these deals are fairly complicated to understand anyway because you've got to pay a management fee and incentive fee and things like that and if there are embedded fees from the portal provider it just makes the complexity so much higher. So I think the key for me is the transparency and I just think that direct real estate is a great compliment to a lot of other stock and bond portfolios. I think it provides inflation protection, current income and appreciation potential. For me, direct real estate is better than reach which are more subject to market fluctuation in price and I just think with the minimums that are out there now and the quality of the sponsors it's a really good way for a lot of investors to access direst real estate without the hassles of property management on your own. So I think it's an important advancement for a lot of investors to diversify their portfolio.
RealCrowd - Thanks again for listening to the RealCrowd podcast. If you like what you're hearing please visit realcrowd.com to learn more and subscribe at iTunes, Google Music and SoundCloud. RealCrowd, invest smarter.
Adam Hooper - Previously you mentioned if some of these more primary markets, if there's an out migration or, not a bubble, but some kind of a correction there with those reverberations might be, right we're in Portland. Huge growth here obviously, big run up in pricing for single family because it's comparative to the Bay Area, Seattle, it's much more affordable while the actual dollar on price has been rising significantly. What are the impacts of, if we were to see again selling single family in California or wherever and moving to some of these other markets, how are you guys, are you planning for that, is that something you work into your underwriting, your analysis or is it just something you're kind of monitoring now.
Mike Madsen - In our economic modeling we track migration patterns, we see where people are moving to and from, we also track the ratio of how many of those people that are moving are buying verse renting. For example, there's a big trend of people moving to Colorado for better jobs and better income and what the data's showing is that most of the people that are moving there are a little bit younger and they're choosing to rent rather than own by a very wide margin and RealSource identified Colorado Springs as a target market, I think back in 2013 or '14. We're actually able to acquire the largest apartment complex in Colorado Springs and we've just noticed the rent's kind of taken off. Obviously, the market and supply and demand will kind of dictate where rents go and we've seen the market go up at an average of seven to 8% for about three years now. A lot of that is because people are not only migrating there and there are people that are taking good incomes but they're also people that want to rent either by necessity or by choice and it's created a little bit of a housing shortage in Colorado Springs and it's created a lot of demand for people to get a good apartment and when there's a lot of people that want to rent in a specific area, rents are naturally going to increase.
Adam Hooper - Well and you've got, like you said, if you've got there positive demand drivers supply constrains, certainly when you're talking about new construction as well. We were at a conference in Florida a month or so ago and a developer was saying that their construction cost have gone up 10% plus every year for the last five years. That makes it very difficult to deliver new supply and if you've got all these demand drivers, like you said these demographics, generational shifts scheming more towards renting it's a pretty good story for multi-family, isn't it.
Mike Madsen - Yeah, no doubt, and you bring up a really interesting point. A lot of people forecasted that 2017 would be the year of peak new supply, be the year that we saw the most new supply come to the market and a lot of that has actually been delayed and they think it could be 2018 but at the end of the day you're exactly right, it's the cost of construction has increased so much further than where rents have that by the time investors and underwriters look at a deal, there's just not the upside to warrant the risk for new construction. We've looked at a lot of different markets to where we see the gap is so wide that the only place they're building new apartments is right downtown in premiere locations.
Adam Hooper - Class A, high end.
Mike Madsen - Yeah, exactly but as far as trying to go and build that class B, more affordable housing, until the rents catch up and make it more attractive to investors, new supply is not just going to storm into these markets. There's no doubt about it.
Adam Hooper - That's a big issue. Right, the rents, you say, are not going to be increasing as much as they have been historically and wages haven't been increasing commensurate with rent growth by any means, construction cost increasing. What needs to shake loose, will anything shake loose to be able to deliver new affordable, right whether it's not even like low income affordable but just general population affordable, non-class A, CBD, kind of product or is that just, that's just not possible for the foreseeable future.
Mike Madsen - What's going to happen is it's going to take some growth both on the economic side which will reflect in rent growth but I think it just needs a little bit of time. I think it's going to be a while until you see kind of the rents catch up there but at the same time rent growth is slowing down but we're talking about slowing down from 4% down to two and half.
Adam Hooper - Sure and still growing but just not as fast.
Mike Madsen - Yeah and it's still growing and I think the pace of growth next year will be kind of similar to what it was this year but I think there's definitely big time potential for rent growth to really overachieve peoples expectations and say like, 2019, 2020, 2021, that time frame, I'm expecting more growth than what people are forecasting. Obviously, like I said, people are being conservative, they're not underwriting inflation in the multi-family market yet but there's a good chance that we will get back above 3% rent growth a year. There's a good chance that part of that will be because National GDP goes above 3% a year, it'll take time but all the signs are there showing that the market is expecting economic growth and definitely asset inflation. Not next year but the year after and the year after for sure.
Adam Hooper - And so now do you guys, not to put you on the spot here, but do you guys track wage growth compared to rent growth in the markets that you're looking at and if so what does that delta.
Mike Madsen - Oh yeah, absolutely, we track average income growth, median income growth, we kind of compare it on our affordability index. There's a lot of markets that show that rents are almost behind and rents are going to really grow and we've been trying to target a lot of those places but we do measure and track that in about 225 markets right now. That's a big factor, I think we discussed it last time that some cities are seeing significant wage growth and others are just flat and if you look at it on kind of a macro level, it's been flat for a while but the good news is, we are seeing average incomes increase at a better pace than they have in the years past. So I think that's the hope for a lot of people, a lot of economist is that we can get average incomes up for average people and that everybody can start making more money not just people at the top. I think that's the goal, I think there's a lot of political stuff going around and a lot of people formulating opinions on tax reform and income growth but I think what people forget at the end of the day, it's not about how much money you're going to save next year on your taxes or your neighbor, it's about creating a better job growth environment for everybody, it's about creating a tax environment to where the tax dollars want to return the US. That's where capital flows, it just happens naturally that if people can save money by moving their money legally to a different place, then they will. The one thing that nobody's really talking about
Mike Madsen - that can have a huge impact is this repatriation of funds. We have multiple sources that are estimating that that impact could be in the two to three trillion dollar number and I don't think everybody realizes how positive that would be to have that much capital return to the US.
Adam Hooper - I want to talk about that for sure but before we get there you had mentioned the spread between what would be a good market and maybe not as good market or bad market is going to widen. Can you go a little bit more on what that, what do you mean by that, where's the opportunity there, does that mean good asset in bad market or are you just really trying to identify where those good markets, stay away from the bad markets or is there still opportunity there. Kind of dig into that a little bit if you could.
Mike Madsen - Well, those of us that have been doing this a long, long time and we've got a great team at RealSource that a lot of us have been working together for over 10 years and we've come a long ways, we've been through some ups and downs and some different cycles and I think it's really important to look at a sponsors experiences, I think a sponsor that's been around before the down turn and after the down turn is a little bit of an advantage with that learning experience. We've always known that it's all about location, location, location as everybody's heard many times but in times like these to where some markets are doing so well and some markets are growing at 7% a year in rent growth and some markets are declining at 2% a year. That's the time where location matter more than ever before and it kind of goes back to those migration patterns we were talking about that depending on what happens here in the next 60 to 90 days, there's already migration patterns, there's already hundreds of thousands of people moving to cities in Texas, away from other places. The trend is already happening, it's already ramping up but it has a chance to increase even further and it's just one of those things that every market is different and understanding market cycles and market timing is our niche, our passion and we just think that there's a big, big potential to where that gap can widen. There's certain years, like 2013, to where every good market is doing well and the difference between the best and the worst just isn't that wide
Mike Madsen - but the trends are showing and our economic models are showing that that's just widening a little bit. I can remember back in early 2005, 2006, I'd speak to a lot of investors who just weren't comfortable not owning property where they couldn't drive to the property. I mean you wouldn't believe how many people at the time were just, it was so different for them to think of buying a property out of state and now you look at that and I don't think very many people even talk about it anymore. I think with technology changes and the power of communication and knowing what's going on in other places has changed enough to where you just don't hear people talk about that anymore. People are more comfortable investing in different markets and we've kind of always had a saying of live where you want and invest where it makes the most sense.
Adam Hooper - I like that.
Mike Madsen - And people are pretty caught up to that but at the same time I think people really need to focus on where they're investing. I think last time we spoke, we talked about our emphasis on looking at things on a state level and we ramped up our focus on that in our model I think two years ago and now, I think it's making more sense than we ever imagined because as some of these states see negative migration and some see positive, a lot of that is spurring from what is that state and city debt obligations. You certainly have some cities and some states that are aggressively raising taxes to pay their debt obligations, particularly state and city pensions and we foresaw those issues and problems before they happened and we're glad that we paid attention to those things and are investing in favorable states rather than unfavorable states. That's why we see that gap widening and we're adjusting to it.
Adam Hooper - And so it is, not to say that there isn't the possibility of finding a good deal in a subjectively or even objectively bad market or worse off market, it's just it's going to be far more challenged to try to get to those returns if you're in a market that's not showing some of those attributes that a good or well performing market has.
Mike Madsen - Yeah, absolutely, there's always good deal in every market, if you buy right. I think a lot of people have learned that investing in apartments and multi-family that the bigger apartment you buy, the more economies of scale you have, the easier it is to improve your NOI, cut cost, increase your cash flow. Which is why the trend has been for a lot of people that have been doing this for 20, 30, 40 years have gotten away from just owning and managing their own properties and realize, from testing the waters, they're going to do a lot better investing in large apartments with a large group and letting a professional managers manage the day-to-day. If that's where you're at and that's what you believe in and that's what you want to invest in, you're usually talking 150 to 200 units plus and finding a good real estate investment in the single family market or small office or retail space in some of these markets, it's a little bit easier than going and finding a 300 unit apartment complex for the right price and buying it to where you're offset by the location because of your purchase price. In our world of 200 unit plus, you're not going to go to rough markets and get good returns.
Adam Hooper - Okay, well Mike, again, really appreciate it as always. Looking forward to getting you back on.
RealCrowd - This podcast is brought to you by RealCrowd, the leader in online real estate investing. Visit realcrowd.com to learn more about how we provide our members with direct access to commercial real estate investments. Don't forget to subscribe to the podcast on iTunes, Google Music or SoundCloud. RealCrowd, invest smarter.
