JF1592: The Implications of Increasing Rentership in a Booming Economy #FollowAlongFriday with Joe and Theo

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Joe and Theo are back for another episode of Follow-Along Friday to discuss a few fascinating economic metrics and what they mean for apartment investors if/when the next economic correction occurs. If you enjoyed today’s episode remember to subscribe in iTunes and leave us a review!

 

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Joe Fairless: Best Ever listeners, how are you doing? Welcome to the best real estate investing advice ever show. I’m Joe Fairless, and this is the world’s longest-running daily real estate investing podcast. We only talk about the best advice ever, we don’t get into any of that fluffy stuff.

We’ve got Follow Along Friday today. I hope you’re having a best ever Friday. Like we normally do on Follow Along Friday, we will be talking about what we’ve learned, as well as some observations – and by “we”, I mean Theo Hicks and I. It’s all about what we can do to help you on your real estate journey.

We’re gonna kick it off… Theo, how do we wanna start it off?

Theo Hicks: Today we wanna have a little conversation about the commercial real estate economy. We’ve got a couple of statistics that we’re gonna go through, and kind if just have a conversation about that and see where it goes. Do you wanna lead that, Joe?

Joe Fairless: Yeah, so I have fairly recently been a subscriber to the Wall Street Journal and I’m really digging it. Lots of good content. I’ve always subscribed to the Dallas Morning News; most of our portfolio is in Dallas-Fort Worth, so I’d better have some intel on DFW through that newspaper… And there were a couple articles and data points that I’ve come across recently that I just wanted to point out… And if for nothing else, it’s important that we take note of them, and whatever we want to do with them, it’s up to us, just like any data or really any piece of information in life – it’s up to us to interpret it how we choose to.

One thing that I read — and this really surprised me… That mortgage defaults in the United States are the lowest they have been in 18 years. This is as of this past November. So over the last 18 years – we’ve now set a record for the fewest or the least amount of people defaulting on their mortgages. And fun fact – I looked at the chart and it looks like San Francisco has the lowest default rate, so props to you, San Francisco people.

What I find interesting is, well, what does that mean? Because a stat is a stat, but what are the implications and why is that the case? We always have to ask that question, why. And one consideration I think that we should take into account is that people are better qualified now for their loans, because the lending requirements did get more strict, as they should have since 2008… But we’re 11 years now past 2008, so surely it’s more than that.

Well, then there’s something else, when we combine this information with another article I came across, and that is that the percent of renters have increased 20% since 2008. That’s probably not as surprising to Best Ever listeners, but what I found surprising is from 2005 to today renters have increased by approximately 2%.

Theo Hicks: 2015.

Joe Fairless: Thank you, 2015 to today. So I think we can all agree that the economy has been humming along quite nicely since 2015. And for the percent of renters to increase — not total number of renters, but percent of total households who rent, has increased since 2015 to today, while the economy has been humming along nicely… Well, that says something about our approach as Americans for renting versus owning. And when you combine how we’re at the lowest amount of defaults for over the last 18 years, with that we’re renting more, that leads me to believe that 1) people who are qualifying for the mortgages are truly qualified, and 2) that we’re continuing to be a nation of renters. And Theo, you and I are in the right business.

Theo Hicks: When you had initially told me that statistic about we hit the lowest point in 18 years in regards to the mortgage defaults, I didn’t really know how to think about that… But once you mentioned that it likely has to do with more qualified people actually renting – that completely makes sense, because obviously we’re talking over an 18-year point, and back in 2008, in that time period, there were probably people that were not as qualified, that were owning a home, and once they experienced 2008, they were like “Okay, now let’s just rent instead.” You have to qualify for rentals, but the qualification is streamlined and simpler than it is to qualify for a loan… So I’d be curious to see — we’re at the lowest point of those mortgage defaults in 18 years, but over those 18 years what was the growth, or I guess reduction in the actual number of mortgages? And if it is indeed going down, that kind of proves your point that less people are getting those mortgages, because they’re likely not qualifying for them; banks aren’t doing those crazy loans anymore, they’re sticking to their strict standards, because they don’t wanna get punched in the face again like in the 2008 recession.

And when you hear the fact that since 2015 – and I guess a little earlier than that – the economy has been doing so well, during that time people are making a ton of money, you’d expect them to go out and buy a house, and some people obviously are, but if renting is going up, that means that home ownership has to be going down, because there’s really only two options. So if renting is going up when the economy is really good, what do you think is gonna happen if something bad happens to the economy?

And it’s been going well for so long, so a lot of people — you see this on Facebook, Bigger Pockets, people doing blog posts with their predictions of when the market is going to take a turn again…

I just saw an article today, all these economists are saying that we’re headed for another recession. For some real estate professionals, that might scare them, but as a multifamily investor in general that shouldn’t scare you, because you know that people are gonna have to rent. But then when you see the fact that since 2015 the stock market has gone up a ton, and renting is increasing, that number is just gonna have to go up even higher if a recession were to happen. Now, the only consideration of why it wouldn’t go up even more is the fact that those mortgage defaults are so low… So it’s gonna continue to increase by that percentage, most likely; this is just my opinion. But it’s probably not gonna be as large of an influx of renters if there were a recession because of the fact that the people that are not renting, that are buying and owning aren’t defaulting on their loans right now.

Joe Fairless: Right, they’re gonna stay put with their ownership, and then the renters are gonna stay put with renting. Yeah, you mentioned the elephant in the room – there is likely a recession coming; I don’t know when… Or at least a correction. But when the times have been very good from an economic standpoint, and the renter percentages are increasing, then it’s highly likely that when the times are worse than they are today from an economic standpoint, that the renters are going to at least remain flat, but probably gonna increase slightly.

As landlords, I wonder — and this is something I don’t know… I wonder for all the other economic cycles in our history, if percent rentership has increased during the good times. I wonder if that’s ever taken place before. That’d be something interesting to look at, if this is the first time when the economy has just been flourishing, and the percent of households had actually increased for renters. Because I would think typically when the economy is flourishing, people historically have been purchasing more homes… But that’s what caught my eye – since 2015 it’s actually increased 2% according to that Wall Street Journal article.

Theo Hicks: Yeah. I’ve gotta note to look that up, because we definitely wanna write a blog post  going into a lot more detail on the conversation we’re talking about today, and kind of just historically seeing “Okay, has this ever happened before, that the economy is doing really well while the rentership is also increasing?”

Joe Fairless: Yeah.

Theo Hicks: Something else too that’s interesting, that I was thinking about as well, is that — obviously, I’m looking for apartments in Tampa, but I’m also still looking to invest personally in Cincinnati, and I’d probably say for the past maybe year, a year and a half, the majority of the deals, or actually all of the deals that I get… And I just do the MLS, so I get those automated e-mails, and then I’m still doing the direct mailing, but even on those deals, and I’m not getting many of those, but still even if ones come through, the price that they’re asking for is just so insanely high… And the MLS – I know those deals are selling close to list price, and from someone who’s looking for cashflow, the deals make no sense whatsoever. These are duplexes and fourplexes; I’m not talking large multifamily.

I’m just curious to see what a strategy is of the people who are buying them, because there’s no way for them to actually cash-flow… So I’m just curious to see what’s going to happen if there were to be a correction, what’s gonna happen with those types of properties specifically. Even if it’s just 5% of them that can no longer hang on to their property, they’re gonna sell them at a reduced price. I’m not saying that I’m looking forward to this happening, but when it does happen, I wanna make sure that I’m ready to buy, because I really like the Cincinnati market, those duplexes and fourplexes. Right now, even in Norwood – if you’re not from Cincinnati you don’t know that area, but it’s probably a C area… It’s got some low-income people, there’s a couple of businesses that move in there every once in a while, it’s technically not even a part of the city of Cincinnati, so the taxes are a little bit higher… And  just a year and a half ago you could buy a duplex for 120k-140k, that rented for $1,400-$1,600, and now the past couple of weeks I see those same types of duplexes going for over $200,000, at the same current rents. Some of them are renting for $550/unit, so they’ve got $1,100 in rent, selling for $200,000. I don’t understand how that could cash-flow, because you’re not gonna be pushing those rents any higher than a couple hundred bucks.

Joe Fairless: That’s the thing, yeah – the only way I can think of is if they have a value-add play, where they’re renovating the interiors and pushing rents. But if you’re saying that’s not feasible…

Theo Hicks: It’s really not in that market, at least for right now. I guess the whole point is I’m curious to see what happens to those types of properties. We know what’s likely gonna happen to single-family and we know what’s likely gonna happen on a larger scale, but kind of the middle of the road… And another thing too is that’s where people who aren’t as experienced — I guess there’s a higher proportion of people that aren’t as experienced pursuing those types of deals, because duplexes and fourplexes are perceived to be easier than 8-unit, 10-unit, 20-unit, and they’re less expensive to get into. So I’m just assuming that some of the people that are buying these properties aren’t as experienced as they would like to be.

Joe Fairless: Yeah. And it’s likely those individuals have full-time jobs, which might get affected during a correction, an economic downturn. So then you’ve got a perfect storm of bad stuff, unfortunately for them, where they could get a hit on their salary or lose their salary with the job that goes away, and they’ve got a  negative cash-flowing property, and now you’ve got some trouble.

Adhere to the three immutable laws of real estate investing. If you don’t know what those are, just google “Joe Fairless three immutable laws of real estate investing” and then you should be alright when a correction takes place.

Theo Hicks: That’s funny, that’s exactly what I was gonna say, too. I was on Bigger Pockets yesterday, and someone was asking all these questions about the economy, and I saw a really good response that was saying [unintelligible [00:13:34].19] millions of factors that go into the economy, so it’s impossible to predict what factor is going to affect something else, that could lead to this, so instead just make sure you’re conservatively underwriting deals… My response was “The three immutable laws of real estate investing.”

Joe Fairless: Yeah, there you go. That came from interviewing thousands of real estate investors and hearing their stories, and I was like “Wait a second… Some common things here. What are some common denominators…?”

The second thing, real quick, separate from that conversation, the second interesting thing that I thought would be of interest to everyone listening – and while it is Dallas-Fort Worth-specific, it is interesting for any investor who is investing in any market. The thing I read, in DFW there are about 700k apartments, and they range from efficiency to four-bedrooms; maybe four-bedrooms… I haven’t come across four-bedrooms, but I’m sure there are. And of the percent rent growth last year for each unit size – so efficiency, one-bedroom, two-bedroom, three-bedroom, and I’ll throw in four, just in case there’s a couple – well, the highest percent rent growth was an efficiency apartment. They had the highest percent increase in rent the last year. But there are only 19,000 of those in all of DFW. So if you do that percentage, it’s about 2.6%, because I round it down… There’s 714,000 apartments in DFW, 19,000 of them are efficiencies, so 2.6%.

What I find interesting is — well, first off, it kind of makes sense, because you have smaller unit sizes, so the lowest amount of rent, so when you’ve got a lot of renters, well, you’re gonna have a significant demand, and if that’s the cheapest option, then a lot of people will want the cheapest option. But what I find interesting about it is when I started in apartment investing, I used to only want one and two-bedroom apartments, and predominantly two-bedroom apartments, because they were easier to rent – or so I thought – because with the two-bedroom when the times get tough you can always rent to someone who’s looking for one, and just fill your two with that person who’s looking for the one-bedroom. The person who’s looking for the one, they’ll rent a two-bedroom, if the price is right, or a concession, or something. It’s fine. Or it’s what they’re looking for. But if you have all one-bedrooms and someone needs a two-bedroom, they’ve got a significant other and  a kid or two – well, they can’t have a one-bedroom; it doesn’t make sense. So there’s less flexibility. So you have more flexibility with two-bedrooms.

But what this article was saying is there’s such a small percent of efficiencies, at least in DFW, but likely other markets, that they go like crazy, and the rent just increases more so than any other unit size. And that’s because of recent college graduates, they need a place to live, and they’re for the most part not moving in with someone. And young professionals too, who are out of college for 3-4 years, they still might be living in an efficiency.

So the takeaway here is when you’re looking at an apartment community and you see just efficiency units, don’t necessarily dismiss that as an opportunity, because it might be an opportunity for you to have greater rent increases relative to if it was all two-bedrooms. Now, you’ll want to make sure you look at what the vacancy rate is for that unit type within your market, so you wanna make sure that there’s demand, and you want to logically know where those renters are coming from. Is there a college close by, or is that an area where young professionals like to reside? Knowing those variables, you could very well come across an opportunity that’s all efficiency, where you initially would have dismissed it,  but now after hearing this perhaps you’ll take a second look at it.

Theo Hicks: Yeah, I’ve been seeing something similar in Florida. There’s not many efficiencies here; I’m not sure what the number is… I haven’t seen that many on the rent rolls. But for the one-bedrooms compared to the two-bedrooms, the rent per square foot is 10, 20, some even 30 cents higher for the one-bedrooms and for the large two-bedrooms… And when doing rent comps across two-bedrooms, it’s more like “two-bedrooms rent for this, no matter what size they are”, because you have a massive two-bedroom renting at $900, and then a smaller two-bedroom renting at $875, and the dollars per square foot are way off, because they’re renting for the exact same. I’ve seen something similar in Florida.

Joe Fairless: So two things to consider, both from an economy standpoint, and also from selecting the assets that you wanna underwrite and perhaps pursue to purchase.

Theo Hicks: Great. I wanna talk about one more thing before we move into the trivia question… That is about a book called Traction by Gino Wickman. My business partner read that over a break. We kind of took a two-week break from having our meetings, and then when we had our meetings, he had our apartment syndication to-do list, a shared Google document… And he began to fill it out with information he learned in the book, because I haven’t read the book yet… But essentially, it kind of falls in the concept of if you’re trying to fill up a jar completely, you put the rocks in first, and then the sand, and then the water… So the rocks are kind of like the priority. So your priority items are called rocks, and you wanna make your one-year rock and then your quarterly rocks… So we’ve got a list of what are the main things we wanna accomplish this quarter.

Based on that, we created a scorecard, which is very similar to the accredited investor engagement tracker that we have in our client program… And I don’t think we’ve given that away for Syndication School yet, but I’m pretty sure we will in future episodes. Essentially, it’s a document where you can track all the different duties that you’re doing that are bringing you closer to attracting passive investors – posting on Bigger Pockets, recording podcasts, things like that. We have a list of all those, and then we have a goal, and then for each week we fill in how many we’ve done. For example, “Theo – Bigger Pockets posts – 50”, so how many have I done this week?

Then we have an overall to-do list, so when we have our meetings we can type in “Okay, by next week we’re gonna have these things completed.” I just wanted to mention that really quick; I know I went over that really quickly, but one of the things that we have at the top of our Rocks sheet is “No deal is better than a bad deal”, just because one of the things that [unintelligible [00:19:59].26] was we’ve been looking at deals for around 4-5 months and haven’t closed on one yet, so we don’t want to push ourselves and be like “Alright, we haven’t done a deal in five months. We have to do the next deal that we get, even though it’s a bad deal; we fudge the numbers and make it make sense.” No. Having no deal at all at the moment is much better than doing a bad deal and completely screwing ourselves forever with those investors.

So if you wanna check out that book Traction, I’m sure it’s a pretty quick read. It’s kind of just turning your business into doing what corporations do. When I worked for [unintelligible [00:20:32].29] this is essentially exactly what we did as well.

Joe Fairless: Yeah, that’s great. I have not read it, so I don’t know if it’s good, but I like the concept that you’re talking about. What is your quarterly goal that you have?

Theo Hicks: I’m filling it out tomorrow, but right now my three goals are to underwrite two deals a week, meet in person with broker relationships, so meet in person with each of them at least once this quarter, and then train five underwriters… Which is funny, because I had three, and then I wrote this down, I went to Bigger Pockets and I had two messages from people who were interested in underwriting. Five, right there.

Joe Fairless: Cool, alright. Nice.

Theo Hicks: I wish I had brought this up last week, on our goal-setting talk, but fair enough. Alrighty, to the trivia question. Last week’s trivia question was “What MSA had the largest population growth in 2017?” I think Joe guessed Dallas-Fort Worth, and that was in the top five for sure. The answer was actually Boise City, Idaho. That was the MSA with the largest population growth percentage-wise… So not overall, percentage-wise.

This week’s question is going to be similar to last week’s question, but it’s going to be “What MSA had the largest projected population growth in 2018?”

Obviously, 2018 data isn’t out yet, but they did their projections, so what MSA had the largest projected population growth in 2018?

Joe Fairless: The question before that was ’17?

Theo Hicks: Yes.

Joe Fairless: Okay, and this is the same question, but for ’18…

Theo Hicks: Yeah. Before it was actual, because they had the data. This was the projections.

Joe Fairless: Okay. And it’s percent increase, not total number increase…

Theo Hicks: Percent increase.

Joe Fairless: Argh! I’m going Fort Worth. I’ll just stick to my guns.

Theo Hicks: Okay. I’m pretty sure Fort Worth was two or three.

Joe Fairless: Arghh!

Theo Hicks: So those who guessed Fort Worth… I think people will get this one. I was surprised, but I think people will get this one, because it’s not a Boise City, Idaho; it’s more of a well-known area. Submit that question to either info@JoeFairless.com, or comment on the YouTube video that we post. If you get the correct answer, we’ll send you a signed copy of the first book.

Joe Fairless: If you’re the first person to get the correct answer, then we’ll send you a signed copy of the Best Real Estate Investing Advice Ever Vol.1. Sweet.

Theo Hicks: The Best Ever Conference, in February 22-23. A little over a month away. This week the featured speaker we’re gonna talk about is John Chang. It’s very relevant to the conversation we had earlier about the economy, because he is going to do a talk on his take on the commercial real estate economic outlook. From what I’ve seen, I think it’s just gonna be him doing it. There’s not gonna be  a panel.

Joe Fairless: What’s his title?

Theo Hicks: John Chang.

Joe Fairless: No, that’s his name. What’s his title? He’s with Marcus & Millichap; I don’t know his title, maybe you can find it, but… I know what he does, and he is responsible for…

Theo Hicks: Senior Vice-President.

Joe Fairless: Senior Vice-President, but his focus is on forecasting where the economy is headed for Marcus & Millichap. He’s phenomenal, and it will be a dynamic talk, with a lot of value. Our whole conference is focused on commercial real estate, and he’s actually gonna kick it off on Friday morning.

Theo Hicks: Tickets go up weekly, so you can secure a ticket now at BestEverConference.com. And then lastly, we’re gonna do our review of the week. If you submit a review on Amazon for the Best Ever Apartment Syndication Book… We’re up to 117 when I checked this morning… And send us a screenshot at info@joefairless.com, we will send you a package of the free content that the people who pre-ordered the book received.

This week’s review is from Paul…

Joe Fairless: Oh, wait, it’s not the exact content people who pre-ordered the book received… We updated it some. And the reason why is because we want to reward the people who pre-ordered the book something extra-special, so it’s a little bit different. But it’s still good stuff.

Theo Hicks: So Paul said “I consider myself a multifamily real estate professional, having financed apartments for 25 years. But moving from a provider of financing to being a sponsor encompassed much more. This book really helps to organize each step necessary to achieve your goals. Along the way, it goes beyond the mechanics and digs into the mindset necessary to achieve each step. When you combine this with the regular interviews contained in the Best Ever podcasts, the amount of useful information is abundant. I have not attended, but have also heard that the Best Ever conferences are also top notch. That’s on my list of things to do. Thanks to Joe and Theo for the excellent work and continued stream of content. I highly recommend this book.”

Joe Fairless: Paul, I hope to see you at the conference in February, and thank you for that review. Most importantly, I’m glad that it is helpful for you as you evolve your focus in commercial real estate.

I enjoyed our conversation, everyone. Theo, great catching up with you again, and we will talk to you tomorrow.

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