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 property 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. This is episode number three hundred and fifty-nine, and if you’re all still listening after my last two shows—well, three shows—it’s like the odd grouping of people on all sides of the socioeconomic and political spectrum. We had John Stossel, Noam Chomsky, and Bill Ayers, the man who made Obama, many people call him. So, it’s been quite an odd thing. And I’ve got one of our great investment counselors here with me today, and that is Sarah—how you doing, Sarah?
SARAH: Good, thanks for having me!
JASON HARTMAN: Well good! I’m in San Diego. We just came off our Meet the Masters event, and you are in Orange County, so we’re both California this time, I’m not Phoenix. And enjoying it down here! But wow, I was tired after Meet the Masters. Were you as tired as I was?
SARAH: Well, maybe you can tell by my voice, I’ve kind of lost my voice over the last couple days. Lots of great conversation. Hours and hours full of great content. Yeah, I’m feeling a little winded!
JASON HARTMAN: But it’s like when you have a really good workout, you know, you’re tired, but it’s like a good tired. You feel good being just a little bit worn out. So, it’s not like worn out in a bad way, it’s worn out in a good way.
SARAH: Oh yeah.
JASON HARTMAN: But that was an awesome Masters event. I think that was our 13th event. And you know what, it’s a little hard to count, of course, because we used to do them twice a year every spring and every fall, and now we’re just doing them once a year in January. But I think that was number 13, if I’m not mistaken. We gotta go back and figure out the count. But we can call it Masters 2014, that’s the name of it. So, we talked about some great stuff, had a whole bunch of speakers—I’d say with everybody, we had about 100 people in the room there. And what were your impressions on the event?
SARAH: It was a great event. I was really excited to meet our new investors, all the way from Japan—that was pretty exciting. Great conversation with them. And we had some visitors from the east coast, and of course our market specialists and experts from all across the country provided some great content for us. And you know, I have a lot of clients asking when we’re going to do it again, and why we don’t do it twice a year anymore.
JASON HARTMAN: Because it’s a lot of work to put that on! You know? We’ll just keep it once a year. But I will tell you Sarah, and maybe our listeners can give us a little bit of feedback—I think I mentioned this to you maybe a month or two ago. I’m thinking of another type of event, which is like a weekend event where we host it in—we’ll rent a mansion or something like that, and have like a really cool intimate event, so we’re kind of thinking about something like that. It’d be a little more expensive, and so some people will like that, a more exclusive thing, and some people, they won’t wanna come to that. They’ll want to come to the less expensive things.
SARAH: Yeah, it’s funny you mention that. It’s like, after this long weekend of meeting all our clients that I’ve known for years, some of them, but never met face to face—you leave wishing you had a night at the movies, you know, or just a night out at dinner to hang out, because you make friends with so many people. So yeah, it was great from that perspective as well.
JASON HARTMAN: Yeah. One of the things that I think—at every masters event, there is always new, new content, new ideas, and we started off recapping 2013, where we talked about Bitcoin, which is a big deal—one of the evaluations said, you know, I found it to be like an interesting discussion, but I didn’t know exactly what to do with that, that whole discussion about Bitcoin, and you know, I mean, think of how amazing it is, everybody, that we now have a major currency that is not attached to any one country. And last year was really the year that these cryptocurrencies, or cybercurrencies—Bitcoin being the most popular, but there are many others—kind of came into their own, and I think they may well be squashed. I’m not saying invest in them at all, but it’s just interesting that so many people around the planet want an option to get out of the central bankers’ fiat money scam. They want their currency really to be independent of their country and independent of bankers who keep inflating away the value of their currency. So that was interesting. We talked a lot about the JOBS Act, which is I think going to have a very significant impact, and when we talked about crowdfunding, and crowdfunding of real estate, you know, we had kind of the usual core topics—self-corrective IRAs and 401(k)s and so forth; asset protection, tax planning, things like that. But one of the things I definitely want to talk about with you, Sarah, is how we talked about separating the price of real estate from the utility intrinsic value, which we believe is monthly rent or income, but gosh, what else did we talk about? We had so many market presentations, what did you think of all those?
SARAH: We did, we had a lot of great market presentations. It was nice to have some fresh new faces and new markets to announce during the weekend. And you really do learn a lot from each providers, because they each have a different input for proper management, and just acquiring your portfolio, it’s all good stuff. One of the things that I know our investors really enjoyed was the Q&A panels we did. We had a panel with all of market specialists and investment counselors, and we really let the clients just have a go at us, and put us on the spot and ask us those tough questions, and boy did they!
JASON HARTMAN: Right, they did! We had more panels this time, I think, than any other Meet the Masters event. We had a lender panel, and we started that a year ago. And that was really good. People always want to ask financing questions, and the great thing that I think we did with that panel when we started doing it as a panel discussion last year, is we put three lenders up there. They’re sitting on the stage, sitting on stools, and people can just attack them with questions, questions, questions! But the great thing is that the three lenders really hold each other accountable. So you know none of them can get away with making a bunch of big fancy promises they can’t deliver on, because the lender next to them, she’ll say, hey, you can’t do that! I know you can’t do that! [LAUGHTER]
SARAH: Right, and it’s so funny! It’s almost like they’re trying to one-up each other. And because it was the same three lenders we had last year, they were really on their A-game this time. I mean, Aaron, with his bag of tricks…I don’t know if we can mention on the Podcast—
JASON HARTMAN: That was hilarious! That was so funny. One of the lenders was talking about how some of these underwriters, when they’re underwriting a loan, they just get kind of nutty and bureaucratic and all caught up in technicalities. And then others, they basically don’t know what they’re doing, they don’t know how to underwrite a loan properly, and so, Aaron is such a funny guy—he says, I have a kit for this. And he comes up on stage with a big brown paper bag [LAUGHTER]—Sarah, what was he pulling out of that bag? It was so funny!
SARAH: I’m not gonna say! [LAUGHTER]
JASON HARTMAN: [LAUGHTER]
SARAH: It’s totally X-rated! [LAUGHTER]
JASON HARTMAN: [LAUGHTER] No, no, no! only one thing was X-rated! The rest was okay! But—[LAUGHTER]
SARAH: Well, he brought out like a bottle of Jim Beam, and…I don’t know. Handcuffs? Maybe not handcuffs.
JASON HARTMAN: No, he didn’t have handcuffs. He had duct tape, and like an X-Acto knife, and then he had a bottle of Jim Beam, so he had the whiskey, right, and then he had the underwriting guidelines manual, the book, which was this big thick book with a bunch of guidelines for underwriting mortgages, and…I don’t know, he had a few other things. There was one thing in there that was kind of X-rated, and he lays it all out on the desk of the underwriter and he says, look, we’re going to use one of these things to get this loan through and get the job done—[LAUGHTER]. It was so funny. We’re probably not doing it justice.
SARAH: And the funniest part about the story was that—yeah, the funniest thing about the story was that it was a true story, and the client that he did that for to close his loan was there, for Meet the Masters, so…that made it all the better.
JASON HARTMAN: Oh, funny stuff. But you know, in terms of the other panels, we had an investment counselor panel where we put all of you up there, and you guys were in the hot seat, and you got grilled all together, and it was interesting to see the way you disagreed with each other. That actually kind of surprised me a bit.
SARAH: Yeah, well, you know, I actually got an email from a client this week that said, they really liked that we didn’t all say the same thing and agree with each other, we all had an opinion, and had some different experience to back up our opinion. So that’s the beauty of it. We really were put on the spot. There was no script. Kind of like this Podcast that you put me on the spot all the time [LAUGHTER]. But you know, it was just good, raw discussion.
JASON HARTMAN: And then we had—we had a local market specialist panel, where we had all of the local market specialists up there, and gosh, there must have been I don’t know, 15 people on the stage at that point, who were sort of giving advice and you know, I kind of led off with, what are some of the self-sabotaging behaviors that you see investors engage in? And you know as you say, Sarah, when people shoot themselves in the shoe, right? [LAUGHTER]
SARAH: [LAUGHTER] Oh boy, yes. Shoot yourself in the shoe.
JASON HARTMAN: Folks, just so you don’t get that inside joke—on a prior Podcast where I had Sarah on, she said, sometimes I see investors shoot themselves in the shoe. And I said, Sarah, it’s ‘shoot themselves in the foot.’ That’s the way the expression goes [LAUGHTER].
SARAH: Right, right. I think that’s why I haven’t been on the Podcast in a while [LAUGHTER].
JASON HARTMAN: Yeah, I called you out on that one [LAUGHTER].
SARAH: Well yeah, that was a great panel as well. We took a lot of Q&A, and the funny thing is that we were supposed to go until about 9 o’clock. And you would think that by 9 o’clock people would just be done. But we were there until almost 10 o’clock just because everybody was really enjoying the discussion!
JASON HARTMAN: So we started at 9—this was on Saturday, everybody—and we started at 9 AM, and we said that we would end at 9 PM. And of course we had lunch and dinner breaks. And we went until 9:50 PM. And the vast majority of people were in the room, at about 9:20 I said, I understand we’re over time. If you want to go and get to bed, or go to the bar, feel free to leave. And a couple people got up and left and said we’ll see you tomorrow morning at 9 AM. But most people stayed, and the discussion was pretty lively and good. But, one of the things I really wanna—and oh, before we get to that—we presented more markets at this Meet the Masters event than any prior Meet the Masters. I can’t think offhand how many there were, but there had to be about 8 markets, did we present, something like that?
SARAH: Well, I can name them for you.
JASON HARTMAN: Okay, go ahead! You’re more organized than I. I’m still recovering. But yeah, name them!
SARAH: Off the top of my head, we had: a couple providers from Memphis; two from Indy; we had Birmingham, St. Robert, Kansas City, Atlanta, Ohio…
JASON HARTMAN: And we had Little Rock.
SARAH: And Little Rock.
JASON HARTMAN: Does that cover them all? It wasn’t that we had as many markets, but we had a lot of different local market specialists there. For example, we had two from Indianapolis, two from Memphis, and so there were a lot of presenters presenting a lot of different ideas, a lot of different investment property inventory, and good stuff. Really good stuff.
SARAH: I think the real beauty of this event is that people learned—took something new home with them. So just a great weekend where we’re all learning and sharing ideas.
JASON HARTMAN: Well, one of the things I want to talk about, specific content-wise before we get to today’s guest, is one of the concepts that we really teased out among so many others this weekend—the concept of these cyclical markets where prices fluctuate dramatically; the bubble markets, the markets that the gamblers rather than the investors are attracted to, and those are markets like pretty much the whole state of California, anything in say New York City—really high price markets—Boston, some areas of Connecticut—a lot of the northeast is like this. Miami would be like this. Markets where the properties don’t get good rent-to-value, or RV ratios. They don’t cash flow well. In fact, they cash flow terribly—negative cash flow in most of these markets. And they’re markets where people think they’re investors when they’re really gamblers, and it is so sad, because you see so many people go broke in these markets. So many mistakes made. And here’s one of the reasons, okay? Now, we’ve talked about this before on many past episodes. But, the real value of a property, I think, can be quantified in either the monthly cost to you, if you want to rent it, or the monthly income to you if you own it and you’re the investor. An example here is the million dollar home that was in Irvine, California. So, Irvine, where I owned a traditional real estate company for many years, and I was a traditional real estate agent there for many, many years before I owned my own company. And in that market, the typical example would be a million dollar home in Irvine, California, the suburbs of Irvine, right, and that home will rent for about $3,500 per month, maybe $4,000. It’s give or take, but that’s an approximation. So that’s a 0.35 RV ratio or rent-to-value ratio, rather than the ideal that we want to see, which is 1%. We think if you invest a million dollars in real estate, you should be generating at least $10,000 per month from that million dollars invested. And so, the real value of that property, I say, is what it rents for. That’s the utility value. That’s the total indicator of its value. Not its speculative bubble nature, where people might pay a million dollars for it in a good market, and then they’ll only pay 650,000 in a bad market—when even at 650 it’s not worth that much. Because the concept we have to understand is, it was outlined very well when I was—I was at church years ago, and I was listening to the pastor Tim Timmons, and he was saying that none of us really own anything. We are all just the trustee from birth to death. And that’s most certainly true, right? We come into the world with nothing except for our own lives and ourselves, and we leave the world with nothing. There’s no luggage racks on the hearse, as the old saying goes. So all we get to do is manage things while we’re alive. And the value of a property is what it costs, or what it generates, per month. That’s how we have to look at it. Everything else is gambling. Everything else is speculation. The real value comes in—what experience do you have, now—I’ve talked before on the show about the Khan Academy, which is a fantastic website where people can go and get free education on a multitude of topics, and my foundation last year donated some money to the Khan Academy, I really like what they’re doing. Because, you don’t even have to go to college anymore, really. If you just go watch every video on the Khan Academy website, for free, you’ll be more educated than the vast majority of college students, I would venture to guess. And they had this video that was made back in 2008, and it was about, should I buy or should I rent? And he was giving the example of, should I buy a home in Silicon Valley, right, in Palo Alto, which is super expensive—a $1 million house, which would buy you a crappy little two bedroom one bath, old old house—or should I keep my $250,000 which would represent 25% down—should I keep that in the bank and earn interest on it, which—now you really don’t earn any interest in the bank, but, it’s just an example; back then you might have had 4% interest. And what he said was very telling. He said, I can rent this property for $3,500 and have the exact same experience—which is all we really own, is the experience—as buying it and paying $250,000 down plus a mortgage payment on the remaining $750,000 per month. It’s the same experience. So, the real value of the property, I say, is what it rents for. That’s the real value. It’s not what you can buy it for. Any thoughts?
SARAH: Yeah, I mean, as you know, I just became a renter about a year and a half ago here in Southern California—
JASON HARTMAN: Congratulations!
SARAH: —and so I’m finally experiencing what you’re talking about for the first time. And it was tough, because—I still have my other house, and it’s not a great deal; the RV ratio isn’t great, but it’s supporting itself for now, until I decide what to do with it. But you know, another piece of this equation is the sense of freedom I have, that I’m not attached to that mortgage anymore. Like I said, that property stabilized, and now not only am I getting a great deal on my rent—far less than what the mortgage would be—but you know, if my income goes down at some point, I can downsize, I’m not attached to that house. If my income goes up, I can get a bigger house. I just feel really free.
JASON HARTMAN: Not just that, what if your husband is off for a job in another area? That’s a really good opportunity, you can move without a lot of attachment and hassle. I have long said that the best deal is—most of our listeners are upper middle class or wealthy people, right, and so they live in a high-end property, or an upper-end property, probably. The best deal is to rent a high-end property for yourself, as do I, and you do too, and own a lot of lower end properties that you rent to other people, because there the RV ratio is so favorable to you the renter. I was talking about this area right near us in, it’s called Crystal Cove, it’s in Newport Beach, California. And it’s a beautiful, beautiful high-end area, and it was right near where we had the event, so I mentioned this area. And I remember looking in there and I owned at the time—I’ve owned my own home almost all my life; very few times have I ever been a renter. I almost kind of look down on renters now; I think they’re really smart, you know, if they’re renting a high-end property. So now I’ve got it right, I think. And at the time, properties that were selling for $6 million in Crystal Cove, you can rent them for like $8,000 a month, $6,000 a month even sometimes. Whereas, if you invested $6 million in properties through our network? We would want you to get 1% per month. What is 1% of 6 million? Well, it’s $60,000. So, you just see how good a deal it is to own a lot of lower end properties—and when I say lower end, I mean properties that may be average $100,000 each for a single family home. Some a little higher, some a little lower, but about 100,000. And they rent for $1,000 a month. For $6 million, you could buy 60 of those. Versus one home that you would live in for yourself that you could “own,” in quotes—the exact same experience for maybe $8,000 a month. Or at least, at the time I was looking, maybe 4 or 5 years ago—it changes a little bit. But the concept remains the same. The concept is that you double arbitrage this. Because from the people that rent your lower priced properties, you’re getting a great ratio. Everything in life is all about ratios and percentages, okay? Or at least in investing. And the property that you get to experience, and you own the experience without all the obligations of ownership—you experience and own that experience every single month. Maybe for years at a time. For pennies on the dollar, in terms of RV ratio. Very good deal, huh?
SARAH: Yeah, it is a great deal, and I’m sitting here thinking about all the young couples that might be listening that are just trying to figure out how they get their start, and maybe they’ve been saving and saving and saving for their first home—for example, in an expensive market like Southern California—and they’ve got this slush fund here waiting for their first home, and I would just encourage them, go rent where you want to live, and use that to start investing, because it’s only a matter of time until you’re going to miss out on these low interest rates. So get in while you can, because you don’t know how many people I talk to that are trying to figure it all out, and they don’t know that there are opportunities for them to get started.
JASON HARTMAN: Yeah, no question. Well, what other thoughts—I mean, we’ll tease that out a little bit more. We had some great examples on the concept of that RV ratio stuff from Meet the Masters, and big discussions on monetary policies and all sorts of things like that. But any other thoughts and impressions from the event?
SARAH: No, I really think we covered it all. It was a good time and I’m looking forward to the next one. Maybe a property tour, so I’ll be looking forward to hearing the announcement on that, and hope to see some new faces and some old faces as well.
JASON HARTMAN: Oh, there is one thing I have to say. This was the first Meet the Masters event I think ever where we did not have the Lone Star State of Texas represented, amazingly. One of them, because we basically cut off one of our providers, who was not up to par, up to standard there. But the other one was because a good provider that we have from Houston was not able to come. So, surprisingly, no Texas. We still like Texas quite a bit, but at this particular Masters, we did not have a Texas local market specialist. What are your impressions in terms of markets? What markets do you like the most now, Sarah?
SARAH: It depends on the overall goal of the investor. For cash flow, if you’re looking for strictly cash flow, I really like Memphis, Birmingham, Little Rock. You know, I think even Ohio is going to be a good market for strictly cash flow. But I still really like Houston as a growth market. I have my house there, I bought it brand new in 2007, and I’ve increased the rents every year, I’ve had very little maintenance. So the rents are definitely trending up in that market, so again, increasing the cash flow. But, I think from a rental standpoint? All of those markets have been very strong, so, I would say those are my favorites.
JASON HARTMAN: Good, good stuff. Did you want to talk about any specific properties today by any chance?
SARAH: So, here’s one I found, since we’re talking about Houston…this one is brand new construction, it’s a three bedroom two bath home, 1,345 square feet, and purchase price is $126,990. Now, typically in Houston with these new builds, you’re purchasing—putting the property under contract, and it’s about a 30-60 day build until it’s complete and ready to close. But this particular one is ready to go right now, so if you’re looking to get started in Houston, we have one that’s already built and ready to close. It was going to an owner-occupied buyer, and their financing fell through, so it became available to us.
JASON HARTMAN: Okay, good. Let me tell some of the numbers on this. So, total cash needed, of course, subject to qualifying, is $37,800, basically. And here your projected cash flow is about $3,100 per year, and that gives you cash on cash return projected at 8% annually. Not as good as they used to be for sure, but where else are you going to get 8% on your money? And also retain the advantages of having appreciation, tax benefits, and the multidimensional characteristics of an income property investment? So not only do you get capital appreciation potential, not only do you get dividend potential, but you get those other multidimensional characteristics. That’s why they call income property or real estate the IDEAL investment, and that IDEAL is of course an acronym that we’ve talked about before. But total return on investment here, projection Sarah, what’s the number?
SARAH: Total return on investment 32%.
JASON HARTMAN: Annually, yeah. So, again I always like to say it—if it only goes half as well, that’s 16% annually. Not bad, and it’s a brand new property. And of course we’ve got our conservative assumptions in there for a vacancy rate that’s included at one month per year; management fees included at 8% per month, and maintenance—and this is a brand new property, but we’re still projecting 3% of the income to be used to maintain the property. Probably the first couple of years you’re not gonna use anything. So, looking pretty good. And the mortgage is quoted at 4.75%, so, investor mortgages always a little more expensive, but in a way, who cares, really? Because we outsource our debt to tenants; we don’t pay our own debts in real estate. The tenant pays them for us. So, pretty good deal. Any other thoughts on this one, Sarah?
SARAH: No…brand new, and that includes the refrigerator, microwave, stove, dishwasher, blinds, landscaping, garage door opener…it is ready to go. So if you’re looking to get your feet wet and want something real conservative, maybe something a little more passive, less hands-on, this is a great starter property for somebody.
JASON HARTMAN: Great, good stuff. And you can find that as www.jasonhartman.com in the properties section, and take a look at that as well as many other properties in many other cities as well, so, regardless of what area you like, we’ve got them in many areas we like all over the country. So, good stuff. Well hey Sarah, thank you for joining me today and recapping on Meet the Masters a little bit, and let’s go to our guest, okay?
SARAH: Yeah, thanks for having me!
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JASON HARTMAN: Hey, I’m here with Caeli Ridge, and I was wondering, Caeli, what are some things that an investor needs to be prepared for when applying for mortgage on an income property?
CAELI RIDGE: Good question! Lots of different variables, but the top three things they want to be concerned with are their credit score, their debt to income ratio, and their asset allowance.
JASON HARTMAN: Where can they find you?
CAELI RIDGE: www.ridgelendinggroup.com.
JASON HARTMAN: Fanstastic. And if you don’t remember that, you can always contact your investment counselor through www.jasonhartman.com and get the information.
[MUSIC]
JASON HARTMAN: It’s my pleasure to welcome Ken Wilson to the show. He is the president of the Appraisal Institute. And valuation, appraisals, and all of the things related to that, like lending and mortgage sizes, obviously very important. This all came to light again in the last financial crisis, so there’s a lot to talk about with Ken today, and Ken, welcome, how are you?
KEN WILSON: Just fine, Jason. I’m happy to be here with you today, and how are you doing?
JASON HARTMAN: Good, good. And I guess you’re located in Plano, Texas?
KEN WILSON: That’s my home town, yes.
JASON HARTMAN: Fantastic. And for those who don’t know, that’s a suburb of Dallas. So, what is going on with the world of appraisal since the financial crisis? The last one, of course. We always seem to have one every several years [LAUGHTER]. But the last one, I think it maybe changed a bit what these appraisal management companies—so I want you to touch on that, but the question is more broad. So go ahead, I’m sorry.
KEN WILSON: Well, unfortunately, you’re correct, we seem to do have these financial crises about every 5-7 years, and every time we have one, we feel or believe that we’re going to learn from the past one. But shortly thereafter when the market conditions improve, it seems that everybody reverts back to old habits. But coming out of the last crisis, there was a lot of pressure put on the lending community and the appraisal community, from the regulators, to decree a separation, or a firewall so to speak, from the lending process and the underwriting process, from the credit or the risk part of the equation, and—
JASON HARTMAN: So, let me just address that with a real world, simple idea, okay? The appraisers I’ve known over the years that I’ve personally known—friends of mine—in the old days, Ken, this is the way it would work: they would know all of the loan reps, they would in fact court the loan reps, the loan officers, to give them business. And I remember them coming into the mortgage offices and bringing everybody cookies or bagels or treats, and sending them a gift basket at the holidays. And so, when that loan rep, who was doling out business to the appraiser, needed to get the valuation of an appraisal at a certain place to make the deal happen, there’s some pressure there, right?
KEN WILSON: Absolutely.
JASON HARTMAN: So that’s how it used to be. Now, how’s this concept of these appraisal management companies—and I’ll let you explain what that is for the listeners’ benefit. But how does that work? Is there a separation? Is there a firewall? Or do they still know each other and they’re still all friends, they’re still ratcheting up the prices of deals to make the refi work or the sale work?
KEN WILSON: Well, for the most part, I think the intentions were good, and they’re there, and there is that separation. But like in any business, that does not totally eliminate pressures, and that is still occurring. So part of the process, part of the Dodd-Frank Act that Congress enacted, created a hotline where complaints could be called in, or go to a website to direct them to the right place, to try and eliminate these pressures. And what you previously described too was a relationship-based business, and there’s nothing wrong with that, but there is a certain line that you have to draw where you remain professional, and an appraisal is defined as an independent, 3rd party opinion, and we did get away from that to a certain degree in some markets, residentially based especially. So the intent was to create these appraisal management companies to create that firewall of separation, and for the most part they’ve accomplished that, but unfortunately, as part of the process, money came into the equation. And now the pressure is on the appraiser. They’re basically engaging the individual or individuals who can perform the quickest and the cheapest. And with that, you don’t necessarily get the quality that is commanded when an institution is making a decision on a high dollar loan. That’s one of the unfortunate consequences.
JASON HARTMAN: Yeah, so now we’ve got a new problem. So they have separated the parties a little bit, so maybe there’s less pressure before—you’re not buddies with the person on the end of your deal. The loan officer and the appraiser aren’t good friends. So you’ve reduced that, but now they’ve put in these lower quality appraisers, I guess is what you’re saying, that are just not as experienced, or not as good?
KEN WILSON: Well, I won’t say it’s in all cases, but in many cases that is what the result has been. And it’s been a flight from quality, where instead of giving a reasonable period of time for the appraiser to do their work, they’re demanding it in a very quick turnaround fashion. There’s downward pressures on the fees, along with that. Because part of the process is the lending institution engages the appraisal management company for the entire process, and they give them x number of dollars per transaction, and within those x dollars, they have to pay the appraiser. So, to maximize their profits, they’re putting the pressure on appraisers to come back with a lower fee quote, and unfortunately it goes back to the premise, you get what you pay for. And then also adding to that; because of the pressures on fee and time, a lot of the competent and qualified appraisers are choosing not to continue to play in this arena, so they’re going down to a lower common denominator. And in many instances, they’re bringing people in from outside the market area that may or may not know it. It’s what we refer to as geographic competency, and that’s also contributing to the problem.
JASON HARTMAN: Well, very interesting. There’s always the law of unintended consequences, right? So, tell us a little bit about the Appraisal Institute, if you would. What is your organization? How many members do you have?
KEN WILSON: Well, we have roughly 22,000 members, and one thing most people don’t realize is that we’re not just an US-based organization; we’re an international organization, and these members are in almost 60 countries on 6 continents. Having said that, the majority, roughly 21,000 of those individuals, are in the United States, but we are represented throughout the world. And what we do is establish, maintain, and publicize our designation requirements, that are generally known to be well above any other governmental, regulatory, or customary minimum requirements. As we speak, it’s been this way for more than 20 years. In order for an appraiser to practice in the market in most states, and in any transaction that’s titled federally related, they have to hold a stat license or certification, and in order to get that, they’re basically meeting the minimum promulgated standards and requirements. But in the case of the Appraisal Institute, we require advanced education, advanced experience, as well as testing requirements. So we like to say we represent the best of the best.
JASON HARTMAN: And how many members in the US?
KEN WILSON: Roughly 21,000.
JASON HARTMAN: And how many appraisers are there in the US?
KEN WILSON: Well you know, that’s actually an interesting—
JASON HARTMAN: It’s hard to know, probably.
KEN WILSON: —well, actually, through the states and the licensing agencies, there’s about 82,000 right now. But that’s down from a high of 100,000 about 5 years ago. So, part of the problem is that we’re an aging and a graying profession, but also at the same time—and that’s forcing retirements, and unfortunately deaths, and people get out of the business for various reasons, but one of the reasons is that well, we’ve talked about prior, with the pressures on fees and turnaround, especially in the residential community, people feel, oh I can go do something else and make as much or more money without the headaches.
JASON HARTMAN: Well, it’d probably be a broker in a high-end area.
KEN WILSON: In a good market.
JASON HARTMAN: Well, a good market, yeah. I remember in Newport Beach, where I’m from, there were a lot of starving brokers that were losing their houses and their cars, last time around, and the prices went—when it’s good, it can be pretty good. So, talk about licensing. I mean, what happened since the last financial crisis? We had licensing in some states for that, I believe California did have licensing quite a while ago.
KEN WILSON: Well, this licensing came about around 1991. This goes back to the financial crisis from the 1980s. They created a federal doctrine known as FIRREA—the [Financial Institutions Reform, Recovery, and Enforcement Act of 1989]—and at that point in time they required licensing and certification for appraisers, so, it’s nothing new, even since the last financial crisis. This has been in existence for the last 23 years, give or take.
JASON HARTMAN: And, so, you’re talking about California?
KEN WILSON: No, all states had this going back to 1991. Prior to that, very few states had any requirement as a licensure requirement for an appraiser. Some states, Florida is an example, required an individual to have a real estate sales or a broker’s license in order to appraise. But prior to the mid to late 1980s financial crisis, there was no other requirement; they had a specific appraisal license.
JASON HARTMAN: And do you segment the market, or do appraisers segment, into different types of markets? One of the things we teach our investors all the time is that there are three basic types of macro real estate markets. There’s a cyclical market, like most of California, where you have grand highs and really ugly lows, or troughs, and then you have these more linear markets like Texas that just sort of chug along and appreciate and perform well from the cash flow perspective for sure. The cyclical markets don’t perform well from the cash flow perspective if you’re an investor. And then we have hybrid markets, and Phoenix the last time around because a hybrid market, in the last boom and bust. Where it was always pretty linear, until a lot of California money flowed into it the last time around, and I remember giving investment seminars in Southern California, and it seemed like every other person I talked to owned a couple rental properties in Phoenix! Not necessarily wisely.
KEN WILSON: Right.
JASON HARTMAN: So, it’s interesting. Do you segment things into different types of markets?
KEN WILSON: Not in the same respect that you do. Many appraisers are involved in what we call the capital markets, and that’s just the buy and sell market whereby appraisers are looking at point-in-time values, and that’s pretty much what lenders are looking at. But recently, the appraisal [unintelligible] has really developed some education and terminology to benefit our appraisers to do more than just point-in-time values, and it’s called fundamental market analysis, whereby they’re looking at a lot more information than just the comparable sales and rentals and making a short term projection. This is actually looking at more information from the market, not only in terms of real estate but employment, population growth, and seeing the way these cycles have behaved themselves over the course of time, and then making some additional projections based on what direction the market has the possibility of going. So, we’re enabling our appraisers to do more type of work than just point-in-time values.
JASON HARTMAN: So in other words, the appraisers are actually making predictions?
KEN WILSON: Well, if you think about it, they have been over the course of time, even before this new concept, because part of commercial valuation on a multi-tenant property, you’re looking at a discounted cash flow, and you’re making projections over the course of time, what rents are going to do, what expenses are going to do; capitalization rates, discount rates, etcetera. So, appraisers, so to speak, have been making predictions for a while, but this is just taking it to a new level.
JASON HARTMAN: But that’s still…when they appraise a hundred year old apartment building, for example, they’re not predicting the future, they’re just saying, this is what it’s worth today based on various multipliers.
KEN WILSON: Basically so. They’re reflecting what the market is doing today and just extending it out, but with fundamental market analysis, you can actually make some of these predictions, because you can see how a particular market has behaved and reacted over a period of time. If you go back and look over any kind of statistical analysis, markets haven’t really acted linear for the most part, like you say. There are these troughs, and curves, and bell curves, and they have peaks and valleys, and actually fallen value, and in terms of point-in-time value, that’s what lenders want to know. That’s all they’re really concerned with, and that’s what the traditional appraisal market has revolved around. But there are other types of people in the market; the investors, and entities like that, that really want more information. We’ve been told by the National Association of Real Estate Investment Trusts that we really don’t care what the value is on any particular day—we want data and information so we can make these types of projections, and that’s where appraisers can come in, because they have access to this information.
JASON HARTMAN: So they’re looking at path of progress, they’re looking at growth and job creation in various cities, things like that?
KEN WILSON: They certainly are, yes.
JASON HARTMAN: Ok, good. Back when I was in real estate school, a long time ago in the old days, we were taught that there are three basic kinds of appraisals. There’s the income approach, there’s the cost approach, and the comparison approach. And you talk about this fundamental approach that you just mentioned. Has it evolved? Has anything more come about other than those three basic things? I mean, the fundamental thing is sort of a different category, but are there any other ways to look at value nowadays? And I just want you to know where I’m coming from when I ask this question [LAUGHTER], because it’s kind of a funny place in an unrelated industry, okay? It’s the crazy tech world. We all heard a few weeks ago about that offer that the company Snapchat turned down for like $3 or $4 billion that Google was willing to pay, and I think they must be out of their mind, is what I’m thinking! They’ve never had any revenue, they have no plan to have any revenue in the future, and it just seems kind of like a gimmicky product to me, but hey, maybe I’m just out of my mind, I could be totally wrong here. Apparently they would disagree with me. And so after that offer happened, there was all this talk about, do we even understand valuation anymore? Is it really all about a multiplier of net income, price to earnings type of concept? So I’m wondering—my take on the whole thing there, in the world of stocks and Snapchat, etcetera—real companies make money, period. Okay? Real companies have revenue, okay? And same with real income properties. So, I’m just kind of wondering if people are getting funny about appraisal valuation in the real estate world and all, or if there’s any newfangled stuff.
KEN WILSON: You know, there’s newfangled stuff so to speak, and I wouldn’t call it newfangled stuff. There’s new tools for the tool belt, to allow appraisers to do their job. Going back to the original part of your question, there are still really only three traditional methods for valuing properties, as you mentioned: the cost approach, the sales comparison approach, and the income capitalization approach. The cost approach is less relied upon these days than any of the others, just because of the fact that when you’re talking, something that’s not a brand new property, that’s a little bit older and established—many buyers and investors and lenders aren’t concerned with what the cost to replace or reproduce that property is. In the case of an investor, they want to know what the absolute cost is and know that they’re getting it for less than that. But you still have to factor in depreciation and other things, and that’s very subjective.
JASON HARTMAN: And your insurance company is always interested in the cost approach that way.
KEN WILSON: They are interested, but you know, in their respect, it’s not a true cost approach, because they don’t care about the land value, they’re just looking at the improvements, so it’s not a complete cost approach. You may be doing a replacement cost analysis or something along those lines, so for the most part, I won’t say the cost approach has been eliminated, but it’s been abandoned in many instances. So that leaves you with the sales comparison approach, and the income approach as we said. The sales comparison approach looks at sales of similar properties that have transpired in the hopefully not-too-distant past. Similar market, a lot of things being equal. The problem is with that is that they’re always historical, and they may only be a few days old, but it some cases in a down market, they may be 6 months, 12 months, or 2 years old, so you’re really looking in the rearview mirror, and just a traditional sales comparison approach, and that makes things a little more difficult. And the most reliable approach, I think, in a commercial appraisal anyway, because obviously it’s not really going to apply to residential unless it’s a small income producing residential property, is the income approach. Because that’s taking the income that is in place with the tenants looking at future projections, any vacant space, what market rates are, deducting expenses, and then capitalizing that income. In talking about new tool in the evolution, if you go back 20, 30 years, the only method, or the real method for the income approach, was direct capitalization. You take that potential income, subtract expenses, capitalize into perpetuity, and you get down the road; now we have the advent, going back into the late 70s, early 80s, of the discounted cash flow, where it’s a little bit more intuitive, and a lot more information going. Instead of just taking a snapshot of one year of income, you’re actually doing a projection, typically over a 10 year period. But it could be as few as 3 years, 5 years, 7 years, or even up to 15 years, and that’s going to give you a greater snapshot of the way that property performs over the course of time.
JASON HARTMAN: On that note, how do you analyze market cycles? Or did you just answer that?
KEN WILSON: I think I kind of answered that. Or actually, I answered it prior in the conversation. That you look at more than just what somebody is asking for a property, or a rental rate today, or what somebody signed the contract rate 3 months ago. You obviously have to look at that information. But in fundamental market analysis, it’s much more. You’re looking at what employment has been doing in that particular market area. Has it been declining? Has it been increasing? Stable? Same thing with population growth, that’s important for retail properties, what the demand for retail space is going to be. And just what disposable incomes are, and all of that. And looking at it over the course of time; what have they been doing in the past in making those projections.
JASON HARTMAN: Are there any specific tools, Ken, that you can recommend, that appraisers are using, that maybe the public has access to? Websites, software, places for data? I mean, everybody knows about Zillow and Trulia and those, take them with a big grain of salt. It’s better than nothing, which is what we had before. But they can be misleading too.
KEN WILSON: Oh absolutely. One of the problems with those sites is that they’re dependent upon public information. And I’m not saying they’re bad, but you’re only as good as the information that’s input, and public information isn’t always or necessarily accurate. They’re taking it from public records, the assessor or the appraisal district websites, the square footage of the property could be inaccurate; age, condition of properties, etcetera. But those are probably, at least from a residential standpoint, the primary sites that are out there and that are available, unless you want to get into subscription sites where you’re paying a lot of money to get that data, and I think your typical consumer probably isn’t interested in that.
JASON HARTMAN: Good points. What’s next for the Appraisal Institute? Before you go, what’s on the horizon? What’s coming up this year, or next year?
KEN WILSON: Well, we hope it to be an exciting year. A couple of years ago the board of directors decided to move from a professional association to a professional society, and focus on our designated members, the people that have decided to elevate their skills and their careers, and we created a candidate for designation program, which was implemented and took effect January 1st of 2013. And during 2013, we had a near-record number of new designees who were getting through the process. It fell a little bit short of 2012, which was a record year: we designated 515 individuals; that’s the greatest number in any single year in more than the past 20 years, so we’re very excited about that. And we’re just exploring some new initiatives that we’ve come up with. Expanding our education network. We’re actually creating a separate wholly-owned subsidiary to create specialty certifications for people who are interested in setting themselves apart in let’s say, the category of green building. Or valuation for financial reporting, when you’re talking about companies that have real estate on their books. It’s just an added credential for people that are interested in really establishing themselves as true professionals.
JASON HARTMAN: Good stuff. Well, give out your website, Ken, if you would, and tell people where they can find out more.
KEN WILSON: Well I’d be happy to. The website is www.appraisalinstitute.org, and if you go there and take a look at it, be patient, we’re in the process or rolling out a brand new website, that should be some time this month, and we’re really excited about that as well.
JASON HARTMAN: Fantastic. Well, Ken Wilson, president of the Appraisal Institute, thank you so much for joining us.
KEN WILSON: Thank you Jason. It was my pleasure.
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ANNOUNCER: This show is produced by the Hartman Media Company. All rights reserved. For distribution or publication rights and media interviews, please visit www.HartmanMedia.com, or email [email protected]. Nothing on this show should be considered specific personal or professional advice. Please consult an appropriate tax, legal, real estate, or business professional for any individualized advice. Opinions of guests are their own, and the host is acting on behalf of Empowered Investor, LLC. exclusively. (Image: Flickr | familymwr)
Transcribed by David
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