Jason Hartman starts the show by explaining why capital appreciation is attractive to the amateur investor. He also explains the two principles that would let an investor know if the real estate market is overvalued. Jason also talks about rent to value ratio and construction cost approaches, as well as the benefits of using proper metrics to analyze properties.
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This show is produced by the Hartman media company. For more information and links to all our great podcasts, visit Hartman media.com.
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Welcome to the creating wealth show with Jason Hartman. You’re about to learn a new slant on investing some exciting techniques and fresh new approaches to the world’s most historically proven asset class that will enable you to create more wealth and freedom than you ever thought possible. Jason is a genuine self made multi millionaire who’s actually been there and done it. He’s a successful investor, lender, developer and entrepreneur who’s owned properties in 11 states had hundreds of tenants and been involved in thousands of real estate transactions. This program will help you follow in Jason’s footsteps on the road to your financial independence day. You really can do it on now. here’s your host, Jason Hartman with the company LEED solution for real estate investors.
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I want to take just a moment to tell you about renter’s warehouse and award winning property management company that services over 13,000 investors with over 18,000 properties nationwide. They are the only residential property manager rated by Morningstar. Their centralized model with local staff provide trustworthy support across multiple markets. These experts track all aspects of your property and never try to profit from maintenance repairs. Plus you’ll enjoy flat rate pricing and warrantied tenants up to 18 months. Check this out for a free three month property management trial. exclusive to Jason Hartman listeners visit renters warehouse comm slash Jason again that’s renters warehouse comm slash Jason Welcome to the creating wealth show. This your host Jason Hartman with Episode Number 828 828, thank you so much for joining me today. I appreciate having you here. And always try to deliver some great value, some new ideas, some stuff that’s not just the old cliches that you hear from real estate investors and in the real estate business. And you know, last week I had the pleasure of speaking at my friend Ryan Moran’s kind of adult summer camp for entrepreneurs, I guess is the way to describe it. His what he calls his tribe summit, and that was in Austin, Texas last week. By the time you’re hearing this, I will be in Europe somewhere maybe in maybe in Germany, I think by the time you hear this podcast, but yeah, and one of the things that struck me I did a presentation there. Then I was also on an investor panel with some investors who do some different kind of investing than I do. And one of the things that always strikes me when you talk to People about real estate investing is how they just completely lack this fundamental understanding that I don’t know. It seems so simple to me. But hey, I live in it. You know, fish live in water, and they probably don’t notice the water they take it for granted. We all live in air. And you know, unless it’s really smoky where we live, which, by the way, when I was in Cairo, Egypt years ago, I gotta tell you, it was so smoky. You did notice the air right near you, you know, just several feet away from you. You could tell how small gate was it was disgusting. But yeah, so before we get on a tangent there, we usually don’t notice the air yet we live in it. And pretty much everything in our life is generated out of it. You’ve heard me talk before about the idea of context versus content. And unless I go down the rabbit hole of philosophy and self development, I will refrain. But if you’re interested in that subject, which is pretty interesting, I must say, go to Jason hartman.com. And I don’t know, you might try searching context versus content, because I’ve done some episodes on that type of subject and it’s quite fascinating. So, the context in which most investors live is this context of capital appreciation, capital gains. That is the siren song. The seducer, the mistress, not the reliable wife, hate misters could be fun. But, you know, they’re usually not too reliable and they’ll ruin your life. Right? And, hey, this is coming from a single guy, you know, I’ve never been married. So I guess I won’t even speak to that. But you know, I get the concept, right. Understand the idea of it. And this is this is what happens right? You know, I believe that you really need to dig a little deeper than most people do when they think about investing in anything, whether it be real estate, whether it be precious metals, stocks, bonds, mutual funds, any other type of alternative investment out there, and there are many, those are just sort of the main ones. And that is to get away from this idea that the market is either good or bad, and that it’s all about capital appreciation or capital gains, because the amateur thinks and runs into the market after they hear for a couple of years, or maybe a few years. They hear stories from everybody in their brother, and their shoeshine boy as Rockefeller talks about that famous quote, you know, I knew the I knew there was going to be a crash when I started getting stock tips for my shoeshine boy, he said, or something to that effect. He’s right. You know, that’s a good saying, you know, when the when the lift and the Uber driver and the taxi driver, hopefully you never take a stupid taxi because they suck. But hey, Uber kind of sucks, too. They’re getting a lot of trouble lately, aren’t they? So when you start getting stock tips, or any type of investment tip from people that are not, you know, not usually sophisticated people, right? They’re not financially sophisticated. They may be extremely brilliant in some other area, but they’re probably not financial people. They’re probably not great investors, when you start getting tips from them. The tip is always related to the concept of capital appreciation. Oh, this stock has a great story. Oh, the real estate market in my city is on fire. And you know what? That’s usually after it’s been on fire, or the stock market has been booming for a couple three years. You know, or Whatever market it is, or gold has been going crazy, they never you never hear this type of investor talk much about yield rate of return. They talk about capital gains, capital appreciation, the stuff you cannot predict the stuff that is fickle, like the mistress, like the young girl, she’s just fickle. You know, one day, she likes you the next day, she doesn’t, you know, you get a little more mature woman, you know, she’s kind of more consistent, which is nice, right? So, so that’s, that’s the thing. And that’s what every investor talks about. They talk about this idea of capital appreciation. So I thought that I should share with you before we get to a little live clip today. If I don’t ramble too long, we’ll have time to play it. If not, we’ll play it next week. Okay, so this concept is how do you know How do you know if the real estate market is overvalued in a particular place? Well, of course, you know that there are three types of markets. Lest I say this again, I’m getting so tired of saying it myself. But I have to keep repeating it. There is a linear market. There’s a cyclical market, there’s a hybrid market. Those type of markets, every real estate market on planet Earth can be put into one of those three segments, linear cyclical hybrid, period. That’s the end of the discussion. There are only three types of real estate markets. Now maybe if we colonize the moon or Mars, that’ll change but on Earth, there are three Okay, according to Jason Hartman, that’s it three, just three. Okay, done with that. We know there are only three types of real estate markets. Now. The linear markets they rarely get overvalued many They never really get overvalued by much, you know, it’s always a matter of degree, right? This is, you know, this is all shades of grey, you know, young people that haven’t fully developed their thinking yet tend to think in very black and white terms, you know, very uninformed people think in very black and white terms very racist people thinking, well, pardon the pun black and white terms. boy didn’t know that one was coming anyway. And that’s not good, right? Because it’s always a shade of gray. There are there are it’s a spectrum, right? You know that it’s a spectrum. So in linear markets can be on the high end of their value, or the low end of their value, but they don’t fluctuate that much. The cyclical market, on the other hand, is radical fluctuations. It’s the up and down the peak, the trough, the peak Valley, the roller coaster, okay, so those are the markets that typically become overvalued in the hybrid markets do it a little more than the linear but a little less than cyclical, as the name would imply hybrid in between the two. So how do you know if the real estate market is overvalued? This is amazing to me that people don’t understand this. So I thought I would share it with you today. Now, it’s just one man’s opinion. And his disclaimer is coming. Well, my disclaimer, nothing like talking about yourself on a third person. Right? Okay, stop doing that. It’s really weird. It’s annoying people hate it. Okay. So, one man’s opinion here my opinion. My disclaimer is I could be wrong. But I doubt it. I’m wrong a little bit, but not too much. I’m usually right. Oh, gosh, yeah. Anyway, so how do you know if the markets overvalued? Let me give you two really easy ways. You know, I love to take all This absolutely stupid complexity in the world. and break it down to really simple, simple, not simple, simple principles that you can remember in your head that you don’t need a spreadsheet. You don’t need a software program and you don’t need a calculator. But if you do need some software, we have some great software for other purposes, run over to real estate tools.com that’s real estate tools, calm and check out some of our swanky iPhone and iPad apps and online software as well. But this, you don’t need any software for you can do it really easily in your head. It’s like my simple rule of RV ratio, rent to value ratio. You know, really when I was talking about that, 14 years ago, no one was talking about that. Now many people have copied me since and I’m sure I wasn’t the first person to talk about it. But you know, no one talked about it back then. I mean, I don’t know. Maybe somebody did, but I never heard of it. And I’d been to a zillion seminars, read a zillion books and listen to a zillion. Yeah, tapes, cassette tapes, not eight tracks, but cassette. They were tapes nonetheless. I miss those good old cassette tapes, you know, I have a bunch of them in storage, Earl Nightingale, Denis waitley, Jim Rohn, Zig Ziglar and a whole bunch of other great ones. And I just refused to sell those things because they had such a profound impact on my life. Those cassette tapes. Okay, how can you tell if the markets overvalued folks, let me just give you two really easy ways. Really easy. This is a cinch ready? super easy. You don’t even need to write anything down because you can remember it. The first one is the cost of construction approach. So that goes like this. One of our celebrity clients who might be listening, sent me a Zillow listing last week for a house in Los Angeles. And it was absurd. Really overpriced. Now granted, could it go further? Yes, it could. But, you know, you’re in dangerous territory, when the cost of the property is way, way above the cost of construction. Why is that? Because if you follow the Hartman, risk evaluator, go to Jason hartman.com, type in the search bar Hartman risk evaluator, and listen to those old episodes for more on that. If you follow that, you understand that high land value markets are highly risky. Okay. So the cost of construction approach simply says that to build a property, it will cost you anywhere from about $75 per square foot. And by the way, we talked on a prior episode about the national home builder, what is it the nhp, the National Home Builders Association, we talked about their survey of the cost of construction and all these different markets around the country. And you know, it’ll generally cost you anywhere from $70 $75 per square foot on up to maybe the real cost being about $150 a square foot. For a single family home, their index didn’t even go that high, I went higher. Because, you know, I’m from the Socialist Republic of California, and I understand how hard it is to build anything there. Let me give you a quick example of that. And, you know, I have a feeling we’re gonna have to play that live clip on the next episode, because here we are, in another one of my ranting monologues. I remember when I was trying to buy a self storage facility, my first one, and I never did buy a self storage facility. I ended up with a partner client listener, probably listening now. Hey, Steve, how you doing? And we bought a mobile home park. We were trying to buy a self storage facility together years ago. And we thought, well, maybe we’ll just build one and in the world. Self Storage investing. Those are like Tinker toys or erector sets or Legos. I don’t know what’s the right way to compare them to the toys we played with when we were kids. They’re really easy to build. They’re just like modular, they just come and put those Self Storage things together. You know, they put the little structure up, they put those rolling doors on and boom, you’re done. And you’ve got a self storage facility really, really easy. Which means the barrier to entry is low. Well, we were talking to one of the companies that builds those and we’re thinking maybe we’ll just buy a piece of land, and we’ll build a self storage facility because it was so damn hard to buy one. You know, there were just too many buyers and we just felt the market was overvalued and hey, this is back in 2010. You You figured that one out, right? But everybody always thinks whenever they’re buying, that they’re paying too much. Until you look in the rearview mirror, and then you realize, like the reluctant investors limit poem, which is great. And you should all hang on your bathroom mirror with a couple pieces of scotch tape or generic brand tape if you wish. It doesn’t have to be scotch brand, and go to Jason hartman.com pronounce a copy type reluctant investors lament. And that’s that beautiful, brilliant poem by Don Weil, written back in 1977. And it just shows to go Yeah, goes to show you the way everybody always thinks they are buying at the top of the market yet. Only sometimes are they doing that. And only in the cyclical markets. Do they have a big danger of doing that? So here’s what let me tell you the Self Storage story then I’ll get back to the overvalued how you how you tell the two ways. So we talked to this company and they were telling us About the projects they were doing around the country. And one of them was a self storage facility in I believe it was Indianapolis that they had just built. And another one was one that they have been trying to do in Napa Valley in the Socialist Republic of California. And in Indianapolis, they said basically, they got the whole deal done in no time flat boom, lickety split. I think they got the permit, and they put it up in like four days. Yeah, really, it’s insane how fast they can build those things. It’s just a, you know, it’s just an erector set. And then, they’ve been wanting to do this one that they had not done yet. I wonder if they’ve done it by now seven years later, I’d be interesting to ask them in Napa Valley. And they had already been through four years of trying to build this thing. And you know, environmental impact reports bureaucracy. pay this fee tax that fee, you know, blah, blah, blah, jump through a million hoops can’t still can’t build it. Now, here’s the problem. A lot of you might think and you’re right, that buying property in areas like California, where you’ve got a very strong environmental lobby, and a high barrier to entry. Okay, you might think that makes your investment safer. And you would be right. But here’s the, here’s the huge problem with that theory. Okay. The problem with dealing with the law, and depending on it’s actually not even the law, it’s more of the whim of a government bureaucrat. The problem with depending on that, to solidify the concept of your investment, is that it’s inconsistent. It’s very inconsistent, you know, if you lobby them correctly, which means pay him under the table or Trade some favor, do some crony capitalism somehow, you know, there’s always a way to get around the rules somehow or other and exert some influence, right? How is it that all these frickin scumbags in Congress are so rich? They only make what 180 grand a year or something yet somehow they’re all multimillionaires. I, you know, and they didn’t walk into office being multimillionaires. It’s really odd. Doesn’t it show you that there is some sort of corruption going on? Some sort of crony capitalism. Of course there is of course there is it’s disgusting, but it is the way of the world. So you cannot rely on the government bureaucrat to protect your investment. For example, if you jump through all the hoops, and you lobby the bureaucrats, and you get to build your project, and then the next guy, and then say yours cost you a fortune. And it takes you four years and you finally get their approval and the approval wasn’t for what you really wanted to do. It was some massive compromise that makes the property less valuable than you had hoped, even though you paid all that money for the land, and you’re in so deep, and you got to just build it anyway, right? Because you might as well that’s pretty much the way it goes when you’re working with these really heavy bureaucratic environments. Then the next guy comes along and, you know, he’s the cousins, brother of, you know, Nancy Pelosi, and he just his project goes right up, boom, his cost structure is way lower than yours. Okay? And he got to build a much more premium property and use more of the land and have a smaller or a larger construction envelope, for example, meaning that he could, you know, take an acre of land and build it all out to the max so he could cram more apartments or storage units or whatever he wanted to build in there. And you couldn’t This is the problem with relying on that concept of, well, you know, I’m gonna own property or buy property in this place that’s got a really strong environmental movement and the government doesn’t let anybody build anything. So as soon as I get mine, you know, I’ll follow the old riddle of the environmentalists, right. What do you call a developer? Someone who wants to build a house at the beach or in the woods? What do you call an environmentalist? Someone who already has a house at the beach or in the woods, right? You get the idea. It’s not reliable, it’s inconsistent. So, the land the cost of construction, the, you know, long way, of course, Jason typical. To get to the moral of the story here the cost of construction is one way to understand if the market is overvalued. So, if the cost of construction in the given area is $75 per square foot, plus land cost, and you know, maybe the land cost makes that total go up to $95 or 100. hundred dollars per square foot and you’re paying 500 or 700. Or Believe it or not, this actually happens $3,000 per square foot or even more. You know, you are in bubble Ville, okay. You are seriously out of whack with fundamentals. Okay. Think of it. Would Warren Buffett the value investor invest in that property? would he do that deal? No flipping way? No way, because it’s way out of whack with the fundamentals. Remember, Warren Buffett’s teacher was Benjamin Graham. Okay. And Benjamin Graham was the guy that you know, just really made the world understand that whole kind of concept, you know that Buffett follows being a value investor. Right. And I just, you know, I mean, I don’t like the stock market, as you well know, but I do like value investing. So the construction approach, that’s one the construction cost approach. And by the way, this is one of the appraisal philosophies, right? There are three basic ways that properties are valued or appraise the comparison approach, the income approach, or the construction cost or replacement cost approach, right? The cost approach, it’s called. And so, you know, you’re way out of whack. When you start looking at these ridiculous cost per square foot numbers. That’s one way. The second easy way. Just do it in your head. It’s really simple. You don’t need a calculator. You don’t need software. You don’t need an MBA. Okay, you know, the other really simple way is to just simply look at the rent to value ratio. Okay, now, I’ve talked to you a zillion times on the last 827 episodes about the rent to value ratio, right? But here’s the thing about the RV ratio, you’re probably thinking, well, Jason, I know that you like eight to get somewhere in the neighborhood of a 1% Rv ratio, meaning you want to get 1% of the value of the property per month. And again, I want to remind everybody, that it is not called the rent what I paid for it in 1992 ratio, it’s called the rent to value ratio, meaning the current value versus the rental income. So $1 million worth of property should generate $10,000 per month, somewhere in that ballpark. But when do you know it’s overvalued? Well, here’s how you know when the rent to value ratio gets 2.5. Urine bubble land again, okay, point Five could be a good benchmark. All right. Now, again, I want to tell you that even his properties are overvalued. It doesn’t mean that that can’t go on for another couple, three years. Who knows how long it can go on for? I’m just telling you that this is a way to know that you’re stepping into crazy land. All right, that’s what you know, if the rent to value ratio is way out of whack, you are cruisin for a bruisin. As the old saying goes, right? You are playing with fire. So if you don’t want to play for fun with fire, if you’re smart, and you’re conservative like me, okay, because I’ve lost too much money on too many crazy deals. I’ve chased over the years and, hey, I forgive myself in advance. I know I’m gonna do it again. But at least don’t do it with a substantial portion of your wealth. Okay, if you’re gonna chase a few crazy deals that might be homeruns you know, they might be those speculative crazy deals, you know, look, if you got a few bucks, take 10% and allocate it to, you know, little speculation, little gambling. I’m not saying never do it. Okay, but I’m saying that it’s very dangerous. It’s very risky, obviously. So, if the rent to value ratio is point 7.6 You know, you’re not in crazy land there, okay? You’re not in crazy territory of being overvalued. Ideally, I’d like you to do much better. I’d like you to get 1% or close to it. Now, of course, the past few years the market has been booming and even in the linear markets, it is very difficult now to get 1% rent to value ratio. And folks Like I said on the episode, maybe a couple episodes ago, you got to stop looking at the crap rate. Okay? The crap rate is not a good metric for residential real estate investing. It’s okay for commercial real estate investing the crap rate and you know what I mean? It’s the cap rate, the capitalization rate, the capitalization rate, okay? That one, you know, it just doesn’t give you enough information. It’s an incomplete number, you should be looking at the overall return on investment and the cash on cash return. And you know what else you could look at? This is another good one. You know what I’m gonna say, this is another really good metric. I like this one a lot. Because the older I get, the more conservative I get, the more I just don’t like losing my money, because I’ve lost it a few times. And I you know, earning it again, is a pain. Right. It’s a pain. When you when you go on some, you know, you do some crazy deal and you lose, it’s a pain to get it back, right? It’s hard to earn the money back. So you don’t want to do that try not the first rule of investing don’t lose money. First rule of investing, don’t lose money. Okay. So another good conservative metric for you. Okay, of course, the rent to value ratio. That’s your first one. But after that, when you dig a little deeper look at the debt coverage ratio. Right on our performance at Jason hartman.com. On the right hand side of the page. I think it’s the first one of the financial indicators actually, is the debt coverage ratio, which as I have said before, should be called the How likely is it that I will get into trouble with this property ratio? How likely is it that I will get into trouble with this property ratio? That’s the debt coverage ratio. Okay. And if The debt coverage ratio is above one year in the good side of the equation. If it’s one and a half or two, you’re doing pretty darn good. Pretty happy, aren’t you? Yeah. So that just means if you experience problems, vacancies, whether they be physical or economic, or some big maintenance cost or something like that, the debt coverage ratio is a good protection ratio. It’s a good one to look out for that. And also, obviously have adequate reserves, at least 4% of the value of your portfolio in the bank, or better yet a credit union because credit unions won’t rip you off quite as much as banks will. Banks are good at ripping people off the banksters credit unions pretty good deal. Okay. So at least 4% but don’t have too much. You know, should I have 10% I’m really conservative. Well, no, because then you got too much Money, it’s not working for you. And it also depends on how leveraged the properties are, you know what kind of condition they’re in. If they’re brand new, perfect condition, everything’s, you know, all the appliances and the air conditioner and the heater, they all have warranties for the next five years. And you know, you don’t have too much leverage and your debt coverage ratio is really good. Well, then your ratio, your reserves could just be 4%, you’re probably gonna be fine. Okay, if the property’s older, nothing’s under warranty, highly leveraged. You know, you’ve had problem tenants there over the years because maybe you bought that crappy $40,000 house that we told you not to buy, but you did it anyway. And you didn’t listen to us? Because the $40,000 house is kind of a myth. Okay, you know, just never quite works out as well as it looks on paper, then maybe you want to have a higher reserve ratio than 4% because you’ve got a more risky property. Okay, so you understand that? So the two ways to know if the market is overvalued and they’re easy The easy ways, okay, you don’t have to look at a bunch of statistics. You don’t have to look at, well, you know, what is the affordability ratio in that market? Hey, look at all of that stuff is nice to know. It’s a whole different podcast episode to discuss all of that stuff. What’s the job creation? You know, metric look like this is all good. It’s all good. Okay, but look, they’re really simple ways to just look at the property itself. There will be a million hipsters and promoters and storytellers that want you to throw your money at something that will tell you all the reasons this market is the best market. But all you have to do is look at simply look at the property only. Only the property and look at the rent to value ratio and the construction cost approach. Okay, if you’re at 300 400 $500 a square foot And up. You’re, you’re in that territory where it’s just getting risky. Okay? And if and sometimes it’s a lot higher than that. It’s 800 $1,000 per square foot, hey, maybe it’s $3,000 a square foot, okay? It’s crazy. And this, by the way is another reason I don’t like high rise condos. I live in one, but I rent it. So it’s not my problem, okay? Because they are massively expensive cost per square foot. So that rent to value ratio, anything under that point, point five or under. If you got a million dollar property that rents for less than $5,000 per month, that is moving right into bubble land, and a lot of those only rent for $3,000 a month, maybe 3500 or 4000 per month, a point four or either as low as a point three RV ratio, it’s great to be a renter of one of those properties, but terrible to be an owner of one of them. So, since all investors who seem to think they’re investors talk about investing from a capital gains perspective, and not a yield in that investment perspective, because they don’t know what the hell they’re talking about, I just wanted to share this idea with you that there are just two really simple ways you can know if the property’s overvalued. So, look, we’ll play the four pillars of ROI next week. But before I go, I want to tell you that we have an announcement. Yes we do. We have another Oklahoma or not another one. But we have a another property tour. And jQ Jason Hartman live seminar in Oklahoma City. Yes, this is a new market for us, that we have only dabbled in over the years, but We’ve got a good local market specialist here, who runs a tight ship. And this property tour of Oklahoma City and Jason Hartman University live the Jay Chou live. And that’s the seminar where we dig down. We really go into numbers, numbers, numbers, it’s not the creating wealth seminar. You know, again, we try to kind of rotate these throughout the year. And that will this will be July 8 and ninth July 8 and ninth that weekend after independence day, where we will celebrate your current or future financial independence day. Okay. So you’ll have fireworks just a few days before this. And then we’ll talk about your financial independence day, the weekend of July 8, and ninth in Oklahoma City. We have early bird pricing just for a few more days. Yes, just a few days because we’re already selling some good to gets to this one. And I’m sure this one will fill up quickly. Our last property tour sold out with no problem. You know, the market is hot. So get your tickets ASAP and don’t miss out on the hotel room block deal, because you don’t want to pay these exorbitant hotel prices. Okay, so go to Jason hartman.com. Get the early bird pricing right now. And again, that’s July 8, and ninth in Oklahoma City. And we’re gonna have a great property tour there. And this will be a nice classy event. We’ve got a good location, we’ve got good food and dining. All the meals are included for these property tours. It’s gonna be great. So come July 8, the ninth Jason Hartman calm click on events to register for that, and we will talk to you on the next episode.
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