1374: Reduce Investment Risk With The Jason Hartman Risk Evaluator (Part II)

Just invest. It's still a great thing to do. I know it can be scary to a lot of people. Jason's been doing this a long time. He's got a lot of knowledge. We're in an age of technology and everything's at our fingertips. You can do a lot of homework on your own, but in the end, make sure you're talking to professionals like Jason.

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 multimillionaire 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. And now, here's your host, Jason Hartman with the complete solution for real estate investors.

Thank you for joining me for episode 1374. 1374. It is an amazing time to be alive and floating on the ocean once again. I'm recording from the ship in the stateroom here and you can probably hear the howling winds outside and the splashing surf. It's just great. You know what's really interesting is how air, I mean, do you ever appreciate air enough, right? There's so many things that we have to be grateful for. But in these tropical climates, when the air is just warm and it's humid and it just sort of, it's like taking a bath in air. No water, water not needed. Just the air feels so nice. It's really great. But then again, you know, another kind of air. When we were on the cruise, the Venture alliance cruise a couple months ago in the New England area, the fall foliage cruise, Princess Cruises there, that air was beautiful in a different way because it was so fresh and crisp and that fall air, they're both great. Air is just great. I'm going to form a new society called the Air Society. If the real estate thing doesn't work out. Okay. Anyway, today we are going to explore part two of the Hartman Risk Evaluator again. We are taking a deep dive into the Hartman Risk Evaluator on these three episodes, a three part series here. Remember my definition of an investment to qualify, to earn the word, to earn the term investment, what does an asset have to do? It has to produce income. It has to produce income. If it does not produce income, it is not an investment. It is a speculation. George, who is interviewing me on this show that we're replaying here on this episode that we're replaying all three of these, he says that his definition is to be an investment, it has to pay you. If it doesn't pay you, it's not an investment. And I agree with that. Essentially, we're in agreement. We're saying the same thing. So as we dive into this further, we're going to talk a little bit more about the appraiser, Eric, who came over and I'm appraised my house twice and see what he has to say as things progress here in the story. Remember the ingredients of the property, the ingredients of that improvement, the improvement sitting on the land, that's what we are really investing in. Because we are.

What are we?

We are packaged commodities investors. We invest in a set of commodities that is packaged in the form of a house or an apartment building. Maybe if you don't want to call it packaged commodities, you can use the other phrase. I came up with assembled commodities. They are commodities that are brought together and assembled on a work site into a usable single commodity housing that everybody.

In the world needs.

It has absolute universal need. So packaged commodities investing, assembled commodities investing a very, very good investment and a very good way to think of our investments in those two components, land and improvement, and the ratio of value between those two value drivers, the L LTI ratio, the land to improvement ratio, that's what determines the value and the risk level of any real estate investment. So that's what we've got to think of. Now, remember, the LTI ratio is very out of whack. It's wrong, it's bad. It's too high in terms of L or land. In cyclical markets, the markets we don't like, the expensive markets, whether they be Honolulu, the west coast of California, on up to Seattle. In Canada, it'd be Vancouver. These markets are all in trouble right now, as we know. It might be Miami, New York, it might be across the pond. It might be Paris, it might be London, even further to the east, it might be Hong Kong or, well, before you get to Hong Kong, Dubai, right? Could be any of these places and several others around the world. Cyclical markets have bad LTI ratios. Well, what about the LTI ratio of unimproved or vacant land? What if it's just a piece of dirt, a parcel with no improvement? What is the LTI ratio on that, well, it's 100% L, right? Or 100% land. Land to improvement. There's no improvement. So it's all land. So that would be a highly risky investment because it's all speculative. Now, as an aside, I want to say one more thing before we go into the Hartman risk evaluator. And this isn't really related, it's kind of tangentially related to even saying that might be a stretch. But I don't want to forget to mention this. I was having a conversation here at my conference at sea. That's what I'm doing this week on this eight day cruise. It's basically a floating conference. And so we had two sessions today, a morning and an afternoon session. And yesterday I was having a conversation with a marketing person who's here. We were talking over dinner and he says that he does marketing and sells leads to a company that we've had many of their people, including the founder, Bill Bonner, my favorite financial writer on the show before I've interviewed Bill Bonner. That was a real honor. And that is Agora Financial. And what's fascinating is the way they brilliantly, I mean, this is an extraordinary, extremely successful company. I love their work. I often disagree with their final conclusion, which largely is buy gold. They're gold buggy. And I'm not a gold bug at all. I like income property much more. But what is really fascinating is this. And I want you to think about this as it applies to you as a real estate investor. Here's what he told me and this was quite fascinating. He said that they will pay on a cost per action basis. Now in the Internet world, many of you know what I'm talking about, a cpa, a cost per action meaning if the person clicks the mouse and buys the product, how much is that worth to the seller of the product?

Right?

That's the concept. You know, you might think, well, if you're going to sell a $50 item, a $50 product, you don't want to pay maybe more than about a third of that cost in cost per action or commission essentially to affiliates. Hold onto your chair because this is going to blow your mind. Imagine being so good at knowing your numbers and being so well capitalized and being so intelligent that you could literally pay a very high, seemingly very lopsided cost per action to buy that action. Because you understand something that all of you in business have probably heard of. Hopefully you've heard of it. The very important concept of the lifetime value of the customer. The lifetime value of the customer. Now think of this. If this were applied to income property investments, okay? The lifetime value of the customer. Two ways I want you to think of this. Number one, think of it as though you need to attract a new tenant. And typically to attract a new tenant, if you have a property manager and you're not self managing, you might pay 50% or 75% or 100% of one month's rent as your equivalent of a cost per action. So the tenant signs a lease, they pay to move into the property. They might pay your first month's rent plus a security deposit, maybe some junk fees, application fee, whatever, to rent the property from you. Here are the numbers on the Agora example. $50 cost per action. How much will they pay for that? 1? $82. I was shocked and awed when I heard that number. Imagine paying more than triple what you get because you are so good at long term thinking, playing the long game, and you understand that the lifetime value of that customer will be dramatically more than that first cost per action. So in other words, you receive $50 today, but you pay $182 today to get the $50. You lose money. You lose a lot of money on that deal. So imagine if your tenant was renting the property from you and you paid more than triple what you received. Would you do that deal? You'd probably say absolutely not.

No way.

Well, how about if it was just purchasing the property, right? What if you bought a property and it was $50,000, yet you know that the lifetime value of that $50,000 property was so good and so valuable to you that you were willing to pay $182,000 to get it? I doubt anybody listening would agree to that deal, right?

I wouldn't agree to that deal.

But it is pretty incredible when you think long term, when you play the long game and how you can be very, very successful with that idea. Just something to consider. I didn't want to forget to mention that to you because it absolutely amazed me. Think about how that might apply in your thinking about your investment properties. Kind of an interesting thought experiment. I'll let you noodle on that one as we dive into part two of the Hartman Risk evaluator. Then of course tomorrow we'll have part three and we'll wrap it up on this deep dive into this topic this week. So here we go with part two. And if you want to see some good properties with good LTI ratios, go to jasonhartman.com, click on Properties. And better yet, contact one of our investment counselors, subscribe to our PropertyCast, where you will get those properties sent to you just like new podcast episodes, but they will be PDF files, written files, not audio, with the information, the full details about all of our newest properties as they become available. So whatever podcast platform you're using, type in Jason Hartman propertycast and you'll get that subscription for free, delivered right to your computer or your mobile device, whatever you like. Okay, part two of the Risk evaluator. Here we go.

Let's look at these ingredients of a house.

Just a few of them. Okay.

The raw materials cost. That influences the cost of the improvement in 2004. And this is kind of a good.

Year to pick because as housing prices were just skyrocketing right before the Great.

Recession and inflation, they were telling us, was only 3.3%.

Yeah, right. Is that the CPI or is that the actual broken down raw material cost number?

That's the CPI number. Okay, so that's what they were telling us was inflation. I mean, it could have been core rate versus cpi, but I think it's cpi. Okay, as I recall.

But look at this. The price of steel and Iron went up 34% in the same year, more than 10 times the rate of stated inflation.

Okay. Lumber was up 17%. The prices of wallboard, 20% increase when they told us inflation was only 3.3%.

Are you kidding me?

This is, you know, it's so stated. It's absolutely ridiculous.

And just in connecting the dots for the viewers, guys, if you're watching this, the reason Jason has all these listed out is because that's the materials that you need to actually build a home. So if all the materials are going up going back to the builder and his profit, or her profit, then this is going to force them to sell the these homes that they're building at a higher price in order to make a profit. That means if you already own a home, if you can't have any more supply come online, if there's more demand through population or through excess liquidity, then that's most likely going to bring up the value of your home.

Right, Right.

What's interesting about what you just said is that I remember I was doing a speaking engagement in Phoenix and it was right around 2004 or 5, and.

I had a heckler. I've had like two hecklers in my life in the audience, and this guy just thought he knew everything. He was so smart and he was going to outwit me and heckle me there in front of the audience.

We were talking about The Houston market.

And many of our investors, including myself, have made a great amount of money in the Houston market. It's been awesome. We've been involved in hundreds of transactions in Houston, Dallas, Austin and a little bit in San Antonio too, and then in North Carolina, Indianapolis, many other markets.

But he kept saying, well, you're telling people to invest in Houston, but Houston has like really lax zoning laws. They have very little restriction and builders can just keep building. And I said, so what?

I don't care.

I'm not that concerned about the cost of the land. When land is cheap, I think that's great. I want to be the commodities investor.

And I'm going to show you why in a minute. But that'll, that'll come back in just a moment. Okay, so let's.

On that point too, and this is what I tell people and I want to emphasize that when you're looking at an income property, I think it's incorrect me if I'm wrong. But when I do it, I don't take it from the starting point of do I think the value or the price is going to go up or down. I look at it as though I'm buying a stream of cash flow. You're a yield investor, cheap or is it not? And then, okay, we can talk about it. The price goes up or down, but I don't really care about the price too much because I'm not looking to sell it tomorrow. I'm looking to hold it for the long term. It's more about that income stream.

Absolutely.

You are a yield oriented investor. Really. I think both of our philosophies, even.

Though we're using a different asset class.

Very much mirror the philosophical beliefs of.

What many think is the world's greatest investor, Warren Buffett.

It's value investing. You're investing for yield, for cash flow.

For dividends, if you will, not speculation. Hey, listen, if the price goes up, I can spend that appreciation just as well as the next person. But I don't care if that happens. This is not lunch money for tomorrow, okay?

This is long term wealth building. And the way that wealth is going to be built is through all of.

Those multidimensional characteristics, through the self liquidating debt, the tax benefits, everything else.

And look, we all know a lot.

Of people who have become very wealthy.

Owning income property, yet we probably know one or maybe know people that have.

Become very wealthy buying stocks, you know, if they're starting in the same place, right? So it's obvious that this is the greatest asset class. Now let's just reduce our risk when we invest in it. Okay.

Okay. So the other thing, labor cost, right? The cost of labor definitely increasing.

And that's a huge thing.

Do you know, I was just watching.

A video for the Economist magazine on their YouTube channel and they said that.

The average age of a construction worker in I don't know if it was.

Europe in general or one of the European countries. The average age of a construction worker in Europe or one of the countries.

Is 48 years old.

Wow. That is shocking to me.

I can't believe it. It was in Germany.

I think it was Germany they were talking about.

And it just goes to show you.

That there is just a massive shortage of this kind of labor.

Now, I have seen all those cool little videos floating around Facebook, just like.

Maybe some of you have, about the.

3D printed houses and about new materials and this and that and living in a little pod.

And listen, I hope all that happens, but so far it just seems like a fantasy. I don't know any 3D printed houses.

Anywhere and they still take materials to build.

Now, I've also seen, George, the articles on Business Insider in the Wall Street Journal about how you can buy ahouse on Amazon.com for $19,000. So I looked, and by golly, there are houses on Amazon for $19,000. Go check it out. But I called that company and I called a couple of those other companies with those houses. First of all, they're just a kit for the walls.

They don't include any plumbing, any engineering, any H vac, any appliances.

They don't, of course, they don't include land.

And I asked, I totally grilled this.

One woman who was talking to me. I mean, in a nice way. But I just kept asking till I got the answer to my question about.

How much does it cost to actually live in one of these houses if I want to really build one? I mean, there's all kinds of lots.

Available for single family homes in Florida.

If I buy a lot of.

And I order your house and I.

Do the engineering and I have the.

Plumbing people come in and do the plumbing, and then the electrical people come.

And do the wiring and everything. And she said, she kept telling me the same thing. She said our house competes with traditional new home construction costs. And she kept repeating the same phrase. And I said, give me the dollar figure I need to know how much that is. How much do you think a new home costs? And she's finally told me the answer. $200 a square foot, Right?

Right. Well, okay, yeah, just, I mean, do the math, you got to. Yeah, you got to think about, well, they're not using any different materials. So what would be their cost savings? Like how manufacturer saving all this cost. It's the same material. They got to ship it to you. So if anything, there would be a higher cost to that. It doesn't really make a lot of sense.

I mean, you'd think that it's more.

Efficient to manufacture the components of a house in a factory. I would definitely agree to that.

You just buy trusses, the big thing. When I was a construction worker, I don't know if I ever told you that. In college, I was on a framing crew, and that's one of the ways I worked my way through high school, while I was working in high school, but then worked my way through college as well. And as a laborer, I remember a lot of the homes that we would build in Oregon, in Portland, and some of the cheaper homes, they would just have trusses, and most people probably don't know what those are, but that's where your roof is already built. And they just kind of deliver it to you, and you just bam, bam, bam, kind of tack it in and you're done. It's almost the same thing.

Right? Right.

So they just.

I believe they should manufacture more and more of the house in a factory, but there's a real stigma to that in America. I don't know if that's true in other countries, but in the US, nobody wants to live in a manufactured house. It's a weird thing. I think it's really dumb, actually. I think you could build a house better in a factory and assemble it on the lot.

But even if you do that, according.

To all of those cheap kits on Amazon, by the time you do the engineering and the permitting and all that stuff, it's 200 bucks a square foot. That's no deal. I mean, you can go to Jason hartman.com right now and get properties for far less than $200 a square foot. Okay. Yeah.

And to take that a step further, I want to put that into perspective for everyone, because this goes back to what you're saying. With the Stage Steel price surging in the lumber price. I built a home, not myself, but I did a deal in Portland, Oregon, when I first got into real estate investing, where I subdivided a lot. I bought a crappy home in a great neighborhood, fixed up the home, subdivided the lot, had the new lot, and then I had a new, brand new home built on that lot. And that's where we made all our profit. But back this was2013, maybe, something like that. And excluding the land, just the cost of the improvement value, we spent about 120, 130 a square foot. So that just goes to show you how much the cost of building has gone up just in the last. Call it seven years.

Yeah. And you know what else? It's not just the first point up here, the environmental and building restrictions, but.

It'S also the constant burden that they're adding to builders, to the cost of construction. Because before it was, every house had.

To have a smoke detector. Then it had to have a smoke detector in every bedroom and a couple other places. And now it's got to have a carbon monoxide detector.

And, you know, this is all.

Well, and now it's got to have, like, low flush toilets and, you know, special shower heads, and it's got to have LED lighting.

And, you know, they just keep throwing.

On the regulations and making it more expensive for them to build. And, you know, then it's got to have smart home features and smart thermostats.

And, you know, all this stuff is great.

I mean, I love technology. Okay, I'll be the first to say, but all I'm saying is it just makes it more expensive to build.

Yeah, but I think that's a great point. Most people don't understand why the supply of homes, especially in a lot of areas, is so low right now. They're. Why don't these builders just go out there and make it happen?

They can't. They would love to.

Taking it back to that exact same house that I was talking about in Portland, Oregon, in order to subdivide that lot. And keep in mind I'm doing this, they're going to make a lot more in property taxes. They're actually encouraging people to subdivide these lots to bring the population in from the suburbs, to revitalize this downtown area. So I'm doing them what they want.

Me to do, but they're making it really tough. Right?

Tough.

It's an understatement.

Listen, there was a side road there that this lot was on. They made me, out of pocket, out of my pocket, repave the road, put in gutters. And this old lot, it was run down, it was an eyesore, but it had all these trees on it that we were going to go in there and just level to build this new home. Well, they. They made me hire one of their arborists, which is a tree pro guy.

A tree person. Yeah, this guy.

Three grand to come out and tell me what all These trees are.

Oh, yeah.

And then I had to build a median on. Well, not really a median, but, you know, on the sidewalk. How they've got the row for the trees. I had to build that into the sidewalk. And then they told me the trees that I had to plant and the specific types in order to make up for the trees that I knocked down on the lot where I built a new house that made the neighborhood 10 times better. I mean, all the regulation, it just got more and more and more and more to the point where it took me a year, a year of meeting with them and probably $25,000 out of pocket just to do them a favor. I mean, it's insanity. So that's absolutely why we have a housing shortage. That's why.

That's why. That's why you have a homeless problem, because you've made it really tough to build. And I didn't even mention fire sprinklers, which are hugely expensive.

And any developer of a tract will tell you that whenever there's a cul.

De sac or the planning of the roads within the development that they're building of a tracked home development, that turnaround area for the fire truck keeps getting bigger and bigger and bigger.

Somehow.

I don't know, these fire trucks must be just bigger and bigger now and need a bigger turning radius, because every developer will tell you it's just become ridiculous. The burden is so insane. Look, all of this is increasing the cost. And then the last one that I put on there, of course, is the cost of energy, Right? Energy is probably the world's most valuable commodity of all, potentially. Right? Or energy or land, I guess, one or the other. Or maybe water. Water's in there, too, you know. But energy costs definitely increase the cost of construction, right? Because energy is in everything. It's, you know, everything is energy. Right? So let me show you something. Remember I told you that I was buying two properties at the same time? I was buying the one property to live in in Orange County, California, and.

I was buying the other property across the country. That was my first, or maybe it.

Was my second, because I don't know which one I actually closed on first, but I was buying one in Austin, another one further in Georgia.

Right. In buying these two properties right around.

The same time, I was buying this house for myself. It was a very interesting experience.

I'm going to show you. This is the tax bill for the house I was buying to move into.

Okay.

Orange County.

Yeah, this is in Orange County. Now, look at the magnifying glass here.

And you're gonna see the land value. This is according to John Morlock, the Orange County Treasurer Tax collector, right? Because the tax collector segments the value, the two components, the land value and the improvement or the buildings, right? And this house altogether was $815,000.

Okay? You see that right here?

And the way that divided up approximately.

Was 659,000 in land and 155,000, 753, I guess, in improvements. Okay?

That was the equation.

Now, your listeners or viewers might be.

Thinking, well, how do I know the.

Land value versus the improvement value?

There are three ways.

Number one, the tax collector, on every tax bill, they always divide the land and the improvement up, okay? Because it's taxed differently in probably every area of the country. You know, if it's vacant land, the tax is different than improved land. So they got to know that value, right? So they always make an estimate of what that value is. The other source is, like I said, your insurance company. Jennifer, my insurance agent, told me that that house across the country, they were giving me $135,000 in insurance. So by deduction, I knew what the land value was. Okay?

The third source is just have an appraisal. The appraiser will always divide those two.

Components of land versus improvement. So you know what you're getting. Right? Okay, so here's the way that looked, okay? That's my house that I bought to live in. And I lived there for seven years in this house.

It was 815,000 total, 156.

I'm rounding just a tad 156 or 19% improvement value and 81%, $660,000 in land value. Just so you know, that was a brand new house. It was built by California Pacific Homes, and they're sort of related to the biggest land developer in the country, or at least one of the biggest, the Irvine Co. Many people have heard of.

And here's what happened, okay?

I had this girlfriend at the time. Her name was Monique.

And Monique's mother was in new home sales.

So Monique thought she was an expert, right? We ended up breaking up, clearly. And she told me not to buy this house.

Now, Monique really was vehemently trying to.

Talk me out of buying this house. I'm glad I didn't listen to her.

Okay, here's what happened. I owned this house for just one short year, and I couldn't believe my luck.

I didn't consider this to be any great investment. I didn't consider this a stroke of genius, but it's kind of amazing. What happened?

Okay.

Because one year later, I saw the values climbing like crazy, and I thought, you know, I better refinance and get my money out. I always try to engage in a practice I call equity stripping, because equity stuck in a property is always at risk, number one. And number two, it's not working for you. I want to put that equity to work.

So I call up my lender and.

I said, send an appraiser out. I want to do a cash out refinance, and I want to buy some more rental properties. Okay. So the appraiser came out. His name was Eric. And I'll tell you, Eric came out a year later and appraised the property again.

And then Eric came to one of.

My conferences where I told this story about him, which was pretty funny. Okay.

So here's what happened. Eric came out and said, congratulations, your.

House is now worth $1.3 million.

Wow.

And I thought, in one year, that house went up by $485,000. I am so lucky. Thank God.

That was a great deal. Okay.

But the question is, if the tax collector were to send me another tax bill, how would they have divided up the value in the LTI ratio, the land to improvement ratio? What would the tax collector have said about the new value? Where did it increase? We know that it increased by $485,000. We know that now the value is 1.3 million. But the question is, how would you allocate that value between the two primary.

Components, land and improvement?

He just increased the land value, wouldn't he?

Why?

This will be continued on the next episode. Thank you for listening and happy investing. Thank you so much for listening. Please be sure to subscribe so that you don't miss any episodes. Be sure to check out the show's specific website and our general website, hartmanmedia.com for appropriate disclaimers and terms of service. Remember that guest opinions are their own, and if you require specific legal or tax advice or advice in any other specialized area, please consult an appropriate professional. And we also very much appreciate you reviewing the show. Please go to itunes or Stitcher radio or whatever platform you're using and write a review for the show. We would very much appreciate that. And be sure to make it official and subscribe so you do not miss any episodes. We look forward to seeing you on the next episode.