2409 FBF: Understanding The Property Supply Chain for Real Estate Investors, Inflation Is Here!

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Welcome to the Creating Wealth Show with Jason Hartman. You're about to learn a new slant on investing 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.

Hey, welcome to the Creating Wealth Show. This is your host, Jason Hartman, with episode number 728. 728. Thank you so much for joining me today, listeners from around the world. Appreciate having you always. And I just wanted to do a little impromptu introduction here because I just received a call on one of the properties in which I had a hard money loan and there was an insurance claim issue and, uh, kind of a strange thing. So the borrower had reached out to me and he had mentioned that he just returned from one of our mastermind groups and I was not at this meeting, but he was telling me some very interesting things and I just wanted to welcome him and have him share that with you as the audience because I think this will be very important to you as real estate investors. Dave, welcome. How are you?

I'm doing great. Thanks for asking, Jason Hartman.

Good, good. Thanks for coming on with us just for an impromptu interview here. You had asked if I was at the last mastermind meeting, and I said I couldn't attend that one. And, and I said, what happened there? You know, what was the tone of all these real estate investors and all of these people who are rehabbing properties and, and reselling them and, and sometimes keeping them for their portfolio as well? And, you know, A lot of them are in the construction business, construction management side of the business, as are you. You had said to me that, well, the problem people are facing now is pretty much all the same for all of them. And I said, well, as if I didn't know, and I kind of did, but I asked you, what's the problem everybody's talking about? And share with our audience what you told me, Dave.

Well, sure, Jason. What was interesting about the meetings this week was the fact that probably 90% of those in attendance all said that their number one problem was centered around the construction process, and that everybody's remodeling houses. They're remodeling them at a faster pace than they used to because business is strong, and they are faced with, some cases, 30% increases in the cost of materials and labor in their marketplace, as well as the shortage of good quality contractors that are able to do the work in the timeframe and the budget that was established for the project. And another thing, Jason, that we heard over and over again was everybody's struggle with finding competent leadership and supervision in this area of their business. And we spent a lot of time talking about how you retain talent, but more importantly, how you find folks that can actually actually manage 5, 6, 7 projects at a time without letting them get out of control. And so the problem was completely universal amongst almost all the attendees, and we decided that our next meeting would literally be focused almost 100% on solutions in this area, whether it be hiring strategies or whether it be better bidding programs. Better recruiting of folks to do the work. But I think most interesting thing that I learned in this particular round of meetings was that the impact that a project has on you when you go over budget— if you're going over budget, chances are you took too long to do the job. And secondly, you spent more on materials and labor than you thought you would do. And then also, A lot of guys were saying that they just weren't doing a good job of inspecting the house on the front end, and so you end up finding a lot of additional work that needed to be done to that property before you can sell it for what its full market value is. And all these contributed, along with increased interest cost, etc., to jobs coming in over budget late. And as you know, Jason Hartman, that eats away at your bottom line. And so this, this is what we, we spent hours and hours and hours talking about.

Very, very interesting stuff. So listeners, look, I've been around the block a long time in this business now, longer than I'd care to admit. I have seen this happen so many times before, and Dave, I bet you have too. And this, this happens in every boom cycle And we have definitely been in a boom cycle for the past several years. And it happens in every boom area too. So, let me just share a little perspective with our listeners, and I'm sure you're going to have something to add to this. Two boom areas and one at a boom time. So, it's not just a matter of the overall boom cycle, right, which is the big macroeconomic trend of right now and the past several years, we got everybody and their brother just wants to be a real estate investor. And thank God for that. It's like real estate is getting discovered again. And people don't trust Wall Street, the modern version of organized crime, as I always like to call it. They want to be in control of their financial future and they want to follow Commandment #3: Thou shalt maintain control. Don't relinquish your financial future to somebody else. Be your own master in this stuff. And with income property, you have great control over it. But the providers of these properties are local market specialists. They have challenges, some of which you just expressed. And these ultimately trickle down to the investor and then ultimately again trickle down one more layer to the tenant where we see prices increasing as we have been for the last several years. And we see ultimately that will put upward pressure on rents. However, rents are a little bit slow to come around. They always lag price appreciation. And so I'll just share two examples here. One is the oil areas, the oil boomtowns, wherever they are in the world, but I'll just mention North Dakota right now. Okay. Now, when oil prices were high, this market was nuts. And we were looking at deals up there. And I just decided not to do it because I decided it was just too speculative, too risky. And believe me, it was tempting because the kinds of rents people were getting for crappy little trailers was mind-boggling.

Welcome to this week's edition of Flashback Friday, your opportunity to get some good review by listening to episodes from the past that Jason has handpicked to help you today in the present and propel you into the future. Enjoy.

But then the oil market collapsed and that real estate market collapsed as well. You know, it's a one-trick pony, not enough diversification, obviously. And in that market, and also in Fort McMurray up in Canada as well, when we looked at that market many, many years ago, I would hear from the people building houses and rehabbing houses. I would constantly hear this same thing. And the other example I'm going to give you is Florida during the last boom time, many areas in Florida. Okay. And the same thing I would hear is that literally workers, the subcontractors, whether we're doing framing or painting or plumbing or doesn't matter what they were doing, putting in windows, it does not matter, right? Whatever they were doing. They were getting hired and basically poached off the job. They would literally be in the middle of their workday, you know, doing their construction work, replacing a furnace, you know, fixing an air conditioner, whatever they were doing, okay? And some other rehabber or some other builder would literally just come and hire them away and offer them so much money they would just leave the job. And leave this unfinished property. Contractors are famous for being flaky and not showing up and being difficult to manage and it's difficult to get good quality work out of them and so forth. And this is an inkling of that type of problem where it's becoming incredibly competitive to hire these guys. They're getting a lot of money because it's just supply and demand. There's lots of demand and a limited supply of workers and a limited supply of materials. Prices are going up on both fronts. It's not quite to the fever pitch that I mentioned in Fort McMurray, Canada, and in the oil-rich areas in North Dakota, or the crazy areas before the Great Recession in Florida, which were really markets that had no real economy and was just complete building of sprawl that just didn't even make sense. In Florida, that was just nutty. But workers were just walking off the jobs because they could just get a better deal. And they were leaving unfinished properties. And this led to a lot of litigation, a lot of problems. And it's not that bad yet, is it? But it's, it's kinda moving in that direction, right, Dave?

Well, it is, Jason. That's some outstanding insight. We are faced right now with probably being shorthanded 3 or 4 crews just to keep up with the demand that we have for property. Renovations. And, you know, your options— do I go out and try to— you have to go out and recruit from somewhere, so essentially you're pulling somebody away, a crew away from some other company. And the other thing that you have to do is you have to work on the efficiencies of your organization, and that's the kind of thing that these type of problems produce a need for. It's like any other business. You come to work every day, and you have to work on improving your business. And if you've got supply problems, buying inventory of houses or finding manpower, you have to find ways to overcome that. And that, and that's where you have to buckle down as a business doing what we do and solve these problems because we have a lot of clients that are, that are counting on us to provide good, functional, profitable inventory for them. And the demand from investors really right now has just been extraordinarily high.

It's, it's, it's mind-boggling. It really is. Yeah. Yeah. And this, you know, And look at all the years I've been in business, and I'm sure you can agree with this, it seems like there's never a time ever, ever, ever where the supply and demand is just nice and balanced. During the Great Recession, we had lots of supply and very little demand, but those were the people that made all the money, the contrarians, right? That's where the big profits were, where the people were willing to take a risk, bigger risk when everybody was fearful and everybody was scared, when there's blood in the streets. Streets, right? And that could have easily gone the other way. It could have gone down more because you never know when the bottom is, right? Nobody can ever predict the bottom or the top with any degree of accuracy, at least not that I know. Certainly, the Federal Reserve can't seem to do it, and they've got all kinds of data that we don't have. So if they can't do it, I think we should decide that nobody can do it. And that's why you shouldn't be a speculator and a market timer. You should just buy good quality properties and hold them, kind of the Warren Buffett mentality with with value investing in stocks and companies, although I don't like stocks and companies that much. I like income property. But value investing as a philosophy, I think, is a good philosophy. You mentioned earlier that price increases in terms of building materials of 30%— that's extraordinary. What kind of time period are you talking about there? Don't tell me you're talking about just one year, 30% increase, right? Or what are you talking about there?

Well, I would, I would say, excuse me, I would say it's about a year we've been tracking it. And I recently met with a general contractor who runs an operation that's had as many as 30 to 40 crews working for him. And I told him that we're having a really difficult time bringing houses in on budget. And he said he's just spent the last year dealing with the 25 to 35% increase in materials and labor, both, that he's experienced with his business. And they, they do a lot of work for some of the hedge funds and a lot of investors in our marketplace, and they're really a solid group, and they track these things very, very closely. And so there in our market, there has been tremendous increases in pricing, and it's mostly been a supply and demand issue. And so we're having to deal with that. So that forces you as a business to become an extremely competent estimator and bidder when you're out looking at properties to purchase and resell.

Yeah, this is another reason that the amateurs, the people that, you know, buy an info product on a late-night infomercial and they go out there and try and do this themselves without having connections, without having crews, without having deep trust built with vendors and long-term relationships, you know, they have no pricing power. They don't have the knowledge. They get burned. It's just sad to see it. It happens over and over. The industry has matured dramatically in the last decade or two for sure. I mean, you know, in the last 5 years, and a lot of that's driven by software and just companies, these vertically integrated companies that are our local market specialists in the various markets. They're just getting more competent. They're all networking together. They're, they're in mastermind groups together. They're— they've got software, they've got people, they've got crews. They just know how to do it. And even you guys are having a tough time being good estimators, right? You're getting burned yourselves and you're the pros, right?

That's right. And we just this week— it's funny you would say what you did because just this week we've looked at multiple houses that were presented to us as available properties. Multiple of these houses were homes that were started by folks that thought they could do it on their own. They got about halfway through the project and ran out of money. And what really probably happened is they ran out of expertise to, to manage the project in the proper way, because it's hard enough to do it when you know what you're doing and you have the systems in place to do it. And so to go out there and try to do it on your own versus a turnkey model is really, really tricky business. And we've seen that over and over again. Literally today, I probably looked at 4 or 5 properties online that we were going to consider that were in that exact same scenario.

Did you, did you do any of them, or did you turn them all down?

Well, we're looking at them and assessing them right now and looking at values, and then we'll send our project estimator out. He'll take a look at the properties, and we'll make a quick decision if this is a property that we can that we can put into our system and do an excellent job of remodeling and get it in a price point that fits the investor's yield requirements. And so it's a process, and it may take us 3 or 4 days to assess property before we make a decision to go with it because there's so much— as you know, there's so much involved with understanding the neighborhood and the traffic patterns and the tax records. You know, the comps and all the factors that go into making that kind of decision. So we're— our goal is to protect the buyer, the ultimate buyer. And so you have to take your time and do it right.

Yeah, yeah, you definitely do. When you talk about that 30% price increase in building materials, are there any particular materials that are being hit the hardest? You know, maybe give our listeners just some idea as to How many materials do you need to rehab a house? You know, how many vendors are you guys working with on a typical rehab job? I'm looking for the, the really big pressure points where you can really get crushed on the cost.

Well, as an example, one year ago, we were paying $1.25 a square foot for painting a house. And now the going rate today is $2 to $2.25 for investor-grade painting. So if you put that on a calculator, that's a significant amount of money. So a year ago, we might have been paying $1,800 to paint a house, and now we're paying double that in many cases. And another area that we saw big increases on were roofing materials. And with oil being where it is now, that's probably fluctuating downward again. but we have seen lumber prices skyrocketed in our market. And really, it was really across the board. But you also— not— when you have material costs that are skyrocketing, that's when you have to even be more in control of the buying process. And so you can incur increases in your material costs because of a lack of controls. In the buying process. So it forces you as a business, as we've said earlier, to really become very, very focused and systematized in how you go about acquiring product and labor in the marketplace.

Yep, absolutely, absolutely. And, and what drags on is, is when you miss the time frames and you can't get these people to do the work quickly enough, of course I mean, look, I know this directly because I finance a lot of your deals, okay, myself. You know, one of my companies is your lender on many deals, and you're paying me 12% interest. And, and that carrying cost can get pretty high pretty quickly, can it?

Well, it can. And as I look at our ledger of properties every day, that's one of the things that I track, because we may have— I just looked today, we have 42 houses that were— that are in our quiver right now. And that's a lot of properties that are in some stage of the process, whether just acquired, under construction, post-construction, under contract to sell, and not yet closed. And so when you, when you look at that, time finishing a job in a timely manner is pretty darn important at 12% interest. And especially as you do more and more large-scale projects where you might spend $100,000 on rehab. So it's a very significant factor.

Well, so let's, let's do some quick math on that for our listeners. This is interesting. Did you say 42 or 43 houses that are in right now?

I think it's around 42 houses that are in our system.

Okay. So let's just say on average, because I know you do some higher-end properties properties too. They're not all investor-type properties. But let's say on average that your properties are $200,000 each in terms of what you purchased them for, or, you know, the amount you're financing, for example. So, you know, that's $8 million in outstanding loans, right? Am I doing that math right? You're paying 12% on every month, but you're paying a point per month. Wow.

Right. If you were averaging a $200,000 all-in cost, yes. We're not, but I know what you're, what you're doing, using a nice Round number, yeah.

That can become very burdensome very quickly, and it really means that this job is for the pros, and even the pros are getting burned. That's kind of the point of what we're talking about. The pros are getting their rear end handed to them sometimes. So, what were some of the solutions proposed at the mastermind group? Certainly, I think there's a lot of impact from software on your business, and I think that's helping. It's making it a lot more efficient, isn't it?

Well, you know, that's a great, great point, Jason. We, we learned at this meeting that we are woefully behind in terms of the automation of our bidding process. It's nice and easy to go out and look at a house and say, okay, it's going to cost $65,000 to repair this house, but you need to be able to check that. You can't just look at it and use your your cheat sheets and your little formulas to come up with a number, you have to be able to document your material costs and your labor costs. And what we've seen over the years is the hardest thing to document is what is, what is this property going to cost me to repair from a material standpoint? And you have to have a bidding system where that information is loaded in so that when you're out there on that job site looking at that house and you decide it's going to be $50,000, then you can walk away with confidence that if I manage this job well and have the right folks working on it, that we're going to bring this job in at $50,000. And so automation is of the utmost importance right now, especially with prices changing. So you— not only do you have somebody out in the field using that automation, but you have somebody in the office that's making sure that the data is accurate. That the cost to replace a kitchen, a level 1, is $5,400, and a level 2 is $6,300, etc. And so you have to be really on top of your game and your vendors supplying you really up-to-date information. So that, that's one of the most important factors. And the other thing that I think we heard universally at the meetings was that your project manager has to touch these jobs no less than every other day. If you want efficiency on the job site, you better have somebody checking the work, the quality and the productivity on at least an every other day basis. And so for, I think a lot of folks that walked away from the meeting, they're doing what I did today, which is interviewing, you know, additional project management bench. And literally we were probably a day away from making an offer to one or two people to try to improve not only the productivity and the profitability, but the quality of the houses that we're working on. And so yeah, everybody—

so in other words, that's the person who's going out walking every property every other day, right?

Correct. It's a person that's making sure that that job has the materials that it needs, that the people that you've hired are doing the work that they're supposed supposed to do and that they are sticking with the budget. And so if you— if your project manager is too busy to do that, you've got work being done with no checks and balances. And when the project is done and the buyer sends their inspector out and you end up with a 45-page inspection report, then you didn't do a good job managing that project. And so this is where where we heard the most mileage would be gained was by increasing the amount of coverage that you have in the field and the effectiveness of your project management group. And so that's where our focus is going to be in those two areas, and I'm quite confident it's going to make a heck of a difference.

Yeah, yeah. Well, I sure hope it does. And then it's also the software that, you know, manages the actual workflow of the job and and all the staging of the different, you know, you got to do one thing before the other thing and everything's in construction. There's so many contingencies, you know, you got to get this contract, this sub into that property to do this job before the next sub can come in and do another job on top of that job. And there's just all these, it's a domino effect and it's pretty complicated and software is making that a lot better. But wow, it's a challenging market. And so, you know, what is the takeaway for investors here? I mean, to me, It is number one, understand that this is why it is taking longer to deliver properties. Some of our LMSs in some of our markets, they can't deliver a property for, for 3, 4 months. I mean, and this is not a new home, this is not a new build, this is just a rehab. Okay. But their crews are so busy and they've got so many properties in the pipeline that they just can't deliver them any faster. There's not enough workers out there to deliver and get these properties finished quickly enough. I'm doing a 1031 exchange now and I sold one property and I purchased two more and my God, I thought there's going to be no problem. You know, once I did the 45-day identification to close within 180 days as the 1031 tax-deferred exchange rule is, but we're right up against the deadline now and I still haven't closed. And I'm like, my God, we got to get these properties done. It is just, it's just taken a long time. To get this stuff done. It's mind-boggling. So, patience, I think, and also understanding how hot the market is and what the demand is like. Listen, I will be the first to tell you I think we are in danger of a real real estate bubble in the cyclical, overvalued, high-flying markets. But in the linear markets and even the hybrid markets, you know, to a lesser extent, I think we got a few-year run ahead of us where this is just going to go on and it's going to get even maybe more intense. We'll see what the interest rates do, but there doesn't seem to be any shortage of demand out there. Your thoughts on that? And I know I've kept you a lot longer than I said I would, so we can wrap it up after this.

Well, that's fine. I would say that the demand, investor demand for our product, because we do both retail and investor turnkey, the investor demand has far exceeded our ability to provide good inventory. And so part of the reason that projects take longer to finish is because the properties that we're having to buy are, are requiring more work. And so the projects are bigger. The average cost of an investor rehab is probably up 50% from what it was 2-3 years ago.

Okay, so let's just, let's just dice that up for a second. I want to make sure the listeners understand why that is. In other words, in the old days, you could go to and buy a property where it's, to use the old saying, just put a little lipstick on the pig, right? You know, put some paint, put some carpet, and you're done. And, you know, maybe a couple fix this, fix that. But nowadays, you got to buy properties that are in real disrepair and do major construction projects because those are the only properties where you can add enough value to make a margin, right?

That's correct. That's exactly right. Used to be that somebody got foreclosed, they were living in the house, they were using that house, they're in nice neighborhoods, they just got into trouble with their jobs and, and were no longer able to pay their mortgages. So you would— they would move out. And oftentimes the rehab— I remember work orders used to to say rehab interior, paint interior, paint exterior, clean up property.

Pretty simple, pretty simple work.

That might have been $20,000, and then it, you know, slowly inched up each year just with inflation. And as the market changed, and you have to work harder and harder and harder to find properties that fit the model, the rental model, all of a sudden we're buying homes that are in much, much worse condition because they've, they've been left in disrepair for so long. And so that has contributed to the increase in overall pricing for houses in order to yield at time. Exactly. And so there's, there's a lot of factors. And that's why it's pretty tough for an individual investor to step into a market, even a market that they know, and be successful without help to do it.

Right, right. And without, you know, and when you say investor, you're also talking about the do-it-yourselfers who are trying to do their own rehabs, and they're, they're just asking— that's just too hard. That business has matured so much. In the old days, you could do it, but now it's just become too sophisticated. There are just very, very successful companies out there that they're pros, as, as are you, man. I wouldn't want to compete with you guys. I'd get slaughtered. I just buy your stuff. I don't, I don't compete with trying to, trying to source the inventory myself. That's, that's too hard. And to do the rehab— well, hey, thank you very much for joining us. We pretty much did the whole show. At first I thought this would be an intro, but I've never been accused of being short-winded, so I appreciate you sticking with us.

No problem. It was a real pleasure.

Yeah, thank you. And listeners, go to JasonHartman.com, click on the properties link and check out some of our properties in our different markets. Also, some of the educational products at HartmanEducation.com that can really help you be a much better investor. We appreciate this information. I know all the listeners did, and I'm sure they learned a lot. It's good to hear kind of an insider's view, and that's what we heard today. So, so thank you again for joining us and sharing all this.

All right, real pleasure. Thank you, Jason Hartman.

I've never really thought of Jason as subversive, but I just found out that's what Wall Street considers him to be.

Really?

Now how is that possible at all?

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