CW 522 FBF - Land-to-Improvement Ratios & Regression to Replacement Cost with Jason Hartman

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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 multimillionaire who not only talks the talk, but walks the walk. He's been a successful investor for 20 years and currently owns properties 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.

Hey, welcome to the Creating wealth show. This is your host Jason Hartman for episode number 461. Got a lot of great feedback on the last few episodes. Of course we had Daniel Pink on for episode 460. We had two great case studies. Fernando on with 459 talking about how he acquired 70 units through us and and then David Porter before that on 458 talking about all of his properties that he got through our network and just some great stuff. So keep up the feedback and the listening and thank you so much for writing the great reviews on itunes and Stitcher radio and soundcloud we really appreciate that, so thank you for that. We've got our big Meet the Masters event coming up in just a few days. I think we literally have two seats left. I have not checked but as of yesterday we had four and I pretty.

Sure two people registered.

They said they were registering. So I think we have exactly two seats left for Masters. So if you want to join us, go to jasonhartman.com and get registered for that before those are taken. They'll probably go today or the next day for sure. We're just looking forward to a fantastic Meet the Masters, our best ever, the 16th Masters that I've done and just going to be a fantastic time. So look forward to seeing you there. And just for the attendees, I wanted to make a quick announcement before we get to our content today and that is we are starting Saturday morning at 9:00am that's the start. But be there for coffee and registration. Maybe a muffin, don't get too many carbohydrates. I need you to stay awake but have some coffee at 8:30am for registration. It's gonna be a full room so please do arrive at 8:30 or 8:45 at the latest so you can get seated and situated. We're gonna go till 9pm on Saturday.

So I know that's a long 12.

Hour day, but we're gonna have a couple fun breaks of course for lunch and dinner together. And yes, we will be serving alcohol at dinner and then we're gonna come back in the room after that. Can you imagine?

Remember you're listening to Flashback Friday. Our new episodes are published every Monday and Wednesday. Anyway, that'll be fun. And then we go Sunday again, registration at 8:30 and then we go from 9 to 6 on Sunday. So we're looking forward to a fantastic event coming up. You know, we had about.

What was that?

About a month And a half, two months ago we had an iTunes problem and I recorded some very important episodes during that time and I asked. There were about six that weren't posting for about two weeks and it was driving us crazy. We got it figured out. Those episodes did post and there was a spike in the downloads, but I wanted to make sure you listen to them. And I don't think we have ever replayed an episode on the Creating wealth show however, and I don't. I'm not going to replay an episode for you today. I'm just going to replay part of an episode for you and it's from 34 episodes ago. Because this is so critically important. It's so critically important that you understand the concept of regression to replacement cost and LTI ratios or land to improvement value ratios. So today I wanted to review this concept by replaying just a portion of that episode for you today. We're gonna go back in time and just do a review on that for you. This will very important as a prep for Meet the Masters coming up this weekend. So let's listen to that then on Wednesday and Friday. Even on Friday. I know even if we're setting up for Meet the Masters, we're going to have a couple great episodes coming up.

For you there too.

So let's jump in and here is some very important info on the topic of regression to replacement cost and land to improvement or LTI ratios. Because as prudent investors understanding how to evaluate risk on a deal and understanding how to evaluate appreciation on a deal, we must separate the property into its two component parts. One component is land value. The other component is improvement value. And improvement in our world is the house or the apartment building sitting on that land. These are two vastly different things. As you have heard me say on prior shows, I don't even really like.

Real estate that much.

What I like is investing in what I call packaged commodities or assembled commodities. That's really a major portion of the game for me. Now, the land is okay. I believe it was Will Rogers who said, invest in land. They're not making any more of it. And you know, that's true. But the fact is there is a lot of land in the world. Okay, any of you have flown over the United States recently, you know, there's.

A lot of land.

Now granted, there's not much land that's well located, but there's still a lot of land. So these two things are very important to understand, but especially the improvement component and the regression to replacement cost component. So let's listen into this and we will see you on Wednesday's episode as well. But let's listen in and do a quick review here of regression to replacement cost and construction costs.

So here we go. I want to talk to you about construction cost and when we're investing. As you know, my, my very unique risk evaluator model relies fairly extensively on construction cost and land cost as a way to determine how to minimize risk when investing in real estate. And it took me 19 years to discover that. And so far as I know, it is completely original thought. And my insurance broker at the time helped me discover that on one of my first nationwide property purchases. Before that, I had pretty much been confined to Investing in California. And I did not realize there was a whole new, wonderful, beautiful world of investing out there and great opportunities and I didn't have to rely on this speculative roller coaster of the California cycle to invest in properties. And it's been a great, great ride since then. So what I want to talk to you about today is different construction cost. And this was inspired by article that just came out. And this is the, the nahb, the national association of Home Builders. And they of course discuss economics and housing policy. And they did an article and it is about construction cost per square foot, what it cost to build properties in these various areas. And they look at contract price per square foot of new contractor built single family houses started in 2013. And this is very, very enlightening. And you know, before I've talked about what I call, and this is one of my little trademark terms, trying to add to the language here of real estate investing. And it is called regression to replacement cost. Regression to replacement cost. And this example that I give you, actually two examples, has a lot to do with it. So we know that the riskiest markets are high land value markets because those are the markets that, that are cyclical in nature and they have big highs and big lows and really ugly lows. And people lose fortunes in those markets if they don't time it just right. And we also know, and I've talked about this on prior episodes as well, and that is that over time the linear markets tend to do just as well as the cyclical markets or even better in many cases. And I've given the example of Kansas City, Missouri compared to Orange County, California, you would think high flying Orange county, my former hometown, would be the one that would win because they have such extreme upsides in the market. But over the course of 18 years, Kansas City actually outperformed Orange county in the example I gave where Orange county averaged appreciation. And I'm just doing this from memory here folks, but I think it was 5.2% on average and Kansas City was 5.8% on average. And remember the devastating things about these cyclical markets is that you give so much back when there's a downtime. And in these downtimes, which are very hard to predict, as you know, I have never met or known of anybody, any guru, any economist that can accurately predict appreciation and depreciation. And the prudent income property investor is the investor who invests based on cash flow. And if the appreciation comes, it is icing on the cake. It's wonderful when it happens. But let's not count on it. Let's just have that be a pleasant surprise. So when you look around the country, according to this national association of Home Builders NAHB survey, you see that in the Pacific region, that includes California, Oregon, Washington and Alaska, the average or no, this is median prices. Sorry, There is a difference between median and average statistically and sometimes I prefer average to median. But again, this, that's a whole other discussion for statisticians. And I could chime in on it, but I, I don't know if I can lead that discussion because I'm not an expert, but never took statistics class in college. I should have taken that one. I really would have liked to have been able to understand that stuff better. Anyway, the Pacific region, the median price per square foot is $145. In the mountain region, which includes, you know, Nevada, Arizona, Colorado, and you know, all these states right in there, the four corner states, the median price per square foot of a single family home is $107 per square foot versus Pacific at $145. Now, occasionally you can have actual cost of construction that makes this happen, but the thing you've mostly got here in these variants in prices is you've got a regulatory environment which makes it more difficult to build. So that will drive the price up. But also you have higher priced markets. And when you have a higher cost of living place where you're hiring people, hiring contractors and all these subcontractors to build a house, of course you have to pay them more because they have to be able to afford to live in the place in which they work. Right? And so that drives up prices a lot too. So the Mountain region, $107 per square foot, Pacific, $145. The West north central region, it's called, which is kind of this area that would include Illinois and just kind of that area above Texas. Okay, so that is $103 per square foot on the median price to build a single family home in the west south central region. And that includes Texas and all the states around Texas. It's only, get this folks, $85 per square foot. $85 per square foot. And then the east South Central, which is just a little bit east of Texas, is $84 per square foot. Not much of a difference there. Those are both regions in which we like to invest. And then they pulled out another region here, they call it the South Atlantic region. So that'll include Florida, Georgia, the Carolinas, and that is $88 per square foot. And mid Atlantic, which is a little Bit above that as we get close to the expensive areas, is $103 per square foot. And the New England states way back up, just like the west coast, the Pacific region, at 4, $143 per square foot. Okay. And. Oh, and then you have the east north central region, which is near the Great lakes, and that's $90 per square foot. Okay.

Just a reminder, you're listening to Flashback Friday. Our new episodes are published every Monday and every Wednesday.

So you see how these prices vary pretty significantly around the country. What does this mean to us? Well, before I get to that, I want to tell you that the median for the entire country, by the way, is $93 per square foot. And none of these numbers include land value. They all exclude the value of the improved lot on which the house is sitting. Now, what do they mean by improved lot? What they mean is a finished lot that is ready to build a house on, you know, so it's graded, it's compacted, it has utilities pulled to the curb. And so a contractor can go and build a house there. It's ready to be built. Okay, so $93 per square foot is the US median price. Now, what does this mean to us? Well, it's pretty darn exciting because, as you know, next month, November 21st, I think it's November 21st and 22nd, or 22nd and 23rd. Forgive me for not having the dates on hand, but that is our Birmingham property tour. So I want to talk to you about a property that is available right now in Birmingham and compare it with some of these numbers, and you will find them to be rather interesting. Here. I've got a great property in Birmingham. It is for sale right now. You can go to jasonhartman.com click on Properties, and you can find this exact property. And it is 1104 square feet, and it's priced at $70,900. So that comes out to $64 per square foot that you see right on the pro forma. And now let's take the land value out of it. So I am going to just take a very rough guess here, not knowing what the land value is. And there are three ways that you would basically know the land value. One is the property tax assessor has their own opinion of land value. Of course, these opinions vary. Nobody exactly knows. So they're all an estimate, but they give you some idea. So the property tax assessor, they separate the improvement, the house sitting on the land or the apartment building sitting on the land from the value of the land. Itself. That is one way you would have a clue as to the land value versus the improvement or the house sitting on the land. And it's very important to dissect this and look at both parts of the value driving equation. Another way is you would get an insurance quote and the insurance company doesn't insure the land because the land won't burn down. But the house might burn down. And if the house burns down, they will have to pay to rebuild that house or at least pay some portion after you haggle with them and possibly have to hire a lawyer to haggle with them or even sue them to pay the claim. You know how this can go sometimes. And that's why I always say the best insurance is a high loan balance. Let your lender haggle with them. Let them work with your insurance company to protect their collateral. Okay, this property, I'm going to estimate the land value just as a very rough estimate at $25,000. And the three ways you can find that out. I didn't tell you the third. Here it is. It's an appraisal. An appraiser will make an attempt to dissect the land value versus the improvement value as well. So three sources that I'm aware of, the tax collector, tax assessor for property taxes, an insurance broker, an insurance company that's selling you a policy on the property, and an appraiser. So let's say, just for argument's sake, for discussion sake, that this land is worth $25,000. So let's look at the land cost per square foot, not per square foot of the land, per square foot of the house. Because I want you to see how much of this equation is potentially land cost. Because we know we can purchase this property for $64 per square foot. But if you take $25,000 and divide it not by the square footage of the land, but by the square footage of the house sitting on the land, we're going to divide it by 1104, which is the square footage here. And that means our land value integrated with the house value is $22.64 per square foot. Now let's look at this. Let's take the purchase price of $70,900, subtract $25,000, leaving us with $45,900. So we took the price of both the land and the house. Let's subtract out the potential land value, and that's my estimate of 25,000. Let's look at 5. 45,900 is the value of the structure or the house sitting on the land. The value of the improvement. Let's divide that by the square footage of 1104, and that means that the house cost is $41.58 per square foot. Well, I hope you're getting excited, because I am. Remember, I've talked on prior episodes about my trademark term regression to replacement cost. And the beautiful thing is that you can still fetch a few properties out there. Again, these are drying up. There aren't that many. There is real urgency to be investing because prices have definitely been going up and they continue to go up, and business is very, very strong. So you're going to constantly see a lack of inventory, at least now. And so Here you're at $41.58 cents per square foot is our potential for a calculation that we made in this region. According to the national association of Home builders, it cost $85 per square foot to build a house. Now, this house isn't brand new, but it was renovated this year, so it's brand newly renovated. Okay? So, of course, you know, there is a difference between a new house and an old house. And some people really like older homes better. I mean, there are benefits of older homes. They just tend to have more generous spaces in a lot of ways. And I don't know, they just obviously have a very different style. Some like newer. It just depends. And many people would argue that older homes are built better than newer homes. I don't know. I think older homes were maybe built with a little more care and quality, but newer homes are built with a little more technology. And so we could have that debate for a long time. But let's not bother to rebuild this house. If it burned down, an insurance company would probably spend about $85 per square foot, according to the national association of Home Builders. Okay. And they have lots of members that build homes, so they should know. So if we take $85 per square foot, their number for construction, and we multiply it times the square footage of 1104, we can see that it would cost $93,840 to build this home today. Well, you can buy it for 70,900. So right there, you've got about $22,000 or $23,000 of potential gain already. Oh, you say. But wait a second, because we didn't include the land value. That's just the improvement. It's just the house. It's just the house sitting on the land. What about the cost of the land? Well, let's add back in $25,000, our potential lot value estimate. And then we add those two together. 93,840 to build the house, plus 25,000 for the land. And we get a grand total here of $118,840. So we'll just call it $119,000. That means when all of those construction materials are worth what they actually cost. And I know that's kind of a funny thing to say. You know, it's like the concept of, and I've said it before, when a piece of wood is worth what a piece of wood costs. Again, I used to say that during the down market to illustrate my regression to replacement cost concept and my philosophy. When it regresses toward the actual replacement cost, you have a potential gain in this property. And this is not really the same thing as appreciation. Regression to replacement cost. I would argue that that's homeostasis. It's equilibrium. It's just what it should be worth intrinsically. You have a gain potentially here of $47,940. Now, that's pretty great. Okay, that is pretty darn awesome. You can see examples. There aren't as many as there used to be. But if you go to jasonhartman.com and you click on Properties and you start browsing through all of the property performas, you will see several examples. Not as many as you used to, because prices have gone up and they continue to rise. You will see examples of some lucky deals that you can still get where properties are priced below replacement cost. This is a good example of that. And if you want to see more properties like this, join us next month in late November as we look just the weekend before Thanksgiving, as we look at properties in Birmingham, Alabama. And just like this property that I just told you about, where you are buying below the cost of construction, you've got regression to replacement cost opportunity built into the equation. One of the things I do is I will not allow our local market specialists to represent their properties as being below market value. Even though, in my opinion, many of them are below market value, I will not allow them to represent the properties that way. So when you look on the performance that you see@jasonhartman.com you'll see one number for initial market value and another number for purchase price. And those numbers should always be the same, unless they snuck one by us and we didn't catch it. But those should always be the same. But when you understand the math of the two components of an income property investment, the land component and the improvement or the structure sitting on the Land component, the house or the apartment building, or, you know, if it were a commercial property, it could be an office building or an industrial building or a retail building, whatever. The point is, there are two value drivers in any real estate equation. One is the land, the other is the improvement sitting on the land. And you've really got to dissect those and understand them. One reason also is because you only depreciate the improvement on your tax return, not the land. The land will always be there. So the IRS does not allow you to have this awesome depreciation opportunity. And I should mention, for those of you who are the gamblers and the speculators out there who like to invest in expensive markets, I'll call them overpriced markets, whether they be California, the New England states, as we just saw, or whatever, you know, if they're Miami, you know, these, these expensive markets. Remember, you don't get nearly as much tax benefit in those markets because your land cost is so high and your improvement cost is so low as a ratio to land cost. And you only get to depreciate the improvement cost. The example I give when I talk about the risk evaluator and how to really, really reduce risk, if you want to hear more about this, just go to jasonhartman.com and there's a little search bar on the website. Just go ahead and search the Hartman Risk evaluator, okay? And you'll find prior podcasts where I've talked about that extensively and some blog posts and so forth that explain it. And you know, you really increase your risk when you invest in high land value markets, but you also massively decrease your tax benefits and of course your cash flow. And of course, we are prudent cash flow investors. We're not the gamblers, we're not the speculators. We're on the conservative side. So in this property that I've been talking about with you, I'll just tell you a few more things about it before we get to our guest. The projected return on investment overall on this property is 38% annually. 38% annually. Cash on cash return projection 15% and cap rate or capitalization rate, 9.7%. And get this, your debt coverage ratio with 25% down is 2,2. That means you have your property could go out, go badly half the time, and you'll still cover your debt service on this property because you've got a debt ratio, a debt coverage ratio of 2.00. A lot of our properties, they have debt coverage ratios of 1.4, 1.6, 1.8, something like that. I've actually been looking for one for you. That is a two, and this is a two. So what a champ. I mean, this property has a projected cash flow of $3,400, a little over $3,400 annually. So. And you know, that's with your maintenance, your property management, your vacancy, all imputed into that equation. So make sure you really know how to analyze these deals, folks. And another thing I just want to recommend is the podcast I have several episodes ago on how to read a property performer and the YouTube video that shows the visual. And you can follow along on how to read a property performer. Just look for that and it is a fantastic tool. It will make you a better Investor. It's on YouTube. If you look for our YouTube channel at Jason Hartman Media or you just type how to read a property performer, you can probably find it. You know, just add my name to it and you'll find that. And it's just a great lesson on how to read that. But it doesn't talk really much at all about this land to improvement value equation that I just shared with you. So this is for advanced investors who really are thinking about all the multidimensional aspects of their income property investments. And I know that's you because you listen to the show and you want to know more and you want to be a more prudent, more sophisticated investor. So thank you for doing that and thank you for doing your homework and really studying this stuff. And please do if you like the show or even if you hate the show, go write a review for us on itunes. We had a few reviews come in last week and I really appreciate that. I know I never ask, but it really helps us get the word out there about the show. So please take a moment and go to Stitcher radio or itunes or write a review. You can do it in just three minutes or less. And we really appreciate that.

So thank you very much.

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?

Simple. Wall street believes that real estate investors are dangerous to their schemes because the dirty truth about income property is that it actually works in real life.

I know. I mean, how many people do you know, not including insiders who created wealth with stocks, bonds and mutual funds? Those options are for people who only want to pretend they're getting ahead.

Stocks and other non direct traded assets are a losing game for most people. The typical scenario is you make a little, you lose a little and spin your wheels for decades.

That's because the corporate crooks running the stock and bond investing game will always see to it that they win. This means unless you're one of them, you will not win.

And unluckily for Wall Street, Jason has a unique ability to make the everyday person understand investing the way it should be. He shows them a world where anything less than a 26% annual return is disappointing.

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