CW 556 - Real Estate Absorption Rate, Cash Flow Investing in Chicago

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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 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.

Welcome to the Creating Wealth Show. This is your host, Jason Hartman. This is episode number 556. 556. And I hope you have been enjoying our talks recently about our upcoming event in San Diego. We are so excited about that. And that's at the end of August. And also of course, our Venture alliance event at at the end of September back in Newport, Rhode Island. Mansion tours, fall foliage. It's going to be awesome. But I have our local market specialist from Chicago here because we wanted to talk about a good listener question and kind of put him on the hot seat a little bit and I think he's game. Are you game?

Yep, I'm ready for it.

All right, you're ready for it. This is a, this listener asked a pretty good question and I will tell you though beforehand that I believe the latest update is he did go ahead and buy these six properties that he's talking about. But we will answer his question anyway because I thought it was good. And we, you know, we really value transparency and just, you know, if someone asks us a question that's a curve ball and it's hard to answer, you know, if it's going to be good content for the show, we're going to put it on. Okay, so we'll have that here in a moment. But first I wanted to talk to you about something that we haven't really talked much about on the last 555 episodes, and that is the concept of absorption rates. I have alluded to this a little bit, but we've never talked about it in a whole lot of depth. And what reminded me about bringing this up on the show is I got one of these really fancy schmancy newsletters from one of the local realtors here in my new home, La Jolla, California. This is obviously a very expensive, high end market and a beautiful place to live, overtaxed as it may be because it's in the socialist Republic of California. But it's a great place. And this market snapshot showed some interesting and our guest of course has it as well. So maybe we'll talk about this. And it's a good lead up to the listener question. So here's what it showed. 1.6 million as the median sales price for last month and 243 properties currently for sale in La Jolla and 71 properties or sorry, last month's average days on market was 71 days for the sold properties. Here's one of the things you got to be careful of with these statistics, right? Because that shows you the sold properties, it doesn't talk about the expired listings, the unsold properties, the properties taken off the market that could have had a longer average than 71 days. It's only for the sold properties. So just know that. And also know that this search was for single family residences and condos between $999,000 and $10 million. So obviously it's the high end market, right? Nothing like we would recommend you investing in. But it's kind of telling because we've talked a lot about on past episodes about how the ultra rich are getting ultra richer in our society as the middle class is under attack. No question about that. It has been for a few decades now. So back to the stats here. 71 days on for the sold properties last month. And get this, and you're going to love this, John, Compare this to the Chicago market. Okay? Sold price per square foot on average last month, $780. Whoa, you crazy? What do you think of that? I mean, you guys, you guys do new construction, you build stuff, you rehab stuff from the, from the sticks, right? You know, I mean, that's crazy.

Yeah. So $780 a square foot is just, is really unbelievable when you think about it. For us, if you talk about new construction from the ground up. I mean, we're saying $125, you know, let's call it a square foot. Now that's, that's not your fancy appliances or your fancy millwork, but it's a sustainable living house that's going to last, that's going to be maintenance free. So when I see $780 a square foot, that is really remarkable.

That is insanity. Now I've got to ask you just so to make sure we're comparing apples to apples. When you quote a number like $121 $25 a square foot, is that just construction or does that include the land value?

That would be just construction.

Okay. Because this does, to be fair, include the land value. But again, one of my whole points of the Hartman risk evaluator is that you shouldn't be investing in high land value markets because they are much more volat and much more risky. So the, you know, the construction cost here in La Jolla, if you built these, this, this property new that they're talking about, would probably be somewhere in. I'm gonna just. It could be all over the board. If it's really high end, you know, you could spend, you know, a few hundred dollars per square foot in just construction cost. And of course, you're in a very regulated place here in California, so that increases construction cost too. But you know, about the cheapest you're going to be able to build that house here is probably 1:50, maybe $170 per square foot. I'm kind of guessing in some of our low, low price markets, you can build for maybe $70 per square foot. So you're at 120. And what I'm telling you folks, the rest of that $780, it's all in the land value.

Yeah, that's a great point, Jason. When you talk about what you should look for or not look for, I mean, the land can always change in value, right? But when you're talking about materials, materials are really not subjective unless you're talking about very low end equipment or very high end. So it's a very interesting point.

Yeah, it definitely is. And that's what I say, be a commodities investor. Invest in assembled commodities or packaged commodities, which is the house sitting on the land. It's all assembled for you, but you own all of that lumber, all of those petroleum products, all of that copper wire, all of the glass and the steel and all the other, you know, the concrete, all the materials that go into it. I'm sure I'm missing some materials there, but you get the idea, right? And those commodities, you know, they swing in price a little bit too, but they're far less volatile than land prices. Land prices swinging dramatically. It says very scary pendulum. So just going on with this and then we'll talk about the market absorption rate. Okay. The median list price for the current listings is $2.6 million. I'm just gonna round off it's only five grand. At these prices, that's nothing. So $2.6 million and 78 properties sold in the last 60 days. And you know what, I looked at this quickly and I did my math wrong. It's interesting because I calculated this for the listeners on the absorption rate of 3.12 months of inventory. I guess I would have to double that because I thought that said 30 days and it's really 60 days. So that's kind of misleading. So let's just do that math again for the listeners. And basically I'm just going to cut the 78 number in half. So I'm going to take 78 divided by two, that's 39. And I'm going to assume, of course it's not a correct assumption, but I'm going to just average it, say that it's an average of 39 properties per month with 243 properties for sale. So all I'm going to do there is take 243 and I'm going to take 39 and divide it and it gives me an absorption rate of 6.23 months to absorb the inventory currently for sale. Now, of course, what we know is that new properties will come up for sale all the time, right? So in La Jolla right now, in this ridiculously high end market where the median list price is $2.6 million, it takes 6.23 months to absorb the inventory based on what this realtor sent me in his fancy full color, very expensive newsletter. You know, and this is a market that people would consider hot. Like, you know, things are going nuts here. People say, you know, I mean, it's starting to cool a bit. But overall, the past year or so, past couple of years, really in this market have been really, really strong. Any thoughts on that?

Yeah, you know what I really caught my eye, Jason, was I was looking at the median, the median list price of the homes and then comparing it to the median sales price. So I think you hit the nail on the head is that there's a lot of controversy or a lot of talk at how hot the market is. But I'm wondering if people are getting over ambitious in terms of what they're listing these homes for, because you're talking about almost a million dollar difference between the list price to the median sales price. Did you see that?

Yeah, I did and I'm glad you brought it up because that's a very, very good point. Now here's the problem with that though. You know, as you look at these statistics, I'm sure you've heard of that old book called how to Lie with statistics. Right. It's kind of famous and I have not read that book. I did buy it. You know, it's just too wonky for my little brain. But.

And I never took a statistics class in college or anything. But it's interesting. You just have to note that the median price home that's for sale and the median price home that's sold is not the same home. Right. You know, it could be that last month a few really high end properties sold, then a bunch of lower end properties came on the market. Right. Now this is not average, it's median. So the reason they use median a lot is because it doesn't knock the stats off very much like an average would. The median is just pick the middle one. Okay. Averages. Add them all up and divide by the total. As we all know, this is basic stuff, but. Yeah, so that, that's interesting. I mean, what do you make of that? You know, we have to say it's not necessarily the same house. Right. So that can be also misleading. Right?

Yeah, I think, I think for me, I mean, it's just, it's a big variant. So it tells me that that market, you've probably got some, some. Even though the market as a whole may be a high end market, you've got a big variance. You've got homes that will sell for significantly more than other homes, I think is what it tells me. If you think about our market here in Chicagoland, I think we're saying the average home price is close to $160,000. In Illinois, it may be $155,000, but I don't think you're going to see the kind of sway or variance that you see in this, in this smaller market that you mentioned where you live. So.

Yeah, and by the way, that's another very good point. This is a very small market. It's a small sample. And they only did 999, you know, basically a million dollars to $10 million. Which, by the way, you know, I mean, there are Certainly, you know, $800,000 properties here. Well, there's even some cheaper ones than that, but there are properties above 10 million. Okay. So, you know, it's kind of a funny market. You know, this isn't going to be a very good sample, but I just thought it was interesting to talk about absorption rates. Right.

And that's great, Jason. And when you talk about absorption rate, I think in our market, you know, I think that's where you'll see a big variance as well. I think that, you know, there are Parts of downtown Chicago, that river north or Gold coast or Streeterville, really the highest end markets where things are going above asking and they're going really before they go on the market or I don't know how that always works out with brokers and realtors, but it seems like they're on the market for a day and they went for significantly over.

Over the list price. You mean a bidding warren over the.

List price, but all within one day of going on the market. So it's, it's pretty fascinating. And then you can go to some areas where people invest in, not necessarily where we invest in, but areas that you invest in that the absorption rate can be closer to nine months to 12 months, just because there's a flooding of inventory or foreclosures that really dampen the market in those regions. Again, just a big variance in terms of absorption. Whereas areas that we work in per se, you know, could be anywhere between three to three to six months on, on average.

And, and I gotta just compliment you, by the way, you know, doing the tour with you recently was, was so great and you have such an awesome business model and, and just really, you know, really, really have quite a machine there going so, you know, going there. So it's, it's pretty awesome, you know, so, so good job there. Hey, let's take a tough question. How's that sound?

Let's go for it. I'm ready.

Okay, put your thinking cap on. This is a tough one. Here we go.

Hi, Jason, this is Jeff and I have a follow up question to our recent conversation regarding investments in Chicagoland. In a recent Flashback podcast, you mentioned not to get caught up in analysis by paralysis. I'm looking at six rental properties in the Chicagoland area with great rent to value numbers. However, I notice most of these properties are in areas served by schools with a 1 or 2 ranking on standardized test scores, which may be an impediment to attracting families to the area. Also, Zillow predicts price declines in these areas due to a backlog of foreclosures. Finally, demographic trends show population declines in much of Illinois, including Cook County. Am I getting caught up in analysis by paralysis or are these significant issues that should be weighed in whether or not to invest in this area? Thanks, Jason.

Okay, so that's a good question and it's a tough one. You know that, you know that I thought those were, those were good questions and they were tough questions. What are your thoughts?

You know, Jason, and this goes out to you, Jeff, that they are great questions and I'M glad that you asked them because that means if you're thinking of these questions, other people have them as well and they're sometimes the elephant in the room. So it's a lot easier to really just talk through them and understand why or why not to focus on them. So I think the first point was really talking about the school rankings or ratings. And the reality is that the federal government pays for some of the schools or incentives. But the reality is everything is on a tax basis in Chicagoland. So when you talk about the different regions of Chicago, you've got the, the northern suburbs which predominantly have the reputation of really, the rich live there, right? Price points, 750,000 to a million, let's call it on average, really nice areas. If you think of Risky Business or any of the movies that are shot Home Alone, those are the areas that you hear about. Now those school districts, you're going to hear New Trier, you're going to hear Lake Forest, you're going to hear Deerfield. Those people are paying on average $35,000 to $40,000 in taxes, okay, for one home. Now you go to the western suburbs and you're talking about prices anywhere from, let's call it $250,000 to $450,000. And they're going to have taxes that are going to be relative and they're going to have some really good school districts. You've got Naperville, you've got Plainfield. Those areas are going to have taxes, let's call it around $10,000 to $12,000. Now when you talk about the south and southwest suburbs, which is where Jeff was considering buying his homes, you're going to see that the schools are going to be rated.

In the lower category. And the reality of it is everything is relative, right? It doesn't mean that people are moving out. It doesn't mean that people don't live there. These are blue collar, working class Americans that are paying their own bills and they're going to live within their means and they're not going to get foreclosed on and they're not going to look for a government handout to get a subsidy or a voucher because they don't qualify. But they've got to put their kids through school. So what they do is they pick family oriented areas. And the areas that Jeff mentioned were family oriented areas. And, and I don't focus so much on the actual school district rating. We focus on what is this infrastructure of the school. And Jason, you can really speak to this. You drove through the neighborhood.

Oh, yeah, I saw them. They're nice.

Yeah, the facades are all well manicured.

They're much better than the schools I went to in Los Angeles. I mean, I went to Palms Junior High and Venice High, and they look like they're about to fall to the ground.

And by the way, the movie Grease was filmed at my school. Okay, Venice High. Tell me more, tell me more. That was our football benches. They did that whole thing. Yeah, right there.

That's too funny. So again, you know, my answer to Jeff would be everything. Everything is relative. It doesn't mean that it's any. Any worse or for families. It's just people living within their means. I think the second question said Zillow. Something about Zillow had some price decline.

Zillow predicting a price decline because of foreclosure inventory backlog.

You know, and what I would say is that you're absolutely right. Judicial Illinois is a judicial state, so there is a backlog of foreclosures. I am sitting on close to 75 homes since 2011 that our company would like to purchase.

But it's John. Hey, can you let me just explain that to the listeners, make sure they understand. So a judicial foreclosure state is Illinois, Florida, many other states. I don't know which one's exactly off the top of my head, but these. In these states, the foreclosures take a lot longer than they do in places like California, Arizona, where they have the trustee sales. Okay. And the judicial foreclosure basically is a lawsuit. In essence. You know, it's. You didn't pay the loan, you know, get out of the house. Right. And it takes a lot longer. And I think, personally, I'd love to get your opinion on this, that judicial foreclosure states, really, they're making a mistake because they have. Maybe they have less volatility. Well, I don't want to say that they do, but they have the likelihood of less volatility because the foreclosures happen more slowly. But they don't. They. It's like they kick the can down the road. It's like the same way our government operates with spending, spending. You know, we never want to take our medicine, so we just print more money, you know, and kick the can down the road. And so that's kind of what happens in these judicial foreclosure states. What are your thoughts on that? But. And then just try to remember what you were actually saying before I interrupted you.

Yeah, you know, I would. I would say that. I would say they're less volatile and you see the changes take, take longer. Right. So I mean if our decline, most people's decline was in 2008, 9. But you know, we were really, we were declining from 2008 really to 2012. Then 2012, you started to see the uptick in Chicago or Chicagoland. Again, everything is relative. One thing that I don't like about Zillow and I always tell any investor I get on the phone with who tries to spit out facts or anything from any of these third party sites is you have to take apples to apples. They're going to take all of the homes in the market and they're going to average them together. They're not going to take the homes that are redeveloped or rehabbed. They're not going to take the homes that were bank owned or the homes that were traditional sales. So everything really gets mish moshed in a bowl and spit out to you. So I wouldn't focus too much, and I'd say this to Jeff himself, I wouldn't focus too much on, on what Zillow predicts the pricing to be. I can tell you that I've been in the industry for eight years. I was born raised here. The houses that we are selling today, which are appraised and backed by Fannie and Freddie, just conventional financing, have gone up to the tune of about 2% on average each year. I'm seeing it when I sell the homes, I'm seeing it when I buy the homes. I wouldn't focus too much on that. That would be my answer.

So 2%, that's nothing to write home about. I mean, what do you say to that? Not too exciting to have 2%. Although if you're leveraging 2%, that's basically.

10% on 20% down. That's what it turns into, very roughly.

Exactly. I would say that the markets that are slower to recover are also going to be the markets that are going to be more stable to invest in or the markets that I think at least I can speak in our market that you're going to have a really nice product. And the product, what I mean is that you're going to have a product that's going to have an appreciation. But because the prices are still so low, when you talk about other markets, they've gone above and beyond what the bubble was in 2008. You're really banking or hoping on cash flow. But you should be concerned because you've now hit the ceiling for us. You've got some really nice uptick in terms of values. But you also have that nice hybrid model where you're getting the cash flow. So cash flow is king in some sense.

That's one of the things that I think cannot be understated. There are many things I don't like about Chicago. I don't like the weather. I don't like the government and I don't like the high taxes which are a result of government. The weather is not the government's fault. Rahm Emanuel and Obama didn't do that. Okay, but that's what I don't like about it. But I'll tell you something, it's a fun city. It's obviously a world class city. If you go, you know, and I just say do this test, you know, if you go and you ask someone in Europe have they ever been to the US and say, they say no. Oh, well, you know, do you want to go? Oh yeah, I definitely want to go to the America. They always say that, right? Then you ask them where they would go. They'll say New York, San Francisco, Louisiana. And the fourth choice will be Chicago. Okay. It's, it's, you know, it's, it's on the map. I mean, many of the other cities we do business in aren't really on the world map like that, you know, in the top of mind recognition like that. Would you agree with that?

Yeah, I would. I mean, listen, I deal with investors in a of lot 11 different countries. And when they talk to me and they ask me my opinion, I always take off my hat of where I work and I say, listen, if I'm an investor, I want to go to a market that's a bustling, thriving market. Because at the end of the day, your investment is only as solid as the person who's occupying it. Go just to the basics. You need a thriving market with a diverse economy. Chicago actually has the most diverse economy out of the four metros. Really? Out of any, out of any state in the U.S. so there's the job front. And then you talk about affordable housing.

And then you talk about population. 10 million people throughout Chicagoland, 42% of which are renters.

It's a great market when you're thinking of overall picture. And that's what I always tell people. Don't get bogged down on one or more items. Look at the picture as a whole.

Well, those cities that I mentioned to you when I gave that example of the European, you can't do anything investment wise that makes any sense in any of them except the Chicagoland area. Now, of course we're not talking about the city. We're talking about the suburbs. Here you can't touch anything near New York, L.A. or San Francisco that makes any sense at all. But here, you can do it, you know? And that's why Meredith Whitney. Was it Meredith Whitney or Consuelo Mac? I had them both on my show. I think it was Consuelo Mac, the news anchor. She said that the Midwest is her favorite emerging market. I thought that was an interesting way to say that.

That's interesting. I think that's a great segue into. I think Jeff had a third question, and it was he's concerned about population declines. And all I can tell you is this, is that I consider myself a millennial. I'm 31 years old. I went out to school for college in the States, United University of Oregon. I went out to a boarding school for high school.

First of all, you are only 31. You are so ahead of your years. I mean, you don't look it, don't get me wrong. But wow, I'm amazed. You're a millennial. You're a Gen Y. Wow, that's amazing.

Yeah. And so. And so I take. I take my. I take my peers, and you look at everyone that went to Wisconsin or everyone that went to Indiana or Michigan or Nebraska. All of those friends that I have are all moving to Chicago. Why? Because it's affordable living and it's an awesome city. You get everything that you'd want from a New York in terms of accessibility to things. You get everything from a relaxation standpoint that you get from California. We get beaches, but let's face it, it's not 12 months out of the year just means we appreciate the three months. But what's most interesting is Van Lines did a study in 2014, and Chicago is actually the most moved to destination in their book of business. So that's what I would tell you, Jeff, is people are moving here. People like the accessibility. They're not interested in buying homes. My friends aren't interested in buying homes. They're worried about their job changes or movement. Their priority is their family. They're spending their money on.

The education of their kids. And homeownership today is really just not what it used to be.

Yeah, I agree with you. That's an interesting point. It's great to own a lot of little rental properties. You can rent to other people. Just rent your own house because you're mobile. And the young mobile class, that is very mobile nowadays, they would be very attracted to a place like Chicago. So I agree with you. And where else can you get such good cash flow in a real city type environment? You know, I mean suburbs obviously, but in a world class, the Chicago land area as they call it. Okay, so, so good points. Okay with that. You know what, I guess we went long enough. This will be an entire episode. So I just want to remind our listeners, join us in San Diego. I was working on the content for that event, Jason Hartman University Live. And by the way, you'll be there too, which is going to be exciting. You're going to be speaking, talking about Chicago. So if you want to get some in person info and then we're going to have tell us a little bit about one of your lenders that is going to be present as well, his specialty and so forth. He's going to be at the San Diego event.

Sure. Yeah. So we're bringing our preferred lender to the event and it's someone that is in the top 1% of all originators in the nation. And, and why that really makes a difference, guys, is because it's a volume business. The same way we're able to sell homes at a reasonable price and have them cap out between 8 and 10% and have some nice cash flow is because it's a volume business. We're not trying to be greedy or make so much money on every home. And that goes the same for our lender. Our lender is really giving the best rates that's out there because in reality we're sending 15 to 20 deals a month to this person. But what's really unique is the subject to appraisals, the accessibility of an underwriter, who sits next to the originator, who sits next to the processor, who sits next to the closer. So I think that business is all about accountability. And with this group you get total accountability.

Yeah, yeah, that's good. It'll be refreshing to have another lender at our events. You know, we've had three different lenders that have spoken at a lot of our events. So it's going to be nice. Get a fresh perspective on that. So go and register@jasonhartman.com in the events section if you want 30% off on that event. We're in the last segment of Early Bird pricing, not in level two, level three. And you'll get 30% off though, if you'll just take three minutes to write us a review on itunes. Send a screenshot to reviewsjasonhartman.com reviewsasonhartman.com I'll send you back a promo code for 30% off. That's my ethical bribe. First time I've ever used one. But I'm I'm envious of all my podcaster friends who have so many reviews and that's how they're doing it. So I'm copying them. They're also having a lot of fake reviews too, but we don't engage in that practice. So anyway, if you want to do that, join us for for that event and also check out the Venture alliance stuff by just asking your investment counselor about it. And we'll be glad to send you some info about that event as well. Thank you so much for joining us and being on the hot seat. Tough question Jeff. Thank you for your question. Submit any questions you have@jason hartman.com right on the right hand side of the website there's a little voicemail tab and you can just leave us a message and we will answer your question on the show. So please do that. Jason hartman.com use the voicemail tab. Ask a question. Our listeners love those questions from other listeners and investors. So thank you so much. We'll talk to you on the next episode.

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