Episode 18 - Zillow, Airbnb & Real Estate with Special Guest: Kevin Clark

Welcome everybody. I'm here with Owner Occupied Episode 18. Today we have special guest Kevin Clark. Kevin is an adjunct professor at NYU with a lot of real estate background.. And he and I get into a really great discussion today. We start with a little bit of his background and, and what he's been up to. Then we jump right into Zillow and Airbnb and talk about how he and I first engaged on Twitter and our each unique perspectives on where we see the future of those two platforms going as it relates to rental real estate. We move right into a discussion on real estate commissions and the NAR. And why real estate brokerages and commission structures are set up the way they are today. We actually get into a pretty heated discussion about why we each feel like things are the way they are and how they could be better. Some really fun kind of back and forth there. And then everyone's favorite topic, real estate as an inflation hedge or not. Kevin is a little bit famous on Twitter for his position that real estate is actually not an inflation hedge.. So I pick his brain on that and kind of push back a little to sort of uncover some of his thinking there. And then we wrap up with a discussion of some of Kevin's favorite and least favorite deals that he's done. So thanks for tuning in. And I'll jump right into it here. All right, Kevin, let's get started. Welcome to Owner Occupied, everybody. I'm thrilled to have our third ever guest on the show, Kevin Clark. And Kevin and I are excited to have a good conversation today and hopefully bring some great value as we sort of traipse through some of the hot topics in real estate today and lean on Kevin's deep knowledge here. So Kevin, if you wouldn't mind, maybe start with just a couple minutes on who you are and what your background is a little bit.

Sure. Thanks, Peter. Thanks for having me. Appreciate it. Yeah, so I'm Kevin Clark. I am a I'm a real estate professional based in New York. I've been doing this about 20 years, a little less than 20 years here in New York. Prior to getting into real estate, I was in university fundraising for about 7 years, primarily at the University of Michigan in Ann Arbor, and then in New York. During that time, I went back to school, got my graduate degree in real estate finance at NYU. Shortly thereafter, was asked to teach the real estate economics and market analysis classes as And I've been a member of the faculty there since 2007 or so, give or take. Yeah, so went back to grad school, got into real estate, did asset management at the portfolio level— I'm sorry, portfolio management for a pension fund business called ING Clarion. And then didn't really like that, but had an opportunity to get on the deal side when we were selling a few assets, really liked that part of the business, so decided to transition into brokerage. Went to work for a company called Massey Knackle for a few years and then went out on my own in 2008 and have been primarily doing that as sort of a broker advisor and still continue to teach on the side.

Okay, awesome. So lots, lots there. So are classes back in person at NYU or is it still virtual?

Yeah, well, yeah, you know, we, um, NYU had a, um, had a hybrid program, um, where students were allowed to select either in person or online. So although I've been teaching online there since around 2010, we— NYU actually put a— had a pretty big push into online learning, and I had the opportunity to develop a curriculum for our core class there. And so I was very familiar with it, but— and I do teach— I actually teach live and I teach online, same lecture class. So it's great for the students' continuity, but we did have, we had this period of 2 semesters where students could either come to campus or stay home. And it's the worst of both worlds, right? You can, teaching in person is great, it's very dynamic and interactive. Teaching online can be great also if you work hard at it, but combining the 2, it's pretty funny. But in the fall, they're supposed to come back. So that should be great, hopefully. Awesome.

And before we move on from your teaching career, uh, if I remember correctly, didn't you have Moses, uh, Kagan come in and do a little guest lecture there?

How'd that go? I, I did. I did. I had, uh, I, I did. I was, I was hoping to have you as well. I think where you're on the agenda as well. Um, Moses was great. It was, uh, it was, it was, uh, it was great. He's a good, he's a, he's a very casual, um, very smart guy, but a very casual way of talking about his experience. He's very humble. And it was great because a lot of the students, you know, these are grad students who, you know, most of them are either finance or development focused. So, you know, what Moses is doing is I think what many of them dream to do. So it was a, it was a fantastic, and I'm really hoping to lean into real estate Twitter and get a bunch of people in. Awesome. This, this summer semester is really short. So I don't know that we'll even get any in there. But But regular classes, I'm hoping to get at least a couple a semester.

Very cool. Well, you know, we met on Twitter and, you know, I think we followed each other for a while here. One of the things I've always appreciated about your perspective that you bring to the real estate Twitter community is you bring, I think, a more rigorous economic approach or perspective to the conversation. With maybe a little bit of that, maybe ivory tower would be the cynical way to describe it. But you have an ability to look at things in a macro way that I think a lot of local real estate investors don't necessarily think about all the time. So I think that, you know, maybe a theme through our discussion today. Let's go back a little bit to one of the things we were discussing recently on Twitter was about Zillow. I've had this thesis for a while now that Zillow and Airbnb have the ability to come into long-term rentals and really disrupt that market quite a bit. I feel like their market power is such that because they've controlled and captured the consumer mindshare, they have the ability now to act as an intermediary between potential tenants and landlords, and because of that, extract a lot of value from that relationship. So I'm trying to remember what it was actually that you and I were kind of sparring over related to that. Is this ringing a bell for you at all?

Yeah, I mean, I think you were saying, you know, Airbnb sort of moving into the— I don't want to put words in your mouth, but I think the conversation was sort of that when we have dominant players like Zillow or Airbnb come into the mix, it's going to end brokerage or end the status quo the way it is right now. I think my position was more, I think it's a huge business, and I think that there are certainly areas where Zillow and Airbnb very well will probably try to make inroads in that market, but I think the economics and not the ivory tower economics, I think the literal balancing the books of doing that kind of business is I think pretty misunderstood in the, not from your perspective, but I think it's an expensive proposition to have people showing apartments. And it's very time intensive. I mean, I think some operators, and I would consider you in that group, sort of professionally managing properties where you know your inventory, you know you have a, you know, you have a, you get in there, you get it painted and cleaned, and you get the process, that's going really quickly. The reality is, is even at the professional level, that's a relatively an unusual thing. Many landlords do not communicate with their tenants very well. They don't know that the tenants are leaving. And these are billion-dollar companies, not just mom-and-pops. Mom-and-pops struggle with this, particularly because a lot of mom-and-pops are not making their money, their primary revenue from their real estate. It's sort of passive because they're doing something else. And so the management intensiveness of that, I think that Zillow could do it. I don't think it's a particularly profitable business, so I don't necessarily think that they will do that except in the low-hanging fruit area where Airbnb, I think, was bragging about the fact that 60% of their rentals are a month or longer in New York City. Well, part of that is because it's illegal to do Airbnbs in New York City. The fact that they have that they're not breaking the law, good for them.

But I think— Only 60% of the time not breaking the law, apparently.

Right, right. And I think on the more— the other 40%, I think you're allowed to rent out a room, and there's that sort of thing, the traditional way to do it. But renting an apartment, you can't do for less than 30 days in New York anyway. So anyway, I think my larger point is, I think, I mean, this is a massive, massive business, extremely fragmented, and I think I would rather hear the narrative that hungry, ambitious real estate agents and brokers want to come in and try to make the market a better place than being afraid of Zillow, which Zillow hasn't made a dime in their iBusiness, in their iBrokerage business. IBuying business, I'm sorry. So, um, you know, they've got a lot of things they're trying to do which on paper seem like they should do well, but they're very challenging. And, um, and the market's a very smart market. I mean, the information is readily available to just about anybody who wants to look for it.

So yeah, so I think there's so many good things to unpack here. So there's a few different topics. One of them is Airbnb and/or Zillow inserting themselves further into the, into the rental real estate marketplace, which I have a lot of thoughts on that because that is directly in my wheelhouse. Something, another interesting topic is Zillow, and I'm gonna, I'm gonna go further with that in a second. Another interesting topic here is Zillow's iBuyer slash becoming a broker slash the general topic of real estate commissions as it relates to home sales, right? So, right, you know, famously, the United States has an incredibly high commission or cost of transacting property. It's 6% is pretty standard, 5-6%, other countries much, much lower. That is a, you know, there's, you know, that we could talk about that, make a whole podcast on that. Sure. So backing up to Zillow for a second and Airbnb, my thinking on this is Zillow and Airbnb have consolidated demand or they've consolidated market mindshare of consumers. So to, to put an edge on this, we can't lease property around here without using Zillow. Like not, not effectively, not in a reasonable length of time. So For years and years, it was free to advertise on Zillow. Over time, Zillow acquired Trulia, they acquired HotPads, they've acquired a number of other internet listing sites that we use to advertise our rentals because that's where people are looking. Well, here within the last year or two, Zillow sufficiently combined enough market share, so now they charge. Property managers across the country are paying anywhere from about $0.80 per listing per day, up to like $2 to $3, depending on how many units you have listed for rent. And actually, it varies by geography as well. And basically, Zillow was like, hey, we have, we have the attention of the people who want to rent your properties. If you would like access to them, you need to pay a fee.

Great.

If you look at their financials, that's a relatively small portion of their overall revenue, of course, but it's growing quickly. What I think it speaks to is the fact that Zillow now— that's, in my mind, only step 1, charging a fee. Because they've captured that demand, there's a lot of other things they can do. Let me give some examples. Zillow could start enforcing a standard rental application fee. Zillow could start enforcing a standard rental application. It's like, hey, you want to list your properties for rent on Zillow? You need to use our standard rental application because we think it makes for a better consumer experience. Zillow could start enforcing standard lease terms. You want to post your properties for rent on Zillow.com? You need to agree to use our standard lease, and the lease is going to be, you know, fair and balanced in regards to the power dynamic between the landlord and the tenant. I don't ever envision Zillow actually physically managing properties like showing, you know, employing people to go show units or dealing with turning over the units between tenants., I could absolutely see them doing the things I just mentioned. Another one that comes to mind is you have to, you have to allow Zillow to be the one to collect your rent from the tenants again, because it makes for a better tenant experience. You find your property on Zillow, you apply through Zillow, you pay your security deposit through Zillow, and you pay your monthly rent through Zillow. That could happen. And I think is, I think we're going in that direction. And I think Airbnb can do a similar thing. And I think I see a lot of people when I bring this up, a lot of people in the industry start, they almost explode. They just can't even like understand what I'm saying because they don't like it. They don't like the idea of it. It's like, yeah, I get you don't like it. That's not the point. The point is this company has such, has so consolidated consumer mindshare and demand that they're going to do this like it or not. So what do you think about that?

Yeah, I mean, I think— I mean, one of the things that, you know, Cribdilla, my handle on Twitter, is actually the name of a rental startup that I tried to do and is sort of on hold because of the pandemic. But this is a market or an area that I've done a lot of research on, and I spent a lot of time trying to raise money and had built an app. And so this is a business that I at least for a snapshot in time, I think I understand pretty well. My perspective, I think I share your concerns actually about Zillow and playing a monopolistic role in the market, but I think that a couple of things, a couple of counterpoints I would say to that. The first is I don't think that Zillow would do some of the more extreme things that you're talking about, like application fees? Because I think application fees, at least in New York, and I imagine everywhere else, for a long time, those were profit centers for management companies. You charge $100, $150, $200 for applications.

[Speaker] Of course, yeah, they still are.

[Speaker] Yeah, it weeds out people who just spread applications around, and it also provides, you know, an opportunity to generate some revenue off of the time you're spending. New York, interestingly, actually just eliminated that by legislation. And you can't charge more than $20— you can only charge $20 a month— I'm sorry, $20 per application. That doesn't even cover a credit check. A credit and background check is $5 at the cheapest. But yeah, and so a lot of— there are people trying to work around it, but I don't think it serves Zillow to do something like that, and I think that would— but the other larger issue is I think in some markets, and the one you're mentioning, yours, Zillow is the dominant player. In a lot of markets, it's a little bit more fragmented than that. You know, there's Apartments.com is CoStar, and CoStar owns them just like Zillow owns a bunch of the platforms. There are some independent platforms out there. You know, I think you and I have exchanged this on Twitter, but in a lot of markets, Craigslist is still the number one place that people go first when they are starting to think about renting. That doesn't necessarily mean they rent through it, but where Craigslist is the information warehouse, the thing about Craigslist, which is interesting, and our studies of this found was that it's a linear listing platform, meaning it ages very, very quickly. If you're in a market that's active, and that listing is 7 days old, you have a pretty high probability that that's probably been rented already. Zillow, and I mean, in New York, it's Zillow owns StreetEasy, and StreetEasy, even though they all have the same information, StreetEasy is like our version of Zillow for you. That information dates really, really quickly. And the marketing expense that agents use, there's still a lot of bait and switch. There's still a lot of dated information that's out there. So until, unless and until Zillow and the listing platforms do a better job of culling the information that's in there, and I don't know that they necessarily have the incentive because again, their fee, if it's listed on Zillow, they're charging you for it. It's on you as the agent or the broker or the landlord to clean that data up and take it off the platform if it's no longer available. But on the flip side of that, I've already spent the time marketing the property. I've already spent the time listing the property. I've put all that thing and I've got 7 other units that I'm not listing or 5 other units that I'm not listing that I know I can use this as sort of a, you know, chum the waters to get people to come in.

Yeah, yeah. I'm sure a lot of that goes on. Everything you just described has just confirmed that I'm never gonna move to New York because that Everything you just said in the last 5 minutes made me furious. Everything from the rental application to the brokers doing the bait and switch thing.

Yeah. And, you know, but it's any dense, dense market, I think, is— I mean, I think, I don't think it's exclusive to New York. I'm sure you think it is a particular problem. But I— but again, going back to your, your point, I do think that, I do think that there are areas where Airbnb and Zillow I mean, shockingly, and this is something, I posted this on Twitter, so you may have saw it, you may have read it, but this is something I personally just found out that I didn't even realize Zillow was doing, 'cause I don't do residential, I'm more of a commercial broker exclusively, but my sister-in-law is an agent in New York and she just accepted some referrals from Zillow and Zillow is taking 30% of the fee of the commission on if their buyer buys that property. That is shocking to me.

Oh, that's not shocking to me. We have like 20 to 30% referral fees around here. For Zillow?

For like, if not another agent, like if I as an agent have a buyer and I send them to your market and say, hey, Peter, you know, take care of this person. Let's talk about a referral fee. And it's 15, 20, 30%. Totally, you know, totally there. Yeah, Zillow, because the way Zillow— think about the way Zillow does this. They're getting the buyer leads by— I, as an agent, let's say I have a listing, I'm the listing agent, I'm hired to sell this property, I list it on Zillow. Zillow filters the traffic in a very sort of opaque way to buyers' agents, and they— so they are inserting themselves on the side of the— and now that's fine, I'm a big believer in buyer's brokerage, but Zillow is actually now inserting themselves in between the agent being able to make a living, and that's one of those things where— and if you do the math, I mean, I did the math with my sister-in-law, Zillow will make more money in that transaction on the buy side than either the broker or the agent. I suspect that kind of thing could be a monopoly sort of challenge at the state level, quite frankly.

[Speaker:PETER_LOHMMANN] Anything that makes realtors angry is a good thing in my book.

[Speaker:SEAN_BENNETT] It actually doesn't make me angry because again, I don't— but I think the— people laugh, I think, but buyer's brokerage, there's a reason why buyer's brokerage exists. The reason it exists is not because buyer, because agents want to make money as much as their buyers request it.

But there's a huge— I'm a big believer in buyer's agency and buyers using and working with someone who's advocating for their interests, right? Because we all know that the listing agent, the listing broker, you know, when they do a dual agency, which means they're representing the buyer and the seller, they're really— that's like an oxymoron. You can't really do that. And so I think that should be illegal nationwide. And, but where, where I get frustrated with the buyer's agency discussion is I feel that the buyer's agent should be compensated on an hourly basis for the work that they do. So if you— if they're running around showing their client this property and that property, they should be invoicing their client weekly for the hours that they spent. And getting paid. And this whole, the buyer gets a commission from the split, it creates all these fucked up incentives that really distort the whole marketplace and make it so that, for example, if you were to publish your property for sale and in fact, for years it wasn't even possible to list a property for sale without a buyer split. There's a field in the MLS where you put here, you know, and of course, 99.9% of brokers put 3% as the, as the split for the buyer's agent. And it's like, no, how about zero is what I'm sharing with your buyer, with your, with you, the buyer, your agent, why don't you pay your agent? And if you go and tour one property, put an offer and buy it, then maybe you're going to owe your buyer's agent $200., and if you drag them around for 2.5 years to 1,500 different properties, then you're going to owe them, you know, $100,000 or whatever. We need to sever that very archaic way that this transaction is being done if we're ever going to unravel the mess that is the MLS and everything else.

Wow, there's a lot to unpack there. So, you know, the, the, I think that the first thing is, is that you There is, I think, a very— I think, I mean, I got into a Twitter battle with some pretty big VCs on this, primarily because they're primary investors in Zillow, I think, is why they talk their book on this. But you don't— NAR actually doesn't— National Association of Realtors actually does not control what the commission structure is.

They may recommend it.

Oh, they explicitly are not permitted to do so, 'cause that would be an antitrust violation. And neither is any broker. Correct. Understanding the broker for the audience is the broker has agents that work for them as contract employees. An agent, a broker can't tell an agent what they're supposed to work for.

Right.

And in, you know, In New York and in other markets that I'm personally aware of, but I don't want to say nationally, 6% is hardly ever done. 5% is much more common now. And what is even more frequent is if there's a 6% fee or a 5% fee, it is bifurcated. So if it's a direct deal, the direct deal may be 4% or 3.5%, but it is not 5% or 6% if it's a direct deal. Most agents are offering that out of the gate because, um, because fees are— well, but it didn't used to be that way.

Well, of course, but property values have gone up quite a bit.

Well, that's right. I mean, I guess that's fair, but I think so has competition in the, in the— I mean, we haven't seen a massive amount of transaction volume change over time either. So, um, I think that you're, um I would, from a what's fair, I mean, it's difficult to have a discussion where the discussion is whether things are fair or not. I think part of the issue with buyer's brokerage is I do believe, from a negotiating standpoint, having the rules understood by the entire market is better for the seller. I frequently have sellers make decisions about who they want to sell to because of the terms of the deal, meaning they know what they're going to net and they decide where they're going to net the most amount of money. So if it's a direct deal because the fee structure is lower on a direct deal, they will pick that. If it's better because the outside agent brings in a buyer who's paying more, significantly more than the other, and they'll net more at the end of the day. The other issue with a buyer's broker is many people think that they are better at either understanding the transaction or negotiation than they actually are. And frequently it's because they're negotiating their own asset. I actually, when I sold my apartment in New York, I did not represent myself. I hired a residential agent.

I've got a property for sale right now listed with another broker, even though I'm a broker for that exact reason.

Yeah, you're emotional, you don't make good decisions, you get angry, you can't change the tone in your voice, everything's personal. And so having that layer, and I do, while we say 6% is a lot of money, what's ironic, and I posted this on Twitter, we keep talking about this, is you get the advocates who are, and I'm not suggesting you're one, who think iBuying is the future, where fees are significantly higher than brokerage fees, irrespective of what actual sale prices are, and sale prices are actually lower for iBuying than they are for openly marketing a property, which they should be. So you're talking anywhere from 8% to 12%, 13% are some of those structures, plus discounts in pricing. But there's, you know, when you have a buyer's representative and a seller's representative at 5% of a deal, that's somehow anathema to capitalism and negotiation and fairness. And it frequently comes up, I think, when the markets are crazy, because it is absurd, right? I agree with you that if I was in the residential sale business right now, and I don't even have to list a property, and I've got 20 offers, and things are closing for cash, cash and my right arm and all that kind of stuff. Yeah, it's kind of absurd that commissions are that high, but the seller of those properties can negotiate a lower amount. They can also sell them for themselves. They can do those kinds of things and make those kinds of decisions. Taking a more macro look and a broader look, you know, you talk about, you know, somebody walking in, walking a buyer around 20 or 100 properties. I've represented sale properties, not in the residential side, but in the commercial side where I've shown the property 100 times and there's no buyers.

Yeah.

And, you know, when the market is slower, you certainly earn your money and you earn your fee.

Those brokers should be paid by the hour as well. The whole thing is so messed up. I'm gonna rebut you. I'm gonna do a poor job of it though.

So here we go. Yeah.

Okay.

So wait, can I throw one little— can I throw one statistic out for you? Because I really think that this needs to be, you know, I don't know if this is the million-dollar listing-ification of the real estate brokerage business. Being a real estate agent sucks. I run my own company because I'm good at what I do, and I'm good at negotiation, and I have a sort of skill set that I think I'm sort of well suited for this, but most agents aren't. And the average agent in New York City alone, there's something like 80,000 registered agents in the 5 boroughs of New York, or in New York State, I should say. And something, right. But nationally, the average real estate agent makes $41,000 a year. Right.

That's part of the problem here. That's part of the problem is that it's not professionalized. And you've got a bunch of part-timers running around.

Right? Yeah, right.

So yeah, so, but we, we can't— I have no sympathy for realtors. My concern is for consumers. Realtors can either go get another job or, you know, negotiate with their broker, whatever they need to do.

Where I get frustrated is— I'm not saying it's the way they are. What's that? I said, that's even with fees as egregious as they are, is what your point is, I think.

Right. Well, the money's going somewhere. It may not be going to the real estate agents themselves. I think the brokerages are taking a lot of that. Um, so where I get frustrated, you know, people who just whine because they feel like the fees are too high, that's irrelevant, right? This is, like you said, this is capitalism. If they don't, if they feel like the fees are too high, they can shop around, negotiate, not sell their property, whatever. That doesn't concern me at all. What concerns me is what I love more than anything in the world is a well-functioning marketplace. And this, this goes both to, both to rental marketplaces and for sale marketplaces. So like, I'll give you like, I love the idea of a place where buyers and sellers can come together and through the magic of capitalism, experience price discovery, right? It's a beautiful, beautiful thing. And what makes marketplaces function well is when, like you said, the rules are understood by everybody and the product that is for sale needs to be visible to everybody. There needs to be transparency, and there needs to be some sort of structure. You know, like when you search for size 12 shoes on Amazon, if you got yo-yos listed in with your search results, that would make for a poor experience, and it would, it would not be conducive to a good marketplace. So when I look at the residential real estate space, specifically the for sale marketplace, people buying and selling homes, I see a fundamentally broken marketplace in multiple ways, and it makes me really mad. And I blame NAR for that. They— and so that, that's sort of like the original sin. I feel like the NAR, through a combination of a bunch of different weird things that, that all play off of each other, part of which has to do with The MLS is being controlled by NAR, which means that— So I'll get— So I'm a licensed broker, but I'm not a realtor. And a lot of people don't even know that that's a thing. But the states are responsible for licensing real estate agents and brokers. Realtors are nothing more than a trade organization, by the way, who, who, who are organized for the purpose of enriching realtors. They do not advocate for homeowners, even though they hold themselves out as doing so. They're a trade organization for realtors. And so when they are advocating before Congress, make no mistake, they are advocating for the interests of their members.

So, so, but that's true of the Bar Association. That's true of the medical field. That's true of every organization that represents professionals.

Sure. But I don't think the medical— I don't think those other trade organizations hold themselves out as explicitly being like a consumer advocate. And I feel like the NAR does. I think it may not be neither here nor there, but—

Yeah. No, no, I don't. And I'm not gonna, I mean, I think that there is, I mean, I think we can, I think there's a, we have a lot of, there's a lot of things that we agree on And I think that the first MLS was established in, I think, 1865. And it was established for valid reasons, which was essentially you had people who are working on behalf of someone to do something, and they needed some level of protection. And it actually— I mean, if you think of Zillow as essentially an MLS, that's all it is. It is a publicly available MLS. That level of information that was provided and transparency by that first MLS in 1865, I think is— now, there has not been nearly enough disruption in it, and I would totally agree with that. I think there's two things that I would say where I think we have a fundamental disagreement on. The first is that The reality is, is going back to your point about brokers, brokers actually don't make much money in the current economic structure of a brokerage firm. 70% of the listed, 65% to 70% goes to the agent, and the broker shoulders all of the remaining 35% or 30% goes to the broker. So for instance, Compass, Compass's valuation at $5 billion is absolutely insanity. They're not making any money and their structure very likely will not allow them because brokerage is a very, very low margin business. You hire as many agents as you can, 80% of the business is done by 20% of the agents, and the reality is it's much more like 90 or 95, 10 or 5. The best agents make the most amount of money, and it is a very, very, very low-margin business. Now, I agree with you that there is making things uniform, but part of the problem is the definition of real estate is every single parcel is unique. So we do not— I mean, there may be areas where a lot of information is readily available because it's tract housing and it's— in New York City, as an example, lots of information is wrong, and the only thing that's correct is the survey, and the survey is not something that's usually publicly available. So I'm in agreement with you. I wouldn't have tried to start a real estate platform if I thought that it was perfect. But I do think the other thing, I think the for-sale market is going to be much, much harder to disrupt than people understand because—

Completely agree with that.

I completely agree with that. And the reason for that, I think, is that you have, just like you and I just said, we wouldn't even sell it, but here we are both real estate professionals, hopefully pretty smart guys, or at least we think we are, and ambitious, and understand the value of the dollar, and understand markets, and understand price discovery, and we won't even sell our own homes. The idea that we would expect people to not make exactly the same rational decision that we are, where they— I mean, I can't tell you how many— I mean, last year, I was working with a legitimate billionaire. Legitimate registered billionaire wanted to buy some property in Brooklyn because he thought the market was going to collapse like everybody else did. It didn't, but he thought it was. So we chased a bunch of industrial properties. Yep. Mark prices didn't come down to where we were, but every single time I presented him with something, he wanted me to tell him it was a good deal. This is a guy who has made a boatload of money in the financial markets and did not understand because it's not his wheelhouse. And I understand, and totally legitimately, his point was, I'm paying you to do this because I don't know. And I want you to give me good advice. Now there's lots of people out there who are giving bad advice. And at the end of the day, it's their decision, not mine. But it is one of those things where when you're talking about 30% of somebody's pre-tax income going out the door every day, every year, to support their housing decisions, and for a vast majority of the homeowners, it is their primary source of wealth, they're probably going to be relying on people to do this for a long time. They should be better, they should be better licensed. I mean, the licensing is ridiculous, the continuing ed is ridiculous, how much information is not known, but I can't tell you how many times I've told sellers to hire a real estate attorney. Don't hire your brother-in-law, don't hire your friend's neighbor, hire somebody who knows what they're doing. It's going to cost you a couple more dollars, but we're going to get this deal done. And they still don't do it, which is totally irrational. And we end up, you know, wasting time and they hire their sister-in-law to sell the house and they, you know, their friend to do the contract. I mean, all of those decisions are totally irrational. So you get, you get a lot of irrational parties involved. I, I, I can't see how we're gonna— how Zillow is gonna step in and do things. Now, I do think there are things they're going to do that could make things better, could make things worse, but I don't think they're going to be, um, a dominant player. And, and I think, I think they would be worse off for it too, to be honest with you, if they tried.

I think I disagree with you, but I'm going to put a pin in it because I want to move on and I want to make sure we cover a couple good topics. Um, Uh, so it's gonna be good. Um, so I can't— we can't move forward without giving you a couple minutes to defend yourself, uh, when it comes to real estate as not being an inflation hedge. And I'll give this just a couple minutes of preface here. So going, going back years to when I first got in the got in the real estate game, which was 2008, I bought my first property. Even back then, my business partner and I, you know, the Fed was dumping money to stimulate the economy. And even back then, there were fears over inflation. And I'm not going to lie, one of the reasons my business partner and I got interested in real estate was because we felt it was an effective inflation hedge. We're like, okay, this is great. We're going to buy these assets. And We're going to leverage them with fixed-rate debt.

Beautiful.

So the value of the asset's going to go up with inflation and probably even do better than inflation. And the value of the fixed-rate debt is going to be decreasing relative because the buying power of the dollar is going down. So fast forward years and years, never thought about it again until I started following you on Twitter and you're constantly sparring with people on this topic saying, No, you're wrong. Real estate is not an inflation hedge. Here's why. And your arguments are probably correct because I think you know a lot more about this than I do. But why don't you explain a little bit about what's going on there, I guess, because I think it goes against a lot of people's intuition.

Right. Well, okay. So the first thing is that I first approached this topic when I was actually a graduate student. We had to write a paper and do research on some stuff. And I actually did. I wanted to mathematically try to prove how it is an inflation hedge and where that information comes from. And the only information I was able to find— and now this is going back some time, and there have been some studies, so I can't speak to things that have been published since then. But the only information that it hinges on is essentially rents tend to go up over time. Therefore, if you buy real estate and your rents are increasing, it is an inflation hedge. OK, rental real estate specifically. Well, any— well, real estate— I mean, real estate for income. I mean, it's the only— If you're talking vacant land, we can have this discussion about vacant land as well, because the only reason why the value of vacant land increases is because the demand for that land increases, especially if you don't— if you're not getting any— I mean, presumably, you could rent it as ranch land or something for grazing or something. But even in that purpose, probably you're paying your taxes, I would guess. But you're demand for that land increases, the price will go up. If demand in the space market goes up, rents go up. If demand in the space market does not go up or decreases, rents will go down. The level of inflation has absolutely nothing to do with demand. Now, if you buy in a market that has great demand characteristics, It's a great investment in a low inflation market. It's a great investment in a high inflation market. The difference, though, is if we are anticipating inflation, by definition, we will expect the cost of capital to go up. If the cost of capital goes up, cap rates go up, right? And cap rates are— there's 4 primary components to a cap rate. Interest rates are one, but expectation of rent growth is the second one, and oftentimes is as important, if not more important, than the overall cap rate. The third is credit, and the fourth is treating real estate taxes in the tax code. So if you have debt increasing, cap rates have to expand. If you don't have adequate demand in the market, so you don't have a high expectation of rent growth, you're not going to get cap rate compression. If cap rates compress, values go up. So you're going to be buying an asset that is depreciating in value on the underlying value of the asset is going down. Even if you have rent going up, you can have massive cap rate compression— I mean, expansion. From 2008 to 2019, we had over 100%, something like 130% of assets valuation or asset appreciation, I should say, came strictly from cap rate compression, going from 8s and 7s to 4s, 5s, and 4s, or 9s really, and into 4s, 5s, 4s, and in some markets, including New York, into the 3s. If you believe that markets are cyclical and we should expect cap rate expansion, the underlying appreciation of the asset is not going to happen. In fact, we're going to get depreciation because the asset value itself will decline.

And that's going to outpace any rent growth.

Well, rent growth is only going to happen if you have demand. I didn't say it's a bad— I've never ever said it's a bad investment in inflationary times. What I'm saying is, is don't buy for the wrong reasons. Buy it because it's a great asset. Buy it because you have constrained supply. Buy it because you have the underlying fundamentals of the market, buy it because construction prices are really high and land prices are really high, which is going to hopefully constrain the amount of supply coming into the market. Therefore, you should get some rent growth because demand's coming into the market and supply is on hold. But when asset prices are high, that's when we build the most. So we have to absorb all the stuff that's getting built into the market. Before we can expect rents to go up. Okay, theoretically, in every— every market's different though. You have to, you have to measure, you know, like Asheville and Raleigh, they're, they're experiencing huge population growth. That, I would argue, is absolutely— if you can find a deal that makes economic sense, who cares if we get inflation or not? You're going to do well because you're getting a huge population growth.

Is it useful though to lock up long-term fixed-rate debt in an inflationary situation and in a leveraged situation?

Well, long rate, I mean, depends on your definition of long-term. If you, let's say you over, let's say you pay a sub-4 cap in Allentown, Pennsylvania, which is an absurd idea. It's a tertiary market that probably never seen cap rates. Love Allentown, family that lives out there. I'm not dissing Allentown, but that is a very, very low cap rate to pay in a tertiary market. So let's talk through it. You pay a sub-4 cap, you put enough leverage on it to make it make economic sense. So you've got to think you're putting 70% on. 5 years from now, debt's not at whatever it would be for that asset, let's say 2.8%, 2.7%. Let's say it's at 5%. 4.5. If debt's at that number, your cap rate is expanded from sub-4s to 6s in that market. So you now have a capital call. You have an asset that's depreciated more than the equity that you have in the property. Your debt costs have gone up substantially on a month-to-month basis. So your debt coverage ratio is going to be all out of whack. Your either going to do strictly swapping debt, so you're not going to be able to pull out money, or you may be in a situation where you either can't borrow, or you're going to have to sell the asset or have a capital call. That's the nightmare scenario where I'm saying rents don't go magically up if you're in Allentown, Pennsylvania. Now, if Allentown is experiencing an unbelievable population growth, that's a demand thing. I don't know Allentown. Maybe Allentown is, But so, and here's the thing. Let me just say one other thing. Yeah. If, unless it's a magical thinking idea, right, where if we have this one thing, then this other thing happens. If we have high inflation, rents have to go up. It's gospel, it's going to happen, right? If it's not that, then the opposite would have to also be true. Low inflation means no rent growth. If the dollar value is not going up, or deflating, as the Bitcoiners are saying, then we can't expect to have any rent growth. And any real estate professional, if you said that to them, you would say that's insanity. Of course, you can have rent growth go up in low inflation environment. And in fact, we haven't had high inflation for 20 years. In the last 25 years, I think we've hit 6 twice., and that's not typically considered high inflation. I mean, it's high. I mean, it's especially on today's terms, but it's not, I mean, hyperinflation is 50% a month, not 50% a year even. Right.

So yeah, I guess, you know, when I think about inflation and you say, well, just because we have inflation, that doesn't mean rent prices are going to go up. I mean, what is inflation then? Is it specific to every single individual asset type? An expense that a consumer would have. You could make the same argument, just because there's inflation doesn't mean bananas are going to be more expensive. The price of bananas has nothing to do with inflation. It's strictly related to the relationship between the supply of bananas and the demand for bananas. I mean, isn't it the case that when we experience widespread inflation, there's a consumer mindset shift that comes with that where it's like people just automatically assume that a dollar today is going to be worth— I'm going to mix this up— worth more than a dollar tomorrow. And so there's like a baked in— that's almost what makes it so poisonous, right? As you get this mindset of like, there's this baked-in feeling that my dollar is becoming worth less and less and less quickly, so I better pay more for this apartment now even though I feel like it's too expensive and demand and supply really haven't changed.

Am I missing something here? BRENT JOHNSON: Well, I think— I mean, I would change it and say that inflation is— I mean, that's the other problem with this idea of inflation having— inflation is goods cost more tomorrow than they— cost more today than they did yesterday. I mean, not just one good, and not because of supply chain issues or something like that. The overall increase in goods and services in an economy. You could make the argument if that truly happens, and I'm not going to make this argument, by the way, because I don't want to wade into that, but you could make the argument that if bananas and gasoline and food and services are all more expensive, there will be less money available for housing than more. So this idea that you can then somehow magically expect people to pay more, and the reality is, is your, I mean, I think I made this point on Twitter. You can't go to a tenant and say, my expenses are higher this year than they were last year, therefore you have to pay more money.

I 100% agree with you. I wish I could, you know, engrave that and send it to all my clients who seem to think that just because their property tax went up that, well, can you tell my tenant that my tax—

it's like, no, that's not how this works. That's a great one. I mean, I have this discussion in my class where people talk about expensive relative to rent. The thing that makes real estate really, really hard is you have to balance expense, you have to balance the cost of maintaining the property with what the property can throw off in revenue. And if you can't get that balance right, you're gonna lose money. It doesn't matter how good you are. And most of the time, you can't do much about the rent. Now, you can, you can operate it better, you can maintain it better, you can do a better job, you know, so you don't get your vacancy loss problems with your credit or your tenants. I mean, there are things that you can absolutely do in active management, and that's the marginal difference between what makes a good operator and a shitty operator, right? But the The market, I mean, I had this conversation with— so coming out of the recession, like everybody else, the market was struggling, and I fortunately got a ton of bank business from one of the portfolio lenders that essentially had their entire portfolio of subprime assets go upside down, and they didn't securitize those loans, so they had them all on the books. So I helped wade through their properties in New York and New York State, essentially. They had a bunch of properties in Newburgh, New York. Newburgh, New York is right across the water from Beacon. At one point in time, it was the wealthiest, as far as I understand, the wealthiest municipality in New York State because of its location on Hudson and its industry at the time. It is now essentially a There's no jobs there, lots of crime, lots of gang problems, high unemployment, no opportunity for employment growth. But you drive around the town of Newburgh, and the houses are gorgeous because they were built 100 years ago by barons that were— so the housing stock is pretty. The problem is real estate taxes there are $12,000, $15,000 a year. And the rents on those properties are $400 a month.

Yeah, it just doesn't work.

Yeah, I have—

Forget about paying utilities. Forget about— Yeah, I have this discussion with clients sometimes, especially folks who are looking at C-class and D-class properties, which we don't like to manage. And the rents are just like you said, the rents are $400, $500, $600 a month. And I'm like, listen, there is a floor to what it costs to operate a habitable unit. And the cost of a new toilet does not care how much your rent is. You can't just take 10% of the rent and assume you can spend 10% of the rent on expenses. That's not how it works, right? Like, so, you know, there's a, there's just a bare minimum cost to maintain four walls, a floor, and a ceiling as a habitable space for someone to live. And that number is probably like $300 or $400 a month once you factor in property taxes, maintenance, cost of capital, CapEx, and everything else, let alone property management. So yeah, anyway, we're getting up on an hour here. I don't want to take up too much of your time. We had a good question come in from Twitter. What's the hairiest, makes me shiver in the night deal you've ever done?

Any horror stories from doing deals? Yeah, you know, I had, I saw that one and I wanted to, I wanted to, I put some thought into that. I, you know, I, I have to say that it was, so I had in, I had, this is a, you know, we peaked, New York peaked in probably 2019. We're a little bit ahead of the rest of the market. And I had a, A client who I had sold an estate property for them a number of years ago, and they overseas, they live in, in, in the Middle East, and, uh, out of the blue was contacted and by them, and their father was selling, or their father passed away, and their brother is managing a property in, in California, and they were selling it for a huge amount of money, and she needed to do a 1031, and she wanted to buy in New York, and it was, it was a lot of money, and, um Problem was cap rates were super low. You sell for a ton of money in California for a super low cap rate, you want to buy in, and you're going to be buying into a low cap rate environment. So the stress of that, allocating those dollars, was the thing that I think, if you want to say, sort of keeps me awake at night, is when you have to buy stuff in a very, very high market, which I think a lot of what I say on Twitter reflects this, that sometimes it's better not to buy. I totally agree with that. And when you have to, it's one of those things where— and you just pray that the market is— and I think she— I mean, COVID, she, like everybody else, the assets she bought were improved, extremely well-renovated, decent location. You know, and she knew what she was buying going in. And I think she did okay from— she's doing— she was doing okay until COVID hit, but everyone's doing crappy since COVID hit. But, um, but yeah, that's the, you know, it's— I love it when the market is not super down like it is now, and I don't like it when it's super high. When we're in the middle where everyone's sort of— where you can see where a deal makes sense and everybody does well and you you're at the table and everybody's smiling, you know, that, that's kind of when— that's the— even though you work for it, I'm not suggesting we didn't work for it. I don't want you to tell me my commissions are too high. Um, but, uh, but yeah, when the market's crazy, it's, uh, that's, that's stressful. I mean, partly because I take, I take, uh, my advisory role pretty seriously. So, um, uh, yeah, that's That's rough. Yeah, but I've had some fun ones. I've had, I had a, I had a deal where there was a hammer at a closing being threatened by another family member. Oh my gosh, it was crazy. I've had some, I've had some crazy ones.

But those are probably not podcast appropriate. Yeah, people get very emotionally attached to their real estate, you know, whether it's a home or even a commercial property. It's very personal for people. So well, I appreciate your time so much, Kevin. This has been really fun. I can already envision having you back again to do some more discussions around the iBuyer and the history of how we got to the commission splits that we have and everything else. So thank you so much for coming on the show. And how can people connect with you and, and learn more about what you're up to?

Sure. Best way is probably on Twitter. I'm at @cribdilla, C-R-I-B-D-I-L-L-A. And you can DM me, DMs are open.

I'm happy to engage in any way I can. Awesome. Well, thanks everyone for listening to another episode of Owner Occupied. And that's all for today.