David and Goliath walk into a bar

I recently came across Derek Thompson’s article on the economics of the craft beer industry. The fact that so many small companies can thrive despite operating in a de facto duopoly where the industry leaders produce 90% of the world’s beer is quite remarkable. By creating premium products, and charging premium prices, small companies are able to survive despite lacking the economies of scale that benefit the larger firms.

When thinking about other industries that behave similarly, chocolate and coffee come to mind. I am curious to see how small firms will carve out their own niches and compete in other sectors of the economy that are currently dominated by de fact monopolies like Amazon and Google.

Please use the comments section to share your favorite craft breweries and craft beers that I should try.

Pension Facts of the Day

  1. Sarah Krouse discusses the $4 Trillion Pension Hole in her recent WSJ article.
  2. Ted Dabrowski & John Klingner highlight Chicago's $125,000/household pension debt

I think these articles demonstrate the magnitude  of the public pension funding gap at both the macro and household levels. Even those of us without public employee pensions will most likely be affected whether through future tax increases or decreases in public services as municipalities and states struggle to meet their pension obligations.

While I think it is easy to identify the problem, solving the issue will definitely be a challenge. Personally, I think the long term solution is to reduce future pension obligations by transitioning from a defined benefits to a defined contributions plan. I think both the employer (taxpayer) and the employee would be better off with a 401k style account with a large annual employer contribution. This will prevent politicians from making future pension promises to buy current votes and will eliminate the compounding effect of under-funding pension funds and overly optimistic investment returns currently plaguing pension funds. It will also protect the employee from future benefit cuts as states and municipalities are unable to meet current pension obligations.

While it may appear that this proposed solution will transfer investment risk from the employer to the employee, I would argue that the employee has always been on the hook for lower than expected investment returns. I'd also expect that through tools at discount broker's such as Charles Schwab, Vanguard, Wealthfront and Betterment that employees could get similar returns for lower fees than employer managed pension funds.

Please use comment sections to push back at my proposed solution and share other interesting articles that pertain to this topic.  

How should we evaluate Social Media Influencers?

Taylor Lorenz writes an interesting article about how hotels are struggling to identify the right social media influencers to better market their properties. My biggest surprise from reading the article is that it does not appear that hotels have a systematic approach to evaluating influencers. It seems like they have taken more of a spray and pray approach. 

As a blogger trying to grow my audience, I've become interested in finding the best places to share my content. Thus far, I have shared posts on Facebook, LinkedIn, KevinMD, Instagram and Twitter.  In my limited experience, my Facebook network brings the most eyes to my blog, despite reaching a much smaller audience than other avenues such as KevinMD which gets approximately 3 million page views per month. I suspect the outsized response is due to the fact that my Facebook Friends feel more connected to me and are more willing to engage with my content.  Other than through trial by error, I'm not sure how to assess the level of engagement with users on other platforms. It is nice to see that I am not the only one struggling with this issue.

Please use the comments sections to share your thoughts regarding how you've evaluated/identified opportunities to grow your audience.


Taxi Reform by Uber

To commemorate the 7 year anniversary of Uber's launch in New York City, Barry Ritholtz pens an op-ed claiming that the NYC Taxi and Limousine Commission created the market opportunity for Uber to enter and thrive in NYC. By using its regulatory moat, the TLC was able to restrict the number of drivers through its medallion system. 

I wonder if Uber would have had the same success if the TLC had been more focused on meeting the needs of their riders rather than its medallion holders.

I have included an excerpt from the article that shows how the entrance of Uber impacted the price of taxi medallions. 

All of these failings would be much less likely to take place in a competitive market. We know this is an artificial monopoly because of the price behavior of medallions after market competition began: prices for medallions peaked shortly after Uber came to town, but before it had much of an impact. Bloomberg Businessweek reported that medallion prices, which peaked at $1.3 million in 2013, were already sliding, falling below $900,000 in 2013. Just two years later 2015, prices had fallen another 40 percent.

And it got worse: By 2016, the lowest reported price was $250,000. Last year, medallions sold for as little as $241,000. They are still falling. Axios noted a recent transaction that went for just 8 percent of the peak value, or about $100,000. Other cities, such as Chicago, have seen similar declines in medallion prices.


Tesla Facts of the Day

Dana Hull and Hannah Recht write a critical review of Tesla's cash burn rate and potential liquidity challenges in their recent Bloomberg article.  While I greatly admire Elon Musk as an inventor and innovator, I am also flummoxed by his apparent deficits as an operator as Tesla continues to miss its production targets. However, my interest in the article has nothing to do with whether or not I think Tesla is viable as a long term company. I have included my favorite facts below. Please share yours or links to other articles in the comments section.

  1. The current cash burn rate is $6500/minute. It took me $52,000 to read the article.
  2. Tesla has approximately $875 million dollars in deposits for future cars and prepayment for features that Tesla has not successfully developed yet.
  3. Telsa has received $1.3B or $3,500/car sold from selling Zero Emissions credits.
  4. The company currently has 40,000 employees and majority of its manufacturing process is currently being done by hand and not through automation.

Disclosure: I probably own shares of Tesla as part of Broad US market index funds held in both my brokerage and retirement accounts.

Protectionism in the News

One of the advantages of having an unpopular president is that his bad ideas get the criticism that they deserve.  Listening to the mainstream media call tariffs a tax on the American consumer was music to my ears.  Not sure where these critics were when Trump imposed tariffs on solar panels and washing machines in January. With multinational corportations that source materials and manufacture goods all over the globe, it is impossible to impose restrictions in trade without creating some unintended consequenses. 

Below I have included some articles that I particularly enjoyed reading that are critical of recent tariffs and protectionism in general. Please use the comments to share any other articles that you have come across and feel are worth sharing.

  1. Trade Wars are Easy to Win 
  2. Some Questions for Protectionists 
  3. Trump's Tariff Folly

More than A Bubble?

The recent declines in the US publicly equity markets in response to good US economic data support the argument that quantitative easing and near zero interest rate policy has created a bubble in the US stock prices. There seems to be a consensus that prices will continue to  decline as interest rates normalize.   While I concede that cheap money has been a major driver in the rise in US asset prices, I think there must be other factors at play. Japanese markets have not had the same run up in asset prices, despite similarly low interest rates and quantitative easing.

Tyler Cowen offers a contrarian hypothesis for high US asset prices in his recent Bloomberg article.  He suggests that at least a portion of the rise in US asset prices is due to a lack of alternative financial institutions to store wealth.  According to the Credit Suisse Research Institute's Global Wealth Report 2017, global wealth is up 27% from 2007-2017.  This approximately $60 trillion in new wealth has to be stored somewhere and the US public equity markets have received a large share of invested capital.  I have included an excerpt from Tyler's Article below.

To sum this all up in a single nerdy finance sentence, in a world where wealth creation has outraced the evolution of good institutions, the risk premium may be more important than you think

Make Whirlpool Great Again

George Will shows the tentacles of crony capitalism extending into our laundry rooms in one of his recent Washington Post articles. This is just another example where our government has chosen to prop up a special interest at the expense of the American consumer.

I have no doubt we will be seeing many articles celebrating the number of US manufacturing jobs that will be saved by this tariff. However, the article I'd most like to see is one that shows how much we are spending to save each job. While it will be easy to compare the average price of a washing machine before and after the tariff takes effect, it will be impossible to calculate the potential impact of those additional dollars if they had been spent on higher and better uses.  I'd like to think we would all be better off if we spent the same amount of energy and resources creating new jobs and industries as we did protecting the old ones.

If Whirlpool wants US consumers to choose their products, they should make better or cheaper washing machines.

I have included George's description of tariff and the impact of the whirlpool tariff below.

This is a tax, paid by American consumers, on imports that exceed a certain quantity that, in the government’s opinion (formed with the assistance of domestic manufacturers), is excessive...The tariff/tax, which is designed to limit the choices of, and increase the prices paid by, American consumers would be 50 percent on all imported machines, after the first 1.2 million. U.S. customers caused the importation of about 3 million Samsung and LG washers in 2016.

Lagniappe:  A previous Blog post  about crony capitalism in the airline manufacturing sector.

Crowdfunding Nightmare

Real Estate crowdfunding provides exposure to an asset class that was previously out of reach for most investors. It also allows investors to participate in multiple deals and reduce risk through diversification. While it provides new investment opportunities, it also creates new challenges. Investing with unfamiliar sponsors on platforms with short operating histories increase counter-party risk. While the internet is full of success stories, there are few articles or blog posts that discuss investments that do not go according to plan. I wanted to share my experience of my first crowdfunded real estate investment.  

I signed up for multiple crowdfunding platforms, reviewed multiple deals, sent emails to the platforms to see how quickly they responded to investor questions.  After three months of reviewing deals, I found an investment that looked like a good opportunity.

The Deal

My first crowdfunding deal was a preferred equity investment in a value-add 48 unit apartment building in the DC metro area. The company was looking to raise $1.5 million in preferred equity to complete the purchase, renovation, and stabilization of the property.  At that point, the sponsor would refinance the property to retire the construction loan and pay off the preferred equity investors.  The company had a senior loan of $14.2 million and $2.3 million in sponsor equity. The funds would be used to purchase the building for approximately $9 million, $7.2 million construction and rest for closing costs and working capital.

Investors could purchase shares of preferred equity at $10,000/share. Shareholders would receive a 10% annual dividend distributed quarterly and 11% annual accrued interest at exit.  The length of the deal is 2 years with a sponsor’s option for a 6 month extension.

 For example, a $10,000 investment would get 8 quarterly distributions of $250 and $12,200 ($2,200 accrued dividend and $10,000 initial investment). The preferred equity was subordinate to the bank loan but senior to the sponsor equity.

Due Diligence


I initially broke my deal diligence into 3 parts; the local market, the financial projections, and the deal structure. 

Things I liked about the local market include; a growing neighborhood, 90+% apartment occupancy rates and continued rent growth.  My concerns regarding the local market were the incredibly low cap rates (4.5-4.75%) and regulatory restrictions.  The property was required offer a fixed number of rent controlled units which would limit the ability to raise rents in the future.

Things I liked about the projected financials include; that purchase price and projected rents were in line with comparable properties in the area and the valuation of the stabilized building was calculated using a capitalization rate that was higher than the current cap rate. I was concerned by my inability to effectively analyze the construction cost estimates or if the construction schedule was actually feasible.

The deal structure itself was also something that I liked about the deal. Having a preferred position on the capitalization table to the sponsor meant that I would have to get paid off before the sponsor would receive any return on investment. Also, my projected exit opportunity was a refinance rather than a sale.  Freddie Mac commercial loans require a minimum of 25% equity to refinance which was significantly lower than our projected 40% equity position after renovations. This provides about 15% cushion in the event the sponsor overestimated the valuation of the stabilized property.  The sponsor had a $2.3 million equity position and long-term plans to hold the property, so they are incentivized to meet their NOI projections. My biggest risks based on deal structure would be inability to the sponsor to refinance out of the deal at the end our 2-year investment term or any major setbacks that would delay completion of the project.

The Sponsor

The sponsor had a professional looking website with multiple examples of current and past deals in the DC metro area. After looking at the website, I used LinkedIn and Google to learn about key personnel and looking for history of lawsuits or bankruptcy.  I also used Google Maps to verify the physical location of the business address.  After passing my internet screen, I called the company to verify that phone number listed was active.  I also called again to ask about some of their "current" projects to make sure they were in fact active. My impression after my diligence was that sponsor seemed legitimate and had history of operating in the same market as my potential investment.  My biggest concern at this point was that this deal was larger than their typical deal but I was reassured that they had made a $2.3 million bet on themselves. After performing my due diligence, I was comfortable investing with the sponsor.

The Platform

I initially came across the crowdfunding platform after a friend of mine told me he had participated in and successfully exited an investment on the platform within the past 12 months.  After reviewing the platform website, I again used Google and LinkedIn to investigate key personnel. I also used Bigger Pockets investor forums to get more investor reviews on the platform.  After finding no obvious red flags, I began reviewing individual investment opportunities. As part of diligence, I called, emailed, and chatted with platform investor support staff.  If they couldn't answer one of my questions, they would reach out to the sponsor and get back to me in a timely manner.  They also seemed to have steady deal flow with 1-2 new investments being posted on the website each week.  My biggest concern at this point was their short operating history of 2 years. However, my overall impression was that platform seemed legitimate and I felt that my exposure to their ongoing operation risk was limited by short investment term and minimal responsibilities once the deal closed.  After performing my diligence, I was comfortable making an investment on the platform.

The Investment Decision

After performing my diligence, I felt like I had a good grasp of the deal specific risks and thought there was sufficient upside to put my money at risk. However, I was still not comfortable writing a large check to an online investment platform with less than a 2-year operating history.  After discussing the deal with a friend of mine, we decided to split a share, and each contribute half of the investment capital.  That way we'd have some experience with the platform and would hopefully be more comfortable making future investments.

After Writing the Check

The deal closed as expected and we received our first quarterly distribution as expected. However, shortly after our first distribution, things began to slowly unravel for both the crowdfunding platform and the sponsor. We stopped getting timely updates regarding the project.  When we reached out to platform, we were told that it was taking longer to obtain permits than expected, but the sponsor was going to go ahead and start the demolition work, so they could stay on track.  The platform also stopped posting new deals on the website. The explanation that we received was that the platform needed to get a Broker/Dealer license to continue operations. However, they planned to resume operations once they were back in compliance.  We sent regular emails to the platform trying to maintain a line of communication since they quit updating the website.  

Approximately 6 months after our deal closed, we received an email that the founder of our sponsor was murdered while confronting a man who was loitering near one of his other properties. 

Two months later, we received another email that the platform was going to cease operations.  At this point, we faced the LLC declaring bankruptcy or finding a new manager for the project. Luckily, one of the larger investors was willing to take over management responsibilities for a 1% management fee. We had two weeks to review the new operating agreement then vote whether to hire a new management team or take our chances in the bankruptcy process. After conferring with my co-investor, we decided to vote to hire the new management company.  Most shareholders voted in a similar fashion and we hired a new management company to oversee the investment.

Where We Currently Stand (as of 12/1/2017)

The company that took over the management role is trying to get the deal back on track.  The failed platform had 18 months of interest in escrow, so we are still current on our quarterly distributions to date and should remain current through April 2018. After depleting the escrow account, we will have had 15% of our initial investment returned.  We are also getting monthly investment update emails.   They have also reestablished communication with the sponsor.  The sponsor is having liquidity and legal issues resulting from the death of the founder. Fortunately for us, the sponsor is a family business, so they are motivated to keep the business operating.  They are currently selling off assets to get their business back on track. Our project is still listed as a current project on their website and they are still doing demolition work as of our last update.

At this point, I am hoping for a return of my invested capital.  I am glad that I decided to co-invest with a partner because I reduced my potential loss by 50%.  Also, because of high preferred dividend, there was sufficient margin to hire a new management company to try and salvage the deal. While I had no way to predict the death of a sponsor and the crowdfunding platform did not disclose their dire financial situation, this experience has improved due diligence process.

 I have revised my platform diligence process that I have applied to my subsequent crowdfunding investments. Now when I make crowdfunding investments, I try to make sure that the platform is sufficiently capitalized to operate throughout the duration of my future investments and that they have a plan to close out existing investments if the platforms fails.  I also plan to invest to across multiple crowdfunding platforms to reduce my platform specific risk through diversification.

Please use comments to share experiences with other real estate crowdfunding platforms or any lessons you have learned from making crowdfunding investments.

Lucky or Good?

While many investors concede that it is difficult to outperform the market over an extended period of time, Spencer Jakab argues it is even more challenging to tell if those select few who manage to beat the market are more skilled or just lucky.

You will need a WSJ subscription to be able to read the entire article. I have included the part of the article I found most interesting below.  I think the excerpt demonstrates that we often underestimate how much data we need to prove the difference between two data sets is statistically significant. 

While it isn't always feasible to get complete information before making a decision, it is important to realize that you are acting on incomplete information rather than being fooled by randomness.  I hope this article will make you think twice about paying hefty management fees for a fund manager that has outperformed the market over the last 1-3 years.

He and two colleagues told several hundred acquaintances who worked in finance that they would flip two coins, one that was normal and the other that was weighted so it came up heads 60% of the time. They asked the people how many flips it would take them to figure out, with a 95% confidence level, which one was the 60% coin. Told to give a “quick guess,” nearly a third said fewer than 10 flips, while the median response was 40. The correct answer is 143

Tax Reform: Lies, Damn Lies, and Statistics

With conflicting bills in the House and Senate, conflicting news coverage and conflicting claims regarding the impact of the respective tax reform bills, it is challenging to determine the net impact of the proposed tax bills. Many of the articles I have read make contradicting arguments that are well supported by facts and statistics.  I cannot help but think of the old Benjamin Disraeli adage "there are three kinds of lies: lies, damn lies and statistics" when trying to sort through analysis of the tax bills.

My personal opinion on the matter is that that both proposed bills are very complex and affect a large heterogeneous population making it nearly impossible to determine the net impact of any of the proposed changes to the tax code. Also, since different rules apply to different groups, it is impossible for either bill to have a uniform impact on every taxpayer. 

Below I have cherry picked a few examples to demonstrate that both sides of the argument can be true depending on how the argument is framed.  Please feel free to add more examples or critiques to my arguments in the comments.

The proposed tax cuts are actually a tax cut

Support: The authors of the respective bills have created several hypothetical taxpayer cohorts who will have their 2018 bill reduced compared to 2017. 

Refute: The CBO reports that neither proposed bill will balance the budget and will increase the deficit and overall national debt. Thus, the bills actually are a tax deferral that will have to be repaid by future tax increases. Also, some taxpayer cohorts will actually have their personal tax bills for 2018 increase.

Proposed tax cuts help wealthy taxpayers 

Support: According to the Tax Policy Center research group, 45% of Americans paid zero federal income tax in 2015. While I am willing to concede that there are probably a few high earners in that group, the majority consists of low income earners.  So any additional reductions to marginal tax rates would disproportionately help the top 55% of taxpayers that actually pay federal income taxes.

Refute: According to the same  Tax Policy Center research group, elimination of the state and local tax deduction would increase tax liability for 88% of households with incomes of over $1 million by an average of approximately $46,000 per household.  This creates a scenario where some taxpayers will pay higher tax bills despite having lower marginal tax rates.

Changes to mortgage interest deduction will damage housing sector

Support: A Brookings Institute research paper reports that 26% of US taxpayers (35 million) took advantage of the mortgage interest deduction in 2009.  So if all other conditions are held constant, this group could see their tax bill go up with the elimination of the mortgage interest deduction.

Refute: Home ownership rates in Canada (69%) and UK (71%) are higher than in the US (60-63%) despite not having a mortgage interest deduction.  The additional $12,600 in standard deduction would more than offset mortgage interest deductions for all mortgages below $307,000 (assuming 4.1% rate on a 30 year amortization). 

Proposed bills are simpler than the existing tax code

Support: The proposed GOP House Bill will reduce the number of personal tax brackets from 7 to 4. According to multiple sources, it is also expected to reduce the number of filers who itemize their deductions from 30% to approximately 6%.

Refute: The GOP house bill is reported to be almost 500 pages long and still contains a large number of loopholes. Also take a look at the calculation for tax treatment of small business in this Washington Post article. This is definitely more complicated than the 25% rate for all that is being reported.

RealCrowd on Hard Money Lending

Broadmark Capital's Adam Fountain shares his insight regarding the role of hard money lending in Real Estate investing in this podcast episode. I found his strategies for mitigating risk particularly interesting.  

While most of us do not have the liquidity of a multi-million dollar fund to make multiple loans at the same time, there are still ways we can use diversification to reduce risk.  One strategy is to invest in a fund like Broadmark Capital. Alternatively, investors can use crowdfunding sites to purchase portions of debt offerings to spread their investment capital out over several loans. 

My personal strategy is to make multiple investments of equal amounts so that the total investment income will be greater than any single investment. For example, if my average return is 10% and my investment unit is $1000, I will make at least 11 investments of $1000 so that my investment income can make up for a failed loan. 

RealCrowd is a real estate crowdfunding platform for accredited investors. However, they do have a lot of free learning resources available to the public. 

Protectionism: a Euphemism for Crony Capitalism

While protectionism seems to have strong supporters within both major political parties, it often falls short when put into practice.  George Will's Washington Post editorial shows just how difficult it is to implement protectionist trade policy in the modern economy. Multinational corporations with international supply chains create an economic impact that extends well beyond the borders where their headquarters are domiciled. It is very difficult, if not impossible, to punish intended targets without causing significant collateral damage. At best, it is a futile attempt to appease a nationalist base. At worst, it is an opportunity to perform a favor for a special interest.

I wonder if the 7000 direct Bombardier employees or the thousands of indirect employees supported by $3 billion in materials Bombardier purchases from the US suppliers every year feel protected by the tariffs. Do more expensive airplanes and the resulting higher ticket prices help Delta Airlines and its customers sleep more soundly at night? 

Quadrupling the cost of an airplane seems like a high price for the American consumer to pay to protect Boeing's opportunity to create a competing plane in the future. Unfortunately, this is just one example of cronyism created by protectionism.

Like Mr. Will at the end of his article, I am left wondering,

 Who will protect Americans from the radiating mischief of protectionism?

Using Technology to Unlock Value in Real Estate

Listen as MIT's Steve Weikal and RealCrowd's Adam Hooper discuss some of the ways technology may impact Real Estate in the near future.  I found the sections regarding the Uberfication of buildings to increase usage of space during idle time particularly interesting.  They also discuss how implementing blockchain technology would help address many current challenges of researching title for real property.  Listen to the entire episode on the RealCrowd Website.

RealCrowd is a real estate crowdfunding platform for accredited investors. However, they do have a lot of free learning resources available to the public.