A Weak Investment Thesis

The Real Estate Espresso Podcast

A Weak Investment Thesis

Spotify Google Podcast Apple Podcast Subscribe via RSS Leave a Review

Welcome to the Real Estate Espresso Podcast, your morning shot at what’s new in the world of real estate investing. I’m your host, Victor Menasce.

Today’s show is focused on an investment thesis that sounds good on the surface. It comes from a listener question. The idea is that a logistics hub, like Houston, is a growing market, which continues to experience population growth. The need continues for more apartments, for more industrial warehouses, for more commercial, and for more industrial storage.

Specifically, the argument was that there’s need for more truck parking in Houston. The problem with this thinking is that it’s focused purely on the demand side of the equation.

I happen to be a student of the law of supply and demand. To me, supply and demand are to be respected with the same reverence as the law of physics, maybe even gravity. If you try and cheat gravity, chances are you’ll fall and get hurt. So, violation of the law of supply and demand can have similar consequences.

Now, it might be possible to assess the demand side of the equation. You could conduct a market study, you could reach out to various folks in the transportation business and see what their needs are. Put together a thesis on that basis. The harder part is to assess the supply side, and Houston in particular has a problem on the supply side, and that is that it’s too easy to almost build anything.

Houston has no zoning. As a result, you can put anything anywhere. Now, of course, the landscape in Houston has changed in recent years. If you remember, back in 2018 there was Hurricane Harvey that caused a significant amount of damage in Houston. It also changed the flood maps for Houston as well.

Now, Hurricane Harvey wasn’t so much of a wind event as it was a devastating rain event. These were almost biblical rains, where that storm stalled over Houston and just grinded over top of Houston for four days.

Parts of Houston can be described a little bit like a bathtub, so there’s no gravity-fed pathway to get rid of all that excess water. It had to be pumped out of the bathtub. Areas closer to the Gulf Coast, like Galveston, Texas, received a similar amount of rain, but that rain just flowed harmlessly into the Gulf of Mexico.

So there are commercial properties spread throughout Houston that technically are condemned. They’re part of now what is considered a flood plain, but they’re very difficult to identify. You can almost think of that as a shadow inventory that’s almost of unknown quantity, because truck parking is not the current use. You could not perform a search of any kind that would identify those properties as truck parking.

The barrier to converting that property to truck parking is extremely low, and that’s just with existing properties. If you were to look at undeveloped land, there’s plenty of that as well. In the Houston area, land falls into a couple of different categories. There’s raw land that you can do anything with. However, if it’s not part of the municipal utilities district, then it’s not being serviced with water and sewer. That would be essential for any residential development or any major commercial development.

But if you’re only doing truck parking, you may not need to be registered in the MUD, or in the municipal utilities district, in order to have a viable product. That opens up a whole other inventory of land that could be used for truck parking.

And so, when you have a situation where you maybe have growing demand, which, by the way, is still unproven, and an unknown amount of potential supply, it becomes extremely difficult to make a meaningful supply-demand assessment. Even if you could make that supply-demand assessment at a given point in time, given that the barrier to entry is so low for new supply entering the market, there’s always going to be downward pressure on rents. And that’s where it becomes extremely difficult to add value.

In order to create value in a market situation, you need demand, but you also need a constraint on supply. And if you don’t have that constraint on supply, then there’s no upward pressure on prices, and upward pressure on prices is what’s essential to create value.

And we see this in the Houston area in other asset classes. We see a tremendous amount of supply being added to the market, in particular in apartments. While the vacancy rate in Houston is above the national average, running in the range of about 10%, the vacancy rate in new purpose-built rentals is significantly higher than that. Occupancy in that asset class is only in the range of 80–85%, depending on the location. Those numbers are below economic break-even for any of those assets. It’s another symptom of exactly the same problem, albeit in a different asset class.

In a situation where your supply is not constrained and demand can fluctuate up and down, it becomes extremely difficult to put together an investment thesis that’s defensible. So whenever we look at an opportunity, we always look at it through that lens, among other things. It’s not the only due diligence item that matters, but it’s one of several, unless you have a situation where demand is robust and supply’s constrained.

So have an awesome rest of your day. Go make some great things happen, and we’ll talk to you again tomorrow.

Stay connected and discover more about my work in real estate and by visiting and following me on various platforms: