Let Them Eat Cake

Hey folks, just a heads up before we get into the show. I've been moving more episodes out of the public feed and into the private sub-stack, so if you've listened to everything that's in the Spotify library and you're looking for more, be sure to sign up for the sub-stack. I label all of the old episodes with the word "archive" so they're easy to find. Anyway, just wanted to mention that, and I hope you enjoy this episode. Yeah, I mean, we're pretty focused on California at this point. I think that, you know, what's happening in Portland or Seattle where there's been thousands of ADU condos that have been built over the last five years or so is great because it shows that these types of projects can pencil that there's homeowner demand for them as well. And, you know, at a high level, you know, what's happening in Seattle is probably, you know, the most scaled example of recent legislation that's passed. Those units are selling for, you know, 30 to 40 percent less than a single family home, you know, fitting three to four properties on what was formerly a single family parcel. But they're really penciling for developers as well because you're getting, you know, three to four units of yield on that land. And I think SB 684 is better in every way than the legislation in Seattle where, you know, rather than being condos, these are actually fee simple single family homes. You can get more units per parcel. Obviously, the state is much bigger from a TAM perspective. And so we're very focused on California right now. But we do see similar legislation passing across the country. You're listening to Risk of Ruin. I'm John Reader. This is episode 46. Let them eat cake. One of the ideas that we hear repeated on this podcast is the importance of change. If you go back and listen to the episodes about casino advantage players or sports bettors or people that trade stocks, you'll often hear that they're greatest opportunities coincided with a disruption to the status quo. The canonical example is the legalization of sports betting where there were just tons of opportunities as the market participants got up to speed on what was what right. No one really knew how to price the huge menus of bets. There were a bunch of different books opening all the time and you could make money just from bonuses. A good amount of the value flowed from the newness of the thing. Then over time, the easy money dried up. That's the obvious example, but change and volatility and disruption appear in pretty much every story. Well this episode is about the housing market. But the reason I'm interested in this topic right now is because of the potential for change. Let me tell you a story to illustrate what I mean. Earlier this year, I spent one night each week for about a month attending city meetings in the town where I live. This was all related to a proposed 70 unit townhome development. It wasn't my project, but I kind of knew who the developers were. So I offered to show up in support because very often these things end up with 40 residents opposed and none in favor. Alright, so here are some details about the project. It is located on a parcel that adjoins a motel six, a denny's restaurant, a former Greyhound bus station, a chevron, a starbucks, and then beyond the starbucks is the i10 freeway, which sees a quarter of a million cars every day in each direction. In other words, this seemed to be a very good location for townhomes. The project in question was to be all electric with solar and EV chargers in the garages. And then the density, as in units per acre, was basically the amount called for in the city's newly updated housing element. So the city had recently said, "This is the appropriate number of homes for this parcel." If you have listened to this description and you think there's nothing particularly noteworthy about this project and who cares? Okay, well that is not how the neighbors saw things. In their eyes, the meetings were like the end times battle between God's army and heaven and the minions of hell. So every week, I would sit for a couple of hours and listen to a laundry list of complaints, stuff like, "There's not enough open space. The units are too tall. The developer isn't undergrounding the existing power lines. The traffic will be unsafe. And also, the electric vehicles parked in the garages will probably burn the whole place down." The developer repeated comments about the future air quality for the residents of this project. Actually one person, alluding to the project's location near the freeway, called it a "gast chamber." And I just have to point out that this project is all electric, which means that the people who live there will almost certainly breathe in less carbon monoxide than the people making the gas chamber comments. But I have to give these neighbors some credit because they had gone over the project's environmental documents with a fine tooth comb. Like they were Johnny Cochran looking for there if the glove don't fit moment. They even figured out that the traffic report had omitted a nearby intersection, and they seized on this fact with extreme vigor. For a moment, it looked like the band of Facebook-organized nimbis might prevail until the traffic engineers stood up and said, "Oh yeah, we missed that one, but we account for the signals on either side of that intersection. Despite this moment of brilliance in challenging the traffic study, overall the bulk of the comments were what I would call plainly hysterical and nakedly performative, the kind of disconnect between reason and emotion that usually accompanies a teenager's meltdown. Although that is not how the city council saw things. The politicians were running scared. A local city council meeting isn't exactly the big leagues, but that didn't stop them from putting on a show. They made sure the neighbors knew how seriously they took the complaints, and they did this by offering loud sighs into their microphones. They conjured their best dad voice as they told the developer how disappointed they were that such and such change hadn't been made. Also the best acting award would easily go to the mayor whose speech of opposition was so fiery and over the top that no normal person could muster it unless they'd been sitting at home all day, slamming red bulls and watching a continuous loop of alpichinos sent to a woman's speech. Now it might be worth mentioning that this project was eventually approved on a 3-2 vote. The council member that cast the deciding vote said something like, "We don't have the discretion to deny this project if we do. The city will get sued and we'll probably still have to approve it and we'll be on the hook for a bunch of attorneys fees." He was alluding to California's Housing Accountability Act, which says that cities can only deny a project for an objective reason. They can't just make shit up and lean on nebulous concepts like the character of a neighborhood. But that rule is fairly recent, and so no one was really used to the new way of doing business. I mean, I've spent 20 years in the land development industry in California, and I am not used to the new way of doing business. There basically my entire career, things would have gone more like this. A developer proposes 70 units. Then the planning staff knocks it down to 60. Then the developer meets with neighbors who raise hell and lobby for a reduction to 50 units. Then at Planning Commission, another 10 units are lost, and finally, prior to City Council, the project ends up agreeing to pay for a half a million dollar traffic signal that the project doesn't need, except as an inducement to the politicians who are looking for cover. Also earlier, when I said that this episode is about change, I was referring to laws like the Housing Accountability Act, and a slew of other new regulations that aren't just limited to California. Also some of these laws don't just make it possible to get approvals, some of them actually offer edges. Later we're going to hear from two guests that are active in development and are making bets in this space, and I am also making some housing bets. But first, I think we should back up and try to understand how things got so out of whack that governments are taking steps that would have been radical just 10 years ago. Kevin Erdman is a housing economist. He's a senior affiliated scholar with the Mercatus Center at George Mason University. Also he's an unlikely economist. He's written a couple of books about the market, and he writes a sub-stack. But it was almost almost accidental. Here's Kevin. And that was actually my original motivation for studying housing was just making private investment decisions about a decade ago. It tended to spend a couple of weeks looking at home builders, figuring out what had happened after during 2008 and then the pendulum swinging afterwards. Maybe it was a good time to invest in that sector again. And immediately upon studying it, just core primary data wasn't fitting the conventional wisdom about what had happened in 2008. The typical homeowner in, by say 2007, actually had a higher income, better job, more education than the typical homeowner had had in the mid-90s compared to renters, for instance. The Federal Reserve tracks like mortgage loans that take more than 40% of a fan in the city come, sort of a measure of distress to borrowing the basically the entire increase in that borrowing was among the richest households, households with the incomes in the top pentiles. There wasn't an oversupply of housing, the home builders had really become pessimistic before, well before most other people had cancellations increased a lot in 2006. So by the time 2008 happened, home builders had been cutting back on new building for two years. Nobody was speculatively building homes during that period between the peak and the crisis. And by the time we get to 2008, rates of construction across the country were well below long-term trends that would sustainably support household formation. Oh, and during the subprime boom, the home ownership rate actually declined during the subprime boom. So this story of unqualified borrowers being tricked into overpaying for houses they they shouldn't have brought, leading to a big building boom that left us with a glut of houses that it took a decade to pull ourselves out from under just simply doesn't match the facts on any dimension. I have a biased toward finding guests for the show that are off consensus. I think there are practical reasons to do that since value will always be found in the ways that conventional wisdom is wrong. But also, I would just rather hear someone offering something new. Certainly Kevin's comments about the bust are not the same reheated leftovers were used to. And look, even though I think it would be fascinating to do a full retrospective about the global financial crisis, we kind of don't have time for it in this episode. For our purposes, I am mostly interested in one question. How did the narrative that formed after 2008 lead us in the wrong direction as it relates to housing supply? I think the thing that Kevin does which I basically do not see elsewhere is he tries to account for all of the data. His model has an explanation for how we went from the perception of over building to a supply shortage. Now, you might be thinking how have we established there's even a shortage? Maybe home prices today are just overvalued and another bubble is ready to pop. Okay, well, this is the big swings in prices, probably point to issues with supply. Housing is subject to this inherent problem where it takes 18 to 24 months to deliver product that might be needed today. So we had a moderate economic expansion during the 2000s that created this mass migration out of the cities that don't have enough housing. And now that created a classic demand bubble in Arizona, Florida, Nevada, where a bunch of families are now moving in and now they're struggling to keep up with demand. So in those cities, it is a classic bubble, but the core of the motivation for that bubble is families moving out of cities that have a shortage. Kevin is not saying there was no bubble. He's saying that the bubble is misunderstood and it had a cause. This migration out of the closed access cities. I think that's a very plausible story, but I asked Kevin if that is right, then we shouldn't have seen very many vacancies during the great recession, right? I would say if you look closely at vacancies during the boom up through 2005, certainly in the cities that had building booms and price booms, vacancies were never high during the building period. There were a few cities where vacancies were a little elevated that were having building booms or price bubbles. And then when vacancies were really high, that was actually in like 2010 and 2011, that was actually a result of all the foreclosures and all the chaos that happened in the crisis, which also was related to, as I said in the boom and bust, Phoenix had tens of thousands of families moving in from LA in 2004, 5 and 6, and then that suddenly cuts to where by 2008 or 2009, there's nobody in migration to Phoenix, there's nothing. So then a bunch of vacancies happened, but there's no system for building houses that wouldn't have had those vacancies in 2010 and 2011 after that sort of a what's on migration trends. So over those 15 years, households weren't being formed, vacancies were being sort of claimed and used, so I would estimate, starting with the fact that I don't think vacancies rates were actually elevated even in 2005, they were elevated in 2010, but if you compare to 2005, they're probably short about 4 or 5 million vacancies nationwide relative to what a normal functional market would be. So, and that sort of slowly developed a few hundred thousand units a year as rents increased, all these things sort of balanced out to it, we were really in like a disequilibrium and all these things were balancing out on their way back to an equilibrium where new homes could be built and pencil again. We don't really have a great way to understand what home prices should be because it's so hard to get a handle on things like desirability of a city or natural amenities or trends in employment or the rate of household formation or changes in the use of our property like work from home. If you try to calibrate your expectations for home prices based on history and some sense of these factors, you will still be wrong a lot, but if there is some widely respected measure of the reasonableness of prices, it's probably the case Schiller index. You know, everybody's probably familiar with the case Schiller price index and back in that in the 2000s, that was a very popular email share of, you know, look at this chart of home prices that were level for a century and now they're just, you know, now they've gone just clear out of that range. And, you know, in all of history, you know, that century of a flat case Schiller index is a market that is that where supply is amp, amp, we homes are amp, we supplied enough that in general where people want to live their home appears for them. And that was the world we lived in up until the late 20th century. So historically demand factors have really been the whole story in housing. You know, over the course of the cycle prices might go up or down 20%, but over that long century, those little fluctuations are around a stable mean. What happened at the end of the 20th century is that supply constraints became binding enough that in some markets, there was basically a vertical supply curve, basically demand now didn't lead to new homes that led to rent inflation and out migration. Kevin is kind of a lone voice when it comes to highlighting the degree to which our lending policies have affected supply. Most people would think of lending after the greater session as just, you know, let's not ever let subprime in the world again. But that policy choice is going to have repercussions beyond just default rates for lenders. If you starve the market of financing, well, good luck adding supply. So I've compared 2006 and 2017 are comparable years in that the median home price across the country is about the same in those two years. In 2006, builders built more than a half a million homes at price point, under I think it's 250,000 and that they had been building more than half a million homes at that price point for years before that by 2017, it was less than 100,000 and it's never recovered. So we killed the entry level single family home market by making existing homes too cheap by making it illegal for those families who used to get mortgages to fund their to fund their purchases. So what does Kevin mean when he says it became illegal for those families to get mortgages from the mid 1990s up through 2007, Fannie Mae and Freddie Mac both basically were about a 60 65 35 split about 65% of their book of business was to credit scores below 740 about 35% was to credit scores above 7th and that was stable throughout that entire boom when when the private securitizers were going crazy and they lost market share per conspit by the by mid 2009 that had flipped and ever since mid 2009, now 65% of their book of business goes to credit scores above 740 and 35% goes to below 740. 740 is a pretty high credit score. The average is in the low 700s. So in a country with two thirds, how much of rates they stopped lending to the bottom two thirds of the borrower market. If you're sitting there thinking good, let's keep default rates as low as possible by only lending to people with sparkling credit reports. I think that's also a symptom of the narrative from 2008 and it's just miscalibrated. Actually, it reminds me of the mark twain line about how a cat won't sit on a hot stove twice, but it also won't sit on a cold stove. So first is that not giving mortgages to subprime borrowers isn't some magic risk avoidant strategy. You've just transferred the risk to landlords and the landlords have to finance their properties, right? Second is that the acute pain of the financial crisis was very, very likely caused by the fact that Wall Street doubled and tripled down on their mispricing of mortgages. So whereas a pure real estate recession would have been painful, when the two big to fail financial institutions had multiples of the mortgage liabilities in the form of horrendous derivative bets that turned the bust into a systemic widowmaker. But also turning off the subprime tap is just a mismatch of a problem and a solution. The real mortgage garbage from last cycle was really in the adjustable rate category. Whereas defaults on fixed rate loans definitely increased defaults on adjustable rate mortgages went up astronomically. Okay, and if you were hearing that thinking, great, we can just outlaw adjustable rate loans. That's not the point either. just a symptom of the same supply distortions we are talking about in this episode. They became popular because prices were moaning. Kevin says that you can also see the same shift in lending if you look beyond the GSEs. The New York Fed tracks mortgage reginations by credit score across the entire market, not just Fannie and Freddie. And then I compared the scale of original nations to the total value of real estate in the American market. So that basically before 2007, there are refi-booms that cause spikes in original nations. But before 2007, basically every quarter, 1% of the real estate market would be linked to new borrowers with credit scores above there at 760 is the cutoff. And about 3% of the value of real estate does linked to credit scores under 760. And then immediately over the course of 2008, the mortgage just to credit scores above 740 stays at 1% through the entire thing. Up till today, original nations to scores below 740 goes from 3% to 1.5%. Now it's that really down below 1% I think. So even outside just in total using that original nations as a percentage of the total real estate, mortgage reginations to borrowers with scores under 740 is probably down to less than a quarter of what it was. The undeniable outcome of the various policy choices made after 2008 is that Supreme households have gone through this experience. First, lose their house in the crash. Second, get labeled as losers, undeserving of ever owning a home and just generally blamed for the disaster. Third, watches Wall Street receive bailouts and avoided prosecution for their part in the fiasco. Fourth, get cutoff from lending so that while real estate values across the country recovered, those households did not participate. Fifth, get increasingly squeezed by higher and higher rents. Now I think that some of the policy choices made in the fog of war were understandable, but we still have to admit to them now that we have the benefit of hindsight. And admitting to these errors does nothing to improve the position of people who have been on the business end of the "k-shaped recovery" for almost 20 years now. Although even if some of the policies were understandable, that doesn't mean they all were. One of the things that we did policy-wise that just didn't match the what had happened before 2008 is that there was this private securitization boom where originators would make mortgages and then unload them off to the investors in these complicated securities. But one of the things that regulators did after 2008 was put a bunch of regulations on banks making mortgages that they just hold on their own books and take the risk on. Nobody even ever thought that was the problem. But we basically put so many sort of backward looking potential prosicklical regulatory costs on and threats on banks that after 2008 they basically just weren't willing to make any mortgages that had any default risk at all. But we had what they called the Q&M patch where if you could get Fannie or Freddie or FHA to accept the loan, then all those regulatory threats were removed. And so we basically had a market for 15 years where Fannie Freddie and FHA were the only source of investment in mortgages that had any default risk at all. There was no private securitization market and there were no mortgages being kept on bank books unless they were just very high-end low risk. Kevin has put his ideas through various reasonableness checks. But he says he keeps coming up with the same answer. There's nothing about a bubble that happened in Atlanta in the 2000s. Construction rates were stable, prices in both the top and bottom tiers of the Atlanta market were within 10% of normal. And then immediately when the lending to those households gets cut off in 2008, the top of the market in Atlanta continues on flat as a pancake. The bottom of the market loses more than 50% of home values from normal valuations. We were in the midst of a moral panic nationally about mortgage credit. So that was a story nobody was interested in hearing. And today, whenever I mention this, there's this novel credit tightening that's totally unassociated with the subprime boom. The normal person that hasn't been paying attention to this or has, they want to equate it with the subprime boom. Well, surely we got to reckless and that needed to be corrected. No, this was a lending standards that had never really changed and then it was a multi-sigma change in standards that had devastating effects on markets across the country that had never even taken part in the boomer bubble. I asked Kevin, how is it possible to really know how much housing we should have given that we don't know what household formations will be. For years, the narrative around millennials was that they were rejecting conventions of adulthood that had been followed by earlier generations. They were going to live downtown forever and spend all of their money on avocado toast. It's an amazing coincidence that the millennials all decided they'd like to be rentals at exactly the same time that Fannie and Freddie raised their average credit score by 50 points. Right. I think probably the first thing caused the second thing because the millennials look, they just look at the world that's presented to them and they have less ability to buy a home than their parents and grandparents did. They're just interpreting the world that's presented to them and renting is the option for them that it wouldn't be the case if they could actually get a mortgage in a market where rents were taking 30% of their income instead of 40% of their income. Also, in another way, I think that the supply issue leads us to overestimating these demand shifts is that we destroyed the entry level housing market in 2008 over the next 15 years. There was just a number of reactions to that. Household formation had to slow down. Basically, instead of households forming a new homes being built, rents rose until those households wouldn't form. Earlier, I said that the risk of subprime households doesn't just get erased from the system. I was referring to the emergence of the institutional single-family rental funds. These are companies that own at least tens of thousands of homes each. Actually, there was an excellent podcast by Rezzy Club on this topic and I will link to it in the show notes. They had the CEO of one of the institutional landlords and he said basically, "We exist because subprime lending had been a pretty good business historically, but it went away and we view our tenants as acceptable credit risks. That's why we're willing to rent to them." If you pay attention to this stuff, then you've probably seen that these landlords are currently the punching bag for various populist-oriented groups. That large institutional single-family rental market shouldn't exist. It never existed before 2008 and the reason it never existed before 2008 is that families that can get mortgage funding always outbid corporations for single-family homes. The people that make those arguments are generally incapable of thinking about that and thinking about the market in a way that corporations aren't the ordinary cop-cop-lons, but the reason that market exists is because it literally is the only part of the market that is legally allowed to expand from where it is. Everybody that can qualify for a mortgage on a reasonable homes, getting a mortgage and buying a home they want. Multi-family developers are lined up in queues for years at the city, at the municipal building, trying to get approval to build them. They're maxed out at political capacity. We need millions of homes and the only avenue for getting new ones right now under our current legal system is for large institutions to come in and start building single-family rental neighborhoods. If we ban that, there is no option after that. If we ban that in addition to what we've done everywhere else, it's literally paving the last mile to hell. The homelessness crisis that we have will just get worse because we will literally have made it illegal for people to get housing on the march. Even if we could wave a magic wand tomorrow and fix the issues with financing, there would still be a huge remaining obstacle to housing affordability. That's because the way we regulate land use tends to be pretty inflationary to housing costs. Local policy makers do not care that they are constructing supply, and my experience is that they're not at all focused on construction costs. Also, when I say that zoning blocks supply, that is not some unintended consequence or just a byproduct of the process. That's the intended consequence. I think it's what economists would call a collective action problem. It's the sort of thing that everyone actually acting individually makes a rational choice that collectively leads to do. So, in 1926, there was a Supreme Court ruling in the city of Euclid and Ohio that basically said before then there were limits to what cities could do to direct investment and construction. Basically, they said it's okay. Cities can legally create zones and plans to separate nuisances from residences. Essentially, they said apartments are in the nuisance category. Basically, that set off an arms race where all these little municipalities that individually make up metro areas, basically all started racing each other to be the municipality that was the least comfortable place for the poorest residents of the metro area to live in. So they would, so 'cause they are more costly than rich residents. So everyone's trying to get the poorest residents to move to the other part of the metro area. And that's sort of the core of the collective action problem for each of those municipalities. That's a reasonable thing to do for their city budget, for their local crime rates and everything else. But those people have to live somewhere. And by stressing them, the end result of all this is actually stressing them and making cities that are hostile to people with lower incomes. It actually makes every city worse as a result of all these individually rational actions. - There is an undeniable truism about development, which is that it is impossible to build inexpensive housing if you're trying to build expensive housing. I realize when I say that, it sounds stupid. And yet, I don't see many people focused on the fact that development standards have been infected by lifestyle creep. The easiest way to see this is to drive through a subdivision that was built in 1980 and look at the general level of improvements. Then drive through a new subdivision. It will be much nicer with things like spacious landscaped boulevard improvements. You know, a separated median that in the past might have been just a paved and striped middle turn lane. There will be clay tile roofs instead of shingles. The forgettable stucco boxes are replaced by foresighted architecture, highlighting positive and negative space. Wood fences are gone in favor of block walls. Maybe the development will have piseos and trails possibly even a clubhouse. If that sounds like things got better in a lot of ways, sure, of course. But all of that stuff also costs something. And if the costs are baked in by governments, then it creates a floor which new construction cannot go below. Now, if you mention this to anyone in local government that their development standards are going to impact who can buy a home, you know, it's not that their policies are explicit to end up with that result. It's more like indifference. Elected officials and their technocratic city staff have a set of norms they want to enforce. And so they don't spend any time thinking about which of their straws broke the camels back. Keep in mind that some of the damage comes from requirements that are enumerated, like written down in the city's code. And some of the damage is administered on more of an ad hoc basis. As in, a developer comes in with a proposal, but it requires a discretionary approval from the planning commission and council. OK, at that point, the city can kind of size things up and ask for as much as they think they can get away with. Part of that is the negotiation. Once you have zoning in place, and now everyone has to receive variances to build anything, you know, something that's illegal to build has a cost of infinity. And so for the builders, you know, OK, I can make money on this. If I can build this project for anything less than $5 million. And materials are going to cost me $4 million. The city says it's infinity. What if I go to the city and say, oh, I'll fund this park down the street for half a million. And then will you approve it? And so in a lot of ways, I think the extra cost is get baked in through the zoning process. You can't really talk about the way that zoning throttles development without admitting that when that happens, it's usually democracy in action. City councils obstruct new homes, because voters want to obstruct new homes. And the more localized the elections are, the worse it gets. There's a study that says that when city switch from at large city council elections to district based elections, i.e., were the members answer to a smaller geography. OK, after that switch, those places build fewer new homes. Most people are pro-growth in general and against growth specifically. This brings us to something that we have to cover in this episode, which is the anti-Nimbee movement, i.e., yimbee, or yes, in my backyard. Yimbee is also kind of related to abundance, which was a book written by the journalist Ezra Klein and Derek Thompson. In that book, Klein and Thompson argue that we should build, and left-leaning governments should get out of their own way. When it comes to delivering the outcomes, the liberals claim to value, like providing a place for people to live. Even though the book was published in 2025 and is directed at liberal audiences, it shares a lot thematically with the 2020 essay titled, It's Time to Build by the venture capitalist, Mark Andreson. This seems undeniable to me, even though Klein and Thompson do not mention this in the book, as far as I can tell. But I think that if we understand Andreson's essay, then that will give us a better context for understanding abundance and understanding yimbee. Here is Andreson from the audio version of the essay. You don't just see this smug complacency, this satisfaction with the status quo, and the unwillingness to build in the pandemic or in health care generally. You see it throughout Western life, and specifically throughout American life. You see it in housing, and the physical footprint of our cities. We can't build nearly enough housing in our cities with surging economic potential, which results in crazily skyrocketing housing prices in places like San Francisco, making it nearly impossible for regular people to move in and take the jobs of the future. We also can't build the cities themselves anymore. When the producers of HBO's Westworld wanted to portray the American city of the future, they didn't film in Seattle or Los Angeles or Austin. They went to Singapore. We should have gleaming skyscrapers and spectacular living environments in all our best cities at levels way beyond what we have now. Where are they? Andreson continues with a challenge to left leading governments that they should prove they can deliver the results they claim to value, which is again thematically very similar to the abundance book. In fact, I think building is how we reboot the American dream. The things we build in huge quantities like computers and TVs, grab rapidly in price. The things we don't, like housing, schools, and hospitals, skyrocket in price. What's the American dream? The opportunity to have a home of your own and a family you can provide for. We need to break the rapidly escalating price curves for housing, education, and healthcare to make sure that every American can realize the dream. And the only way to do that is to build. Building isn't easy. A read already be doing all this. We need to demand more of our political leaders of our CEOs, our entrepreneurs, our investors. If this all sounds terrific, I agree. But I have to make a confession and admit to some trickery. The reason that Mark and Jason's voice has made its way into this episode is not because of his plan to recapture the American dream. I have included him because he illustrates precisely why we suck at building. You see in 2022, so not long after the essay was written, the city where Andreessen lives, Atherton, California, was trying to update their general plan, housing element. Included in that update was a proposal to upzone some properties to multifamily. This did not go over well with Mr. It's Time to Build. Any wrote a strongly worded letter to the city and protest? I'm going to read selectively from the letter, but in the interest of fairness, I'll provide a full link in the show notes. Okay, here are the highlights. Dear Mayor and members of the Atherton Town Council, I am writing this letter to communicate our immense objection to the creation of multifamily overlay zones in Atherton. Please immediately remove all multifamily overlay zoning projects from the housing element, which will be submitted to the state in July. They will massively decrease our home values, the quality of life of ourselves and our neighbors, and immensely increase the noise pollution and traffic. Then the letter is signed by Andreessen and his wife. So this is a great letter for a lot of reasons. You can't see it because this is an audio podcast, but the letter relies on all caps in multiple places, like it's a one-star yelp review for the Red Lobster. Andreessen is one of the world's big brains, and his wife is a lecturer at Stanford Business School, but they don't bother to come up with anything beyond just very boilerplate, nimby complaints, property values, noise, and traffic. And of course, there's zero evidence for any of the claims. It's just unsupported vibes, but I think the letter doesn't bother with more sophisticated arguments because they're unneeded. The city of Atherton ended up taking two years to update their housing element because Andreessen and his neighbors were so pissed off. In fact, the city only approved an amended plan because the state threatened fines if they didn't approve something. Remember that Andreessen said the failure to build was the result of smug complacency. He wasn't just disagreeing with people who have objections to growth. He was sneering at them, but here's the awful reality. Andreessen's split personality on this issue isn't the exception, it's the norm. We are all basically terrible, and not to be relied upon when it comes to the collision of our ideals and our self-interest. In fact, I live across the street from an elementary school and the traffic is horrendous twice per day. The parents drive like shit. And in the trade-off between, you know, waking up five minutes earlier or acting like a complete maniac at 7.58 a.m., they're going with maniac, thank you very much. If the city ever held a vote as to whether to bulldoze the school and replace it with a grass field, I would quickly become the leader of the Facebook group devoted to the industry. initiative, my Google search history would become filled with queries like "Good anti-school slogan" and "Where to buy cheap yard signs." I would also stand up at town meetings and say stuff like "It's not that I'm against education, but does it have to happen here?" The fact that children need somewhere to learn would be pretty much nonexistent on my list of priorities and certainly well below how triggered I am that one time three years ago a parent parked in front of my driveway when I was trying to go to Starbucks. Okay, the problem with "Mark Andreessen" and the problem with "Me" and the problem with "People in general" is that we have shown again and again that we cannot be trusted. We just generally suck when it comes to thinking about anything besides ourselves. Which raises the basic question, how can you get things done once that dynamic is well known? You can probably see where this is going which is that if local politics is not capable of producing the needed result then there is no way forward except to take away that local control. But I think people overestimates like the sense of like chaos that would happen if people were allowed to build everywhere. Pre-Zoning New York City had the Lower East Side and the Upper East Side and those weren't going to mix. The both parts of Manhattan were serving the needs of the people that lived in them and the people that lived in the Lower East Side weren't looking to move into a 4,000 square foot apartment with the door-man. And the people on the upper East Side weren't going to buy up a block and the Lower East Side and tear down the tenements and build a mansion on it. They were naturally seeking to segregate. And so I sort of feel like whatever radical means are attempted to change these land use obstructions. I think the fears people have of the downsides of all the change that would happen are just greatly overstated just because the marketplace itself probably over-sigricates is compared to what might be healthy. The title of this episode is Let Them Eat Cake which you know I barely even know anything about the French Revolution so if you also know nothing then we're in the same boat. But the phrase is just a once great princess who, when told that the peasants had no bread, replied Let Them Eat Cake. That's good enough for our purposes and we don't need to get into this business about how it wasn't actually Maria Antoinette that said it and the word is actually Brioche, not cake. We only care that it is a perfect encapsulation of elite indifference and of course the political bill that one day comes due from the Calis disregard for the problems of ordinary people. For everybody housing is a basket of necessities and endowments and luxuries. For the richest families it's a lot of a dyslectries so they can just trade off those luxuries. They're not going to overspend on housing to have the extra office space or the media room or to live in a neighborhood with people with $150,000 income versus $130,000 income. So basically what happens is families with $150,000 income end up buying houses and neighborhoods that used to be filled with $130,000 income families. And that just builds up a wave of that downward trading demand builds into the poorest neighborhoods. But as you get into the poor neighborhoods they have fewer trade-offs to make. Now they're just holding on to necessities. Now they just are holding on to a roof over their head in a place to sleep at night and a place that's close to grandma because she takes care of the kids in close to the job that they've had for 30 years. And so those are the families that end up spending 60% of their income on rent because they're holding on to these endowments, these idiosyncrasies of location that people shouldn't have to pay for. But they do when you get into this environment of adequate supply. I went on an interaction on Twitter between the mayor for a relatively well-known California city and some pro-housing type accounts. The mayor was defending his no-growth policies by saying there's really no reason to build more considering that California is flat on population. Okay, this is an amazingly sneaky argument because it relies on the fact that people who cannot afford a home leave for places like Arizona and Texas. Right? That is how population stays flat. Then you use the result of your policy to argue that it was the right policy all along. I hate to say it, but I always have a grudging respect for a galaxy brain. Checkmate. So eventually, so basically what makes a market like L.A. sort of reach equilibrium, the thing that makes home prices where they are in L.A. is what is the rent inflation necessary to get 100,000 families to move away this year. And so you get this regressive cost and price inflation where there's a shortage. So like I said in 2005 and Phoenix, the whole city wouldn't up and down during because it was a demand boom. Now Phoenix has a supply shortage. So now Phoenix looks like L.A. did in 2005. The richest neighborhoods are basically priced normally and the poorest neighborhoods, the priced income ratios are twice what they had been in the past. So you can say so there's this pattern in prices that tells you whether it's a demand or a supply issue and it's screaming that it's a supply issue. We're actually cyclically pretty neutral right now. And it within every city in the country, the poorest neighborhoods are the highest price. So you know, people make two mistakes on this. So because because commercial wisdom says demand, this is all about demand, they say, oh, New York and the San Francisco and L.A. are expensive because people want to live in nice places and those must those are expensive. So they must be the nice places. But it's it's the least nice parts of those places that got more expensive. And people will actually say this out loud explicitly, they assume that like the Beverly Hills, the Beverly Hills is the neighborhood that's expensive, right? And it's the pressure to get, but it's content that's gotten more expensive, not Beverly Hills. Kevin has been studying housing for over 10 years. You can probably tell he's been through all of the data and all of the numbers, but I also think his a very good ability to look at our collective psyche and understand which of our fears and insecurities led us to this place. In the, you know, I call them the closed access to these New York, Boston, L.A., San Francisco, in those cities where, you know, literally there's a cap on population. They that really creates a Malthusian limit locally in their economy. And one thing that we sort of have been able to take for granted is the degree to which living in societies that have growth released us from the Malthusian limit and created the ability for a win-win ethic. When you, when you're living in an ancient, you know, hunter-gatherer system that's maxing out the capability of the forest to feed your tribe, when somebody has a baby, somebody else has gone as starve and, and, you know, basically populations, you know, the ethics of those old civilizations reflect that, that, you know, doing bad things to each other or to your neighbors is part of the process of equip relating your society. And so they did things that we consider terrible. I think a lot of it comes from that sense of there are no winners, there are only trade-offs. And, and so we've all internalized that, or most of us have internalized that sense that we can find win-wins. And it's actually allowed us to, to improve ourselves ethically as societies to find ways to do that. And one, and then now that we've clamped these Malthusian limits on to cities, now the people that live in those cities experientially, like, palpably feel that sense of that ancient idea that nobody can win, we can only take. And so, you know, at least to these strange, you know, like people will complain about, and San Francisco or New York City, they'll be against like some new corporate headquarters maybe in the town or something, because their reaction is, oh great, now, now the housing's going to get more expensive, or, you know, people today complaining about immigration. I think all that's downstream from us creating a cultural, devolving culturally back to a fixed-py world. And so I actually think that, you know, that started in the close access cities, now we spread at nationwide, and it really actually has created a cultural devolution. And then it's sort of self-reinforcing because now people are actually against growth because they see it as being in competition for resources. In fact, I think that's sort of a way to explain the sentiment that led to the crisis in 2008. And a lot of ways, if you look, you know, across the spectrum, all the different ways that people have to react to rising housing costs. A lot of it, you know, whether it's, you know, that there's too many rich people moving into my city, or the Fed needs to raise interest rates, or, you know, we just need a good recession to clean out the shaft and get prices right again. Those are all versions of the same story, which is we need to make ourselves poor enough to fit into our poor housing stock. We spent the first part of this episode talking about structural problems in housing, but now we're going to move on to the actual bets. Okay. And I do not think that if you just blindly bet on residential real estate right now, you're going to do very well. There's a ton of resale inventory, which, like an iceberg, is sitting just below the surface. The home builder's also have a lot of supply they're trying to get rid of but I think there is opportunity if you can actually increase affordability. So how would you do that? To keep things very very simple it's just think about all of the materials that go into a home and how do you reduce those materials. Well the total construction costs are correlated to lot development costs which are tied to lot size and that's it. I mean it's simple arithmetic you pretty much need by right small lot development where cities can't stop you and they can't tag on a bunch of requirements that undo all of the savings you get from going to small lots. So that's what we'll be talking about for the rest of the episode. It's basically find a property previously zoned for one house but new regulations allow four to ten units. In California this is possible through starter home bills but in Oregon they have something similar called a cottage cluster. Well the next guess you're going to hear from is building cottage clusters in Oregon. So I should say that I don't know this guest from being in the development industry. I met him when I was at a meetup for advantage players it was completely random. You know at this meetup there were a bunch of people who bet sports professionally and have one millions from playing casino games and through lotteries including former guests of this show. Most of these people have stories that are just nuts but I couldn't believe my good luck at finding a guy who said he racks up credit card points on his concrete orders. This is Cody. He's a home builder, turned advantage player, turned home builder again. He got started during the housing boom of the 2000s. It was like the height of it when everything was like boom like crazy so I just noticed it going on and I thought that seems like something that I'd like to learn more about and get into and everyone is making tons of money doing it. So I built my first house just based on reading books and kind of faking it because loans were so easy to get back then too. You could just go into your everyday bank and get like a real estate loan over the counter almost. So yeah I built my first house, spec house that sold and then I built the house I'm living in now actually in 2005 to 2007 and I had a few other projects that were kind of starting that I was working on and then the market crashed if I can float it as we all know. So I got through that okay because I really just didn't have much going on that would hurt me but I didn't really have an income but I scraped by and I saw an opportunity from the crash which was all this land was not selling it was sitting there was a lot of land owners. No big builders were buying anything. Developments just weren't going to do anything at that time but there was still people who had money who had good jobs that didn't get affected by the downturn that wanted to buy in because they could see the value so I teamed up with land owners and marketed custom homes for sale. So I wouldn't even buy the land I wouldn't spend a dollar I would just instead of them saying this lot for sale we would say this house for sale for 600 grand on this lot. So that generated a lot of business because then these people were like oh great I get a custom home out of this. So that worked out well because I had no risk I knew what I was going to make I didn't have to put in any money the homeowner got the loan the person sold them the land everyone was happy I made incentives for real it is which was kind of on her to have on custom home so that got a lot of attention to so that's how I really started building I built several houses doing that until about 2011. Let's see Cody taught himself construction by reading books and quote unquote faking it and then when the world fell apart he was able to find a small slice of the market where he could still make money so pretty much a prototypical guest for the show. And by that point I had built up enough money because I had already known out of count cards I learned to count cards actually like 2000 early 2000 because there was casinos in Washington card rooms and stuff but I knew I didn't have enough money to make it worth doing because you would make you know based on my bankroll I would make less than minimum wage card counting and I could still lose money so I never really did it but after building all that time I actually saved up enough money to where I had an actual bankroll I was burned out on the custom homes because it's really just hard to deal with a bunch of people husband and wives and stuff building them their dream house and multiple people at a time it just got really stressful and I was sick of I fell in ringing 24/7 from these people so I just quit building at that point and went into being an advantage player full time. So and I started off card counting because that was all I really knew I didn't know on single other AP I never actually even heard of anyone making money in a casino I wasn't even 100% sure it could work to be honest I read the books and I knew the basic math but I still was like I don't know you know it was this actually gonna work out I played like the best games known really I didn't know at the time but there was double deck deeply dealt all good rules 3 to 2 surrender so that's what I started counting on and like lucky lady side bet but I still lost for a couple months just bad variance and then it finally turned around I started actually making a little money got backed off everywhere I didn't even really know that that would happen honestly until it just did all the time but in the process I met a bunch of other people along the way and I learned about like better things to do other than card counting and just kind of went from there and a lot of my best friends now were people I met during that time as an AP so it worked out really well. If I was ever going to recruit a team of advantage players I would run an ad that says want to see the world and then I would leave out the fact that the part of the world you're going to see is the part with casinos okay I'm mostly kidding some of these casinos are located in actually nice places even if lots of them are located in dumps but the part that serious is you are definitely going to see the world. Yeah, ton of the traveling well see I started off not traveling because I was like great I can just play Washington forever these games are great I'll just drive here and this will be my job because I really didn't know I was not aware that you can't really do that because they're just going to kick you out. So that lasted a few months and then pretty soon all the Washington casinos were like no you can't play here anymore. So then I was like well where can I go Vegas that's close so I started going to Vegas and then within like a couple months of the biggest casinos were like oh this guy you know I was getting flired and so that's when I was like I got to figure something else out because card counting so obvious you're just betting $5 and then $600 anyone can pick it off. So I actually did play Vegas for a while still just not counting and then I realized to really make good money I have to find better games and travel more so I was traveling a ton. I actually took an RV trip to every state in the 48 states in I think 2013-14 and just played along the way that was really great. I took my current girlfriend and baby's mom with me that was like our first trip together we're still together so that was nice and I met a lot of friends that I still have during that trip so it was great. We always frame these things as the AP against the casino because that's more fun you know casino suck but the reality is that advantage players are also in competition with each other. It just became more publicized it used to be people were keeping their mouth shut about things you know if you had a good opportunity you wouldn't go posted online or like talk about it because I never would I still don't in a way that would hurt my wallet or even a friends wallet or like people that I respect you taught me things I don't want to talk about I'm just out of respect for them because I don't want to give away their thing but people these days don't really think like that so there's just a lot more info out there and a lot more people talking about the stuff that I used to do. I'm sure there's new plays now that no one's talking about maybe so that's probably where the money is but yeah as far as like whole card in and slots and just things like that everyone knows about it nowadays it wasn't that way 10 years ago. I see accounts on Instagram that are trying to be influencers in the hustle economy and they're all like check out how I bought this liquor store with no money down but none of them have a story for spinning up their capital that's even close to as interesting as codies. It was about the time sports betting was getting a lot harder because used to be the legal books would just take the action and your account would last till you want a certain amount you find a good bet you could bet it you know and then it got to the point where oh I know how to beat this and you just can't get the money down and you're losing accounts and you need lots of your it's about the time. Like that started happening. I was like I think it's time for me to get back into building. I always wanted to do it where I didn't have to do pre sold stuff because I hated the thing I hated about building was having the client I didn't want to work for someone so I was like now I have the money I can do spec this will be more fun and I do not rely on someone else. So I just started looking at land and kind of thinking how I can get back into it and I just noticed a listing actually that said cottage cluster you know or zone for cottage cluster and I'm like what the hell is a cottage cluster so I looked it up and I was like oh wow this is like huge because as you know it's really about density a 10,000 square foot lot for one house is worth almost the same as a 7,000 square foot lot for one house but 10,000. a thousand square foot lot for as many as you can fit is worth way more than one for one house. So that's when I thought, wow, this is what I need to do. I just find these lots that I can develop into multi houses, basically your multi-family or multiple houses, because it's like a mini development. Every lot becomes a kind of mini subdivision. After I met Cody and he told me about the cottage clusters, I flew to Portland to see what was happening. I had already started working on similar deals that were made possible by the California legislation and I thought there would be value for sure. But when I mentioned this stuff to other people, no one got that excited. You know, you want to be early, but if you're talking to other value-oriented real estate people and they give you a blank stare, that's not exactly the reaction you want. So kind of as a sanity check, I wanted to see with my own eyes that this stuff could work. I went to Portland on like a Wednesday and yet somehow there were a bunch of open houses for these little four to eight unit developments. I mean, they're pretty cool because they're in established neighborhoods where everything is built up around them and then the actual cottages are just standard new construction of plus or minus 1200 feet. Also, the product looked nice. I think that people don't really realize how nice a new home can be even if it's small. The folks building these things seem to be local companies, but some of them had multiple projects. I actually chatted up one of the developers outside his project to try to get a sense as to where he thought the landmines would be. He told me the same thing Cody did, which is that in the early days, it was very easy to get good deals. But things have gotten more competitive over time. It used to be you just buy all the lots, I think, honestly, just any 5,000 square foot lot, which is probably that is the minimum it has to be to do a cluster. So any 5,000 plus square foot lot that was not having issues of some sort that had utilities and stuff. I think you could have just bought that two years ago immediately and done well. Now the price has gone up quite a bit, but I think finding lots with existing houses can still be good. I think this is a good example of how real estate is very much a show me business. Even though all of the market participants had time before the rules went into effect to think about which parcels would benefit the most and they should have been able to back into a new land value based on the ability to add units. That didn't really happen. It took time for everyone to really figure it out. At the start they really didn't realize how much more and now it's kind of changed to where they think it's way more than it is mostly. Anyone mentions it and their listing that just means they're way overpricing it. So the best deals I got they didn't even mention cottage clusters. They probably didn't even know about it. They just kind of priced it based on comps and then put it for sale. So really the land prices for big at Watts that are big enough at least doubled and that's probably correct really. If the prices for suitable properties doubled then the biggest mistake you could have made was saying no to deals. I asked Cody if he had any regrets from being too cautious. There's one that in its right next to another project that I have and I really did want it and I thought I could get them to carry it until I got permits and they were going to do it. So I was like great I don't even have to put any money out right away but I could have cashed it out too. I was just getting a little nitty-un. Like you said and trying to save on 200 grand for 12 months and then they said you know what? I don't think I want to do it and I'm going to relist it and they did and I thought I'll just offer them cash tomorrow whatever and then it was gone. They relisted it and someone snatched it up that morning because it was a pretty good deal. There's sort of a paradox that exists for developers which is that they should want rules that are straightforward and allow them to build and they don't want regulations that are too onerous or capricious but if building is too easy then it's going to be a race to the bottom in terms of profit margins. Okay well policy makers should be able to see that dynamic and use it to form their rules. They should want cut-through a competition. So when I visited the various cottage clusters in Portland and it was a bunch of developer names I never heard of who are not the DR Horton and the NARS of the world that seemed like a very good thing but I asked Cody whether all of the competition made him nervous. I just looked at how many permits were in the queue and I was like holy crap when all these come out what's going to happen but then I realized we're in a big housing shortage still in Portland and also the price point that I'm building there's a major shortage because I'm building as cheap as I can really honestly so it's all starter home really cheap pricing which there's a real lack of and when you look at the mortgage payment versus rent it's about the same for a similar unit and you're getting like a yard and a driveway and a detached house and like new appliances and things like that so it is much more appealing than renting so with that said I don't feel there's any risk to me because I can just hold them I could place DSCR loans on them for more than I probably have in them and have my rent cover at and then I just have a bunch of rentals which I probably will end up doing with a lot of them anyway. I mentioned earlier that I think the opportunity is concentrated in projects where you can actually drive down prices so our cottage cluster is getting there. Well the median home price in Portland is in the 500s but Cody has new product well below that number. I actually have some that are going to be in the 350 range so I'm trying to stay in like 350 to 450 so that's what I'm saying like when you look at what an apartment rents for a crappy two bedroom one bath that's like run down is 1900 bucks so if you can own a house for 400 it's a no-brainer for people who can afford it so and if I can rent it for two grand I can easily just get my money back out of it so yeah that's the key to me I'm really not trying to build anything above that 450 mark. I think the main buyer for me it's not going to be anyone who owned a house before it's going to be someone who rent it or maybe even lives with their parents or whatever like the last one I sold the people got alone from their parent they were probably late 20s you know and they got alone from their parents for the down payment and they had two small children and they were just really happy to be buying instead of whatever their current situation was. Because Cody is a small builder he shouldn't really be at a disadvantage when it comes to costs but he says he's been competitive. So yeah my pricing is actually compared to like other builders I talk to it's lower and I think it's partly because I spend a lot of time getting it down it's just my AP instinct if I can save I will. So someone who's just like happy to make money and they don't want to get a lot of bids and they just want to make it easy and not work harder on it they're probably paying more because they're like just looking at and going well I'm still making 27% or whatever this is great you know I'm always trying to get it down if I can. There's a lot of ways you can overspend or save money along the way it's crazy and it really adds up when you're dealing with 30 aspects for one project you know saving like 2% each aspect can be huge and so that's the way I look at it like lumber for example I'll pin four or five companies against each other and they all want the business especially this time of year it's pretty slow for building an organ because the weather's bad and I notice I kind of like building this time of year because it's slow so I get better deals from people but like with lumber for example that's a big cost I'll get four or five bids they all want the business I'll ask them to come down even more on negotiate credit card points and stuff so I can get that in there or I'll get them to float it for 45 days because free money is good too when you can have interest free loan. Cody's projects do not require a discretionary approval he submits his plans and then the city has to act on that submittal within a certain amount of time so there is no way for neighbors to derail that process but just because the neighbors can't show up to planning commission doesn't mean they don't have opinions. Yeah they don't like it ever really even the ones that are like oh this is great for the neighborhood once we start building oh it's that close oh no where am I going to park oh so yeah no one likes it and then they want to buy it when it's done even sometimes but while it's being built they just hate it you know I had a big fight with one neighbor because their fence was like 10 feet off and you know things like that happen all the time when you're building in a city it's already tight so you're kind of right on top of people so they don't love it. Even though these cottage clusters aren't going through a discretionary planning process that doesn't mean they're being designed with no consideration for aesthetics or livability but it does mean that some of the decisions that were previously the subject of debate among neighbors or city staff or planning commissioners have now been shifted back to the developer and so they get to make choices about layout and density which means that the developers actually get to experiment to see which features homebuyers value and which ones they reject. Just getting hung up on how many units you can get and not realizing like no one wants to live in these because some of these people they would take like a hundred by hundred lot stuck in between other houses and they would just stagger houses you know little square houses all the way back. with no parking. So the people that live in the back or in the middle, they're not only just surrounded by houses six feet away from them on all sides. They also have to park on the street somewhere and when you add 12 more houses to the street and probably 20 plus cars, then there's no street parking. So what I've seen happen with those is they may sell like a few right away, the ones right on the street, and then the rest are just sitting. They end up renting them and I've seen some that seem even close to going into foreclosure. I think because the people got really high interest rate loans on them and they probably didn't have much of their own money in them. And they just kind of built a really crappy product because they're thinking, my land costs, wow, if I do 12, it's 20,000, not realizing they'd be better at 50,000 a lot with actual sellable houses. I actually choose to do less on a couple of these just because I think a better quality product is worth more and less risky. And you really only lose, like if your lot cost is 60 grand a lot, you know, and you go from 6 to 5, you're not really losing that much because you're only losing that lot cost, percent, not the percent of the total profit. And it's one that I'm doing on a 10,000 square foot lot. I could have easily jammed 8 units in there, but I just think it would have been a bad idea. And I ended up doing 5 because then they all have garages, they have driveways, they're like nice, they have yards, and I know they're going to be sold really quickly. And people are going to really like them versus if I did 8, I could have had a lower lot cost, but I would have had a lot more risk of being stuck with a couple of those. And the good and bad thing about this stuff is there are so many moving parts and every one of them is a tiny puzzle to solve. Yeah, unfortunately it even just keeps me awake at night sometimes because I'm always trying to find the thing that I'm missing the big angle really. So yeah, that is a big part of my strategy. And it's not just for the cottage clusters, it's really just development in general. I think that's a big part of it. The guys who are making like big money developing, they're definitely not doing cottage clusters. So they're doing big multi-family high rises with bond from the city or whatever, working with the housing bureau, getting all these other incentives from who knows where. And that's kind of what I want to get into eventually if I keep building, I think is this bigger stuff and that's probably where the big time AP developers are. So I am always thinking what's the next big angle, what am I missing, what can I do, I'm looking at land listings constantly thinking how can I make this worthwhile. So yeah, it is kind of like similar to the advantage play for me. I do like building right now, I'm having kind of fun because it's new and different and it is kind of challenging. I can stay home with my kid, which is nice. I miss the AP stuff too though a little bit, traveling with friends and going on trips and making money. It was always fun. When you don't have to do it to pay your bills, it's actually kind of fun. So yeah, for now, building is going to be number one for me. I still take AP trips sometimes. I took one a month ago. It was again just kind of like fun slash try to make money type of trip. But I'm definitely not done being an advantage player for sure. I think I'll probably do that for the rest of my life. Maybe you've noticed that I started this episode talking about a systemic problem in housing. And then we heard from Cody who's building half a dozen units here and half a dozen units there. IE, it would take a lot of code's to make a dent in the larger problem. Well, there are people working on these problems and trying to achieve scale. Well, I guess we're going to hear from is Ben bear. He is the CEO of build Kasa, which is a venture back startup working in the same space. And the thing about a startup is they can only succeed if they achieve scale. Here's Ben. Initially started out as the 23 year old VP of revenue for a mobile advertising startup called Vungal. So thank you for playing temple run, diet the end of the run, and then get some coins and watch a video to continue. Ended up being a proxy bet on the growth of candy crush saga and Supercell in 2012. So went from eight people on a dog to a $70 million run rate, and then ended up selling to Blackstone for about 800 million in 2018. I study political science in college and I've always been really fascinated by running towards regulatory change rather than away from it. And so prior to this, I was an early employee and then subsequently CEO of Spin, an electric bike and scooter company. And we ended up selling to Ford. And so I was looking for an opportunity in housing because it's big, it's inefficient. And there are a lot of regulatory changes happening all the time. And first opportunity that we saw with my co-founder and we just did a brainstorm at my house was around SB 9. And so that was a law that went into effect in 2022 that basically made it a lot easier to subdivide residential single family properties from one lot into two. And I just thought it was fascinating. And a little bit of background might be helpful as it relates to SB 9. It is one of the laws that California has passed which tries to thread the needle between increasing housing supply and yet ensuring that no developer makes money while that supply gets increased. And I am sadly not joking about that. SB 9 did allow homeowners to do a streamline lot split, but the sub-divider had to sign a pledge that they plan to live on the property. Then it also included another provision to keep developers out. It said you couldn't perform an SB 9 split on adjacent parcels. When you read a law that is written in that way, you just want to shake the people that wrote it and ask them, do you actually want anything to get built or not? In any event, the nonsensical nature of the bill actually could have been build costs of opportunity. The original business plan was to take the friction that SB 9 created and then cure that pain by matching homeowners with small builders. And we thought that at a moment in time like today, there's probably a lot of homeowners sitting on access land that they're not really using that could turn into new lots and produce more housing. ADU laws have been continuing to evolve and iterate in California over the last 10 years and started to make a dent on supply. And this felt like the next logical step in that journey. And so that's kind of how the idea came about. We felt like people who owned the properties are not developers and so going through a complex entitlement and subdivision process or even knowing about the law and what it potentially unlocked. It felt like there was a need to potentially bridge that gap, which a startup like build costs that could play that role. You can kind of see how Ben's original business plan could have maybe worked, but it didn't. Our initial focus on SB 9 didn't turn out to be correct from a venture backed business model perspective. So initially the model was that we would partner with the owners and then give them a cash offer for their extra lot space. That wasn't super scalable because you've got to do all these one-to-one partnerships with existing owners. The people that wanted to transact were not necessarily the folks with the best lots. It's never easy to move on from a sunk cost, but luckily build casa was presented with a much better opportunity than SB 9. I've been through quite a few startups at this point and fortunately three of them have worked and one of them didn't. As a result of that, it was very easy for me to see that what we were doing wasn't going to get us where we needed to go from a sort of venture scalability perspective. When SB 684 passed, we quickly latched on to it and started figuring out how we could leverage that to further the mission of creating more starter home opportunities and build a more scalable and viable business. I think you really have to be flexible and fluid and like, you know, dogmatic about what the mission is, but not dogmatic about how you get there from a business model perspective to be successful in startups. I want to go over some of the key differences between SB 684 and SB 9 so that we can understand why a build casa is in a much stronger position today. Okay, SB 9's owner occupancy pledge meant that the opportunities would always be painfully linear. Every deal you work on would require coordinating with an actual person who would be living on part of the property post split. And that is not easy. People are difficult. And you know, you could spend months getting them comfortable with the structure of selling off their excess land. Then on the day they're going to sign the contract, you get a call from their cousin who is a real estate agent and even though they haven't had a transaction in four years, they've been brought into just make sure everything is okay. From there, you have to decide if this deal is worth it considering that it now requires sign off. from someone who has only proven how much they don't know about real estate. Alright, that is just completely gone with SB684. There is no owner occupancy requirement. And instead of splitting into two parcels, you can split into 10. I think one of the beautiful things about the laws that we leverage, and the primary law that we leverage today is called SB684, which is slightly more expansive in terms of what it unlocks than SB9, is that you can really centralize a process. And so you need a network of surveyors to actually do the on the ground surveys, but it's not as complicated as building a house in a hundred different jurisdictions. And then from a processing perspective, we could build out a central function that was very efficient to actually go through the subdivision and entitlement process. And so it felt like it could be pretty scalable from that perspective. And so when SB684 passed last year, went into effect this year, we felt like it was a much more compelling opportunity from an in-fill scalability perspective. And now on the build cause aside, our business model is partnering with in-fill developers and builders and serving as their buyer's agent and entitlement specialist. And so it's much more scalable both from a unit production and an overall tame perspective as a result of that. I think there are some interesting decisions to be made around, whether to start with a vacant parcel or to find a lot with a house, where you can flip the house and then sort of get the land for free. I think that there might be more potential to get a longer escrow if you're dealing with vacant land, which is good. It helps with carrying costs and reduces risk. It's also nice to not have the purchase price of the house, counting against your return for however long it takes to flip out of it. But the cool thing is that either route offers a good amount of upside, Ben said that they've been mostly working on parcels with existing houses, which Cody also told me he thinks offers the most potential going forward. You buy a house, we're actually able to see what the ones that we've thought that, you know, they're on corners or alleys or geospatial algorithm can find things that have really good access. And so what we've been able to do is, you can buy a house, you can keep the existing house, resell that, and then you're left with, in the case of these two projects, four lots, that basically zero basis on both of them. You then pay off the bridge loan with the sale of the existing house, and then you basically are able to go ground up on essentially free land. And so sort of a two-stage process, but is a very elegant way of unlocking the arbitrage. I would describe BuildCasa as essentially a facilitator layer in the building process. They're working to source deals and complete entitlements so that small builders can focus on building. Yeah, I mean, I think a lot of those folks are our customers. And so the reason that they are willing to use us as a broker and entitlement specialist is because we have a lot of familiarity and a track record with getting the approvals and doing it in a cost-effective and timely way. In terms of when a good property comes up on the market, as a brokerage, we're able to see it early. We can see the coming soon listings were very plugged in to various networks. And from an offer perspective, I'd say most are still not looking at it as an SB684 opportunity. They're looking at it as a flip or potentially just to add ADUs. And so ultimately, the sellers really care about price. And so John buys houses or any of these home flippers. It's very much an I win-you-lose type of dynamic. Whereas because of the fact there's such a strong arbitrage built in today, our buyers are able to pay market or above market for the homes and still make the numbers work from their perspective. The California starter home rules are still fairly new. And cities are in the interesting position of having to administer them while also having very limited discretion. You know, not every city is crazy about that idea. I've met with a few cities to discuss these projects. And the reactions I've gotten have been a mix of just confusion as to how things are supposed to work. And some light obstruction. Like trying to subtly redefine the timelines in the statute. Although I asked Ben if they ever run into problems with cities dragging their feet. And he said, "Not really." Most cities at this point realize they have a problem from a housing production perspective. And so they've gotten comfortable over time. Starting with ADU laws with these bi-right or ministerial processes where the neighbors don't have direct input. The Planning Commission doesn't have direct input. Provided you meet the local requirements. And so a lot of that is dictated by the state law. There are city-specific regulations that get introduced. And so one thing that we really focus on is working with advocacy groups like the Cassida coalition, California, Yimbi, working with the legislators directly so that we can help the cities, you know, get up to speed on sort of what we're seeing and what other cities are doing. And one of the things that I think is most compelling about SB684 in terms of how it's playing out so far in the very early days is that there are these areas that, you know, developers would completely avoid because they'd think it would be a sinkhole and sort of not possible to get through the process. But we had an application get approved in three months in Santa Monica. When I started working on these small-lot development projects, the first thing I did was build a GIS dashboard. GIS is basically just mapping. Actually, as an aside, the first programming language I ever learned was called VBA for ArcGIS, which was like a super janky way to script your mapping applications back in the day. The good thing is that today it's pretty easy to write this stuff using an AI coding assistant and geospatial database like post GIS. Anyway, the opportunity set for these projects includes tens of thousands of parcels spread across California, which is not a small place. And I wanted a systematic approach so that I could evaluate sites really quickly. Some of the data in my system is from government sources like you need to know whether a property is in a high-fire zone. But you also need to know if it has sewer. And the utility agency's data is not all standardized. So I had to figure that out. And then there's the valuation side. You should be able to quickly price the product you expect to sell. I landed on something that is a more dumb down than a Zillow estimate, but it's close enough for my purposes. Also, their development impact fees, these can range from $50,000 to $100,000 per door, and every city sets their own fees. The flow that I settled on is probably 50% automated and 50% manual. I use the standardized data to get close. And then when I think I have a good candidate, I start digging into the harder defined numbers. Oh, also because when you get down to sites that are half an acre to one and a half acres, the actual dimensions start to matter in ways they don't matter for larger projects. For instance, the maximum street length you can get without a turn around might be 150 feet. So you need to know if that's possible and the effect it will have on your lot yield. So I built like an automated layout generator so I can quickly figure out how many lots are realistic. I am just one guy, but this system has allowed me to evaluate thousands of parcels. I mean, some days I just sit there and click, click, click through sites. And then I've written about a dozen offers and I have two projects in escrow. I also use the same system to generate unsolicited offers, but I am over on those offers resulting in any deals so far anyway. I've actually talked to a guy working on a startup that sounded like a much more sophisticated version of the system I use and then build casa also has a tool that they built in house. We built it in house. It uses a lot of public data, but the complicated thing to figure out is one, how do you sort of put all those pieces together and get the live MLS data feeds flowing in and then the geospatial component of it as well. So you know, really having a polygon for where the existing structure sits, what the access looks like. We know down to a couple inches of how wide access points are geospatially, whether something's a corner lot, an alley lot, a flag lot, we're able to see all of those things and then move very quickly when good opportunities come across. I spend a good amount of my time talking to sort of the usual suspects in Southern California land development and I would say that most of them are dismissive of the various Yimbi bills. I think because so many of the bills include poison pill provisions like a requirement to pay prevailing wage, there's just a default position of no one ever got hurt ignoring this stuff. But also as we've covered, real estate is a show don't tell business. The developers aren't going to get excited until they see someone else make money. Well, Ben and build casa realized this dynamic might exist. So they have tried to illustrate the potential. We've done a couple deals that we've syndicated just as sort of proofs of concept for what's possible with SB684. Those are really interesting opportunities in San Diego, a couple that are also filled with philanthropically funded by Chan Zuckerberg in Sacramento and Richmond. But the purpose of those is not necessarily to be a developer ourselves, but to create case studies and to sort of educate other developers and builders about what's possible and sort of show the ball go through the hoop and show that it works. But people are starting to get excited about the opportunities. I wouldn't say from an institutional perspective yet. I'd say it's more, you know, sort of house flippers, you know, John Buys houses, you know, mom and pop developers that you know are comfortable with their own capital being early movers and sort of taking advantage of the arbitrage before institutional money starts pouring into it. I've seen some polling that says that if you tell people these small, byright subdivisions will be built by a local developer, then public support increases. It's kind of a silly distinction since so much of the labor and construction is done by subcontractors anyway. But if it makes these laws more popular, that's good enough for me. And so far, the various rules do tend to favor smaller players. I mean, do your Horton build 70,000 homes a year? They cannot be bothered with 10 units here or 10 units there. But I do hope that policymakers have an eye on driving down costs by increasing the scale of the opportunities. The increase to 10 units was a good first step because there are some economies of scale even at that level. Yeah, I mean, I think with these sort of four to 10 unit development opportunities, there are some efficiencies, particularly if you can get a couple going at once that are relatively close by. So sort of sequencing the trades is something that our builders think about a lot. There are folks that build it surprisingly low cost as well. In Sacramento, the market is dominated by Ukrainian builders where the plumber is also the H-RAC guy, is also the painter. And so they're able to do things pretty efficiently from a cost perspective. BuildCasa has been in a challenging real estate market for pretty much all of its existence as a company, although real estate is a cyclical business. So staying in business during down markets is like table stakes. Yeah, I mean, I think there's two ways to look at that. One is certainly it's it's harder. There's fewer transactions rates are higher for the developers that we're working with. So it's harder to make things pencil. But it also means that both for BuildCasa and for TurboHome, we have a lot less competition than we would have had in 2021, when money was sort of flowing like crazy into the ProkTax space. And so you've got to be conservative with expansion and not overspend and get ahead of your skis, but it's been really good in terms of having the sort of freedom to build very differentiated offerings with limited competition. The politics around building are on one hand really frustrating and on the other hand just endlessly fascinating. For example, I think that progressive left people really struggle with the idea that we should severely limit the influence of zoning, which is kind of crazy when you think about the fact that zoning is sort of like a segregation had better PR. Okay, but I think that folks on the left want to have some technocratic guardrails and they want some way to slow down the capitalists. From that standpoint, they just try to block out that zoning has historically not been done for the "right reasons". You know, these are people that have yard signs that say, "we believe in science" and yet they do not believe the mountain of evidence that shows the regressive reality of zoning. And then there are also weird things like in California, some of the most fanatical opponents to development are found in the reddest cities. There are pockets of California that are very strong Trump places and yet those places have kicked and screamed like children in the face of new rules from the state that make it harder to obstruct building. There is another political oddity, which is that making actual stuff in the United States and blue collar job creation, these are the state of the policies of Republicans and Democrats at this point. I see very little disagreement on this, but then there is just no urgency when it comes to taking an easy win by creating incentives to build new homes. I will also point out that we have heard in this episode how construction and building are perfect for self-starters and how entrepreneurship can ensue. So again, I can't take another way to put it, but it is extremely frustrating to see the lack of urgency on this issue. If you want to see what I mean, just try to keep track of the next time you see anyone right or left, mention that tariffs are hurting construction job creation. So like I said, this is a bizarre political issue, but has been points out that at least means the pro-housing position is a rare one that doesn't cut perfectly along party lines. What's interesting is that this topic, this sort of yin-b topic, is one of the only really bipartisan issues in the country at this point. So you know, the Democratic view is we need more housing, yin-b, the Republican view in places like Texas where there's been somewhere with legislation and a number of cities is, you know, sort of the libertarian view of this is your land, you should get to do what you want with it. And so Houston as an example, passed minimum lot size reform all the way back in like 1999, and there's still a ton of development. It's one of the fastest growing cities in the country, and they've had tens of thousands of small format townhomes and due complexes that have been built as a result of those changes. When I first started working on these small sub-divisions, I probably actually would have ignored them. If I didn't see them as part of a larger trend, it's not just California. For instance, even outside the US in places like the UK, they're having to get serious about their housing issues. Then I met Cody and heard about the stuff he's doing in Oregon, and actually, he told me something else that didn't make it into this episode, which is that Portland wave, the developer fees, they charge to new projects. It's like an incentive equal to tens of thousands of dollars. And so part of the reason I'm interested in this stuff is there is no way that SB 684 can even be the end of it. Policy makers are going to have to keep trying stuff until they figure out what works. So when I started this episode talking about change, some of that change is already visible, but it's just very hard to see a world where this is the end of it. Ben says that being part of the process of change is explicitly build costs of this plan. We also are very involved in providing suggestions to the advocacy groups. And I think one of the things that's the biggest benefit to legislatures is real-world examples. And often if you're in Sacramento and you can sort of see that there's not a ton of permit applications, we can help them understand why that's the case. And obviously Macro is a factor as well, right? You know, it's hard to make development pencil. In general, I think the small lot subdivision opportunities are among the only opportunities that are really penciling right now because you have this sort of unlock of turning one lot into four to ten, which really brings the land basis down a lot. But we come across things like, you know, with SB9, initially there was no shot clock. And then we were very actively involved in the cleanup bill, which, you know, applied a shot clock to SB9. Another example of something that we come across is that, you know, even though there's a change from what's possible from a zoning perspective, if the property had an underlying CCNR that said, you can't subdivide it, then that would override SB9. And that's actually still a problem with both laws at this point. And so, you know, there's a constant sort of two steps forward, three steps back, two steps forward, one step back dynamic with these laws. But I think there've been five or six ADU cleanup bills that have been passed since the ADU was first wanting to affect. And there is a lot of desire in Sacramento to move things towards making these laws work. Build Castle was formed just as real estate was softening, and then the regulation they were formed to capitalize on turned out to be a goose egg. At this point, just still existing is a good outcome. But actually, things probably look better for them today than they did on the day they were founded. Their linear opportunity has been replaced with an exponential one. No, I mean, I think that we've really got, you start two things working, both the developer focused offering with Bill Kassah and TurboHum. We're still a small company. We're like 12 people, but we're, you know, over a $4 million run rate. We have strong gross margins. And so, you know, it's such a big tam and we're so early that we feel really good about sort of where we are in the value chain as well as the track record and experience we've built and the tools we've built around, you know, finding and doing feasibility analysis very quickly on the best opportunity. Riska Bruin is written and produced by me. Special thanks to Kevin Erdmond, Ben Bear, and Cody for taking the time to speak to me for this episode. I'm going to provide a link in the show notes so that you can find these folks online. If you want to get in touch with the show, you can email, risk a ruin pod, at Gmail, or you can follow me on Twitter @halfkelly. [Music]