Do you aim to build wealth in real estate? Listen in as Neal Bawa explains his own experience in the industry. Neal is known as the “Mad Scientist of Multifamily” because of his experience in the technology industry and his use of data analysis in his real estate business. As he figured out the importance of building wealth rather than building income, he decided to shift and focus on real estate. In this episode, he shares valuable insights on technology, data, and statistical analysis related to real estate investing. He also discusses how true wealth is having control of your time, your health and your money. If you want to learn some tips for creating wealth rather than chasing income, this is the episode for you!
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Building Wealth Through Understanding Data and Trends with Neal Bawa
I’m very pleased to have Neal Bawa with us. He is known as the Mad Scientist of Multifamily and is the President and CEO of Grocapitus Investments, a firm specializing in apartment buildings, student housing, and self-storage properties in high-quality markets across the country. He’s also the founder of a real estate community with over 30,000 members, which is amazing. Neal, welcome to the show.
Thanks for having me. I’m very excited to be here.
I love to hear your journey, how you got into real estate, how you got into syndication, and how your financial journey got you to where you are now.
I’m a technologist, a geek, a nerd, and a data scientist by profession. I have a Computer Science degree like lots of people that have come in from India. I came to the US. I was part of the technology field and then started to get burned out because each year, I was working harder and getting higher salaries. Because I live in Forney, Texas, I was paying 50% of my salary to do the man. I went and complained to my boss who directed me to real estate as the only way to build wealth as opposed to just building income.
I went from wanting to build an income to wanting to build wealth, and real estate was the path that I selected in 2007. I continued along that path until 2013. For the first six years, I was just by myself. During that journey, I learned how to apply my data science and statistical analysis abilities. I became known as the Mad Scientist of Multifamily. Even before I was taking investor money, they started calling me out to conferences. Hat’s a long journey but I’m an example of the application of statistical analysis and technology to commercial real estate
You started out trying to build income and you changed to building wealth. Was taxes the light bulb that sent you on that journey, along with the guy you worked with? Talk a little bit more about how you figured out real estate was the key to building wealth?
Taxes are one of the two key parts of switching from building income to building wealth. When you’re building income and you’re chasing these ever-higher salaries, I was making $300,000 a year, the fear goes up that one day your company is simply going to replace you with three people at $100,000 each. That didn’t happen for me. I stayed at that company from 1999 all the way to 2013 when we sold the company. I was a partner there, but the fear was always there. The higher your tech salary goes, the more fearful you become that some young hotshot is going to replace you with 1/3 of the salary.
When you’re chasing income, what you realize is that you’re in the rat race. You are a rat. As you go, the speed at which you’re running is increasing. Your stress level is going completely crazy. Your health is going completely ballistic. Your weight is ballooning. All of this happens to millions of Americans in white-collar jobs. Now I’m the exact opposite. I do Pilates three times a week, yoga seven times a week, and walk an hour a day. I have a quality of life that is astonishingly high. It’s there because I’m chasing wealth. Part of wealth is not money but control of time.Taxes are one of the two key parts of switching from building income to building wealth. Click To Tweet
For most people, if you’re not wealthy, the first thing you want to do is get wealthy, but have a vision. Your vision needs to be, “I have a wealth of time, wealth of health and wealth in the bank.” That’s what I’ve been chasing for all these years. I’m happy to get to this point. I have been able to do some amazing things with it. For example, I’ve been able to make myself carbon net neutral, or net neutral in terms of my carbon footprint. Now I’m engaged in making my entire company carbon net neutral.
I would like to talk about that. How do you make yourself carbon net neutral? That’s fantastic.
I’m a data scientist, so I research everything. I will read articles and white papers. I became obsessed with the idea of becoming carbon net neutral. The first thing I did was do the research. The study that I liked was from MIT. It basically says, “A typical American creates five times the carbon that the typical person in the world does.” We’re hogs when it comes to this thing. The total amount of carbon that an average American produces is 44,000 pounds of carbon that are being released into the atmosphere.
I started looking at myself and saying, “Am I the typical American?” I went to websites and plugged in the size of my house, and how many international and national vacations I take because flying is very polluting, and I plugged in my SUV. I came to the unfortunate conclusion that not only was I a typical American, which is already five times the rest of the people in this world in terms of carbon, but I was also 50% higher.
I was polluting 7.5 times compared to the average person on the planet. I was like, “This is bad.” To fix this problem, you have to start with yourself. Don’t talk about what the politicians are not doing and all this climate change versus non-climate change bickering. Start with yourself. Initially, I started with twelve solar panels. Now I installed a total of 29. I’m a mathematician. When I did the math, it was still nowhere close to the footprint.
I came to the conclusion that I had to wipe out that 44,000 pounds plus the 50%. It’s 66,000 pounds a year of carbon for my entire lifetime, which I estimated at 75 years. I got the math, looked at the solar panels, and I realized I would have to rob a bank. I started looking at other solutions. The solution was really simple. For an average American, if you plant 919 trees, you wipe out your entire lifetime’s carbon footprint. In my case, it was 1,379 trees because I was a mega polluter. I have the big fat SUV, house and vacations, so I needed 50% more.
I was like, “How can I plant 1,379 trees, and what does it cost?” I looked at Chinese, Brazilian, Mexican, and Indian nonprofits. I looked everywhere. I found the answer here in the United States. There is an organization here that works with the forest service. This organization is called One Tree Planted. All I had to do was donate $1,379 to them and I became carbon net neutral. These 1,379 trees were planted in my name in British Columbia. The nice thing about this is you can plant them in China or Sahara. We share one biosphere. The air moves from here to China, to India, and back to the US every few months. It’s one biosphere.
Now there are 1,379 trees growing somewhere in British Columbia in my name, and I’m carbon net neutral. My company has an open offer to all of our employees. They’re not mega polluters like me. They probably don’t have the big fat SUV and house. They just need to knock off 919 threes or plant them. We pay for half of that. Any American employee of ours can pay $460 to this company, the One Tree Planted. We pay the other $460 and they become carbon net neutral for life.
All of our Filipino employees only pay $92. Why? Because Filipinos have a much lower carbon footprint than Americans do. They pay $92 and we pay $92. They become carbon neutral. As employees come into our company, we let them know about this initiative. I know it’s a lot of trees and you can’t say, “Let’s have seven billion people and plant 200 trees for each of them.” We don’t have the space in the world to do this. Luckily, we have this space in the world to do this for a few hundred million people, and I’m one of them.
That’s phenomenal. I love that. I’m going to check out One Tree Planted because that’s a neat thing. We’re not here to talk about the carbon net neutral but that’s a fantastic way to open up this show. I would like to pivot now to The Real Estate Trend Accelerator. You have ten trends. We don’t have time to talk about all ten. We’re going to talk about a couple. Can you start by generally talking about how you came up with these trends, and then also about COVID and why COVID is going to accelerate many of the trends that were already starting pre-COVID?
What people don’t understand is that the nature of humanity is such that there are full-stop events in our lifetimes that affect us all. We would like to think that 911 has affected every person on this planet. It made a significant difference to 200 million to 300 million Americans and the people in Iraq and Afghanistan. It was truly not a world event at all. The last world event that affected every person on this planet or almost every person was World War II, and then COVID.
COVID affected more people than World War II. There were hundreds of millions of people that didn’t participate in World War II. There was no one on this planet that didn’t participate in this COVID disaster. When an event like this occurs, it’s not a turn-on turn-off thing. It changes us. It changes our mentality. It creates new fears and initiatives. It changes society. COVID is the truest of the true Black Swan events that we’ve ever had. Once we understand that, the question we ask ourselves is, “What are the long-term impacts of COVID?”
Everybody at this point knows all the short short-term impacts of COVID, so there’s no point talking about it. Let’s talk about what this does to our economy, real estate or business. List all of the long-term impacts. I’m more interested in those because the short-term impact obviously was that 1,030,000 people died in the United States and ten million people died worldwide. We know that. It’s a horrible tragedy, but the long-term impact is much greater because it’s going to have an impact on seven billion people on an ongoing basis.
When we track that, the first one that comes to mind is hybrid homes or hybrid work. That’s a huge impact on the way that we live and work. The second one is healthy homes. That is a massive change in the way that we are going to be building homes in the US and worldwide for the next 50 to 100 years until we get another pandemic. Those two are very key examples, then interest rates and inflation are byproducts of COVID. There’s zero chance that we would have 8.5% inflation in the US if COVID hadn’t happened. Inflation, interest rates, and all the things that come because of that, the impact on prices for single-family and multifamily are also byproducts of COVID.
Let’s start with hybrid work. People are starting to slowly go back to the office. It seems like even the people that are going back have options for part part-time and all that. How is hybrid work is going to change?
Looking at the statistics from the last few months, the attempts made by companies to bring people back full-time into the offices have been a complete and unmitigated disaster. Do you know when you go into a corporate office and you go into a building, you have this key card and swipe that? You enter the building and it unlocks. Imagine how much data the companies that do the swiping thing must have. There is one such company that I follow their data. According to them, there are less than 50% key swipes in May 2022 compared to February 2020. You can’t say, “The data is one year old. Things have changed now.” The data from May 2022 suggests that there are less than half the key swipes compared to February 2020.Start with yourself. That’s how you get started and set yourself up for success. Click To Tweet
There are no excuses. It’s clear now that the nature of work has changed and it’s not going to switch back because if it was going to switch back, it would have done so already. More than two years have passed since COVID started. Because of this, fundamentally, there’s a power shift that is happening. It didn’t start with COVID. COVID isn’t creating trends. It’s accelerating certain trends and slowing other trends down.
There was already a massive impact with people moving out of California to places like Phoenix, Austin, Boise, and even Seattle, though that has slowed before COVID. People were already moving out of California, but California still had population growth because some people were moving in. They were replacing some of the people moving out, and it had immigrants from other countries.
Once the Trump administration came in, immigration to the US slowed to a tiny amount. I know that we’ve got a real problem with the wall on the Southern border. Overall, when you look at immigration numbers, they’re very low. For the first time, California is losing population. Nobody would ever think that would happen. The San Francisco Bay Area is losing population. The City of San Francisco lost 15,000 people in 2021. Hybrid is changing the way we work. It’s also changing the radius that cities have.
A lot of people are like, “Does this mean that everybody is going to go live in the boonies now?” They’re not. People still want to live near cities. They have culture, beauty and events. They still want to live there, but the radius is changing. If the radius for the San Francisco bay area was, “I can go as far as Livermore,” now it’s Tracy, Modesto and beyond. That radius has expanded by 30 or 40 miles. That changes the way real estate is done. There are people who are leaving all of these places. New York is losing population, and so is California. I think there are going to be three people left in Connecticut in the next ten years. Those three will be thinking about leaving.
It’s terrible to see this because it’s bad news overall for the country, but it’s good news for the Southwest of the United States. I call it the crooked smile. It is getting an enormous one-time 100-year benefit from COVID. The crooked smile starts in Idaho and then right below Idaho is Utah. Below and next to Utah is Nevada. Below that is Arizona. It goes across to Texas, and then you’ve got Georgia, Tennessee, and then it goes down to Florida, then up to North and South Carolina. I probably missed out on a state or two in there, but it’s a crooked smile. Imagine that map of the US and you see a crooked smile across it.
These states are winning extraordinary numbers of people from the other states. Their real estate economies have become very bullish and now have got to the level of being bubbly like Boise, for example. It is the most overvalued city in the US. A few years ago, if I said Boise, Idaho would be the most overvalued city in the US, you would laugh at me, but it is by far. It’s more overvalued than any other city in America because if you look at any statistical analysis, everyone mentions Boise as the most overvalued. All of that is because of COVID and hybrid work.
Can you talk about what overvalued means? When I think of overvalued, I think that it’s going to come plummeting back, but there still is a housing shortage. People are still moving to places like Boise and Phoenix. What does overvalued mean for an investor and how should we be dealing with properties or syndications that we own in those cities or the ones that we’re evaluating in those cities?
Let me define that. Firstly, how do economists tell if a city is overvalued from a real estate perspective? They look at the incomes of the people that live there. They look at their median incomes, and then they basically say, “Here’s the average median home price.” What percentage of the median home income of the people that live here is needed to pay for the median home? It should be about 30% or 33%. If it starts to go up to 40%, that area is overvalued because people are pushing to buy homes. If it goes to 50%, it’s horrendously overvalued. At some point, it’s going to revert to the mean. Boise is 72% overvalued.
It’s way beyond what the people there can afford to pay for it. The only reason the real estate sales even happen in Boise is because there’s this continuous inflow of Californians who come in and 1031 their homes in California. They basically bid up that market. They’re coming in from other states too like Washington, but California is the key problem in that example. Phoenix is the same thing. Californians are coming in and bidding up the local market. The key question is, “Does this mean that overvalued markets must crash?” The answer is no. Most overvalued markets do not crash.
The common scenario is often we could see a 5% to 10% decline in some of these markets in the single-family realm. I will tell you what happens to the multifamily side because it’s different. On a single-family realm, you could easily see a 5% to 10% price correction in Boise, Phoenix, Austin, and several other markets like Miami, especially as interest rates go up. The second scenario is also pretty common. It is that the city adjusts and salaries increase. When salaries go up in that city, let’s say they start going up at 6% a year because the Boise has got humongous home price growth of 20% to 25% a year, you might say, “That doesn’t work. How does 20% equate with 6%?” It does. Let me explain.
If a person’s salary goes up by 6% and they were previously putting 1/3 of that salary towards rent, let us say Jim’s salary is $100,000. He was putting 1/3 of it towards housing, so that’s $33,000. When his salary goes up by 6%, it goes up from $100,000 to $106,000. That’s 6% of his salary, not 6% of the real estate. If he takes that entire $6,000 and applies it towards real estate, he can afford real estate going up 12%, 13%, or even 14% because your real estate is only a portion of your salary. Your rent or mortgage payment is only a portion of your salary.
When your entire salary goes up, if you start applying all of it or most of it towards rent, some of it goes towards food because food is going up. If it only goes towards food, gas and real estate, with a 6% increase in salary, you can often afford 12% more in real estate. The city starts to adjust. Its salaries go up. People get used to paying more of their income towards real estate. What happens is the city’s boom of real estate slows down, deflates or often plateaus. I’m expecting Boise, Idaho to go down by 5% to 10% but in Phoenix, because it has so much in-migration, home prices might plateau for a while. On the multifamily side, completely different things happen, but that’s the initial answer to your question.
Talk a little bit about multifamily because that’s what a lot of us are investing in. What’s different about multifamily in that scenario?
When home prices get completely out of whack, I’ll use Phoenix as an example, home prices are going up 20% or 25% a year. Incomes in Phoenix are going up 5% a year. Even with my example, they’re out of whack. What happens? More people that were expecting to be living in single-family homes and were going to own single-family homes or townhomes are now renters. They’ve lost the race. Home prices went past their capability to catch up. That race is lost. That train has left the station.
These people though have these desires and visions of living in a beautiful property. What happens is based on their income, they end up going in a couple of different directions. Number one, they rent a single-family property. Single-family properties are way more expensive. The rents have also gone through the roof. Their next option is to rent an apartment. The ones that can afford to do it rent classy apartments. The ones that can’t will go to refurbished or rehabbed nicer looking class B and class C apartments.
The newest group, which is one of the key accelerators of COVID, is if they can afford it, they’re not going to apartments or to single-family. They’re going to Build-To-Rent communities. A BTR community is a horizontal multifamily product that has single-family homes or more often, townhomes for rent. You’re in a community of 250 homes and each home is either a townhome or a single-family. It’s very tiny like 1,000 square feet, postage-stamp-sized single-family, and they’re going there.The technology hasn't changed one bit, but today almost all of the new classy products have some aspect of healthy homes. Click To Tweet
Now they’ve got one extra choice compared to a few years ago because BTR didn’t exist 5 or 6 years ago as an institutional asset class. BTR, they’re going to apartments. Essentially, what is happening is that this spike in home prices has actually created more tenants in the marketplace, so much so that in 2022 multifamilies have a record occupancy. It’s coming down a little bit in April and May of 2022, but in Q1 of 2022, the occupancy of multifamily in the United States was the highest in all time since we’ve been measuring it.
You might say, “That’s crazy. How can people be buying all these homes? There’s a frenzy of it but still, we have so many people in our multifamilies.” That’s because as prices go up, we’re creating more lifelong renters. This is good news for multifamily, not be on a certain point because you don’t want the housing market to crash. You don’t want it to plateau. The best outcome for multifamily is that housing prices slowly increase by 4%, 5% or 6%. They don’t plateau and they don’t go downwards. If they go downwards, then market sentiment changes and that usually affects the rents.
You mentioned healthy homes. Can you talk about that?
As you can imagine, with COVID, people have become more aware of the air and water in their houses. If you look at the way we built apartments in the US, we’re not building them any differently from the 1980s or the 1970s. The ceilings are 1 foot higher. All of the new apartments in the US are built with granite countertops instead of laminate. Other than that, it’s the same apartment. The technology hasn’t changed one bit. Nowadays, almost all of the new classy product has some aspect of healthy homes. I’m doing a webinar on Prop Tech and how it’s changing real estate forever. That webinar is going to be on my website, MultifamilyU.com. About 5,000 to 6,000 people will attend that.
The bottom line is companies like Delos are disrupting real estate by making sure that there is an aspect of healthy homes when you’re building apartments, single-family homes, and build-to-rent. For example, I’m building thousands of build-to-rent units and 100% of them are healthy homes. You might say, “That’s a lot.” Most of the new apartments that have been built in 2022 don’t have healthy homes. The answer is, “Yes, but I have to sell my properties 5, 6 or 7 years from now. I have to basically see the change that is coming now and be ready to adapt to it when I sell my property 5, 6 or 7 years in the future.”
Seven years in the future, it will be a disadvantage to sell a property that is not a healthy home, that doesn’t filter the air or the water, that doesn’t deionize, that doesn’t give you a dashboard next to your house on an iPad. All of this stuff is happening in real-time. It’s a huge change because this is the first change in the way apartments and homes are built in the US since the ‘50s. It’s a big deal and we’re seeing it roll across the class A first. You might say, “Yeah, but I’m in the class C realm. I buy class C homes. This doesn’t matter to me.” Of course, it matters to you. How do you think class C came about? All of the class C properties that you’re buying now were class A properties in the ‘80s. When they were built, they were class A.
Class A becomes class B twenty years later and then becomes class C about 35 years later. If you look at the’80s, about 35 years have passed. These are not class C properties. As time goes on, if all of the class A stock is going to be healthy homes, and some of the class B stock is going to be healthy homes, how do you think that’s going to affect class C? It becomes difficult to compete. What we’re seeing now is it’s harder for class C buildings that are 8 feet high to compete against newer buildings that are 9 feet high. The rent growth nowadays for class A and class B buildings has exactly doubled that of class C. Class C has been the rent growth leader from 2014 to 2021 when I started tracking it. For seven years, class C rent growth beat the crap out of class A and class B rent growth.
Now, the situation flip. It reversed. Why? The biggest reason is people want bigger spaces and class C offers bigger spaces. Class B offers bigger spaces than class C. People have higher incomes because COVID has increased the bank balances of Americans by $5.8 trillion. That’s an astonishing once in a lifetime gift from world governments, not just the US government, to its citizens. It will go away but for the moment, there are people fighting over these buildings. A lot of Class A and new construction offers healthy homes with filtered air, filtered water, and many other benefits. That’s the healthy homes phenomenon. It has 10X because of COVID. It was already there.In seven years in the future, it will be a disadvantage to sell a property that is not a healthy home. Click To Tweet
You mentioned briefly a healthy home. It filters the air and water. What changes have to be made? It doesn’t seem that putting in a few air filters or water filters is significant. What is a healthy home?
On the one side, you’re entirely correct. If you simply filter the water or the air in your apartment or your home, that’s a healthy home. It’s as simple as that, but what’s happening is that these days, they’re tying it with technology. They’re saying, “Your home needs to be able to inform you when there’s too much carbon dioxide or whether the air or water quality is low.” They’re tying it to technology, apps and smartphones. It’s becoming something that’s filtering plus tech. It’s tied back to either an iPad that’s next to the door or an app on your smartphone that’s giving you an alert every time something is wrong with the home. In the end, it’s a sexy way of saying, “I’m going to filter my air and water.”
I would like to pivot a little bit here to interest rates, inflation and cap rates. Can you talk about the trends with all of those and where you think we’re heading?
The Federal Reserve of the US has raised interest rates nine times since 1961. They’ve had nine interest rate hike cycles. If there’s one thing you remember from this show, it is all nine of those interest rate hiking cycles were sharp up, sharp down. Meaning they hiked and get to the top. It’s not a plateau of any kind. They get to the top where they gut punch the US economy. Imagine a big boxer like Mike Tyson punching Jim. Jim is like, “This feels like death right now.” A few minutes later, Jim is not going to feel that bad, but now it feels like death. That’s what the Fed is trying to do to the economy. They make it feel like that without it being dead so that the economy slows to the point where inflation dies.
The Fed doesn’t want to put it into a recession, so it has to back off immediately. What the Fed does is first it does the Mike Tyson punch and then immediately it starts to administer a sell there, so it makes you feel better. It’s sharp up and sharp down on all nine instances since 1961. This concept of interest rates are going to be high for years is truly nonsensical because clearly, people who say that have never looked at what has happened in the last nine times in the last 61 years that the Fed has been doing this. There have been no plateaus. One could argue that 1982 was a plateau. That was a very special situation with the oil prices going on. It was sharp up, down, up again, then down. Even then, the plateau at the top was only about nine months long.
For every other case, it’s sharp up and down. We’re not going to see years and years of high-interest rates. The US or world economy does not function well when ten-year treasuries are beyond 3.5. The Fed’s job is not to keep us in crisis. It’s to get us out of a crisis. We have an inflation crisis. We think interest rates are going to go up. The Fed is going to raise it by 0.05% this month, then 0.05% again next month. They’ll watch and wait to see how the world economy is doing before they continue the rates. We think that the peak of interest rates is going to be at the end of 2022 or the beginning of 2023, and then the Fed will start to drop rates.
We’re seeing problems with the world economy. The US is still at negative interest rates. Chineses are going back to negative interest rates because its economy is a total disaster with the shutdowns of major cities. Their economy is doing horribly. The Indians are confused. They don’t quite know what to do. Outside of the US, there are very severe problems. We are the one economy that recovered fast. Every other economy hasn’t recovered from COVID. We can’t just keep raising our interest rates because if we do that, our trade deficit will be a debacle.
The Fed can be completely out of tune with every other central bank in the world. What they’re hoping for is, “We’re going to raise and everybody else will follow us up.” What if they don’t? The Fed has to slow down because what we’re doing is we’re making the US dollar expensive. When we raise rates, the US dollar becomes more expensive. If we make the US dollar expensive, our exports are going to get crushed and put our economy into a recession.
Those nine hikes since 1961, eight times we ended up in a recession. One time in 1994, the Fed bought us in for a soft landing. Given how extraordinarily quick they’ve had to raise rates this time, the chances that the Fed doesn’t put us into a recession is very low. I’ll say 30% or 40%. There’s a 60% chance of a recession. When does it happen? Does it happen this year? No. If you look at when the Fed started raising rates in the past, it takes a good year for the economy to get into a recession.
I’m thinking this time in 2023 that the US economy might be in a recession. Most of these recessions are very soft. They are 3 or 6 months. People might not even realize there’s a recession. They’re not like 2009. That was a depression. This time it will be a recession. A vanilla US recession that’s six months long. Probably in Q1 or Q2 in 2023, we’ll get into a recession. Here’s the good news for everyone that’s reading real estate. The moment the Fed declares a recession, what is the absolute first thing that they do? They cut interest rates. They had already been cutting before that point because they would start to see the economy going downhill, so they’ll go sharp and down. The moment they declare a recession, then they cut interest rates.
We’re going to see an interest rate cut sometime in 2023 but I don’t know how deep. We have a chance at this point to refinance our buildings. We get hit by interest rates in 2022. Bridge loans get hit. I have properties that got hit both on the value-add side and the new construction side. This is not the end of the world. We are tied or the world is addicted to low-interest rates. We are on a long-term cocaine drip to zero. Interest rates are positive. If you look at the history of interest rates in the last 30 years, all the trending is downward. There’s no upward trending.
All of the economists that had said this will result in hyperinflation have been wrong. Most of them have given up and said, “Because world growth is reducing, hyperinflation is less likely.” The bottom line is interest rates go up. It affects single-family to a smaller extent than multifamily. I’ll explain why. In the short run, what happens with single-family is when interest rates go up, people start using Adjustable-Rate Mortgages. They start using ARMs.
I don’t expect single-family prices as a whole around the US to fall. I expect them to go up by maybe 4% or 5% instead of 2021’s crazy mad 18% growth. That’s just madness. That creates bubbles. I’m glad to see that go away. The 4% or 5% is pretty normal. Keep in mind that it’s still sub inflation. Inflation is 8%. If your home’s price goes up 6%, technically, your home has declined in value. In dollar terms, it’s going to go up to 5% five or 6%. The individual markets in the US will decline. I’m thinking Boise might decline. There are a few other markets. Tacoma, Washington was too expensive. Individual markets will go down but overall, if you look at 400 markets in the US, it is still going up a little bit.
Multifamily is different. If there is a single person that appears on this show and says multifamily prices haven’t already gone down, that person is an unquestioned liar. Multifamily prices have already gone down. They may not have gone down for this property in this market or that property in that market. It usually takes a quarter because multifamily is in contract for 3, 4 or 5 months. The short answer is that Q2 prices will be lower than Q1 prices, but the real impact will be felt in Q3 because some of the multifamily impacts can only be felt after the Fed raises rates.
On the single-family side, mortgage companies already adjust their rates before a Fed hike occurs. They do it preemptively. With multifamily, we’re tied to LBOR or SOFR, and those haven’t changed yet. They’re going to change in the coming few months. The impact is going to be stronger in the second half of 2022. When people come and tell me, “The multifamily has so much demand and we have millions of homes short,” the short answer is you are completely wrong because banks can’t lend to you anymore.
I’m talking about one of my buildings. I was selling it for $45 million. There were ten offers, including people going $1 million hard, on day one. This is a gorgeous class A property with 97% occupied. Everybody and their mother wanted to buy it. The highest price is $38 million. I only had an $18 million loan. My investors were making 40% IRR, but I was trying to make them 60% IRR. I backed out of it and walked away because when rates go down in 2023, I will be able to sell it for $50 million because my net operating income is screaming upwards because I’m renewing everything at 10% higher.We are the one economy that recovered fast. Every other economy hasn't recovered from COVID. Click To Tweet
My NOI is going upwards. I can’t sell it at the same cap rate. I could have, back in January, but I’ll wait for a year and a half. When interest rates are in the mid-fours, I will put it up on sale for $50 million, so I walked away. That property is now worth $38 million from $45 million. I could have sold it in Q4 of 2021. It was still in construction, so I couldn’t have. I would have definitely gotten $45 million for it. Now I can get only $38 million. Why? Because no bank is willing to lend more than a $30 million-plus down payment for that property now.
When people say multifamily prices won’t be affected, it’s a terrible lie. They are already affected depending on the market, between 5% and 15%. The cool news is this, the moment the Fed starts to talk about interest rates going downwards, even before they go downwards, the multifamily market adjusts again, and cap rates drop. We think it’s a short one-year increase in cap rates, and they could come back to where they were earlier in 2022 and by the end of 2023. Who knows? It depends on the rates.
What’s the relationship then between the interest rate and cap rate on different asset classes?
It’s very similar across the board because if you think about a class A property. You want to have 75% leverage and 25% down. For a class C property, you want to have 75% leverage and 25% down. Banks are going to look at it the same way whether it’s a class A, B or C property. The ability for you to get a bigger loan has decreased because your overall cashflow is going down. You’re paying more in your mortgage payment. They’re all affected equally.
Banks typically tend to be a little more skittish with class A in a bad time and more skittish in class C in a good time. The US economy is doing brilliantly. Unemployment is under 4%. Salaries are increasing. The banks probably want to go with more class A and B loans, but that will switch if the economy starts to weaken and then they’ll start looking at class C because a lot of those class A people can move into class Bs and Cs at that point.
We talked about COVID, hybrid work, interest rates, healthy homes, and how things are moving. What do passive investors that have capital have to do? Are you allocating that capital? Are you holding on to wait until 2023? I can keep on going but I look at things differently. Maybe I underwrite them a little bit more severely than I did a year or two ago. What do you think should people be doing right now?
Let me split that between passive folks and active because you mentioned yourself. You’re not a passive investor. For the active investors, it makes sense for them to keep going and just underwriting for the new reality. The building you’re buying for$30 million in 2022 might have been one that you would have bought for $33 million in January 2023. You’re now paying less. You’re keeping that in mind, and keeping an eye on rent growth. What’s bailing out multifamily and what’s making us such a strong asset class is our rent growth is stunning. April 2022 is crushing rent growth. May 2022 has incredible rent growth. Month after month, the rent growth is incredible. On the one side, prices may drop because of cap rates going up. On the other side, net operating income is going up.
You may not see a big decline in prices later in 2022 because your NOI is making up for that cap rate change. I’m not saying multifamily prices are going to drop a great deal because they might drop, then they might plateau, and then they might increase as rents increase. At some point, that cap rate is going to stabilize at a higher level than it was in January 2022. January cap rates for multifamily were in the low 4s. Now they might be somewhere in the high 4s or low 5s. We’ll see what happens in a few months. I don’t know the exact numbers.
Syndicators don’t change anything. Underwrite carefully, but don’t be foolish enough and think that these ultra-high rates are going to last for years. There’s no evidence in the past that they do. You’re not being data-driven when you assume the worst. You were assuming the best when you were buying in Q4 2021 or in January 2022. Don’t swing all the way from best to worst. Stay in the middle. It’s still a great asset class. For individual investors, it’s a very difficult decision. There’s no real evidence that home prices in the US are going to decline.
You’re not going to get much of a Delta there waiting for single-family homes. That’s going to be a very long wait. I do not advise that you do it. It still makes sense for you to invest in syndications. It also makes sense for you to invest in new construction because anybody who’s in new construction right now is in a great place because he doesn’t have to deal with cap rates at all. It’s new construction. They’re still building it. If it delivers in late 2023 or 2024, you skip this interest rate hiking cycle. Remember sharp up and down, and you’re on the down as well. Look at new construction projects and value-add, but make sure that the syndicators are adjusting their reality. You’ve got to find the ones in the middle, not the ones that are very bearish or bullish. Both would make bad decisions at this point.
The last question I always ask is if you’re a podcast listener, what’s a great podcast that you listened to?
I like to listen to the Timothy Ferriss podcast. I idolized him because he’s always looking for greater efficiency. I’ve tried to model myself to be a mini Tim Ferriss. If you don’t know who he is, please check him out. He’s absolutely incredible.
If people want to connect with you, what’s the best way for them to do that?
It’s easy for me. I happen to be the only Neal Bawa on the worldwide web. On Google, you’ll see several hundred podcasts. You’ll see my conference appearances where I talk about these kinds of things and lots of different topics. I talk often about virtual assistants. I have a virtual army in the Philippines that helps me with everything that I do. I talk about lots of interesting topics. If you’d like to see my full-length webinars, they’re all stored at MultifamilyU.com. That’s the best place to start the journey. If you’re interested in investing with us, still start that way because I think you should know our philosophy first.
This has been fascinating. Thank you so much for your time. We appreciate it. We’ll connect with you again to get another one of these because this was great. I appreciate your time.
Thanks, Jim. Have a great one. Bye.
There was a lot of good stuff in there from Neal. That was fun to have that conversation with him. Some of the things that stood out to me are he’s paying a 50% tax bill on his income and he was trying to look for ways to reduce that. He changed his mindset from building income to building wealth. That’s powerful. Instead of worrying about building up your taxable income, start worrying about building up your wealth and then you will be able to get rid of, defer, eliminate or reduce some of your tax.
He also talked about how many of our community are highly paid employees. The danger there is that he was always worried that he was going to be replaced by someone who could do the same job for less or for multiple people who could do the same job for less. When you have that big W-2, not only do you have high taxes, but you might have high stress because you could always be replaced.
I also liked how we talked about wealth is the control of three things, your time, health and money. If you have control of those, then you are wealthy. That hit home for me because it’s not just about the money. You have to have a wealth of time. Meaning that you have abundant time and the control of your time is yours, the same with your health. I thought that was powerful.
Also, I love the carbon-neutral stuff, One Tree Planted. I’m definitely going to check that out and see if I can make myself carbon-neutral and work on my family. It is carbon neutral because you’re planting these trees. You can also reduce it in other ways, but this was an interesting concept and an interesting way to do it. That was super neat for him to talk about that. He talked about some of the trends that COVID accelerated, but they slowed down some trends as well. That’s worth looking at.
He kept talking about being overvalued. I wasn’t exactly sure what he meant, but it turns out that overvalued is when the rent is more than 30% of your income, but it does not mean that a crash is coming. The thing I took out most from what he said is that just because it’s overvalued doesn’t mean it’s a bubble. It might reduce or incomes could increase, which will probably happen, and that will take care of some of the valuation issues.
He talked about build-to-rent, which is all the craze now. More companies are doing build-to-rent and he said, it’s small properties, but a homeowner or renter would get their own space rather than being an apartment. That’s a trend to look forward to. A lot of development deals are there, and I’ve been shying away from development, but perhaps I should reconsider. He talked about since 1961, 8 of 9 rate hikes were sharp and down. We’re in it right now.
We’re looking at these rate hikes coming. It seems like interest rates are going forever. According to history, if history repeats, which it does not always, but that’s not going to be the case. We might be through this in six months to a year or at least in a more stable place. We can’t just panic. We got to look at the facts and make predictions based on things that we’ve seen before. It’s not always going to be exactly the same but it’s likely that it will be similar. That’s good news there. It is something to look forward to.
One of the most impactful things he said was avoiding operators who are very bearish. He is looking for a stable outlook. He is not anybody who is like, “The sky is falling, you’re going to avoid them,” or “This is going to run up forever. You avoid them,” because they’re going to make mistakes. If they’re on either one of those ends, they’re going to make mistakes. That was pretty cool to know. I enjoyed this conversation. He has ten trends and we barely got through two of them. I definitely will see if I can get Neal on again because he’s got a whole bunch of information. He’s a fascinating guy and I enjoyed the conversation. That’s it for this episode. We’ll see you next time in the left field.
About Neal Bawa
Neal Bawa is a technologist who is universally known in the real estate circles as the Mad Scientist of Multifamily. Besides being one of the most in-demand speakers in commercial real estate, Neal is a data guru, a process freak, and an outsourcing expert. Neal treats his $508 million-dollar portfolio as an ongoing experiment in efficiency and optimization. The Mad Scientist lives by two mantras. His first mantra is that We can only manage what we can measure. His second mantra is that Data beats gut feel by a million miles. These mantras and a dozen other disruptive beliefs drive profit for his 440+ investors.
Neal serves CEO / Founder at Grocapitus, an iconic, data-driven commercial real estate investment company. Grocapitus’ 28 person team acquires and builds multifamily & commercial properties across the U.S. With more than 440 active investors and over 2,000 reviewing our projects, the Grocapitus portfolio currently spans across 10 states with 22 projects (1 sold) and 3,300 units/beds. The powerful Grocapitus brand has a cult-like following of data driven investors. The result – Completed equity raises of $146 million* for Multifamily, Mixed-Use and Industrial acquisitions in the last 18 months, over 3,000 units purchased. Grocapitus is on track to close another 1,500 units in the next 12 months.
Neal loves public speaking and is an energetic and humorous speaker. He also serves as CEO at MultifamilyU, an apartment investing education company. He is a top-rated, in demand presenter at conferences and events across the country. Over 5,000 students attend his multifamily seminar series each year and hundreds attend his Magic of Multifamily Boot Camps. Tens of thousands listen to his podcast appearances and he has been featured in over 50 top rated podcasts and radio shows. Neal’s asset management and revenue optimization techniques for multifamily are considered unique in the industry.
The Mad Scientist engages very frequently and deeply with his vast investor and RE Pro community, with tens of thousands of active connections and conversations across Facebook, LinkedIn, Meetup.com, Youtube and other channels. Neal is a backyard tomato farmer and a protein diet health nut. He believes in positivity and Karma. He is passionate about the sport of Cricket and about the enormous potential of self-driving electric vehicles to solve the global climate crisis.
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