Are We At The Top Of The Market? w/ Jonathan Twombly

Hey, capitalists, this is Ryan. And if you're like most entrepreneurs and investors, when you're going into a new area where you're investing or you're pursuing an opportunity, there's always that question or that fear, well, what if we're at the top of the market? What happens if there is a crash? What happens if there's another recession? What happens if I lose all my money? And in this episode, I interview one of my more conservative investor friends. His name's Jonathan. He lives in Brooklyn, and so he sees a lot of this top of the market stuff. And so what I was going for with this interview is we're talking about how you invest and how you think about investing. When we're at the top of the market, how do you find opportunities? What do you look for? If you are trying to enter into an opportunity when things are at record high prices, whether it's the stock market or it's real estate or it's businesses, isn't there value somewhere in the market? How do you find that when everybody else is competing for the same exact stuff? And that's what we talk about in this interview with Jonathan Twombly. If you want to be a part of these conversations live, you can join us inside the 1%. That's@Capitalism.com join. And until then, I hope you enjoy this clip from our chat with Jonathan Twombly. It takes one free person to create change.

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And we're live. What's up, old friend?

How you been? How are you? Long time no see, man.

It has been. I think last time we connected was. Has it been since we got together in New York City for the back room?

I think so, yeah. I think that was the last time.

That's crazy, man. Well, it's great to see you. What have you been up to?

I don't know, but you're looking buff, man. Are you like, roided up or something since I talked to you last?

That's it, Jonathan. Steroids to look like this.

Well, anyway, you look good. I'm glad to see it. Yeah. No, I mean, gosh, a lot has been going on since we last connected.

I mean, when we last saw each other in New York City, you were. You're talking about kind of the pace of the market and saying whether or not you thought we were at the top or not. And from what I remember, you're saying you prepare for us to be at the top, like you buy like we're at the top, but you continue to pursue new opportunities. And I was just curious how or if your overall approach to where we are in the economic cycle has changed.

So I'll tell you sort of what I got right and what I got wrong since then and just for the context for the audience. So you know what I had talked about, what you'd had me come and talk to your board members about was investing in multifamily real estate and kind of where I thought the market was at the time. And this is a couple of years ago. And my read on the market at that time was that it was really at or very near the top and that this was a time to be quite cautious in investing in any kind of real estate just because along with everything else, it's been rising and rising and rising for a very long time fueled by cheap money. And.

There'S not a whole lot further for it to go without something really dramatic changing to keep it going. So what I got right was that all that was basically right, what I got wrong was that the market didn't correct. Since then it's continued just to be hanging out at the top. So basically it had peaked and it just sort of stayed at the peak. It's very unusual market probably caused by just this unusual unprecedented amount of just cheap money from every central bank in the entire world supporting prices of every kind of asset. I think probably, I wouldn't say necessarily the consternation of investors like me, but it's kind of like to the mystery of investors like me who think that assets need to be attached to some sort of value and not just the market deciding that hey, the Fed's going to put more money in so the prices will keep on rising and it doesn't really matter.

We're getting a little bit into the weeds.

Absolutely.

Where do you think we are in the cycle now?

I think we're still at the same point. I think we're stuck at this kind of bizarre plateau at the top of the market. We're just hanging out there. Prices haven't really gone up very much in the last couple of years beyond what has been generated by the rent growth that's happened.

Just for the listeners background, the way that you understand the value of a multifam property is basically two parts. There's your net operating income, which is essentially a function of your revenues and expenses, and you multiply that by what's called the cap rate, which is the prevailing market return in the market. So for Prices to go up, One of two things has to happen. Either your NOI has to go up because of the rents going up, so you're multiplying it by higher noi, or the cap rates have to go down so you're multiplying it by a smaller or dividing by a smaller number. What's happened in the last couple of years is cap rates have gone down as far as they possibly can, which means pricing is. They just really can't go down any further. So the resulting growth in prices over the last couple of years has just been because rents have continued to go up.

So basically. Basically what you're saying is we've squeezed the value in real estate to the point where the only thing driving the increase in commercial or multifamily real estate is when rents go up.

Yeah. So.

Because they really don't have any room to appreciate anymore.

Exactly. So that just kind of naked market appreciation is gone at this point.

I understand.

Yeah. And all you've got left is. So you summed it up in a really concise way. So thank you for that.

So let me ask you a couple, a couple questions, Jonathan. Would you catch us up to speed on right now since you're not. You don't have deals pending and you sold a lot of your assets. How do you make your money right now?

How do I make money? Well, I made a bunch of much of money, bunch of money last year, which was good. Right.

I'm making money actually now while I'm waiting for deals to become more attractive. I'm doing a lot of coaching in this area right now. So because the market is very hot, there are a lot of people who are very interested in learning about this right now. I have taken the approach that, hey, look, because of my own personal view that this is not the best time to be investing. I want to educate people about how to do this properly and to be sure that they're approaching it the right way. Because I think what you see out there right now is a lot of hype about this and a lot of people who are kind of selling.

There'S a little snake oil going on out there right now. I think where people are kind of saying this is the greatest thing since sliced bread, it can never go down.

There's always mal investment whenever things are hot. Right. There's always going to be people trying to squeeze every dollar out of every deal. And that's when you get malinvestment.

It's not just that. What you see in every market cycle is.

There'S not just a market, sort of like a financially driven market cycle. There's a psychologically driven market cycle as well. And what you see is the people who get in early are the people who have the, the kind of great, the best read on the market and are willing to go against the grain. When everybody else is panicking, like after a crash, and everyone thinks that it's the worst time to invest in real estate, that's when you see the really smart money getting in. But what happens is the further you go up the cycle, as things start to correct and come back up, you start seeing people taking profits early. And people on the sidelines are watching that. And the higher up you go, you draw in the more and more and more cautious and less sophisticated people. So it's always like the people who jump in at the end. You see this in the stock market, in the real estate market, whatever. The people who are drawn in at the top of the market are the people who have been sitting on the fence for the longest and are drawn in, know the least about it. And it's kind of like, for lack of a better word, sort of like the dumbest money comes into the market at the top. Because these are the people who are. They're reacting to the feeling of the fear of missing out. They're not reacting to market fundamentals. You've seen everybody else making money and they're like, oh my God, if I don't get in, I'm going to miss out. And of course, when they all pile in, when the last of them piles in, is when the market corrects.

So what I'm curious about is how do you actively pursue opportunities while also understanding the part of the cycle that you're in?

So, okay, so there's two things that you should be doing right now to be concrete about this. One is very easy one to explain is stockpile some cash on the side, because when the opportunity comes, you're going to want to have that money ready to take advantage of really, really great.

Pricing, whether it's now in today's economy or if it is 10 years from now, if and when there's a correction.

But you want to have that cash stockpile because cash is an option on opportunity. So people who say you should have every single penny invested, I disagree with them because they're not keeping that optionality alive. That's the easy part. The more difficult part is, okay, let's say you want to look for opportunity to invest now.

To put it really simply, you should not be getting too big a Mortgage on whatever property you're investing in. Right. To just bring it into layman's terms. Because.

You want to look for assets that are going to provide a return. You want to look for assets that are cash flowing. You don't want to get into a speculative game right now because if you're at the top of the market already, you don't really want to bet on more appreciation. What you want to lock in is essentially a cash flow.

If it's cash flowing at a level that you feel comfortable with, that is essentially your margin of safety, let's call it, to know that this asset is going to continue to perform over time.

In other words, when you've got a market where asset values are as high as they can be relative to cash flows, you want to maximize the cash flows as much as possible. And that means not over leveraging the property.

Well, those are kind of two separate things. You want to make sure that the cash flow you're generating is going to support your debt service so your mortgage payment and the people who got in trouble the last time around. It's always the debt that's the problem. And the reason that the debt is the problem is because the value of the property will fluctuate according to the market, but your debt stays the same no matter what. And so you run the risk that the property, that one of two things can happen. Either the property becomes less than the debt, the value of the property becomes less than the mortgage, or the cash flow the property is generating can't pay the mortgage, so you go into default. I also think that there's a little bit of a. There's a little bit of like a misunderstanding about real estate in general that you see kind of pervading throughout American society. And that is essentially like.

Real estate is kind of like a no lose proposition and that it's totally passive and that it's easy. Right. And I know you and I have had this discussion before about what makes it truly passive. You know, it can be, but it's not what people think. But.

There'S a lot of, I don't want to call it propaganda necessarily, but there's certainly some very well funded groups out there, like the realtors and stuff, who have an interest in saying that real estate is easy and always goes up even though it's not the case. And I think that draws in a lot of people who are unsophisticated and don't realize that like it really is a business. And then the other thing is sort of the misnomer is that people can get wealthy investing in real estate. But traditionally it's not really for people to get wealthy off of. It's for people who are already wealthy to put their money into something that's safe and will provide a return for them. If you are, for instance, an Amazon seller and you are doing well in that business and you are spinning off cash and you don't want to just have it sitting around in the bank and you can't reinvest it in your business profitably, or you just want to diversify or whatever reason you've got that you want to put it into something. Real estate is a safe place to put it and it will generate a return for you and it will grow over time. But the expectation that you're going to put money into real estate and that's going to make you rich fast is really something that people should disabuse themselves of. It can happen, but it only happens if you get in at the right time of the market and get essentially get lucky and have the market wind at your backs. But if you get in, if you expect that to happen all the time and you're then drawn in at the top because you've seen all these other people like me who got in early and sold at the top making money and you think I'm going to go do what Jonathan did, you've missed that boat.

That makes sense to me. So let's address what you just brought up about it being a place for more conservative returns. Because I happen to be of the opinion that if you're an entrepreneur, you make your money in business and you put your money elsewhere and you trust the people who are in this full time that you know, that you have a relationship with, that have a track record to be able to run it as their business.

Yes.

And you're essentially investing in other businesses and it's kind of silly to try and be a full time entrepreneur and a full time investor.

Yeah.

So to that person who has an Internet business that spits off cash, where do you suggest or where do you point people to be able to put that cash to generate passive income and wealth over time?

Yeah. So then this gets back to kind of what I just alluded to a moment ago that we talked about before, which is this idea that real estate is a passive investment. And if you're looking for it to be truly passive, the only way for it to be truly passive is, as you said, if somebody else is doing it for you. Because even if you own, say you own the house next door to you. You live in your house and you own the house next door. You are going to be responsible for running that house. You've got to find a tenant to live there. You've got to collect the rent from them. Depending on what their response. Either you're taking care of the property or they're taking care of it. But you got to make sure they're taking care of it. You've got to collect the rents. If they don't pay you, you've got to get rid of them. You might have to go to court. I mean, so this is not a passive business. It doesn't mean it's a business that is going to keep you busy all the time, but it's not passive. And if you treat it as a passive business, you can very, very quickly get really hurt. And this happens to people quite a bit.

Even if you get a property manager to run the property for you, you still have the business of managing the manager. And just as an aside, I have this great story. I wish this was my story, but it belongs to a friend of mine who's in real estate. One of the best assets that she ever found was something she bought well below market. This is years ago when, I mean, it was easier to find below market stuff. But she found this property that when the guy who bought it was a Wall street guy. And like a lot of Wall street guys, they think they're smarter than everybody.

So he bought this property in Jersey City, New Jersey, which is just across the river from Wall Street. And first year he bought it, did great. Second year it was still profitable, but not so great. Third year it started losing money. Fourth year it was losing a ton of money. And he's like, this is a terrible property, I'm going to get rid of it. His property manager was telling him, nobody wants to live here. This property stinks. You're going to have to put all this money into it to make it rent worthy. So he sold it at a loss to my friends. So what happened? They take over the property, they get in there, they find the place is full, right? What was happening? The manager was taking the rent and putting it into her pocket and telling the Wall street guy who was not paying attention because it was a passive investment and he had a manager for that. It couldn't be rented and he never went and checked it out. So even if you have a manager on site, you still have to be on top of your business. The only way to make it truly passive is to invest with someone like me whose Job it is to be putting the whole deal together, making sure the manager is doing their job, overseeing the fancies, doing all of that stuff that you would be doing.

If you've got somebody who's basically me to do your job, then it will be completely passive.

Yeah. Investing in it as a business, treating it. Treating it as like you're funding a business.

Yeah.

Like you are. You are doing that. But in real estate, and it happened like in your case, you do syndications, I think, where you raise money from investors and you buy multifamily. And if you're a limited partner in that syndication, then that's passive for you. It's that idea of there's no such thing as passive income, but there can be passive for you.

Exactly.

Someone has to be paying attention to it.

Someone has to be doing the work. Exactly. You want to talk about locations? I like for.

I'd love to hear that. Yes.

Okay. So.

Starting kind of big to small, there are certain markets that I think are. I don't mean like certain markets like Austin. I mean certain market profiles.

That work no matter what state you are in the economy. So I like to look at. Well, first of all, they have to have population growth. That's the baseline. If there's not population growth in the market, stay away from it. Unless you really know that market very well, you live there, you know which parts are growing, which parts are not growing, you can get really granular. In that case, it's okay. But don't be the guy who lives in California and is like, oh, I heard Cleveland is great. I'm going to go invest in Cleveland. Cleveland is great. But Cleveland is also losing population. Right. So if you know the areas in Cleveland to invest in, that's great. If you have boots on the ground, if you know the market really well, you know what the good areas and bad areas are. But if you're from outside, it's very likely the case that you're not going to have that kind of knowledge and some broker is just going to sell you something in an area that you shouldn't be buying in.

Generally, stay away from the markets that are not growing. The next thing to look at, which I really like, is what I call anchors. An anchor is something that is not going away no matter what happens to the economy. So state government, really large public, doesn't have to be public university, really large university, like a university that's so big that it dominates the local economy. Because things like that in bad economic times, they don't go away. And even if they get their funding cut somewhat, they're not getting their funding slashed to the bone. If you look at markets like after the Great Recession, I was following a couple of markets closely. Charlottesville, Virginia, Ithaca, New York, Madison, Wisconsin. All of those markets, the very different markets in terms of geography and size. But what they had in common was domination by big university. And in Madison's case it's the state capital also. And those markets at the height of the recession, their unemployment never went beyond like about 6.5% because they were so while we had like 11% or higher unemployment than the rest of the country, those markets, because they were anchored by those recession proof institutions, they were really safe. So markets like that are great. If you can find markets like that.

Major hospital, like major hospital hubs. Right. Can be really good anchors if you're kind of like near those healthcare institutions because again, not going anywhere in a recession. Right. People are going to get sick in a recession. They're not going to, you know, they're still going to be needing health care. So things like that can be very, very resilient in a recession. Then the other thing when you get sort of more granular about it is good school districts, like really, really top school districts are great places to buy in. And the reason for that is that you get kind of the cream of the crop tenants in those neighborhoods. If you're zoned for really good schools, you wind up getting the renters who want to live in those neighborhoods because of access to the schools even though they can't afford to buy there. And those tenants will bend over backwards to pay the rent because not paying the rent means their kids get booted out of that school. So those are places that are very stable to look at. And.

That'S really where I recommend looking is places like that. So population growth anchor good schools are really kind of like the top three things.

So Jonathan.

That'S a great piece of advice. It also seems very common sense. So where do people get this wrong?

I think what people get wrong is.

Well, there's for one thing, there's the you have to invest in your own backyard thing where people think you should never buy real estate somewhere else because you don't know it well enough. Like I said before, that may be true in certain markets you really want to have local knowledge, but that doesn't.

Mean you should not investor. It's true if you may be just starting, but it puts blinders on the criteria that you're talking about. That makes a good market.

Yeah. And it doesn't I'm not saying you shouldn't invest in your own backyard, but I'm just saying, like, don't think you have to invest in your own backyard because there may be places that are better.

People, I think, also get this wrong by.

They. Well, so what I was alluding to before, and I didn't mean to pick on Cleveland, I just mentioned it because Cleveland is sort of a hot place for out of staters who don't know much about real estate to go these days. And the reason for that is because the returns, nominally speaking, look better than they do in California. So what you've got is all these people from California going to Cleveland and buying these properties and the locals are scratching their head going like, what is wrong with these people? Right? What are they?

Because what people make the mistake. I'm sure everybody's heard this example of like, when you're buying a house, right? You don't like if you're moving from New York or California to.

Indiana, wherever, and everything is cheaper. So people will go and like, they'll buy the most expensive house and overpay for it because it looks so much cheaper than what they're used to.

People do the same thing with investment properties all the time where they're so used to. If you're coming from New York or the west coast or Boston or any of these other markets that are really, really overpriced, then they go to a place like Cleveland and they're like, oh my goodness, look how cheap it is. But what they don't realize is that it's expensive for itself, right?

Yeah. So basically what I'm hearing you say is what makes a good investment is the fundamentals of that market and that investment. And where people get into trouble when they start comparing this market's fundamentals to another market's fundamentals and basing their criteria on the numbers that are represented, the price of the property or the cash flow of the property, rather than the actual fundamentals that are within the context of that area.

Exactly. You have to compare apples to apples, right? You can't compare apples to oranges. And that's what people do a lot. So it's just like with business, like you may have an Amazon seller. If you're going to sell, your business may trade at a certain multiple and you may have another manufacturing business trades at a different multiple. And if you compare one to the other and say, oh, this is a good deal because it's trading at a better multiple, you may be wrong because they have no comparison to each Other, it's the same in real estate. The cash flow that a sophisticated investor expects in place like Cleveland is going to be different than it is in San Francisco. And if you make the mistake of comparing just simply like, oh, well, look, the cash flow is higher in Cleveland, therefore this is a better deal, that's where people get into trouble. Because it may be the case that yeah, 12% annual return, Cleveland looks awesome compared to 4% in San Francisco. But the real long term market return on that Cleveland asset may be 20%. And if you're getting only 12, you're seriously overpaying for it. So.

People don't make that calculation most of the time they get into trouble doing that. And then people get into trouble just with.

By assuming that real estate is too easy, assuming that it always makes money, assuming it's a no brainer business, assuming that they don't have to do any.

Real sort of underwriting or investigation. And also.

People get into trouble by buying speculatively. So it's. You see this happen in New York all the time where you have neighborhoods that over the last 20 years have gentrified and the prices have gone up 10 times. And people coming in now just think, oh well, they went up 10 times over the last 20 years. So they're going to go up 10 times. They're going to continue going up. And what they don't understand is that that was a function of this neighborhood transitioning from a very bad neighborhood to the one where like the wealthiest people in the world live. And like, you can't, the neighborhood is not going to transform from a like 1% to a 0.0001 percenter neighborhood, you know what I mean? To get that same appreciation. Right.

But people make that mistake all the.

Time of thinking basically people make the mistake of looking in the rear view mirror and assuming that that trend is going to continue.

Which is really just fear of missing out. It sounds to me like your approach is more to look at the market itself, the fundamentals of the market and where it is now, and look at how stable those indicators are going to be to determine whether or not it's going to perform consistently while you hold it as an investment.

Yeah. And again, you can't ignore where you are in the market cycle, but you just can't, you can't ignore that.

So Jonathan, I know that you have like a really lively Facebook group where people talk about this stuff and I believe you've got a podcast that's doing pretty well too. Give a quick plug where people can find you.

Yeah. So I'm not doing the podcast at the moment, but if you want to find me online, there's numerous places where you can. So one is the Facebook group that Ryan mentioned, which is called Multifamily Investment Community, or MIC for short, but Multifamily Investment Community that we've got about 9,000 members or so that talk about real estate all the time. And if you are interested in trying to figure out the syndication thing on your own that has any interest to you, I have a download on my website which is a ultimate checklist to doing these deals. And you can find that at www.mifamilylaunchpad.org.

Cool. Twomley, it's good to see you again, my friend.

Yeah, you too. It's good to catch up. Thanks a lot.

All right, man, we'll see you next time.

All right, take care.

Hey capitalists.

Before we jump into today's episode, if you've crossed seven figures and now you're stuck and you're frustrated and you're overworked and you're not seeing the same growth and excitement that you had when you started this thing, but you know that you're sitting on something special and it's driving you crazy that you can't get what is in your head out into the world. I know why you're stuck and I can help. Go over to capitalism.com 7. I've put together a write up about why you're stuck, how to get unstuck, and how I can help you in 2020 and beyond. Looking for exciting businesses with fun entrepreneurs who are frustrated because they know that they're capable of more. So go to capitalism.com7 and we'll get you growing again.

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