Ep 179: The Interest Rate Storm is Here with Neal Bawa

I was paying 110,000. Right. But I was paying 90,000. Well, the sellers wanted the buyers. The sellers wanted 110,000 and I wanted to pay 70,000. The buyer seller gap never goes away, regardless of good or bad markets. So to expect it to go away at this point and wait for it to go away, sensical, you never will never end up buying any properties.

Welcome to the Next Level Income show where it's our goal to take your income, your investments and your life to the next level. I'm your host, Chris Larson. If you haven't yet, get a copy of our book for free at our website, nextlevelincome.com. that's www.nextlevelincome.com. just click on the book link and I'll even send you a copy if you put your address in. On today's show, we have Neil Bawa. Neil is a technologist who is universally known in the real estate circle as the mad scientist of multifamily. Besides being one of the most in demand speakers in commercial real estate, Neil's a data guru, a process freak, and an outsourcing sourcing expert. Neal treats his billion dollar plus multifamily portfolio as an ongoing experiment in efficiency and optimization. Today, Neil and I are going to talk about the interest rate environment today, how it has affected multifamily and commercial real estate, and what are some upcoming opportunities that you can take advantage of over the next two years. Neal, great to see you again. Welcome to the Next Level of Income show.

Well, thanks for having me back. It's tremendous to be back and having conversations at this very interesting time in commercial real est.

Yeah, no, look like you, Neil. I'm a data guy, you know, with my engineering background, I try to let the data, you know, drive my decisions and not emotions. I know you're big on that. As we talked about in the intro and last I, I saw you and heard you speak out in Salt Lake, we were, you were talking a little bit about, you know, kind of the, the, the potential storm that was on the horizon for this year. And we're seeing some of those ripples here as we come up towards the end of the year. So I'd love to, love to kind of have you start off by sharing a little bit about your background as a technologist before we get into kind of where the economy's head and what we're seeing here in the real estate markets.

Yeah, well, I think that storm is an appropriate metaphor for, you know, where we are today. And I started with a different storm. So 2008 is when I started buying real estate. I was introduced to real estate as a technologist. I was running a tech company, 300 plus employees, nothing to do with real estate. And the senior partner in the firm decided that he wanted to build a campus and needed my help. So in 2003 we built a campus. No investors, no debt. It was a company's money. Company was rich and we built it from scratch. And I realized the massive depreciation benefits of that. I live in Taxifornia, I have a big fat tax salary and I was paying huge amounts of tax until all of a sudden I wasn't because I was a partner in a, in a company that owned real estate. And so that was eye opening. And so I started gathering money. You know, I was living the, the lifestyle and you know, because I didn't have tax sheltering, I was basically spending all the money that I was making and paying a lot in taxes. So it took me a while to, to gather the money. I was very lucky in that by the time a storm arrived in 2008, I had gathered up money and I ended up buying dozens of properties. As a techn. Use data science and technology to find the right markets. In hindsight, it seems like almost everywhere you bought them would be good, but that's actually not quite true. And so I, and, and you know, I, I fell in love with real estate because I found that I could take technology driven data science and apply it to real estate and improve my returns. So that's how I got in. In a storm.

Yeah. And that was like you said, that was a great time to buy real estate. You know, there's a lot of opportunities there.

Sure, but, but while you were doing it at that point, you didn't think that nobody thought that I would tell them my data science is showing this is the best time to buy real estate in the last 50 years. And they would kind of look at me like I was a complete idiot. So back then didn't feel like it. Hindsight is 20 20. Everyone thinks, oh yeah, whatever you bought in 2008, 2009 must have been fantastic. But back then you were terrified with what you were doing. You're using data science to make yourself just be assured that what you were doing wasn't like the stupidity that other people were telling you it was.

Yeah, and it's, you know, there's, there's a lot of returns that are driven by the, the lack of emotion. You know, I think one of the statistics with respect to financial advisors is they earn their, their percent fee, their, their fees that they charge by keeping investors calm, by, by investing in the stock market. The flip side is I love, I love real est lot more than the stock market, but real estate's illiquid. So I think, you know, one of the, one of the challenges that investors have is that they can't sell it. But that also prevents a lot of the volatility with respect to real estate versus what we see in the stock market. And that means that, you know, volatility is lessened. You know, if you can't sell, then, you know, the price isn't, isn't down. What do you think?

Maybe some of the stock market investors that value liquidity should be listening to somebody like, like Warren Buffett? I mean, today Warren has more money sitting on the sidelines, right? And if you think about it, that's illiquidity. You're not invested, you're not getting a return. There's no return on money that's sitting on the sideline. And he has the just hoard in his company's history, right, because his belief is that the only right way to make money is to be ill a massive majority of the time and then to be liquid or then to make an investment get a return a small percentage of the time. So the truth is that the reason he's considered the greatest investor of all time is he's one of the most patient. And the philosophy of the stock market is designed to drive you completely insane. In fact, I wrote a presentation about this called Everyone's a Speculator, the Profit Paradox. And it's one that I actually given away to other syndicators because I think investors need to understand that the. There is no statistical evidence that investing in the stock market on a day or week or monthly basis is better than investing on a yearly or five year basis. But there's enormous amount of evidence, Chris, that if you invest on a one year or five year basis, you do better than the people that are doing it on a short term basis. And so I think it's our sense of wanting to do something about every piece of positive or negative news that drives us emotionally to terrible decisions. And so I find that since I am subject to these as much as anybody else, I like real estate because it slows me. So I don't react to one piece of bad news or one bad video that I see on YouTube. I'd much rather gather data over time before making a decision. And why I get higher returns in real estate than I've Ever done with the stock market? Even though, you know, I've invested in the stock market lots of times.

Yeah, absolutely, absolutely. So Neil, when you started back in 2008, were you, did you go straight into commercial? Were you buying single family houses? What were you, what did you start in back then?

So started with single families, then did duplexes, then triplexes, then four plexes, then seven plexes and then jumped from seven plexus, 235 units. So it took a while.

Linear but non linear.

Yeah, I was pretty careful about it. I. I wasn't in a hur. A lot of people go into real estate to make a living. Well then they have to go pretty fast to get to a certain level again. I had the big fat tech salary so I was not at all in a hurry.

Yeah, no, I love it. And yeah, I love to say real estate is a get rich slow game. And as you mentioned, we talked a lot about demographic trends and you know, different trends that you can follow and get in. I've followed several of your investments and we'll share with the audience how they can follow you and some of the educational resources like your upcoming webinar that you have as well. But what so you got started in multifamily, Neil, what asset classes have you been invested in in real estate since then and what are you currently focused on right now?

So multifamily homes to sell, townhomes to build, which are also called build to rent. So it's a different asset class. It's still like multifamily but people are living in a townhome as opposed to living department student housing. I've done multiple student housing projects, office and flex industrial and then self storage. So those are the different asset classes that I've tried out and I mean I came to the conclusion that amongst them the best asset classes were unquestionably multifamily and built to rent. There's. That doesn't mean that there aren't better self storage deals or there aren't single, you know, student housing deals. That's not my intention to say. But what's interesting is if you take a thousand multifamily deals and a thousand build to rent deals and a thousand student housing and a thousand self storage and a thousand everything else. So you're looking at it at a very, very high level, 35,000 square foot level, the multifamily thousand deals and the build to rent thousand deals are represent a lower of risk or a higher risk reward. Right. So you can look at it that way as a risk reward. Those thousand deals were definitely better. The all of the other asset classes that I've looked at, and I haven't looked at hotels yet, I've been told that, you know, the risk reward there is highly unusual and it's a very sick product. So I'm curious about that. Maybe we'll get to do it one day.

Yeah, no, I love, I love what you just said there. You know, the risk reward. We talk about the Sharpe ratio in my book. And you know, what's interesting is, you know, you mentioned, you know, some of the statistics in the stock market with respect to, you know, how long are you invested? So you're going to be more successful if you have a longer term view. You're also going to have higher returns if your volatility is lower. So if, if overall you average a 10% return and you fluctuate between 5 and 15%, you're going to have a higher return than if you fluctuate between positive 30% and negative. What would that be? Negative 10%. Right?

Yeah.

Yep. If you're going to, if you're going to add those together and divide, divide that up. So, you know, and that's, that's variance drag. And I think that's, that's the other thing that you mentioned. You know, we have, we have less volatility in multifamily. I've talked about demographics. I think we've been on a terrific demographic ride or wave as I talk about it with millennials. Do you foresee that continuing here into the near future? And you've talked about Bill Durant. I would contend that, you know, Bill Durant has really benefited as these millennials have formed households, but maybe they can't afford a house and they've, they've decided to rent a townhome or a home instead.

So, so the answer is yes. And, and the honest answer is this. The United States is different from all other rich countries in the world that I know of, that we've always had a very high, an extremely high ownership rate. Right. So the, if you look at the last 20 years, the rate is somewhere in the low 60s. What that means is about 62 to 64% of Americans live in homes that they own or American families, Right. Live in homes that they own and the rest of them basically rent. Right. In some shape or form or the other. So that ratio, and I've read three different studies on this, the best one is from the University of California. Every single study says that must go down that 66, 62% was a point in time before construction costs started going down nationwide, before infrastructure costs started going up, before we became extremely nimby. You know, all of that, all of the things that are basically driving up construction cost harder to do construction have happened really in the last 15 or 20 years. And as a result, when you look at what the average income is today, right, the medium median income today compared to the, to the median home price, it's astonishingly out of whack compared to it was 10 years ago or 20 years ago. It's also astonishingly out compared to what it was the day before COVID So if you look at the day before COVID snapshot of median income versus median home price, and take a look at it now, you'll notice a staggering difference from that day, which really three and a half years ago to today. A staggering difference. So one statistics that I saw, which was very interesting is said today because of recent home prices and increase in interest rates in the last three and a half years, you need to make 88% more in income in the last three, three and a half years to own the same home that you would have bought one day before COVID And I don't know of anybody that got an 88% hike in three years. The average American got somewhere between 10 and 16% salary hikes. So as a result, we've ended up in a very sad situation. I feel like this is a crisis that maybe the Republicans and the Democrats need to spend more time talking about. It's a crisis. It's a tragedy that between 6 and 10 million American families, mostly the millennial generation, but also some generations before and after them, are simply priced out of being a starter home. Simply priced out. And in previous generations before 2010, these people would have had no trouble buying that starter home and then building wealth for the next 40 or 50 years by sort of moving up. Right. They don't have a chance. They never will get there. Today as we're recording this, at the end of 2020, a mortgage rates are above 8% for a 30 year fixed above 8%, they were under percent only 24 months ago. So how do you deal with your interest rate more than doubling? So, you know, you're this, these, you know, between 6 and 10 million families, they have to go live somewhere. And the standard answer is they go live in apartments. But their income levels are pretty high. They're actually fairly high for apartments. So they're looking for in between solutions. And I believe that the in between solution is built to rent, which essentially is you're building home, not amenities. They don't have pools and gyms and any of those things. But, but instead of being single family homes, they're townhomes and they're fairly small. They're between a thousand and thirteen hundred square feet. But they've got a little backyard, they've got a little front yard. They've got some cheap amenities like a playground. Right. Where kids can play or a barbecue pit. You know, those kinds of things are a little dog park. So you've got minimum amenities. But. And you're trading those amenities because apartments have them. You're trading those amenities for the right to have a home. Right to an actual home. Of course it's a, it's not your home and you're renting it. But I think what I've is American families are like, yeah, that's preferable to, to an apartment. And so that's why we are building built to rent. Here's the forecast. The 19.6 million, you know, units of multifamily in the United States that are being tracked. I think there's probably 4 million more that are much smaller and then there's a bunch of single family homes that are being rented out. But let's call it 20 million. There's 20 million apartments in the United States. Apartments. And it is now projected that we will end up with about 10 to 20% of that number over the next 10 years. Will end up being these kinds of townhomes. So that's 2 million to 4 million units. Right. And if you look at the total size of the market today, out of those 2 million to 4 million, we've only delivered 44,000 total in the United States. All time build to rent, total every 44,000. Now that's going to grow. It unquestionably will grow, but there's a lot of room there and I'm looking to be part of that process. That's why I like build to rent. But otherwise I like multifamily.

Yeah, I love it. And I think it's, it's all, it's all slightly different flavor like you said, of, of multifamily. And we have, we have, four of our properties are either build to rent or have builder rent adjacent to our apartment complexes, which gives, we've actually combined one. It gives those residents the amenities that they have with the apartments with that builder rent. But yeah, I think the statistic is we need about 5 million new housing units and then we need about 4 million new apartment units on top of it. So 9 million combined, we have to increase that number, you know, around about 20%, maybe even 40% that you mentioned to house all these people. And if, if you prefer a house instead, then I think that's, that's a fantastic area. We've seen that, we've seen the builder rent communities and outpace the apartments on, on the whole in terms of rent growth, rent growth and occupancy and those sorts of things. Yeah, they've been fantastic. But you mentioned something else, Neil. You talked about interest rates and yeah, it's, we have, we have the highest gap that we've seen historically between the cost to buy versus the cost of rent. And I've, you know, I've had this conversation with many young individuals who say, I got to buy a house, I got to buy a house. It's like, well, we'll slow down. You know, it's more expensive to buy a home. Do you want to buy a home? But you don't have to buy a home to create wealth. You could, you could invest it in different way, ways, but obviously it's forced savings. There's a lot of really positive things, which is why it's, it's correlated with wealth creation in this country. But setting that aside.

Yes, but, but the past is not like the future. I mean, I think that if you really look at that wealth creation, that wealth creation was mostly created when homes were much cheaper. Right. So if you have a home that was, you know, $150,000 in 1982 and that home today is $750,000, can you apply the same benchmark of wealth creation? What I am finding, and this isn't true universally, what I'm finding in general, the people that are buying home, they are not in the previous cycle of wealth creation, they're caught cycle of debt traps. So their home unfortunately has gone from being the biggest asset of their life to being the biggest preventer of their wealth because of these, this 4x5x increase in prices in, in many markets, again, not a universal statement, but I think that there are hundreds of markets in the United. But that statement is true.

Yeah, no, I think that's a great point. And I think, you know, if you're listening, that's something that you can take away from this. Especially if you're in the early stages of your life building that wealth. There's other things that you can do and not just rely on, on buying a home. We've talked about interest rates a few times here, Neil, and that's not only sent ripples through the residential markets. But as a lot of listeners that are investors know, it's also sent ripples through the commercial markets. And you know, you talked on stage about this out in Salt Lake where we saw each other and you have a webinar which it hit. It'll air by the time this episode comes out. But the title the Storm is here. Interest Rates Slam, Multifamily and Commercial Real Estate. So let's talk about why interest rates are so impactful with commercial real estate and then talk about, you know, what are some of the assets segments that are, that are really getting hit and where the opportunities could be for investors that are out there today. Today's show is sponsored by Money Insights and their investment optimizer strategy. In my book, I share how I use the same strategy starting over a decade ago to invest my money in two places at one time. This strategy has been used by the wealthiest for generations for estate planning, minimizing taxes, preserving wealth and increasing stability for their investments. Now you can do the same thing. In addition, you can build a plan to build an emergency fund, pay for college, fund a business plan for retirement, and ultimately optimize your total financial picture. To find out more information, check us out at the banking link@nextlevelincome.com.

Sure. Bottom line is that home prices, multifamily prices are highly, highly sensitive to interest rates and always have been, right? But what we've found is that home prices are less sensitive than multifamily and multifamily is less sensitive than all other forms of commercial real estate. So one least sensitive single family homes because it is the most emotional decision out there. Most people that make, you know, decision to buy a home are not really at it from a internal rate of return or, you know, equity multiple perspectives. They're just saying, you know, I want to buy a home because I want to live in a home that I own. So it's, it's an emotional decision. So they tend to be, you know, less sensitive. And then you've got multifamily, which is quite sensitive. It's heavily sensitive to interest rates, but it's not sensitive as all other forms of commercial real estate. And I'll explain why in just a second. Multifamily amongst those commercial real estate asset class is the most privileged. And I will, and the moment I say this, I think people will get it. So of all the different commercial real estate classes, you know, whether it's, it's, you know, self storage or retail or hotels, office, there's Only one asset class where there are three government in agency, quasi government agencies whose only job it is to make sure that that asset class is liquid. And so for multifamily, those three quasi government organizations which have over $100 billion a year to meet their mandate of stability are Fannie Mae, Freddie Mac and hud. Right. So Housing Development Authority, all of these three are very heavily tied. And there's their mandate, their reason for existence is make that the multifamily and single family market are liquid. Right. And if their liquidity drops, then do something about it. Right. So for example, recently introduced a shocking 35 year amortization program. We've seen some of those in the single family market for similar reasons. But now in the multifamily market, they're saying we're going to amortize your debt over 35 years. Like it's a little crazy, but I'll take it. Right. Because it's the government's money that's being spent, not mine, not yours, government's money. The government hands out a very large budget to Freddie Mac and Fannie Mae and said please spend all this money because if you don't, then next year we'll give you less. Right?

Yeah, it's wild.

There's one thing that exactly, and it's like, oh, you want us to spend this money? Oh, so if you don't spend this money, you'll give us less or we will find a way. And it, sir, don't worry about it. We shall spend every freaking dime by December 31st. Right. So you have three agencies that do this and you have none for hotel, for retail, for office, for self storage. They don't care about that as far as those, those are concerned. Well, there's you know, private banks out there, private lenders out there, they'll take care of it and we might lend some money to them, but it's not a mandate thing. If we're not, we're having trouble lending money to multifamily or we have a big bucket, we might, sure, we'll do something about it, but it's not our job to do that. Therefore you have this trifecta of single family, least sensitive, multi quite sensitive, everything else even more highly sensitive to interest rates. And what we've seen is that the peak of pricing on a cap rate basis. Cap rate is a way of measuring multi family prices because otherwise different buildings, different sizes, different locations, how do you, how do you compare them? Right. The cap rate is a very useful way of doing that. Yeah, yeah.

So let's let's pause real quick. So for newer listeners, the cap rate is essentially if you're going to pay a dollar per dollar, how much are you going to get in return? So for every dollar you pay, if it was a 5% cap rate, you would get 5 cents for every dollar in price that you pay. With no leverage, right?

No leverage. If you didn't use a loan, then you would get basically $0.05 each year on your, on the buck that you just paid and of looking at it is, is in multiples. So if you're, if you're basically got a 5% cap rate, then you're basically paying 20 times the properties, right? And if you got a 4% cap rate, then you're paying 25 times the property's income. And so the lowest cap rate in that notice, 4%, you were paying more than 5%. The lowest cap rates happened in March 2022. So they happened a little over a year and a half ago. And at that point in time it was very common to see buildings where the actual going in cap rate was below 4%. So people were paying 25 times income, which is a number. Right. Bottom line is those numbers were not sustainable because they assumed ever low interest rates. So they were predicated based on interest rates being historic lows and staying there. So once the Fed started raising rates and they started raising them in March 2022, note that that the cap rate height in the same month that the Fred started rate Fed started raising rates. Now that the Fed has raised rates by about 550 basis points on their side, we're now seeing the opposite end of that process. We are now seeing the highest cap rates that we are likely to see in this cycle. Right. And people might say they can go up a little bit further and they might because there's distress coming. So you might see this. I think that if there's no distress, we are absolutely at the peak the, the cap rate. So we've got, we've gone from the lowest cap rates, highest price to highest cap rates, lowest price. But the X factor there is distress because stress can bump you above what is the reasonable highest cap rate or the reasonable lowest cap price. We saw that in 2009 in places like Phoenix and in Florida where basically home prices just were ridiculous because the cost of building was 250,000 and you could buy a home for 80,000. Right. Which made no, that that was the distress driving the price down far below what it should be. So distress being the X factor, we have seen a decline in multifamily in 19 months of roughly 25% in the cap rate world, we've gone from roughly 4 cap to 5 and a half for certain kinds of properties that syndicators like. So these are properties where you can add value, right? So those properties, we've seen them go from 4ish cap to 5. These in the last few weeks I've seen numbers higher than five and a half cap. So it might be that in certain markets in the US the discounts are now exceeding 25% but itself 25 is a staggering discount. Right.

In two years or less than two years.

Yes, in less than two years, right. Because there's, I'm going to make a fundamental statement that every investor, every, everyone looking to buy this as a general partner should, should heed. If your belief is so clearly your belief that prices should be that high based on, you know, 18 months ago that belief was wrong because prices came down right as soon as rates went up. So that belief was highly logical because it required interest rates to be that low forever. Right? Now if you think that today's price is still too high, then you're making the exact same mistake. Because now you're believing that interest rates will stay this high for all times in the future. Which means that you haven't studied any of the last nine interest raising cycle by the Federal Reserve since World War II, they've raised rates nine times. And every one of those cycles looks like this zoop. Zoop. None of them looks like zoop. And then plateau for the next five years. Right? None of them. They always overshoot the Federal Reserve's job, and they don't like saying this because it's not a nice thing to say, is to put the economy into a recession, into a brief recession so that demand can be killed. Because the only way to kill inflation is to first kill demand and then wait six months. That's how demand dies. That's how inflation. You must kill demand. The only way to create negative demand in the United States is to create a recession, because that is the definition of recession. The destruction of demand is the definition of a recession. So Federal Reserve's job is to destroy demand enough and then wait for six months. And when you do that, then they can start dropping rates. The Fed, of all the organizations in the world, the one that wants to keep rates high the least is the Federal Reserve. Because they only exist, these tens of thousands of people that exist at the Federal Reserve. They have mandates. Mandates. And neither of those two mandates work with high interest rates, right? High Interest rates are their weapon to get back to their mandate.

They're reloading their gun, essentially, Right?

They're reloading their gun. Right. You can't get there without basically over high interest rates. So today, you know, this is my core belief, based on studying these cycles for, since this, since World War II, nine times I've seen the Fed do this. Is the cap rate today is too high. The cap rate 18 months ago was too low. If you actually pick the middle point of those two, you're pretty close to where the Federal Reserve wants us to go for asset prices. And it's also pretty close to where their interest rates usually are.

So study like mid fours, mid to high fours. Is that what you're.

4 and a half, 4.75 matches today's market and matches the reality of the world there, rather than four or five and a half caps. So at some point they will retrench. So the total discussion really is when and what does the next year. So next year is that X factor with the distress. Because next 2024 is the distress year for multifamily. We can talk about that, but that's the X factor. So you could, you could also see an overshoot where you see cap rates even going up further when they shouldn't be because now interest rates are starting to come down, but the distress can drive them up a little bit further. But let's pass the distress here and let's get past 2025 as the stabilizing year. In 2026, I don't foresee cap rates being any higher than 75. So when I buy an asset today that I don't intend to sell until 2027 or 2028, I'm buying it cheaper, I'm getting a discount and.

Yeah, no, I like that. And I love what you said. I heard you, heard you say this. In the past year or so, you know, when, when, when cap rates were low and interest rates were, or cap rates were, were higher, interest rates were lower. You know, we were getting paid. Or when cap. I'm sorry, when, when cap rates were.

Low and interest rates were low.

Yeah, and. And inflation was higher. You're getting paid to borrow because, you know, if you're borrowing at 4% or 5% or 6%, inflation's 10%, you're getting, essentially getting paid to do that real quick because I want to move on to the distress segment before we have to wr, you know, today. And I think. Let's see here, where are we about four and a half percent on the 10 year today on the 10 year treasury, you know, we were down in the 1% or even lower range, you know, in the past couple years. So how do TRA, how do CAP rates track within the 10 year? I know we've seen fluctuation, you know, on the whole we've averaged about, you know, a couple hundred basis points, plus or minus around the 10 year. But we've also seen it get really close to the 10 year with respect to cap rates. So we've also seen that gap yawn or widen. Do you look at that or what have you seen with respect to that, that trend?

It's a terrible rule of thumb, but I'll say it. You know, with every 100 basis points increase in Treasuries, cap rates are likely to move about 50 basis points. So your cap rate is going to go up 50 basis points. If you're treasuries go up 100 basis points. And so if your Treasuries have gone up 300 basis points, which is the truth right now, they've gone up 3%, then you, you, your rates have moved 50, 50 and 50, 150 basis points. So that, that rule of thumb works in most cases and it should work in the future as well. Simple reason that the, the only reason that multifamily prices have moved is not because demand has died. Demand is as high as, as it ever was, possibly higher, but simply because people can get loans of a specific price. As Treasuries go up, the amount of money that banks will lend you on that property goes down. Therefore that drives the price more than anything else.

Yeah, and that's, you just made a really good point. I want to underscore that. So a couple things. One, as cap rate go, as cap rates go up, prices go down. They're inversely related. As your interest rate goes up, up, the amount you have to pay for debt service goes up every month. That means that a bank is going to lend you less because they're going to look at the cash flow you have. So if you could get 75 loan to value two years ago, that might be say 50 or 55% today, which means you need more capital, which means your, your returns are going to come down. I think those are really important things.

And that's really forcing the prices down in a very smooth, I mean I'm seeing smooth reduction in prices, you know, and, and the only thing I want to point out is people are expecting that the gap between buyers and sellers will go down. This is a very foolish idea. I hear about it all the time. It's a nonsensical idea because there's this feeling that if it's a bad market, the gap buyer and seller expectations should be, should be lower. It's nonsense because even in 2009, when I was for a property that cost $250,000 build, I was paying 110,000. Right. But it's, I was paying 90,000. Well, the sellers wanted the buyers, the sellers wanted 110,000 and I wanted to pay 70,000. The buyer seller gap never goes away, regardless of good or bad markets. So to expect it to go away at this point and wait for it to go away, nonsensical. You never will never end up buying any properties.

Yeah, and I think that's what we have all this liquidity sitting on the sidelines. You know, as those prices start to come down, you know, buyers jump, you know, jump on these opportunities. So I guess leading up to, you know, what we may see here in the next year or two, you know, what, what is the source of the distress for those that, you know, may not be aware of kind of what's happening and how will that manifest itself in the market, in your opinion? Sure.

Between 2020, 2023 inexperienced syndicators purchased thousands of properties and they, they bought those with the assumption of interest rates staying extremely low. Many of them either forgot to buy rate caps or bought, you know, rate caps that are very high. So with that rate, I wrote rate cap does is simply caps your interest rate. So you buy it as a separate component. It's like insurance. If the rate goes above that, then you don't have to pay that bit. You know, you get capped at that level. And so many of them have rate caps, but they're set high and many of them have rate caps and they're fine, but those rate caps are going to expire. So 2024 is the year when it all comes together. There's a large number of these properties that have two or three year bridge loans. Those loans are ending. There's a large number of other properties that may not have bridge loans ending, but their rate caps are running out and they're. The current price of Those rate caps is 3, 4 or 5x what it was for. There's also properties where we had underwritten for very, very dramatic rent growth to match the rent growth that we saw in late 2021 and early 2022. Well, that dramatic rate growth didn't happen because in the across the United States for the last 12 months, rent growth growth was zero so it was zero for the. And certain markets up, certain markets down, but, you know, zero overall. And so that growth hasn't happened. The value of the properties has gone down. The banks are basically saying we won't even give you more money to do your rehab because the value of your property is down. We don't want to put more money into it. You put more equity in. So happening is we are, we have roughly 3000 properties in the United States. That number was 2500 when I was presenting at the best ever conference where you heard me in February. Now that's gone up to 3,000 because interest rates have gone up to the fed funds rate went up to 550. I thought they stop around 5. So with each of those increases there's more properties getting added. 3,000 properties that are at a debt service ratio of below one, which is a fancy way of saying they can't pay their debt, let alone pay anything else. If they just pay for their expenses and then they pay for their debt, there's a shortfall, right? Shortfall means that the property is bleeding on a monthly basis. And also as each month goes by, it's easier to fix the bleed in the first three or four months by using trading cash. Then you start running out of operating cash. Then you borrow money from one person, then you run out of that, then you borrow money from another. And every time you borrow money now you have an interest to pay on that money. And so the situation starts to snowball over time. And 2024 is the year when that snowball finally hits something big and causes. Now keep in mind that 3,000 properties are. 3,000 properties in the US are still a very tiny fraction of the overall family market. So while the word distress is useful, the word contagion is not. Because 2008 was a 8 trillion dollar problem. 8,000 billion. Today it's a $75 billion problem. So less than 1% of the 2008 issue. So the people thinking you're going down the wrong path, people thinking limited distress in a certain markets in the United States, you're on the right path.

Yeah, I love, yeah, I like, I like that you said that. Because, you know, it's, you know, you watch the news and I discourage you from watching the news if you're listening, like just, just get rid of it. Get rid of.

You got messes with your head.

Yeah, yeah, yeah. Listen, listen, listen.

Watch the news. You know, Chris, you can watch the news and be a speculator or you can read boring scientific stuff and trade papers. And be an.

There you go. We're listening, we're listening to smart people like you. Like you, Neil. Yeah, so, okay, so there, there are going to be opportunities. Those are going to be limited opportunities. I don't, I don't think we're going to see a big sale like when you walk into the supermarket and you see, you know, a big display stand. You know, I think these opportunities are going to be kind of like the off market deals, you know, that get done on the sidelines. How do you, this is going to manifest deal. And how do you think these deals are going to manifest, Neil? And how, how can investors take advantage of these in your opinion?

Well, first is anything you buy today is 25 off, right? One can argue that. Well, it should, should have been some percentage off anyway because they were too expensive, I'd say.

I said she saved, she saved 25 bucks on the pair of jeans. That was 100 bucks. Is that the same thing?

Almost the same thing. Except I, I would say that if those pair of jeans were a hundred dollars below before and they were 75, the right price for them to begin with was around 87. So you're saving half of that. 25 is real and the other half is fake. Okay. So saying it that way, you know, gives you a sense. So you're really saving 12 and a half percent if you think about it. And you're saving that because of interest rates that are going to go down, you know, I don't know, but they're going to go down over the next year or two years and then you would have saved that 12 and a half percent. And it's worth it because think about it, you, you know, 12 and a half percent doesn't sound like a lot, but it's, it takes you almost 40% of the way through to doubling your money in five years. That's how, that's how multi family math works. Big deal. What we are going to see is in certain markets the prices are going to drop by 30 or 35% over the next 12 months. I can speculate on what these markets are, but there's too many factors for me to really give you a strong answer. You know, Phoenix could be such a market that we could see, you know, those prices drop more than percent from peak, maybe 35% for peak for short amounts of time. The other thing that I think we're going to see is the one you employ, we're talking about which is off market opportunity where seller financing may become something that, that we see. So if you take on seller financing for two years or three years on a project, now you're taking on less equity so you're raising less money because you know, the seller is essentially the other part of the equity and you're able to make deals work that don't work today. And there's no. The word seller financing was a four letter word a year and a half ago. But today there's so many sellers willing to accept that because they. And so I think creative financing is going to lead us out of this distress but is also going to be the biggest opportunity in the rough distress.

Yeah, no, I like that. And we're seeing that in our mobile home parks that we're buying. You know, over the last five years, sellers did not want to, one they didn't want, they didn't have to, they didn't have to do sell financing. And why would they, why would they take 3 or 4% interest rate, you know, when they can just sell it outright and go invest their money? Well now, you know, they'll sell or finance it to us at 6 and 7 or 8%, which is still a good deal for us given, given the terms and those sorts of things. So. Yeah, I like that. And I think, you know, the point I want to underscore that you just made, Neil, is that if you're listening, you know, I agree with you. I don't think a contagion is coming. I think there's going to be opportunities, look at the long term, work with operators or look for opportunities to find operators that you can, you can partner with and find these deals that are either off market or be creative. But what worked over the last five years probably isn't going to work over the next year or so, in my opinion.

Absolutely. I think we have to be creative. The other, the other option of course is, is A Z loans, which I think is the cleanest option. There's not enough of them and there's not enough of them that work really well. So work extra hard to find true assumptions, true assumable loans. And I think that that is, those are incredible options if you can find them and they're, they're there. We, you know, we bought two properties recently. Them was assumable, the other one was not. And I think that frankly the one that was assumable was a better deal.

Yeah, yeah. I love it Neil. I, I've enjoyed this, this conversation. I'm a nerd at heart going back to my middle school math team and I'll be, I'll be continuing to follow you with your webinars and the materials you have out. For those listeners that are just getting to know you today, what's the best way to learn about how to follow you? Get your educational material and and all the things that you have between you grow and grow. Grow capitas.

We don't sell educational material or programs. We give it away. We have a website. We believe that education should be free. And so this website is multifamily you.com that's multifamily followed by the letter u.com we hold interesting webinars a year. Some of them are about multifamily, some are about real estate, some are about other things like AI or climate change. So we do a dozen webinars a year, one a month, and about 25,000 people that are interested or intrigued about these kinds of discussions join us on those webinars. We're actually doing a series of four Distress Watch webinars where we will get into the distress in multifamily. We didn't talk about other forms of commercial real estate today, so we have webinars as well and I think those will be very, very interesting for listeners. You can join@multifamilyu.com There is no upsell, there's no subscription. There never will join. Benefit from the ecosystem and who knows what we might do together.

Yeah, no, I love it Neil. We love what you do. Check out multifamilyyou.com I try to track every webinar and watch every webinar that Neil does. And no, you've never tried to sell me anything above that, Neil. So I appreciate what you do. We have a similar philosophy here@nextlevelincome.com look forward to staying in touch my friend and thank you so much for sharing your knowledge here on the Next Level Income Show. Hey Chris, here again. I hope you found this episode valuable. Now I have one more thing to give to you. We have a page for my coaching clients where you can get a free copy of my book as well as much more from previous guests on the show. Just check out nextlevel income.com coaching to get a free copy of my book, audiobook and much more. I'll send you a copy of my book and cover all the shipping costs as a thank you for listening to the podcast. Also please like share and take just 90 seconds to give us a rating on Apple Podcasts.