Next Level 274: The Future of Real Estate and Where We Are In the Market Cycle with “Big” Mike Zlotnik

Are you learning to invest or you investing to learn? You're doing both all the time because if you're doing something else, you're missing on an important element.

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, Next Level Income.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 Big Mike Zlatnik. Mike is the CEO of TF Management Group LLC. He's a passive real estate investor since 2007. A full time fund manager since 2009, he brings over two decades of experience in navigating both bull and bear markets. With a background in mathematics, a passion for chess, and a 15 year career in technology, Mike takes a data driven, analytical approach to evaluating investment opportunities, focusing on risk management and return optimization. As a longtime member of Top Tier Real Estate Mastermind groups, a frequent speaker industry events, and the host of the Big Mike Fun podcast that I've been on, Mike is recognized for his insightful real world perspectives on alternative investing. He's also the author of how to Choose a Smart Real Estate Investment Fund. We're gonna have a lot of fun on today's podcast. Listen up. Mike, great to see you again.

Great to see you, Chris as well.

Yeah. Welcome to the show. We're gonna be talking about kind of where we are in the real estate cycle today. But Mike, you have a really interesting background. I'd love for you to share a little bit of that with the audience before we dive in today.

Sure. So I'll start this way. A lot of us have seen or have heard James Bond movie From Russia with Love. Very old one. So I actually come originally from Moldova. It was part of the former Soviet Union. So I come from Moldova with love for whatever.

I love it. I love it. The love is the most important part. But yeah, man, I used to watch while I was taking exams in college, I would watch all the James Bond. They do a James Bond marathon over the holidays. So I've seen all the James Bond movies multiple times. Some of my favorites, they got, they got okay for a while, then they came back. I think they're doing a pretty good job now. But man, you could be, you could be like one of the, one of the, the main characters. Mike with Your, your chess capabilities and your, you know, be a mastermind in there, maybe at a blackjack table or something like that. You ever gamble? You ever go play cards?

Yeah, yeah, yeah, for sure.

There you go.

It's kind of, it's, it's funny talking about that. As kids we played chess. I was a, let's call it, you know, I was a mathematician, a chess player. And the chess players at night, they play cards for many hours. So there we go. There's a game equivalent to a bridge played, just sort of an old version of it.

So. Yeah, yeah, wonderful. Have you read, you know, who Josh Waitzkin is, I'm sure, right, yes, yeah. He's written about searching for Bobby Fischer. Yep, searching for Bobby Fischer. And then, you know, Josh has written about, know, some of the things that he's learned from chess and how he's applied that and, and different things to, you know, businesses and, and how he's looked at life and learning. I think he's a jiu jitsu master as well now, if I recall.

So.

Yeah, it's fascinating. I think it's, it's a good point. It's, you know, if, if you can learn how to learn and how to apply things, then you can, you can apply those lessons, you know, throughout life. So, yeah, I'd love to, love to learn a little bit about, you know, what you've learned from chess and, you know, how you've applied that to the real estate world because you guys are involved in a lot of different things. You very dynamic on your views. Yeah. So what are, what are some of the big things, Mike, that you've taken from chess? Which is amazing. I've had both my boys playing since they were young. And what are some things that you've kind of picked up along the way?

Yeah, funny you said this. Josh is a jiu jitsu master. I'm a third degree black belt in taekwondo. And there's something about, I don't know, chess players that one day they wake up and they learn martial arts. I don't know how it works, but.

Well, what's crazy is my boys, they started playing chess at Taekwondo. They had an after school program and their, their instructor taught them how to play chess, which I thought was amazing. So, you know, you're learning, you know, chess is more like in, you know, it's a slow version. With martial arts, you have to think a little bit quicker and do that. But the process of learning, you know, I find is very similar. Have you seen the same thing?

Yeah, yeah. So we'll talk about chess. Chess is very analytical, very logical. It's a game for learning. And martial arts. Yes. You can't think and strike at the same time, like Sun Tu said. So when you do martial arts, if you go, if you're gonna go through just like thinking for 30 minutes about the next move, people gonna, you know, it ain't gonna happen. You're gonna get beaten.

You'll be laying on your back. Yeah.

But there's some, some, some different, you know, thinking physically with your body, learning moves and remembering through martial arts. But let's go to chess. So chess, the way we learn chess. And this is, I, I just know, I don't know if it's a old Soviet school system or there's something new, I'm sure with the new technology, new evolution. But the learning process, very straightforward. You learn from the great grandmasters, world champions, Very, very important. You basically analyze games of the masters, right? And you do the same in investing. You, you, you study Warren Buffett, Charlie Munger, Ray Dalio, Howard Marks and many others. Brilliant minds. Very, very important part of a learning process. So you study their games, you study their moves, you do their conclusions, and then you also study from your own mistakes, Right. Analyze your own games. The learning process has other elements. There's some stuff you learn, openings, a few other things. But in general, study of the best and two, study own moves. There's a famous book by John Maxwell called sometimes you win and sometimes you learn. And it's a great book. So it's very important in investing and in chess to be constantly learning. I literally have this question constantly on my head, and I ask myself a question, and I ask the question to the audience. Are you learning to invest or you're investing to learn? You're doing both all the time.

All the time.

Because if you're doing something else, you miss on an important element. So chess is really all about learning all the time as you're practicing and preparing for the next game. Same thing in investing. You have to analyze your decisions. You mentioned cards and people play poker. What's really fascinating, I'll add this fact creates a game of skill and there's an element of a chance. Life is much more like poker than chess because element of circumstances can change and you don't have exactly predictable outcome. You can't compute everything. You have bad run of cards, unfortunately, bad market cycle, bad timing. You can wind up with a good decision, but bad outcome. So in poker, it's all about making the right decision at every point of time. Same thing in chess. But in chess you can compute everything. In poker, you don't know what the card's going to be next.

Great analogy.

These are important lessons for investing. Preparing for possible outcomes, being diversified, being smart about each investment strategy, risks and what are the possible outcomes. Not living by predictions of a crystal ball, but by living by preparation to different outcomes. That's a better way to think about investing.

I love that. Yeah, and that's a great analogy because the real estate market, the investing markets are constantly, are constantly shifting and changing and doing that. So I think that's terrific. And I think you brought up another good point, Mike, which is an investor has to go into any investment decision and look at their hands, so to speak, and say, am I comfortable with the risk I'm going to take, knowing that the outcome might not be certain in that example. So let's talk about some of those uncertainties in the market. Donald Rumsfeld once famously said, you have your known unknowns, you have your no knowns, and then you have your unknown unknowns. And I found that in investing, it's those unknown risks that tend to get you, that tend to bite you. We've seen the interest rate market rise faster than we've ever seen in history. We had Helene hit Asheville, North Carolina, thousand year storm. No one thought that a hurricane would hit Asheville and cause the flooding that we did. We had something kind of similar. Know this hundred year storm in the interest rate market that, you know, investors, you know, our age, our, our genre have never really seen before. So what, where do you see the market today, Mike? In the real estate space? You know, let's talk about interest rates and kind of, you know, what are you seeing out there?

Yeah, great comment. Comment or quote by Donald Rumsfeld. And I have a different quote for you. I, I'll, I'll, I'll. Because it conveys the same point. Howard Marks, he talks about risk. He says risk. What is risk? Risk is basically a possibility of a loss. In short, but the most fascinating thing about risk, it's difficult to really understand or estimate before the investment and even after. This is the crazy. You can make an investment, it can produce good results or bad results. If you judge your investment decision by the results, you'll be doing pretty poorly in the long term. Sometimes you make the right decision, but a hurricane, 100 year rare storm hits and suddenly the outcome is bad, then you might have made a decision and vice versa. So that's the best way to think about this problem is you're Trying to be a decision maker within your own buy box. And I talk about buy box and don't buy box and a lot of investors don't think about it. So what is your buy box and what's your don't buy box? And every investor should really get crystal clear on their own goals.

Yes.

What is their risk tolerance? What's their time horizon, what's their liquidity needs? What's their tax efficiency or tax benefits? And there are many other factors and if you think about those things and you build it first, then you can build a buy box and everything else outside of the buy box is a no go and why it's important. Eliminating bright and shiny objects in your clarity.

That's right.

If you're looking for safety first like Benjamin Graham, you're looking to invest. An investment is an operation in which provide safety of principle and an adequate rate of return. Now you're not shooting for the stars, you're not looking for home runs, but you're looking to hit singles and doubles. And your strategy is much more defensive in nature than you look at a credit fund or you look at a low leverage conservative income deal where there's a higher predictability of income through private quality tenants or long term leases or a number of other characteristics where the volatility or variance is lower while your outcome is much more predictable. However, if you are much more comfortable with a little bit more risk and you could see bigger upside, maybe you go into ground up development. Right. It's a risk tolerance.

Yes.

I just give you one comment. I've been contacted by some really good great projects on the ground up today. And then the moment they talk about 35% IRR, 40% IRR, these numbers, we're getting phenomenal deal. I tell them that's not my cup of tea. Thank you. But save yourself, spare yourself time. So knowing what you want and what you don't want is just as important. Back to saying no a hundred times and saying yes once for that one deal that really fits.

Mike, that's such a great piece of advice and I think that can apply. That's one of the things we talk about in our coaching group is what is your buy box? And if it's not your buy box, just let it go. You don't even, you could take a look at it. Maybe you learned something from it looking at the prospectus. But you know, you want to, you want to say no as quickly as possible. You know, if you're, you know, when I was a hiring manager, I have a hundred interviews or 100 resumes, how many can I say no to and get them off my desk as quickly as possible? You know, if you're, if you're dating, you know, it's like, hey, this person isn't a good fit for me. I'm not even gonna, not even gonna spend my time and do that. You can do things. It can apply to so many different areas of life. I know. One of the reasons I wanted to have you on the show, Mike, is because you are in several different asset classes. So you have a really great perspective across different things. Share with the audience what asset classes you've invested in in the real estate space.

Yeah. Thank you, Chris. So we have a broad range of strategies. And I'll tell you what, we today and in the past we've made some adjustments. So we do like private credit, we do some private lending, we do primary debt, we do mezzanine debt. And lending typically could be on commercial deal or residential deals. Right. But we don't like ground up as I said, on either side of the, of the strategy. We do like the family today, especially when the values have corrected meaningfully off the peak. If you can buy well below reconstruction cost at a actually pretty positive spread between the cap rate on acquisition and the cost of money. No matter how difficult it is, if you can find a deal that fits that, you are in really strong position.

So pause right there. Just dive into that a little bit for the audience. So you said positive spread between cap rate and interest rate. So dive into that just a little bit.

The technical term for this is called equity spread. So equity spread is a delta between the cap rate that you're buying it at and the interest rate. You're so example, we bought a, was a large 1046 doors in Q1 of 25 multifamily. We bought it at a cap and financed it with a 7% interest rate. It's 200 basis or 2% positive spread. Right. So with that type spread, you are locked into a strong cash flow from day one. Why? Because the math works this way, right.

Even if you have. Yeah, even if you have basically no, no leverage on that, you're still going to have a 2% positive spread.

That's what definition of the cap rate means. If you have no, no debt, you're getting 9% cash on cash without any debt leverage. That's what cap rate means. Yeah, you add leverage 50%, you know, you, you get a little bit of enhancement to cash flow. You, you, you had 70% little more. So from that Perspective that's a great way to create a margin of safety and cash flow is having a strong positive equity spread cap rate to interest rate. So that's. We look at it in everything today. Other strategies we're looking at today we just closed literally open air shopping, buying a property in San Diego, downtown San Diego, literally at the seaport. Nine and a quarter cap rate open air shopping and financing it at 6.5% cap rate. So that is 2.75% positive spread. Right. It's a phenomenal strong downside protected fixed rate debt for 10 years. You're very downside protected. Yes, you have some prepayment penalty but burns off year after year. So if you hold it for five years your whole penalty burns off. If the interest rates come down, you have optionality. You can either sell in a better environment or you finance while you're downside protected through fixed interest rate. So we like open air shopping. Very contrarian play. It's been very little new supply and still really good growth. And the fear of Amazon effect and E commerce destroying that asset class completely worked the other way. There's been no new supply and E tailors had to open up physical stores. Take Warby Parker glasses. They open up 600 stores where they started as pure Internet. So we like that strategy. Very contrarian. Why? We like it because the cap rates are high. You can get those spreads industrial. So we love triple net industrial, absolute triple net where you can buy 8 to 9% cap rate and purchase finance with debt, let's call it six, six and a quarter. You can get 200 basis points spread. You could have 20, 25 year lease with a great long term tenant. And you have rent as close as 2 to 3% a year. And you basically have no property management issues of any kind. Everything is on a tenant. Insurance goes up, taxes go up, roof goes. They have to fix the parking lot. Anything defense, they're responsible. So it's just an example of a strategy we like and we do some other niche place but I'm going to stop minute at least turn it back to you.

No, it's fantastic. And yeah, I think you know San Diego market. I'm. I'm quite familiar with. I spent a lot of time out there with the company I used to work with.

So I'll give you the name. It's called Headquarters at Seaport.

Okay, I know where Seaport is. I've stayed there multiple times at the Marriott right there. So yeah, I know.

So this, this Marriott, this Hyatt, there's two towers of Hyatt next to the convention center. Right. And it's literally, literally across the street from Hyatt. It's an, it's a historic building. The building looks like old Spanish style with a big beautiful open courtyard and you have a seaport village that goes.

Around, that's beautifully spread.

And then the headquarters of Seaport is that older historic building structure with the courtyard. So that's a beautiful, I've done a.

5K there on the waterfront.

Yeah, I know where the, the biggest problem is this. You're going to appreciate this joke. So I'm at a property meeting up with a partner who's driving from la and there's a traffic. California.

Yeah.

Oh yeah, he's, he's running late and he says, Mike, I'm so sorry, I'm running late and I'm, I'm so sorry about the weather. What are you talking about? You got a weather here? It's 70 degrees. I'll hang out, just enjoy the weather.

Yeah. Yes. And you. 70, 75, 72. Now it's, it's, it's phenomenal. Yeah. So I like how your dynamic, you guys are constantly evaluating where the market is in different spaces with respect to that. Let's talk about Fed policy as we're recording this. There's some controversy right now with President Trump firing one of the Fed governors and that's going through. So there's been Fed raised rates a lot to counteract some of the money printing that was done over the past several years. Now let's, let's look at the crystal ball. I know we talked, we joked about the crystal ball being smashed on the floor, but if you had a crystal ball, Mike, where do you see the interest rate environment today? Where do you see rates going in relation to the economy?

Sure. So, yeah, crystal ball broke. Can find another one for sale. You know the drill. Speculative in nature. It feels to me, again, this is all touchy feely, that even though the tariffs are still taking time to sink into the system and it feels like we may have a little bit of volatility, it'll settle down one way or the other. In general, tariffs expected to have one time impact on inflation, although importers might need time to sink in their price increases, but it's a one time exercise on a long term basis. So inflation in general is in my view is expected to be cooling gradually over time. Also AI boom. What is AI Massive technology revolution, productivity gains. Productivity is deflationary in nature, in general. So I expect a number of forces in the economy to Be anti inflationary in nature and that should, should take overall inflation down to a lower level and that will be significant reason for the Fed to cut and for the long term interest rates to come down too. This is my theory. I may be completely wrong. You still have the issue of the deficit, right? The deficit as a percentage of GDP, 6, 7% it's too high. However, tariffs are bringing new revenue. We may see significant acceleration in productivity and growth driven by AI, we don't know. That's unknown. But in general, maybe some GDP growth, maybe lower inflation, maybe combination of those things, tariffs, overall trade, the trade deficit and the budget deficit may come down. So my view on inflation cooling, overall economy, consumer is stretched, I don't know how else to put it. Number of people have talked about it. 60% of the consumers are stretched. There's probably top 10% doing really well. The other 30% are doing okay. And overall recent news from Walmart, recent news from McDonald's, they are talking about giving consumers more discounts to make sure people can actually buy.

Yeah.

So the inflation and the long duration rates, they're supposed to be joined at the hip 10 year treasury yield is supposed to be a reflection of overall long term inflation.

So if I, which is why Trump says, hey, the rate should be lower. Effectively, yes.

So now we're going to go back the President of the United States versus the Fed chair who is more powerful.

Yeah, this is fun.

Yeah. President Trump is obviously a very strong armed president. And I mean this, you know, some people think it's great, some people think it's not great. I think in some ways it is. You know, he's a decisive president, he's pushing things forward. So he's accomplished a lot of things. Not everything is perfect, but at least he's doing a lot of things. So in general, monetary policy is independent from the, from the government, from the politics. However, however, Jay Powell's term is coming to an end and he's been a hawk for too long. It's pretty clear that he's going to start cutting how much and how fast. He'll probably go slower than the Trump would like, but give it next 12.

Trump wants zero, right?

Yeah. I mean we're talking about. Yes. Depending on the point of view, they could cut rates by you know, 150, 200 basis points kind of. It wouldn't surprise me over the next 18 months. So we might start a little slower, might go a little faster, but short term rates are going only way down. There's no other way. Plus if unemployment picks up we may see some 50 basis points cuts, not just quarters. So it's not going to be the way they raised that some 75 because they had to quickly get to a higher level to fight inflation. On the cutting front, it's almost like this years ago, I watched it, they used to cut fast and race slow. They did exactly the opposite this time and I would expect they're going to cut gradually, look in the rearview mirror, continue probably with the process. If consumer breaks a little bit harder, they probably going to step into the emergency room medicine. I have a good friend who actually knows Jay Powell and she's been on tv. She's very vocal, she's a commentator. And you know what she said? She said this. Jay Powell is not preventive medicine. He's an emergency room medicine. So he's not trying to. Yeah. If the data starts looking like he's asleep, he's going to wake up and cut a little faster. That's my view. But one way or the other he's going to cut and then the next Fed chair probably going to cut more because Trump will put whoever is going to put a very dovish chair next.

Yeah, and that's some of the things that Trump has said. He wants to see real estate, the real estate markets loosen up. He also we've got a lot of short term government debt on the books that needs to be turned over. That paper needs to be turned and it's very expensive for the government. We're about a trillion dollars a year in interest at this point.

Right, exactly. Ray Dalio. Right. We talked about this quite a bit. Ray Dalio has talked about multiple ways to get the budget under control. Some of it is increased taxes, some of it is cut spending. And the third one, the biggest by far is to get interest rates down. If you get interest rates lower, the impact is much more profound on overall deficit. So yes, real estate is suffocating and badly needs rates. Some of the technology, not the Magnificent Seven, some of the startups and technology companies that very much depend on level of interest rates are suffering. Private equity systems suffering there too. And Trump is a real estate guy. So we're talking about huge need for the interest rates to come down from political point of view as well as from the U.S. overall monetary, well, fiscal policy. Right. We need the lower level of interest rates to roll debt, corporate debt, it would be, what's the word for it? It's much overdue, really needed and I think it'll be significant tailwind for real estate. That's the bottom line.

Yeah, I think I was going to ask you that. How do you think that affects the real estate market? Because we have, you know, 100% depreciation coming back, which is, is a benefit for investors that want to, want to come in and they can basically depreciate sometimes nearly the entire cost of the property on the front end, which can help offset, you know, income or gains from other properties. And then if interest rates come down, do you think we're going to see cap rates start to. I know we've seen slight cap rate compression here over the past quarter. Mike, you think that'll follow interest rates as well? What's your take on that?

Yeah, I think that the previous action is that if the Trump office is just forward expectation. Right, Forward expectation. First 100 days in office, expecting him a good pro business, pro real estate president, and then now the one big beautiful bill passed and 100% bonus has been made permanent. It's basically confirmation of what expected. So I definitely think that that passing increases tax benefits for the new investments. Two and a half X. Right. 40% bonus on the expiring schedule now going back to 100 and becoming permanent. It's a very significant tailwind too. Interest rates themselves, Right. If we see a little bit more cuts, maybe 10 year adjusts, mortgage rates come down, we're going to see a lot of help. Just psychological directional move may be enough to stimulate demand and the recovery itself. Going through cycles in the past, look at 2008 cycle, we had a fast crash and a slow recovery. So we had essentially a fast crash. If you think about this, higher for longer fast and furious hikes. We saw a relatively fast crash and the recovery might take a while to materialize. However directionally we are at a point where on many KPIs or metrics, commercial real estate is very attractive. From all the benefits tax, you can get cash again if you buy, right? I'm not talking about paying 5 cap and financing at 575 cap and self storage and then hoping the rate's gonna go up. I'm talking about buying deep from a motivated seller situations and then writing it forward.

Absolutely.

So to me it feels like great time to diversify out of max 7. Maybe some crypto, maybe some other appreciated assets where people have done remarkably well and they should take some chips off a table and then put them into what's undervalued. Back to Warren Buffett and think about this chess learning, learning from Warren Buffett. One of his most fundamental wisdoms is be greedy when others are fearful. And be fearful when others are greedy. Greed is high in max 7 stock market, bitcoin, crypto and I have no idea where those things go. AI revolution can keep pushing them further. Bitcoin may go to the moon. Right. I have nothing negative to say other than the risks have increased based simply on the fact that the prices are higher and they are no longer looking or looking a lot less at the actual income projections, especially in investments. It's all about the race US versus China. So valuations approaching stratosphere risks are increasing. It's only prudent to consider diversification. We're dealing in commercial real estate. The deals we're looking at, you know there are no guarantees in life. Right. But the probabilistically based on likely or possible outcomes the risk reward profile has created what is known as asymmetric risk adjusted return profile in some of these deals. That's the wisdom.

Absolutely. And you brought up a Great point. Diversifying 2022 investors were not seeing great returns in the stock market and the bond market. They piled into real estate. Today people are staying in the stock market but we're valuations at, at or near all time highs with projected future returns over the next five, eight, ten years of, of zero or potentially even negative based on price to earnings and those sorts of things. So I agree. It's a great time to rebalance your portfolio and look at things. Mike, if investors, if our listeners want to learn more about what you and your company does with your Tempo family of funds and syndications, what's the best way for them to get in touch with you?

We're going to get really cheesy now. People call me Big Mike. Look my background. Big Mike Fund podcast right around the podcast with the chief and I've been on it. Yeah, yeah, you were great guests. I'm grateful for you to, to come on that podcast. So it's very simple. Big Mike fund.com right. It's easy to remember and if you miss it, if you just go and you forget the D at the end. Big Mike fun dot com. I promise it's not a kinky site.

That's it's not. But I'll tell you when we hang out it is. It is big fun with, with Mike to be. Yeah, Mike, you're a lot of fun. You've been a lot of fun to have as a guest and yeah love having you know this, this conversation. Talk about what you're seeing with your chest brain and my engineering brain. Try to figure out what the markets are going to do and Maybe we get together, we can piece together our crystal balls and try to glue them back together. But until that time, thank you so much for being on the next Low Income show.

Thank you, Chris.

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 nextlevelincome.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.