EP 14: Neal Bawa: When Tech meets Real Estate, with The Mad Scientist of Multifamily Part 2

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I'm your host, Madhvi Jain. And now we will continue our discussion with the mad scientist of multifamily. So Neil, we were continuing our discussion and we talked about actually how recession is helpful for the real estate investors. Let's talk about the SVB failure. What is your opinion about the SVB failure and how does it impact the real estate industry, especially the commercial real estate and multifamily? The media is really freaking out the investors. There is so much narrative against the real estate industry. What do you think about this?

Sure, be freaked out, you know, I mean, the media's job is to freak you out. They're doing that really, really well. I'm just sitting and watching to see what's happening. And with what happened with the bank failures, why would that be bad news for multifamily? I think that the multifamily family industry caught a break when Silicon Valley bank failed. Why? Because we were looking at interest rates or the Fed funds rate, which is right now at 5% going up all the way to 6.25. That's a lot. That would have hurt us a lot. Right? Because our interest rates would have increased. So there would have been potentially some contagion, some distress in the multifamily industry. But today, because of the failure of svb, the Fed is clearly backing off and saying, you know, we might raise interest rates a little bit, but we're not gonna raise them like crazy. We see what happens when we raise interest rates like crazy. So they might go up, I'm thinking in May they go up another quarter point and then they sort of hold, but they don't hold for as long. They start to drop a little bit earlier, earlier than they planned. So there's benefits there because that helps the multifamily industry to Stabilize. So once again it's, that's one of those things where it's good and bad. If you're buying now, your window of opportunity is going to shrink because if rates start to drop, then prices will go back up. So that's bad. But if, but if you're buying, you know, you're not overly worried about there being some future contagion or crash in multifamily prices because it clearly looks like we're either at a plateau or close to a plateau for interest rates.

Right. I love that perspective, Neil. And actually I'm just mind blown how you have kind of put that SVB scenario in terms of multifamily. Never had thought about it. That actually for Feds is kind of a red flag that, okay, they need to slow down a little bit. And I always say that perspective is everything. So thank you so much for bringing in that completely different perspective and going back to what you said. Right. It's really important to understand, I think the cycles that you have explained. In different cycles you can have different strategies and make money in different ways. It's just you should know where to look for these opportunities. Right. So I think that's really important. So thanks for highlighting that. Having said that, let's talk a little bit about multifamily. I mean people often ask me that, is multifamily still a good asset class investing in it? Right. And you know, I believe in the fundamentals of multifamily really strongly, essentially from the supply and demand perspective. Give us your perspective on it that do you think that multifamily is a still, you know, good investment for a.

Five year time frame? Yes. Is it a good investment for a 18 month speculative sort of investment of the sort that people did in 2021 or 2022? No. I think that that speculation phase has ended. So if you're the sort of investor that believes that five years is a good time frame, then it makes a lot of sense because here's what our data shows us, right. We know there's a recession coming. Well, recessions are not particularly good for rent growth. You might have, you know, 1% rent growth. In a 6% inflation environment, that's not good. You might have 0% rent growth, you might have negative one, negative 2% rent growth for the next six to nine months. So for the six to nine, nine month perspective is probably not good for multifamily. Now, once we end that recession, let's say next year, we should also get some tailwinds because as a recession starts to end, the Fed starts to cut interest rates. Remember, they put us into this recession. They're forcing a recession. The US Economy is not going into a recession. It doesn't want to go into recession. It's fighting the Fed. The Fed's putting us into a recession because they need to cool inflation down, right? So the goal is to use the recession as a tool to cool down inflation. So at the end of the, by the end of that recession, you achieve that goal. Now you can start lowering interest rates. So as, as the rates get cut. Every time the rates get cut, that's a tailwind for multifamily prices. So you slowly start to see them stabilize. You slowly start to see them increase, right? But just as that happens, we have this, this issue. We have a very large amount of supply, 700,000 units of class A product coming into the marketplace. And they come into the marketplace in the second half of this year and the first half of next year. And so as they do, they're going to depress rents for a short amount of time. I would say they're probably going to depress rents in the first half of next year, maybe, maybe even until the, the second half of next year. Now, 2025 is when we really start to benefit because what's happening is right now in 2023, construction activity in the US for single family homes and multifamily has declined dramatically. Dramatically. So, you know, new construction activity for apartments probably down 30%, and that 30 percentile is increasing. I think it'll go up to 50. Single families already been more than 30% down for the last six months because they felt the pinch very early. And so what we're doing is we're creating a hole in supply. The United States is a growing country. Our population is slowing, but we are a growing country and we need a certain number of multifamily units in a certain number of single family units every year. And we're currently constructing the right number of single family, right number of multifamily. So we're keeping, you know, in growth with our needs. There's, there's a hole that we had created in the, in, you know, in the 2008 recession that we haven't filled up. So there's still that right supply gap, that supply, demand gap, but we are certainly not making it worse until this year. So in 2023, it's very clear that we're not building a lot of new construction, multifamily, new construction, single family. Now you might say, is that going to benefit us this year? No, because it takes a while to build them. Will it benefit us next year? No, because there's still new supply coming in. But by 2025, we should start to see this lack of new construction in 2023 this year start to affect supply in 2025. So now you are in an environment where you have low interest rates and you have insufficient new supply coming in. And we should start to see some pretty significant rent growth. I wouldn't be surprised. 6, 7, 8% rent growth occurs in 2025. Something like that could occur in 2026. Hard to tell. But I think from a timing perspective, those are good times for us to increase rents. Those are good times for us to sell our properties. Maybe we get lucky and we sell them in 2025 and 2026. Maybe we wait until 2027 so we can get the benefit of two years of rent growth and sell our properties. So it's key to understand this. If we create a supply hole and the US basically needs about 800,000 new construction single family homes, about 400,000 new construction multifamily, that's 1 million, 2 units. Right now it seems like we're going to have a 500,000 unit shortage. That 500,000 unit shortage in 2005 can easily drive rents up 6 or 7%. And while 6 or 7 doesn't seem like a sexy number, please understand that in our world we only need about 15% rent growth total over 5 years to achieve our goals. Right. Most indicators are looking to get about 15% of rent growth. Now we also get rent growth from something called rehabbing. That's separate, that's a natural process. We get that. But from generic rent growth we're looking for 15. And if you get two years, one at six, one at eight, we hit it right? So that, and that allows us not to create extraordinary returns of the sort that we've been creating the last two years. I'm sure you're aware that crazy market had a lot to do with that. But 15%, 16% returns in a world where the stock market's down 20% and typically only produces about 6% over a five year annualized timeframe for us to produce 15 or 16. I'm very proud of it. Can I do more? No, I'm sorry. Find somebody else. But I'm pretty proud of my 15 or 16.

I always say to people that, you know, don't look at the shiny numbers, you know, see, look at what, you know, risk managed way, what kind of returns that we're going to produce. Right. And you talked about few important points here. That that supply and demand, that imbalance that it has created, that the hole that it has created. Now staying somewhere, having a place to stay is a need that we always talk about. It's not a want, it's not a choice. Right. Everybody needs a place to. So I think that was a great kind of a bird's eye view of what this supply demand dynamics are going to do. What in short term we should be cautious about. And in long run it actually is creating a much healthier cycle when it comes to multifamily. So thank you so much for that perspective. Now going a step beyond that in terms of real estate, if multifamily is kind of suffering a little bit. And I'm very cautious about multifamily too. I'm kind of waiting on the sideline for multifamily unless I see be really extremely good thing that we can go into. But if not multifamily, what other diversification that the passive investors can look into? And I know you talk about a lot of asset classes. You are also, you know, syndicated in different asset classes. So what are you bullish on when it comes to real estate? Other asset classes than multifamily?

Right now I'm bullish on industrial as long as it's being purchased at a high cap rate. So the property that I mentioned earlier on I'm investing in small project is with somebody who knows what they're doing. They've done this before. I've invested in industrial with them several times. They clearly understand the asset class really well and basically they're buying it in 8 cap. So I think the cap rate matters a great deal. 7 cap, 8 cap. If you're able to buy industrial at that cap rate, great. I like industrial, nothing wrong with it. I think we're going to continue to have needs for industrial assets. So that's an opportunity. You know, I'm not offering any industrial projects. I'm simply a passive investor like you, just sharing my thoughts. I do offer built to rent projects. So what has happened is, you know, until about 20 years ago, our homeownership rate in the US was very high. I mean it much higher than Europe, much higher than most parts of the, of the developed world. Almost close to 66, 67% of Americans were somehow homeowners or lived inside a home that's owned by their families. And that balance started to break as we started to run out of cheap real estate. Right. So you know, we started to run out of Cheap real estate construction costs went up, that, that balance started to break. And then Covid happened and post Covid construction costs went up by a shocking amount. We didn't build a lot of homes or didn't build enough. But most important what happened is now that interest rates have gone up, the gap between a average monthly mortgage payment and the average rent is the highest in history. And this has been recorded in April 2023. So in April 2023 it's a little less than highest in history. It was the highest in history a couple months ago. Right. So that gap has increased a lot. Why? Because imagine the difference what happens to your mortgage payment when you jump from an interest rate of 3% to an interest rate of 6 and a half percent. So the mortgage payment jumped like crazy. Rents have gone up like crazy too, but they've gone up about 15%. The mortgage payment's gone up about 50%. Right. So when you see these kinds of insane gap increases, what happens is that you're leaving behind well paid people. So there's a lot of people in America that make as a family might make 120,000 or individuals that make 70 or 80,000 and they believed in the American dream of owning their own home. Well, that dream is gone. I don't see the single family market has responded so well to these interest rate hikes that we've only seen a 5% price decline US wide. Obviously that dream is not getting any closer. Right. So even with six and a half percent interest rates, even with seven percent interest rates, if the single family market's only going to go down 5%, well obviously there's going to be a big gap there. So now you have these mid market Americans that normally are not renters that have no choice but to rent simply because the mortgage payment is unaffordable. That segment I believe is somewhere around 10 million families. And so, you know, somewhere around 10 million families that you know, would have normally owned their own properties. Those people don't want to live in apartments. They don't even want to live in class A fancy apartments. They actually want to live in a home. And so my goal is to build townhomes. I started off by the way with single family and realized that that was, I was not meeting the requirements of those people. While they want a single family home with a backyard and two car garage, they can't afford that. So I backed off and I reengineered and said I need to understand how much money these people make. Right. And then I came to the conclusion that the single family dream, even as a renter is lost, the dollars make no sense. But the townhome dream isn't lost. So in a townhome, you live in a three bed, two and a half bath home. You have a small backyard, you have a small front yard, and you often have a one car garage. There's a few townhomes that I build that have two car garages, but mostly it's a one car garage. And then you've got, you know, the area in front of the house where you can park a second car. And plus you also have a parking spot somewhere else in the property. And to me, I think I realized that townhome was that solution. And so while I continue to build apartments and enjoy building them and I continue to buy apartments, I think that the mid market solution is inexpensive townhomes. My townhomes are not fancy. I'm not trying to make them sexy with 10 foot ceilings and massive windows. No, I offer just three things that an apartment doesn't have. A backyard, a garage, and no neighbors above and below you. That's it. And I do not want to offer anything more than those three. So I, you know, I believe built to rent is the most disruptive asset class in America. As long as we don't overbuild them, as long as we're not trying to make them into fancy condos. And I'm trying to stay very, very hard away from that. I don't, I'm not building in fancy cities. I'm building in secondary markets with people who are like, yeah, I can commute 20, 30, 40 minutes and I still want to live in that home. I still want to have a dog that can pee in the backyard. And that's very close to my heart. So in the middle of building apartments and buying apartments built to rent is something that I continue to do.

To me it looks like a scaled down version of that American dream. So if you cannot have that big single family house, you kind of still have that scaled down version and still live in it and enjoy with your family and your pets if, you know, if you want to continue doing that.

That's my belief.

Yeah, absolutely. I love that. And when it comes to, you know, your kind of the location, location, location that we always say, right. In real estate, it's really important. I typically have questions from investors that, oh, do you, I stay in Austin, right. Do you have something in and around Austin that we can invest in? And I always try to tell them that, you know, it's not really the city around you that you should be investing in, but you should be looking at different parameter and, you know, when it comes to the algorithms that you built and the data that you have, you know, the supporting the location logic that you have, I. I would. I should say location magic that you have. Can you highlight a little bit on that, that, you know, what are the different factors? You know, in just a kind of a quick recap, what are the different factors when it comes to location that you look into that passive investors should also look into?

Sure. So the typical location factors, and by the way, Austin does really well on those factors, are things like population growth, job growth, income growth, home price growth, and crime reduction. Right. So those five, as you can imagine, Austin would do really well on all five of those, with one exception. Right now, its home prices are falling. So, you know, Austin and Phoenix are the two in the United States that have seen the most home price declines. Right. So they. They went up the most. So they. They were the two cities that increased the most. And then they've gone down 10% or 11% from peak whenever. I think peak was. Was June 2022. So I think both cities do really, really well on those. But beyond those, I look for cash flow. I'm looking at, where can I give my investors cash flow? Where can. Where can I have reasonable cap rates? So I love Austin. I'm building a project at South Park Meadows. I am building a project east of Austin. I also purchased a multifamily that's doing really well north of Austin in a city called Killeen because of the Austin effect. But I can tell you today, I'm not interested, by the way, in buying anything in Austin. I'm not interested in building anything in Austin. I think it's. I tell people Austin is the greatest city in America that I don't want to invest in.

Right.

And they're like, why? It's such an amazing city.com, all this capital coming in, all these people coming in. Short answer is math. I'm only interested in math. So it's clear that there are better options for investment that give us higher cash flow at lower risk than Austin. Today, Austin has become. Austin has become a Californian city in Texas. And I see that as being very problematic. I think it's a great place to live in. My son wants to live there. And I'm like, yep, this is an amazing place to live in. Go, go there. So he did his internship this summer or last summer in Austin. Loved it. He was. He worked for Dell, so it's a great place to invest in. And I think that in the long run, if you had a 10 year time horizon, you'd probably want to invest in Austin more than any other place. Bottom line, though, is the math tells you that often the greatest cities in America are not the best places to invest in simply because what you're doing is you're paying for their greatness. I would like to pay for things like rent. I would like to pay for things like property value. Right. I would not want to pay for greatness. So to me, as great a city as Austin is, the mathematics, the numbers don't show it to be a good place to invest in. Right now. Everything's a cycle. I'm sure I'm going to change that answer in 12 to 18 months.

Right? Right. So if not, you know, of course we talked about Austin. So what are the cities that are on your kind of a radar for 2023?

The cities with distress. So the CBRE publishes a report that I consume almost like it's a dessert. It's like my tiramisu. And it's a cap rate report. It just came out so that the data is all fresh in my mind right now. It makes sense to buy in Phoenix right now. It makes sense to buy in Atlanta. Why? Because Phoenix was a 3 cap market that today is a 5.75 cap market. In other words, you can get a 25 to 30% discount in Phoenix right now. And yes, Phoenix has lost some rents. They're down about 7%. But don't forget, Phoenix had the highest rent increases in 2021 of any city in America, large or small. It was crushing it. Rents are up 25, 30%. So they were adjusted. And that's good. Remember, rents are also bubbles. If rents get too high too fast, it creates problems. So we are seeing the Phoenix market adjust not just because of interest rates, but also because its rents were too high. And that adjustments happen. And you're like, yeah, that sounds pretty bad for the seller. I'm a buyer, right. It's bad for them. They're selling a lot cheaper. So to me, when I look at a high quality market that's high growth like Phoenix, that checks off all of the location magic numbers. And I can get a 25% discount from 18 months ago. I'm pretty happy with that. And I'm pretty sure that Phoenix won't have any rent growth for this year. My investors will know that you can't do the Warren Buffett thing if everything's going great, if everything's going great. Where's the discount?

Right, Right. Thank you so much for sharing.

Atlanta's in a similar place, but not as bad. Right. So you might get a 17 or 18 discount with Atlanta. It still has rent growth. So Atlanta's, you know, rents are not declining. So you don't get as much of a discount as Phoenix. But you know, you're in a slightly better position. You'll get a bit more cash flow than you would in Phoenix. So I'd like to buy in both and maybe the investors that are more sensitive to cash flow can go into my Atlanta properties and the ones that are less sensitive can go into the Phoenix properties. So I like those two. I don't like Miami at this point of time because it's still extremely expensive. Low cap rates. California I still think has very low cap rates. So there's a few markets that are doing well. I think that some of the mid markets are also very interesting. Usually I don't invest in them. Oklahoma City, I think is terrific. Tulsa is a place to look at. Indianapolis. Those three would be my count. They don't do phenomenally well from a location magic perspective. You know, job growth, population growth, home price growth. But those cities are doing well because they are simply inexpensive compared to all of the other cities that we just talked about.

Interesting. Yeah, thank you so much for that perspective. I think Atlanta and Phoenix is the market that even I'm watching. So it's kind of good to know that you are looking at those markets too. So with that, I mean, this was a great conversation. It's kind of coming to an end to our next segment. And in my next segment, I like to ask my guest that, you know, how do you, how do you. Neel Baba thinks outside the stocks?

I think what I do is I address my fears like everyone else. I have these fears, oh my God, interest rates are going up. Oh my God, a recession is coming. And I write down those fears. I say, these are my fears. So I use Apple notes, I write them down and say, these are my top three fears. Then I go and spend an hour researching every fear. And then I write a paragraph and that paragraph says, this is why I agree with this fear or this is why I disagree with this fear. By the time I'm done writing that fear, I feel liberated. I feel like my mind is now back to logic. My fear is either gone or it's been pushed back to where it should be so that logic can take over. It's a very useful exercise.

Right? Wow, there's like A method to the madness. Right. I love that. And when it comes to your portfolio, if we are to look at, you know, what percentage that you see that you know it's in the stock market, is there in stock market and what are the other asset classes? I could see that, you know, BTR and the multifamily syndication is maybe a majority of portfolio. So where would we see Neil's portfolio in terms of like just the distribution of different asset classes? And what are those, you know, some fun asset classes that you know, people don't even know or didn't even think about that you have invested in Right.

Now I'd invest in oil, I'd invest in shale because I think energy prices are going to skyrocket in the, in the coming five years. I want to invest in food, so I want to do food syndications that involve farms. I want to do, you know, oil syndications. Multifamily is fairly evergreen and obviously is discounted at this point. So it's in my list. The one asset class that I have absolutely zero interest in is office. I think office is in a 10 year debacle. So I would not touch office with a 20 foot pole.

Thank you so much for sharing that. So the last round that we have is our rapid fire round where we just ask some fun questions and quick 60 second answer to it. So are you ready for the rapid fire round?

Ready?

Yeah, absolutely. So tell us one fun fact about you in terms of your hobby and what do you think do when you're not doing not being the mad scientist of multifamily.

I grow tomatoes and I'm obsessed with getting the highest possible yield using data science. So I've tried everything from LED lights to trying different colors of sunlight, to trying different soil mixes, to trying different heights, to trying pruning. I like to document all of those to try and hack my way to the greatest tomato harvest of all the of time.

That's incredible. Thank you for sharing that. What is that one advice that you have received that has completely changed your life?

It's the miracle morning. So the, the book that basically, you know, allows me to spend 60 minutes in the morning structuring. My day has really been life changing. Even though it's not my favorite book, but I read my favorite book through the miracle morning.

I think both are, both them of us are big believers of that. I remember that. And what is that one quick advice that you will give to passive investors?

There is no such thing as a passive investor. It's a silly name. You're active. Your active job is to find the right syndicators. Ignore the the simply ignore the the the terms or the returns that they're offering. It doesn't really mean anything. I don't know what the returns are going to be be for any of my properties. We make assumptions invest based on their thought process. You're an active investor and your job is to find the right people to invest with.

Thank you so much for sharing that eye opening. Thank you so much again, Neil, and it was such a great conversation. I'm so grateful to have you here today and thank you so much for your time again.

Thanks for having me, Madhavi. Have a good one.

You too. Thank you so much.

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