From Neal Bawa’s perspective, multi-family is the “Right Now” investment opportunity. It all comes down to a more rational approach to underwriting and avoiding the tendency to chase trends or try to time the market.

Neal is known in real estate circles as The Mad Scientist of Multi-Family. In this episode he contrasts investors with speculators, saying many believe they are the former, but are actually the latter. 

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Why cap rates and net operating income are crucial metrics in real estate investment
The relationship between cap rates, NOI, and property value and how cap rates can indicate a buyer’s or seller’s market
Why underwriting is so important
Why speculation is counterproductive in periods of market moderation or downturns

Besides being one of the most in-demand speakers in commercial real estate, Neal is a data guru, a process freak, and an outsourcing expert.

Neal treats his $1+ billion-dollar multifamily portfolio as an ongoing experiment in efficiency and optimization. The Mad Scientist lives by two mantras. His first mantra is that: We can only manage what we can measure. His second mantra is that: Data beats gut feel by a million miles. These mantras and a dozen other disruptive beliefs drive profit for his 900+ investors.

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Full Transcript

Neal Bawa (00:00):

So many of these properties that cannot be sold today will be sold probably at break even or maybe small losses, but let’s assume the worst case scenario, 3000 of them get sold in distress. That’s 3% of the multifamily market, a total of 90 billion. Compare that to 8,000 billion in 2009. And you have the answer to your question. This isn’t 2009. It can’t be. There’s not enough money involved.

Greg Lyons (00:34):

Welcome to the Passive Income Brothers podcast.

Tim Lyons (00:36):

Here we take the fear out of real estate investing using real life stories of everyday successful investors. Let’s go. Welcome to another episode of the Passive Income Brothers podcast. My name is Tim Lyons, and today I’m joined by two absolute rock stars, one of which be, and my brother Greg. Hey doing today, buddy?

Greg Lyons (00:54):

Tim, I’m doing fantastic. It is a hot summer, but we have a fire guest today. I mean, I can’t wait for the guests. We have going to drop some knowledge on us. We have a real superstar in the multifamily world, and I’m fired up to have Neal on.

Tim Lyons (01:12):

Yeah, so Neal is a person that I have, we have been listening to for a while, and I dropped the terrible joke about being a first time caller and long time listener to Neal. But listen, when we talk about this stuff about passive investing, about real estate, it’s really no joke, right? And what you really want to do is surround yourself with high performers and who make good decisions based upon that data, right? Because the worst thing we can do as investors is go with our gut feeling. I don’t know anybody who’s really done well judging by their investment history. So today we have Neal Bawa, who is a technologist who is universally known in the real estate circles as the med scientist of multifamily besides being one of the most in-demand speakers in commercial real estate. Neal is a data guru, a process freak, which I love, and an outsourcing expert. He treats his 1 billion multifamily portfolio as an ongoing experiment in efficiency and optimization. He lives by two mantras. The first one is we can only manage what we can measure, and the second is data beats gut feel by a million miles. Neal, I love that. So welcome to the show, Neal.

Neal Bawa (02:20):

Well thanks for having me on the show. It’s exciting to be on. It’s also thrilling to know that we connected with each other virutally through this amazing podcast medium. I’m just thrilled to be here.

Tim Lyons (02:34):

So I remember one of the first podcasts I heard you on and someone asked you, Neal, how come you don’t have your own podcast? You said, oh God, I would never do that. Why would I want to spend that money and that time? And he goes, I could just go on everybody else’s podcast. And I was like, man, this guy’s awesome. But anyway, that’s one of the first podcasts I listened to. Neal, listen, we’re recording this in mid-August in 2023. There’s been a lot going on in the macro picture. We’ve had a historic rise in interest rates, and some people say it’s unprecedented, but it’s not right? This is not the highest interest rates have ever been, but it’s been one of the fastest run-ups in history. And that in itself can cause a lot of distress in multifamily, in real estate investing in general. And I think that’s probably one of the main things on investors’ minds. They don’t want to catch a falling knife. Interest rates are going up. Are we going to have a recession? There’s a lot to talk about here today, so I’m glad you were able to join us.

Neal Bawa (03:36):

Yeah, let’s start with that falling knife. So all opportunity is created by knives that fall. There’s actually very, very little opportunity that is created at a point where there’s no distress, no evidence of distress, and no future chance of distress. I’m not saying you can’t money make money then, but if you look at the averages of people that have made money, it’s extremely likely that they made it during some form of downturn. Knives were falling. And what I find consistently is that every investor goes to every cocktail party and tells every other investor buy low, sell high, or they say, Warren Buffet says, be greedy when others are fearful. Be fearful when others are greedy. You hear this a lot and everyone says that this is what they plan to do. And it is my premise, Tim, that 99% of the people that say this actually never do it.


They don’t do it because they freeze. That’s because very, very few investors are actually investors. In my mind, high 90 percentile of investors are actually speculators. They like to follow trends. They like to follow in things that their friends have been successful at or somebody in their family has been successful at. They like the fact that something is booming. Even though when things are booming or out of control booming, that should be a red flag. But a lot of them are actually, if you look at the amount of money that people invest, you’ll notice that an overwhelming majority of it is invested. When the things are booming or going completely ballistic or crazy, that’s when the massive amount of money is invested. And then what happens is because they’ve invested in this ultra booming time and they follow everyone else in, well, things fall and when they fall, the lesson that those investors take away ironically, is not that you shouldn’t be investing in a boom or in the middle of a boom.


Ironically, the lesson is that what is happening now that fall is bad? Well, actually that fall is the correction. It’s good. Correction is what happens to moderate things. Correction is what happens to moderate people’s psyche. Their thought process of nothing will ever go wrong and things will continue to move forward. So the only part of a correction that’s bad is that people who invested at the top lost money. Now what’s interesting is that people who are thinking this actually should be thinking the reverse of what they’re thinking. They’re thinking, well, I invested at the top and so I lost money and now I’m going to make it up because I know that things are cheaper. I know things are 20, 30, feel 40, 50, 60% cheaper. I know that everyone that’s underwriting today is being much more careful. Everyone’s being less frivolous in their design.


So today I like this market. I like this normalized market. I like this market where everyone’s a little cautious and no one’s saying we’re going to make huge amounts of mountains of cash. No one’s saying that, right? I like this market and I’m going to use it to recover the money that I lost. How many people do I hear say that Almost none, right? And that’s what’s happening in today’s marketplace. We have an incredible opportunity because of the extraordinary runup of interest rates, but also the fact that the market was extraordinarily bullish before those rates went up. And now we have moderation. Now we have a market that looks closer to normal, and of course there’s distress. There’s that. Multifamily prices, for example, are down 22% office prices. And this, I’m actually, I’m going to quote a source, Tim, because I hate giving numbers out, not saying where they’re from.


Credit IQ did an analysis of 190 properties in the United States in about two weeks ago, and these were large properties. So these numbers are for larger properties, not smaller ones. You can just knock us like five or 10% off of each of these numbers. For smaller properties, they tend to be less distressed, but multifamily prices have gone down by 22%, industrial by 21, retail by 57%, office by 47%, and mixed use by 41%. Ironically, storage hasn’t gone down at all though it’s predicted to drop. So this is what’s happened because of interest rates being extremely high and also because of the market moderating. That’s like people like me and Tim and Greg saying, Hey, we need to be more careful. And so we are being more careful with our underwriting. We’re less willing to offer higher amounts, and so today we’re mentally in a better place. And as a result of that, you’re seeing price declines. If investors were truly investors and not speculators, three times as much money would be in the market today as there was 18 months ago. The reality is it’s the other way around. There was three times as much money in the market 18 months ago because nothing was going wrong. And that’s the big lesson of investing versus speculating that people don’t seem to learn.

Greg Lyons (08:34):

Neal, that’s a great explanation of what’s going on, and I think when you get your mind out of the headlines and do a little bit of a deeper dive, the investors can really learn something. Because I think back in 2021, at the height of multifamily madness, you’re right. I mean people even reading ppms and they were throwing money at anyone that could walk and talk like a syndicator. But from that peak in 2021, I think there’s been obviously a raise in interest rates, but that also affects cap rates. And I think when you start talking cap rates and interest rates, you lose some of the, we’ll call them investors, people that are just throwing money where you actually have to become a little bit more of an educated investor. And can you kind of walk people through the effects of interest rates and cap rates from 2021 now to present day and why this may be a good buying opportunity coming up in the next six to 12 months?

Neal Bawa (09:42):

Absolutely. So multifamily, when you buy a multifamily property, you’re buying a business, okay? You’re buying a business and you buy that business based on two numbers, just two. The first number is net operating income or N o I think of it as the income of the property before you pay your mortgage. So you look at all of the income, you look at all of the expenses, you subtract them, and the net is N O I. You haven’t paid your mortgage yet, so it’s net operating income. Now why not have the mortgage? Everyone’s mortgage numbers are different, right? One person might be able to get 3%, another one, four, another one, six. So to measure the property, you want to take that factor out, and that way you’re measuring the property, property, net operating income. That’s your first number. The second number is called the cap rate.


And so the multiple of N O I multiplied by a certain cap rate, which is expressed as a percentage, is usually the selling price of a property. And cap rates go up and down. They go up and down for a variety of reasons. So firstly, cap rates go down in markets where the economy is doing extremely well. So when cap rates go down, values go up because anything that you express as a percentage, right? If you have N O I multiplied by 5% in a really depressed market, and then you also have that cap rate changes to four, remember, cap rates go down in better markets. Well, the property’s value now has not jumped by 25%. And I’ll give you an exact example. So let’s say the property’s net operating income is a million dollars, $1 million N O I, and it’s a great market like early 2021, and everyone’s buying properties at four cap or 4%.


Well, you take 1 million multiply by 4%, what’s that number? The answer is 25 million. You’re basically selling your property for 25 times its income. So that’s what you’re selling the property for, or that’s what you’re buying it for. Okay? Well, fast forward 12 months later, interest rates have gone up like crazy, and now that same property, the prevailing cap rate in the market has changed. So instead of four cap or 4% cap rate, it’s now five. So you take that same property with the same million dollars of N O I and you multiply it by five, and now its value is 20. So it’s gone from 25 million to 20 million. Here’s the very, very, very cool part of this, right? This is the part that I really don’t see people explaining. It’s temporary just because cap rates were temporarily low in 2021 because everyone and their mother had a trillion dollars of money that we reigned on people and interest rates were zero effective.


Well, not interest rates. The fed funds rate was zero, which means interest rates were artificially low, so everyone had money, everything made sense, and so we were basically able to pay too much for properties in the same way Today we are in an artificial environment where the reverse has happened that interest rates are artificially high, they’re absurdly high. There’s absolutely no requirement that anyone has ever come up with that says they will stay this high, that the Fed funds rate will say this high. Even the Federal Reserve makes very, very clear written statements telling us that they won’t stay this high. It’s called the Fed plot. Just go to Google and type in Fed plot, and you’ll immediately see the Fed’s predictions of how rates will come down over the next two years. These are artificially high as a temporary punch to inflation to bring it down, right?


There’s no economist that I know of that says the Fed funds rate has to stay at 5.5 for several years. There are arguments about whether it should come down in the next three months, six months, nine months, or 12 months, and that everyone has their own opinion. There’s no one that says it shouldn’t come down in two years. There’s no economist that says that. So bottom line is just like 2021 was an absurd time. Now in the middle of 2023, we have an absurd time, and the real truth is somewhere in the middle, and that’s what we have to figure out as investors. What is that truth, right? Cap rates have moved by one 150 basis points or one and a half percent. So let’s call it 3.75 to 5.25, though the real numbers are slightly off from there. So if we had a million dollars and we were multiplied by 3.75 cap, we were buying a property for 26.5 million today, if we’re doing that same million dollars in N O I and we’re buying that property for 5.25 cap, we’re probably buying it for 18 million. So we’ve gone from 26 million to 18 million, which is about a 25, 20 6% decline in value.


My belief is half of that is going to retrace. Is it going to happen over the next year? No, over two years, maybe over three years, almost certainly because I’m looking at what happened before Covid in 2019, where were cap rates then? Because the Fed funds rate was neither zero nor five, the extremes that we’ve seen in the last 18 months. The Fed funds rate in 2019 was normal. It was a normal economy with normal inflation. Inflation was at 2%. The fed funds rate was at 2.25. That’s where they like to keep it. They like to keep it around two. So you have to look at a normal time and say, where were cap rates back then before the insanity up and insanity down? And then you get a very good answer to your question, and that answer tells you that cap rates will retrace, go back down, right?


So they’ve gone up. Remember, cap rates go up when prices go down. So if they’ve gone from 3.75 to 5.25, that’s 150 basis point move. What 2019 shows us is in a normalized environment, you come half the way back, that’s a 75 basis point change. Now, most people are like, that doesn’t seem like a lot. Are you freaking crazy on that same $1 million property? If I change the cap rates by 0.75 instantly I’ve created $3 million of profit. That is a huge, huge profit number. So it doesn’t have to retrace back to madness. It just has to retrace back to a normal environment. And because no one is buying multifamily to hold it for a year, most people today are not even buying to hold it for two years. They’re buying it to hold it for 3, 4, 5, 6, 7 years. We have all the time in the world for that retrenchment to occur.


This is investing, this is math, and I don’t see anyone explaining this to me. I see everyone saying, we should not be investing at this point because we have a falling life and rates can go down further. The answer is, are you going to sell your property in the next year? No. In that case, why do you care? Well, prices will go down further. Fine, you’re just going to hold, right? Your net operating income is independent of price. Price is dependent on demand for multifamily. Demand for multifamily is extremely high. We are at 95% occupancy at the end of the cycle. Where were we at the top of the cycle? Over 97% an all time high, not going to see it again. But in a normalized cycle, we’re still at 95% occupancy. So our demand is extremely strong. So there’s no reason why rents would drop simply because prices are dropping.


That doesn’t make any sense because rents are dependent on overall demand in the marketplace. So bottom line is if prices drop further in the next six months, which I by the way, do expect, why would that bother anybody that’s buying? You’re not selling in six months, you’re not selling in 12, and you’re not selling in 18 or 24, you’re probably selling in 30 months. And if anyone says that in 30 months prices could be lower, then they simply do not understand cap rate math and fundamental cycles. And I strongly encourage that Those people educate themselves by looking at cap rates in 20 17, 18 and 19, and normalize those three years, understand what cap rates are and their relationship is to normalized interest rates. And when you finish that process, you’re going to go out and buy a multifamily.

Tim Lyons (17:32):

Well, Neal, I feel like this is called the masterclass on cap rate math and cycles within real estate. So listen, when I was a brand new investor just getting started, I started with a three unit and I didn’t understand commercial real estate. It was cap rates. It was N O I. It was cap rate expansion, contraction. It was spreadsheets. I was like, man, I feel like I need a PhD in Microsoft Excel to start figuring this stuff out, right? I’m Tim the firefighter, Tim, the ER nurse. This is just a little too complicated. Until I got over that limiting belief, Neal and I said, no, I can learn this. Anything I put my mind to, but I had to take ownership over becoming that investor that you were talking to or about before in the podcast. Nobody’s coming to save me. No one’s coming to save you.


No one’s coming to save your 4 0 1 k or anything like that. You have to take ownership over it, getting yourself educated, surrounding yourself with people like Neal and getting that education so that you can take ownership of being an investor and not a speculator. So many people want that event, but they don’t want the process that precedes that event. So a couple of things I just want to comment on. Nobody is so good at investing, Neal, that they just magically wait for the bottom and they scoop in and they deploy all this capital and really nobody’s that good where they could just scoop in at the bottom because they know where the bottom is. So so many people like our registered investment advisories or a financial advisor will say, you have the dollar cost average into the market. And I will argue against that and say, well, everyone’s so comfortable with their 4 0 1 K or their direct deposit, every paycheck going into the dollar cost averaging into the s and p.


Why wouldn’t you have an equal opportunity over in the real estate space? Are you going to catch a falling knife? Nobody wants to do that. Are you going to time the market? Well, really no one’s track record is that good? But if you buy on fundamentals, you understand the cap rate path, you understand the cycles interest rate cycles, liquidity cycles. If you have a strong investment thesis with say, multifamily, that’s where Greg and I live. 85% of our portfolio is multifamily in addition to self-storage and industrial triple net leases. If you have that strong investment thesis about multifamily, people need food, clothing, and a place to live, it’s simple. And now you layer on top of that to cap rate math and understanding the underwriting, that’s your recipe for success. A couple other things that you had touched on. Investors like to follow trends, right? You said three times as much capital as chasing after deals when the cap rates were averaging three and a half, three. Sometimes I sourced some deals come across my desk at like 2.75 cap rates and some sexy sunbelt markets.


Right? Too much. So people want to follow those trends because there’s a safety factor with the herd. Just like when we talk to brand new investors and they’re like, Tim, how come my financial advisor never told me about multifamily syndication or private placement investing? They want to be with the herd. They want to do what everybody else is doing. They don’t want to be the guy at the cocktail party that’s talking about private placements and everyone’s kind of eyes are glazing over. But look, if you don’t run out of time or you don’t run out of money, these are great investments. And how do you do that? You do it with math, right? You do it with good solid underwriting. So Neal, given that underwriting right now, underwriting right now is so much different than it was say 18 to 24 months ago because things have changed.


Cap rate expansion, insurance costs, especially in states like Texas and Florida, Arizona, even for that matter, actually all across the country. I mean, insurers are pulling out. Yeah, they’re pulling out at record paces, renovation costs. I mean, the price and materials are now, they were pretty elastic during covid, right? There were supply chain issues and now they’re largely resolved, but you’re not really going to see renovation costs coming down substantially. Labor costs and taxes, right? I mean, there’s so much to that goes into underwriting. So with that being said, I just want to say before you start going, Neal again, that if you’re listening to this podcast and you’re overwhelmed, right? It’s okay. I was there too. I’m sure Neal was there too when he was doing his IT job back in the day before he got himself educated in this space. Listen to it again, rewind it, get the notebook out and get the pen out. But Neal, let’s talk about underwriting these days. In the face of all these different costs,

Neal Bawa (22:08):

Underwriting today actually makes sense. So if you listen to a podcast that I was guessing on in 2021, late 21, early 22, I was basically just telling people don’t do anything. Don’t buy anything. Absolutely. Everything that you buy now is going to be problematic. And I obviously ate my own dog food. I’m telling people today, this makes a lot of sense. Everyone that was putting in three and a half percent rent growth, well now they’re forced to put in two, even though rent growth today. So in the last 12 months, rent growth in the United States has been 0.78%. But when I’m underwriting, I put in two. Why? Because if you average it out over 24 months, rent growth has been ridiculously high because we had an extremely high year and then we had a retrenchment. That’s normal. That’s what normal markets do. When they go up too much, they come down a bit and that averages things out.


So the average rent growth over the last 24 and 36 months has been extraordinarily higher than inflation, even though inflation has been extraordinarily high. And so rent growth almost always is above inflation. But what’s nice is people are doing 2%, even though historically rent growth’s been closer to 3%, I like seeing that. I like seeing 2%, two and a half percent. I like seeing exit cap rates that are not in the four. So exit cap rates that are in the fives. So the message to you is this, no matter which syndicator you invest with, they’re all more rational today than 18 to 24 months ago. That is to your benefit. That is to your benefit. If you don’t want to invest in a rational market simply because you’re seeing distress out there and you are fine with investing in irrational markets, then you’re making the same mistake that you made in 2009.


There’s a lot of people that say, Tim, if I could just go back to 2008, I’d buy everything there is. The question is, you were in 2008, you were there. It’s not like you missed it. You didn’t actually live on another planet when 2008 were happening. There were people like me back then saying, this is the best time to buy multifamily. I was buying properties in 2008, 2009 by the dozens, I wouldn’t close on a property. I would close on a dozen all in cash, go back, refinance, fill them up, finance my money out, pull out money, move on to the next dozen, and people like me were there. So it wasn’t an anomaly, right? It was a choice that you made back in 2009. And I can tell you back in 2009, my family banned me from coming to family parties because I was infecting people in my family with my enthusiasm to buy, and they thought that I would basically completely dissolve the family fortune.


So I was prevented from going to parties. It’s never easy opportunity and distress our brothers and only come together. There’s just no way to create opportunity without distress. You can create it for very short periods of time. If you were lucky enough to buy in 2020 and then you exited in the middle of 2022 before prices went up, well, that was just luck. If you hung on for another nine months to your property, well, tough luck. It didn’t work out well for you. So long-term opportunity, midterm opportunity only comes during distress. And the underwriting today, Tim supports that. It supports that, right? So to me, the only challenge today, and I’ll say this even though most people don’t agree with me on this, is that I have to get a fixed loan today because I can’t convince investors that this is the best time to get a bridge loan.


When I say that, I’m going to qualify it by saying the end of this year is the best time to get a bridge loan, but can I actually buy a property with a bridge loan? No, because I can’t find any investors to agree with me. And we can go into why that is and why institutional right now will absolutely not get a fixed loan if they can get any kind of bridge. So bottom line is this is a good time to buy multifamily, and the next 12 months are all going to be a better time to buy multifamily. And I strongly believe in dollar cost averaging. One thing I’ve never ever managed to do is to time the bottom. So what I’ve managed to do is to call the bottom about a dozen times and been wrong exactly a dozen times. So I don’t have any belief in my ability to call the bottom, but I do have belief in my ability to tell when properties are discounted.


And so as far as I’m concerned, I’m going to start buying now and buy another one in three months, and that’s six, and then nine, then 12, and then 15, and then 18. And then I’m going to have what I believe is a smile, a smile of values where one or two of those properties are going to be at the bottom, and I don’t know which ones, but some out of those six are going to be at the bottom. And then in 18 months, I will simply do what I tend to do, which is abruptly stop and then not buy anything at all.

Greg Lyons (27:05):

And that’s what the market cycle is all about. And for our listeners, we are not offering advice to anyone. We are just kind of saying, Hey, this is Neal’s point of view on things and you could take it or leave it. But we’re listening to a highly educated person that’s been in the business for a long time. But again, this is not advice for anyone to jump into anything. So Neal, do you think we’re in another 2009 right now buying situation? Because you talk about bridge debt, you talk about rates. I love that smile analogy because really proformas that you see are the operator’s kind of best guesstimate of what’s going to happen. So if they predict there’s going to be a 1.78 equity multiple, nearly 0.0 times, does it ever become a 1.78 equity multiple? It could be 1.8, it could be 1.6. It’s kind of our best guesstimate of market conditions. But when you talk about bridge interest rates, I think we have a supply problem in the United States. Do you feel like the rest of 2023 and going into 2024, is that going to be a 2009 buying opportunity or just a really good one?

Neal Bawa (28:26):

There’s just no possibility of it being 2009, 2008. And I’ll explain why. If you look at the total number of assets in the United States that were at distress in 2008, well, firstly, there were four or 5 million homes that no one was paying mortgage on four or 5 million homes. Combine those together. And 5 million homes is roughly the equivalent of 10 million apartments, 10 million apartment units. So 10 million apartment units people are not paying a mortgage on. That was the size of 2008. What were the total number of assets at potential risk? The number is 8 trillion, which is 8,000 billion, right? So 8 trillion is actually a very significant part of the US economy. The entire economy was distressed. It wasn’t simply real estate. It started at real estate, and then the contagion basically went into any kind of stock. So the size of the market is very, very important.


8 trillion of assets were at risk, and eventually we had to pump in 700 billion through a series of bills through Congress. Some of that money came back later when those assets went up in value, but that’s what had to be done. So keep in mind that that was a contagion driven by an event, which an entire industry, the mortgage industry lying to millions of people and thousands of people should have gone to jail. And I won’t get into why they didn’t, but that’s what should have happened. So it was a failure of ethics on part of an entire industry comprised of hundreds of thousands of people. Now, here’s what’s happening today. Interest rates have gone up, demand hasn’t changed. Demand is actually very strong for multifamily assets. And I’ll tell you why that supply issue is actually a blessing. So it’s a downside and then a blessing.


So what we have today is Yardi Matrix recently said 2,500 properties in the United States are below a D S C R of one. I’ll explain to you what that means, but first we should know, well, okay, 2,500, what does that really mean, Neal? How many properties are there in the United States, Neal, that are the bigger properties that Tim and Greg buy? Right? The answer is 105,000 properties because there’s roughly 30, 25, 30 million rental units in the United States. Let’s assume every property is 150 units. And if there’s a hundred thousand properties, that’s 15 million units. So that jives right? There’s about 105,000 multifamily properties in the United States of those properties, the one that are bleeding, that have A D S C R under one, which essentially means when they pay their mortgage, the income from the property doesn’t cover the mortgage. So you have to basically put in extra money which comes out of the syndicators pocket or by cash calls from investors or by begging and borrowing money from other people.


2,500 properties are at risk, and that number, we believe is going to go up to about 3000 properties. So firstly, note that it’s less than 3% of the entire multifamily market. Now, why? It’s like, no, no, no, no, that seems too little. That seems too small, Neal. The answer is, the vast majority of the multifamily market, our properties with fixed rates owned by rich people, very rich people or institutional, they’re the much bigger portion of the market. And those properties, if they were purchased, let’s say in 20 16, 17, 18, the incredible rent hikes that we saw in 2021 we’re to the advantage of that property so it can pay its mortgage. Now, I’m saying that there’s probably tens of thousands of properties, Tim, that have stopped paying distributions that were paying 6, 7, 8, 10, 15, 20% distributions, and they probably cancel those distributions, but they’re able to pay their mortgage, and if they’re not able to pay their mortgage, there’s so much equity in those properties that they can sell them today without distress.


They can just simply go to the market and sell ’em today that probably will sell ’em for $5 million less than they could have sold them 18 months ago. But so what? It’s still selling at a gigantic profit instead of three x or four x investor money, they’re making two x, right? That has nothing to do with distress. Those properties have options. We’re talking about the 3000 properties that simply are bleeding. Also, any property that was purchased using fixed rate debt in 20 20, 20 21, 20 22 is not part of this mess. It has fixed rate debt. So by the time you parcel out all the different kinds of properties, and you realize really the property had to be purchased by syndicators in the last three years using bridge debt without a rate cap that wasn’t a high rate cap, or they basically forgot the rate cap or they’re a really high rate cap, you realize that that’s actually a pretty narrow portion of the multifamily industry.


3000 properties is what Yardi matrixed to say. So let’s do the math on that. If there’s 3000 properties and each property is 1 million, that’s 3000 million or 3 billion. But of course the properties are not $1 million. Let’s assume that they’re $30 million. So that’s 3 billion multiplied by 30. So the total size of distress in the United States multifamily market is $90 billion, right? And that’s assuming that none of these 3000 can be saved, which is outrageous because many of them have options. Cash calls are options, private equity, rescue funds, all kinds of things, options, and also an important option that most people don’t consider. It’s called kicking the can down the road. Have you heard of it? It’s an amazing thing. It’s called, there’s this can, and you kick it down the road and the lender says, just keep paying me. Or you know what? Pay me 80% and the remaining 20%, I’m going to add it to your loan.


I think you have a good property is going up. I realize right now you’re bleeding because your interest rate’s 11. We’ll work it out because I don’t want a hundred keys back. It’s kicking the can down the road is an incredible strategy. Please note that banks kick the can down the road for four years in Florida, four years in Florida during the 2009 recession because they didn’t want too many properties back, right? Even people that were paying 50% mortgage were given a chance to kick the can down the road. And to us, because there is strong belief in this marketplace that this is our official recession. This is an artificial housing recession created by incredibly high interest rates. And at some point in 2025, the market will normalize the same exact property will be worth more because if cap rates retrenched 75 basis points, a property that sells for 25 million today will sell for closer to 30 million. So many of these properties that cannot be sold today will be sold probably at breakeven or maybe small losses, but let’s assume the worst case scenario, 3000 of them get sold in distress. That’s 3% of the multifamily market, a total of 90 billion. Compare that to 8,000 billion in 2009. And you have the answer to your question. This is in 2009. It can’t be. There’s not enough money involved,

Tim Lyons (35:13):

Neal. I love that breakdown. And the other thing I wanted to stack on top is if you believe in multifamily as an investing class, an asset class, and you believe in the thesis that people need a place to live and a roof over their heads, there’s also, besides kicking the can down the road, which could be referred to as a workout because we’re special servicing, they’ll do workouts, special servicing. There’s also Fannie and Freddie, which are two government sponsored entities that are charged their So charge is to provide liquidity into the residential housing market. So hotels don’t have that. Self storage doesn’t have that. As far as I know, retail and industrial don’t have that, but Fannie and Freddie have to put, that’s their main job, Neal. So listen, people are going to get hurt. I think there’s going to be some hurt and some pain, but there’s ways to mitigate some of these risks and losses. And what I spend a lot of time talking to investors about these days is the news cycle. And they’ll say, commercial real estate, oh my God, all I see is commercial. Real estate’s in trouble. Isn’t multifamily commercial real estate? We have the conversation, right? Yes, multifamily is considered commercial real estate. However, there’s a big problem in office. There’s a big problem with regional banks having an overexposure to office versus multifamily. Do you have any data surrounding that or you have any comments?

Neal Bawa (36:35):

Yes. So the first thing I’ll say is when you say multifamily is part of commercial real estate, you have to make the statement accurate. Multifamily is a privileged part of commercial real estate because there are two lenders, Fannie Man and Freddie Mac, which are quasi government organizations whose only job is to keep the multifamily and single family market liquid. And they are given an enormous amount of money by Congress and they’re terrified that they won’t spend that money. So today, Fannie Mae and Freddie Mac to keep the market stable, they’ve done a bunch of things already. So let’s just talk about what they’ve done already. And none of these things they’ve done to save hotels and offices and malls, they’ve done it all to keep multifamily stable. Number one, they’ve reduced their spreads. So the way that a fixed loan fixed a 10 year fixed loan or 30 year fixed loan is put together by Fannie Mae, Freddie Mac, is that they take the 10 year treasury.


So currently at 4.19% as of today. And then on top of that, they add a spread in. Now, in good times, their spreads are often pretty wide. It’s 2%, two and a half percent. Why? Because the 10 year treasury was zero, right? Was anybody getting a 2% mortgage? No, people were getting 3% mortgages. So everyone had access to 3% mortgages. Well, if the treasury is zero, then the spread must’ve been pretty big. It must’ve been 3% for you to get a 3% mortgage. Okay? Where’s that spread today? Well, it’s at 0.1, 0.6. Why? Because Fannie Mae and Freddie Mac has to spend money. They get $140 billion from Congress, and if they don’t spend it, they get less next year. They’re a government organization. Guess what they do? They make sure they spend it all. And because they can’t do anything with the treasury part of the rate, because that’s affected by the Fed funds rate, they then reduce their spread.


So today, as of mid August, even with a treasury rate in the four, which is shockingly high, you can actually get a fixed mortgage under 6%. Now, does this apply for any other commercial real estate class? No, because it’s not a mandate from Congress. It only applies to multifamily. And I know that there’s supply coming in, so I’ll address that. Is supply going to be bad for multifamily? Yes, in the next 12 months, it’ll keep rent growth below inflation. If you look at a 50 year chart of inflation versus rent growth, you can walk away with one inclusion throughout those 50 years. Rent growth is above inflation, even when inflation spiked to seven, eight, 10% in the 1980. What did you see? You saw rent growth higher than that. Inflation rent growth consistently tracks higher than inflation, except right now. Right now, rent growth is 1%, inflation is three or four or five, depending upon which measure you want to look at it.


So we are below inflation, and you might say, why is that? It’s been a while. Clearly, occupancy is at 95%. So there’s no occupancy issues. People have money. There were 400,000 jobs created every month for the first four months of this year and 200,000 since then. So employment is doing really well. And also, did you notice that people are getting salary increases, right? Salary increases are not anemic. There’s four point a half percent. It’s like why would rent growth be at 1%? The answer is very simple. From the beginning of 2023 to the midpoint of 2024, we have a very large supply of incoming apartments, and that’s the reason why rent growth is at one when inflation is at three or four. And so I expect that pressure to keep rent growth below inflation, which is a very unusual thing until the midpoint in 2024.


And here’s the good part. So that means that net operating income for multifamily is not likely to grow at all in the next year as we pass through this period of pressure. Here’s the good news. After the period of pressure ends, and it mostly ends by Q three of next year, so one year from now, there’s very little supply coming. Why? Because once interest rates started going up in mid 2022, early 2022, the portion that was hit first was new construction. Because new construction, their spreads went from 1% to two, to three, to four to five to six. That didn’t happen with Fannie Mae, Freddie Mac because they have a mandate. Private lenders that give money to new construction. People don’t have any such mandate. They said, you know what? The risk is high. We’re going to double our stretch. So that started to hit construction hard in Q two, Q three, Q four next year, and certainly hitting it very hard in Q one, Q two, Q three this year. So now 2025 supply is affected. So while rent growth’s going to be weak for the next 12 months because of incoming supply in 2025, you get to make it up because there’s going to be supply well below demand. And so you get to have a bounce in 2025.

Greg Lyons (41:21):

I mean, fantastic.

Neal Bawa (41:24):

Know I, I can fry people’s brains.

Greg Lyons (41:28):

Oh, man, fantastic. I could see people listening to this a couple of times just because there are so many nuggets there, and I think different people identify with different points you’re making about supply, about interest rates, about cap rates. I feel like people are going to listen to that over and over again because this has just been a fantastic view on multifamily, the history of multifamily over the last 20 years. I mean, this has just been fantastic. Neal, we could go on and on here. I feel like, because I have about five more questions, but we are going to transition to our three thoughts at the end of each podcast. And we’ve covered this. We’ve covered this one in a pretty good fashion here. But what do you say to investors? You talk to a lot of investors. What do you say to investors that say, especially now investing in real estate is too risky.

Neal Bawa (42:26):

If you bought Netflix locks 18 months ago and Netflix stocks is now down 30%, you’ll buy it, right? Especially because their income has gone up, their membership has gone up. The same exact thing has applied to multifamily. How’s it different from Netflix?

Tim Lyons (42:42):

I love that. Listen, I mean, that is great, right? I mean, especially with the stock market. I love when investors try to challenge like me on a call. I used to try to convert everybody. Neal, if they were trying to challenge me on stock market versus multifamily. I don’t do that anymore. I just can’t. I don’t have the bandwidth for it. I just wish them well. And I say, thanks for the time, but are people reading 10 Ks? Are they going over earnings reports? Are they asking Tim Cook or whoever the CEO of Netflix is about their forward guidance? I mean, no, not even close, but people will stick to that like it’s religion anyway. Number two, there is a quasi mentor of ours, Robert Kiyosaki. You may have heard of him. And he says something that goes like this. He says, savers are losers and debtors are winners. And to the uninitiated, that might sound a little crass and they don’t understand what he’s saying. But what does that mean to you, Neal, when you hear that

Neal Bawa (43:35):

Leverage? So when you take a dollar and you get $3 in loans, you have the ability to multiply returns by three, sometimes even more. And that is an ability that’s built into the world financial system. The world financial system will do anything and everything, and has done a variety of extraordinarily unethical things to protect leverage. So everyone that’s rich and everyone that is in power will protect that multiplier because that’s what the world economy is based on, and that is designed to punish every saver in America because savers can never use leverage.

Tim Lyons (44:19):


Greg Lyons (44:20):

Beauty right there. And Neal, our last thought is one, especially good for you because I feel like you’ve just blown away any college professor in the last 45 minutes of what it’s like to be in real estate. But this next door is from Jim Rohn, and he said, formal education will make you a living. Self-education will make you a fortune. Take it away. Neal.

Neal Bawa (44:49):

Jim is an incredible person, and he’s actually inspired an entire group of people, including Tony Robbins, who’s a huge fan of Jim Rohn. I think what Jim recognized is the world over the last 50 years has become a have and have not world. And the haves are people that can pull away from traditional education. We’ve created traditional education essentially to create channels, people who work for other people, and people who get work out of other people. The traditional channel stays away from any form of education that could make people jump over into that second channel, and that’s why traditional education has become highly, highly dangerous. Why is it that you’ll go to college to school and spend years or hours learning about nimbus clouds? I don’t give a f*** about nimbus clouds. Why am I not being taught things like leverage? Why am I not being taught the way real estate works?


You realize that half of all wealth in the United States is real estate, and we never actually teach people about that. In a fair world where people were being set up to be fair, I would have an entire section, like a chapter on money and all different forms of money and how to manage your money. What we get is a single two hour course that people are taught in high school, which is an elective. This is a system that is designed by a bunch of people that don’t want you to learn a bunch of things that are beneficial to them, and that’s what Jim Rohn is trying to point out.

Tim Lyons (46:21):

I don’t think we ever had a question answered like that, Greg, and I just love it. I just want to stack on top. I mean, you have to do your own research. You have to do your own education. And Neal, for me, I mean, I didn’t know how much. I didn’t know about money until I realized that I didn’t know anything about money. But what helped me was podcast and books specifically. How about the creature from Jekyll Island, right? If you want to learn about money and banking and how that is just the system that we live in today, and it’s been around for, I don’t know, decades, about over hundred years. How about the secret life of real estate and banking by Philip J. Anderson? If you want to have your mind blown by something called the 18.6 year real estate cycle and money in banking, and how it became from the colonies until now. I mean, incredible stuff. So Neal, we’re going to have to have you back, my man, because I feel like we only scratch the surface, and I love the energy and enthusiasm, and yes, we’ll work on that. But if people in the meantime want to know more about you, grow, capita, multifamily you, what is the best way or some of the best ways for them to get in touch?

Neal Bawa (47:32):

Easiest way, I’m the only Neal Bawa on the worldwide web. Google me. There’s a huge amount of content out there, and it’ll allow you to connect with me. Structured way, multifamily, followed by the letter That’s multifamily We teach a dozen data-driven, entertaining and explosive webinars. Each year, 25,000 people sign up for them. There is no upsell. We don’t offer any educational products, and there never will be a subscription. It’s a completely free community of free thinkers that want more aha moments to make them better investors. So check out multifamily and through multifamily Once you join us, maybe you’ll see some of our projects that we do under the company Grow Capita, but my feedback to you is this. If right now money is burning a hole in your pocket and you want to give it to me, don’t do it. Be part of a syndicators community for six months, nine months, 12 months. That’s when you can make effective decisions, because before that, you don’t truly understand their philosophy. So please don’t give me your money.

Tim Lyons (48:39):

Oh, I love that one too. Well, with that being said, Greg, this was a great episode. Neal. Thank you so much for sharing your time and knowledge and wisdom with us. That’s going to do it for this week’s edition of The Passive Income Brothers Podcast, and we look forward to serving you again next week. Thank you for listening to another episode of The Passive Income Brothers podcast. We would be grateful for your support of our podcast by giving our show a five star rating and review and subscribing to our show on your favorite podcast platform. Don’t forget to take inspired action after listening to this show so that you can start building out your passive income streams. Finally, head on over to cityside to connect with us and find out more information about how to get started passively investing in real estate.