This podcast guesting Neal Bawa is hosted by Hunter Thompson of Cash Flow Connections Real Estate Podcast

When it comes to market analysis and market selection, the same answers are repeated over and over; “We look for jobs. We look for population growth”. Population growth and jobs are what everyone looks for, but what does that actually mean? Learning how to take these suggestions and replicate them for your own business can produce success, but to start, you must know how to master market analysis.

Our guest for today is Neal Bawa, known by his friends as The Mad Scientist of Multifamily. He is a technologist and entrepreneur in love with the power of numbers and the way they create profit for his real estate investors. Neal is the CEO and Founder at Grocapitus, which is a commercial real estate investment company where he acquires commercial properties across the U.S. for 300+ investors. He also serves as CEO at MultifamilyU, which is an apartment investing education company.

Today we are going to discuss…

• What it means mathematically when people say they want population growth
• What metrics people are looking for in terms of respective housing costs when tracking median income
• When investors say they are looking for strong employment, what data they are using to validate that claim and where they are getting it from

HUNTER THOMPSON: how’s is it going, everyone! Our guest for today is Neal Bawa, affectionally known by his friends as the Mad Scientist of Multifamily. He’s a technologist and entrepreneur who are in love with the power of numbers, the way they create profit for his real estate investors. He’s the CEO and founder of Grocapitus which is a commercial real estate investment company where Neal acquires commercial properties across the US for more than 300 investors. His current portfolio has more than 1800 units of multifamily and student housing it projects to be a closer 3000 units in the next 12 months. He also serves as the CEO at multifamilyU which is an apartment investing education company, massive amount of content out there, many webinars, he’s a great speaker, spoken at many conferences all across the country, and nearly 4000 students have attended his multifamily seminars each year, and hundreds attended his magic of multifamily boot camps. Well, Neal, it sounds like you and I have a little at least 2 things in common, maybe more depending on how it goes, but both of us are true love of real estate and also it sounds like we both love to help educate people, that’s something I like and 1 of the reason I was really happy to have you on. Thanks again for coming on.

NEAL BAWA: Thank you so much for having me here, absolutely my true passion isn’t even real estate it is simply education. My mother was a teacher and my sister was a teacher, sister in law, father in law, mother in law are all teachers so I came from a family of teachers, I came to the united states as a network engineering instructor and I was in 1997, to me education is less important than aha moments that stick in people’s minds. So my goal is not to educate people, my goal is to get the nuggets that cannot get out of their head because the information was transferred in such a way that nugget is now stuck there in the next 30 years.

HUNTER THOMPSON: absolutely! It’s like inception strongest way to make that connection with memory.

NEAL BAWA: I love that! I’m going to steal that, I’m going to use inception. I should have already figured that.

HUNTER THOMPSON: Perfect! We’re going to talk about education; we’re going to talk about multifamily we’re going to talk about the economy. Let’s talk about how you got in this sector you mention you came here with an educational engineer, let’s talk about that and how you segwayed into investing in real estate.

NEAL BAWA: Yeah, it’s interesting how I got started. Most people got started in a single-family in real estate as a single-family rental. So that’s the most common or a fix-n-flip, those are 2 super common ways. I started in reverse hunter, so for my day job in 2003 I was tasked along with my CEO on building a campus from scratch for our company so it was a technology education and health care education company based here in silicon valley and we are growing fast, and our revenue was going up so we had the money to buy a building and build it from scratch. It was just a shell building, it had four walls, 27,000 sq.ft, and the ceiling was 22ft. high. And so basically we have to convert it into a mixed-use campus which had offices, it had classrooms, it has storage base, it was a lot of different uses and I was thrown in cause my CEO decided that we were not going to renew our lease by the time we got in to contract on this space we only have 9 months left. And our landlord general motors, they have a building here in Freemont said that if you go over on your lease we will charge you $10,000 a day. So imagine the pressure of taking a complete shell building and building it from scratch, getting it approved, going through all of the processes that the approval. I learned so much, everything from egress to fire codes to room loads to conditioning to heating requirements. There was so much to learn, and all of a sudden I went from knowing nothing about real estate to know a heck of a lot about real estate construction. And then 2 years later we filled that out the campus and I had to repeat the process. The only difference this time building the campus this time, the building behind us was bigger and more expensive and as a result, we don’t have enough money to buy it outright and do the work. So this time we invited a bunch of doctors here in Freemont California. And we went to them and said, everyone buys from a 2000sqft, we build a suite for you and then we’ll rent it back from you, and under I thought maybe 1 of those 10 people that we were talking to would say yes, 10 out of 10 said yes. And it took me 4 years to figure out why, they were all laughing at me because I was supposed to charge them 5% of the project as fee because typically when doing new construction as a syndicator, you charge 5% of the project’s size in this case the project size was 7 million so I should have charged them at $350,000 fee, but I didn’t know that I was supposed to charge the fee. I didn’t know that what I adjusted was called syndication I didn’t discover that for another 3 or 4 years, but it’s not the bad story because everyone won in that story my student won, they got a nicer, bigger campus my company had a space to grow. I had a suite and then all these doctors for the last 12 years had their suites rented out in my business so it was a happy ending story that was a win, win, win, win and catapulted me into real estate, and from then onwards I went to the standard path. The single-family, the triplexes and then the big syndication passive first and the active.

HUNTER THOMPSON: interesting! That’s a really interesting story there so what is it that made you go the route, specifically focused on housing as supposed to somebody asset classes was it just because that’s what you knew and then made you transition at the duplex, triplex into the larger multifamily syndications.

NEAL BAWA: So, as a senior executive in the company, the first thing that I learned was the biggest job of a senior executive is to keep an eye on scale. We went from 10 employees to 400 on the day that we sold the company in 2013 and the only way to get from 10-400 is to reinvent your company basically every 3 to 4 years, you have to restart and reinvented and so you’re focused on scale and I noticed very quickly that multifamily had vastly better scale than single-family. I bought 10 single families in 2 009, and in 2010 I bought 10 triplexes in Chicago in 2011-2013. And I notice that the triplexes scale is better than the single families but my passive investment into multifamily syndication I put a more than million dollars in the passive syndication in multifamily scaled massively better. Obviously, as a passive, you don’t spend much time, but I was reading all of the reports that are coming in from the active syndicators I could see that the scale was incredible. I looked at it and said, for the summary that respects the value and its time this is vastly more efficient than a single-family, just more efficient it’s 10x or a hundred times more efficient. And I love that efficiency, having said that hunter I did invest another asset classes. So as a passive, I’m invested in office, I’m invested in retail, I’m invested in hotels, but when I looked in all of those ii still came back to these fundamentally if you look at the 10 to 20-year timeline because multifamily is a need and both offices and hotels and also retail is a wand. The overall 20-year performance was not just better but also more stable for multifamily. I am very conservative so I’m going to naturally gravitate to the thing that has better long term stability, not the better cash flow. Hotel’s cash flow better than multifamily.

HUNTER THOMPSON: Right! Just incredibly sick, because the first thing that goes is all those trips whether its corporate or not corporate non-commercial vacations and such, it’s the first thing to go. So the predictability outcome significantly decreases, casual can be good, you’re one terrible, and I mean it’s not the way to build in our portfolio for sure.

NEAL BAWA: Exactly, what I want was a higher level of stability and so it’s very hard to get that to the hotels, to be honest, they’re extremely sick and then this point beyond retail, I’m scared beyond retail because we’ve had 3-4 years of sub far growth retail, malls, and strip malls and those things while we’ve gone from 3% to 6% of all transactions in the US being online, that’s just 3-6. We are projecting that over the next 10 years we go from 6% to 25% the blood bath that ensues in that point is going to be spectacular and as a multifamily syndicator. I am candidate looking forward to that cause what will end up happening that is so many strip malls would be getting out of business and so many malls will become insolvent that they will need solutions and multifamily syndicators like me will come in and do mixed-use I’m already reaching out to malls and high-quality places and saying ” hey let’s see if we can convince the city to do a mixed-use and I’m going to build a parking lot, you know a mall is huge amount parking may not need a parking, may need a parking, but let’s build a parking lot if necessary I’m going to build a 7 story multifamily building above your mall, right? And then rebrand the mall. so ill build the retail, so you go and brand the mall to a higher level and let’s make it work together so there’s going to be solutions to this, but there’s no doubt that retailers would be going to place a blood bath from 3-6 we’ve seen so many problems imagine what happened when we grow from 6%-25% of all transactions.

HUNTER THOMPSON: Yeah, we’ll certainly find out the cause. I don’t think there’s any arguing that numbers to continue to increase, so within the multifamily sector that’s your typical bread and butter purchase if there are a typical bread and butter purchase just right now in the cycle.

NEAL BAWA: Yeah there is, and we got an acronym so my bread and butter, which by itself is a term is called lipstick on a pick, so we do 3-4 projects a year that we called stick-on-a-pick, and we buy 60’s mostly 70’s products, some 80’s products. some mixture of ’70s and 80’s product and these are buildings that we need a lot of attention they need a lot of work but they don’t need a structural work what they don’t need is breaking through walls, what they don’t need is fixing foundation, what they don’t need is replace a 100% on roofs what they need is a lot of cosmetic work, and so what we do is some of these projects we put lipstick on them, some of them lean more so its lipstick we put mascara, eye shadow and you know those source of things to get them to the point where I able to boost rents by $150 to $200. In this we are no different from anybody else from the US, our secret sauce is not the product that we’re buying, because everybody else is buying the same product and doing the same things with it. Our secret sauce is data. Both before the purchase and after the purchase so we use data very uniquely both before buying and after buying and both of those things give us a class-leading advantage in our industry. And we are recognized as people doing these 2 things different from anyone else in the US.

NEAL BAWA: sure. Just so you know most textbook multifamily markets are also textbook single-family markets. There are very few exceptions to that. So to me, it is all about demographics and everything I’m about to say is I’m not going to be new to your listeners. What is going to be new is the rangiest, the specific of those metrics so we tend to first look at 5 metrics and by the way, I see a lot of people talking about this stuff. I also see them on the podcast, but then I see what they’re buying, those things do not match. They couldn’t be doing the demographics; they’re simply talking about them.

HUNTER THOMPSON: Yes, this is exactly why I wanted to have you on. Just saying demographics are not answers to that question; it’s like, what does that mean? Let’s do it.

NEAL BAWA: Exactly! So to me here’s what people say, and here’s what they should do. Alright, so first let’s talk about what they say, so we go to places where there is population increase, that’s correct. So we should always invest in places where there’s a significant increase in population, but the increasing population is not the basis in which we should make investments a certain percentage of population increase. So for most markets in the US. 80% of investor markets in the US. That population growth number is roughly 1.5% a year. You’re looking at 1.5% population growths or as close to that as possible. I also cut corners on this because sometimes the other 4 metrics are really good, but I’m never investing in a market place that at zero population growth. And I consistently see people investing in places, for example, Google, how many syndications you’ve seen in places like Shreveport Louisiana. You’re going to see syndications in Shreveport Louisiana people buying stuff. Well, that’s a market where the population is declining. What about Dayton, Ohio population decline? What about Detroit, Michigan’s population decline? What about the Cleveland population decline? So people are continuously investing in areas that have population declines, and what’s even worst is they’re taking 10 million dollars of investor money and investing in places that are population decline. Now, can they not make money on those places, Hunter? No that’s not true; you can make money, but let me explain what they are doing. A typical aircraft, when it travels to the US travels at 550 miles an hour. That’s the most typical speed. When you have a declining population, think of that plane as having a 200-mile headwind. That’s what a population decline is. Your plane which was going at 550 now is a 200-mile headwind, so now its average speed is 350, not 550. Now think of a 2% annualized population growth as a 200-mile tailwind and a 1.5% population growth as a 150-mile tailwind. So now in an area that is Provo Utah which is 2% or higher population growth, your 550-mile plane is flying, zooming screaming a 750. That’s what these are. These are headwinds and tailwinds. They don’t destroy you but they allow you to go much faster so that’s population. And that’s the first metric I looked at. The 2nd metric that I always looked at is the median household income so that metric is more important than population growth because let’s say you’re investing in Cleveland, which slightly declining population. You might do well if you’re investing in Cleveland in an area where the median household income is between 40,000 and 70,000 hopefully more on the 50, 60, 70 than the 40, why? Because people there can’t afford payments for housing. You might have trouble paying rents, but your project still does well. But what I’m seeing and what I am horrified by is not only our people investing places that are losing population such as Dayton, Ohio, there are investing and doing syndications in areas where the median household is lower than $40,000. Well do the math on that, how are you going to charge, you’re going into a building that’s $850 in rents. You’re now going there and have it, now you going to charge $2,000 in rents and you want to rise that by 3% a year which means a 15% increase over 5 years. So by the 5th year, people have to be paying a minimum of $1150 minimum. A lot of your units are going to be above those 13-1400 dollars. And so essentially, you’re charging $15,000 a year in rent well if people’s incomes are 30,000 thousand dollars. How can they afford to pay $15,000 in rent? This is just gross rent, there is another living cost in an apartment there’s pantries there all source of other fees that have to pay so now your cost of rent, not even including the bills that they’re paying, their gas bill or whatever other bills they’re paying, their cable is already over 60% of income. How could there be a good outcome to a project like that but I continuously see it, I see it all the time people investing in areas where the average income is 30-36,000. Here’s the rule of thumb hunter. Once your median household income decreases below 40,000, your delinquency starts to rise between 40,000 and 35,000 you’ll see a spike, and that spike will meet that delinquency will be higher, your legal cost will be higher and your churn the speed that which people live or getting kicked out cause they’re not paying is going to go up but it’s manageable until 35. Once your income goes below 35,000, the average tenant that lives that area doesn’t care about their credit. And so now your delinquency starts to spike, and by the time you hit $30,000 in the median and come lower. Your delinquency is so insane that the chances of your making money at all are highly remote. You have to be a superstar to make any money. Basically, below $30,000, your plane has a 4 or 500 headwinds so it’s not moving at all. And that’s how important income is, but I don’t see people understanding these numbers, the 40,000, the 35,000, the 30,000 are not numbers that understood, and these numbers are not understood by the people have 200 million dollar portfolio. And you might say, well you got a 200 million, but Hunter 200 million dollars is not a sign of success. What’s the sign of success is cash flow to investors. God knows how many of those people are actually, how many projects are cash flowing, right? So maybe he’s good at marketing.

HUNTER THOMPSON: Uhm hmm…

NEAL BAWA: Maybe he’s good at sales. So to me what we have to understand is there’s a very direct relationship between success and median household income, why not you go the other way about 45, you know 45,000 property starts to stabilize. At 50 you are now entering a B class, so a lot of people talk about what is a C class and a B class; they are tied back to income. So around 50 you’re entering B territory, and that B territory is going to run about $50,000-$70,000 and beyond that, you’re now entering A territory beyond $70,000 and there’s going to be no cash flow, once you go beyond $70,000 in median income. It’s going to be very hard for you to make a property cash flow. Some might, but it’s rare.

HUNTER THOMPSON: Right!

NEAL BAWA: and so these classes that people talk about all the time, brokers routinely stop like this is a B minus area, they say stuff like that and absurd I hear this all the time, it’s a B- area. What’s the median household income, well they’ll give you a household income, but you notice that the median household income, they’re using zip code. Now if you use a neighborhood tool like neighborhood scout and pull that income you’ll notice it’s always lower, like 34,000. Well, how can that B- neighborhood be $34 in income? You’re in the C- area because you drop below 35,000 and this is what happens every day of the year with every project that I looked at. Everyone just messing these things up, because they don’t understand these 2 first numbers, there’s 5 metrics, but just these first 2 I see that they’re being used in just ways to get investors. Everyone’s mutating these numbers, not using the way that they were meant to be. Because they don’t understand that they don’t spend time with them.

HUNTER THOMPSON: Right. Its marketing deck, by the way, I’m sure my listeners are just chatting calling this is why; you guys can tell why he and I are going to get along, right? Just complaining about the things we’re saying in the market place right now just by using buzz words essentially, okay cool. So we’ve got in the first 2. You made some excellent points on those, but we’re on number 3.

NEAL BAWA: Number 3 is a median home price increase, so a lot of times people talk about things like the population they talk about things like income, but it’s also important to look at increases so what you want to see is growth you want to see growth on income. Now the income side, I want to see a growth of roughly 1 ½ % a year so I want to go into a market where the incomes growing 1 ½% a year because our inflation rate in the US is 1 ½% since 2011, and so I want that 1 ½% increase so that the people living in that area can tolerate at least tracking inflation than most the time I go in the area where income is increasing over 2%. Now home prices, I want them to increase a lot faster. I want home prices in that area to increase by 2 ½% a year. So population 1 1/2, in the income side 2%, on the home price increase 2 ½ and most markets that I go into home prices are increasing at 3% or greater. Now you might say over the last 5 or 6 years, that’s every market in the US, but that was the past. I looked at the last 12 months because the market has become saner in the last 12 months. What happened before that was one-time insanity, so it’s best to avoid it and not get your numbers mixed up, but now when you look at the last 12 months home price growth the of the US become insane. The San Francisco area, for example, the price went down. They went down very fast but the area-id becoming sane was flat for the last 12 months. Denver was slight increases so now the market looks insane for the last 12 months and saying where can I get 2.5% annualized home price increases and again most of the markets I’m going to give you today they just blow all these numbers away. They’re not better; they just crush them, because there are such many markets in the US. And that is my answer to the question, are we at the end of the cycle. The answer is we are at the end of some cycles; we are the beginning of some and the middle of some. There are 2200 real estate cycles in the United States because there are 2200 cities. So every city is in its cycle. I’ll give an example of the cities that are at the end of the cycle and cities that are closer to the beginning cycle. So that’s the 3rd one, the 3rd metric and the 4th one, I’m looking at crime reduction, I want to see crime go down as many ways to find crime statistics on the web, you can Google your preferred city like you’re looking at Philadelphia, you can Google Philadelphia crime, another easy cheat way of doing it is to Google Philadelphia crime city/data.com. and you will see a table on city/data.com, and in that table, the city data crime index should be lower than 500 per city. So firstly, it should be decreasing. It will give you the crime for the last 10-15 years so you can look at all numbers in one line and what you want to see is that over time crime is decreasing, and the newest number, the most recent number tends to be at 2 years old should be below 500 in terms of the crime index. So that cities that way above 500 are parts of Oakland all of south Chicago, Memphis Tennessee, Saint Louis Missouri, very high crime cities, extraordinarily high crime cities. So that’s why I tend to not invest in them because high crime cities are perfectly viable when unemployment is below 5%. But when unemployment goes to 8,9 or 10, their crime doesn’t double, it quadruples, because they’re high crime in nature, and when people are employed, they don’t have the time to commit crimes. When they are unemployed they have an equal system of crime around them and so crime goes insane in cities like Memphis, when unemployment rates go over 7 or 8%.

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