The Power of Data and Technology to Drive Commercial Real Estate Investments
Announcer: Welcome to the Multifamily 5, where industry experts provide raw information about how they are achieving success in the current market conditions. And now, your host, Dallas-based real estate broker, Mark Allen.
Mark: And welcome to the Multifamily 5. Super excited today to have Neal Bawa, Grocapitus. Neal, how’s it going?
Neal: Fantastic. Thanks for having me on the show, Mark.
Mark: Yeah, absolutely. So, I think this is Episode No. 28. I try to do one a month and for those that are new, it’s the Multifamily 5, where we ask five questions to understand how investors are achieving success in today’s market.
Neal has a very interesting model, has been in the business for a very long time, so I’m excited to have him on. Neal, if you want to go ahead and introduce yourself. Talk a little bit about your background and current focus.
Neal: Sure. Well, I’m a little different from some of the other people on your show. I’m not real estate royalty, I haven’t flipped a hundred homes, haven’t done a thousand loans. I’m a technologist. I’ve had a full tech career and a successful tech exit, and I took the money from that exit, invested it as a passive investor in multifamily and then started learning more from the syndicators that I was investing with. I realized that a lot of them actually were missing lots of pieces of the puzzle and that I was able to, by working with 13 different syndicators, passively learn from them and I was actually able to aggregate some of those pieces and over time build my own syndication business.
It took me a while to do that. I started in real estate in 2003 on a part-time basis and I didn’t go full-time until 2013. Since then, things have gone well. I’m a data scientist, so everything is really all about data, data structure, process, audit. That’s my world. It’s a world that I live in, and that world has been appreciated by my investors. I now have well over 300 investors investing with me. The portfolio is $150 million and we’re actually going to hit $250 million this year.
Mark: Great. Just curious, when you started in 2003, did you start with multifamily?
Neal: I started in reverse. My story is interesting in that everyone starts with single family, get a rental, so on and so forth. I started in reverse. In 2003, I was a business that was growing very fast. The senior partner in that business, my boss, he was a CEO of the company. He came and said, “Our office lease is up. We’re not going to rent anymore. We’re going to just go and buy an office.” We had the money, so I said, “Great, boss, you go look for the offices, I’m running the company.”
He comes back ten days later and said, “I bought something.” I’m like, “Yay, we still have eight or nine months left, why did you buy so early?” And he said, “That’s because it’s a shell. It’s just four walls, Neal. It’s 22’ high ceilings, four walls, you have to build it.” I said, “Are you crazy? There’s only nine months left. We’re a functioning business. Our landlord doesn’t want to renew our lease. That’s crazy.” He’s like, “No, no, no, I have all these great GCs and I’m an expert at this stuff and I’ll help you and you’ll help me, and we’ll figure it all out.”
And I was terrified, Mark. I was absolutely terrified, couldn’t sleep at night. But in hindsight, it was the best thing that could ever happen. Trial by fire, thrown in there, knowing that our business would be affected if we didn’t get it all done in nine months. We got it done in basically eight months and 29 days. We moved in over the July 4th weekend. We had our entire executive staff had sleeping bags because we had to move over one weekend. Imagine trying to move 30,000 square feet of stuff over one weekend because our landlord didn’t want us to extend and we had to pay $10,000 a day in penalties. We didn’t pay $1.
I started with large commercial and then I went out two years later and helped my boss build another campus, which was even larger, 33,000 square feet. What’s interesting is, I did a syndication in 2007 without knowing I was doing a syndication. I had no idea. I didn’t even know what that word meant. All I knew is I needed to buy a building. It was too expensive, so my boss and I went to a bunch of doctors here in Freemont and we told them, “Look, here’s the opportunity. We’re going to have everybody buy 2,000 square feet inside of this building. We are going to build the suites for you. Like you have to do nothing. We are going to build it and then we are going to rent it back from you when they’re complete. You do nothing, just provide us with the equity.”
I thought nobody would listen, but like in half a day, we had all the money that we needed and later on we realized why. We didn’t charge an acquisition fee. We didn’t charge a developer fee. We didn’t charge a split. Right? These were the luckiest doctors ever. They ended up with beautiful, 2,000-square-foot suites built to their requirements and then a lifelong tenant.
That was 2006, we are still—that business, I’ve sold it now—is still occupying those suites.
It took me a while before I understood that we should have charged a heck of a lot of money and so I started doing research on that and then I realized there’s this thing called syndication where people charge money to do these sorts of things and that’s how I got into syndication as a passive investor and started putting money in.
Mark: Very interesting. Right now, in today’s market, it’s a very interesting time. The fundamentals are extremely strong, stronger than they’ve been, and I think stronger than they were last cycle, if you look at the data, and you’re a data guy.
Neal: Much stronger. Much stronger.
Mark: Much stronger. But at the end of the day, there’s going to be an economic contraction and at that point, obviously, occupancy will dip, and rents will dip. What are you doing today, just from a macro level to hedge against that? We’re ten years in, call it nine, ten years on the cycle, one of the longest economic expansions in history, so being that you’re a data guy, what kind of data are you looking at and what are you doing to make sure—just call it hedge against a potential dip?
Neal: Sure. There’s a number of things you can do there and there’s also a couple of aha moments that I want to mention to you.
My first aha moment is: You cannot simultaneously worry about interest rates and a recession. It is one or the other. We’ve never had a recession with interest rates being too high. They’re always low and the Federal Reserve will cut interest rates as soon as we get into a recessionary situation.
So, the choice for you as a data person is: Today, which do you believe? That interest rates are going to spike? Or that we’re going to have a recession? Four-and-a-half months ago, I was worried about interest rates. We had a record Q3 with excellent GDP growth. Everything looked like going up, stocks were going crazy.
At that point, my defensive strategy was I need to make sure that all of my loans—if they are bridge loans, I’m not taking a two-year loans, I’m doing a 3+1+1, and I’m buying a rate cap. That’s what I executed four-and-a-half months ago, because of interest rate risk.
When you have interest rate risk, you simultaneously cannot think about recession, these things are opposite.
Now today, things have changed. In the last four months, the Federal Reserve has turned very dovish. If you listen to what our chairman, Jerome Powell, is saying, that’s very dovish. The world economy is slowing, the U.S. economy is slowing, even though we are easily the strongest economy on the planet right now. We’re still slowing compared to where we were before.
As a result, I’ve changed my mind to the point where I’m saying, okay, today, I’m worried about recession. If I’m worried about recession, then I’m not overly worried about locking in a rate because rates will not spike if we continue to slow down. In fact, I’m going to get cheaper rates.
So, my focus today is about having a larger operating budget. It’s about not getting into a situation where my DSCR is below 1.1, or there’s projects you can do right now where you DSCR is below 1. Well, I’m making sure I’m not buying those kinds of units.
Then, when you’re worried about recessions, you buy in better markets. So, today, I would much rather buy a 5-1/2 cap project in a superior market with lots of jobs than buy a 7-1/2 cap project in let’s say a market that is losing population, so maybe East Pittsburgh or South Cleveland, because I know that markets that are fundamentally weak, get hit the most in a recession. My numbers are not going to pencil out there.
When it’s the other market, I may be paying a low cap rate, but those markets, if they’re fundamentally strong, will weather the recession well. I probably won’t give any cash flow to my investors. I might even have to put some money in from my own pocket to keep the property going. But when that recession ends, that market, because it’s underlying fundamentals were strong, is going to go back to its original growth path. If it goes back to its original growth path, over a five-year timeframe, I will still make my numbers.
That’s my thought process today. I want to go to high quality metros. You do not want to go into a low-quality metro so close to a recession. No, at this point, I’m not worried about interest rate heights because I think that we are at equilibrium. In fact, it looks like the Fed is even going to stop quantitative tightening, which really shows how worried they are, because they’ve been tightening for the last year, year and a half. If they’re going to slow down on that, then right now they’re not too worried about inflation. They are worried about recession.
Mark: What are your top three markets?
Neal: My top three markets today are Atlanta. Atlanta because of the fact that there’s so much inward migration. I love markets that are gaining population, but I also like markets where home prices are so low that you cannot do a lot of new construction. All of Atlanta’s new construction is focused on that Buckhead market and that market is over-supplied.
But let’s say you move 10 miles away from Buckhead. Well, home prices are so low that you really cannot pencil out new construction. Some of the submarkets that I’m in that I’m looking at in Atlanta, you can still buy something for $60, 65,000 a door, where the cost of construction is $130,000 a door, and home prices are so low that you really cannot build a class A.
Those markets are protected markets. They’re good markets. Atlanta is one of those markets. In fact, right now, of the top 50 markets in the U.S., it is the only market, one market, where home prices are below what is known as the income price, which is the equilibrium price for homes. It’s -4%. No other market is like that. I like Atlanta because of that. Strong growth, strong job growth, home prices below equilibrium price, that’s a good market to invest in. I’ve bought three properties in Atlanta in the last six months, or I should say, Greater Atlanta.
I like secondary and tertiary markets now. The time for primaries has past. If you look at the last six months, the Yardi Matrix Reports, you look at Marcus and Millichap, you’ll notice that secondaries and tertiaries are accelerating, and primaries are decelerating. In fact, there’s a slide in the Yardi Matrix’s presentation that shows you all of the markets decelerating, all of the markets accelerating. Well, the secondaries are accelerating, so that’s where the money is going to and that’s what I’m interested in right now.
Today, I’m more interested in Jacksonville, Orlando, and Tucson than I’m interested in Phoenix, Miami, Denver, San Francisco Bay Area. I’m not interested in the primaries anymore because they are at the end of the cycle, where the secondaries still are one to two innings behind in the ballgame.
Mark: Right. It’s all relative, but prices are much higher than they were three, five, seven years ago. We talked a little bit about interest rates and where they’re at today. If you don’t want to be on the sidelines, and this comes from—it seems like more so private investors that are using their own money are on the sidelines today. But if you don’t want to be on the sidelines, what can you do to make projects pencil out?
Neal: I think the first thing that you do is you look at long-term growth more so, because everyone has to now, as a recession is either coming in 2020 or 2021. You cannot be a responsible syndicator today and not assume that one of those two years is a recession year. I am not penciling in the great recession to be occurring again, because the chances of that, in an economy that is so fundamentally strong, it’s very low. I’m just penciling in the vanilla U.S. recession into my projects. When you know that you have a recession in your three to five year purchase cycle, the key thing is metro quality. The key thing is very strong, across the board, fundamental job growth. That’s what you need to be focused on.
The second piece of it is, that make your bridge loans, if you have them, a lot longer. Don’t do a two-year bridge loan. Do one that is 3+1+1. Buy yourself some choices. If you’re worried about interest rates going up, buy rate caps. You know, buy caps on all of your bridge loans.
And then, give your investors a variety of projects. Don’t just give them bridge loan, bridge loan, bridge loan projects. Give them projects that have 10-year or 12-year fixed and let the investors decide. If they are low risk, they’re going to pick the project that has a 12-year fixed loan. How do you make that project pencil out? Make it longer. Because if you make it a five-year project, it’s not going to pencil out. You’re not going to be competitive; you’re not going to raise the money.
But if you make it a 10-year project, that is a different kind of project. There’s a lot of people that like long-term cash flow. They don’t want to be in a three to five-year project. Now you have a different audience, at a different IRR level, at a different cash flow level.
We just did a project called Chelsea Place. People loved it. We told them we were going to hold for 10 years. How many people do that? But in today’s environment, holding for 10 years allows us a 12-year fixed loan and we’ll probably sell it in year 8 with 4 years left on it, for the next guy to have 4 years of a fixed loan, something like that. But that’s choice.
We are diversifying in our choices of projects and our type of projects for our investors. If you’re an investor, then that’s what you want to do. You want to get into different kinds of projects and that’s a great way to hedge against it.
But I don’t think that anyone should spend a dollar in today’s market if you believe that we’re about to see a repeat of the Great Depression. If that’s your belief, stay on the sidelines.
Mark: What about underwriting? Are you doing anything outside of the variables that you can effect change on? Are you doing anything different to your underwriting? Maybe in the second half of last year, into this year?
Neal: I’m going to give you an answer that’s—I’m not directly answering that question. I’m going to answer it indirectly. I believe that in today’s market, with interest rates having gone up over the last year and cap rates still going down, prices going up, there is only so much you can do on the underwriting. Underwriting is the process of typing numbers into an Excel spreadsheet and doing analysis. If you want to be in the market, if you want to get projects, if you want to actually win bids, I think we’re coming to the end of the underwriting refinement era. That’s done. We were able to do it for the last five years. Now, when you’re doing it, you’re just deluding yourself.
I’m going to flip that question around and say, “I am no longer making underwriting optimizations because the for that is past. I’m doing something else.” I’m saying, “How can I operate my property more efficiently than the market?” My focus is on operational efficiencies because I still feel that our industry, that uses technology so poorly, that they’ve let so many operation deficiencies, they’ve left them on the table. Let me give you an example of that.
There’s a covered parking spot that you can sell and it’s $40. Let me tell you what your property manager is thinking, he’s thinking 3% of $40, $1.20. It’s not even worth my time to go and tell somebody or push somebody to sell that parking spot. So, guess what happens? Every time you sell a parking spot, it’s the customer. It’s the customer that walks in and says, “I want a parking spot.” They’ll say, “Hey, we have 50 parking spots, we’ve sold 30.” The truth is, they’ve sold none. They just happened to sell 30 because people wanted them. Those remaining 20 parking spots? $40 a month each are a huge amount of money to investors. A huge amount of money to syndicators, but they’re nothing to property managers.
We have built an infrastructure, a second property management team in the Philippines and we are now spinning up to do some of the last 20% NOI optimization ourselves. Let the property manager manage the property. Let him collect rents. Let him kick out tenants. Let him rehab units. We’re going to take the top 20% that nobody focuses on and we’re going to optimize it.
That’s my solution. It’s not underwriting anymore.
Mark: Very good answer. I like that. I want to kind of key in on that. Can you share some other stories as far as whether they’d be value-add strategies or using technology to optimize operations?
Neal: Absolutely. There’s so many pieces to it. Number one is optimize rehab. If you want a full demonstration of how to optimize rehab, tonight at 6 P.M., we have a raise—it’s a project that one of my most brilliant students is doing. He and I have had conversations about this, and he’s basically gone out and done exactly what I suggested, which is he’s using virtual assistants in the Philippines to optimize his whole rehab process. He bought it in-house, he’s the general contractor, he has contractors that are working with him, he’s buying directly from China, and he’s lowered his cost of rehab by 30%.
Now, he’s doing it on a small scale, and it doesn’t really scale there. But let’s say you’re a syndicator with 2,000 units. Consider doing that. Consider doing what he’s doing using technology, having full-time people in the Philippines that are doing everything from calling vendors in China to scheduling contractors, to doing that whole infrastructure piece. I know it’s hard to set up, but once you have it set up, you’ve created something of true value because you’re going to cut your rehab cost by 20-30%.
If you’re a syndicator, you know how much money that is for your investors. You know that projects that don’t pencil out, will instantly pencil out. That’s rehab. That’s one area in which you can apply process and technology and efficiency.
The second area is this: I see people with huge portfolios, 3,000 units, 5,000 units, 10,000 units, and I ask them a simple question: What are you doing to make sure that your property manager has enough leads, your property manager has enough applications, and your property manager is signing enough leases? I have never found somebody to give me a good answer.
People at the 50 and 100,000-unit level, they’ve brought the entire process of leasing in-house to a centralized call center. But the point is today, with technology, you could do the same thing.
Mark, I have a property in Chicago, where my staff—not the property manager—my staff in the Philippines has generated 10,000 tenant leads a year for the last 3 years. We have processed all of those 10,000 leads in the Philippines. We’ve got Philippinos calling people in Chicago and processing leads and putting them in AppFolio, bringing them to the property. That is true optimization, because when you do that, you provide your property manager, you give him the strength to take the best tenants. You give him the strength to say no. You give him the strength to even pick within the bounds of the Fair Housing Act. You give them the ability to pick the very best tenants. When he’s only got one unit and he’s got two qualified tenants, fully qualified, one of them is a family that he thinks will stay for three years, another one is an individual that might stay for one year, at that point, when he only has one unit, he can make a decision to give it to a family. But if he only had that single person, he would’ve given it to them.
Now, that single person stays for 18 months. When he leaves, you have rehab costs. The family stays for 30, you have a lot less rehab costs. Your net operating income goes up. That kind of optimization can happen if the syndication company says, “I know that there’s a property manager, but I need to do something to increase lead volume. I need to do something to market this place. I need to do something to make sure that my property manager is getting enough qualified tenants.” That is post-purchase optimization. I’m talking about real people putting in thousands of hours into my portfolio every year to optimize net operating income and top line revenue.
Mark: That’s very interesting and a great point because I feel like a lot of syndicators, specifically the newer syndicators, so much on the front end of the transaction and maybe not treat acquisitions and then operations. Well, just owning real estate as a business. That’s a very interesting point. I feel like I could probably pick your brain on that for quite some time, especially as a broker. Because I’m on the front end of the transaction and not more so on the asset management side, but I feel like that’s where there’s not a lot of creativity, so interesting stuff.
Neal, what’s the best way for listeners to get in touch with you?
Neal: I’m an educator first and foremost. I have a website. It’s called MultifamilyU. That’s Multifamily, followed by the letter U. It stands for Multifamily University. You can go and join Multifamily University. It’s free. I teach about 50 webinars a year. A lot of them are about optimizations.
For example, I’ve invented a system called LASAL. It’s a five-step system to increase velocity of leasing. I’m about to teach a webinar on step-by-step processes on how to use LASAL to boost your net operating income. Those kinds of webinars are on my website and there’s 50 of them every year. My email address is on the website. Feel free to reach out to me. You can even reach out to me now. My email address is [email protected] Feel free to send me an email. I think the website is probably the best way to interact because there’s incredible amounts of education there and for those of you that are interested in our passive syndications, our website is Grocapitus.com. All of our syndication projects are there. We work with both accredited and nonaccredited investors.
Mark: Very good, Neal. Thanks so much for the time. I appreciate the insight. Specifically, on how you’re using technology to maximize or be more efficient on the operational side.
Again, thanks for the time and look forward to connecting soon.
Neal: Thanks for having me on the show, Mark.