Sep 17, 2019
James: Hey audience, this is James Kandasamy from Achieve Wealth
Podcast. Achieve Wealth Podcast, talks to and interviews, a lot of
commercial real estate operators and focusing on a lot of our
discussion about value-add real estate investing. Today, I have
Neal Bower. Neal Bower is from Grow Capitas Commercial Real Estate
Investment Company. He negotiates [00:32unintelligible] and
acquires commercial real estate properties across the US. He has
almost 400 investors right now. A total portfolio size of 1800
units, in which, like around 1400 is multifamily and another 400
student housing. And I would like to welcome, Neal. Hey, Neal,
welcome to the show.
Neal: Thanks for having me on the show. James. Very excited to be
here.
James: Good. So, Neil, he has been on a lot of podcasts and you
know, a lot of discussion goes around the data collection and
experiments that you do in your asset management and in terms of
your operation and just finding the right cities, right?
[01:14unintelligible] and also operation leasing. So there's a lot
of data that's being collected. Right. So we can go to that in a
short while. My question to you, Neal, in the first place, why did
you start collecting all this data?
Neal: Well, I started collecting the data because I screwed up big
time. So I started my real estate career in reverse. I mean, most
people will start with a single family rental, right? I was a
technologist and I got a chance to actually build campuses from
scratch. My boss, you know, helped me. He was the CEO of the
company, I was the chief operations officer. This was a technology
education company and we were growing so much that we decided we
were not going to rent offices from somebody, we would build our
own campuses. And so that project of building that campus was
insanely complicated because, I mean, I hadn't even built a
single-family home. Here I am, building a 27,000 square foot campus
that's mixed use. It's got classrooms, administrative areas, and
restrooms and I had to learn everything from, you know, egress and
fire codes. And you know, doors that lock when there's a fire and
you know, ceiling heights, air conditioning, cooling, heating, and
500 other things related to that.
So it was a trial by fire. I learned very quickly and did that in
2006 and so 2003 then again in 2006 and got very confident about
real estate. I think in my mind, I got overconfident and so I went
and bought 10 single family homes in California, I timed them
correctly due to no credit of my own. It was just, you know, 2008,
2009 and got crazy confidence. I thought I knew it all. I mean that
the fact was I knew nothing and I didn't understand that. And so I
went to Chicago and bought 10 triplexes and I screwed up really big
time. I made massive mistakes.
None of those 10 properties really ever made any money and I
realized just how little I knew and I start because of that
disaster, which basically was a million and a half that got tied up
for five years with no returns in the middle of one of the
greatest, you know, gain markets of all time, I realized that I
needed to learn more. So I started collecting data about why those
units never made any money. And what it came down to is that I was
spending too much time looking at the rents and looking at the
units themselves and not spending enough time looking at the area
quality. The quality of the tenant base, the demographics of the
area, the income levels, job road levels, the population growth.
All of these demographics are mega factors that affect every single
thing that we do. And they affect them in a way that's very
difficult for us to ascertain.
It's almost like you're being carried along on a boat that's going
somewhere at 50 miles an hour, but you cannot see outside the boat,
right? That is a situation that is the reality of what is
happening. And so I started doing a lot of research and data
collection. And the more I collected data, the more I realize how
powerful it was if I could go beyond data collection to doing data
analysis and applying the analysis from one city to another,
applying these analyses from one neighborhood to another, from one
state to another. And the more I did it, the better I got at it.
And so I decided to do more and more and more of it. And that's how
my journey started.
James: Yeah. I think demographic analysis has been missed by a lot
of gurus out there who are teaching real estate investing,
especially even on the multifamily side, right? People are just
looking at numbers right now and I think commercial real estate
consists of two things and what is the user and the space, right?
So and we are missing out the demographic side of it, which shows
that the demand and I think that's what you're talking about in
terms of demographic and also what is the submarket demand, right?
What is changing over there? How is the crime rate, who is staying
there, what is the renter profile, right? What's the percentage of
renters versus owners? It's just not many people know how to
analyze that and that's a very important factor.
Neal: They don't even look at it. I mean, keep in mind a
neighborhood that has 30% homeowners and 70% renters is very
different. Both good and bad from one that has 70% homeowners, 30%
renters, right? So these things matter so much that if you ignore
them, then if you think that you're in control, that is an
illusion. That is an absolute illusion because those things are
really driving either your profit or your lack thereof. That's
really what's driving things, right? And so one example is, I mean,
I teach a course, it's called Real Focus. It's about the power of
demographics and how to apply them to create profit. And I teach it
Live to about 4,000 people a year. And I teach it online, to
another 4,000 people so there are about 8,000 people that take that
course. And one of the examples that I like to give people is this,
one of the most common statements, in fact, it might be the most
common statement of all in real estate is that real estate is
local, right?
So you hear that all the time, real estate is local. Well, actually
real estate is not local. James, real estate is hyper-local. So one
of the cities that I use in my examples when I'm doing demographics
labs for students is I talk about Columbus, Ohio. Columbus is a
good city to invest in, right? So doing really well, population
growth, job growth, income growth, all kinds of good things are
happening there. So in Columbus, there is a small neighborhood that
has an average median household income of $183,000 right? That is
not an A that is like an A++. So you couldn't really go much higher
than that unless you're in the San Francisco Bay area, you couldn't
get much higher than 183,000, no. Well, the point is that 500 yards
away from this neighborhood is another neighborhood where the
median household income is not 183,000 it's not even 18,000, it's
6,000.
500 yards between the richest neighborhood in Columbus, I think
it's the second richest actually, and the poorest neighborhood in
Columbus, that's how hyperlocal real estate is. And if you don't
understand how much that impacts you, obviously in this $6,000
income area, that's a condemned area, no one there pays any rent.
Everyone lives there for free in abandoned buildings to this
underneath $83,000 area where there's absolutely no cash flow,
right? Because the income levels there are very high, there's
really nothing available for sale. Everything's taken, everyone
there is rich, you know, single family homes that you know,
probably are like 1 million bucks. The differences there are
staggering. And that 500 yards shows you how much you're missing if
you don't understand how demographics drive everything.
James: So I mean, I definitely agree with you because I've seen
deals in the hottest market in the country and people just talk
about the city, right? But they don't talk about the submarket
itself or the particular location, right? So how would you go about
defining the boundaries of where you want to define the demand for
a specific deal?
Neal: You know, that's a very interesting question and what you're
really talking about is, you know, where does the neighborhood
stop? Where does the neighborhood end? So you could say something
like half a mile from me is a Whole Foods and next to it is a
Starbucks, therefore I'm in the best area. But the reality of the
situation is half a mile is also a very long distance. It's a very
short distance and it's a very long distance. Remember 183,000 to
6,000, right? That was half a mile. So what really could be the
case? Is that right where that Whole Foods is, a hundred yards
beyond that, there's a street, maybe it's a railway line, maybe
it's a freeway, maybe it's just a regular street and everything
beyond that is a different neighborhood, right? Different quality
of neighborhood. So you can't really compare this neighborhood to
the Whole Foods and Starbucks side.
And maybe, just maybe that neighborhood is only half a mile wide
and right where your property is, that street actually is another
neighborhood, even lower class. So it's very common for people to
say half a mile from me is Whole Foods. But actually, they are not
in the Whole Foods neighborhood. They're not even in the
neighborhood next to Whole Foods, which is lower grade, they're in
a third lower neighborhood themselves, like two grades lower now.
And that's what everyone has to figure out if you're looking to do
syndications or if you're looking to invest in projects. How do you
figure these things out there? There are many ways to figure them
out, to figure out where neighborhoods start and where
neighborhoods end. I use paid tools, so we'll talk about those and
I'll also give you some free tools. Neighborhood Scout is the best
neighborhood tool I've seen.
I've seen many of them, but neighborhoodscout.com allows me to do
two things. It allows me to basically plug in an address so it
could be a 200 unit property, I plug in the address, I basically
take, pull out a report and it shows me the neighborhood and it
also shows me the micro-neighborhood. Now there's a difference
between those two, right? The neighborhood itself is very powerful
because it'll tell, you know, income levels, crime levels, you
know, degree-granting levels, is it walkable? It'll tell you an
insanely large amount of extremely useful and immediately
actionable information. But the micro-neighborhood part is even
more powerful. So you'll see a map and on the map, you'll see the
neighborhood, right? You can clearly see what roads are part of
this neighborhood, where does the neighborhood start, where does it
end? Does it go all the way to that Starbucks, does it not go all
the way?
But then, inside of that map, you'll see a yellow dotted line,
which will show you a micro-neighborhood, and the property that you
just plugged in, the address is always inside that yellow. And what
neighborhood scout is trying to tell you is, okay, the greater
neighborhood, maybe it's a mile by a mile, right? That's the
typical size for a neighborhood. You know, one mile by one mile is
this, and then your property is part of a micro-neighborhood inside
of that. And how does it figure that out? What it does is, it looks
at your property, let's say it's a single family home and it looks
at the home opposite it and says, are these comparable? Okay, yes,
they are. Then it goes another block, are these comparable? Yes.
Are these comparable? Yes. Are these comparable? No. This is a
completely different kind of unit. So it says, okay, those units
are really not inside your micro-neighborhood. Something changes
there. Something's different. Maybe they're really ghetto or maybe
they're really brand new. And so the neighborhood quality changes
right at this line.
So that dotted yellow line is very important to me because the
moment I see that dotted yellow line, I put it on one of my
monitors and on the second monitor, I bring up Google and I go
switch into street view and I drive around the edges of that yellow
dotted line because I'm driving around the outside edges of the
neighborhood that I'm investing in. So that gives me a feeling
about that neighborhood. And then I'd drive the insights of the
neighborhood, it's a micro-neighborhood, so you can on Google, I
can basically drive it in about 15-20 minutes.
It gives me a really good idea of what's going on in that
neighborhood. Obviously, boots on the ground are better, I get
that. But at this point, I've just received this property and I
want to make a decision on whether I even want to, you know, spend
any time on the property and this gives me that information. And
Neighborhood Scout is very inexpensive. I think you can even get
like Neighborhood Scout for 39 bucks a month and you get 10 reports
out of that. So essentially for $4, less than a cup of coffee at
Starbucks, you're going to learn an astonishing amount about this
neighborhood.
James: But I mean, end of the day, we want to get rent comps and so
let's say the property they're looking at is within that yellow
dotted line but there's not a rent comp and now you have to go out
of that yellow dotted line, you would you look at your rent comp,
how would you compare the rent comp that point of time? Because
it's two different demographics.
Neal: It definitely is, right? So there's an art and a science to
the rent comps. Some of your rent comps will be inside the dotted
line so there'll be good and some of them will be outside the
dotted line. I think it's still useful because it's telling you
where's your micro-neighborhood and where's your neighborhood? But
normally you'll find that the vast majority of the time, the comps
from the broker are not inside the yellow line and they're not
inside the neighborhood.
James: They are in one-mile circle radius.
Neal: Exactly. And so people are like, well this is only a mile
away; are you kidding me? I mean, in San Jose we have areas where
the average home value is $1 million and half a mile away, the
average home value is $400,000 right? And those are bad areas like
really high crime areas. So everything can change in a mile. And I
think what this neighborhood scout does is it allows you to
basically firstly figure out if you should even be using that rent
comp, right? So it might only be three-quarters of a mile away but
Neighborhoods Scout shows you that your neighborhood, your
property, the one that you're looking at, is actually just at the
end of that neighborhood. So that neighborhood is ending right next
to your property and then this is three-quarters of a mile away in
a completely different sort of neighborhoods so you shouldn't go in
that direction looking at rent comps.
But another rent comp that the broker provides, it may not be in
the neighborhood, but it's on the edge of that neighborhood, it's
still only three-quarters of a mile away. But that one makes more
sense because your neighborhood ends right next to that comp. So
that comp from the broker actually makes more sense. I'm not saying
that every comp from a broker is fictional, that's not true. A lot
of brokers work hard on the comps. All I'm telling you is that out
of five comps that a broker will give you, truly two or three are
your neighborhood's comps. And this tool will show you which ones
to pick. And then there's going to be a couple that are going to
be, geographically speaking, still be in that one-mile radius, but
they have nothing to do with your neighborhood and that this tool
will allow you to basically ignore them.
And then on top of that, obviously there's rent comp tools, there's
you know, tools like Rentometer and a number of others. That four a
five or 10 you know, dollar report. There's another one, for the
moment, you know, also starts with the word rent. There are these
tools where you paid $14. I remember paying $14 for this report,
rent something and it gives me a report that is specifically about
a single family and multifamily rents, right? Nothing to do with
anything else, not demographics, simply about rents. And it gives
me all kinds of rent criteria, you know, it gives me occupancy
levels. Now I'm paying another 14 bucks and I've got rental
information for my area, right? It's not giving me comps, it's
basically explaining the per square foot rent. It's explaining how
many units in my neighborhoods are one bed, two bed, three bed,
those sorts of things so that I understand what the unit mix in
that area is and if it's a good unit mix. So now I've spent $18 but
I've gotten a huge amount of information.
And what I find is people are unwilling to spend these $18 right?
And syndicators are unwilling to spend these $18 and here's my
message to you, right? As a syndicator, you only make money if your
clients make money because they usually have a pref, right? So
they're going to make money first and then you have to make money.
You realize that on a 300 unit property if it does well, you can
make $1 million or even 2 million and if it does really, really
poorly, you make $0 million so you're paid less than the janitor
that cleans that property. And it might be that the only difference
and I know this is best case scenario, but it might be that the
only difference between that 2 million bucks and not even making
the janitor's salary, it might be those $18.
Because you forgot that part. You look at everything else in the
property and you fell in love with it and it had a beautiful pool
and it had a beautiful clubhouse and it had a beautiful this and a
beautiful that but you forgot to look at the demographics. Because
one of the things I can tell you is some of the worst properties
have the best looking clubhouses, right? So don't look at a damn
clubhouse because they made it that good looking because they want
to sell the fricking property to you and get out.
James: Yeah, yeah, yeah. I mean demographic analysis and in some
markets like what we're discussing right now, it's very, very
micro. And how do you really decide the deal has an upside in terms
of rent, that's why we look for in a value-add deal. Unless you're
not buying value-add deal, you just want cash flow.
Neal: Well, I think more and more of those deals, I mean more and
more of the value adds are becoming cashflow. I mean, let's be
honest here, James, nobody that I know of, no syndicator that I
know of is able to drive up rents as much today as they were two
years ago and certainly not as much as they were four years ago. So
I think that true value add is becoming less and less available.
Even the deals that are a full value add where we say, okay, we're
upgrading 80% of the units, I get that, that technically speaking,
if you're upgrading 80% of the units, that's a full value add. But
I would challenge whether 80% of those units would receive $150-200
rent bumps. Some will, some won't. I mean the market is changing,
the environment is changing. There's only a certain number of
people in that neighborhood that can afford to pay that higher
rent. And as you rehab more and more and more of the properties in
that neighborhood, it becomes more and more and more difficult to
achieve those rent bumps. So I think more and more people are doing
light value add. At least that's where I'm seeing the industry
moving to.
James: Oh No. Even myself, I moved from deep value add two years
ago to lighter. I mean, I still do value add, but it's no more the
deep value add I used to do and just because I'm doing more agency
loan nowadays, no more bridge loans19:47inaudible]
Neal: I think that's really wise because we have to be cognizant of
where we are in the cycle. And so I think you're doing the right
approach because a lot of these deeper value add projects, there's
another name for them and that is they're higher risk.
James: And you also pay a premium for it, right?
Neal: Yeah. Yep. Absolutely.
James: Nowadays, the sellers and brokers, you know, you're
basically overbidding the price up and you're basically taking the
value away by paying more.
Neal: Unfortunately that's the case. I mean, our company right now
has three rules. Number one, everyone is overpaying. Number two,
everything we buy, we've overpaid. And number three, if you don't
find new ways of adding value to the property after we buy it, we
weren't at our performance. These are our three fundamental rules
today in everything that we do. And none of these rules existed two
years ago.
James: Got it. So coming back to the submarket analysis because I
think you have talked about a lot of CT level analysis in lots of
other podcasts so I don't want to repeat that again here. Coming to
sub-market analysis, so let's say you're trying to prospect a
market, right? So let's say I know you like Boise, Idaho, right?
That's the top market that is. So let's say now you have Boise,
Idaho, how do you go about prospecting within this city, right? How
do you look at whether the deal, because the cap rate in the
southern part of the city may be different in a certain part of the
city, right? So how do you go about prospecting or do you just get
the deal and start going?
Neal: The true answer is that you know, several years ago I didn't
have the kind of broker and partner operator relationships that I
have today. My initial approach was to use a tool like city-data. I
use a number of different tools, but neighborhood scout is my
favorite, neighborhood level tool, city data, plus local market
monitor, plus housing alerts, these three are my favorite city
level tools. And then, of course, there's Costar. Costar is not
just a demographics tool, obviously. Costar has a huge number of
other benefits. The biggest benefit of Costar is supply. It
understands incoming supply in the market, which as far as I know,
no other demographic tools understand. Simply because Costar has
these 50 Prius cars that drive around 50 US Metros on a daily basis
trying to figure out all new construction that's going on and
totaling it up and trying to figure out if demand is in excess of
supply. And in many great neighborhoods, really good neighborhoods,
demand is often not in excess of supply.That's because the
neighborhood is so great that people are building 3000 units in a
two-mile radius of you, which means that everything might be hunky
dory now, but two years from now you'll be in trouble. So I don't
have a cheap answer to give you when it comes to neighborhoods
supply levels, really, Costar is the best option to look at supply
and make sure that you don't end up in a market where you'll have
3000 brand new units, you know, delivering and they'll have, you
know, two months off as concessions and basically tank your rents
for a year. So that's my feedback on supply.
Now away from supply, looking at demographic trends, you can do
that analysis on a tool called city-data.com. So when I look at
city-data, there's a map on city-data so you plug in the city. So
it could be Houston, could be Columbus, could be whatever city
you're in; it works better on midsize and large-sized cities.
Doesn't work well on like a really teeny tiny city like Saint
George. You're not going to get as much value out of that too. So
let's say you're in Houston, right? So go look at, you know, scroll
down, you'll see this very nice blue colored map of Houston and you
notice something very unique. This is something I haven't seen in
any free tools. That map of Houston is already broken up into bits.
And you'll notice that some of the bits are really tiny, like half
a mile by half a mile and some of the bits are big, two miles by
two miles, three miles by three miles. And what city data is
telling you is that that tiny little bit, everything inside that
resembled everything else inside there, but that big one that's
next to it, the two mile by two mile, once again, the same
principle applied, everything inside of that two mile radius
resembled everything else. That's why some of these neighborhoods
are tiny, some are mid-size, some are large size.
So what you're really looking at in that map are the neighborhoods
in that particular city. Right? And if you click on any one of
those little tiles, a box will pop up and that box will give you
information specifically about that neighborhood. And there are
five metrics in that box that I like to use. Now keep in mind if
you pay for neighborhood scout for that particular address, you'll
see more information than this, but obviously you're paying for
that. If you want something for free here it is. That box, the
first thing we want to see in that box is the income level in that
micro-neighborhood, remember it might be like 400 yards by 400
yards. You want the income level, the median household income level
in that neighborhood, you want it to be above $40,000, 38 is still
okay in some of the Midwest states, but what I find is when you're
down to 35 it doesn't matter where in the US you are, you're going
to have delinquency trouble.
So the median household income of 38,000 is the minimum acceptable
level for multifamily projects. Obviously, this number has to be
higher if you happen to be in San Francisco, it has to be higher if
you're in New York. So I'm going to basically say the rule doesn't,
that 38K number is really for markets that cashflow, right? So
Texas markets, Florida markets, you know, maybe not Miami, but the
rest of the Florida markets, that cashflow, maybe not central
Austin. So understand what I mean by cashflowing markets. Here's
what you'll see at 38K; when that number, the median household
income in that box, when it starts going below 38 K, your
delinquency levels start rising. And the true killer of profit is
not occupancy. The true killer of profit is churn. And churn is
tied to delinquency. Delinquent tenants, some of them do care about
their credit, and so they just simply move out. They just leave a
key and move out and they basically say, yep, you know, I'm going
to skip and let's see if this guy's going to chase me. Because they
know 90% of the time, it's not worth your while to chase them and
try and get that money. You just move on. You rent out your unit,
you move on with your life. And these skips and the delinquency
connected with them, the repainting, the time that it takes, the
marketing costs, the effort, the people time, kills your profit.
And what I found is by the time you dropped from $38,000 in median
household income to 30, the property and the project, for the most
part, has become viable. I do not know of any syndicators that can
make a profit in a neighborhood that is under $30,000.
I've made that mistake myself. I haven't been able to make money.
So to me, that first number that is an absolute is, go into a
neighborhood that has the income to support what you are trying to
do. Keep in mind, you're trying to raise rents, right? So even 38
is kind of borderline, right? I tend to basically use 40,000 as my
minimum number. I have properties that are at 42 44 46; if you're
in the fifties you're doing really well. If you're in the 60s then
your property is getting closer to a 'B' and by the time it hits
$70,000, you are in a 'B' area. So a 'C' area, one of the
definitions, my favorite definition of 'C' area is 40 to 70,000
income, right? And a 'D' area is $30,000 and below. So 'C' minus is
40 to 30.
And obviously, these are metrics I made up myself. You could
successfully come to me and argue, no. In my area a C minus is not
40 to 30, it's 35 to 25 I'll just say, okay, that's fine. These are
rules of thumbs that appear to work in the vast majority of the
United States that people are investing. It may not work in your
area, no argument, but I think that within the bounds of them being
rules of thumbs, they do work really well because they allow me to
understand the quality of an area.
James: Got it.
Neal: There are states that have lower delinquency. Utah for
example, for cultural reasons, you can go a little bit lower than
that simply because 10% of their income is going to the church,
right? Everybody in Utah, very religious people, they contribute
10% of the church, which means that when they do get in trouble the
church helps them out, right? So many times in Utah you can have
lower delinquency even in markets that are under 35K. So that's a
cultural issue, a cultural benefit that they have, but it doesn't
necessarily apply to most parts of the US. So that's the first
thing that comes up in that box. Remember, we're in city-data,
we're looking at the blue map. We're looking at the tiles and we're
clicking on them in a black box comes up. Well, the first thing
there was income.
The second thing that comes up on that box is the poverty level,
right? It's very much tied back to the income. And poverty level,
you want to be below 15% as much as possible. If you can be below
10%, you're going to do really well, but 15% I think is acceptable.
And if you don't mind taking more risk, if you're in a noose
indicator and you really need to get going, then maybe 20, but I
can tell you if that number is 30, you can't make money. It doesn't
matter how high the rents are. It doesn't matter how many units
have been bumped up by the previous guy and they have $200 in rent
bumps and 300 and all that wonderful stuff, it doesn't matter. At
30% poverty levels, you cannot get 12 consecutive months of rent
from your tenants.
James: So do recommend, I mean, I know that's the job of the active
sponsor when they find deals, right? So even the passive investors
should go and look at deals...
Neal: Why not? Everything I told you, if you, you know, take this
podcast and it's going to be on James' website, you can go to
Florida or whenever the heck you feel like. Right? So it shouldn't
take you as a passive investor more than 10 minutes, the rule still
applies. And keep in mind that a lot of class 'C's are going to be
borderline on this so don't expect that good syndicators are really
buying properties at 5% poverty levels. 5% is not a good deal; at
5%, that's a class A area. And your syndicators not going to make
you any money, so there's no problem with it being borderline. You
just don't want it to be too far from these numbers that I'm
giving.
James: Correct. Correct. So let's say you get a deal today on the
neighborhood that meets all your criteria, right? Poverty level,
household income and all that, so how would you go about
underwriting that deal? What's the first thing that you will look
at?
Neal: Well, I look at the numbers, the same demographics numbers to
determine what my delinquency numbers are going to be. Because I
find that I can raise a property's occupancy so there are certain
levers that I have that are typical syndicator doesn't have.
Syndicators don't have marketing teams, right? Syndicators
basically have a property manager. That property manager might be
good at marketing or bad at marketing. They're typically bad but
they're never excellent, right? So we basically decided early on
that that extra value add that we have to add in that no one else
is adding in, is marketing. And by marketing, I don't mean investor
marketing, I mean tenant marketing.
So for every property that we have, we're actually adding more
leads on top of what the property manager is generating. For some
properties, it's 30% more than they're generating; in other
properties, it's three times more than they're generating. So
they're generating a thousand leads a year, we're generating 3000
leads a year and giving those leads to them. So I can basically
move occupancy numbers up, you know, and I'm very confident about
those. So I go back to delinquency. So I look at the delinquency of
that particular area. Obviously, Costar gives you delinquency
numbers, so that's very good, useful information to have for that
particular neighborhood.
The other thing that I like to do is, and this is not always
available, is you can get bank statements from friendly sellers.
Not every seller gives it to you, but some do. And one of the nice
things about the bank statements is that some property managers,
previous property managers have basically put all the money in like
in one check. But most of them actually put the money in like every
few days. So they collect the checks and then they go to the bank
every day or every other day and they put the checks in. So to
understand what the quality of the tenant basis and what they're
capable of absorbing in terms of rent hikes, simply look at the
checks to see how much of the money is coming in in the first five
days, how much of it is coming in the next five days, how much of
it is coming in the five days after that? Then the five days after
that, then the five days after that. They might be saying that my
delinquency rate is 2% but what if their delinquency rate was 25%
on the 15th of the month?
Well, that area, that kind of area where you still have 25 30% of
the rent hasn't come in on the 15th, you have to be careful about
not being over bullish on how much you can really raise the rents.
There's a limit in that market, right? It may not be $200, it might
be $120 that you can raise. And accordingly, you want to also cut
down on your rehab budget. Because your rehab budget can be 6,000,
it can be 8,000 give me 12,000 but in an area where you know,
overall income levels are low, let's say 38,000, and you can see
that 20 30% of their tenants don't even pay until the 15th, I'm not
sure there's any benefit to doing a $12,000 per unit rehab. I'm not
even sure you want to do an $8,000 per unit rehab. I think six or
four might be better.
Rehabbing does have benefits. The velocity at which your lease
increases tenants, like the newer units, but beyond a certain
level, it's not that they don't like the units, of course, they
love it, they're just not able to pay for it. And when you don't
want to end up in a situation where the tenants, all of your new
tenants that have come in, those are the guys that are becoming
delinquent because really their capability was to get $850 a month
units, but they're all in the thousand dollar upgraded units. And
so now, all of your upgraded units are the ones that have very high
delinquency so when I'm underwriting, those are the sort of things
I'm looking at.
James: Got it. Got it. Yeah, it's very interesting to see
delinquency and you say Costar has the delinquency data?
Neal: Costar has neighborhood level delinquency data. Yeah, some
market levels. So you can basically go in. That very long report,
that's like 86 pages, it has averaged delinquency for a particular
market. I'm not sure how they get it. No, I have no idea. But
what's nice is they also have expense data, right? So they have
expense data. Obviously, you talk to property managers about
expense data as well but Costar gives you, you know, kind of the
average expense for the submarket, the average payroll for that
particular submarket. I find that people trying to beat the average
payroll by 20%, it's wishful thinking.
James: Yeah. How do you differentiate delinquency between the
property management's skill versus real delinquency for the area?
Because it could be just the property managers are not doing a good
job, right?
Neal: I think so. So one of the services that we provide on in
properties that have higher delinquency, sometimes we have
operating partners that don't want to do it but most of the time we
do it is we make my staff, our staff, not the property management
staff, will make delinquency calls on the sixth or seven. So we
don't do it all the time, we don't want to do it. But let's say the
property has consistent delinquency problems, consistent; one of
the ways to figure out the answer to your question is, is this a
tenant problem? Is this a PM problem? Hire somebody, give them a
script, have them call every tenant that is not showing as having
paid by the sixth of the month, make three phone calls, actually
make two phone calls and two text messages on the sixth and the
seventh. Repeat the process on the 10th and the 11th. If you do
that for three straight months and your delinquency is still high,
it's not a property manager problem.
James: Well, you find that out after the fact, after you bought the
property. Is there any way to find before you buy?
Neal: Well, other than the demographics information I gave you? No,
not really because the truth is that it could still be a
tenant-based problem. But it could be that the previous owner was
self-managing the property and let a bunch of deadbeats that should
not have been in there. That in my mind is a management issue but
not a property manager issue and that's also an opportunity. You
bought this property because you think rents can be at 1100 with
low delinquency. Right now, they're at 900 with high delinquency.
Maybe the guy just let in a bunch of deadbeats so you can ask for
credit reports of the last 25 people that have been put in, what
was the actual credit report? Some owners will give it to you, some
won't. If they're not giving it to you, you have to question
yourself why that is the case? Was he just basically trying to just
fill up the property? And, in that case, it's not such a bad thing.
You just have to know that when you go in, you're going to have a
lot of evictions to deal with. But in that case, it's not a tenant
base problem. It's not a property management problem. It's a
previous owner problem and you are going to benefit once you churn
through all those bad tenants, you're going to have four years of
good tenants in your property so you can still hit your performer.
You just need more maintenance budget, you need more operating
budget and you need your investors to be a little bit more patients
because your first 12 months are going to be very rocky.
James: Yeah, absolutely. I'm sure you've seen a lot of financials
when you're underwriting a deal, right? So is there any dirty
secrets by sellers that you have found from the financials or when
you walk the unit and see, aah, they are tweaking these numbers
here to make the property more appealing to the buyer?
Neal: I mean, everybody has their own stories about these
financials, right? So the one that I find that is fairly common is
that you're going into a property, you want to be able to tell
during your due diligence, don't do this during their contract
negotiation. But during your due diligence, you basically call them
and say, hey, we'd like to talk to a bunch of your tenants. And you
randomly, always pick a bunch of tenants to talk with and make sure
that there's nothing shady about their rent. So you have a tenant
that's at $900 and everybody else is at 800, let's pick that tenant
and let's talk with him. Let's make sure that there isn't some side
deal where that tenant actually is paying 900 bucks and is being
reimbursed $200 in cash.
James: Has that happened?
Neal: that has happened; not in a 250 unit type property, but in a
70/80 unit property. Basically, what had happened was all the new
tenants that had started in the last four months, were all
receiving cash back, right? I think there were 12 tenants and
between them, $2,400 a month of artificial rents were created,
which is $2,400 a month is $30,000 a year, $30,000 a year at six
cap is basically $480,000. So that $480,000 for the seller was
created by him negotiating direct deals with those 10 people and
giving them $200 kickbacks. So his cost was 2,400 a month for three
months and his profit was 500.
James: Wow. I never heard that. That's really sneaky.
Neal: Very sneaky. But you think about how much of an incentive
that guy has to do it, right? Technically it's not illegal, by the
way.
James: It's not illegal?
Neal: It's not illegal. He has to disclose it to you that there's a
side arrangement, but you can't actually send somebody to jail for
this. I mean, you can't sue them and win, in my opinion.
James: You can't say it's a fraud?
Neal: I think you can. I think that that's going to be fought over
in court. In my mind, it's something that you should basically, in
due diligence, if you look at higher numbers, make sure you talk
with those tenants. It doesn't take that much time; during due
diligence, you're at the property for multiple days. Right? Why not
have conversations with four or five people and make sure
everything's above board. Say, hey, we were looking to buy this
property and just checking your rental contract and it shows $900 a
month, is that correct? And if there's anything shady, that guy is
not going to fall on his sword for the previous seller.
James: Yeah. I mean, I've done all the due diligence for my
properties. I never talked to the tenants. Do they allow to talk to
the tenants when you are doing?
Neal: Usually they do. I mean, obviously, they won't allow you to
talk to a hundred tenants, but if you randomly pick three or four,
they do. It's just not something that people ask for commonly, but
there's no reason for them to have an objection. So that's one that
I've seen commonly.
The other one that I've seen commonly is that everything that
you're looking at is actually coming out of the property management
software, not from the bank statements. So you look at the property
management software and it says $111,000 in monthly rents. But when
you look in the bank, it's just 88. So what they're doing is
basically they're not allocating for bad debt properly. And they're
saying, oh, I'm sorry, this the way that our property management,
Blah Blah Blah Blah Blah software works. What they're trying to
basically say is, Oh, I'm sorry you caught us, but we're going to
try and explain it away as some idiosyncrasy of the way our
property management software works. But you know, yeah, we didn't
actually make 111 that month, we only made 88,000. So I think
reconciling bank statements to what the property management
software says, is very useful.
They may not be trying to screw you over or anything so the
difference may not be 88 to 111; it might be 88 to 91 but it still
shows delinquency in that property.
James: So have you had any of these cases and you backed out of the
contract?
Neal: Yeah, I have.
James: Okay. It's also tricky nowadays, in the hot market nowadays
because people are paying day 1, hot money.
Neal: It's very difficult. That's what scares me a lot. I mean, you
pay hard money and then you find something where they've tricked
you. The only way to get that money back is to sue them.
James: Correct. Because people are paying like in a hot
market...
Neal: Even $200,000. I mean, it's ridiculous. I mean, that tells me
that something is wrong. In my mind, there is no conceivable reason
why anyone should pay $200,000 hard on day one. This is all frenzy
that has been created by brokers and it's a sign of an unbalanced
market. There is no reason why that should ever happen.
James: Yeah. Yeah. I mean they do have something called early
access agreement where you can go and see the rent roll and all
that, but you can do a thorough due diligence. Some sellers allow
it, but nowadays, even that nowadays they don't allow.
Neal: Well, in my mind, James, I mean, if that is their intent, why
don't they just say, okay, well we'll go hard on day five. When
people want you to go hard on day one, there's no way to tell if
they are doing it because they are unethical or simply because they
weren't, you know, somebody who has enough skin in the game and
enough confidence in his ability to close. The majority of the
time, the reason is perfectly legitimate that they want you to
close and so they want you to go hard on day one but I don't think
that that's the reason 100% of the time or anywhere close to 100%
of the time.
James: Awesome. Yeah. It's a bit scary when you do day one hot
money. So coming back to value-add, I presume all the deals that
you're doing is value-add deals, is that right? Not a deep
value-add or not completely.
Neal: I have some deep value-adds but a lot of them are, you know,
standard $6,500 type value-adds.
James: So what is the most valuable value-adds that you see?
Neal: Oh, it's easy. The single most valuable value-add are USB
ports. One in the kitchen and one in the bedroom. So of all value
adds, nothing comes close to that.
James: Really, especially just because everybody needs a USB.
Neal: Because everybody that comes in comments on it, right? So
everybody that comes in comments on it and this is one of those
universal things where men and women comment on it equally. And the
better value add is, you know, these days, the wall plates, right?
You get the wall plates with a two USB ports, correct? So if you
wanted to really wow people, the new USB Dash C standard, pay $4
extra for one that has two standard USB ports, but the one in the
middle is that new USB Dash C. So I think those are incredible,
incredible value adds; they give you a hundred X return.
James: Awesome. Awesome answer. That's absolutely helpful. So now
let's go to a bit more personal side of questions, right? So why do
you do what you do?
Neal: The truth is I fell into it, right? So this hasn't been a
conscious thing. I did technology. I started doing real estate
because I was paying 50% in tax. So basically tax avoidance was the
primary reason why I fell into real estate. But I think the bigger
thing was that on the technology side, when I had W2 income, you
know, many years I made more money than I made in real estate but I
always felt nervous. It's like when you have $150,000 salary,
you're always nervous about your position. Like, I always have to
perform, I can never have a bad year, right? Because they might
start thinking, well, we could hire two guys for 175 k each and get
rid of this guy, Neil. So there was always that nervousness about
not being in control of my destiny. And I don't feel that now. It
doesn't matter if I have a bad year and I only make a hundred
grand, but I still have control of my destiny and always make it up
next year. So to me, I think it was less about ownership and more
of our control over my destiny.
James: Okay. But you will keep on buying deals? I mean, is that
what your plan is? I mean, where do you want to stop? So what
drives you to bite the next deal
Neal: In my mind, what drives me is that I still feel like I'm
creating value in each additional project. I'm finding some way to
make those projects work. I'm contributing and I'm making investors
happy and also, you know, increasing my own net worth. Will I keep
doing it? No. I think that truth be told, I mean, I admire people
like JC Castille who just love it so much. He says, Neil, I'm going
to be doing this for 30 years. And I said, if I know one thing for
sure, I mean you're very sure about what you just said JC, I met
him recently. I know for sure I won't be doing this in 30 years and
I know for sure I may not even be doing it in 10 years. I mean, to
me, I think that life is an evolution and I don't mind telling my
investors, look, I'm going to do this for five to 10 years and then
I'd like to do something else because my career is very
diverse.
I've done solar education. I've done basically businesses around
nursing. I've done high technology; like three different kinds of
high technology, staffing, consulting, education services. I've
even been a primary investor in a gas station. I'm an entrepreneur
and what that means is at some point, I want to create the systems
and processes so other people who are smarter than me can continue
running the business forward.
And so my most coveted title is not founder and it's not CEO, it is
chairman. And so the longterm goal is that at some point, I want to
switch to doing that. But I would not hesitate to shut down the
business if I didn't feel I was adding value. This business only
survives when it adds value if it doesn't add value, making it or
forcing it to survive makes it a parasite.
James: So when you say add value means, add value to your personal
life?
Neal: Add value to my investors. So by default, I don't say add
value to my personal life because if I add value to my investors,
the adding value to my personal is automatic. It happens by
default, right? So to me, the only kind of add value that we should
be looking at is adding value to our investors. And if it doesn't
add value, we'll do something else. It doesn't mean I'll go out of
real estate. You know, one of the things is I'm a very unusual
syndicator in that half of my projects are new construction. And
the project that I'm coming out with this week is called The Grid.
It's a $30 million student housing project, new construction. And
so why? Because as the market shifts and Class C properties become
so expensive that everyone's buying six cap on actual or five and a
half cap on actual, then in the back of my mind, I'm going, well,
you know, I can make a brand new class A for seven cap. I know it's
risky during construction, but let's say I get through the
construction phase, isn't it less risky? Because at this point, you
know, maybe it's not seven cap, maybe six and a half cap, but don't
I have a six and a half cap, Class A building? What's the worst
that could happen? Do we have a recession after dropped rents? So
what? It's still a seven cap building and it's a brand new. That
part of it is not going to change if I can't raise my rents. So I
look at that and I go, you know, there's this whole business of
buying Class C's at five and a half cap is scaring me.
James: Yeah. I was talking to a broker the other day. He was trying
to get me to buy a 1960s product at six cap. He says Austin is good
now. Then I say what about the B class 1980s? Oh, it's like five
and a half cap rate here. I'd rather buy the five and a half cap
than buy the six cap; doesn't make sense, right?
Neal: I agree with you. And honestly, you should not be, you know,
between a B and a C, if there's a half gap difference always, by
the B.
James: Yeah. Yeah, exactly. So is there anything that you do in
your daily life that you think has contributed to your
effectiveness in becoming very successful?
Neal: I think structure. I'm a robot that has some human,
characteristics and I like being a robot. I am extremely
structured, absolutely structured, all the time and I feel that
it's difficult for people to tie themselves to structure. That's a
very hard thing to do because we feel like we are losing something
about ourselves. We feel like we're losing a part of our humanity.
What I have found is that it's actually the reverse. I'm very
structured. I start my work, I work with an extremely high
intensity and then I stop and when I stop, I completely stop. I
have nothing to do with work because I make sure that every second
of those 11 hours or 10 hours that I work really count. And to me,
I think that that makes me have a significantly greater output than
some other folks.
James: Got It. Got It. Any advice for newbies who wants to start at
multifamily?
Neal: Yes. Right now be careful. Please understand that while there
is no crash on the cards, I don't believe in all this nonsense
about, you know, prices going down 20%. People say that they
clearly don't understand macroeconomics, but you are buying at the
peak. This may be a peak that is sustained for a significant amount
of time, due to the fact that basically, it's very difficult for
prices to come down because of macro reasons, but you certainly not
going to see the kind of all ships rising effect that we have seen
in the last five years. You're starting now, please do not apply
the past to your present. This is a tough time. It's going to be
very hard. If I was starting today in 2019, the 2013 version of me
would advise the 2019 version, not to start. That's how frank I
have to be. If you're starting that's fine, but I think you should
be cautious and be aware of what kind of environment you're in.
James: Got it. Got it. Well, Neil, thanks for coming to the show.
Can you let the audience and listeners know how do get hold of you
and how to find you?
Neal: Sure. I think the best way is through education. I'm an
educator, I connect with people through education. I have a portal
called multifamilyyou.com. We have about 50 webinars that we do
every year on multifamilyyou.com. We archive all of them. They're
deep dive webinars. They're very different from podcasts because
there's a lot of displayed content and tens of thousands of people
attend those webinars each year. So that's probably the best way to
connect with me. I don't mind people having my direct email
address. My email is Neal, that's the Irish spelling, n e a l
neal@multifamilyyou.com. So you connect with me.
I also connect with people on Facebook. I think about 10,000 people
connected with me on Facebook. And then multifamilyyou.com. If you
want to learn more about demographics, I have a free course. It's
at udemy.com/RealFocus. That course, I think right now has about a
thousand people enrolled. So it usually has 1,000-1200 people
enrolled at any given point in time. So that's also a completely
free course. We don't believe in pitchers, if you're a presenter
and would like to present our platform, approach us, but it has to
be pitched free.
James: Awesome, Neal. Thanks for coming and adding huge value to
our audience and listeners, I'm sure everybody would have learned a
ton of things today. Thank you.
Neal: Thanks so much. Thanks for having me on the show. Bye,
James.