BiggerPockets Podcast 052 with Ken McElroy Transcript
Link to show: BP Podcast 052: Buying Apartment Complexes, Raising Millions, and Building a Profitable Business with Ken McElroy
Josh: This is the BiggerPockets Podcast, Show 52.
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Josh: What’s going on, everybody? This is Josh Dorkin, host of the Bigger Pockets podcast, here with my man, Brandon Turner. What up, B?
Brandon: What up, J? How’s it going?
Josh: It’s going all right, man. It’s going all right.
Brandon: How’s your week been? You want to tell people what you’ve been up to?
Josh: Laugh at my misfortune.
Brandon: I will laugh at your misfortune. People will get a kick out of this.
Josh: Before I tell you what my week was like, I will tell you that I got a Facebook message from my brother-in-law who said that your new nickname is Murphy. So I was in Southern California for the past two and a half weeks for holiday with the family, and yeah, it was cool, man. We drove out, had a good time, arrived, had to go to the emergency room a couple of days later. Christmas morning, had to go to the emergency room that night. Daughter almost drowned. A couple of days later, she fell off a horse. Couple of days later, I had to go to the emergency room and when I got home from our wonderful trip after a nice, long drive with the family, of course, I show up to a house whose boiler was not functioning.
Josh: Yeah, so when we got in, it was a nice balmy 40 degrees in here, with the bricks as cold as ice in my nice, brick house.
Brandon: This has been the week where everything in the country froze. This was like the coldest in 20 years or whatever. And you have no boiler. That’s awesome.
Josh: I can’t complain. Honestly, 40 degrees in my house is better than minus 500 up in Canada and Detroit and other places.
Brandon: Well, for those who can’t see, because this is obviously an audio podcast—Josh is in a Eskimo parka on on this podcast recording right now. It’s pretty great. He’s bundled up, nice and warm.
Brandon: It’s awesome.
Josh: For sure. I’m glad you got your kicks off of my misfortune.
Brandon: Yeah, it was great. Laughing at your pain. Anyway.
Josh: Yeah, man. So we got a cool show today—I think this one—no, I know this is one that you are personally very excited about because our guest is one that you’ve been a monster fan of for a long time.
Brandon: It’s like Justin Bieber to me.
Josh: Yeah, that’s kind of creepy. So what you’re saying is, you like Justin Bieber?
Brandon: No, no, no. I like our guest today like some people like Justin Bieber—admire and respect and look up to.
Josh: Yes, because Justin Bieber is—
Brandon: I admire and respect Justin Bieber as well.
Josh: Yes, of course. Of course. All right. So, today’s guest is Mr. Ken McElroy. Ken is a very active real estate investor and the author of The ABCs of Real Estate Investing and The Advanced Guide to Real Estate Investing, two bestseller books.
Brandon: Those are two amazing books. It’s actually on our list of the Top 21 best real estate books, which I’ll link to in the show notes.
Josh: For sure. For sure. So the cool thing about this story is Ken started out like most of our listeners, with absolutely nothing, and now runs a company with over 250 employees doing multi-million dollar deals left and right. So he’s definitely somebody to get inspired from and learn from. Today, we’re going to talk about his story and even get into some specifics on a $9 million dollar apartment complexes that he funded in just 20 minutes, which is a pretty cool story, so of course, stick around for that. But really quick, before we bring in Ken, we’ve got to do our Quick Tip.
Brandon: All right, today’s Quick Tip is—make sure to check out the BiggerPockets’ Member Blogs. We send you guys to the BiggerPockets Blog all the time but we also have this network of blogs that anyone can create a blog for, and there’s a ton of really, really good content in there so definitely jump in there and see what your peers are writing about at BiggerPockets.com/blogs . And for those of you who are wondering how we decide who shows up on the BiggerPockets blog, we actually do pick our bloggers mostly from the BiggerPockets member blog area of the site. So if you’re interested in potentially becoming a writer on the BiggerPockets blog, get working on one of our member blogs and maybe we’ll ask you to come and join us.
Josh: Cool. That’s actually how I started.
Brandon: It is indeed. There you go.
Josh: See? Quick Tip.
Brandon: Quick Tip.
Josh: All right, man. Let’s get to the show. Long intro. Sorry to keep you waiting, but well worth it. Let’s get to it. Ken, welcome to the show. Good to have you here, man.
Ken: Thank you, thank you. Great to be on.
Brandon: Yeah, it’s good to have you. I’ve said this on previous podcasts but I might as well say it here publicly to you, Ken—your ABCs of Real Estate Investing—that book is actually what got me into apartment investing and why I bought my first apartment complex, so I want to say thank you.
Ken: I hope it worked out.
Brandon: It did. I still have it today and I love that thing. So yeah, thank you. I’ve been looking forward to this show for a while.
Josh: He’s very excited.
Brandon: I am excited. Look at this. Look at me.
Josh: All right, go ahead, Brandon. Come on.
Brandon: All right. First question that we like to ask everyone—well, before I actually ask the first question, let’s actually go back a little further. How long have you been investing for? Then, I’ll ask the normal [inaudible][6:11].
Ken: Ah, good question. I grew up in the Northwest, not far from where you are, Brandon—
Brandon: That’s awesome.
Ken: I went to Pacific Lutheran University in Tacoma and I start buying small single-families and condos just like a lot of people, how they start. That was in the late ‘80s.
Brandon: Okay, cool. You got started—was that in college or right after college?
Ken: Right after. I completely stumbled upon it. Like a lot of people do in real estate, it wasn’t calculated. I didn’t go to school for it or anything like that. I actually went to school for business. And I just completely stumbled on—a buddy of mine was doing a condo project and I ended up buying one of them.
Brandon: Okay, cool. You’ve got to tell us a little bit about that first project.
Ken: Yeah, it was a two-bedroom, two-bath. It was about $110,000 and it cash flowed at like $100/month, right at $100—that was of course if it was occupied. And then like a lot of people, I just kept doing it and luckily, I was in the property management business. I lived in Seattle so I was managing properties all up and down I-5 there, all the way up into your area, actually. I had some stuff in Aberdeen and all the way north of Bellingham, so I kind of cut my teeth in the Northwest, learning all about tenants and occupancies and rent and expenses. So that was really my competitive advantaged. When I got an opportunity to buy, I really understood the business.
Brandon: So what got you into the property management field? You got that first condo. Why did you decide to sell and deal with the headaches?
Ken: Like most students, I was broke. I had no money. I needed a place to stay and my buddy was working for the company. The big company in Seattle now, it’s called Pinnacle. And it was, at the time, called Goodman Management. John Goodman. He worked there, he called me up and said, hey, I’ll give you a free place to stay and a salary and that was it. I did it.
Josh: So you started working for Roseanne’s husband.
Ken: Yeah, exactly right.
Brandon: That’s the same guy?
Ken: No, no.
Brandon: I was like, wow, I didn’t know he was into real estate.
Ken: I was loaded with student debt and I had just a very little salary, and of course, when you’re a student, you have none. So a little salary and a free place to live was a good place to start. And actually, I learned a lot about the business. It was a 60-unit apartment building right at downtown Seattle at Cedar and 4th, so right by Cobalt TV and underneath the Space Needle, so that’s where I started.
Josh: That sounds great. It’s something I hear a lot of people do is barter their time for free rent as a resident manager and we haven’t really talked to anybody who’s done that before. I’d be curious to kind of pick your brain a little about what that was like.
Ken: Well, it was a huge education. My dad had a construction company, so I did know a little bit about how to fix things, but man, trying to figure out how to keep the place clean, keep the place occupied, market it, do the books, and all that kind of stuff, school cannot prepare you for those things. I just had a lot of people at my disposal and the things I didn’t know, I asked. And I ended up staying there about a year, a year and a half. I got my real estate license while I was there and then I started to work for that company more on a regional basis. But we could do a whole show just on the stories from that one place.
Brandon: Oh, sure. So you got thrown into the fire and pretty much learned very quickly that way.
Ken: Yeah, literally, no joke—the manager and the assistant manager—my very first job was to fire both of them. And I was fresh out of college. I had never terminated anybody in my life. It was a huge education because I had—people that lived there were a little upset when they had like, to pay rent, and those kinds of things.
Brandon: Wait, I have to pay to live here?
Ken: We’re just here to party and have fun. So it was fun from that standpoint, but one of the stories—I could go on and on and on—but it was a great way to start.
Brandon: Really quick, would you recommend that other people start out that way?
Ken: I would. I would. In fact, it’s funny you asked that question. We actually have had people that want to work for our company now, because now I have a large firm as you know, and it’s based in Scottsdale, Arizona. We have 250 employees so what we do is we actually take people and put them at the property first. So they understand what it’s like to lease a unit, what it’s like to clean a unit, what it’s like to deal with a resident dispute, what it’s like to collect rent or try to collect rent, and all the pressures and all the things that happened at the site level because it makes them more valuable when they work in the corporate office.
Brandon: Okay, cool. Let’s move on a little bit to something we like to ask a lot of our guests, especially guys like you who have written books before and are a little more well-known—we want to know a little bit about mistakes or things that you’ve maybe screwed up on in your life. Do you mind sharing the downsides or things that haven’t gone well for you?
Ken: You want me to just focus on today, you mean?
Josh: Yeah, what’d you break today, Ken?
Ken: You know, it’s funny, school kind of teaches you not to make mistakes, obviously. So I was afraid when I first got out of school to even admit that. And it took me a while to figure out that the faster that you fail, then the faster you make mistakes, the smarter and the more educated you get. And you know, I never took any real massive risks but I always took small risks. And boy, I really have quite a few mistakes in every single way. Mistakes in what I thought I needed to do before I bought a building. Mistakes in hiring people. Mistakes in raising equity and getting that. Mistakes in the property management business when I was getting in that. Gosh. It’s just—mistakes in hiring employees at a later date. Mistakes of making the wrong choice of residents and tenants and letting them into your property. The list goes on and on and on.
Brandon: Maybe we can touch on some of those when we dig in a little bit. What I’m curious about is, you started with this resident management. You got your real estate license. You started to kind of expand from there. Can you very, very quickly just so the listeners have an idea of where you started and where you are today—you said you have 250 employees. But what was kind of the path? You got that management job. Next, what happened?
Ken: For the very first company that I worked for that I mentioned earlier, I started on-site and then I started managing multiple properties—four units, eight units, 12 units, 20 units, and I learned that. And then as I was with the company a little bit, I started getting larger and larger companies. I ended up moving to Las Vegas, opening an office for them when I was 28 years old, and we did not have a presence there and again, I opened an office, hired new people, and at that point, I was in what they call the fee management business. I was actually going out and managing properties for other people for a fee.
And so, I was really fortunate, I think, for the first eight years of my career to come up in the property management world. And I was actually getting an education of the people that I was managing the properties for. People would buy properties and then come to us and ask us to manage it. So I got to understand how they capitalized it with the debt and equity and how they bought it and what price they bought it for and all those kinds of things.
That was my firsts real job when I was in Las Vegas and then I partnered on my first business—I’ve had many now over the years—but I partnered with my first business in the early ‘90s. Mid-90s. Which was, I’m going to do this on my own. So I started—we were building properties and buying properties and now, to fast forward, I started this company that I have now which is called MC Companies. We have 8,000 units in multiple states, mostly Texas, Oklahoma, Arizona, and we buy and build apartments. We’re just in the apartments business. That’s it. We have five, six projects under construction right now. I’ve got one in escrow right now in Tulsa, Oklahoma, that I’m buying. And we’ll probably buy—we’re scheduled to do somewhere between $200-$300 million in acquisitions already for 2014.
Brandon: That’s awesome.
Josh: So these are large, multi-family properties. These aren’t like, 5, 10, 15, 30 units. These are like in the hundreds?
Ken: Right, great question, Joshua. I started on those, as you know, but what I quickly realize is it takes the same time and effort to run a five-unit than it does to run a 200-unit and it’s actually easier, in my opinion, because the larger the property, the more staff it supports. So once you can train your staff to handle a lot of the day-to-day stuff, those phone calls don’t come into the corporate office. They get handled right there at the property level.
Brandon: Yeah, that’s awesome. Well, you know, on a lot of our shows so far, we focused a lot on small multi-families and single-families because I started with small multi-families and a lot of people start that way. Today, definitely, we want to go 201 level here and go with the apartment complex things so I guess, why don’t we just start at the beginning? Why should somebody look into large multi-family properties to invest in?
Ken: Well, what I chose to do early on in my career, because I had lots of choices on what I wanted to do, but I chose to specialize in one sector and I think that’s a mistake that a lot of people make. A lot of people—they might try to buy a retail center or try to go buy a strip mall, then buy a duplex. I’m not saying that investing is wrong. I’m saying that what I want—what I attempted to do was I attempted to really know a lot about my one business and I also knew that there’s millions of apartments in the United States and it was easier for me to really understand the sector that I wanted and then what it did was it made me an expert in that one field. So everybody—I get a lot of people asking me about the apartment world, because I literally study—and I still study it. I’m still studying and still learning.
So for me, it’s a trend business like everything else. Apartments were not in favor in ’07, ’08, ’09. And now, all of a sudden they are. They’re kind of the hottest topic on Wall Street. But like anything, like single-family homes or malls or strip malls or industrials, or even single-family custom or affordable or condos—everything has a cycle and apartments are definitely on a high point of a cycle right now, primarily due to the fallout of the single-family market and the fact that we have some job creation.
Brandon: So let me ask you—unless I misheard—it sounds like you were saying that you think it’s a negative that you’re so specialized in apartment buildings and I look at that as a positive. I see you as somebody who, you can own that niche. You’re the guy to turn to. I’m just curious what you see as a negative about that, particularly for somebody starting out.
Ken: No, no. I don’t see it as a negative at all. What I think is what happens is, people think that the jump from say, 20 units or a bunch of houses to a 200-unit or 100-unit is a real significant jump and I’m here to tell you that I did it, and it’s not. It’s literally the same thing, just more units. Different people. Different team members are needed, but the economics are the same.
Josh: And obviously, in terms of capital resources needed, those are certainly going to be higher. I mean, if you’ve got 50 units, you’re going to need the capital to take care of those if things go wrong.
Ken: Absolutely, yeah. It’s all scalable, you know—it’s just that was one of the things, Joshua, I believe—when I first made the jump from buying a lot of single-families to larger properties, is that I actually needed a bunch of money in the bank and I needed all this cash in order to start. And what I found very quickly is that there is a lot more money out there than there are deals. So once I got educated on the market and I started to find deals even though I didn’t have a nickel—I found people to help me with that piece.
Brandon: I definitely want to touch on the financing thing. I got that in my list of 50 million questions here for you. But before we go on, I just want to point out, I love what you said about focusing on one niche, because that’s something that I harp on all the time—to pick one niche like apartments, single-family, whatever, and then one strategy. Do you want to flip them? Do you want to buy and hold? And when you’re getting started, especially, you don’t need to know everything. People get so overwhelmed easily. But by just focusing on one niche and one strategy and learn everything you can about that, you can always branch out later. So I love that.
Josh: And ignore the shiny object syndrome, of course.
Brandon: That’s the problem. Every week, we sit down here with a guest that tells us their amazing story of how they’re making money in real estate, and every week, me and Josh are like, oh, we’ve got to do that. That’ll be fun.
Josh: And if it’s happening to us, it’s happening to our listeners as well and we get it. But to them, we say, definitely take all this stuff in and decide what works best for you and really learn it and once you become good at it, move onto the next thing.
Ken: That’s exactly right. It’s baby steps and finding good team members around you.
Josh: Yeah, for sure.
Brandon: So we’re going to jump around a little bit and touch back upon a lot of the topics that are nagging at us here, but let’s go to local investing versus investing at a distance. You know, it sounds like, obviously you’re acquiring properties around the country, but you’re also an expert. You’ve been doing this a long time. You know what to look for. You know what to do. What’s your take on buying these multi-families at a distance? Let’s start with as a newbie and then progress to anyone else.
Ken: What a great question that is. First of all, I always believe if you’re either using your money or you’re using somebody else’s money, there’s a lot of responsibility with that. And so, I always advocate, try to start local. Try to learn local. Try to make mistakes local. Try not to even outsource your management if you can, if you have the time. If you don’t, of course, finding a property manager is a whole other show, but it’s really important, I think, that the people you’re raising capital from, especially as you start to scale, knows that you understand all the different components. So there’s really no way to do that if you have to jump on a flight and fly to Orlando. And a lot of times, by that time, the problem’s gone or over. So I always advocate to start local. I like to drive by my properties. I like to pop in unannounced. I like to walk them at night. I like to walk them during the day. There’s just a lot in order for the properties to run well. There’s so many details that need attention. It’s just so, so hard.
And a lot of people are in that trap right now where they have properties all over the country and they’re trying to find—they’re burning through property managers as their places are vacant and they’re sitting back in California or Washington or wherever and they’re frustrated and they’ve got to fly out there for a weekend and try to interview ten on a Saturday or whatever. So it’s just easier. And then what happened was, when we made a decision to get larger, at first it became city to city, so I started, obviously in Seattle, but then I moved to Vegas and I did it there and now I live in Scottsdale and even though I have properties all over those places, I use that same philosophy here in Scottsdale and then I started branching into Tucson and then I went up to Flagstaff, which are two hours north and south, and again—each of those markets is no different than flying to a different state. They’re different.
The people are different. The rents are different. The demographics and the makeup of the community are different. The community leaders and what they believe in are different. All the jurisdictions for water, sewer, trash and utilities and everything—they’re all different. So they might as well be a different state. That’s how I started. I just started to master these other cities and then from there, I started looking at the bigger picture on the trends, the job growth, employment growth, and that’s when I first started—that’s when I went to Dallas and I bought a different management company there six years ago during the recession. And etc., etc., etc.
Josh: Got it. Got it.
Brandon: I actually want to dig in a little bit on that, if we could. What are you looking for when you say you’re looking at kind of the demographics or the numbers in another city? What are you looking at—just population or those kinds of things?
Ken: That’s the best question. People always laugh because it’s so simple but, I need renters. And so, jobs clearly—sometimes, even population growth, don’t bring that because you can have an influx of seniors in an area that aren’t working, but primarily it’s job growth. So let me give you an example. When we started to look at Texas in general, we looked at the big major cities—Houston, Dallas, San Antonio, Austin, Fort Worth. And each one had a completely different genetic makeup. So Dallas is more services-oriented and financial, Houston is more refineries, a little more blue-collar, San Antonio is actually health care and some tech, and Austin, of course, is tech. Early tech. It’s also where the state capital is, so each city is different and each one has a different bell curve to it.
So we started buying in Austin because of the spillover of what’s going on there in tech. So, of course, we bought there in ’07, ’08, ’09. We bought a bunch of properties in Austin and now, of course, it’s one of the hottest markets in the country. And we could have been wrong, of course. But what we were doing was trying to take a look at where housing was, where the jobs were going, and could people afford it? So we look at that on an individual basis, sub-market by sub-market, even in those individual cities.
Brandon: You know it’s interesting, when I started, I looked at what market is an affordable market, not what market is a hot market. And I ended up buying into a market that was inexpensive but with which the demographic trends were going the wrong direction. And I pretty much plowed together every mistake which was wrong demographics, economy turning the wrong way, I’m at a distance so I couldn’t drive and check out the property and that really lead to a lot of problems.
One of the things I like to harp on for new folks—there’s always somebody trying to sell you something. Hey, come buy in Cleveland—I’m not going to say it—come buy in Cleveland because it’s cheap and it’s reasonable. Again, cheap doesn’t always mean that the trends are going in the right direction. I think it’s awesome you guys are trying to buy where the renters are. I think that’s probably the right move versus what I ended up doing.
Josh: That’s cool. Hey, I have a question—kind of a big picture question on your strategy. And that’s, how much does appreciation versus cash flow play into your decisions? You talk about buying into a hot market—sometimes that can be expensive.
Ken: Great question. You probably know, I study a lot with Robert Kiyosaki a lot. We’re really, really close friends. I did a radio show with him this morning, actually. And I’m really a cash flow guy. In fact, when I read Rich Dad, Poor Dad, that’s what he talked about in there. He talked about the importance of a property manager and cash flow and I would say the majority of real estate investors aren’t really focused on that like they should be even though they say they are. Most of them are capital gains based or appreciation based. I do think appreciation is important but I don’t base any of our investor money or even our strategy on it, unless it’s forced. In other words, if I’m buying a property—like I’m buying my property in Tulsa, Oklahoma. We’re closing on the 30th of December, 208 units. I’m putting a million bucks into the property with the intention of getting somewhere between $75 and $90 in rent growth over a two to three year period. I’m creating that appreciation. So it’s important but I never do it—I never base it on where I think the market is heading.
Josh: Hey, Ken, really quick for the folks who aren’t familiar with it—so the forced appreciation is you can either increase rent or increase the vacancy rates or just get other revenue streams coming in and as a result, these commercial properties are valued more. Is that correct?
Ken: That’s exactly right, Joshua. It’s essentially—we found an old, tired property on the corner of Main and Main that is what we would call an ‘A’ location, across the street is Whole Foods and a 24-hour fitness and the area is completely changing and the homes in the area are $500,000 and higher and then here’s this property where the rent’s $800 and it was built in the ‘80s and nobody spent a nickel on it. But in the day, it was new. Beautiful in the day. So our plan is, we’re going to put washers and dryers in. We’re going to put new stainless appliances in. We’re going to put wood flooring in and we’re going to completely redo the interiors. We’re also going to paint it and do a bunch on the outside, but that’s exactly what we’re talking about. We have a long-term strategy. We’re buying it. We’re not flipping it. And we want to be a good landlord for the people that live there, but a renovated unit commands higher rent than one that’s unrenovated so that’s the opportunity.
Brandon: So when you go into a place like that, are you planning on just doing the vacant ones as they become available or are you going to kick everyone out and do it and get it filled?
Ken: Good question, yeah. Well, the bank would not be happy if we kicked everybody out.
Josh: That’s true.
Ken: They’ve got to pay the mortgage and the utilities and the taxes and you know, all the other things. Great question. I get that question a lot. We do it on turnover. So obviously, when we first get on the property, we’ll do the vacants first and then we’ll be testing the markets on the rent, and then as units turn over and people move, we’ll do those. And what we found is that a lot of times, there’s some amazing residents that live in these places that have been there 10 years, 15 years, and what we found is, they actually, because they like the location, will oftentimes move into the new one, which will create an opportunity for us to renovate one that they were in. So it’ll take at least two years to spend all the money and upgrade all the property.
Brandon: I found the same thing. It created a chain at my apartment. Each one I did, somebody would leave and then I had like six or seven people move because of that.
Ken: I tell you, the other thing that’s been great about doing this is that the surrounding community—they come out—the Chamber of Commerce, the local police department, and people say, hey, we like what you’re doing here. So you really, to freshen up real estate in a market that people live in is usually a great PR opportunity as well.
Josh: It’s one of those interesting things. Real estate investors always get a bad rap. That’s the slumlords and the bad guys and all these bad guys doing all these bad things and this is the story right here. This is what we do. We improve communities. I mean, there are some bad folks out there. We can’t deny that. But there is in any segment of the economy. But I think it’s cool for you to even point that out, is how much the community really appreciates when you do it. On a small scale, we may not notice it if we’re doing a house, if we’re doing a duplex or something, but once you start getting into these larger properties, it makes a much bigger dent.
Ken: It does, and I’ll tell you, this is going to sound bizarre, but thank God for those bad landlords because I get great deals. These guys I buy these buildings from is an idiot.
Josh: How do you really feel?
Ken: He’s an idiot and he’s just run this thing so bad, and I was talking to our property manager this morning in Oklahoma. And by the way, we have our own management company but I use a local guy down there in Tulsa because I really trust him and like him and he’s managing other properties for me in the area. And I just said, I’m just happy that the tenants and the managers and the staff are sticking around because this guy is an idiot.
Josh: That’s awesome. Hey, so how do you find these properties? How do you find the idiot landlords who screw up and get it all wrong?
Ken: It’s funny, obviously you’ve got all the internet stuff that everybody in the world is looking at and all the websites or loop nets and things, but my experience is I actually haven’t found very much on those very often. More than not, when I find it, it’s a face-to-face relationship, almost always generates a lead. So let me give you an example. When we decided to Dallas, Texas, we’ll just say, I flew down there. I met with all of the top brokerage people, spent two or three days and started to build relationship. Got on their mailing list. Started to e-mail them, call them, etc., flew down there to look at deals, made offers, and so I built relationships with these people so then what happens, as you know, there’s always the alpha in every market, whether it’s male or female. And they always dominate that market and even in the single-families, I’ve found that this happens.
And so if you can create relationships with those folks, what happens is, somebody even thinking about it goes to them and it’s very rare that you find owners that sell without first going to the market to find out what the value is. Because my experience is a lot of them don’t even know. So they almost always go to some kind of a broker to find out what the thing’s worth, even if they don’t use them. So that’s been a really good way for us. We also have a full-time acquisitions person in-house and we probably look at maybe 15 to 25 deals a week.
Josh: Gotcha. So is your acquisitions guy doing marketing or is he just hitting the loop net, the costars, or just kind of dealing with potential leads that come from the brokers that you’ve got relationships with?
Ken: Mostly brokers sending information. It’s funny, it’s free to get on brokers’ e-mail lists, and then my experience has always been that most brokers don’t understand what they have. They are just folks on the commission. So, for example, when I saw this property come through, and I’m buying it for $9.1 million, I already know in three years, it’s going to be worth $13.5. So before I buy it—I’m going to close it in, what, 12 days, so I have a whole plan to get it to $13.5 million bucks and so most of them are focused on that commission, so most of our leads come from that. We get a lot from banks and property managers, you name it.
Brandon: Because in the residential space, the small residential, like houses, MLS-type folks, most of those agents really don’t have a clue, right? When it comes down to, as it pertains to, investment property. But my presumption would be that the commercial guys know a hell of a lot more and it sounds like you’re saying, that may not be true. And I’m shocked to hear that. But I get it.
Ken: You’d be surprised. It’s like anything—I know residential real estate agents that know quite a bit about this and I know some that don’t know any, and the same thing is true in the brokerage world for commercial. But what happens is in some of these secondary markets, you find just a lot less deal flow than you would in some of the major core markets, and in a lot of the major core markets, you’re going to find the real dealmakers.
Brandon: Gotcha. That’s cool. Hey, what do you think makes a good property? You mentioned this one—we talked about forced appreciation and this one needed work. Do all of the properties you look at buying do that? Is that what makes a good property? What are we looking for if I’m going to go buy an apartment?
Ken: Yeah. So kind of touching base on a little bit about what we’ve discussed already, the first thing we do, really, is look at the market. And I think a lot of the people, what they do is look at the property, kind of like what Joshua did. He was looking for an affordable property and something that was cheap. That’s a very common issue that people do. But once you buy stuff like that, it’s oftentimes, there’s no renters. And so, the first thing we do is really focus on demographics. So I probably spend half my time trying to figure out where our market’s heading. Because each one has a different bell curve like the ones I talked about in Texas. Once we get past that, then we drill down into the individual market itself.
So for example, Dallas is a big place but when we decided to buy in Dallas, and we bought a lot of property there in ’08, ’09, and 2010, we bought in only north. So we bought in areas like Plano, Frisco, Carrollton, Addison, in markets that were going. Because in every city, there’s hot areas and not-so-hot areas. And there’s areas that are going through re-development or maybe have a higher crime and then there are areas that have better school districts. And the path of development is heading that way. So we always look for that second. So once we get past those two things, then we go down into the submarket and we start to look at opportunities in the individual submarket. Because then it makes it really simple.
So for example, in a given month, I might get 20 deals from Dallas. But I might only be interested in three or four because they fall into that spot. And so that’s how we underwrite every single deal and then from there, usually, there are not very good deals either. There’s no, what I call, meat left on the bone, at all. I don’t want to buy something that doesn’t have some opportunity in it.
Josh: Ken, so you’re out there making these deals. I’m thinking about it. I want to be you. What is a day in the life of Ken look like? I don’t need the mundane like eat Cheerios and brush your hair kind of stuff.
Ken: So really, my entire goal of my company was to replace myself. That was my goal from the beginning and it still is. So I actually, believe it or not, I take all summer off. I spend time with my kids. I have a home in Coeur d’Alene, Idaho, and I work probably 30-40 hour a week at this point and anything I ever touched or did, I try to find someone better than me to do it. That was always my goal because I didn’t want to be chained to the company. So my day is quite different now.
Essentially, I come in, I sit down with my acquisitions guy. I find out what he’s working on. We’ll sit down and we’ll take a look at some of the deals that he’s working on and then if I need to, I’ll pull the president of my property management company in. Her name’s Leslie. She’s been with me for 12 years and she manages most of all of our employees, and then there’s different pieces and different team members that we’ll utilize in our resources now. So if I’m looking at something in say, San Antonio, I’ll call one of my employees down there or I’ll have my acquisitions guy call and we’ll have them go by the property and we’ll have them do a red survey, those kinds of things. So I spend a lot of time finding deals and then also managing the debt and equity relationship.
I had a big meeting yesterday with Wells Fargo on a construction deal that we’re doing in Tucson and I’m in the middle of negotiating another one with a group out in Laguna Beach and so, and then I did the radio interview with Robert today so it just depends. I do some teaching and books and things like that, but it’s really very secondary. I donate all that stuff. I donate all those proceeds to charity on everything we do, everything with Kawasaki.
Brandon: That’s cool. Let’s move back to the process. We talked about finding properties. We talked about kind of looking at them and figuring out what the market is, but actually, we find a property, let’s say. We do our due diligence on it and now we want to buy it but we don’t have any money. Obviously most people don’t have $9.1 million to go out and buy property. So what are you doing and what do people do to finance these things?
Ken: It’s important to know that I started at the same spot. I didn’t know at all how to raise capital. I didn’t know what the bank was going to ask me when I went in. I think what happens is a lot of people stop right here because they’re fearful that they need to know, especially what I call the ‘A’ students. They want to know everything before they step in but what they find out is even then, they don’t. Because you just never know what people are going to ask and what they’re going to do. So I jump in feet first on everything. So, what I found is the first people that I ever went to were friends and family, of course. Now, they’ve got great things like BiggerPockets, they’ve got these things on LinkedIn—there’s a lot of resources where you can get your deal out there quickly. That didn’t exist when I started, but I got a lot of ‘nos’ and those ‘nos’ were good for me because you’re like, okay, and I never asked—I never was trying to sell through it. I was always asking, how can I make this presentation better? What do I need to learn?
So I just got a whole heck of a lot of ‘nos’ until I finally—and of course, the very first deal, I used my own money, but then after I used my own money, I didn’t have any money. So like everybody, at that point, you’ve got to figure out how to scale it. So what I chose to do on the equity side is I chose to go out and find what they call accredited investors. So we now have a database of over 500 accredited investors that work with us. And it took a long time to get to this point, but when we put this deal out in Tulsa, Oklahoma, it funded in 20 minutes with our accredited investors. That sounds all great, but I want you to know that the road to get to that point was not that easy.
Brandon: That was not a 20-minute road.
Josh: Hey Ken, tell us what an accredited investor is just so people know.
Ken: Sorry. Accredited investors—you can Google it, too—but it basically means you have $1 million net worth, not including your house and you have $300,000 in income coming. My experience has been, especially now, people are really confused as to what to do. They’re saving money, the stock market’s dicey, 401K stuff’s dicey. People lost money in their pensions and there’s a lot of people that’s really confused. So if you put together the right team and you can say, listen, you’re going to make 7, or 8, 9, 10% cash on cash over here in this investment and it makes sense, it’s actually not that hard to raise capital if you know what you’re talking about.
Josh: Do you offer just a flat interest or do you offer equity as well or does it depend on the deal?
Ken: We give equity, of course, to our investors on every deal. Yeah, and I invest alongside them now. When I started, I didn’t because I didn’t have anything. But we invest right alongside of them.
Brandon: That’s cool.
Josh: Ken, what would you say you think is the most important part of your presentation that really needed the most refinement over all the years? Clearly, folks are out there putting together packages but where did you really screw up the most or where did you find your investors are most interested in?
Ken: Great question. I think the most overlooked person in the whole team is the property manager. And the reason why I bring that up, I really believe I had a competitive advantage when I started and here’s why—I’ll give you one example. This was back when I was doing fee management. I got this call from this one guy in San Diego and he got a crazy offer on this building and he did a 1031 tax-deferred exchange, which means that he can roll all his proceeds into the next building without any tax. Well, he found a building, put it in escrow, went hard on the money which means it’s non-refundable, in a property in Phoenix, which is where I live.
He called me one day before he closed and he said, hey, I need a property manager. Oh, that’s right. I need a property manager. So we showed up, and of course, the building’s full of thugs. It’s got all these problems and he overpaid and the expenses didn’t add up and all those things. So, this is a guy that came out of a 75-unit building in San Diego that was 100% occupied and he was on his boat every day, to fly into Phoenix for a 150-unit building that was, in the first six months, went more vacant than it was occupied. So then he was pissed at me, right? I ripped the Band-Aid off and said, listen, this is what you have. You’re the idiot. So anyway, it’s a great question but I think that if somebody has that type of folks, those folks on their team, it all boils down to how the property performs after you buy it. Period. So whatever the property produces in free cash flow is a direct result of the manager. And if that’s you or somebody else—if that manager, and you made a good selection—that manager can sell the investment for you.
Brandon: That’s cool. That’s really good advice. Because I don’t think most investors even consider that. Like you said, they just—here’s the numbers, here’s how cool it is, here’s how great it is. But what about the actual making that? Now what?
Ken: That’s what it’s all based on, right? We’re going to buy it but you don’t get any money.
Josh: Ken, so really quickly on this, what makes a good property manager. How would you identify the difference between somebody who’s a total loser and somebody who’s killing it?
Ken: Obviously, we have a management company so I have a lot of experience in this area. First of all, experience is a big one. So, gray attitude. I know it sounds simple, but if a lot of people don’t—just like any business, you can find people that have been in the management business for 20-plus years, and they have a bad attitude. So you’d be surprised when people walk in the office, if it’s like Nordstrom, everybody’s happy and things are good and customer service is high, they’re going to stay, they’re going to pay the rent on time, things are going to get done. The maintenance requests are going to be done. I think attitude and experience are the two main things. And then, if I had to choose between the two, I would choose attitude first and train them.
Josh: Pick somebody who’s trainable.
Ken: Yeah, because people with good attitudes are trainable. They’re like, what can I do, what can I do? How can I get better? So I mean, it’s nice to have people with experience and of course, you don’t want to put them in a disadvantage situation when you’ve got these multimillion dollar assets but what we’ve developed is a system to where we bring great people in with great attitudes and we put them underneath people and have them trained for a while and as the company evolves, they become managers and leaders in our company.
Brandon: That’s cool. Why don’t we go to one more topic before we kind of begin to start wrapping things up here, and that’s the due diligence period. I talked about it a little bit ago. What should somebody be doing after they get their property offer accepted and before closing? The period you’re in right now in this Oklahoma property. What are you doing to make sure it’s good?
Ken: In my opinion, that’s where all the magic happens. We do everything in due diligence, so when I say that, and in ten days, I walked all 208 units, I audited every file and I had contractors on the roof, the landscaping, the parking lots, the electrical, the plumbing, everything. So it’s really got to be coordinated and orchestrated. Of course, I have a full-time person. That’s all she does is orchestrate that. We have a huge checklist. People can find it on my website, actually. KenMcElroy.com. I’ve got a due diligence checklist up there and it gives like eight or nine pages and we ask for everything we can and we go through everything. So what it does, in my experience, it’s been that that’s when you find out everything. So we’re looking at bank statements, we’re looking at financials, we’re looking at vacancy. I don’t want to spend a lot of money after I buy it. I want to know what’s happening inside the units. I want to know if I have to replace a carpet or a refrigerator in three or four months or six months or one year, even two years. All that stuff, we do. We package it all up and we make it a part of our business plan. So I love due diligence because it’s the opportunity to flush everything out that even perhaps the seller doesn’t know.
Josh: It’s like discovery when it comes to legal pursuits, right?
Ken: Exactly right. Yeah.
Brandon: Sorry, real quick. You actually said you personally walked through all 208 of those units.
Ken: I said we—my team. I actually haven’t even seen this property yet. I’m going to fly down there after we close it in January but we have a team now of people. I underwrote it, I’ve seen all the pictures and I’ve talked to the managers and I’m involved. But we have lots of people at the property, but I haven’t been there yet.
Brandon: I was just trying to do the math on how long it would take to walk through 200 units. You’d be there like a month.
Ken: Well, a team of two can do about 60 units a day. So if you bring three teams down there, you can knock out 200 units in a day or two.
Josh: Have you found any kind of pushback at all from potential sellers, like we’ve got people and they don’t want you to see the units. I mean, that’s obviously a massive red flag but I’m assuming you’ve dealt with that kind of stuff before.
Ken: Oh yeah, of course. There’s all kinds of great stories of what you find inside the units and the little cellars, yes. And tenants change their locks and there’s all kinds of stuff going on behind those doors.
Josh: Oh yeah, for sure. I think that due diligence is probably, for the experienced investor, that’s probably the most fun. I think everything else is kind of operational but that’s where the excitement comes in. What kind of pig am I going to end up with and can I turn this thing and make it into a beautiful white horse, right?
Ken: That’s right. I love it. I’m with you, Joshua. It’s when everything gets exposed or should be at least. And it’s your opportunity to go back and also to tell the seller about things that he may not know or she may not know. We found that in some cases, at one property in Richardson, Texas, they had put a third roof on, which is illegal from a fire department’s standpoint. You’re supposed to do two. And so that was a red flag. That was a $700,000 fix. So there’s things like that that come up and are important.
Josh: For sure, for sure.
Brandon: Why don’t we move onto my favorite part of the podcast? We call this the Fire Round. All right, the Fire Round—these are all questions that come directly from the BiggerPockets forum so these are questions that real people are asking. I thought I’d fire some of them at you.
First of all, how do you determine a local cap rate? Who do you ask about that, or do you not ask anyone?
Ken: The cap rates—the brokers all know what they are. The capitalization rate—all that is, is if you paid all cash for a property, the rate of return will be the cap rate. If you put debt on it, it’s the NOI divided by the sales price, so it’s pretty simple. Whatever the NOI was and whatever the price was, it determines the cap rates. Stronger markets have lower cap rates and of course, interest rates can also make cap rates go up.
Brandon: Okay. And we’ll link to a couple of articles, too, in the show notes at BiggerPockets.com/Show52 that talk about the whole cap rate thing, too. So anyway. If people are more interested in that, we’ve got stuff.
Josh: All right. So should somebody start with apartments or do you advise they start with single-family houses and other property types?
Ken: I do. I advise they start small with a single-family house or a condo or a duplex and then move up. It’s just the mistakes are smaller and you’re going to make smaller financial mistakes, too.
Brandon: 55+ communities—do you recommend them or do you say stay away from them?
Ken: Well, I have them, so I’m going to say yes. No, I’m just kidding. Stay away! No, here’s the deal. If you study—one of the trends I study is the demographics of the Baby Boomers, of course. They started retiring a couple of years ago, what 50,000 a day or something like that, so it’s coming. And it is definitely coming. What I found, however, is there’s pros and cons. The pros are they never move. Once they make a decision, they stay there if the place is run well, and they’re amazing people. And they have great stories and the downside is that they don’t make decisions quickly because they don’t have to, so if you’re leasing one up, it’s brand new, it’s going to take a lot longer than you think.
The other thing is they don’t want anything to do with the next level of care for them. So they don’t want to see assisted care. You’ve got major different levels. So you have active seniors that are 55 and then when they start getting to a point to where they need some kind of assistance in whatever manner that may be, there’s the next level. And then of course, there’s congregate care, which is towards the end. And so, there’s been—we live in Arizona so down in Sun City, they’ve tried this. They’ve tried putting all three in one community and it failed miserably because none of the active people wanted to see where they’re heading.
Josh: Nice. It’s funny, since I was a kid, my mom was always like, “Don’t you ever put me in a home. Don’t think about it”. I don’t know—I think about it. When I’m 55, 65, put me in one of these communities. I want to go play checkers and hang and shuffleboard and dancing all the time. I’d be bored stiff if I was in a house with nobody nearby.
Ken: Dude, let me tell you something, men are a commodity, too, because they [inaudible][1:00:39] first. If you can make it, you’re going to be a stud.
Josh: Nice, nice.
Brandon: That’s funny.
Josh: So next question—how does financing work for construction loans on apartments?
Ken: Quite a bit trickier. There’s a lot of underwriting that the banks—as I said, I just met with Wells Fargo on this yesterday. Typically, they’re underwriting somewhere between 65-70% loan to cost. So let’s say, it costs $20 million bucks to build an apartment project, they’re going to lend you 65-70%. The other thing is, they’re usually recourse loans, which means that you personally are on the hook for the performance of the property. So from my standpoint, it’s a pretty risky loan. Because most of the apartment loans that I’m doing are non-recourse with Fannie Mae or Freddie Mac. They typically don’t have those kinds of restrictions.
Brandon: All right. I want to buy an apartment complex. What is my very first step? What should I do today?
Ken: The first thing is, you want to go where the demand is. Like, I have a friend that’s actually based out of Seattle that they specialize in student housing. So I was just talking to them last week. So he just bought a building near Oregon State. Because the student housing was full or had a big waiting list. So when you start to see opportunities like that, wherever that might be as you start to do your research, therein lies the reason. And so once you start to study a specific sector and become specialized like my friend in student housing or even in senior housing or affordable housing or high-end, whatever. Because there’s all different kinds of apartments. You really don’t understand that niche. That’s probably the very first thing because you can really make a lot of mistakes if you don’t understand it from a demographic standpoint.
Josh: Gotcha. Gotcha. All right, Ken. The big question—real estate goals for the future. Where do you see yourself in five to ten years?
Ken: I see myself working about the same, and taking a lot of time off. I see our company more than doubling and I also see the apartment market is going to peak, probably in two to three years. So we’re already starting to look at things like self-storage and mobile home parks and things like that to take advantage of whatever that next phase is. But construction has a cycle, apartments have a cycle. Everything has a cycle and the worst mistake I can make is investing at the top of the cycle.
Josh: And knowing what that cycle is and just paying close attention to tops and bottoms and understanding that is really key to sustaining a long period of time.
Ken: It’s the difference of legacy versus making a lot of money on the cycle.
Josh: Yeah. No, that’s great. All right. Well, it’s time, Brandon.
Brandon: It’s time for the Famous Four. So these are questions that we ask every guest we have on here. First question—Josh, why don’t you start us off?
Josh: All right. So besides your own books, of course, because those would likely be your favorite real estate books, what other than your own would be your favorites in real estate? Should I try re-spitting it out there? That was really difficult for some reason.
Ken: I get it. Actually, I have it right here. This book here—
Josh: Art of the Deal, is that what that is?
Ken: It’s what Donald Trump wrote. It’s called The Best Real Estate Advice I Ever Received. It’s interesting. It’s a small book that didn’t get a lot of fanfare, but it’s got a lot of really, really good advice in it. He just went to a bunch of his buddies and put it all together in his book. So this is one of the best ones that I’ve read in a long, long time.
Brandon: I haven’t read that. I’ll make sure to get that. That’s cool. All right, what about your favorite business book, non-real estate?
Ken: Non-real estate. Well, you may know, I’ve got a few. We study books as a company. Last year, we studied a book called Turning Pro, which is this one, Steven Pressfield. We’re just trying to get our employees to think differently. We just got done with one called tribal leadership, which is a great book. It talks about tribes and how the natural hierarchy of tribes, and we just did that last week. We brought 100 of our people into Scottsdale to study that and then I just did a book study with Robert Kiyosaki, actually. He gave me this book and I read it, which is a great book called Crash Course, Chris Martenson. And this has a lot to do about trade and foreign currencies and things like that. It’s very big picture trend stuff. The guy’s a scientist and he puts it all together in graphs and stuff. So these are the books that I just got done reading. So those are great.
Josh: Awesome. All choices we haven’t yet heard, so that’s fantastic. What about hobbies? What do you do for fun? It sounds like you’ve got some kids so I’m sure spending time with them is a part of it.
Ken: Oh yeah, kids are a big hobby. My goal is to make them entrepreneurs and my fourth book, it’s called The Sleeping Giant, is all about entrepreneurship so they’re on their third business. They’re 15 and 12 and you know, I’m having a great time just talking to them about all the things that come up day to day. I had a meeting with the marketing, a PR company here in Scottsdale and they did the presentation and I’m slowly—that’s a biggie for me, a big passion of mine. I don’t want them to be spoiled rich kids and I don’t want them to be entitled. I want them also to have the freedom to do what they want when they want it. So that’s a biggie, but also I love outdoor, water skiing, snow skiing. I’m going up to Whistler in a couple of weeks and golf, I’m playing golf tomorrow. I’m in a tournament.
Brandon: Good luck.
Josh: Right on, yeah, yeah.
Ken: So yeah.
Brandon: Very cool. Awesome. Last question from me and the last question of the Famous Four—what do you believe sets apart successful real estate investors from those who maybe never gained any traction or just don’t find success?
Ken: It’s funny you bring that up because it’s in this book. You know, there’s five levels that they determine in there and the third level is what they call, “I’m Great and You’re Not”.
Josh: The nana-nana poopoo level.
Ken: This guy was a professor at Stanford. He interviewed 20,000 companies and he felt like 50% of everybody falls into this category which is a very ‘I’ mentality. And then the fourth level is more of the ‘we’ mentality. So the whole theme of my company event was going from ‘we’ to ‘me’, or from ‘me’ to ‘we’, sorry. So anyway, the point is, this is all team-based—every successful person I’ve ever seen, and you know the list is huge, guys like Richard Branson and Steve Jobs, and you look at these guys and they leverage their talent with people around them to do—to make an impact. Of course, those are big names. But there’s a lot of small guys that do it, too.
So where I’ve seen people kind of up and down and rise up and down based on economy or a trend, it’s because they think that they’re the reason they’re successful. And they’re very egocentric and they’re very eye-based. And they don’t value the power of a team. And for me, one of the reasons that we’re in business is that we grew—we doubled in the recession. We bought three hundred million dollars’ worth of real estate in the recession. And that was when I went out and found the best people because they were in the market and built my company up to where it is. And I think that’s the biggest mistake, is they try to do everything themselves and they don’t realize that there’s people out there that are very, very good at certain things that will free them up to grow.
Josh: That’s great. And can I say, Brandon—I value you.
Brandon: Thank you, Josh. I’m glad you leverage my talents.
Josh: Well, Ken, listen. It’s really been a pleasure. We kept it brief. We didn’t really get to dig in too deeply on a lot of the topics that I think Brandon, myself, and I’m sure all the listeners would have loved us to and perhaps down the line at some point, we can have you back and we can do an intensive or some kind of focus on one or the other.
Ken: It’s easy for me. I just do it right from my desk, so—
Josh: There you go. Where can people find out more information about you?
Ken: Well, my company is MC Companies, so you can check that out. www.mccompanies.com and then I have a personal website, which is KenMcElroy.com. And I’m launching a video series next year for a lot of these questions I get, just two to four minute videos on a number of topics, because I get a ton of e-mails, as you can imagine, from the books and the Kiyosaki stuff. So this gives me a format to kind of direct everybody to that. That’s going to be called Ken Flix and that’s coming out in January so I’m excited about that.
Josh: Right on. That’s great. Well, Ken, it’s been a real pleasure. I’m very glad that we were able to have you on and we look forward to keeping in touch.
Ken: Yeah, thanks, guys, and just reach out whenever you want to chat again on any topic. Happy to do it.
Brandon: Thank you, Ken.
Josh: All right, everybody. That was Show 52 of the BiggerPockets broadcast with Ken McElroy, bestselling author and very, very experienced real estate investor. And let me add a very, very nice guy, as you guys can tell and super cool and it’s kind of neat when you’ve got these folks who we all kind of look up and admire because they’ve written or done something special like Ken and his books and they turn out to be pretty decent people, too, so it was nice to get to chat with him.
Brandon: It was also cool—I don’t know if people noticed—I’m sure they noticed but I just wanted to point out the fact that he donates all the stuff he gets from the whole Rich Dad thing and the book, he donates all that to charity. That is awesome.
Josh: That is definitely awesome. I don’t know. I’m sure other people do that but I imagine they’re selling thousands and thousands of books and the amount of money that he makes is probably not insignificant, so that’s fabulous.
Brandon: Yeah, very cool.
Josh: All right, well as usual, thanks again for checking us out. If you are new to the show or unfamiliar with BiggerPockets, please come and join us on the site with BiggerPockets.com , an amazing network of real estate investors and there’s tons and tons and tons of free information to check out. Join today, get involved, and introduce yourself to the community. Otherwise, of course, join us on Facebook, Facebook.com/BiggerPockets. Definitely get with us on Twitter, G+, YouTube, and all the other major networks as well. And of course, come back next week for our next show, Show 53, which should be a good one as well.
We appreciate you listening. Thanks again. I’m Josh Dorkin, your host. Brandon, take it out.
Brandon: All right. Well, this is Brandon, signing off.
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