Ken McElroy Doesn't Do Apartments At This Point!

69 Replies

In a 2018 video, Ken McElroy said he doesn't do apartment investing anymore. Talked about how it is too hard to make them work with the low cap rates, and instead he builds from the ground up. He's obviously a big name in the field so I gulped, because I heard from Ashcroft/Joe Fairless about a deal in WInter Park, FL that seemed so solid I pulled the trigger last month. My first-ever multifamily investment. 

Of course, Praxis is good, too. And I like 4 Mile Capital, and someone said something positive about Three Pillars. Neil Bawa certainly seems to know what he is doing. Ryan McKenna is all over deals these days. 

I'm just wondering if ya'll feel that Ken is mistaken, or being gimmicky. I mean, Joe F. says he has done this 27 times, and I haven't heard that Praxis is getting out of the game. I'm trying to use multifamily passive investing to build wealth and be my heavy hitter. I get that a lot of syndicators are in this space, and that cap rates are quite low. But a value-add investment not being able to "work", gosh I just doubt that Joe Fairless would be able to be convinced of that. 

Then again, sometimes a vehicle with a lot of inertia can't slow down if it wanted to. Perhaps that is why Rod Khleif lost $50,000,000 in SFDs in 2008; the idea of throwing in the towel just didn't occur to him.

There is a huge building boom going on right now in many markets in MF.. 

and if done right I suspect the spreads are larger and the hold times shorter.. 

Just look at Charleston all sorts of new MF going up.. 

the reason many don't do it is its much harder to finance those type of deals than what syndicators are doing.

just go shopping for a 20 million dollar construction loan  :)  

Building ground up is a great strategy but requires a whole different skill set and serious expertise but the upside can be double the typical value add play. 

As Jay mentioned the loans are more difficult to get and take a lot more time than the typical stabilized or value add purchase.

It’s 3 year timeline now for a project from the time you break ground to stabilization.

Some REITS will buy the property once you get the CO so you can spec a multifamily project now.


@Jason Merchey

You have a good reason to be concerned. However just like the syndicators doing their DD on the market, and the property, it is up to you to do the DD on (1) the operator (if they are new to you and you have never invested with them), (2) the market and of course (2) the deal to decide if it's worth your time and money. Another strategy that's recommended all over the place including Wall Street is to ensure you have a well-diversified portfolio to keep your investments out of trouble and/or minimize the hits during the recession. Now, this may mean diversifying across multiple markets for some and/or going even deeper and diversifying across multiple asset classes for others. You decide what works for you. 

Here're a few articles to give you more food for thought:


https://www.biggerpockets.com/member-blogs/10850/81214-what-goes-up-must-come-down-or-market-cycles-fluctuation

https://www.biggerpockets.com/member-blogs/10850/84063-private-equity-meets-stock-market

https://www.biggerpockets.com/member-blogs/10850/76519-dont-put-all-eggs-in-one-basket

 It just means that with the cap rate compression and the delta between A/B/C so small now, he found more value in just building new. It's a high barrier of entry though so not everyone will be able to do it. 

That doesn't inherently mean that B & C Value Add is dead.

Originally posted by @Jason Merchey :

In a 2018 video, Ken McElroy said he doesn't do apartment investing anymore. Talked about how it is too hard to make them work with the low cap rates, and instead he builds from the ground up.  

To say that you don't invest in apartments, but build apartments from the ground up is a bit of a red herring.  Make no mistake, building apartments from the ground up is not only investing in apartments, it is doing so with a strategy carrying one of the highest risk profiles.

If prices fall (which means a reversal of the cap rates that are being faulted for making investing unattractive), developers would suffer just as bad as owners of existing buildings, and perhaps worse.

But Ken is selling investments in developments, so it is his job to articulate his reasons why his strategy is better.  I sell investments in multifamily value-add syndication investments, so it would be my job to market those by pointing out the availability of multifamily investments below replacement cost in the marketplace, and rising construction costs which make development less attractive.  But I suck at marketing, so I'll say that the truth is that there is room for both strategies and there is nothing wrong with either of them.

Developers and their investors are willing to accept higher risks to chase higher returns.  Value-add operators and their investors are willing to accept lower returns in exchange for lower risk.  In my observation, these are often two different investors.  We did a several-million dollar development fund last year and it oversubscribed in 30 hours.  But by and large, the investors subscribing to it were a different set of folks than typically invest in our acquisition vehicles.  So, to each their own--and no matter what the strategy, it works--until it doesn't.

@Jason Merchey I don't understand Ken McElroy's point of standing on the sidelines. Makes no sense to me. If you're a value add investor and will be leveraging your equity with debt, I wouldn't get so hung up on cap rates. Key metric should be the cash on cash return and IRR. The cap rate will improve as you improve the property through your value add business plan. Just my thoughts

I thought and thought about Joe Fairless/Ashcroft's latest "Amber Lakes/Winter Park" deal and I am pretty darned comfortable. You would almost have to try to screw that up it has so many solid elements in it. Having said that, as Greg Dickerson points out, wisely, there are a number of operators out there who are lured by very attractive financing, but that is a crutch for them, not the keystone of a successful strategy. And as Rod Khleif says, you have to stress-test these things because "A lot of sponsors [of value-add multifamily] are doing deals right now that, frankly, scare the heck out of me." 

I would also note that I put up a thread four or so months back which I think was called "Why Do Syndicated Apartment Deals Fail?" I got a lot of responses, which tells me that yes they do fail, and it is for a certain discrete number of reasons. But I don't think the conclusion I drew is as drastic as McElroy does.

This is the type of headline that makes under $500k net worth people an excuse to stick their head in the sand. Where in reality they need to make moves. :(

There will be a lot of companies that falter when the cycle finally comes to an end and I don't think it will be just the "new" investors. There are companies out there that have thousands of units that are buying properties assuming the market will grow to the sky. Be cautious about companies that are expanding quickly in this market. 

There is no hiding that deals are scarce and hard to find. In my opinion 95%+ of deals are being sold for more than what they are worth today, but as long as the market continues to cruise along everyone will be fine - but that is a big if. With that said, if you are very patient, there are a few deals to be had here and there. Be patient, stick to your criteria and don't worry about what others are doing around you. 

Originally posted by @Brian Burke :
Originally posted by @Jason Merchey:

In a 2018 video, Ken McElroy said he doesn't do apartment investing anymore. Talked about how it is too hard to make them work with the low cap rates, and instead he builds from the ground up.  

To say that you don't invest in apartments, but build apartments from the ground up is a bit of a red herring.  Make no mistake, building apartments from the ground up is not only investing in apartments, it is doing so with a strategy carrying one of the highest risk profiles.

If prices fall (which means a reversal of the cap rates that are being faulted for making investing unattractive), developers would suffer just as bad as owners of existing buildings, and perhaps worse.

But Ken is selling investments in developments, so it is his job to articulate his reasons why his strategy is better.  I sell investments in multifamily value-add syndication investments, so it would be my job to market those by pointing out the availability of multifamily investments below replacement cost in the marketplace, and rising construction costs which make development less attractive.  But I suck at marketing, so I'll say that the truth is that there is room for both strategies and there is nothing wrong with either of them.

Developers and their investors are willing to accept higher risks to chase higher returns.  Value-add operators and their investors are willing to accept lower returns in exchange for lower risk.  In my observation, these are often two different investors.  We did a several-million dollar development fund last year and it oversubscribed in 30 hours.  But by and large, the investors subscribing to it were a different set of folks than typically invest in our acquisition vehicles.  So, to each their own--and no matter what the strategy, it works--until it doesn't.

my Oregon bank had a property just outside Portland that could hold about 200 units.. Once I dove into it.. I realized that these are not something that can be done by just a normal syndicator.. the requirements for the construction loans are not like agency debt .. and the contractors and such have to have LOTS of experience.. And then there is that pesky insurance  HOLY COW.. Especially wood construction. 

where as the value add 1 MF is something those with minimal experience can put together.. I mean U can go to the how to be a syndicator class's and actually put one together.. no way this can be done in the ground up arena.  :)  

you make some great points about lead time as well as basically it is all A class and your going for the top of the rental market.. Not to mention build cost are pushing 400 a foot in our area..  like all things its Risk / Reward 

 

Originally posted by @Todd Dexheimer :

There will be a lot of companies that falter when the cycle finally comes to an end and I don't think it will be just the "new" investors. There are companies out there that have thousands of units that are buying properties assuming the market will grow to the sky. Be cautious about companies that are expanding quickly in this market. 

There is no hiding that deals are scarce and hard to find. In my opinion 95%+ of deals are being sold for more than what they are worth today, but as long as the market continues to cruise along everyone will be fine - but that is a big if. With that said, if you are very patient, there are a few deals to be had here and there. Be patient, stick to your criteria and don't worry about what others are doing around you. 

 Well said! Todd! I'm not in the business of just getting deals under contract. I'm in the business of revenue. Keeping that in mind and my criteria, often times submitting offers stating that this is our best and final. That draws the line in the sand stating that this is it and allows stick to our criteria as not every deal pencils out once its countered by the seller/broker. 

I'm going to stick with what I know and that's syndication.  You can listen to everyone under the sun on what strategy and how it's better than the next.  I simply congratulate them on their success but stay right here in my lane.

@Jason Merchey While I cant speak for syndication or large MF deals, I can speak for Winter Park. I grew up in that area and know it will. Depending on where exactly hes building, didnt listen to the podcast, WP is an class A/A+ market.

I've spent the last 28 years in that area and no one I grew up with has anything bad to say about it. Obviously you have your low income parts but if you're around Park Ave and Rollins College, it's gorgeous.

Originally posted by @John Fortes :
Originally posted by @Todd Dexheimer:

There will be a lot of companies that falter when the cycle finally comes to an end and I don't think it will be just the "new" investors. There are companies out there that have thousands of units that are buying properties assuming the market will grow to the sky. Be cautious about companies that are expanding quickly in this market. 

There is no hiding that deals are scarce and hard to find. In my opinion 95%+ of deals are being sold for more than what they are worth today, but as long as the market continues to cruise along everyone will be fine - but that is a big if. With that said, if you are very patient, there are a few deals to be had here and there. Be patient, stick to your criteria and don't worry about what others are doing around you. 

 Well said! Todd! I'm not in the business of just getting deals under contract. I'm in the business of revenue. Keeping that in mind and my criteria, often times submitting offers stating that this is our best and final. That draws the line in the sand stating that this is it and allows stick to our criteria as not every deal pencils out once its countered by the seller/broker. 

And you're likely getting beat out on your offers the majority of time and often times by the "experienced" companies

Originally posted by @Jay Hinrichs :
Originally posted by @Brian Burke:
Originally posted by @Jason Merchey:

In a 2018 video, Ken McElroy said he doesn't do apartment investing anymore. Talked about how it is too hard to make them work with the low cap rates, and instead he builds from the ground up.  

To say that you don't invest in apartments, but build apartments from the ground up is a bit of a red herring.  Make no mistake, building apartments from the ground up is not only investing in apartments, it is doing so with a strategy carrying one of the highest risk profiles.

If prices fall (which means a reversal of the cap rates that are being faulted for making investing unattractive), developers would suffer just as bad as owners of existing buildings, and perhaps worse.

But Ken is selling investments in developments, so it is his job to articulate his reasons why his strategy is better.  I sell investments in multifamily value-add syndication investments, so it would be my job to market those by pointing out the availability of multifamily investments below replacement cost in the marketplace, and rising construction costs which make development less attractive.  But I suck at marketing, so I'll say that the truth is that there is room for both strategies and there is nothing wrong with either of them.

Developers and their investors are willing to accept higher risks to chase higher returns.  Value-add operators and their investors are willing to accept lower returns in exchange for lower risk.  In my observation, these are often two different investors.  We did a several-million dollar development fund last year and it oversubscribed in 30 hours.  But by and large, the investors subscribing to it were a different set of folks than typically invest in our acquisition vehicles.  So, to each their own--and no matter what the strategy, it works--until it doesn't.

my Oregon bank had a property just outside Portland that could hold about 200 units.. Once I dove into it.. I realized that these are not something that can be done by just a normal syndicator.. the requirements for the construction loans are not like agency debt .. and the contractors and such have to have LOTS of experience.. And then there is that pesky insurance  HOLY COW.. Especially wood construction. 

where as the value add 1 MF is something those with minimal experience can put together.. I mean U can go to the how to be a syndicator class's and actually put one together.. no way this can be done in the ground up arena.  :)  

you make some great points about lead time as well as basically it is all A class and your going for the top of the rental market.. Not to mention build cost are pushing 400 a foot in our area..  like all things its Risk / Reward 

 

 That sure is different from my markets. I am seeing groups with no experience get loans to build complexes. most of them are under $20mm projects, but still surprised at how easy it is for them to get the money. 

Originally posted by @Todd Dexheimer :
Originally posted by @John Fortes:
Originally posted by @Todd Dexheimer:

There will be a lot of companies that falter when the cycle finally comes to an end and I don't think it will be just the "new" investors. There are companies out there that have thousands of units that are buying properties assuming the market will grow to the sky. Be cautious about companies that are expanding quickly in this market. 

There is no hiding that deals are scarce and hard to find. In my opinion 95%+ of deals are being sold for more than what they are worth today, but as long as the market continues to cruise along everyone will be fine - but that is a big if. With that said, if you are very patient, there are a few deals to be had here and there. Be patient, stick to your criteria and don't worry about what others are doing around you. 

 Well said! Todd! I'm not in the business of just getting deals under contract. I'm in the business of revenue. Keeping that in mind and my criteria, often times submitting offers stating that this is our best and final. That draws the line in the sand stating that this is it and allows stick to our criteria as not every deal pencils out once its countered by the seller/broker. 

And you're likely getting beat out on your offers the majority of time and often times by the "experienced" companies

Haha "experience" wins. They can have those. I know where our threshold is and I know you preach that. Keep doing what your doing with your mastermind group. Love what your doing Todd!

 

Originally posted by @Mark F. :

@Jason Merchey While I cant speak for syndication or large MF deals, I can speak for Winter Park. I grew up in that area and know it will. Depending on where exactly hes building, didnt listen to the podcast, WP is an class A/A+ market.

I've spent the last 28 years in that area and no one I grew up with has anything bad to say about it. Obviously you have your low income parts but if you're around Park Ave and Rollins College, it's gorgeous.

Yes, I think Ashcroft/Joe  F. have such deal flow (off-market and such) and such a good rep. that you just can't buy that kind of thing. Brokers will stiff-arm you until you show you have the gravitas to play in the big leagues. So I think that plays into all this: a small guy, a beginner, just as smart as Joe F. or some other big dogs, would have a very hard time getting the kind of deal that Winter Park is for going to be for Ashcroft. In fact, Frank Roessler said it best when he pointed out that there really isn't anything amiss with the numbers in any way (my words), the risk is operational risk. They could screw it up, drop the ball, etc. But to believe that the 28th deal by Ashcroft is going to crash and burn, well, it strains credulity. I mean, risk/reward and all that, but totally dropping the ball isn't how Fairless made a name for himself. 

Then again, I could be biased. As you know, there is a cognitive bias that indicates that human beings overvalue the things they have selected and undervalue those they passed up. 

Though Caps are compressing, there are still some deals out there in specific markets with decent IRRs and true Value Add plays. 

The way I see it is so far time is ticking, we, as syndicators, are always going to have Investors who are retiring and want to sell their portfolio and some of these investors do sell at a reasonable price. 

Congrats on your deal with Ashcroft!  

Thanks, Ola. And congrats to you on being a syndicator in this space. It's a bit intimidating for me, even having been through a Rod Khleif bootcamp. Good on ya!

@Jason Merchey I am convinced that the syndicator and the property need to have a solid story. I invest in my own backyard and help people understand why. We are so active in our space we know the market better than anyone. I think that's important - having deep roots in the market you're investing in - or making sure the syndicator does. We own 600 units here and manage 1400. It's important to be active in the space, in my opinion. 

Investors that have been through cycles likely have a different insight then those investors who have been riding only an up wave and doesn't know what a wipeout feels like when that wave can come crashing down.

If you talk to lots of banks they love multifamily and their underwriters think the asset class can do no wrong. I saw it getting absolutely pounded the last down cycle. I mean it was getting crushed. It's just like food restaurants. Everyone has to eat and everyone needs a place to live but that doesn't mean it will be YOUR place or property.

There are still deals for MF but 1 in thousands these days. Lots of sellers selling 3% vacancy, 35% opex, 4% rent growth and trying to sell for a 5 cap. Buyers are having a euphoria or can't lose feeling with multifamily. That is when investments can get dangerous.

I don't have exact statistics because have been out of MF for awhile but over decades of time annual 1 to 2% rent growth, 50 to 60% opex, and 10% vacancy is more reasonable underwriting. 35% opex can be usually achievable when the property is built brand new for years 1 to 5 or an older property where everything was replaced. Lipstick patch jobs where the operator is selling off as (newly renovated) those buyers are going to get crushed with future accelerated ongoing capex. Sellers often like to sell a 10 year old asset they owned brand new and point to the low capex number while they owned it but years 11 to 20 will look different than years 1 to 10 as systems start failing and need replacing and physical updates to the property have to occur as useful life expectancy wears out.   

Last down turn I saw landlords fighting for market share to rent MF properties and service their debts. Vacancy increased and rents flattened or slightly declined. Brand new class A can get pounded as when incomes stop growing those renters tend to look for cheaper places to live ( older Class A or B type properties). New developments ground up as others mentioned get built and leased up in phases of construction which can take years. If you had 240 new units at leasing velocity of 10 a month that is 2 years to full stabilization. When demand is outpacing supply everyone wants to jump in and build, build, build. As supply starts tipping to neutral or outpacing demand that is when it can get dangerous and the developers are playing a game of musical chairs where you can fall straight on your butt. So new development you better make sure the location is an A and the market is an A to be able to achieve the rents you need to validate penciling a project because land costs are up, legal, materials, and labor as well. Some developers are building assisted living type facilities because the rents per month can be much higher. These are not acute care facilities but 55 and older type places to live (senior housing).  

The low interest rates and long term debt are attracting people to buy MF as well but you have to make sure underwriting on the property itself is good as well.

To be a developer you really have to have a passion for that and want to do that full time. Even those that have developed larger properties do ground up maybe 10% of the time and the rest of the time buy value add stuff. It can be easier to take a vacant or existing eyesore building and the county, city, public at large want something done with it to improve the area. That versus taking raw land and you have what the developer wants to build, what the tenant or tenants want, what the city or county wants, and what the public wants. You have to try and take all of that, make it work,  and still have a profitable project you are excited about. 

There are different levels of passive investors. The raw land to land entitlement phase ( typically highest return ), funding of construction and build up to stabilization (higher return),  buying fully stabilized property with max cash flow ( medium to lower returns). It's risk/reward and the time to get there.

The ground up stuff on larger projects investors often do not get paid until 3 years in. So higher overall return usually but that is if things pan out over time as anticipated with 7 to 10 year horizons. You can have systemic risk with market cycles impacting that long of a time period for a development.

@Todd Dexheimer @Jason Merchey

Todd makes a good point about being cautious of companies with high deal flow in this market. I'm underwriting deals here in Texas and consistently seeing teams overpaying for properties by millions of dollars. I just underwrote a property here in Austin that absolutely does not work as a syndication for 11mm. Maybe at 10.5mm it could work, yet the buyer is paying 12mm. I do think that there is a class of buyer in the market right now that can beat the syndication buyer out every time. I'm referring to the wealth preservation buyer who can overpay b/c they're doing a 1031 exchange and do not need to satisfy LP appetites for a 15%+ IRR. If that's whose buying, then there is some rationale, but if it's syndicators who are buying, then I just can't see how they are making it work. Many will get hosed and their LP's also.