The state of multifamily today with Ken McElroy

During our Invest Like a Billionaire book launch summit this summer, we had a live Q&A session with Ken McElroy, and we wanted to bring it to the podcast feed because it says a lot about where we are at in real estate today, but also where the real estate market is going over the next several years. And Ken McElroy, if you've been in real estate, you know who he is. He's a legendary real estate investor. He's an author. He's a co-founder and CEO of MC Companies, a leading multifamily real estate investment and development company. And on this interview, Ken joins Bob Fraser for the live Q&A and questions from the audience that are facilitated by Ellis Hammond and myself. Enjoy.

Ken, here's a question I think a lot of folks are asking this. I mean, clearly with the last couple of years, it's gotten harder to raise capital. There was a capital flood for a while and then there's it's probably harder for everyone. And this person asked, you know, they're an experienced syndicator in the self-storage space, but challenging. What are you doing this year and in the future to continue to raise equity and continue to raise capital from a retail perspective?

Well, let's go back though. I think Bob Fraser and I agree on this, like raising money should be hard, like, right? Let's just start there because what we just went through was a period where it wasn't hard. You know, and so I think that the expectation needs to be more based on reality. So raising money is hard. What happened was people were online doing influencer stuff. And so asking people for money is the easy part. The hard part is placing it correctly, returning it correctly, managing it correctly, communicating correctly. That's actually what's unraveling now. So the investors that invested with, you know, call it inexperienced operators or people that were raising money, you know, you're seeing that get flushed today. And so we didn't really buy much in the last 3 or 4 years. So part of raising capital is identifying what I would consider to be red flags. And so when we were losing deal, we were always in the top 2 or 3, let's say, before this, the craze started, then we dropped to 10th and then we dropped to 20th. And so we were always in the bottom on being able to, you know, even get a deal. And so what that means is that people were stretching the price. They were shortening their due diligence time, even collapsing it to zero. Uh, they were doing non-refundable right away without actually stepping on the project. They were doing all these things that I would never do. And so we backed away from the market and then just kept running, specifically I think as a result of the low interest rates at the time. But regardless, that's a different issue, you know. So when we turn the on button back on, a lot of our investors— we have about 4,000 A lot of our investors knew that we took a pause. That's why I think we've done north of $200 million in equity this year with our existing base that kind of got us here. By the way, we've been doing this 25 years, multifamily. So we've seen multiple cycles. And so the key was actually identifying the cycle and pushing pause and not running your investors into that high price, low margin, and all based on an exit 2 or 3, 4 years later. That's not our model at all. Our model is cash flow day 1, and then some kind of forced equity component if there is one, buy below replacement cost and hold 10 years. It's very different. So for us, when we turned it back on, we had a lot of investors and LPs that were excited that we were back in the market.

I've been through 4 business cycles, And I've seen, I mean, you know, the crashes and, you know, multifamily is one of the very best places to invest your capital historically, but it's had a really rough period, right? And no one, you know, I think the inexperienced investors really weren't expecting this and not realizing that, hey, everything sucks at some point, right? Even the best stuff sucks at some point, right? But that's not the only thing. And, you know, I'm actually grateful that there was a little reset in the multifamily space and even in the real estate space because there's other, you know, it's like staring at the banqueting table that's empty when there's 10 banqueting tables behind you that are full. And it's like, hey, look around. There's a lot of things that are doing really, really well. Oil and gas is awesome. Private credit is insane right now. Industrial real estate. Really hasn't had hardly any reset. So, it's important to think, and this brings up the whole story of diversification, right? No matter how great something is, and, you know, yesterday it was multifamily, today, hey, maybe it's Bitcoin or maybe it's industrial, don't put all your eggs in that basket, diversify so that when something has a sucky time, it's not killing you. And also, it really says go to more conservative investments and go to more conservative operators, right? You know, somebody was complaining about, yeah, I lost everything in this multifamily deal. I said, what happened to the building? Did it vaporize? And no, the apartment complex did not vaporize. It's still there. What happened was a very poorly designed capital structure, right? It was far too risky. And I mean, we're seeing, you know, deals that are being 90% leveraged. That's a bug looking for a windshield. And these are young operators that overpaid for an asset, got debt terms that were stupid because it's the only deal they could get done. And as Ken said, they're an influencer, they could sell the investments, even though it should never have been done. I think it's a good time to remember, pay attention to the capital stack and pay attention to the debt structures and pay attention to leverage, these kind of things, because the truth is a multifamily deal, even in the suckiest of times, should not be an equity loss, right? You shouldn't have to endure a loss. Maybe your returns go down, but it should be a temporary thing. So, you know, I think those are some of the, some of my big takeaways from this reset.

And I'll just add one thing, like in Bob's book, he talks to us this, I can't remember if it's a chapter or a piece of a chapter, but he says one of the things the LPs need to learn is they need to learn to invest. And that's right out of the book. That's it. You know, so a lot of these LPs, they didn't know the right questions to ask. And so that's part of it. That's part of the education. That's part of why we do these things. Exactly. That's why we write books. Do this online education because it's really on the LP to decide, do they want to go with this operator? Do they want to invest in this deal? And then it's really on them to ask the appropriate questions and to challenge the business plan, challenge the underwriting and all that stuff. And that's actually what you should be doing.

I'll ask Ken a question here. So you saw, I mean, the whole bubble in the '21, 2021 period, you saw a lot of younger syndicators putting these debt structures in place with 80% bridge debt, 10% pref equity on top of that, and they're promising these killer returns buying at a 4 cap, and the returns are probably beating what you were promising, but you had a much safer structure, right? It was not a house of cards, right? What was your feeling in that period? And how did you deal with that?

Okay, well, I remember specifically I was on a stage somewhere in Vegas, on a multifamily panel. And the guy sitting next to me, I won't say who, was talking about how he was raising equity at 12%. And the only thing I could think about was, that's a problem. Because my properties, if real estate makes 12%, I'm buying all of those I can, as fast as I can. Which basically means that the real estate cannot pay the equity, period. So you're way behind the cost of capital. And so the only way for that to happen is for that property to appreciate and there to be some kind of an exit. And so you talked about a capital stack, that's essentially what that means. It's the same thing that happened back in '08 when I was checking out at Target and the checkers gave me a card for real estate and said, you know, do you wanna buy a house? I'm like, okay, we're done. Like in 2008, you know, this is gotta be the end. It was the same moment for me when I was sitting there listening to this guy raising money at 12%. I was like, That's just a recipe for disaster because the market does transition down. Cap rates do go up, interest rates do go up, operating expenses do go up, vacancy goes up, concessions come into the market. You got to anticipate all of those things. And you said it earlier, the inexperienced person doesn't consider those things just precisely because they don't see them. So that was when we were like, okay, I'm done. I'm done raising money into this market.

Can let me ask a follow-up question. Going to your point on education and how important it is, you know, a lot of limited partner investors entered the market in 2021, 2022, and invested in their first deals in that cycle. And so the things that maybe they were seeing were commonplace, but from someone with your perspective of 25 years through multiple cycles investing in multifamily, you know, what are the biggest differences? And from an LP's perspective, what would be some yellow flags that you would say, or you need to dig a little deeper on in a deal that may have been commonplace a few years ago, but as the market settles out and normalizes, that maybe should be commonplace but weren't, and how you look at things differently than people were doing it a couple of years ago.

Well, I'll give you a real story. So, during that period of time, my partner Ross and I decided, we had a 140-unit building in Houston that was really nice. That we couldn't move the needle on. In other words, we took 3 or 4 units and we, by the way, it was a newer property built in like 2020 and we renovated and we just couldn't get higher rents. So we're managing the property and we just couldn't get higher rents. We were doing everything we could to try to increase the value. We just couldn't do it in that market at the time. So we're like, oh, hey, listen, we got some equity here. We're not really making the return. Let's sell it. So we listed it with a CBRE agent And lo and behold, we picked a buyer. Well, I was on that buyer's LP list, so they sent me my own deal. Now I'm the seller, but I'm looking at it as an LP. And guess what it says? All the stuff you would imagine. You know, the operator, which is me, there, you know, we could save 10, 15, 20% on expenses. There's a lot of upside on the rents. You know, the market's trending this way, you know, all the stuff that you would expect to raise capital. Now, did they believe it? I don't know. But we had already tried all of those things. And the point is, the business plan can say whatever it wants to say, and the LP has to verify all of those things, you know? So why would I sell? And then, you know, somebody else— and we sold that property for a really, really good price at a great time. And so the LP has to be able to sniff out those nuances on rent growth, on is there concessions in the market? Is there really value add for real, right? And if anybody, I'll tell you one pro tip. If anybody says that they can bring lower expenses, that's BS. Because I've been in this business for 30 years. I've never ever seen a year where my expenses aren't more. Like, I'm battling insurance, I'm battling our labor costs, I'm battling my, you know, all the stuff that we have that, you know, the component piece. I'm battling our property tax stuff. Like, it's constant. So, you know, there is that rare one, but generally it's all on the income side. And so what they do is they project based on what they think. And so it's the LP's job to dig into that and verify.

Ken, there's a lot of questions here in the chat. Let's get to them. So several questions about the market and how you pick markets. You focus primarily in Arizona, Nevada, and Texas. Have you been following Midwest markets for multifamily? Are there other markets you're considering right now? I think there's just a lot of questions on what do you think about just regions for multifamily?

I'd love to hear Bob Fraser's perspective on this too. Like, one of the things that blows my mind, I grew up in the Seattle area, so that's where I cut my teeth. And I cannot believe the landlord-tenant laws, and they're actually spilling over the governmental stuff on the way they run credit for the tenants, the way that they're kind of going around the rent control. They're doing that in Oregon. These are markets that I cut my teeth on as a young man. So when I look at a market now, I look at those things. I never really had to consider that too much. I mean, I knew that California and New York had rent control. I think that's going to get way worse in the next few years. I look at property taxes now. So I know I'm going to get to the market piece, but these are all really important things. We decide not to invest in Florida because of the insurance costs. There are markets that emerge with these crazy policies, these crazy things that really restrict. I had somebody call me from Oregon wanting to sell me a building and said, what should I do? I go, what's the problem? He said, well, they're capping my rent. There's no rent growth, but they're jacking my property taxes. So my margins are going down. So you gotta like really look at, you know, those things broadly. And then the very basic, easy thing is to— where are the people going? Because real estate doesn't do well without people. So, I mean, people forget this, but it blows my mind. You have to be in an area where there's a lot of people moving and for all kinds of reasons. So right now, you know, we like several areas in Texas. We're buying in Las Vegas right now. I've been there before. We like Arizona. They don't have hurricanes, they don't have tornadoes, they don't have hail, they don't have all that stuff from a property insurance standpoint. Property taxes are pretty stable and there's a pretty decent growth. And so, you know, those are the markets that we're really focusing on now. But I have— I'm always looking throughout the West Coast at all times. We have a team of analysts and acquisition folks out meeting with brokers and in multiple markets, including Colorado and New Mexico and some of those— Idaho, which is where I am now. So we're always looking.

I'll say our favorite markets are Midwest and Rust Belt right now. They're actually having positive rent growth for the last several years where the Sunbelt markets have been very overbuilt. So I think, you know, it's temporary. You're gonna see next 2 or 3 years, Sunbelt continuing to struggle generally because just too much supply coming on the market. So you have demographics and you have supply, right? And demographics are positive, but actually Florida demographics, I don't think they're that great. People are leaving right now because the insurance and other reasons. So, you know, those, that stuff always changes. That's in multifamily and industrial. We love secondary markets. So a lot of the primary markets are rebuilt. Secondary markets are, are really nice right now. And you have not only the e-commerce boom that's going on, but now you've got a giant reshoring, nearshoring trend that's taking place. So we love industrial, you know, buy a piece of land, pour some walls, tip them up, slap a roof on it, and 9 months later you're leasing it. If you get the market right, it's just a W every time. So we're loving that as far markets go.

Here's a question. Are the banks beginning to no longer extend and pretend? Are underwater deals coming up for sale at good prices? Ken, you mentioned you've purchased a couple deals this year. What has created opportunity for you? I'm curious.

Well, I'll tell you a deal I passed on and why. So I got an email from a broker in Dallas and they had like a 250-unit, 35% occupied, and they were going to sell it for $14 million and it was 250 units. So I'm like, oh yeah, I'll take a look at that. Well, the loan was $25 million, so it meant that 100% of the equity was gone, all LPs wiped out, and the lender was going to take an $11 million write-off. Okay. So these are the deals we're seeing. Uh, we looked at it, we figured it was at least 2 years to fix it. No cash flow, obviously can't be financed because it's 35% plus, and the 35%, it had a horrible tenant base in there and there was a bunch of CapEx and all that stuff. So by the time I had negative carry, By the time I had to fix it, by the time I had to wait, I passed. So those are the deals that we're seeing, you know, and not all that extreme, but we've been buying multiple projects for different reasons. We've been buying newer Class A stuff actually at below replacement cost. So we bought a deal in Vegas at $260 a door, brand new in Henderson, 330 units, and it cash flows day one. And we just did that in Scottsdale on another one. And then we're doing some other value-add stuff, but You know, we are seeing the distress. I think that these syndicators have run out of money. They've been trying to Band-Aid these things for a while. We're starting to see a resurgence of listings and stuff. And the brokers know about all these deals, by the way. You know, they've been asked to do BOVs, or broker's opinions of values, on these repeatedly over and over and over and over. So they're starting to hit the market. I think you're going to see an inordinate amount of multifamily this year. Hit the market. We're looking at construction deals that are built and 50% occupied. I love those deals because takes all the construction risk out and, you know, we could step into something for the cost of the note. For example, we made a couple offers on those last couple of weeks. So there's definitely deals out there. But, you know, it's like anything, it's like you got to say no on everything and then, you know, maybe let it get through on a yes. And for me, You know, we'll probably look at well over 100 deals easily. We looked at 7 or 8 Tuesday. I said no to all of them. So that's a pretty common week. So you just got to really, as we've been talking here, stick to the fundamentals. You shouldn't buy something just because you can raise capital.

I mean, I think we've seen, you know, the lenders take a very soft approach for the last few years. You know, I mean, these lenders don't want— they don't want to run all these properties, you know, thousands and thousands of these properties. So they're trying to work with the borrowers and So I don't think we've seen the flood that a lot of people predicted, right, of market sales, kind of a crash in the market. We've seen more just cap rates slowly kind of trending up and then kind of stabilizing. I think we are going to see more deals as the equity guys are tired of putting in money. So I think, well, I think we'll see that tick up. But I think a lot of people are still hoping that interest rates bail them out. And now we're talking about a possible rate cut in September. You know, of course, we don't know if that's the beginning of something or what, but Everybody's hoping that that solves the problem for us.

Here's a good question for passive investors. You know, this is what the whole point of this summit is for both of you guys. How do you guys approach allocating your real estate portfolios or alternative portfolios? You traditionally stick to one or two asset classes, especially for you, Ken. I mean, you're specialized in multifamily, but do you diversify outside of that with the rest of your cash, or do you try and spread exposure across multiple real estate asset classes?

Yeah, I think the first thing we do is we believe that the market is more important than the property, because the market doesn't matter if you're in A, B, or C, the market will save your butt, right? So if the market's trending correctly, that's really, really, really important. And then the second thing is we take a look at, is it oversupplied, is it undersupplied? So I'll give you a harsh example. Downtown Phoenix, which is an area that I know well 'cause I have a home in Paradise Valley. You can rent a brand new Class A building for 4 months free on a 12-month lease right now.

Oh my God.

Okay, so what does that tell you? It tells you that there's a tremendous amount of new Class A that entered the market at the same time. It's kind of what Bob Fraser was talking about. Now, I love the distressed stuff like that. So it's way too early to jump in on something like that. But it'll go from 4 months to 3 months to 2 months to 1 month. That's what'll happen. Some of those will go back to the banks. Now, the reason I bring that up is because the Class A's, when they're 4 months free, affect the B's, and because then the B's have to do something which affect the C's. So it is a waterfall effect. So, so what you do is you completely stay away from a market like that, but you watch it. And then what we would do in a market like that is we would try to buy the Class A's when they're somewhat stabilized after they've absorbed, right? And it's probably a couple years away, but we're keeping an eye on that. Then you fast forward to Scottsdale, which is just, you know, my backyard. You don't have that kind of construction development, maybe in some particular submarkets, but the absorption's much, much different. So in Scottsdale, I would buy probably Class A or B unrenovated, let's say. So it's really market-driven for us. This last cycle, we bought a building from a guy in Florida, hadn't touched it for 25 years, right next to Arizona State. It's literally untouched, unrenovated. So it's a huge value-add, but we're not doing the value-add yet because rent's being disrupted right now. It's flat, there's concessions. I'm a long-term hold guy, so I'm like, I don't really need a value add in year 1, 2, or 3. I can do it in year 5 or 6. I can do it whenever. I just have the asset ready to go, and I know that there's forced equity in it and it cash flows today. So I look at pretty much everything except for, I would say, anything that has environmental issues, really poorly located. That could be A, B, or C, you know, but if there's a C that I could scrape and build new, we would do that. We're also building 1,500 units right now. We have 6 projects going. We're in lease-up on some, we're in construction on 2, even with today's high rates, because they're going to open in 2027. And when the, you know, all this disruption is going to be over, like there's no meaningful construction that's opening in 2020 after '26. And so we're going to see really, really nice rent growth because rents for the most part are stabilizing, not in the area of Phoenix, not in some other areas. You're going to see most little disruption for a couple of years. But the cool part about real estate, you can go 10 minutes this way, 15 minutes that way, 30 minutes that way, and you have entirely different markets because people, they congregate where they want to be based on where they're working or walkability or the lifestyle that they want. So you can have extremely different submarkets with very, very different results, even in You know, like Arizona, Tucson's so different than Phoenix, and then there's 50 different submarkets of Phoenix, you know, and they're all very, very, very different.

You know, I, I think one of the main lessons of the book and The Billionaire Model is diversification, and professional investors never put all their eggs in one basket. And so I think you want to think about diversification and our alt continuum. The very first stop is private real estate, and a lot of people are heavily in multifamily, and of course that's been a a tough market. And I think you need to think about diversification. That means diversifying geographically in multifamily, means diversifying across sponsors and operators, but it also means diversifying into other real estate classes. And ultimately, it really means diversifying outside of real estate. I think a lot of people are overinvested in real estate and looking into private credit and looking into natural resources, private equity, and these other things that the billionaires are invested in. So I think we always want to be thinking about diversification because there's magic in the math and there's magic in the peace. If multifamily has a meltdown, hey, that's not the only thing I'm in. And if the public markets have a meltdown, hey, that's only X% of my portfolio. So you want to have diversification as really core, core tenant and be disciplined in your allocations. Awesome.

Guys, we're going to wrap up here in just a few minutes. Got one question, so let's be quick on this, okay? So a year from now, we're back at the Invest Like a Billionaire Millionaire Summit Year 2, where interest rates at? Ken, you're our guest.

We'll let you— we'll let you go. Yeah, I mean, we follow the 10-year, right? So a lot of people look at the Fed funds rate and depends on where you are. But for us, we've been doing deals this year, Fannie and Freddie at low 5s. So I, you know, the cash flow's there. So I think 3 quarter point cuts, a lot of people are saying that, but is that really going to move the needle that much? It's not. In my opinion, not this year. And by the time Trump gets his Fed chair in there next May, there's a lag as well. So, I think people should just strap on and try to make deals for the next 18 months based on these rates. And then maybe in '27, when Trump gets his way, we'll start to see that 3% cut that he wants. And it's just going to create a bubble again. But you know what's going to happen then? All the big boys are gonna come out, all the big managed money. That's when they're gonna jump into the market. So this is the time for the nimble, small private investor to be able to scoop up deals and weather the storm for the next year and a half. And then if that happens, then that'll be a blessing. You know, there's, there's two things the Fed has on their mandate. One is interest rates. The other is unemployment, which is a wild card with AI. And we just had our conference, the Limitless Conference, and George Gammon, uh, and I were chatting and he, He thinks that, you know, we could be at 10% unemployment. I don't know how much this is on Trump's radar, but you know, I've talked to multiple people. The job market's hard right now. The entry-level white-collar stuff. I have a buddy that owns a big law firm. The one sold it, uh, he is a securities lawyer, sold it 'cause he said AI's gonna be, you know, the PPMs and all that stuff are gonna be basically AI'd. He said the paralegals, We don't really need them much anymore with all this stuff that's going on. And by the way, this is the worst it'll ever be. So I think that's a big wildcard, and that's another issue the Fed's going to have to contend with. We all think inflation's higher than it is, and I think unemployment's a little bit of a wildcard. I know Trump just fired the BLS director. I think we're at 4.2. That'll be really interesting to see what happens there. But this isn't all about that. The Fed's going to be looking at both of those things, and don't forget, there's There's what, 12 or 13 governors, not just Powell. He's the one taking the brunt. So Trump's gonna have to stack the deck to get what he wants, but all that's gonna do is create another bubble. Yeah.

Bob, just real quick, just so we can wrap up here, your thoughts.

Yeah, well, which interest rate? So I think we probably see the Fed funds rate come down because Trump is banging on it so much. And yeah, I think he's personally gonna fire enough people to raise the unemployment rate. So yeah. Great. And so, I think we'll see the Fed funds rate come down, but as Ken pointed out, he pays attention to the 10-year. Well, there's a reason, because that's the rate that most investment is based on. And the 10-year is determined at auction. It's not determined by the Federal Reserve. And what's happened, we've seen structural changes in the Treasury markets. Since the Great Financial Crisis, we've seen the amount of debt outstanding, the amount of government debt outstanding, US Treasury debt, outstanding go up sixfold. Sixfold. Well, that means you've got to find buyers. So who's going to buy? It's just supply and demand. And if we've got a supply that's crazy because of the deficits. So anytime the government runs a deficit, they take the deficit and they issue Treasuries. Well, you got to find buyers for all that. And if there's not enough buyers, you have to raise rates to attract more buyers. And we're seeing this. So I do not believe the 10-year is going to soften that much. If any. So I think it might come down a little bit. And then I absolutely, I'm with Ken. I, I think you create another bubble and inflation is this monster hiding in the closet right now. And, uh, we've not seen the end of it yet. And again, for structural reasons, you know, I personally, I'm not super afraid of AI. I went through the, you know, the internet was supposed to do the same thing and it didn't. It just changed jobs. It didn't disappear jobs. And I think we'll see the same thing with AI. So, I'm less of a doomsday type person there, but I do think we're going to see inflation is just not going away and it's going to continue sitting there.

Guys, amazing. Hey, I'm going to wrap up here. Ken, thank you. Thank you for being here. What an honor to have you at this summit, someone like yourself with your experience. Thank Thank you so much.

Appreciate you, Bob. Appreciate you, Bob, as always.