The Multifamily Market Is Quietly Resetting | Ken McElroy

There is a major crash right now in multifamily housing. Apartment buildings that have multiple units are now facing a significant crash. Our guest today is Ken McEnroy who owns and manages about 10,000 plus apartments and he's been deep into the multifamily market. He's here to tell us what he's seeing right now in the market and where the opportunities potentially are. There's a lot of properties that are sitting there getting funded and there's a lot of talk with lenders going on right now. The real question is at what point do you toss your hands up and say I can't fund this anymore and or I'm going to foreclose or I'm going to move forward and take the property back and do whatever you need to do. That all kind of started in 24 and 25 and now it's really going to come to fruition in 26. I'm Siamak and this is Market Insider. Ken it's great to have you on welcome. Yeah thank you it's great to see you again. You are in the real estate space and you're very active in the multifamily. We want to hear from you what's happening right now in the multifamily investments. It's rough right now because of what happened when interest rates went up in 2022. A lot of people that had let's say floating mortgages their mortgage payments went up and when mortgage payments go up cash flow goes down. If some people were in that situation they've been cash strapped for a few years now. Some people didn't have the money to hold on and the real issue is when that happens the values also go down because if I'm buying something for cash flow I don't want to pay as much right because the mortgage payment's higher. When interest rates went up eventually cap rates capitalization rates also went up so values went down. First it was 20-30% now it's 40% and I'm even here and even higher than that. So what happens is that's not such a big deal if you can hold on right because if you can hold on it doesn't matter. It's like it's like buying a home and at one number and then it goes down and if you're living in the home it doesn't matter and it goes back up eventually. But if the loan matures which is the real big issue. And can you tell us about these loans? You have maturity dates on loans. You have a beginning and an ending. There are people that track maturity dates and especially if like if you're a bank loaning to me there's a maturity date right. So a maturity date literally means the loan's over time to refinance or sell it or you know resize the loan or whatever it might be. It's literally trillions of dollars in the last few years of maturities. Now not just multifamily that's commercial office and retail and industrial so it's everything. If somebody just googles the debt wall is what they're calling it you'll see these different kinds of maturities and the cool thing is you can actually see what product type literally because these are all recorded loans right. They're all on the deeds and the lenders of course know when all this happens. The problem is because the values have come down because the cap rates are up and the interest rates are up. These loan maturities are creating issues because now in some let's say you're a lender and I'm the borrower. If the property is worth less than I owe you then we both have a problem right. You have a problem and I have a problem so my equity's gone and now you have to take a write down on the loan. So that's what's happening right now is the industry's been repriced. If you have a loan maturity issue then you either have to do a cash in or resize the loan. So if for example if my property is worth less than the loan you're gonna say okay we need to resize this so you're only gonna want maybe 60-70% on the loan. So I really have to come in with a lot of cash. You have to come up with more cash to keep the property. So that's what's going on. So it's happened before the market cycles will always happen but people just forget right. That's really the issue. Market cycles happen people forget. There are ways to mitigate this and as cycles begin all you really need to do is just be in the right positions. A lot of this happened when people bought when they maybe shouldn't have bought. You know so they bought when if you're buying something where you believe next year is going to be worth more it's a bad strategy. So that's what happened. There was a lot of people that jumped into the space. Was it after the pandemic or was it before the pandemic? And even before but during and after certainly. The flags were there all the red flags were there. I mean we saw because we have an investment committee that meets every week and we look at lots of deals every single week and we're plugged into the markets and we're looking at all the stuff coming. We're getting outbid which is fine but we're getting outbid with people that are putting non-refundable money up and just no due diligence and just buying things because they had the cash at what we thought was kind of the top of the market and the problem with that it's all predicated on next year's value being higher and we all know that that's not how real estate works. Real estate can hopefully go up but it can also go down. Nobody thinks of the down part and so I think a seasoned investor always considers the down and so we had a bunch of what I would consider amateurs come into the market, prop the prices up, dump a bunch of money in there, raise a bunch of capital from a bunch of limited partners and kept the bubble going and also at the same time we had interest rates go down. You had those kinds of things happening. The professionals most of them just sat on the sidelines so I didn't buy a lot in the last few years. 22, 23, 24, hardly anything. It was frustrating because imagine with the track record we have over 20 years of investing taking your foot off the gas and watching these deals trade and you're like am I missing it you know you start to think all these things but we just I said listen guys we need to focus on operations because at the same time we had inflation hitting. We had problems with the property taxes, our insurance, our utilities, our payroll, our labor, our labor costs, our materials, all the stuff that it takes to run these things. We just went inward and started working on our operations and then what happened was interest rates went up as we know to kind of counterbalance inflation and that's what crushed everybody. So that's where we are today and the people that have made it are the ones that have enough cash and the ones that have the track record and probably the ones that put themselves into good positions. So if you're looking at the industry as something that you own today you're probably frustrated because values are down and that's where we start working on our operations but if you're looking at it as a time to buy which is exactly what we're doing we think it's a great time to buy because when do you want to buy anything when there's value and the problem with that of course is if there are all kinds of issues you know you have occupancy issues and you have expense issues and you have the loan issues and all those kinds of things but the experienced person jumps into that arena and unwinds all that and and finds all the nuggets you know that you can create value for the for the for the so it repriced and I think that's a good thing. So how much is this repricing is right now like and we we don't hear a lot about this yeah what do you see out there? Yeah I'll tell you why you don't hear it that's very interesting so let's you know like we own an apartment building let's say in wherever Texas or in Arizona two three hundred tenants in there you know everybody's just going along doing their thing the leases don't change the tenants don't see a thing but the ownership might change but they don't see anything right and what's what's really happened is that the properties changed hands but the residents don't see it so it's really at the wall street level right. At the bank yes it is the banks are the banks doing these transactions or are they owning them? Yeah you got Fannie and Freddie you've got debt funds you've certainly got local banks for sure and then you've got on the equity side typically high net worth or family office or private equity or institutional equity so it just depends on the property but there's definitely a repricing that's happening and it will make its way into wherever it goes but it's not really hitting main street it's hitting people's savings for sure maybe their retirement accounts it's hitting people that invested real money so I don't want to discount the fact that there's definitely people that lost real money. The next thing that you're going to see is these banks are going to write down these loans they have to because otherwise it just sits on their books so nobody's going to pay what the loan balance is if it's worth a lot less so that's kind of the next thing and where that shows up you know of course in the performance or the stock price or whatever of that financial institution if they're reporting that way so that's all happening and it's very different from single family of course you know which is when there's a problem in single family when single family is let's say not affordable they move to rentals right yeah when it's really affordable it hurts multifamily so they're counter cyclical really those two those two things and single family of course is main street right and of course Trump even made that more so at Davos recently he's like no more institutions are going to buy single family so he's kind of anchoring that now but the apartment buildings that the people that own office buildings and the big apartment buildings typically are more more more wall street you're seeing valuations drop significantly 30 40 50 percent is there a lot of volume are a lot of people that are losing here's the thing if if I own a deal that's not performing and you're the lender I'm trying to do whatever I can to save that thing because you have to refinance right every five years yeah you want me to be successful too because you already underwrote me but you know you're looking at the math and you're saying okay what's it worth how much money can we put into this thing and you know where's the haircut going to be taken it's either going to be me or you or maybe both of us you want me to be successful because you've already put your faith in me once and given me a loan but the reality is is that a lot of these deals are so far below the loans that there's just no reason to have me involved like you'd be better off taking the asset figuring out what to do with it take the right off and then package it up and sell it off to the next person so that's what's happening now and this is a lot of properties too I was on a webinar last week where a guy told me that there's thousands thousands of multifamily properties that aren't hitting what their debt service coverages at all debt service coverage is literally where is the where's the loan payment and where's the net operating income they need to be at least 1.2 1.3 and they're below one which means that they're not covering so they have to pay every month well they don't have to it depends on the loan covenants the point though is there's a lot of properties that are are sitting there getting funded each and every month by somebody or and there's a lot of talk with lenders going on right now and so the real question is is at what point do you you know toss your hands up and say I can't fund this anymore and or I'm going to foreclose or I'm going to move forward and take the property back and and do whatever you need to do that all kind of started in 24 and 25 and now it's really going to come to fruition in 26 it's a tale of two cities right if you are going through that it's painful but if you're putting your dry powder together and and you're you're watching this real time which is exactly what our company's doing it's a heck of an opportunity to buy things significantly below replacement cost and to make sure that they cash flow it's a complete repricing which in my opinion needed to happen you know how things can get really highly priced a lot of people as always they buy at the top and that's what just happened and just popped and it's being repriced the question as I was telling you earlier is are we at the bottom and you know so the real the real issue is if I buy something how much worse is it going to get right I have to bake all that in to my assumptions how long is this going to take to actually fix itself we look at properties every single week and I was looking at something the other day four months free on a 12-month lease just to put that in perspective that basically just covers the expenses it doesn't at all even pay for the loan they are giving this kind of rent discount just to get a tenant if you're going to rent there you would get four months free on a 12-month lease now you can call that whatever you want but it's it's a rent discount rents are going down it's it is what it is but when you started to build that property you had your rent at a certain number you did not budget four months free and then you have your expenses and then you have your loan we are looking at these deals and so why would I look at a deal like that because it's broken I that that's actually how you create value in this in this business the last thing you want to do is buy something that's perfect because there's nowhere to go and you're kind of relying on the market you really want is you want to buy things that are that have that are broken of some sort now we passed on the four month free deal for the exact point I just made first it has to go to four months then it goes to three months then it goes to two months then it goes to one then it goes to half off then it goes 100 off and then then it's and that's a long period of time we're going to stay away from that one and we're going to look over here at some other properties there's an unwinding of the way a property runs but it's it's absolutely the greatest time to to find really really good deals that are lender owned because lenders don't want to own real estate what they want is to find somebody that can take it off their hands and manage it well and they want to loan against it to a good borrower so we're looking at a lot of projects do you see a difference across the country is the is it the same for multifamily everywhere or do is there markets that are doing better than others oh definitely there's definitely markets that are doing better so there's a number of variables the first variable that that is obviously easy is an overbuilding there were 500 over 500,000 units added to the u.s in 2025 of multifamily yeah so okay so where that's the real question right atlanta dallas phoenix you know wherever so you start to look at you know where did they add that supply like the four months free four months free i can already tell you that's because there's a whole bunch of new supply added in an area and they're all competing with each other for one tenant or two tenants you know that's how it works that's called absorption so you wait until those get absorbed they will be good deals at some point the question is how long does it take right is it one year two years what is it that's kind of the game so certainly supply is a big factor and that can completely disrupt the market it's a great opportunity for a tenant really really good opportunity so i have to go and negotiate oh yeah so i have an employee for example that works for me and i said you got to go over to this new place and because you're you're living in a 30 40 year old property you ought to go over here and move into this brand new one and get your four months free your rent's going to be less you got a parking you got elevator it's gorgeous it's a really good time in a lot of respects to be a resident a tenant for sure now so that's one thing the other thing is population and and employment growth right so we see all these stories of companies kind of moving around right based on all the all the things that are going on and the policy yeah all that right yeah they're strategic locations for them so you see that as that happens that creates demand somewhere else right so if they pull out of here they pull out of portland and they go to phoenix now all of a sudden you've got a couple hundred people that are they're going to be hired or move there or whatever it creates demand in that particular market for housing for rentals for restaurants for schools for whatever population migration patterns are extremely important as you start to look at that in phoenix which is where i live we have the the taiwan semiconductor plant right which is billions of dollars incredible facility that they're building in north phoenix it's adding thousands of jobs and of course all around it is you know the housing the multifamily you know the the corner shopping centers and all that's all the infrastructure has to be built too that's what you look for you look for you look for investing into the path of progress and you look for migration patterns of people where are they going and why and and you know what kind of jobs are they so that's what we look at when we're investing so it really depends on on the market you know the midwest oddly enough has done extremely well it didn't pop it didn't bubble and it didn't pop actually i've invested personally in some properties in like columbus ohio and cleveland ohio there are markets that are doing remarkably well and there are markets that are overbuilt right now like las vegas is definitely overbuilt right now so it's experiencing this high concession high vacancy time period but if you look at the population growth it's still good so if you can buy it today when the numbers aren't great and so how long right do you want to catch a falling knife right and so how long do you hold that one year two years so you just you just reserve the amount of cash for you know that time period and then at some point you just do the calculation how many people are coming and how many months do i have to hold this thing until it starts to stabilize and is there any new construction and if all that checks out then you might want to make an investment there so that's that's some of how we decide on where to go which markets do you see opportunity right now and you feel confident that that will do well there's a lot actually a lot of if you look at like boise for example salt lake city phoenix tucson we're looking at dallas certainly so there's a market that we're looking at i know a lot of people that are doing things in charlotte nashville atlanta you start to look at the one of the there's a there's a few little hacks that i'll give some of your viewers that we use one very obvious one is out-of-state driver's licenses so for example like once you find out how many new people are coming yeah like when when a family moves somewhere they go they're supposed to at least they go get a new driver's license okay that's that's a that's a data point right u-haul and north american van lines they actually publish data you can actually go online right now and type in u-haul and you'll see you who moved from phoenix to atlanta or who moved from seattle to phoenix one way now it's not perfect but you can do that there's also cell phone you know cell phones right so during the pandemic they were doing this like how many people are taking the subway how many people are in the city of san francisco oddly enough that's a data point so there's these things that you can use to kind of see what's happening and then you can be on the forefront of that we use all of those things including employment employment's the easy one because that always is in the paper you know this xyz company moved here and brought 500 employees or they're opening a division or whatever it is those have always been around but now there's all these other ways that that that show up the thing that that's interesting is like anything it takes so long to build something right like an apartment building because we have a lot of properties under construction apartment building will take almost two years to finish from beginning to end we don't even open the office for a year and then we're still under construction and so we're leasing up a two three four hundred unit apartment project it could take two to three years to lease up something like that the reason why that's important is as people are moving they're they're creating the urgency themselves the occupancies are up high so if you see a market where has really high occupancy and no concessions and there's a lot of people moving there that might be a market we want to invest in because especially if there's not a lot of new supply so there's a reason a lot of people are moving somewhere and you know you're going to have the demand and it can work quite the opposite too right so yeah like yeah you could buy you can own something it's happened to me for sure you can own something and like we had a prop we had properties down near the border in sierra vista arizona and the border patrols there and also is fort huachuca it's a military base so so when there's a military deployment our occupancy goes down right as the border patrol hires or or lays off people which happens you know i just saw this week amazon's laying off another 12 000 people that has massive real estate implications because those people maybe they get jobs maybe they stay local maybe they don't you know like there's all kinds of things that happen and so they stop going to a grocery store or they take their kids out of a school or whatever it is so those kinds of things are really important and they all have implications uh based on whatever real estate class you're investing in in terms of rents yeah how much do they fluctuate a lot in areas where they don't have rent control what what does it look like so rent it's a great question the rent actually fluctuates based on supply and and demand so demand are the people that are there and supply of course of the number of vacant units if there's a lot of supply then the renter has their choice right but there's not the renter doesn't in markets where it's really really hard to build like think of manhattan manhattan's a great example it's an island you only really can build up right so you tear down something you build up and it takes a long time well there's a reason why rents are so high it's because it's constricted all the way around by water if you want to do anything you got to go up so that's an extreme example but it is it is an example so you have a lot of people that want to be in new york and therefore they're going to pay three or four thousand dollars for 500 square feet you know or whatever it is right same thing with san francisco now that's changed but then you of course go to you know columbus ohio where you know you're going to get a 2 000 square foot place for 1200 it's just literally a supply demand things if there's too much supply the renter has the upper hand if there's not enough supply and there's a lot of demand then the landlord has the upper hand if there's not enough supply and there's a lot of demand rents are going to go like that if there's too much supply and not enough demand then rents go like that do you think there is a lot of supply in the multifamily right oh yeah yeah absolutely because we we got 500 000 units that hit the market by the way a 50-year high think about how many that is and the other thing i'll just take people back so why would that happen in 2025 these are projects that started in 2021 2022 so you buy the land you go through all the entitlements and all the stuff that you need for the city then you get it designed by the architect then you get it approved then you pick a contractor you know there's a there's a good period of time could be a good good year just in planning then you go get a loan then you break ground something that started in 21 maybe uh started construction in 2022 isn't really even uh finishing until 24 pay possibly 25 that's kind of the time frame these are slow moving projects if a lender lent on with me let's say in 2022 and my construction debt was four or five percent by the time i got to 2024 it's more like eight because the interest rates yeah interest rates went up right because it uh construction so now that now the deal may not work correct right it doesn't work but you're already under construction you know we have the technical term of you're already pregnant you got to finish the project right regardless so you're certainly your costs are and then not to mention the fact all the supply chain issues and you know all the stuff that was going on during that period of time all that stuff matters and then of course when when you're when you're done that's when you start to lease up so all of that stuff is extremely important so when we're looking at the market today we're looking at all those factors i personally want a market that's over flooded with with the supply that has a lot of interest and a lot of a lot of population growth that's actually what i want i want a disruption with a new build or an existing project with maybe a bad loan that in a market that a lot of people want to be in that's what i want the question is how how long do i want to sustain the pain of after buying it right and how long do i have to give away concessions and and how long will it take to stabilize and our world is called absorption so how long does it take that property to absorb and stabilize and stabilize for me means 92 occupancy so that's kind of the goal we just finished a 300 unit project in tucson when you start it you have 300 vacancies like think of that 300 vacancies so i'm very used to filling vacancies that is the game i have it on my existing properties you know we have almost 10 000 units but on the new ones they're 100 vacant the minute you open we're very used to filling units attracting tenants and managing uh you know a lease up or even vacancy for me to take over a project that's 75 or 80 occupied or let's call it 25 or 20 or even 30 vacant i have no problem with that i just got to fix it figure out how much money it's going to take to get there to get there and uh and i bought a lot of stuff like this in 2008 9 and 10 11 we bought a property in san antonio 680 units it was 50 vacant owned by a bank so you negotiate with the bank and i i put a bunch of money on the side it's called interest reserves and then i knew that i was going to spend a bunch of money on the capital work you know the parking lots and the roofs and the interiors and all that stuff so you basically budget all those things and then you deploy your team to fix all that and then it's really a race of occupancy how quickly can i get this property occupied the secret to that really is quite simple it's 50 vacant in a market that's 92 93 94 so you have a you have a failing asset in a really good market it's the assets yes it's the asset whatever yeah yeah so you're fixing it for the lender and obviously for your investors you mentioned there is a significant amount of supply in the multifamily is this going to spill into the single family or does it not the multifamily business the tenants and the way it works is completely different from the single family yeah it can't if you're a single family landlord then for sure you could be competing with a new apartment community nearby because the apartment community could win but it might not so if you have if you have a family and you want a garage and you need a yard you're going to win as a single family but if you don't and you've got the apartment community with let's say this beautiful exercise facility area beautiful pool you know has all these community things that you can do then you might want to move into that you know where you have more of a community so but it definitely can spill over to that but i do not think at all it will compete with just a single family owner can with all of your experience and what you're seeing right now do you have any recommendations for investors right now if you look at what happened in the last few years a lot of investors jumped in and they're gun shy and they should be the big issue here is if you buy you need to buy with somebody who's seasoned if you're investing yeah you know let's say let's say you're just investing yourself or you're investing in somebody else's deal you want to really question the business plan the methodology the assumptions the underwriting all of those things that you know and really really really do that because that's actually what got everybody in trouble before and i'll give you a quick story ross my partner and i we decided to sell one property in houston texas and before we decided to sell it we renovated four units to see if i could push the rents any you know what i mean because the property was it wasn't that tired it was built in like 2010 but we said let's let's put some granite countertops in here and paint it and see if we can at least get 50 60 70 maybe a hundred dollars more per so we did that first that we couldn't get it like we tried you know but the market's the market i mean the renters tell us what the what the market is the landlord does not drive rents the market drives rent so anyway okay there's no more meat on the bone let's sell this we have a lot of equity in it let's let somebody else uh buy this we listed it and i happen to be on the list of the person who put it in escrow so now i'm the seller and they're the buyer and i get their business plan on my project that i own so you can imagine so i open the project and what does it say horrible management lots of red upside you know and you know this is we're going to reposition this and how all this stuff that i already tried now we're an escrow and i'm they're asking me to invest and and i sent it to my partner ross i go check this out this is pretty interesting and now it's possible that that happened for them but i'm just saying the point and this of the story is you can put anything you want in a business plan anything but to be able to back it up and ask the good questions that's that's what an lp or an investor needs to ask is really the rent assumptions the expense assumptions if somebody in this market right today is saying we're going to have massive rent growth you need to run because i personally for the next 24 months have said no rent growth it needs cash flow today if somebody in this market is saying we're going to slash expenses run because expenses are not going down so you know there's little things you can there's nuances and i guarantee you there's going to be business plans out this year that say we're going to have 10 12 percent rent growth we're going to slash expenses we're going to do this we're going to do that we're going to value add and there's no value add options right now like that is not this is not the time to value add what you're trying to buy today is real estate that cash flows as it is today you know with the existing tenants existing rents and existing mortgage and then from there you have those options later when the market's better but if if you have to make the deal based on next year being better than this year then then they should pass. Ken McElroy, it was great to have you on Market Insider. Thank you very much. Let us know what you think about this conversation with Ken. Do you agree that there is a major downturn in multi-family housing right now? Do you see the same thing? Tell us in the comments. I'm Siamak and this is Market Insider. We'll see you next time.