Best of Ken McElroy: How to Find Profitable Real Estate Deals

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0:37While Robert is away, enjoy the best of Ken McElroy, his top insights on real estate cash flow and building wealth through smart investing.

0:49Primarily what I do is invest in real estate. So we have multifamily, we have self-storage, we have office, we do land development, and that's what I do full time. My partner, Ross and I, we have 250 employees. We're in multiple states, primarily Texas, Arizona, and we're building, we're buying all the time. In fact, we were talking about two deals right before we jumped on the show here today. So I use debt, as you know, Robert and Kim, I think, why wouldn't you use other people's money? That's basically what it is. It's borrowing money from a bank. People put their deposits in the bank and then they give them to me to invest in property.

1:27And so that's, it's the greatest thing ever. And then we only have to come up with the down payments. And so we use debt and then, you know, Tom works his miracles on the depreciation side and the bonus depreciation and all the other advantages that we get on the tax side. So we make millions and millions of dollars every year and we pay very little taxes and sometimes none. Yeah. And to your point, Robert, about you can't do this on your own. when we met Kenny, we were doing it on our own. And we'd got, I was basically handling all the properties and we didn't have a lot at that time. We had two apartment, three apartment buildings and some single families.

2:03And, um, I couldn't handle anymore because I took up all my time. And so when we met Kenny, I'm like, Oh yeah, can you manage my properties? And he said, no, he said, I cannot. So we only work with like 120 units or more. And that's when the team came together because as I was doing it on my own, I could only go this far. And I know a lot of people that are in real estate that can't go farther because their time is all they've got. So you've got to bring a team on. So we had Kenny and then we brought on Tom and it's the team that lets us grow.

2:35Ken McElroy:Yeah. That's a very important point. There's most real estate investors right here. You know, they have a duplex or a fourplex and then property management gets them. Yes. And so what Kenny said to Kennelly broke her heart. Kenny said, Kim was so proud. I have a 30-year department. Kenny says, it's too small. Not that you can't do the same tax laws, but Kenny can't manage it because in real estate, unlike stocks, see, the reason stocks are good or paper is good, there's no management. But real estate is management and Kenny comes from the management style. So when Kim and I met him 20 years ago, he was like godsend to us.

3:23Ken McElroy:This guy can manage property. And unless you've been in real estate, you don't know that is the Megillah. If you can manage real estate, you got it, right Kenny? Yeah, in fact, even when somebody's giving you money, it doesn't matter who, that's the number one question they ask. Who's your team? How are you going to manage it? Who's going to manage it? Who are they? What's their experience? And so it's the most important thing because giving somebody, handing somebody money is not that hard, but then having that money produced is hard. Yes. So Kenny, how did you get started? I mean, you started as a management guy, right?

4:00Yeah, I did. I started, you know, I was in college, you know, trying to, you know, not rack up a lot of student debt, even though I had some and I was managing a property and I was getting paid a whopping$600 a month. And I was, and I got a three, one bedroom and, um, I was managing an apartment building in downtown Seattle and I liked it. I actually really liked the business and I felt like it was really horribly managed when I moved in. And, and I was like, well, if I just get people in here that can pay rent and I can clean this place up, it'll be a lot less work for me. And, um, I did that.

4:35And, And then the owner came over about three months later and he's like, Hey, thanks for cleaning this place up. And, you know, income's up, place looks great. And I was like, I need to be on that side of the desk somehow. So that's when I started to add my mind shift is like, okay, how do I, how do I buy these and then apply these same management principles?

4:56Ken McElroy:So like, you know, when guys like Dave Ramsey say live debt free, what goes through your head? Well, I think that it's the dumbest advice ever, actually. I really do. It just makes no sense to me. I don't know. I mean, people are getting debt right now. So 2.5%, 2.3%, 2.4%. That's going to be less than inflation. So if you can lock that, if you can borrow at that rate, why wouldn't you? It's free money. It's literally free money. And I think Dave Ramsey has a different audience. I think the debt that he's talking about getting out of is bad debt is your home. No, no, no, no, no, no. Dave Ramsey is a friend.

5:39Ken McElroy:I've had dinner with him several times. I meet with him. His advice is good for stock people. Yes. If you're going to go into real estate, debt is your best asset. And the reason that Ken and I always talk about this, this is a financial statement, okay? See, if income expense, asset liability, for the people on the B and the I side, the biggest liability is cash. Yes. Am I correct, Tom? Absolutely. And it's, it doesn't produce, it doesn't produce anything. No, they're printing, they're printing it. Yep. They're printing it. Since 1971, they've been printing it. So what happens is when Kim and I make money, income comes in here and we have cash, we've got to move it into debt.

6:28Ken McElroy:Right. We're converting cash into debt as fast as we can, but the key is property management and then investor management and market management. So that's why anybody saving cash today and living debt-free, it's good advice if you want to be poor. Now, but don't switch into real estate unless you're willing to understand what Kenny knows about real estate. So that's why his three books, give us your three books again, Kenny. The ABC for real estate investing, the ABC for property management, and then we have an advanced guide to real estate investing. And that's what you need to understand because when you say move your money into debt, if you don't know what you're doing and you're buying a property and you have no education, you have no experience, you don't know what you're doing, that debt's going to be bad debt.

7:21Ken McElroy:This is the irony of it all is twice a year we have to call Kenny and say, Kenny, we need more debt. Kenny, why is that? I think when you said debt became money, I think that a lot of people have a stigma around debt. You know, it's kind of a bad word. And for many it is, you know, credit card debt. You know, that's kind of what gets a lot of the media attention. But, you know, we're borrowing, as you know, from banks at 3 % or less. And we already know just in the last few months inflation is reported by finally higher, way higher than than than we're borrowing. So why wouldn't you borrow other people's money in the form of debt?

8:08Because you're actually just like it's like taking money from people and fixing it at three. And and inflation is your friend right now. So, you know, you're crazy, as you know, to save money because you're purchasing power on that money is eroding. each and every month. And it's starting to show up in the numbers.

8:28Ken McElroy:And Kim and I panic when Kenny doesn't have a deal because without Kenny, we don't borrow money. And what's funny is about twice a year, I'm on the phone with Kenny begging. I need more debt. You have a lot of guys like that, Kenny, right? Yeah, yeah, yeah. I mean, but I'm in the same boat as, I mean, we all are, you know, we all know that debt is your friend. you know why wouldn't you borrow other people's money buy real estate and then have other people pay it off for you and then you get the tax write-offs you know so you get income plus you get the tax benefits for that kim is that what we do that is what we do that is what we do and i wanted to say to kenny's point um i bet there's a lot of people watching this right now they're going oh yeah that's good but you know the prices are too high today so there's no deals out there and we just closed on a deal what a few weeks ago any comments or kim yeah well i have a question then if okay so they're going to keep printing money they're going to keep propping up the stock market until they can't anymore um so what's a person to do what do you do today well i'm still finding cash flowing deals kim you're still finding them oh yeah yeah yeah in fact like literally right after this call here, we're on an investment committee call.

9:50We're doing, we're looking at six to eight deals a week. And you know, obviously, you know, we don't buy anything that doesn't cashflow or doesn't have a value add.

10:00Ken McElroy:So Kenny, Kenny, that's, that's the, I think the key question, Kenny doesn't just flip the property. He improved the property. Would you say that's true? Yeah. Yeah. I, you know, if it doesn't have a story, I'm not going to buy something and hope it goes up. That's not, you know, I, I do what that's Tom knows and we, we, we, we, we call it forced equity. So, so like the last deal that we just bought, as you guys know, you guys are in it. It's a$20 million value add. Now I know that sounds like a lot to a lot of your folks. Yeah. What that means is that there's, there was a million dollars of NOI growth that operate you can grow inside.

10:39And so think of a, think of anything that's mismanaged, or not manage well, or maybe the ownership doesn't see. So you go in and you inject some money and you create more value. So you improve the property, you increase the rents, you manage your expenses better. And on that one property, it's gonna take a couple of years, we're gonna get to about a million dollars more in revenue than we had when we bought it. And so that's what investors buy into. And if you take a look, now then you bring that property to the bank, the bank should value that. We bought it around$80 million. The bank should value that around$100 million.

11:23Now, it's possible that I'm off. It's possible that I'm a little bit wrong, but I will tell you this. We're definitely going to increase the cash flow. That's for sure. We just don't know what the value is going to be. We think it's going to be somewhere between$96 and$100 million. That's what I'm talking about. So we have cash flow and we have value add.

11:40Ken McElroy:So Kenny, what was the total package from the purchase price and the value add? So we're somewhere in the mid, in the low 70s to buy both properties of 648 units. And they were next door to each other. So we're combining operations, we're renovating the property, and then we're adding washers and dryers. So all of those things equal to about$150 ,000 to$200 ,000 per month in rent growth. based on our improvements and giving and putting washers and dryers in the unit, that's going to be around a million dollars in additional cashflow that we hope to get somewhere after year two. And, and and so what happens is you then bring that back to the bank and you say, Hey, we bought it.

12:28Then the net operating income was here and now it's a million higher. What's it worth now? And then we put more debt on it. And then that's a, that's a cash out refinance value add as cashflow, as value add. And then we, we, that's how we get the investor money back. And it doesn't have to be a 600 unit property. It'd be a single family house. You get the same formula. You know, I love the house hacking. You know, a lot of people, you know, I have a ton of friends that start by, they, they, they have what's called house hacking. They basically get a free home. So you take a duplex, you buy it, you live in one side, you rent out the other side, it covers all your expenses and you're living tax-free and for free on the other side while the people living next door to you are paying off your place.

13:18And then I just, I literally just met last week with a young kid that I've been mentoring. He's 24 years old. He just did a cash out refi and took 138 grand out. He did that two years ago when I mentored him and I met with him he he's like i i got 138 right now that was because the market went up that's that's a gift that's not strategy and that's no that's not um something that he could have predicted thomas that tax-free money well it is tax-free money and what i'm thinking about when ken's talking about the washers and dryers and all that kind of stuff that's all tax deductions as well. So not only is the purchase price deductible through depreciation, but all of those improvements that Ken makes, those are deductible and they're just additional tax benefits to his investor.

14:08In every crash, people move to rentals. And so, you know, what's going to happen in the next three to five years for sure, it's already starting as we're moving more toward a renter nation. So whether you like it or not, rents are going to have to go up because there's only a limited supply of rentals right now. And people are going to pour out after these forbearance issues and all this stuff starts to correct. They're going to pour into rentals just like they did in 2008. And that's what created the rent growth. So that's happening, whether you sit back or not, or whether you're involved or not.

14:45And so we're trying to have liquidity and buy rentals in places where we think people are going to be. So when we go build properties or, you know, we're borrowing from insurance companies, we're borrowing from pension firms, you know, we're borrowing from banks and that's all OPM or other people's money. That's what it is. All the people sitting up in New York and all of Wall Street is basically just a bunch of really smart people managing Main Street. That's all it is.

15:13Ken McElroy:Just selling passive, passive investors. Yeah. So anyway, I think that's my greatest advice to young people, young or old. If you want to get ahead, ask yourself this question right now. Who are the five people you spend time together with the most? And what do you do? What are you doing with your five people you spend the most time with? And it's pretty telling their future from there. It's like being a fortune teller, you know.

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18:45I have a great story of a guy that he had a property that was 75 units, fully rented, cash flowing like crazy. He was out on a sailboat. He lived in San Diego. And a broker convinced him to sell that and to buy 140 unit in Mesa, Arizona. Okay. So he did that. It's called the 1031 tax deferred exchange. But here's what I remember the most. He called me the day they were closing. He said, we need a manager. And unfortunately, this is what happens. So what he really needed was a property manager to actually look at that 140 unit in Mesa and tell them whether it was a good deal or not. Because the broker, they're just working for commissions.

19:29The property managers, they're the ones that actually have to make it perform. And so what happened was he was so far behind, he was already committed and he had to close. And so he ended up buying it. And here's the, here's the problem. The property was filled with a bunch of bad things. So we, we actually had, it was already had a lot of vacancy. It had a lot of deferred maintenance. And in addition to that, we had to evake, we had to evict a number of people that were paying rent. Cause you know, why would you rent to anybody that can't pay? and so pretty soon the occupancy on that thing was like 60 70 percent and so then you guess what he did he fired us you know what i mean he's like oh it can't be my fault you know and i'm like dude like you know you know you bought a mess and so we'll clean it up for you and it took a while took like eight or ten months but finally i he was trying to you know project back onto me like as if i had something to do with it i'm like all i'm trying to do is fill this thing up with good people, you know, and he's like, well, now I'm like flying over to Phoenix all the time.

20:32I'm working all the time. I go, dude, you sold a hundred percent occupied boat property that had a lot of cashflow. You're sitting out on your boat and now you're flying to Phoenix and you bought this property. That's, you know, a board in a borderline area. It's your own fault. He didn't want anything to hear about it. And the point is, is that, you know, people like you said in the beginning, Robert, it's easy to buy something. It honestly is easy. It's not that hard to get money. Having money can be very dangerous, you know? And so people are doing that right now. And this is a, that was a great example where a guy, you know, he just, he had, he had a comfortable life.

21:09And then all of a sudden it was riddled with, and he fired the property manager after that. And then after that, and then he ended up selling the property again for a loss.

21:18Ken McElroy:And sometimes those are your best investments. Yeah, I know. I know. I wish I was just managing property at that time. And I wish I would have had the cash because I would have went in and swooped in and bought that thing. Because it really, you know, it takes a while to turn around a property. You know, in some cases, it's taken me a year, year and a half on big ones. You know, we have a 680 unit property in San Antonio, Texas, for example. I think, remember, you and I went to it. It was 300 units. There were 300 vacant when we bought it. Wait, wait, wait. It was worse than that. It was the worst property I've ever seen.

21:56Ken McElroy:We walk into the first unit. All the walls are taken out because they took all the wire out of it. And sitting in front of the fireplace was the toilet. I'm looking at that and Kenny says, God, this is a good deal. There's an effing toilet sitting in front of the fireplace. All the drywall was taken out. All the electrical, all the copper wire is taken out. and there's no carpet. And I said, Ken, I said, this is the best jail he's ever seen. This is the worst I've ever seen. So that, but the guy I listened to was the guy that turned the property. What was his name? Ken, his name was Ken also. Yeah, remember?

22:33And yeah, no, you're right. He was the property manager.

22:36Ken McElroy:Yeah, he looked at this thing. He said to me on the side, he says, this is the best jail I've ever seen. He said, you guys are nuts or I'm blind. I'm missing something here. And that turned out to be one of the best cash on cash returns we have. Still in the last 10 years, it's been the best deal that I've been able to buy. You know, we bought it for$25 million. We got the bank to write down another three. So our basis was like 22. And then we put seven into it. And now it's worth over 60. And we got our money back. And the bank loans you the money to rehab it, right? Yes, right, right. And that is actually the power of real estate investing.

23:16is seeing that, you know, as you say, Robert, a lot, you say, you know, deals are done in your mind. You know, it's something that you see that no one else sees. And I knew in two years, I would be able to turn that property around, put new debt on it, get up, get all the investor money back and own it free and clear, as we like to say, infinite. Again, Robert, once you start to do this, whether it's one unit, in this particular case, there was 400 that we needed it to fix. It was a 680 unit property. It's just math. Literally, some units are a thousand bucks, some units are$10 ,000. You have to figure all that out before you buy it.

23:57That was a big number. That's why we raised all that extra money. And the bank wants that. The community wants that. Everybody wants that. Everybody wants somebody. It's no different than if it's a house in the exact same condition. But it's also part of your formula, Kenny, and you touched on it earlier. Your formula is, number one, you like properties with problems, but number two is you look for a property where there's jobs. And that fit that core formula to a T. Right. And it's easy to buy something that's fully, you know, 100 % occupied. You're not going to move the needle a lot there. I'd rather personally buy something that's 100 % vacant and then figure out how to occupy it.

24:40And that's management. And then that also, if the building is vacant, it's worth a lot less than if it's full. And that's how you double the worth of your property. Start small. Start small. Yeah.