All Forum Posts by: Serge S.

It is not so much that Ken is not buying multifamily or bullish on the space, it is that Ken is NOT BUYING MULTIFAMILY IN ARIZONA . He has been buying and syndicating in the state since the early 90s and has seen the cycle repeat itself. He  would rather build as his per unit construction cost is generally the same as a class B-C build in Maricopa County. He still owns thousands of units in state but will not buy based on a broker proforma at a per sq/ft cost equivalent to a new build. Most of the guys doing this in AZ are either from out of state or have not been around long enough to appreciate our submarket specific cycle. This cycle has repeated itself over and over and if you can read it then you will know the right time to buy in PHX, Tucson and tertiary. If you can read between the lines, Ken's just saying in a round about way that right now is not the time to be a buyer of multifamily in PHX Metro and I agree. 

@Michael Ealy thanks for posting. I like most transitioned from SFR to MFR and have been able to build a portfolio of over 500 doors in MF. I'm currently spreading out to Mobile home parks and have been looking at hotels for years not but never able to pull the trigger. I had one in contract that was around 100 keys in a town where I had a MFR presence. I had a great SBA loan lined up at 10% down and it was a smoking deal on paper but what spooked me the most was the franchise dictated repairs. They were coming in every 2-4 years and dictating major lobby renovations, furniture upgrades etc to the tune of $400k plus. This made me very uncomfortable underwriting 5-10 years out. Second thing was management. I was able to find professional hotel management but these guys are not easy to qualify and they can make or break your investment.

A few questions for you - how are you financing your deals? Do you always use the same management teams? Have you had renovation cycles dictated to you by the franchise and how did that go down? What are some of the main metrics you look for when flagging a deal? Do you invest in primary, secondary or tertiary markets and what size hotel makes the most sense?

@Andrey Y. It can be tough for an LP to sort through the details and promises. Everyone  operator is seemingly "conservative" and sees what others do not.  At the end of the day its as you said, a game of trust and relationship. There is no substitute for experience and past results. This is not the time in the cycle when you want to be rolling the dice on an operator's first few deals. 

Aside from the list that @Brian Burke detailed, the common thing I see is cherry picked comps. Operators promising huge swings in rents of $300-$400 and comping to assets that are not at all comparable, either in different submarkets altogether or a different asset class. I'm not sure how an LP would sort through that. Generally at this stage in the cycle these assets have been purchased and resold 2-6 times since the lows of the recession. Now the new owner thinks he is smarter than the last 5 guys all of which made millions on the exit. Not saying there are no deals but projecting huge NOI swings can be a reach.

Second thing I see is operators pitching a "story." The story of how they were special to get the deal or how much the neighborhood is changing due to gentrification, light rail, opportunity zone, capital investment or the next big company moving in next door. If you have operated in one area long enough then you have seen all of the stories come and go. A low income neighborhood does not change quickly and a community of $700 rent residents doesn't turn into a community of $1400 rent residents in a year. Average median income in micromarkets change slowly and companies leave just as fast as they come and and opportunity zone are usually just a nicer name for a terrible neighborhood. 

The concern is rather obvious. When people pay over the cost of new construction for C class assets under the premise that post renovation rents will be more affordable than competing new construction; there is some serious inherent risk. If you talk to large experienced long term players in Arizona multifamily like Ken McElroy, he will tell you that it makes no sense to buy C class when you can build for the same or less all in. Hence all of the new construction.

Rents will not grow indefinitely and when it gets competitive the new construction assets with the same basis as the C class rehab junk will have room to maneuver while the over rehabbed, maxed out rent C class goes back to the bank. It doesn't seem possible that can happen again but it will. There is a real affordability crisis and a renter that qualifies for $1300 rent must gross $45k/year. If your business plan is banking on average rents of $1300 in a demographic where median income is half that do you see how that can be a problem?

The people who say its a great idea to buy a rehab at 3% cap in a gentrifying opportunity zone area are the 2019 version of the SFR investor of 2006. Take a hard look at SFR rents in said gentrifying opportunity zone and ask yourself if people will pay the same rent for rehabbed one bedroom apt as a 3-4 bedroom house around the corner. Ask yourself if your end buyer will pay the average regional SFR median price for 1-2 bd apartments in one of the lowest county median income regions. Be careful who you listen to on BiggerPockets. You will not hear @Brian Burke boasting about his latest 3 cap deal.

@Yonah Weiss as others have mentioned, if cash flow and scale-ability are the goal then SFR is definitely not the asset class. I see SFRs as little 7-11 convenience stores. You need to run it and put in all the work to squeeze out a tiny margin and you need a lot of them to make anything substantial. I started in SFR and got up to nearly 60 quality homes. I come from a corp background and did everything possible using tech, software, etc to make it efficient. Nearly impossible. On top of that all your expenses on a per unit basis are nearly double that of multifamily from insurance, capex, etc. The only positive is tenants tend to stay longer term. SFR is a great play in recessionary markets as a store of wealth but a terrible and risky play in a late stage cycle. All risk and very little upside or exit strategy.

@Shiloh Lundahl sounds like this has been working for you so who really cares what others think as long as your model is ethichal:) I have been investing since 2009 in the same markets that you are in particularly Pinal County. I have also done my fair share of lease options, notes, etc. What I can tell you with certainty is to forget your tenant buying the home or actually keeping up with repairs in the long run. Won't happen. Not one of my lease option tenants ever were able to purchase the house. Everything from credit never being repaired, no longer satisfied with the home, life changes and many other reasons. A person that can't afford to FHA a sub $100k home is by definition unstable and unstable people generally stay unstable.

Furthermore it sounds like you are not putting them on title rather giving them a paid option. This payment and model has been challenged and there are court cases that indicate this is a risky practice. Dealing with primary buyers is always challenging and the landlord rarely looks good when these issues make the AZ Republic. What is the likelihood your tenant in a $85k home in Casa Grande will be able to afford a substantial repair like an HVAC or slab leak? They simply won't notify you, skip or raise hell for you to repair. I have 200+ tenants in that submarket paying similar rents and I highly doubt anyone of my tenants can afford to make such a repair. So the reality is that you should still be reserving for capex and if you do there is no positive cash flow in the long run. That's the big problem I see. The homes you are buying for $125k are the homes I purchased for $50k 10 years ago and they hardly cash flowed at that basis. I can tell you that all the money I made in SFR was from equity appreciation and not cash flow, these tenants just murder the homes. The appreciation only came after 3-5 years of ownership, everything I sold as a flip or short term hold had nominal returns after all of the buyer concessions in that market. It was a hard lesson as it took me a good 5 years of results to see the writing on the wall. Once I saw it clearly I sold out of SFR as fast as possible and moved to Multifamily. Not trying to be negative in anyway, just sharing my experience with that asset class and submarket. I think you would be better off just flipping these homes and keeping the quality ones longer term.

@Wes Blackwell great summary post! I own roughly 20 STR throughout the state. I had one in a high end HOA complex and the neighbors lost their mind and the HOA battled me until I just sold it and moved on. I have another in an HOA for 4 years with no issues. Today, I would not do a STR in an HOA community, not worth the aggravation. The neighbor backlash is ridiculous in my opinion. My guests pay upwards of $4000/month in the peak season. These are travelers with disposable income that I have found generally respectful. Every STR tenant issue I have had has been with longer term stays that were probably an evicted local with no where else to go and my inability to screen them properly.

By far my biggest issues are regular long term tenants. These are neighborhood destroyers. By definition a tenant in AZ paying a $1000 monthly rent is most likely paycheck to paycheck, will not maintain landscaping and will end up being the bad neighbor. You can't compare this tenant to the STR tenant. Yet there are no restrictions on a long term tenant. Futhermore, the STR model increases demand for housing and as such home prices. The not in my backyard owner simply doesn't understand this.

AZ was supposed to be the bastion of the gig economy yet we are falling prey to the same demonetization of the industry as you see in CA. I live in Fountain Hills and will certainly be letting Rep John Kavanagh know my position. Where else do you see a conservative republican mandating such outrageous regulation on an industry? This is the hotel lobby at its best, they are alarmed at how many homes are coming to market and the effect it has had on the demand for their hotel units. At the end of the day, the best strategy is owning an entire small multifamily and using those as STRs. In this scenario the hand of the government shouldn't touch you. This is the only way I would consider growing this business. 

@Matthew Lessard Northern AZ is a fantastic market. Scarcity, slow growth in construction and high rents is the name of the game. Price per door is also going to be higher for similar quality than in metro PHX. Most profitable strategy is no HOA SFR or small to mid size multi with a heavy slant on vacation rentals. Also look at Camp Verde, Cottonwood, etc. There is a 30 unit with a great location in Prescott close to Whiskey Row at over $100k/door. Inventory is scarce but I would not hesitate on the Northern part of the state. Also keep in mind the weather is quite harsh on the typically wood construction. The swing from below freezing and snow to 90+ summers will lead to higher maintenance expenses than in metro PHX.

I agree with @Nick B. regarding length of experience. I simply toss any offering with a sponsor that does not have a track record of executing an exit and/or 5 years in the game which I believe to be a very reasonable hurdle. Yes everyone needs to start somewhere, but they can do so with their own money, not mine. The world of syndication is not a world of scarcity and there are so many quality people/offerings. 

I know one syndicator who spent the entire years 2010 to 2017 "underwriting" deals and none were good enough. Everyone buying was a sucker in his mind. Now in 2018/2019 at the top of the cycle, he is suddenly active and now everyone else on the sell side is the unsophisticated sucker while those same sellers are making 4x on the real estate he buys. He will show people a 3 month track record and tell the world how brilliant he is as an underwriter using a model pilfered from others. There are exceptions to every rule but remember that a track record is difficult to hide. Its easy to say that any idiot could have made money investing in 2013 but that idiot had the cash and brains to execute. 

As far as false beliefs, I really feel for someone looking to passively invest at the LP level in multifamily. I'm not sure how that investor can be expected to know which assumptions are full of **** and which are legit. I'm not sure how he would know that a syndicator cherry picked comps and has no chance to achieve the promised rents or that a projected economic vacancy is unattainable in that submarket. Only way is to underwrite yourself and the bootcamps are pitching such training but in reality these bootcamps are just marketing for the syndicator to show how smart he is in an attempt to attract capital. I have been underwriting multifamily for over 10 years and been in the same market during that time and can tell you that there is just no way to know what you don't know. So at the end of the day it is indeed trust in the sponsor and a close examination of past performance. There is no substitute. 

@Jordan Mantel as others have told you, quality small multi is rare in PHX metro. There are one off decent deals that would require vacation rental to make any money. Standard long term leases just will not be worth your time. But you really need to know the submarket to know if its viable or not. Or you can do a casita house hack if you don't mind living next to a registered sex offender. No matter what anyone says there is no reliable screening process for short term guests. Keep them at arms length.