One bad habit I’m trying to kick

One of the bad habits I’m prone to falling into is failing to grow my network of capital providers.

For any given deal, if we’re not deploying a discretionary fund, it’s easiest to reach out to the 3-4 families with whom we do the most business and get one of them to write the check.

You can see why, right? They trust us, we trust them, and we’ve already got the documents worked out. So it’s really just about explaining the specific deal and hammering out a few key economic terms.

The problem, from our perspective, is that doing the easy thing does not grow our capital base, which is essential if we’re going to grow into the company we envision.

So, I have been making a point of researching and cold emailing prospective equity partners over the past few months.

It’s not the most pleasant part of my job. The response rate is pretty low and, even when I end up speaking with a relevant decision-maker, I’m in the role of a supplicant, when, if they could see our operation and track record, we would be on at least equal footing.

But, somewhat surprisingly, it does work. The key, it turns out, is not trying to sell too much on the phone. Instead, I aim to get the decision-maker to come to our office and then take a tour of some of our projects.

Once they take the tour and meet the team, things start getting serious pretty quickly.

Why we’re sticking to our knitting

Regularly get asked the following questions: Are you planning to venture out to other cities? Start doing other product types (office, retail, etc.)?

The answer to both is that I would love to branch out. Aside from the intellectual stimulation that comes from learning new things, expanding the pool of potential projects would allow us to put more capital to work, which would be good for Adaptive.

But we’re pretty unlikely to expand to other cities or product types any time soon.

Why?

It comes down to “circle of competence”, the range of potential deals were our existing skills and knowledge give us an advantage over competitors.

When it comes to fixing up apartment buildings in Los Angeles, I can say, with no exaggeration, that our organization is the best. We know, with great certainty, how much we can pay, what we’ll do with a building, where the potential pit-falls lie, what kind of rents we can expect, how to finance the deals, etc.

Are we perfect? No way. This stuff is really hard and we make plenty of mistakes. But I’m confident, because we’ve fixed up ~80 buildings over the past 10 years, we know what we’re doing.

This is utterly not the case when it comes to buildings in, say, Austin. Or office buildings, even in the submarkets we know well.

Now, if we were in the midst of a down-cycle, when everything gets cheap and you can depend on subsequent rent / price increases to bail you out if you screw up, I would absolutely be looking to try new cities and/or product types.

But, since we’re in a pretty hot market, where we need to pay top dollar for assets, we’re going to stick with the type of deals we truly understand, even if it means I get a little bored of looking at hundreds of apartment buildings every day.

Some advice for new graduates

Recently, have found myself giving advice to some recent college graduates beginning their careers in business.

Figured I’d share here, since plenty of my readers are in the early stages of their careers and this is the advice I wish someone had given me.

As always, my advice is worth what you’re paying for it.

Here is what I recommend:
  1. Immediately begin reading the Wall Street Journal (focus on the “Business” and “Markets” sections)
  2. If you’re in LA, begin reading the Los Angeles Business Journal
  3. Go to the Berkshire Hathaway website and start reading Warren Buffett’s annual shareholder letters, beginning with the first one in 1965(?) and continuing through this year’s letter. This is like a free, very high quality education in insurance, management, and corporate finance.
  4. Pick out 4-5 public companies in the industry you’re looking to get into (ideally, ones headquartered in the city in which you want to live) and go read their most recent annual reports, paying particular attention to the CEO’s letter. You will quickly get a sense for the challenges and opportunities facing the industry.
  5. Using the annual reports, the WSJ and (in LA) the LABJ, pick out 5-10 leaders in your chosen industry, cold-email them, and ask you if can come into their offices at any time that works for them for a 30 minute conversation. If any agree, do a TON of preparation for the meeting – read everything you can find on the person, their company, their industry, etc. Prepare a list of really good questions and memorize it. Go in there and impress the hell out of them.

If you do the above, you will be about a million times more prepared than your competitors. The rest is up to you.

The numbers are out of whack

Our business model allows us to generate yields which are consistently 200 basis points in excess of “market”.

In other words, if any random ding dong can buy a 4% cap, then we can reliably create a 6% by doing what we do.

But, right now, a 6% isn’t that great.

Why?

Well, interest rates for multifamily loans are ~4.5% / year.

So, if you borrow $2MM, you’re looking at annual debt service (inclusive of principal pay-down) of ~$121,150.

$121,150 / $2,000,000 = 6.1%.

That means, the more you borrow against your 6% yield, the worse the cash-on-cash yield gets. Ouch.

We really need to be making 6.5% yield deals to make the math work… but prices right now make that hard to achieve.

Eventually, if interest rates keep rising, prices are going to come down, which will allow us to make higher yield deals and bring the math back into alignment.

But you can wait a long time for an irrational market to come to its senses!

Some thoughts on negotiating

Repositioning an apartment building requires obtaining the consent of a huge number of people and institutions, from tenants to contractors to city inspectors and on and on.

This consent doesn’t necessarily have to be enthusiastic. But you still need it, because not getting it can screw up your project massively.

So, a big part of what we do is figuring out how to help people or institutions say “Yes”, when they could say “No”.

And a surprisingly large part of getting that consent is just simple human decency and compassion.

It’s about carefully thinking through what, exactly, you are asking someone, whether it is within their power to grant your request, and how painful consenting will be for them.

Then, it’s about crafting your offer in a way that anticipates and mitigates their issues and presenting your offer firmly but, always, respectfully.

Next, you have to actually listen to their response, because often they spot problems with your offer that you never considered… but they’ll only engage honestly with you if you’ve treated them respectfully.

Finally, you need to be willing to leave a little meat on the bone. By this, I mean that you should not try to absolutely kill the person against whom you’re negotiating. Once you get into a position where they’re prepared to accept terms you can live with, think VERY carefully before trying to push them again.