How I quit worrying and learned to love raising capital

All the capital for my second through 12th deals came from one of my best friends from highschool.

Once he forced me to start raising money from other people, I remember complaining to him that I hated raising capital.

You should have seen the stupefied look on his face, right before he said: “You realize you’re in the most capital-intensive business in the world, right?”

I admit that I had not realized that until that conversation. Not my finest hour.

I bumbled along, asking close friends and family for money, but doing little to expand my network. I adopted this totally self-defeating mindset, where I felt like our results were so good that people should be falling all over themselves to invest with us, and that, if they didn’t it was because they were stupid. And I refused to do the type of things that other capital-raisers do, like quoting IRRs and ROIs, because I felt like doing so was totally dishonest.

If you’ve ever run any kind of business, you can spot the problem right away: I needed customers (that’s what capital providers are: very special, highly-valued customers), but I wasn’t doing anything to find them and tell them our story. This is conceptually stupid, and the results bore that out: Adaptive Realty Fund 3 boasted a whopping ~$2.3MM in investor equity.

Anyway, over the past few years, I have radically re-shaped my approach to raising capital.

First, I really examined my own weird, defeatist nonsense. No magic fairy was going to descend from the heavens to Historic Filipinotown and shower me with capital. I needed to take ownership of this process and get good at it.

Second, I realized that I wasn’t trying to get people to do something bad. We do really good deals. The numbers are great. Smart people who really pay attention invest with us once, then do it over and over again, because what we do makes sense. So telling prospective capital partners about what we do isn’t like being a sketchy used car salesman – it’s doing them a favor.

Third, I figured out a way to tell our story that doesn’t make me feel gross. We’re not sellers, I’m not going to quote IRRs and ROIs, and I’m not ashamed of it. That turns off the majority of potential investors and that’s fine. Instead, I focus on educating people about how we think about the world. There are enough weirdos with money who like to hold real estate forever to allow us to build a business. I just focus on those people and forget about everyone else.

Third, I realized that capital-raising isn’t really about sales, anyway. You’re not going to convince someone who doesn’t want to invest with you to change her mind. Instead, it’s about telling our story, over and over and over again, in blog posts, meetings, at conferences, over dinner or drinks, whatever, to as many relevant people as I could. Not in an annoying way (no one likes being cornered and bored to tears). But in an open, helpful way that meets people where they are and educates them about an opportunity that might be great for them.

Is capital-raising ever going to be my favorite part of the business? Nope… there’s just nothing that matches the thrill of finding the right building, seeing in my mind what it can become (physically, and then, as a result, economically), and then working with my partner and our team to actualize that vision.

But capital-raising is now something I enjoy. And that means I’m happy to do it, which has translated into major growth for our business. Which is what I should have known would happen, all along!

An olive branch to the competition

For years, I struggled with whether I should keep writing this blog.

On the plus side, the blog has introduced me to hundreds of people who became brokerage clients, property management clients and/or investors in our deals.

On the negative side, I have educated a whole legion of people who compete with me for deals, which used to drive me insane.

However, recently, I have come to the following realization: Rather than being upset that some of you compete with me, I should instead offer to go into business with you.

Here’s why: When we were starting out, I went around meeting management companies to find one to manage our properties upon completion of the rehab process. I walked away from those meetings unconvinced, and we have self-managed ever since (with a few, minor exceptions).

We built exactly the kind of management organization you want for new / newly renovated buildings: responsive, transparent, totally buttoned-up on the financial side, etc. And it was expensive… for years, until we reached ~400 units under management, Jon and I had to subsidize the management company from our deal fees (ouch).

Now, we’re at ~600 units and we actually like the property management business. It’s no longer a necessary evil; it’s one of the two core things we do (the other, obviously, being buying and renovating buildings). And I am confident we’re better at leasing-up and managing new / newly renovated small-to-medium sized apartment buildings than any other organization in LA.

So, back to you guys out there competing with me: Since we have the team set up already, and since you’re going to need someone good to manage your deal(s), we might as well work together.

On the growth of Adaptive

I have a very clear vision for my career. I have known where I want to go (I want Adaptive to be a huge company) and I know what I have to do to make that happen (a series of very good deals for the people who trust me with their money, so that they will trust me with more of their money and tell their friends).

The annoying part is that the kind of deals we do unfold over years. Because we do such extensive renovations, we usually aren’t able to begin returning capital for 14-18 months, when we refinance the projects. And, thereafter, we settle into a boring series of quarterly distributions… not exactly the kind of thing that makes people jump up and down and tell all their buddies at the country club.

Some of our savviest investors pay close attention to the market and our regular investor reporting, and can see pretty quickly, well before the deals stabilize, that we’re doing a good job. These are the people who have turbo-charged our growth over the past 3-4 years, because they have been willing to commit more and more capital to us, without waiting to get to the end of the initial project(s). And these investors have been rewarded for their faith.

But, for most investors, committing capital to us is much more passive. They like what they hear, they write a check, and then they tune out, sometimes to a comical degree. I’ve had investors email me asking if the deal is over, because we returned all their capital after 18 months. And I have to explain that, no, this is just the beginning, you’ve got your money back and now you’ll be receiving checks forever.

The problem with those tuned-out investors is that they kind of inhibit our growth rate. Because there’s no big moment where we sell the property and announce that we’ve got them a 26% / year return or a 140% ROI or whatever crazy numbers you want to imagine, there’s no prompt for them to realize that, actually, things have worked out incredibly well and maybe they should tell their friends.

And that’s where things like speaking at conferences, networking, cold emailing, and, yes, this blog come in. For years now, I have been doing what I can to bring in new capital partners and start driving them up the learning curve about what we do. And, finally, recently, we have begun to see the fruits of this labor, where old investors are committing more capital and helping us bring in new investors, who, in turn, we hope will do the same in the years and decades to come.

Growth is almost never as fast as you want it to be… that’s the nature of our business. But, if you consistently provide a really good service and consistently communicate about it, eventually you enter into a kind of feedback loop where good things compound.

Connecting the generations with real estate

Years ago, when we were still working on the Better Dwellings portfolio, before we started Adaptive, I remember having a conversation which I now realize contributed to my bias towards holding real estate permanently.

Can’t remember who it was, but the person told me about checks he receives each quarter.

The source of the funds? Apartment syndications in Hollywood in which his grandparents invested in the 1980s.

He told me that, over the years, his family has received many, many multiples of the capital his grandparents invested. (Of course, I’d love to have access to detailed records to calculate rates of return, etc., but I don’t!)

What appeals to me about this story?

Regular readers know I’m fascinated by the concept of capital as a means of tying a family together through the generations. (The capital for my first deal came from the sale of a building my great-grandfather bought in New York decades before I was born, capital which passed through the hands of my grandfather and mother before coming to me, and eventually, to my children.)

I love the idea that, by investing with some syndicator, the grandparents helped provide for their grandchildren and, presumably, the generations beyond, long after their own time on earth passed.

And I love that, in some of our deals, there are members with names like “Trust for [Person X]”, where the trustee making the capital allocation is a grandparent and “Person X” is a grandchild I’ve never met, but who will benefit from that investment, long after the grandparent is gone.

My hope is that, when those grandchildren receive the checks, they pause for just a second and think of their grandparents, the way that guy I met thinks of his.

A surprising admission from Mr. Fund of Funds

Was at a terrible conference early this week, when I heard something amazing.

It came from a guy who runs a fund that invests in other managers’ private equity funds… in other words, a “fund-of-funds”.

Someone in the audience, presumably an aspiring fund manager, asked Mr. Fund-of-Funds how much of a co-invest he wants to see from the fund managers. In other words, he wants to know how much of their own money asks the managers to put in.

Ordinarily, investors like managers to invest a lot of personal money in their own funds, to make sure they’re incentivized to do a good job. (Honestly, it bogles my mind that anyone would take money from a partner and then do anything less than the absolute best he/she could, but anyway…)

Mr. Fund-of-Funds had a superficially counter-intuitive take. He said something like: “I don’t like managers to have too much of their own money in their funds(!), because then they start acting like a family office and refusing to sell.”

If you think about it for a minute, this actually isn’t so surprising. Mr. Fund-of-Funds needs his underlying fund managers to sell so they can return capital to him and he can, in turn, return capital to his investors. So I get why he wants them to sell.

The interesting part is at the end, the part about how people who actually put in their own capital don’t like to sell.

Of course they don’t!! Selling vaporizes capital, in the form of transaction costs and taxes. It forces capital allocators to find new deals to put their money in… when they had a perfectly good investment already. And it robs capital allocators of the principal benefit of a great investment – slow, steady compound growth of cashflow and asset valuation over decades.

If you know me at all, you know we, as a rule, do not sell assets. We buy them, we fix them up, we refinance to return capital to our investors, and then we hold forever. Don’t think we’ll get any capital from Mr. Fund-of-Funds… but plenty of other capital allocators think like us.