There are no bad assets

I love Quora, the question and answer site. But, multiple times per day, people post questions like “Is buying an apartment building a good investment?” or “Should I buy stock?” or whatever.

These are dumb questions, because whether an asset is good to buy is 100% determined by the price.

For example: Imagine a run-down buildingon a street with lots of other beat-up buildings. Is this something you should buy?

Maybe… it all comes down to price. If that old building is generating, say, $100k / year in rent and you can pick it up for $600k (eg 6x GRM), then it might be a great asset to buy. At $1.3MM (13x) it’s probably an idiotic move.

Ah, you say, but what about assets with real problems, like environmental or structural or legal issues?

Those can be great assets, too, so long as the buyer does enough diligence to be properly informed about the costs / risks involved and pays a price which reflects those costs and risks.

For example: Say you find a commercial building that would ordinarily be worth $1MM, if it weren’t for the gas tanks buried under the property which are scaring off lenders (who generally hate environmental risk). Maybe you find out you can buy the thing for $600k, cash.

Maybe you can (with help from pros) get comfortable that the cost of removing the tanks and remediating any related soil issues will be in the range of $100k. Well, that’s probably a pretty great asset to buy, since you can be all in around $700k on a $1MM asset – a return of 43%. And even if you’re off, and the work ends up costing $200k, you’re still all-in for $800k on a $1MM asset – a return of 25%.

So, say it with me: There are no bad assets, only bad prices.

Thinking about the next recession

One of the key insights in Howard Mark’s book, The Most Important Thing, which I love, is that you can’t predict a recession with any certainty.

All you can do is (i) know that the pendulum always swings back; and (ii) observe where the pendulum is currently.

It’s pretty clear that the pendulum is currently far towards growth.

Equity capital is abundant. Interest rates are low. Amateurs are flooding into my business. Prices, consequently, are high.

So, while I have no idea when the next recession will come, it seems likely to me that one is coming sooner rather than later.

This insight is prompting me to think about how I intend to behave during the next recession, which, of course, causes me to think about how I behaved during the last one.

In 2008-10, one of the greatest real estate buying opportunities in decades, we were just starting out. So, when we bought something, we absolutely, positively needed to renovate it immediately, in order to demonstrate that we knew what we were doing.

That strategy was necessary for us then, but would be a mistake in the next recession.

Instead, the move is to focus 100% on buying properties with great bones / locations at fair prices. Ignore the temptation to get wrapped up in repositioning them. Just buy a ton.

Later, as the market begins to improve, we can begin to refocus on adding value to our purchases.

There’s usually only a short window to get your hands on great buildings at fair prices. As Buffett says, when it’s raining gold, you need buckets, not thimbles.

The forecast on our latest deal

As the economy has continued to improve, both nationally and here in LA, it has become harder and harder to find deals worth doing.

That said, it’s definitely not impossible.

Today, we are closing on a deal with the following characteristics:

  • Currently a vacant triplex
  • Paying $220 / sq ft
  • Suitable for conversion into a 5 unit building

By the time we’re done, in around a year, inclusive of a fee to us for managing the project, am expecting the building will yield approximately 7.5% / year unlevered.

Assuming that rates for apartment loans are at 5% by then (they’re currently around 4.5%), I think we’ll be able to refinance out ~$1.6MM of the ~$1.7MM investment.

The cash-on-cash yield on the $100k remaining in the deal ought to be ~25% / year.

Depending on rent growth, etc., the investor should have 100% of his money back within 2-4 years of stabilization. Then there will be 2-3 years where he gets all of cashflow from the building to pay down the preferred return accrued during the construction process.

Thereafter, the investor and Adaptive will share in a (hopefully growing) cashflow forever.

Who says you can’t find good deals anymore?

Why we love (our) property management business

A lot of people in real estate HATE residential property management.


Tenants understandably get pretty upset when they’re paying good money for an apartment and things break. And, on the flip side, no one calls up her landlord when things are going great and says “Hey! Thanks for my apartment! It’s wonderful!” So the business is pretty rough emotionally.

And the money often isn’t that great. If you’re managing an apartment building for 6% of the rents and you have a tenant paying $1,000 for an apartment, you’re getting paid $60 / month to collect the rent, respond to maintenance requests, handle the accounting, etc. That’s a very bad deal.

So it’s kind of a messy business… all hassle and not enough compensation.

But, at Adaptive, we love property management. Why?

  1. Our buildings are in great shape. The vast majority of our units are recently gut-renovated. And I don’t mean slapping some lipstick on… we replace plumbing, electric, windows, roofs, etc. So, while we obviously have maintenance issues (particularly in the period immediately following renovation, while we’re still shaking out minor construction issues), in general, we deal with many fewer maintenance problems than companies that manage older buildings. That means less hassle for us and generally happier tenants.
  2. We attract tenants who appreciate our product. Our buildings have a point of view. The design choices aren’t random. They tend to appeal to a specific type of person who sincerely appreciates design and is willing to pay for it. What we’ve found is that, in general, these kinds of tenants pay their rent on time and take care of their apartments. So, we spend comparatively little time dealing with tenant-related nonsense like evictions, collections, etc.
  3. The product commands high rent. Because the units are great, we can charge good rent. 6% on a $3,000 apartment is $180 / month, which is a MUCH more reasonable amount to be paid for the effort involved.

I understand why other companies see property management as kind of a red-headed stepchild, something they have to do but don’t really like.

But we actually love the business and intend to be in it (and happily so!) forever.