Moses Kagan on Real Estate

Seems like everyday, I find myself explaining to brokers what it is that I want to buy. And I also hear from brokers that they read this blog.

So, at the risk of boring the hell out of my regular readers, figured I’d remind everyone what we’re looking for.

We want to buy older, dilapidated apartment buildings in improving neighborhoods in Los Angeles. Because we’re renovators, we not focused on the existing physical condition of the buildings, nor on the cap rate or GRM.

Our inspections are quick and focused on the big picture, not whether the light-switches work.

We pay cash and close quickly.

We never, ever re-trade or grind brokers on their commissions.

We’re happy for listing brokers to represent us. We’re also happy to pay buy-side commissions, so long as the numbers make sense.

If you have a building that seems like a fit, please send the address and the rent roll to moses@adaptiverealty.com, and I will get back to you quickly with a price. We treat all submissions as confidential.

Doing good deals is all about resisting magical thinking.

Hour after hour, you comb through possible acquisition targets, looking for the needle in the haystack that will allow you, if everything goes well, to deliver the kinds of out-sized return your investors expect.

When something looks like it might work, you build a model. You input the list price and a bunch of assumptions for how much the rehab will cost, what you’ll get in rent for the finished units, etc.

The model spits out a forecast unlevered yield, and, almost always, that number is too low.

Can you imagine how tempting it is to tweak one or two numbers and cause the forecast unlevered yield to rise above the target threshold, so that you can buy the deal?

After all, your investors trust you. They’ve learned to take your estimates as gospel, because you’ve delivered the forecast yield, over and over again, across many, many deals. So no one is going to bat an eye when you show them the model. They’ll just send in the capital.

And, the truth is, if you juice the numbers, it’s entirely possible no one will even care. Rents in the neighborhood might run, making your “actuals” look good. Or interest rates might come down, allowing you to do better than you should have on the refi.

So, in the end, it comes back to you. Do you have the will power to resist the magical thinking that will put hundreds of thousands of dollars of fees in your pocket, but at the expense of your integrity and, possibly, your fund’s returns?

Have been listening to a bunch of podcasts and reading a lot of blog posts about the venture capital / start-up space.

Don’t worry, I’m not changing fields… am just curious about other kinds of businesses and always looking for analogies and ways to improve what we do.

Core to the whole tech world is the idea of identifying an annoying problem that affects a big market and then figuring out how to solve that problem, profitably, at scale.

So, as I consume all this material about tech, I have been keeping my eyes open for these kinds of problems in the businesses I know best: doing deals and managing residential real estate.

Here’s one I have been chewing on: How does a listing broker know which buyer to trust?

Some more context: In most sales of real estate, there are several bidders offering relatively similar prices and terms. Most individuals don’t transact that often. So, the bidders are effectively anonymous from the perspective of the listing broker and the seller, who have no idea who is really serious and who is just kicking the tires.

To make matters worse, the seller / listing broker can’t be certain that a buyer has the means to close, even if she is serious about moving forward. The present methods for doing so, soliciting proof of funds and, for residential transactions, pre-approval letters from lenders, are rife with issues, from fraud (it’s easy to manipulate a bank statement with photoshop) to identity theft (do you want your bank statement emailed around to 50 different listing brokers?).

And there are real costs associated with choosing the wrong buyer. You go from having a hot-and-heavy auction, where there are loads of interested buyers and you can extract the best price and terms, to a period where a single buyer has the property tied up for an exclusivity period of ~30 days. If the buyer fails to perform, all of that momentum is lost, and it’s very likely the deal will take longer and close at a lower price than if the “right” buyer had been selected up-front.

So, that’s the problem, for anyone who cares to work on it: What can be done to help sellers distinguish real buyer from fakes?

Got asked an interesting question by a journalist at the Opportunity Zone Expo, and wanted to share my answer here.

Question: What is the most important thing to look out for when considering an opportunity zone investment?

Answer: By far the most important thing is the quality of the deal itself.

Right now, Opportunity Zones are a gold rush, and there are already a million amateurs “mining experts” out there. I guarantee that most of the deals these experts are pushing will end up being disastrous… that’s what happens when a whole bunch of capital pours into the hands of inexperienced operators.

So, if someone pitches you an OPZ deal, you need to focus on the numbers, and the question you need to ask yourself is: “Is this a deal I would do with free (ie non-tax deferred) capital?”

If the deal is “blah”, and you would not be interested but for the tax benefits, run. The tax benefits are uncertain… the regulations are not totally in place yet, and even when they are, some unfriendly Congress years from now might change the rules and reduce / remove the benefit.

And, as we all know, most deals don’t outperform their pro formas (though I like to think we have a pretty good record of doing so!). Things can go wrong, and numbers can degrade. So, if you’re starting at “blah but for the tax benefits”, there’s a pretty high probability of ending up at “yikes, with attenuated tax benefits”.

If, on the other hand, the deal is good enough that you’d do it with fresh capital, and you layer the various tax benefits of the OPZs on top, then you’ve got yourself something pretty awesome.

Am joining an interesting panel today at the Opportunity Zone Expo at the JW Marriott downtown, regarding selecting interesting opportunity zones in which to do business.

We’ve done 10+ deals in relevant locations in LA over the past few years, all of which would have qualified for OZF status, had the law been in effect.

Am going to share some of our experiences, including the mistakes we and others have made.

Come say hi if you’re around.