Learning from the crowd-funding sites

In general, I dislike real estate crowd-funding. My beef is that the lack of connection between the sponsor and the faceless equity providers makes it easy, psychologically, for the sponsor to justify to himself screwing over the investors.

That said, RECF sites do provide a very valuable service to new investors and sponsors: They have large repositories of pitch decks, PPMs and operating agreements.

Before RECF sites, it wasn’t that easy to lay your hands on a bunch of marketing materials for different deals. Now, you can go on one of the RECF sites, create an account, and shortly have access to hundreds of deals.

If I were starting out today, the first thing I would do is download a ton of different pitches and operating agreements and read all of them.

I would not pay that much attention to the pro forma financials. After all, these are marketing materials from random sponsors, so you have to assume the numbers are, at best, optimistic and, at worst, borderline fraudulent.

I would, however, pay a lot of attention to:

  • The nuts and bolts of how the deals are structured (the preferred return, the promote, the order of distributions, clawbacks, etc.). This stuff makes for very dry reading, but it is at least as important, from the investors’ perspective, as the characteristics of the target property and business model.
  • What numbers / factors the sponsor emphasizes in his marketing (IRR, equity multiple, location, pics of the property itself, etc.)

I would make copious notes, comparing and contrasting the different structures and ways of marketing. And I would create a list of questions, trying to get at why the sponsors made the choices they made.

You do this with, say, 20-30 of these pitches, and you are going to have a pretty good sense for how the whole game works.

Announcing the launch of Hyperion Property Management

At Adaptive, we’re always looking for ways to serve more partners, whether those partners are investors, property owners or tenants.

We’ve noticed recently that more and more owners of single family homes on the Eastside are choosing to rent those homes out, rather than sell them, once they’re ready to move.

This makes sense. The property taxes are generally quite low (thanks, Prop 13!), and the rents you can get for a nice-size homes in cool, Eastside neighborhoods are pretty high.

But someone paying $8k / month expects a very high level of service, and, until now, there has not been a property management company specifically focused on managing single-family home rentals on the Eastside.

So, we went out and found a guy who knows more than we will ever know about building relationships, Ludovico Marenzi, and partnered with him to launch Hyperion Property Management.

Importantly, Hyperion will never do sales or leasing. Its sole business is property management. Our plan is to partner with brokers and agents who handle sales and leasing, rather than compete with them. Brokers can introduce us to their client and feel totally confident that, when it comes time for that client to lease or sell their home, we will send the client right back to them.

Do you have a single family home on the Eastside for which you need very high-quality property management services? Please reach out to Ludovico at lmarenzi [at] hyperionpm [dot] com.

One way syndicators con investors

Want to take moment to explain and decry a move I see a lot of syndicators making (particularly on crowd-funded deals): Making distributions using investor capital, rather than free cashflow.

Heres’ where the problem comes from: Syndicators need capital from investors. Investors generally want both regular distributions AND high forecast IRRs.

It’s a seller’s market right now, where you can’t just buy a high cap rate, stabilized deal with some leverage and forecast a high IRR. Instead, to forecast a high IRR with a straight face, you need to buy something with a crappy cap rate and add value.

The problem: To add value to a property, you generally need to vacate some material portion of the property while you make improvements, in hopes of re-leasing that space for higher rents.

The (hopefully temporary) vacancy means there is little / no free cashflow. But the investors were promised regular distributions. What is the syndicator to do?

The answer, for a lot of syndicators, is to raise more equity than the project strictly requires, then use equity reserves to pay distributions, even while there is no free cashflow.

By over-equitizing, the syndicator drives down his eventual IRR (because he used more capital to generate the same profits)… but, by the time the numbers are printed (generally, when the deal is stabilized, or possibly not until it’s sold), the investors are already in the deal and the syndicator has made his fees.

You can get away with this shit because most people don’t read the docs, and the ones who do usually aren’t sophisticated enough to understand the con.

But it’s still a nauseating practice.

Learning from Stephen Schwarzman (again)

Just finished Stephen Schwarzman’s new book What it Takes, which is a kind of a combination memoir and business advice book.

Regular readers know I idolize Schwarzman, who founded Blackstone and built it into, by far, the largest manager of alternative assets in the world. As one of the co-founders of a tiny speck of an alternative manager, it’s both inspiring and humbling to be reminded of all that Schwarzman has accomplished.

For me, the best part of the book was Schwarzman’s explanation of the genesis of Blackstone’s culture. How did he build that magnificent machine?

First, he went out of his way to hire what he calls “10s”, people who are capable of identifying big opportunities, developing strategies to take advantage of them, and executing.

Second, he instilled an ethic of intellectual rigor and honesty that allows even junior staff to contribute to tearing apart investment ideas to see if they hold up.

Third, he has done a fantastic job of promoting from within, giving talented people the opportunity to grow their careers inside the organization, rather than having to leave to get more responsibility (and, presumably, economics).

When you’re a founder, it’s easy to believe you have all the answers and scary to admit that other people may know better than you. I hope Jon and I have the humility and the self-confidence to do as Schwarzman has done in attracting spectacular people and giving them the scope to thrive.

Learning from Charles Koch

Have been listening to Tim Ferris’s interview with Charles Koch, which pairs nicely with Sons of Wichita, which I read last year.

In case you don’t know, separate from his efforts to bend our country’s politics to the right over the past 40 years or so (or, maybe, not so separate!), Koch is an extraordinary business leader. He took over his father’s little oil company in 1967 and built it into the second largest private company in America, with $110bn in revenue last year.

The key to Koch Industries’ incredible growth under Charles’ management is a series of astute acquisitions. But Charles seems to think of those acquisitions as partnerships.

His criteria for what makes a good partnership are:

  • Alignment of vision – In other words, having the same big, long-term goal(s)
  • Alignment of values – Obviously, you don’t want to do business with people whose values diverge too far from your own… life’s far too short
  • Complementarity of skills / resources – So that the partners fill in each others’ gaps

Adaptive is, at its core, a partnership between Jon Criss and me. We’ve certainly had our ups and downs, but the partnership has worked well for more than eight years because we share (i) a long-term faith in the future of Los Angeles, (ii) a willingness to work really hard to build a durable company to help create and benefit from that future, and (iii) complementary skills (deals / financing for me, design / construction for him).

And, over the coming years, as we look to grow by expanding into other, related businesses, we will be looking for partners who fit Koch’s criteria. Whatever you think about his politics, the guys is a master of building businesses.