Navigating a hot market by raising cheaper capital

Two days ago, I wrote about how hot the apartment market has got and promised to talk about how we, and others, are navigating it. Yesterday, I discussed a tactic that kind of works right now, though we can’t use it.

Today I want to talk about another way to approach this hot market: By raising the right capital.

Our whole business is about generating unlevered yields that are in excess of what investors could get by buying buildings themselves.

When we started Adaptive, you could buy a 6% cap and we could create an 8% unlevered yield. So we raised money by promising an 8% pref.

Why target an 8% unlevered yield? After all, interest rates were like 4%, so you could deliver an 8% to the investors by doing a 6-6.5% unlevered deal and then putting a bunch of debt on it.

The answer is that we HATE to rely on factors we can’t control, and the debt market is definitely one of those factors. In bad times, banks cut off credit. We don’t want to be in a position of promising our investors a return, only to be unable to deliver it because the credit markets seize up. Instead, we want to do deals where, even without leverage, we can give investors what they were promised… and then, if good debt is available, use it to exceed investor expectations.

Now, the market is offering buyers of buildings 3-4% and our business model allows us to create 5.5-6.5% yields at scale.

If we raise 7-8% money, we’re effectively pricing ourselves out of most deals.

So, unless we want to go do other kinds of deals or take a lot more risk, to put out a lot of money, we need to look for capital with lower expectations.