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.

Why we no longer announce acquisitions

Was browsing the LinkedIn newsfeed yesterday and came across a video a guy had posted of his latest acquisition, which included the name of the neighborhood in which it is located.

The video had a ton of likes and comments (mostly from brokers) and I admit to feeling a bit jealous. (Side note: If you think me getting jealous about a real estate acquisition gives you a window into my personality… you’re right).

So, if letting everyone know about your latest deal gets you a lot of attention, the question is: Why don’t I do it anymore?

The answer is, when we find an area or a building type that works for our peculiar business model, we don’t just want to buy one of those buildings. We want to buy all of them.

And alerting our competitors to what we find interesting is stupid, because it drives up competition for deals.

So, I will (sadly) forgo the ego boost that comes from telling you about what, exactly, we’re buying, in order to give us the time and space to put out as much capital into these interesting opportunities as we can.

Telling our story (again)

I remember reading one time that being the leader of an organization means repeating that organization’s story over and over and over again, to anyone willing to listen.

Lately, I’ve found myself telling all kinds of people what we’re about. So, I figured I’d repeat it here, for those of you willing to listen.

Adaptive:

  • Buys older, dilapidated buildings in improving neighborhoods of Los Angeles at fair prices
  • Closes quickly, paying cash and refraining from chipping price or screwing brokers down on their commissions
  • Thoroughly renovates, replacing / upgrading all major building systems, using permits
  • Re-tenants, leasing to anyone who can afford to pay (without regard to race, ethnicity, immigration status, etc.)
  • Refinances, using long-term, fixed rate bank debt to pull out 75-100% of capital invested
  • Distributes the refinance proceeds to investors (usually, roughly 18 months after acquisition of the property)
  • Manages the buildings thereafter, maintaining them in good condition and distributing free cashflow from operations quarterly to the investors
  • Holds forever

This business model is highly unusual in the real estate private equity space, because it does not print very high IRRs, nor result in the sponsor (Adaptive) getting rich quickly.

However, we’ve never been the kind of people who do things because everyone else is doing them. And this model feels right to us. So we’re going to keep doing it, probably for the rest of our lives.

The “How much are you putting in” Test

Whenever I’m out raising capital for an opportunity, I get asked the following question: How much of your own money are you putting in?

I understand why people ask. They are trying to determine how much conviction I have in the opportunity. The more I put in, the more conviction I have that this is a good deal.

In other words, they want to make sure I’m happy to eat my own cooking. But, what I’m cooking isn’t really for people like me, because I’m not liquid enough (yet).

What Adaptive is cooking is pretty simple: We offer a service allowing people with excess cash to earn high risk-adjusted returns by investing that cash in fairly conservative, very-well-executed Los Angeles multifamily deals.

However, because we never sell renovated deals, and therefore never realize our promoted interests (except in the form of quarterly distributions, after our investors have received back their capital plus a pre-defined return), I personally never have a ton of cash on-hand, relative to my net worth. In other words, I am not one of the people to whom the service is targeted!

Fortunately, we have done so well by our investors for so long that they have learned to focus on the quality of the deals we present them, not my personal investment in them. The trick is finding new investors willing to focus on that track record and give up on using my personal investment level as the key heuristic.