How I quit worrying and learned to love raising capital

All the capital for my second through 12th deals came from one of my best friends from highschool.

Once he forced me to start raising money from other people, I remember complaining to him that I hated raising capital.

You should have seen the stupefied look on his face, right before he said: “You realize you’re in the most capital-intensive business in the world, right?”

I admit that I had not realized that until that conversation. Not my finest hour.

I bumbled along, asking close friends and family for money, but doing little to expand my network. I adopted this totally self-defeating mindset, where I felt like our results were so good that people should be falling all over themselves to invest with us, and that, if they didn’t it was because they were stupid. And I refused to do the type of things that other capital-raisers do, like quoting IRRs and ROIs, because I felt like doing so was totally dishonest.

If you’ve ever run any kind of business, you can spot the problem right away: I needed customers (that’s what capital providers are: very special, highly-valued customers), but I wasn’t doing anything to find them and tell them our story. This is conceptually stupid, and the results bore that out: Adaptive Realty Fund 3 boasted a whopping ~$2.3MM in investor equity.

Anyway, over the past few years, I have radically re-shaped my approach to raising capital.

First, I really examined my own weird, defeatist nonsense. No magic fairy was going to descend from the heavens to Historic Filipinotown and shower me with capital. I needed to take ownership of this process and get good at it.

Second, I realized that I wasn’t trying to get people to do something bad. We do really good deals. The numbers are great. Smart people who really pay attention invest with us once, then do it over and over again, because what we do makes sense. So telling prospective capital partners about what we do isn’t like being a sketchy used car salesman – it’s doing them a favor.

Third, I figured out a way to tell our story that doesn’t make me feel gross. We’re not sellers, I’m not going to quote IRRs and ROIs, and I’m not ashamed of it. That turns off the majority of potential investors and that’s fine. Instead, I focus on educating people about how we think about the world. There are enough weirdos with money who like to hold real estate forever to allow us to build a business. I just focus on those people and forget about everyone else.

Third, I realized that capital-raising isn’t really about sales, anyway. You’re not going to convince someone who doesn’t want to invest with you to change her mind. Instead, it’s about telling our story, over and over and over again, in blog posts, meetings, at conferences, over dinner or drinks, whatever, to as many relevant people as I could. Not in an annoying way (no one likes being cornered and bored to tears). But in an open, helpful way that meets people where they are and educates them about an opportunity that might be great for them.

Is capital-raising ever going to be my favorite part of the business? Nope… there’s just nothing that matches the thrill of finding the right building, seeing in my mind what it can become (physically, and then, as a result, economically), and then working with my partner and our team to actualize that vision.

But capital-raising is now something I enjoy. And that means I’m happy to do it, which has translated into major growth for our business. Which is what I should have known would happen, all along!

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.

Suddenly, everyone cares about insurance

The wild fires currently raging all over California have me (and some of my investors!) thinking about insurance.

In general, the insurance premia Adaptive pays on our buildings can appear high, relative to premia paid by owners.


Most owners do the following: Buy an insurance policy when they first buy their building. Then, each year, renew the policy, eating premium increases which are small in percentage terms. At best, maybe they have their broker re-quote the same policy, to see if she can find a slightly better price.

Sounds fine, right? Wrong.

Say you bought a building in 2010. You paid $1,000,000 for a 4,000 sq ft 4plex. At that time, construction prices might have been $175 / sq ft. So, you bought an insurance policy with a limit of $175 x 4,000 = $700,000. Over time, your insurer slowly raised the premium for that same $700,000 policy and you renewed, because it wasn’t worth the hassle of finding a new policy.

Now it’s 2018, and construction costs are $300 / sq ft, but you still have your $700,000 policy.

What happens if your building burns down? The answer is: You’re in very big trouble, because rebuilding your building will cost ~$1,200,000.

The solution is to review all of your insurance policies annually, and sense-check the limits versus what it would actually cost to rebuild your building, using up-to-date construction costs.

It’s true that your insurance costs will increase quickly (because construction pricing has been rising at a rate faster than inflation). But, particularly in a disaster-prone region like Southern California, somewhat lower NOI is a small price to pay to protect your valuable assets.

A great capital partner

Yesterday, a long-time capital partner and I finalized the operating agreement for the entity for a new deal we’re doing and, because the process unfolded in precisely the way I like to do business, I want to highlight it here:

  • We brought the deal to this partner about a month ago, after we had inspected the building but prior to getting it under contract… our proposal included reasonable deal terms
  • He indicated interest in the project, drove the neighborhood, then confirmed he wanted to explore the deal with us – all within a day or so
  • We gave him all of the relevant numbers and then worked together to determine our bid price
  • We won the auction, then kept our partner in the loop as we went through the diligence process… when issues emerged, we discussed them and agreed reasonable solutions
  • Prior to removing contingencies, we produced a deal memo setting out our final plan and forecasts, plus identifying the key risk factors as we collectively understood them
  • After reviewing the memo, he agreed to our proposal to remove contingencies without asking for any price reduction (this is a major point for me… we never try to renegotiate deals in escrow, so we can’t work with investors who expect that we will)
  • Then, during the period between contingency removal and closing, I marked up an operating agreement we had used previously to reflect the deal terms for this new project
  • He requested one reasonable change to the terms (one which did not hurt us at all), then we finalized the agreement

Take a look at the steps above again. Did we spend time beating each other up over economic terms? Did he start calling contractors to check our construction numbers to see if we’re telling the truth? Did I have to worry about whether he actually has the capital? Did he call rental agents to check if our rent estimates were legit? Did he question our proposed layouts for the units? Did either of us employ lawyers to try to screw over the other guy?

No, because we have done business with this partner for six years and everything he ever promised to do, he did, and everything I ever promised to do, I did.

It’s not that every deal has gone perfectly. Among other issues (most of which I can’t disclose here), a building we were renovating for him once had a major fire during the renovations. But, every time we’ve run into a problem, we’ve worked together to solve it, and the deals have all come out (REALLY) well.

And, because we’ve built up so much trust, we can work together in a close-to-frictionless manner. He gets good returns on his capital. And we get to make money, doing the thing we’re best at.

Once you’ve had a taste of doing business with partners like this, it’s extremely difficult to imagine doing business any other way.

How we think about apartment design

When you’re designing apartment buildings, you need to resolve the following tension: You want the units to be cool enough to attract tenants today, while making them timeless enough to attract tenants for decades to come.

We have settled on what I like to think of as “authentic Socal minimalism”:

  • “Authentic”, because we avoid using any material trying to be something else… no fake wood, no fake cabinets, no cheap hardware masquerading as fancy, etc;
  • “Socal”, because we emphasize informal, open floorplans with indoor-outdoor flow, so residents can enjoy our amazing weather; and
  • “Minimal”, because we keep the stylistic flourishes to a minimum, to allow tenants to put their own stamp on these homes AND to keep the units from looking dated as tastes evolve.

Since we put a lot of thought into this stuff, it’s super cool when we see tenants embrace our aesthetic and use it as a canvas for their own creativity… like these tenants did at a really cool, small building we manage in East Hollywood.