The pain of losing out to a price-chipper

For the last few months, we have been chasing a deal in a neighborhood we know well.

The owner finally gathered offers from a bunch of potential buyers, including us.

As usual for us, we gave our bottom line number and a commitment that we would not chip price. The broker knew us and, as far as I know, vouched for us.

The owner accepted a different offer for a slightly higher price from someone else. Then, after his inspections, that buyer (i) tried to chip price by a material amount, and (ii) announced he needed much more time to close.

We’ll see if the owner accepts the price chip or kicks the original buyer out in favor of someone else.

This is the danger inherent in our no price-chip model… someone can come in, over bid us, then try to grind the owner down below our number.

It’s obviously painful to lose a deal like this. But, we feel strongly that, over the long term, our commitment to actually close at the price we offer will result in us getting to do more deals (plus, doing the right thing feels good).

The surreal experience of turning down capital

Last week, I had three different, current investors separately ask me if I could take more of their capital.

Sadly, right now, I can’t. While we’re deploying a fund, we’re fiduciaries for that fund, so I’m not going to take any capital for rivalrous deals (5+ units, LA County).

And, while I can see some potentially interesting, non-rivalrous deals, as of this minute, none of them is interesting enough to cause me to get off my butt and make it happen.

It’s kind of surreal: When we started Adaptive and buying opportunities abounded, we had a hard time raising money. Now, when it’s super-hard to find interesting things to do, I’m turning away capital.

Hopefully, these people, and the others who have backed us to date, will be willing to back up the money trucks to us when the next great buying opportunity comes around.

Businesses to avoid: Remote, single-family home rentals

Was just reminded by a Curbed article about a mind-bogglingly stupid trend in real estate investment and figured I’d share why I think it’s so dumb.

Here’s the deal:

  • Many people working in big, coastal cities feel locked out of the property market, both for owner-occupancy and also for investment
  • Online platforms have sprung up to allow these people to buy single family homes as investment properties in lower-cost places, where cap rates are higher cashflow (ie prices are lower relative to “forecast” net operating incomes)
  • Supposedly, these are “turn-key” services, where you can do everything from your desk – no need to visit the properties for inspections before buying, no need to meet the management company, etc.

Let me explain why this is a terrible idea:

  • Single family homes (the focus of this model) are very difficult to make work as rentals, because they’re full of idiosyncratic repair risk (each one has its own, particular issues) and the management has negative economies of scale (widely dispersed assets are harder to manage). The SFR REITs have done OK because they got in at such low prices in 2011-2014.
  • Without being on site for inspections, it is very easy for someone to defraud you, by selling you a property with hidden problems. Those high cap rates get much lower when you have to replace a roof or the plumbing unexpectedly
  • Your management company, which is supposed to handle finding tenants, making repairs, etc. has no skin in the game… they literally could not care less about the $300 / month they’re making from your property… if anything goes wrong, they’re gone
  • In investing, risk and reward are generally correlated. If you see a deals advertised on public markets that have what look like unusually high returns, you should be extremely cautious… it is VERY likely there is risk embedded in the deals that you do not see (for example – vacancy risk in a downturn)

This business model, connecting naive capital with remote single family rental homes in tertiary markets, feels like the kind of thing that emerges at the end of a cycle, when valuations are high and the easy money has been made.

I would be absolutely shocked if this story ends well for the investors.

Our internship program paid off handsomely

During this past summer, we had two interns from Princeton (where I got by BA) come and work with us for a month each.

We created the (paid!) intern program mostly because neither Jon nor I knew that real estate private equity existed when we were in college, and we wanted to give some motivated students the opportunity to experience the business first-hand.

Have to admit that I did not expect the interns to add any value whatsoever to Adaptive, because what we do is pretty complicated, with a steep learning curve.

Am happy to let you know I was wrong! Towards the end of the summer, one of our interns found a deal that we absolutely would not have found otherwise, and we’re going to buy it. The fees we’ll earn from the deal massively exceed the total cost of the internship program, and we and our investors will be very happy to own this building forever.

Over a drink or two, I guess I would admit to believing that the universe has a way of giving you back what you put out there. Just don’t usually expect to have it happen so fast.

Anyway, needless to say, we’ll be continuing the program next summer.

And… I’m back

Going to try to get back to writing, both because it brings new people into our world and also because it helps me clarify my thinking.

Figured I’d start with an update on Adaptive.

Long-time followers of our company know that we started Adaptive in 2012 with one employee, $0 in assets under management, and 36 units in our property management portfolio.

As of right now, we’re at 12 full-time employees (plus a bunch of really talented contractors, etc.), ~$125MM in assets under management, and ~650 occupied apartments in our management portfolio.

In general, in the real estate business, you can grow in two ways: Do bigger deals or do more of them. In LA, doing bigger deals generally means sacrificing returns.

So, because we want to continue to generate supra-normal returns, what we have done is build an organization capable of executing many, smaller deals at once. And that strategy has born fruit: We currently have 11 projects in our pipeline.

How have we done this? By obsessively focusing on one asset class (sub-institutional scale multifamily) in a few neighborhoods and treating the people with whom we do business (counter-parties, contractors, tenants, investors, and employees) well.