This is the second episode in a three-part mini series on real estate, which kicked off last week with Nick Huber and is resuming with this episode focusing on residential real estate with Moses Kagan. Moses is the founder and GP of Adaptive Realty, a real estate private equity firm, which acquires and remodels multi-unit residential real estate in the Los Angeles area. Moses is very thoughtful and intentional and I’ve thoroughly enjoyed getting to know him better.
In this episode, Moses and I discussed his family’s background in real estate and lessons he learned as a child, different options for small company owners to invest in residential real estate and the pros and cons of each, and how he developed a unique lens for viewing assets in a different way that’s in competition among other interesting topics. Enjoy.
Good to have you on the podcast, Moses. I’ve been looking forward to this for a while. It’s fun to have you as part of this short real estate segment talking about resident real estate. Would love to hear a little bit about how you got into residential real estate and what you’ve been working on so far.
Excited to be here. As you know, I’m a big admirer of what you’ve done with the podcast and the kind of community that you’re building around it. So, I’m happy to be here and happy to talk about stuff. So, you want to talk about how we got into doing residential. It was not at all a well-considered strategic decision. Basically, my parents had always owned a few small apartment buildings, so I grew up a little bit around the business. When I say small, I mean really small. I think we had a maximum of maybe 10 units the entire time they did it.
So, I grew up around it, and then my brother and I wanted to buy a little duplex for us each to live on one side of in 2007. The market was crazy, and the only thing that made sense to buy was the 16-unit building, which we ended up buying, and that’s how we got into doing apartments in Los Angeles. Again, we didn’t commission McKinsey to do a market study or anything.
What kinds of jobs did your family have you do around the apartments?
The one that sticks out because it was incredibly painful is that … So, we lived at Upstate New York and it snows a lot. On snow days, other kids would be like you’d be, and on snow days, I distinctly remember my father coming in to my room and yanking the covers off the bed and pulling me off my mattress by my ankles because I was holding on not wanting to get pulled out, and then he would take my brother and me to get a quick breakfast of waffles and hot chocolate, and then we would have to go shovel out all of the tenants.
So, it was uncompensated child labor. I hope I don’t get them in trouble. Statute of limitations has expired. We often lived in the complexes. We would one of the units and then there would be other tenants. So, we would have to shovel out our place first so that my mom could get to work and everyone could leave, and then we would drive around to the other buildings and shovel those out. That’s the one that sticks out the most.
The other one that I think is actually relevant is … So, we’re talking late ’80s and ’90s here. In Upstate New York or at least the way that my parents did real estate, there was no credit checks. There wasn’t a way to credit check and prospective tenant or background check them or whatever. There wasn’t the internet to advertise apartments. So, when we had a vacancy, my parents would put ads in the newspaper and then tenants would call, and we, my brother and I would get home from school before my parents. We were typical, whatever it’s called, latchkey kids. We would come in and let ourselves in and hang out till my parents got home.
So, periodically, prospective tenants would call and, A, we’re under pain of death if we did not take a message. So, step one was you write down the person’s name and which apartment they’re calling for and their phone number, and if you don’t do that, we’re going to kill you. Then the next thing, which was more optional was, “Did this sound like the type of person that you would like to rent an apartment to?”
That gets into some politically fought waters, but my parents, they had an interesting idea, which was basically in Troy, New York, a good heuristic for deciding who to rent to is just, “Did this person sound educated? Did they sound like someone who had finished high school and maybe done some college or whatever?” That ended up being … I mean, obviously, every once in a while they had some problems and stuff, but that was a big part of how they decided whether to rent people or not, and it worked out.
So, when we took that message, the first question that was asked of us was, “Did this person sound like someone you want to rent an apartment to?”
Then how did you get to Los Angeles?
After college, I went to London School of Economics for a year, intended to just screw around for a year, and then go to law school. Ultimately, I decided not to do that, but instead to go into media and tech mergers and acquisitions, which I did for a couple of years in London. I had a tiny little boutique bank that no longer exists. Then I knew I wanted to do something more entrepreneurial, and I was kicking around ideas and whatever, and my parents have a friend who used to run the Milken Conference for Michael Milken, which takes place in Los Angeles.
So, they got me. This was in 2007. They got him to invite me for free. It’s an extraordinarily expensive conference. This is a major favor. So, I hadn’t been in LA since I was 21 or something, and I flew in at 27 in February through this conference. My brother picked me up. He was living here already, and he picked me up at LAX with a sweet Mercedes convertible, and there were palm trees and it was sunny, and just amazing. I was like, “What am I doing in London?” So, that was one thing.
Then the other thing to say is that doing something entrepreneuring was always going to require raising capital, and my networks for raising capital were considerably better in the states than they were in the UK. So, if I was going to end up doing something entrepreneurial, it was going to have to be the states and Los Angeles seemed like a pretty good place to do it.
So, with you and your brother behind this apartment building, what lessons from their experience running apartment buildings when you were a kid did you apply to that building, and how many of them actually applied and made sense for a building in Los Angeles?
I think the most important thing by far was just the understanding that this was possible. In other words, I think when someone who has not experienced being a landlord looks at the possibility of buying an apartment building, it looks mysterious. It’s like, “What do you do?” Most people have that experience of being tenants, but most people have obviously not had the experience of being landlords.
Of course, there’s some mystery around that, but for us, there was no mystery because our parents had done it. It felt like something that people of reasonable intelligence with reasonable amount of discipline and common sense could do. My parents, they’re very bright, educated people, but they’re not financiers or something. They’re just responsible people who are good at saving money and wanted to have, basically, an extra income to be able to pay for private for my brother and me.
So, anyway, it was clear that this was not some crazy thing that you needed to have someone’s permission for or whatever. You could just buy a building and just operate it. So, by far, that was the most important thing. By the way, I think that’s an important life lesson for everyone. It’s like, I don’t know, more than 50% of the battle is just showing people that this thing is possible, expanding their horizon sufficiently that they can see that there are these opportunities out there. Then a reasonably smart, motivated person will be like, “Oh, you can do that? Let me go figure out how to do it,” and pretty often, they’re going to be successful.
What kind of issues did you run in to when you were now responsible not just for taking a message or shoveling snow, but you had to do from beginning to end work with an apartment and tenants and all this other work?
I mean, we made every single mistake you can make. Let me start off by saying that the bank required that we hire a property management company as a condition of giving us the loan to buy the building. So, we were not utterly at sea. We had some people who were experienced who could help us, but as we’ll see in a moment, we pretty rapidly lost faith in them.
So, the first thing that happened was we needed to complete some renovations of the building, and it was just small adding in stuff like tiling in the bathrooms, and the spray from the shower would corrode or rot out the wood windows and that kind of thing. So, of course, we had no idea how to go about hiring someone to do that or how much it should cost. So, with the help from a guy who we knew who has now become my partner for the last, whatever it is, eight or nine years, we ended up finding someone to do that. I’m sure we overpaid massively because we didn’t know what was fair.
Then the property management company starts leasing units very slowly. I think the second or third tenant they put in there ended up having a boyfriend who’s a pimp and running prostitutes out of the building. So, we had to get rid of him. That was a whole story. Then we’re like, “Oh, my God! We got to fill this building up.” We’ve got, whatever it was at that point, 13 vacancies. So, we made a deal with this nonprofit across the street that provides housing and services for teen mothers. They needed a place for some of their graduates to go after getting out of the program and they were willing to guarantee the leases and we were across the street and had these empty nice apartments.
So, we went and basically negotiated a deal where I can’t remember if they master leased eight of those units or whether we did individual leases, but they guaranteed them. Anyway, we got basically 18 mothers into the building, which seemed like a good idea at the time, but as you might guess, a bunch of teen mothers tend to attract a bunch of prospective teen fathers, who started hanging around the building. So, it was like this crazy thing where we had all all these people who were living there hanging out in the hallways, and then we are trying to rent units to more conventional tenants, and that didn’t mix.
So, eventually, we round that deal down, and we ended up taking over the leasing. Actually, we told the property management company that they would still run the building, but we would do the leasing. So, we ended up filling the building up with tenants, and the rents were pretty good. So, eventually, it worked out, but that first six months to a year was pretty hairy, I would say.
Then how did you go from that experience to now running Adaptive Realty and running a fund?
What happened was we bought this building I think at very early 2008. So, the money for it came from our family, our parents. Actually, it came originally from a building that my great grandfather had owned in New York and he died a year or two before that. The money worked its way down the generational chain until it got to my mother. She gave it to us as the down payment for this building. So, in a very real sense, my career in real estate was kicked off by capital from my great grandfather, who had a career in real estate also in New York 100 years ago. So, that was a cool intergenerational connection, and one that’s been very meaningful for me as I’ve pursued this career. Anyway, that’s where the money came from for that first deal.
Then what happened was the market fell apart. We were the last idiots to buy anything right before the market fell apart for the great financial crisis. Very early 2008, I mean, I think Lehman had already collapsed when we closed. That’s how stupid we were. Then the world falls apart, and our rents go down, and it’s like a complete nightmare, but real estate went on sale. The short version of this is that the management company that we had hired for the first building brought us another deal in an even a better location and very, very cheap.
I wanted to buy it, but I didn’t have any money, and I happen to have a very close friend from high school who had made a fortune in the high frequency currency trading business. He was the one who capitalized that deal, and then a bunch of subsequent deals. That was how we graduated from doing one family project to what was the beginning of a professional real estate private equity firm. Although to be fair, I’m not convinced that I knew at the time that we bought that second building what a real estate private equity firm was.
I mean, I was doing some reading and stuff. I didn’t have any institutional background in this stuff, so I didn’t have any of the frameworks that people usually come in to the business with from having worked somewhere else. It was totally like, “This building seems cheap, and even though the economy sucks, we think we can get very rich from renovated units because it’s a cool area. So, let’s just buy and see,” and it worked.
Can you walk through the business of actually running a real estate PE firm? It’s a little bit different business than most conventional businesses, but can you walk through who you view as your customers, vendors, key employees, that structure and model for us?
One of the interesting things about the business is that you’re almost running like a multi-sided marketplace. Marketplace is maybe the wrong word, but you have multiple sets of customers is what I’m trying to say. So, first and foremost, you have investors who are going to provide you the capital to do projects. Ultimately, at the end of the day, that’s the one non-negotiable thing. You need to be able to raise equity from rich people or family offices or insurance companies or wherever you’re going to do it from because that’s the jet fuel that your business needs to exist and do business.
We could talk about this more if you want, but I think perhaps most fundamental to starting and successful operating one of these companies is meeting those people, convincing them that you are the person who can be trusted with their capital because that’s a scary thing, obviously, giving someone your money based on a promise that they’re going to give it back to you, but that’s it, just a promise. So, you need to become the person who can be trusted, who should be trusted with other people’s money.
Then, crucially, you need to maintain that trust. As we’ll see as we go along, there are an infinite number of decisions that you’re going to make through the course of a project from when you buy it through when you finish it and renovate it and lease it up and either sell it or refinance it. You’re making all these decisions. Very frequently, you’re called upon to balance competing objectives and interests, and the investors are silent. I mean, for the most part, they’re not really paying attention. They’re just trusting you that you are going to do the right thing.
So, I think most fundamentally to the business is getting that trust and then acting every single day in a way that maintains and enhances that trust such that you continue to be able to do the business because once you lose the trust in your capital partners, that’s it. You don’t have a business anymore regardless of how smart you are or anything else. So, that’s your first group of customers.
Of course, you have another set of customers who are nearly equally as important, which are your tenants. In our business, the tenants are just residential tenants, people who want to live in an apartment in a cool neighborhood, but your job is to create and maintain environments in which those people want to live. Obviously, if you’re doing office or industrial or retail, it’s places where people want to work or shop or make things, but it’s the same concept.
You are ultimately responsible for providing a product that people want to consume and the difficulty in the business is reconciling those two things. You want to generate high returns for your investors while also making a great product at a reasonable price for your tenants. How you navigate through the various challenges inherent in reconciling those two contradictory ideas determines whether you’re going to be successful or not. If you need to cut cost, what cost should you cut? If you identify an opportunity that will make tenants happy or willing to pay more rent, can you justify that in terms of additional yield to the investors to get them to sign off on it? Those two things are often intention. It’s your job to balance and reconcile them. So, those are your two sets of customers.
You also have a number of other groups that I would call maybe constituents or interested parties, who are not technically your customers, but who are absolutely essential to your success. One is banks, who are going to loan you the money to do projects. We don’t use a ton of bank debt, but we use plenty and keeping the banks happy and making sure that they trust us and know what we’re doing with their money is a big deal.
You have various contractors and subcontractors who are going to help you build the thing that you want to build, and then you have government in all its myriad forms. Real estate is probably the most heavily regulated business, and so you have city and state and county officials who have various procedures and inspections and permits. So, knowing how to navigate that world in a way that allows you to move your projects forward and build what you want to build while also keeping government happy is in itself a complicated set of challenges.
Then finally, and this is something that I think many, many real estate operators miss, okay? You also have a set of stakeholders that effective is the broader community. What I mean by that is I fervently believe that every business requires a license from the community in which that business operates. Sometimes it’s an explicit license like if you want to have a bar, you’re going to have a liquor license and put it up on the wall or whatever, but often, it’s an implicit license. It’s basically like you as the business owner need to behave yourself or the community will eject you from the community. That can take many forms. It can be intrusive, obnoxious inspections and fines. It can be protests. It can be lenders stopping working with you. It can be angry letters from your city council member. There’s a variety of ways that a community can put enormous pressure on bad actors.
So, in all of what you’re trying to do as a real estate private equity firm, you need to keep in mind that if you’re going to be continuing to do business in any given locale, you need to avoid whatever. I’m trying to come up with a non-disgusting metaphor. You need to not poison the well. Let’s put it that way.
So, how do you avoid poisoning the well when your business model is concentrated on the LA area? I’m assuming there’s probably pros to that as well. It’s a fixed area that you need to keep happy, but I assume there’s some risks involved, too.
I think the most important thing is adopting a multi-generational mindset. This is going to sound ghoulish, and I say this when I have job interviews with potential employees, and they always would fall, and look at me like I’m insane, but I am probably going to die behind a desk that looks very much like this one, okay? Hopefully, it would be a little neater. Hopefully, if everything goes well, one or more of my children will take over the business, which will mean taking over these buildings that we own. Hopefully, their children will own the same buildings or they’ll sell them and buy other buildings, but my point is that I think about this as a multi-generational endeavor. So, one you regard yourself as being engaged in a multi-generational endeavor, it’s pretty obviously that you should not do things that are going to cause you not to be able to do business in that specific location anymore.
If you get a bad reputation with the local council or whatever, you will be prevented from doing the things that you want to do to grow your business. Some way, they will figure out some way to stop you. So, it’s not rocket science. It’s factoring into every decision you make like, “Okay. This is not the only time we are going to play this game. We’re going to play this game over and over and over and over again, and if we misbehave, we are going to lose the right to continue to play the game, and viewed from that perspective, it’s generally pretty obviously how you should act.
Do you view ownership and real estate as more of a generational asset than other things like equity and a business, whether a private or public or gold or something else?
I think it really depends on the real estate. I think one of the things that I have to guard against in talking publicly about what we do is leading people with the misapprehension that all real estate ought to be owned forever. My bias is towards long-term compounding and permanent holding and passing along to subsequent generations, but that’s not always the right thing to do, and whether it is or not often comes down to some combination of the type of asset and also the market in which that asset is located.
So, let me give you an example. Office buildings require enormous amounts of capex between tenants. So, it’s awesome. When it’s working where you’ve got all your space rent in, particularly if it’s credit tenants, basically, you own a bond. You own this physical thing that’s effectively a bond, that’s key to the credit ratings of the tenants, and that’s awesome, okay? That is worth a lot, particularly as long as there’s a lot of time remaining on those leases, that’s an extremely valuable asset that you can sell or refinance because the banks are going to view the stream of income coming from those tenants as effectively a kin to the credit rating of the tenants. They can’t default on those leases any more easily than they could default on their bonds. So, that’s a great thing to own if it’s leased.
If you have vacancy, though, it can be a long time before you refill it. Often, refilling it will require some enormous amount of capital expenditure on your part. The tenant will say, “Hey, look. We’re willing to sign a 15-year lease here, but we need you to spend $3 million upgrading the lobby and the elevators,” and blah, blah, blah, blah, blah.
So, that may not be the kind of asset that you want to own forever. It might be. It depends on the market, but it might be buy that thing when it’s screwed up and vacant. Put the money in, get the tenants into lease, and then sell it at that new high capitalized value, and let it be someone else’s problem when the leases roll off.
So, apartment buildings generally do not have that problem. They don’t become obsolete. People have needed to rent a place to live since the Roman empire. They will continue to need a place to live. They basically need a bedroom with some windows and a kitchen and a bathroom, and taste change and stuff, and so you have to be a little worried about that, but fundamentally, it’s a lindy business. It’s one that people have been doing forever and they will continue to do forever as long as we’re in a neat space or whatever, not all just in the cloud somewhere. So, that’s the asset type.
Then in terms of the market, if you happen to own assets in a market where there are no supply constraints, let’s take Houston as a canonical example. It’s super easy to build apartment buildings or any kind of buildings in Houston. It’s a cool city. They have very, very good public policy in my opinion in this regard. You can build anything you want. So, when there is a lot of demand to live in Houston, developers just build buildings to service that demand. That’s awesome from a societal perspective because it keeps housing costs low, not so good as a long-term owner because it’s hard for rent. Rents are a function of supply and demand, and if anytime there’s excess demand, new supply immediately gets built to sup it up. You’re going to struggle to have rents grow faster than inflation over the long term.
Somewhere like Los Angeles, which has just insane supply constraints, in other words, it’s just really hard to build stuff in LA for a variety of reasons, mostly relating to government regulation. If you own a building in Los Angeles, you can be fairly confident that even as demand continues to increase to live there, other developers are not going to be able to build enough supply to service that demand and, therefore, there’s constant upward pressure on pricing.
So, it doesn’t mean that rents go up every year. In fact, obviously, they can come down. They did during COVID, but you basically have the wind at your back. So, that’s a forgiving environment to own real estate for a very long period of time because, yeah, there’ll be booms and busts and cycles and everything, but, fundamentally, you’re just benefiting from the slight more or less permanent supply, demand, and balance.
So, anyway, long way of saying I do believe that multifamily real estate in very high quality, which is to say supply-constrained, in-demand markets, is the type of thing that one ought to own multi-generationally.
Can you walk through some of the different options that a business owner who doesn’t currently own any real estate but is thinking about diversifying their wealth beyond just their own business, should residential real estate be part of their consideration, and what options might they have?
There’s basically three, broadly speaking, three reasonable options. In some ways, the worst of which is what we do. So, the easiest thing in some sense to do is just go buy a little apartment building, and either manage it yourself or better, hire a management company to run it. The good news on that, obviously, is that you’re not paying any manager, you’re fully in control, you’re being a property manager, but you can always fire them. So, you’re the owner, you’re in control of the building. If you want to sell it, you can sell it. If you want to refinance it, you can refinance it. You’re getting all the upside if things go well, and you’re also getting all the downside when things go poorly.
So, that is a good option. That’s one that my parents, obviously, have pursued and many families have done extraordinarily well by starting out with a one small building and they buy another one and pretty soon, if they keep at it, they’ll have a little portfolio and that portfolio can grow, and there’s a lot of fortunes that had been made from just that model.
The downside of that is that it requires a lot of time. If you’re the kind of person, if you in your day job running your business or let’s say you’re a partner law firm, whatever, if you’re highly compensated in your day job, it is unlikely that the highest and best use of your time is going around buying little apartment buildings on your own account. It’s just like go get another customer for your business and grow the equity value of your business by that much. It’s not a good use of your time.
So, that brings up two other passive means of investing in real estate. The first is REITs, Real Estate Investment Trusts, and the best one of these or the biggest ones are publicly traded. So, you could just go buy them like a stock. They’re tax-advantaged, and they tend to own really good real estate in good markets. They tend to use relatively conservative leverage. So, it’s very unlikely that they’re going to get wiped out or whatever.
I should draw a distinction there. There’s such a thing called there’s equity REITs that own buildings and there’s mortgage rates that make loans. I do not think anyone should invest in mortgage rates. That model blows up every cycle. A whole bunch of them go bankrupt, not what people should do, but equity REITs, that’s a perfectly good way in real estate, and what’s cool about it is you can come in and out if you decide you need the money for something, you can sell the shares. So, that’s a perfectly good way to own real estate.
The downsides of REITs are, one, they’re large enough that they generally are competing for institutional-sized deals. They’re competing against other REITs that have very low cost of capital to buy buildings and development sites. So, by definition, bigger deals almost guarantee lower returns. It’s just that the way the world works because instead of competing with mom and pops or whatever, you’re competing with pension funds and insurance companies. They just have so much capital, and it drives the prices up and, therefore, the return is down.
So, that’s one thing to say about REITs is they’re playing in a world where returns are capped almost by definition. Then the other thing to say is that management teams are incredibly well-entrenched. The governance model for REITs means that it’s very, very difficult to get rid of a bad management team. So, there are plenty of REITs that are very well-managed, but one of the things that you need to be careful of is that if you get a bad one, ne’er-do-well as the guy running or woman running it. There are all kinds of opportunities for self-enrichment, and there’s no way to get rid of that person. So, your only choice is a shareholder as to sell your shares. So, that’s not great.
Otherwise, I mean, REITs are a perfectly good thing to do, and I recommend it for people who want to get real estate exposure.
The final way that a business owner with excess cash could invest in real estate is via private real estate investment companies like mine and a million other ones. What we do takes various, and what other firms like ours do takes various forms. There are different markets and asset classes, but fundamentally, what is going on is this. The operator, me, takes your money as an investor, invest it in a building, does something ideally to add value like fixes the building up or builds a new building or whatever, and then at some point either through sale or refinancing of that building gets you your money back and profits and, hopefully, you’ve done well in the bargain.
So, private real estate is great like if you happen to work with a great operator, and that person does good deals, then the returns can be enormous, and particularly on a risk-adjustment and a tax-adjustment basis. They can be extraordinarily tasty returns.
The downside is that if you invest in the wrong operator or in the wrong project, you can find there’s all kinds of ways that things can go wrong. So, as with anything else but maybe more than almost any other kind of investment people, it’s a real caveat emptor type situation, like you really want to know with whom you’re investing and in what you are investing.
So, if I’m thinking about the different scale of each one, in your example, the law partner who’s time is very valuable isn’t going to want to spend their time going around to different apartments and so it’s probably hard for them to deploy a lot of money into it, whereas REITs, you can deploy a ton of it or even just a little bit, and then investing it in LLP, probably it has a high floor. Is there a diversification gained through doing a little bit of each one or is it better in your opinion to focus and really develop an expertise in one or the other?
Yes, particularly with respect to direct ownership of real estate. I mean, the good and the bad, so I should start off by saying that sub-institutional scale real estate are the type that a garden variety rich person might buy, a fourplex, eight units, whatever, that world, that sub-institutional scale world, and by the way, this is the world that we operate in. That world is a mess. Owners do not keep good records. They don’t necessarily maintain their buildings. Many of them are going to actively lie to you about the condition. The brokers who operate in that space are, let’s say, mixed in terms of their integrity levels.
I would describe it as a knife fight in a sewer. So, what’s good about it is that it is extraordinarily opaque and screwed up, and so that means there’s alpha. Someone who knows what they’re doing, is going to be able to pick off mispriced assets and buy maneuvering through that market well is going to be able to generate super normal returns. So, that’s great and that’s why we do this.
For someone who is going to dabble in it when it’s their part-time job but really their law partner or they have run a plumbing business or whatever, you are taking some risk because you’re entering a world where there’s not really any rules or there are rules, but you don’t know them and no one takes you that seriously, and you don’t know what you don’t know. It will be like if I try to go run a plumbing company, I mean, I could buy one, but could I run it? Absolutely not.
So, when you’re buying real estate, you’re basically doing a leverage buy on a small business. It’s a simple business. Relatively speaking, it’s lots of fixed assets, your costs are fixed. Apartment buildings market themselves a little bit. There’s not that many things that can go wrong, but things can go wrong. So, it does not reward dilatons. If you do own a plumbing company or your law partner or whatever, and you decide that you want to spend some time in this world, then you should really spend some time in the world and actually learn it and get to know the rules and the players and what can go wrong and all that stuff.
So, if you’re trying to divide your attention between doing your day job, running your business or whatever, and then doing some real estate stuff on the side, I would not recommend buying a little apartment and then starting to read annual reports for REITs and trying to figure out if they’re misappraised and maybe also looking at some limited partnership deal. If you’re going to do direct ownership, do direct ownership. Buy a building, make a bunch of mistakes, figure out, learn from them, go buy another one, and grow that way.
In contrast, if you’re going to be a REIT investor, same thing. There are plenty of people who made a lot of money investing in REITs just like any other stock. You need to spend a whole bunch of time reading into reports and listening to investor calls and reading newspapers and getting it on markets and all that stuff. That’s a very, very valuable skill if you get good at it, but you can’t expect that you’re going to be able to be good at it from doing it every once in a while. It’s got to be the thing you focus on.
Finally, I would say with respect to investing in limited partnership like private real estate are the type that we do. That can be a little bit more part-time. A reasonable thing to do is to find possibly through trial and error or possibly through referrals, possibly through Twitter, other things, find a couple of operators whose business model you like, whose asset class you like, whose market you like, who seem like they’re reasonably trustworthy human beings, give them a little bit of money, see how it goes. If it goes well, feed them more money.
There’s a recycling effect. They’ll give you your money back and then you can give it back to them and do more deals. Ideally, I think you end up with relationships where you’ve got a couple of operators with whom you have multi-decade long relationships where you’re doing a lot of deals together. Once you develop that level of trust, then you can be pretty part-time about it.
The guy sent you an email and it’s like, “Look, this deal is good. I’ve done 12 other of these deals and they’ve all gone well. We’re raising for this new one,” and you just write the check without thinking too much about it because you trust the operator. That is a proven, I would say, method for success.
In the episode with Chris Powers that you did that I was listening, too, you mentioned that you try to look at assets, real estate in particular, but other things, too, in a different way than other people. How do you try to develop an opinion that’s not necessarily just different for different sake, but you try to find a unique view that allows you to have a bit more insight into what the truth is for something.
This gets to the concept of, I think, a differentiated lens. It’s something that we had developed ourselves in some ways without having a name for it, and then I read Francis Greenburger’s memoir. He was the guy who popularized doing coop conversions on apartment building in New York City and became a billionaire. Anyway, I read his memoir, and he uses the term differentiated lands. To me, that just a perfect encapsulation of what you’re trying to do, which is to say you cannot build a career in real estate private equity in doing deals simply by waiting to steal buildings. If you have to wait around to find a dumb owner who’s going to sell a building to you radically under market, you can be waiting a long time, and that’s not a way to build a business.
You can’t just sit there for years and not do deals, particularly when you’re getting started. So, that means you have to figure out a way to buy properties that are widely marketed, in other words, ones that everyone can see. You have to be able to win auctions, because if you can’t win auctions, you’re going to be sitting in your hands for a long time.
How do you win auctions? Well, one thing is you can just accept bad returns. They’re not bad, but accept market returns. In other words, you just say look, “Buildings are selling at some ratio of net operating income that unlevered cashflow that they generate divided by the price that you’re going to pay for them,” this is cap rate, and you just say, “I’m going to accept the market cap. If it’s a five, it’s a five. If it’s a four, it’s a four,” whatever. You just go out of the market and you win those auctions and you buy.
If you want to be in the real estate private equity game professionally, almost by definition, you need to figure out a way to generate returns that are in excess of what someone can buy just by going in and buying the market. Why? Well, because if you don’t, why should they pay you a fee and why should they give you an ownership stake at the building? If you’re not going to figure out how to generate returns that are so good that they can justify paying you a fee and giving you, whatever it is, a 30% ownership stake at the building, what are we doing? Why should they give you money at all?
So, that’s the box that you’re in. You need to buy stuff that’s widely marketed, and you need to generate returns that are in excess of the returns that you can get from just buying those widely marketed things and not doing anything to them. That’s where a differentiated lens comes in.
A differentiated lens is how do you see a building, an asset that everyone else can also see in a way that is different from how everyone else sees it. In other words, how can you make it so that an asset is worth more to you than it is to other people? There are almost infinitely many ways to do that, and we’ve tried lots of them, but the idea is you got to do something different.
A very stupid, simple example is in markets where landlords all pay the utilities. The landlords pay the electricity, and water, and gas for all the tenants. Imagine you get this new technology called RUBS, which this is not new, this is widely available, but I’m just using it as an example. RUBS allows you as the landlord to bill back the utility costs for each of the buildings to the tenants who live in the buildings. So, you basically are putting the utility cost on the tenants.
Now, every building that you look at, if you’re the only person who does RUBS, every building that you look at, you’re looking at the same buildings everyone else is, but when you underwrite the building, your operating expenses are going to be lower than what everyone else is underwriting for their operating expenses.
So, at a given price point, your returns are just going to be higher than everyone else’s. So, therefore, you can go just buy all the buildings because you should own all the buildings because you’re going to generate more return from them than anyone else. So, that’s a simple, stupid example, but that’s what I mean. It’s a way, a technology, a view, a strategy, and it may not be, in fact, I guarantee you that it will not ever be as simple as just one thing. It is frequently a multiplicity of things that little tactics, little things that you’ve learned to do over time, which taken together allow you to generate more returns from a given project than your competitors do, and that gives you a license to go buy stuff that is widely marketed because it’s worth more to you than it is to them.
How much of that is process-driven, where it’s something you can write down on a list and you can go fill the process versus something that’s more just acquired knowledge over five, 10, 15 years that other people just can’t get access to without having that degree of experience?
I could write you a high level list of the things that we do that add value to buildings. I’m not going to do that. I could write you a list and it would help. It would act as a roadmap, but the hard part is executing all of it. I can say do this to the building, but you got to go figure out a zoning code that allows you to do it and you got to find a contractor who’s capable of doing it at a price that is accretive to the overall yield. You got to go figure out how to be capitalizing and afford to pay that contractor, supervise his work, actually see it through, and then lease it up and be proven right that the thing that you plan to do actually was accretive to the yield.
So, again, yes, I could give you a roadmap, but the devil is mostly in the execution itself. To be honest, one of the good things about Adaptive is that my partner has renovated, whatever it is, 100 buildings now. He and I, we’ve done the same tricks over and over and over, and different ones apply to different buildings. We have a big bag of tricks, a big set of possibilities that we could potentially do to each building and it’s our job to look at a new deal and say, “Which of the things that we’ve done before apply here? Also, what are the other out of the box things, like things we’ve never done before that we might do here that will also add value?”
The nature of accumulating that bag of tricks is you try a bunch of stuff over time, and some of it works and some of it doesn’t, and when it works, you’re like, “Aha! That goes in the bag of tricks and let’s repeat it next time.” So, there’s a shorthand that we have developed. It’s like, “Oh, we’re going to do a Bellevue over here and we’re going to do a Clinton over there, and those are names of streets where we own buildings. So, that process of getting your hands dirty and trying a bunch of stuff is how you develop that differentiated lens.
Moving into some closing questions, what class would you teach in college if you could teach about any subject you wanted?
I love this question. If you were to ask me six months ago, I would have said entrepreneurship or business or something, but I’m going to give you maybe a slightly more philosophical answer. I believe that this country desperately needs a new historical narrative, a story about who we are as a people that both acknowledges all of the horrible shit that we have done to Black people and Native Americans and Chinese and you name it, all of the awful shit that we’ve done, but also contextualizes the United States in global history, properly contextualizes it because I think in spite of all the terrible shit that we’ve done, I continue to believe that the United States is mankind’s last best hope, to steal a line from Lincoln, and what we are not doing, I think, in our schools is doing a good enough job of explaining that story.
People are smart enough to understand that we can both have done bad things and still be on balance a good and useful contribution to the world. So, I think the most valuable class that you could teach right now would be to build that narrative and help young people understand it.
I like it. What’s a belief you used to hold strongly that you changed your mind on?
This is more like write down the bill on a fin tweet thing. So, I have for a long time been enormously skeptical of cryptocurrency. In general, I remained very skeptical about many of the claims made on its behalf. However, I read maybe a year ago, maybe a year and a half ago this book about the Reichmann family, which is these Jews who owned, of all things, an egg distribution business in Hungary prior to World War II. They were lucky they had money and they were farseeing, and they saw that the Nazis were coming, and they basically were able to convert at least some of their wealth into diamonds and Swiss bank account wires and basically get out of Hungary with the Nazis being at their heels and transfer some of the family wealth to, I think, ultimately Morocco, and then they ended up in Canada.
So, all that is to say that I have recently become convinced that there is a legitimate use case for crypto, specifically Bitcoin as store value is the wrong word because, obviously, the price bounces all over the place, but there is something good about giving individual citizens the power to move their money in a way that is separate from the state because it serves as even just a theoretical or philosophical check tyranny. I’ve changed my mind about that recently.
What’s the best business you’ve ever seen?
So, I’ve been thinking about this a lot. I don’t know if it’s the best, but extraordinarily a good one. We have these partners, who’s it’s a family office, and they started developing single family homes in California after World War II. Readers who read history know that post-World War II there was just enormous demand from GIs who are coming home to buy houses and no one had built anything during the ’30s because of the depression and then joined the war because all the steel and wood and rubber and everything were going into the war effort.
So, these GIs come back and they’ve got the GI bill, which is going to pay for their houses, for their mortgages but there’s no houses. So, these guys started building houses. There was so much demand that the banks would loan them 100% of the cost of buying the land and building the houses, okay? So, keep that in mind. So, no equity required to buy the land and build the house. They would complete the house and turn around and sell it at a markup to a GI who because of the GI bill did not have to put down a down payment. The government was basically financing 0% down mortgages for these GIs.
So, that’s a perpetual motion machine. There was unlimited demand for people to live in California from GIs coming back. They didn’t have to have down payments, and the developer didn’t have to have any equity because he could just borrow 100% of the cost from the bank. So, these guys built, I think, tens of thousands of homes where they got the money for free, sold it at a markup, put the profit on a bank account, did it again, boom, boom, boom, boom, boom, boom, over and over and over and over and over again.
I think, I don’t know all the details, but just rolled up an enormous, what became the kernel of what became an enormous fortune just from the way that those two financing mechanisms interacted.
That’s fascinating. Thanks so much, Moses, for coming on the podcast and chatting about real estate. It’s a conversation I’ve wanted to have for owners for a little while. It’s been really fun here, perfect guest for it, and I really enjoyed having you.
Well, listen. Thanks for having me and as I said at the beginning of the interview, I’m a major fan of what you’re doing, and if I were younger and didn’t have a family and all that stuff, buying a small business would be something that would be extraordinarily appealing to me. I love real estate. I’m going to be doing this for the rest of my life, and hopefully my kids will, too, but that’s a good yield to buy a small business. It’s a great career path, and I encourage people to look at it closely.