Moses Kagan - Permanent Real Estate Investing
Moses Kagan is a co-founder of Adaptive Realty, the Los Angeles-based real estate private equity firm. Since 2008, through Adaptive and predecessor entities, he has overseen the acquisition and rehabilitation of nearly 100 properties.
Adaptive is laser focused on sub institutional scale multifamily. So these are deals between three and 10 million dollars of total capitalization. The firm is unusual in the real estate private equity world because they buy and hold real estate rather than buying buildings, fixing them up, and flipping them as is done in a more IRR driven model.
In this episode Moses discusses his journey from running a smaller fund that had a single LP to what he does now. One of the most interesting parts of the conversation he discussed is when he had to sell the real estate in his first fund. To the outside world, it may have appeared to be a success. To Moses, however, it was a lesson in how much taxes hurt returns. That lesson formed the philosophy behind Adaptive.
We are happy to have Moses as this week's guest. As always, we hope you enjoy the episode!
This episode is brought to you by Koyfin, one of the fastest-growing platforms for financial data and analytics to research stocks and understand market trends. Check out Koyfin.com to see what a Bloomberg-lite, with tons of high-quality fundamental data and a powerful graph engine looks like.
Album art photo taken by Mike Ando.
Thank you to Mathew Passy for the podcast production. You can find Mathew at @MathewPassy on Twitter or at thepodcastconsultant.com
+ Transcript
Bill: Ladies and gentlemen, welcome to The Business Brew. I'm your host, Bill Brewster. I'm here with Moses Kagan this week. Moses is a real estate investor and GP in a real estate fund, I believe, right?
Moses: That’s right. Among other things, yeah.
Bill: He's got an interesting way of looking at the world. I love his Twitter feed. I love the interviews that I've heard of him. He talks about the intersection of value investing and real estate. It's pretty fun. I hope you all enjoy. As a reminder, this is not financial advice, we're not your investment advisors, we're not your advisors, fiduciaries, etc. Do your own due diligence. This is entertainment purposes only, folks. With that out of the way, Moses, how are you doing, man?
Moses: I'm pretty well. It's raining today in Los Angeles, which is pretty unusual. It's a little bit of a downer, but otherwise, I'm good.
Bill: The nice thing about that is we won't even need to timestamp this because people just be able to go back and say, “Well, when was it raining in LA?”
Moses: Exactly. I think it's literally like the second time and 12 months or something like that.
Bill: Not so in Florida, we get plenty of it here, but that's okay. To give a little bit of your background, you want to just fill people in on where you're at in your career now or do you want to start at the beginning? How would you like to go?
Moses: Maybe start with where we are now, and then if you want to go back and delve into the how we got here, I'm happy to do that.
Bill: Yeah.
Moses: I am the founder and one of the partners at Adaptive Realty. We are a boutique real estate private equity firm. We are laser-focused on sub-institutional scale multifamily. These are deals that are like-- they're tiny, they're between $3 and $10 million total capitalization. One of the things that makes us pretty unusual in the real estate private equity world, is that instead of buying buildings, fixing them up, and then flipping them and being IRR driven. Instead, we buy buildings, fix them up, refinance them to return capital to our capital partners, and then hold the buildings with our capital partners more or less permanently. It's a really weird way of organizing a real estate private equity firm, but I'm sure we'll get into the rationale and everything. But that's us, we focus on a relatively small number of neighborhoods, we're vertically integrated. We do have our own construction management, and we have a property management firm as well, so we manage our own buildings. We just keep turning the crank, basically do the same deal over and over and over again for-- Well, at Adaptive 8 years, and it's 12 years overall.
Bill: That's cool. How did you get into it?
Moses: By accident. [laughs]
Bill: Well, that’s how most things in life that are good happen, I feel like.
Moses: Yeah. We can go through the whole story. The first thing to say is, it was not planned. My family had somewhat of a real estate background. My parents always owned a few tiny buildings in upstate New York where I'm from, so it wasn't--
Bill: Where in upstate New York?
Moses: Troy, which is near--
Bill: Oh, yeah, I know. Troy.
Moses: Oh, yeah?
Bill: Yeah, man.
Moses: How?
Bill: I go to Manchester, Vermont. That's where I spent my summers as a kid.
Moses: Yeah. You kind of drove by.
Bill: That's right.
Moses: My father was a professor of art at Rensselaer Polytechnic Institute, which is there. My mom-- [crosstalk]
Bill: Interesting.
Moses: -worker in Albany. Anyway, that's where I grew up. By the way, when I was a kid, real estate in Troy was basically free. My dad literally--
Bill: I think it still might be, to be honest.
[laughter]
Moses: It's actually experienced, like somewhat of a surprising resurgence, like a lot of people got priced out in New York and moved up to Troy because it's actually a charming city. Or, at least it has charming real estate. The city itself was pretty rundown when I was living there. My dad still owns a building that he literally got for free.
Bill: Really?
Moses: Oh, yeah. It's this beautiful, yellow glazed brick industrial building, like really gorgeous. The city basically was, if you pay the property taxes, we'll just give you the building.
Bill: Really?
Moses: Yeah. Anyway, we always had like a little bit of a-- [crosstalk]
Bill: Hang on. Wait. We're not going on. Did you grow up there in Troy?
Moses: Yeah. I was born in New York City. My dad was on sabbatical, my parents were living in Tribeca, and then, when the sabbatical ended, they moved back to Troy. We lived in a series of these really cool, old, turn-of-the century brownstone buildings. My parents would buy a building, we would live in one of the apartments, they'd rent out the other ones and then eventually we'd move, but they would keep the original building and buy another one. It's immigrant real estate stuff, just not professional. They self-managed and they don't know how one would go about calculating IRR or thinking about leverage.
Bill: Yeah, street-smart stuff.
Moses: Yeah, totally. It's just like do the rents minus what we think the expenses are going to be exceed the mortgage? Okay, let's do--[crosstalk]
Bill: Where they immigrants?
Moses: My dad is. My dad was born in a refugee camp in Germany right after the war. His parents were Holocaust survivors.
Bill: Wow.
Moses: Then he grew up mainly in Israel, and then came to the United States when he was about 13 or so. He doesn't speak with an accent, but he speaks Hebrew and Yiddish reasonably well. My mom was born in the United States. But my family for whatever reason, her grandfather came from Russia when he was 15 in 1910. My family has a real sense of valuing immigrants. Even though my mom's side of the family, she's second-generation born in the United States, she still thinks of herself as very connected to Great-grandpa Morris, who came here on a boat by himself. We've done a good job in our family of preserving that immigrant mentality. I've three sons that are getting raised in a pretty privileged Los Angeles kind of way. It's going to be interesting to see whether we can perpetuate that immigrant feeling with them.
Bill: You’d probably lose a little bit of it.
Moses: I think that’s right.
Bill: Try to keep them grounded. My wife is first generation, so her dad came from Poland. Similar, their stories after the war were crazy. They're not Jews, but I mean, what they saw and really just how they were treated by the Russians-- [crosstalk]
Moses: Oh, yeah.
Bill: It's not great stories that I hear. It's been amazing for me to talk to my father-in-law about what it's to come to the country and not know how to speak English, like how to scrape by and try to make things work. I'm really grateful it’s in my life, it's given me a peek into a different part of the world that I otherwise would have been blind to.
Moses: No, it's absolutely. One of the cool things about real estate in Los Angeles is that it's-- I don't know if it's majority immigrant, but it is to a very large extent kind of an immigrant business.
Bill: Really? The owners or--?
Moses: Oh, yeah, the owners. It's all different nationalities. There's a lot of Persian Jews, plenty of Chinese owners and Korean owners. It's awesome.
Bill: Do you have any hypothesis as to why that is?
Moses: Yeah. There's a couple things going on. One is-- there's an interesting intersection with why our business exists. One thing to say is that Los Angeles zoning is really pretty suburban in a lot of ways, except for in a few neighborhoods that are not the huge buildings that you'd find in New York, like 200 unit, whatever.
Bill: Yeah. Sure, because those are all downtown, right? [crosstalk]
Moses: Yeah, there's some of that downtown, and increasingly in Hollywood and stuff, but your standard Los Angeles apartment building is four units built in 1924. Those are manageable size for a family to save money and just buy their first fourplex, and they buy another one. There's an easy rung onto the ladder that immigrants find that they can seize. Of course, the ambitious ones and the smart ones end up owning bigger and bigger stuff, but there's an entry point that's relatively accessible.
Bill: My father-in-law is much more willing to take a risk on real estate as opposed to like the stock market, too. I wonder if that has something to do with just the historical happenstance of it all works.
Moses: A lot of these people are coming from countries, whether it's Jews from Europe, or Chinese people coming from China, they're coming from places where you literally weren't allowed to own land. The idea that you can come to a city and permanently own land is-- everyone's like, “Are you kidding me? Let's do this?” [laughs]
Bill: Huh. That’s interesting.
Moses: Yeah. the community here is very scrappy. The other thing to say, and this is maybe another interesting intersection with real estate more broadly, is that real estate was not an institutional asset class until, I think, like the late 90s. The people before that, it was just a bunch of weird families, and there wasn't the internet and books and BiggerPockets, and all these things that transmit real estate knowledge to normal people now. It was like a weird, niche skill set that people developed on the side and the buildings were cheaper, and the returns were much higher because there was much less capital floating around in the asset class. The biggest private landowner in Los Angeles is a Korean dentist. He just started syndicating buildings after the Rodney King riots and just kept going.
Bill: Huh. That's pretty smart. That's a good example of one foot in front of the other and some compound growth, right?
Moses: Totally. It's funny, I was on panel with his daughter. She just said that he just was looking around after the riots in Korea Town, just like they're selling skyscraper-- not like huge skyscrapers, but like 12-story buildings or something, and I can't remember what the price per square foot was, but it was like $20 a square foot, just so far below the cost of building that building. I think he had his dentist office in one of them, and he bought the building that his dentist office was in. Then it was, like, “This is a good business,” and then just started buying all of them.
Bill: Hmm, that's smart.
Moses: Yeah. The guy's an incredible human being.
Bill: Yeah, I wish that I had listened to BiggerPockets when I was younger. I did house hack my first house that I had and that was the first time that I saw the power of just basic real estate concepts. It sounds so silly now to say, but when I was younger, I was like, “Well, should I rent, should I not?” Then, I was fortunate to have some capital. I put the down payment, my buddies lived with me. All of a sudden, it's like, “Oh,” a lot can actually go wrong with the price, but the cash flow started can barely [crosstalk] it's nice.
Moses: Oh, yeah. If you pay a somewhat reasonable price, and you use a somewhat reasonable amount of leverage, and you're in a decent area, it's probably going to go pretty well.
Bill: Yeah. Hmm. That's interesting. How'd you get your first building? Not syndicated, I'm talking about how do you get started in the business?
Moses: Yeah. This is one of those privilege alert moments. Back to my Great-grandpa Morris from Russia, he ended up amassing a reasonable portfolio, which he lost over time. Anyway, he died with one building remaining in the 80s. It's the building where Mo’s Caribbean, which is a bar that people used to go to-- [crosstalk]
Bill: Yeah, I know Mo’s.
Moses: Yeah, Mo’s [crosstalk] so that building my great-grandfather owned.
Bill: On what, like 73rd and 3rd or something like that?
Moses: Yeah.
Bill: Yeah. My stepbrother’s part of that restaurant crew.
Moses: Yeah. Okay. You know what actually, that group I believe, ended up buying the building from my family.
Bill: Oh, wow.
Moses: Yeah.
Bill: What a small world.
Moses: Yeah. This is in probably 2006. It wasn't because-- that was actually a great time to sell, but it wasn't because we were pressured or anything. It was just my great-grandfather had died and there was three children and grandchildren and great grandchildren and parts of the family needed money more than maybe my part of the family did. Anyway, so we sold and the money went from my grandfather's estate to my grandfather, who handed it to his two children. My mother got a chunk of cash from this building that my great-grandfather had probably bought in the 60s or I don't know when. Then, at the same time, my brother and I were looking-- this is like 2006, 2007, my brother and I were looking for a duplex to buy to just live in. This is like during the real estate mania, like everyone's-- [crosstalk]
Bill: Yeah.
Moses: -okay.
Bill: Yeah, like ‘07.
Moses: Yeah, exactly.
Bill: Like no doc loans, all that stuff.
Moses: Yeah, exactly. The prices were insane. We realized they were insane, but my brother found a guy who had renovated a derelict 16-unit building in a cool neighborhood, or adjacent to a cool neighborhood and ran out of money before he could finish it and rent it up. We were able to strike a deal to buy that building from him at a price that was reasonable and the capital for that acquisition, the first deal that I ever did, came from Grandpa Morris's building, by way of his son, and then his daughter, and then to my brother and me. I think it's such a cool story that this guy came to America and all these generations later, my career was effectively kicked off by capital that he formed.
Bill: That's awesome.
Moses: Yeah.
Bill: I assume he's not around anymore.
Moses: No. He’d be like a 130.
Bill: He's probably looking down happy.
Moses: Or up. [laughs]
Bill: If you believe in-- yeah, either way, right.
Moses: Morris, I loved him. He was a sharp, sharp dude.
Bill: [laughs]
Moses: But he was not a nice man. To come here when you're 15 and not speak the language and not have any money and claw your way to success the way that he did required a certain backbone. He was just a domineering, tough, tough man. It was really hard on a lot of people in the family and everything. By the time I knew him, he was almost 100, but he had calmed down somewhat, but he was a tough dude. Look, that personality basically enabled a whole family to exist in the United States and thrive and everything. Obviously, I'm eternally grateful for that.
Bill: Yeah, that's wild. My story's not all that dissimilar, a little bit different. Most of what has enabled my life is based on insurance money, but the other side of the family was in construction in New Jersey. Everybody always jokes like, “Oh, you must have been part of the mob.” I don't know, they went bankrupt on a large project.
Moses: Ooh.
Bill: I do wonder, did they cross the wrong people, but I don't know, and we're not in it, so whatever.
Moses: I think in that period, it was tough to do business without dealing with those guys in New York-- [crosstalk]
Bill: That’s what people say, I don't know, it was a long time ago. I'm not doing it myself, so whatever.
Moses: No, fair enough. Listen, I'm interested in the entertainment business, just intellectually interested. You read about these old studios and everything and just all the money for everything was coming-- organized crime was so wrapped around the economy in the 50s and 60s and even into the 70s, that basically every business, every major business had some crossed paths with those guys at some point.
Bill: Yeah. We did big construction projects, like the on ramps, the Lincoln Tunnel, I guess. It was government work, so who knows? I don't ask too many questions. I don't really care about--[crosstalk]
Moses: [chuckles] Yeah, it's interesting.
Bill: I've wanted to get into real estate. For some reason, I have this sickness where I love the stock market. The problem that I have with the stock market is, it's not a very good cashflow game, and it's not very tax advantaged. I'm always wondering to myself, why the hell don't I have a duplex or a fourplex or six or whatever just to get started, right?
Moses: What I always tell people-- so you can imagine, I talk to prospective investors a lot. Many of them are in the situation of they've got extra cash obviously and they're wrestling with whether they should invest with me or someone like me, or just go buy their own building. I think it's perfectly reasonable to go buy your own building. I think that the choice probably comes down to how you or really how the market values your time. If you're extraordinarily well compensated and your job, if you're a partner at a law firm, or whatever, it's like do you really want to spare the time to go deal with buying a unit building? Probably not.
Bill: Probably doesn't make sense.
Moses: Yeah. If you're an immigrant hustler, or just a hustler, and you got some extra money, and owning your own stuff, it's a little bit of a pain in the ass in the beginning. But once you find a good management company, and you dial it in, it's not totally passive, but it's not rocket science.
Bill: Yeah. The podcast game is not paying the bills yet, but we’ll see.
Moses: [laughs]
Bill: All right, so you have your first building, and what happened? You had 16 units, and did you have to finish renovating it then?
Moses: We did. I like the in-depth questions, because I've talked about this story before, but there's so much interesting stuff that happened just in that one building.
Bill: I'm sure. it started your whole career.
Moses: We bought the building. We needed to do some renovations, but we actually hired a guy who was on my brother's soccer team to do some of the work. He overcharged us but we didn't know we're doing so he started finishing the work. But we still have a vacant building, we have a mortgage payment coming up. The bank had forced us to hire a management company, because we didn't know what we're doing. The bank that loaned us the money was like, “You need to hire this management company.” They were okay. They weren't the world's greatest management company, they're fine. They had this leasing guy, and the leasing guy starts trying to lease the building. We're just letting him do it because we're like, “This guy's the expert.”
This guy, honestly, he had weird-- he was just having a creepy vibe around it. I don't know. It's just not someone who you would want to rent an apartment from. I'm looking at this guy--
Bill: Yeah, and you're forced to use him.
Moses: Yeah. Right. I'm just like, “I get this guy's an expert, I get the company’s using him, but he seems really creepy.” He starts leasing the apartments very slowly, but that realization that you shouldn't have creepy leasing agents, like no shit and people are like, “How come you guys are good at leasing in our business now?” It's like, “Well, we like pay attention to who we hire as leasing agents and we try not to make them creepy.”
Bill: It was a good first step.
Moses: Anyway, he starts trying to lease the building, but he's going slowly. Okay, a couple of things happen. One is the second person he brings to us-- he leases one unit, I think the second unit he comes with, this woman wants to rent the apartment, but she doesn't have papers. She's here illegally. We're like, “We want to rent the units.” Also, we're like we want to do a solid for someone, so she seemed like a nice person. We're like, “Okay, look, let’s let her rent the apartment.” Big mistake. Her boyfriend who she didn't-- he never put in an application or whatever. Her boyfriend turns out to be this real low life, who it turns out, she goes to work every day and the boyfriend is running prostitutes out of the apartment.
Bill: Oh, no.
Moses: This is our second tenant. [laughs]
Bill: [crosstalk] And you don't even get a cut of the pimping. [laughs]
Moses: Los Angeles has these really strict-- it's hard to evict tenants in Los Angeles. Even if they're obviously running prostitutes out of your building, you're still going to take 90 days at an absolute minimum-- that was back then, now it's even longer. I'm freaking out.
Bill: Really? You can't even go to somebody and say, like, “This guy's got a prostitution ring. Can I get him out of here?” They won't let you? I guess I understand who they're trying to protect, but that's silly.
Moses: Yeah. I'm freaking out. I'm like, “How are we going to get this guy out of here? We're getting a lawyer.” My brother, who is 18 months younger than I am, was like, “Let's go talk to him.” We just went and my brother is tall. He's bigger than me, he's a pretty forceful personality. My brother was just like, “Hey, dude, no harm, no foul, but you’ve got to get out of our building.” He wasn't like, “We're going to get a lawyer.” My brother's just like, “Look, we own this building, and you can't do this here and you need to leave.” The guy actually left. It was amazing.
Bill: Huh. Good.
Moses: Yeah, it was pretty cool action from my brother. Anyway, so that was experience one with the tenants.
Bill: That was tenant two.
[laughter]
Moses: Then we're like, “Oh, we’ve got to fill this building up.” There was a home across the way for teenage mothers. It's a wonderful charity. They take in teenage women, girls who have got pregnant whose parents kicked them out. They provide services and they help them finish school. Anyway, so I went and talked to them, and it turned out that they needed places to put the girls or women who are graduating from the program at 18, or whatever, they wanted to expand to continue providing services to those women. After they leave the campus of the charity, they're going to help them find an apartment. We were like, “Look, we've got these apartments, we're right across the street.” We made a deal to rent, I can't remember, it was 4 or 8 of the 16 units to graduates of this program, which was great because the charity basically cosigned-- effectively guaranteed the leases. It was like, “Okay, well, we've just filled up half our building in one deal.”
Bill: That’s awesome. That's a win-win.
Moses: Except--
Bill: Sort of. [laughter]
Moses: --the women themselves, I keep calling girls, because they were like 17, 18, they're mothers, it was a weird situation-- they were not very particularly mature, but they were nice enough. The problem is that when you put a bunch of 17 and 18-year-old women in a building, they attract a certain guy. Meanwhile, we're renting the other units that they're not occupying. We have a mix of these women and then we have these other tenants. The guys that the women are attracting are hanging out in the hallway. It’s just, again, disaster. We basically over time, we wound that program down, they eventually left, and we filled units with more conventional tenants. But it was such an object lesson in how important tenant selection is.
Bill: How long did it take you to wind through all these tenants?
Moses: It probably took a year and a half from when we struck that deal. They moved in, and then slowly they moved out and we replaced them with regular tenants. Again, they weren't bad, and they paid the rent. On one hand, that's good, but one thing to say this is-- [crosstalk]
Bill: Dude, [laughs] I'm laughing, I'm just thinking about your first real estate experience.
Moses: Oh my God. We didn’t want to tell our parents. It was terrible. In fact, I actually-- [crosstalk]
Bill: “Mom, I'm basically housing pimps and young women that are--" [crosstalk]
Moses: Oh, yeah, I actually lived in the building for a little while in one of the apartments, it was just pandemonium in there. It's just like, “We’ve got to fix this.” This is an interesting lesson. Actually, I haven’t talked about this on a podcast either. If you're going to run nice buildings in semi-marginal neighborhoods, people will put up with a lot from the surrounding neighborhood. Okay. What-
Bill: But not from the building.
Moses: -they will not put up with is misbehavior inside their building.
Bill: Yep, that makes perfect sense, man, because that's their sanctuary.
Moses: Yes. Things can be rough around the edges, but you can't allow it into the building. Forget about having more than one but even one bad tenant can ruin the whole vibe inside the building, make it feel unsafe and uncomfortable for people. It immediately changes the dynamics in the building, and it changes the tenants that you're going to get to move in subsequently. To this day, we manage 700 units now, half of which we own and--
Bill: Wow, good for you, man.
Moses: Half of which we own, half of which we manage for third parties. To this day, I personally approve all of the tenants who move into all of those buildings.
Bill: Wow, cool.
Moses: It's because one bad apple can ruin an entire building, and then you're talking about these are-- they're not huge assets, but it's a $5 million building and you're going to let some jerk in and he ruins it for everyone else, you can't tolerate that. So, I've kept control of that.
Bill: I'm just thinking, I was part of a-- it was only a nine-unit condo association, but it's somewhat similar. If you get one person in your association that either bitches about all the repairs or whatever, things just become a pain that don't have to be.
Moses: Yep. You're living in a little community with people in a multi-family dwelling. It's just you can't have people who-- I got all kinds of stories about misbehavior, even tenants who we approved and we thought they were good, it's like we get phone calls. It's like the tenant in unit a is like pissing off of his front balcony every night.
Bill: [laughs]
Moses: You're just like, “Dude, you live in a building with other people, why are you doing that?” Anyway, you do what you can to try to make sure that kind of stuff doesn't happen.
Bill: Huh, that's interesting. How many of your buildings starting out-- I mean, even now were in neighborhoods in transition?
Moses: Pretty much all of them. Some of them are more in transition, some of them are-- it's a curve. We will buy at various points along that curve. Sometimes, we're buying neighborhoods that are mostly transitioned and still a little rough around the edges. Sometimes, it's they're considerably rougher and just starting to transition. It's a risk-reward calculus, it comes down to where the numbers work and where they don't. It's hard for us, we've never bought a building, for example, on the West Side. the West Side of LA, it's gorgeous. You're near the beach, there's tons of jobs, but it's--
Bill: The cap rates just don't work.
Moses: Yeah, it just doesn't. The numbers don't make sense. God bless the people who can make those numbers work, because there are people in the real estate private equity business who can raise capital cheaply enough.
Bill: Yeah, their cost of funds is just cheap enough.
Moses: Exactly. My hat is off to them. So far, our investors have required higher returns and those returns are more available at transitional neighborhoods.
Bill: Yeah. When I was in Chicago, for my Chicago peeps, it's division in Claiborne is what I'm talking about, I bought the first house and I actually did pretty okay on. I didn't sell it to do okay, but I collected the rent. Me and my buddies were like, “Oh, we can live near Cabrini-Green. That's not a problem at all.” My bedroom looked at three towers, and my neighbor had two bullets go through his window. We were on the third floor. I was always like, “Well, if a bullet comes through, at least--” [crosstalk]
Moses: It's going to be slanted out, right?
Bill: Yeah. It's not going to hit me. Man, I'll tell you what, when my wife and I sold, she was like, five months pregnant, somebody was smoking crack on our-- [crosstalk]
Moses: [laughs]
Bill: She was like, “I'm not having a baby.” In retrospect, it sounds ridiculous, but it's all true. When we sold, we moved somewhere in Lincoln Park and the people that closed that week were walking their dog and a bullet came into the lobby.
Moses: Oh, my God.
Bill: Those are the only two bullets that came into the building in, what, five years or so. This is all relevant because the question I was going to ask is, when I bought it, I thought like, “Well, this neighborhood is obviously going to change. There's no way that it can't.” I had this panoramic view of the city. It was sick. The rooftop was awesome. Then I found out my alderman was different from the aldermen across the street. The incentives politically, there was no way the neighborhood was ever going to change. I didn't really understand how local politics in Chicago worked when I bought the building-- or the unit. How do you avoid maybe some of the issues that I'm talking about or pick which neighborhood to bet on to transition?
Moses: It's a really interesting question. First of all, I would say that we are very selective about which neighborhoods we go into. We can talk more about this in a minute if you want. We're very, very quantitatively driven in terms of evaluating prospective acquisition targets. By far, the most important factor is what rents we can forecast for a renovated product. We can go through why that is, but basically like,--
Bill: Yeah, let's go through why it is.
Moses: We're totally driven by unlevered yield on cost. It's just an incredibly simple calculation. It's basically a cap rate, because we're doing work to the building, it's not-- A cap rate for everyone who doesn't know is, you take your rents, your annual rent, and so you subtract your annual operating expenses, not including a mortgage. Just your property taxes, and trash pickup and lawn and all that stuff. That resulting number, rents minus annual expenses, is your net operating income. Okay. It's your-- just the unlevered cash flow that's coming out of the building. To get a cap rate, you just divide it by the purchase price. That number will be 5%, if it's a five cap, or it'll be 7%, if it's a seven cap, and the concept is that if you invest a million dollars, in a seven-cap building, you ought to get with no mortgage, you ought to get $70,000 a year in net operating income.
For us, the equation is very similar, except that we're not just buying the building, we're also renovating it. It's forecast net operating income on the top and the numerator. The denominator is the cost of buying the building and the cost of fixing it up. Unlevered yield on cost is just, “What is the net operating income we're going to get every year after investing X amount of cash into the building, ignoring a mortgage?” That's far away the thing that we focus on most when we're looking at deals.
Bill: Can I stop you real quick?
Moses: Sure.
Bill: Just thinking through how this could work, I could see the math getting you into some hairy situations. You ever get into neighborhoods that you don't want to drive into?
Moses: It's interesting. It's a good point. In general, the way that Los Angeles works anyway, is that if you take a realistic view of the operating expenses and a realistic view of the rents that you can get, it is unlikely to make sense to go into really terrible neighborhoods.
Bill: Huh, that's interesting. Why is that?
Moses: Well, one thing is, it blows me away that people run slum buildings in Los Angeles, because even forgetting about the eviction moratorium currently, even in normal times, it's extremely expensive and time consuming to evict a tenant.
Bill: Yeah. I can't believe I forgot that. [crosstalk]
Moses: If you have a tenant who misbehaves, it's going to take three, four or five months to evict them and it's going to cost you-- They can get a jury trial, which is going to cost you 20 grand.
Bill: Yeah, that’s like Chicago.
Moses: One unit or a couple units doing that every year, it destroys your cash flow, both because you're not-
Bill: And your time.
Moses: -collecting any rent from those units, and you're having to spend money on legal fees and maybe a settlement or whatever to get it over with. If you're just looking at a broker package, and you're like, “Oh, it might make sense to invest in a crummy building in a crummy neighborhood,” once you've some scars from that, you realize that those broker numbers don't take into account how many eviction cases you have to file and how many months of rent you lose, and buildings you have to fix because the tenant broke it and that kind of stuff.
Bill: Yeah, huh. How many buildings did you have to live with that on before you realized this-- [laughs]
Moses: It's funny, we do not want to run buildings like that.
Bill: Yeah, no. It's clear why. [chuckles]
Moses: One of the things that we did early on, it was a mistake from a capital allocation perspective, but it worked out really well. Our biggest investment Fund One in Adaptive came to us in 2013, and we're like, “We're doing really well buying single family homes in Phoenix and Chicago. Why don't you guys just take a bunch of money from us and go buy a bunch of single-family homes?” I stupidly was like, “No, I've got this other idea.”
Bill: [laughs]
Moses: My other idea-- and when someone that rich, who's that experience comes to you and is like, “You should do this strategy, and I will capitalize it,” you should say yes to that person, not no.
[laughter]
Moses: I was like, “No.” Instead, what I want to do is buy a bunch of junky buildings in this fairly rough neighborhood. The thought process was that the neighborhood is-- I don't actually want to say the neighborhood because it's little bit politically sensitive.
Bill: Yeah, that's fine.
Moses: The neighborhood is so clearly well positioned for future growth, I’m absolutely categorically certain that the neighborhood would improve. The prices were so cheap, like I was able to buy buildings for $100 a square foot in a central neighborhood in Los Angeles, it was like a no brainer. But the idea was that we were going to buy these buildings and sit on them for a while before renovating them, just run them as is before going through the process of renovating them. We did that. We bought a portfolio of these buildings, and then we hired another management company to run them. I just had to watch. Every month we'd look at the financials, and it's like, “Oh, this so and so stopped paying rent, we're in eviction with that guy.” Like, “Oh, this crappy old building has another plumbing leak.” Surprise, $7,000, that wasn't in the pro forma to fix the plumb-- It really drove home to me that I just do not want to be in the business of owning a bunch of rundown buildings with tenants who maybe are not the most responsible people in the world.
Someone needs to do that. It's just not going to be me. That's just not a good business for us to be in. I learned that lesson. Eventually, we ended up renovating those buildings, and it's done very well, but not as well as it would have been to just go buy a bunch of single-family homes.
Bill: Yeah. Well, again, your return on time is lacking. You get done with that project. First of all, I’ve got to take a little bit of a step back because you said he was an investor in Fund One. You had already raised a fund?
Moses: No. Let me go back and give you the actual chronology for the business. My brother and I bought that first building. The real estate market collapsed. This is now 2000-- I think we closed on that building in very early 2008. Real estate market immediately collapses, but we've done a good enough deal on that building. It turns out okay, like cash flow, it got a little thin there for a while and rents came down. It was pretty painful, but the building is fine. Meanwhile, real estate goes on sale. I have a buddy, one of my best friends, at that time was making an absolute fortune in a hedge fund that he had started. He needed somewhere to put the capital because you probably remember, like, if you were making a fortune in 2008 and 2009, which bank do you put it in?
Bill: Yeah. You're scared of them all.
Moses: Yeah, exactly. Even Goldman Sachs had to go get support to get to whatever was called, they were designated a bank and everything. Every one of them was in trouble. We went to this guy, we had an opportunity to buy another building from the same management company that the bank had forced us to use on our first deal. It was really cheap. They came up with a price and I said, “No, even a much lower price.” They were like, “Okay.” The guy was desperate to sell. No one was buying. We're the only idiots who are interested in buying stuff. This is 2008-2009. Everyone else is like, “Falling knife, don't catch it.” We're like, “This looks pretty good. This is a neighborhood we really like,” and the building was $75,000 per apartment in Silverlake which for anyone who knows, even crappy units-- [crosstalk]
Bill: There's got to be [crosstalk] replacement cost.
Moses: Replacement cost in Silverlake right now is probably $500,000 a unit.
Bill: Wow. All because that creepy salesperson leased up a weird building and they're selling in ‘09. Did they have too much debt or something? What was going on?
Moses: The guy who bought it from was a syndicator. He had been going out and doing a bunch of syndicated deals all the way through the run up, like 2005, and 2006 and 2007/ I think he had cross-collateralized things, and it was just a friggin’ disaster and he just needed out of it immediately.
Bill: Oh, man, good for you.
Moses: Yeah, well, so I went to my buddy and was like, “Look, this building seems cheap.” He is sitting on a load of cash. I don't know if you remember also, everyone was expecting massive inflation.
Bill: I do remember, gold ran like crazy. People wouldn't stop talking about gold.
Moses: Right. Everyone's like, “Well, the Fed’s printing money, it's going to be crazy inflation.” Everyone's like, “Okay, well--” conventional wisdom was go own hard assets. From his perspective, even though we didn't have very much experience, he knew he could trust us as we've been friends forever and we were just going to buy hard assets. Apartment buildings in Los Angeles are probably not a crazy thing to do with money right now, particularly if we're going to have a bunch of inflation. He was willing to trust us to buy a building, and we did. We started executing the business plan of fixing it up and it worked. Then he backed us to buy a whole bunch more buildings very quickly. Between 2009 and 2011, I think we bought deals like 2 through 13 or something like that just really quickly, way faster than you would ordinarily be able to do that in a normal real estate career. It was just dumb luck. A great friend who's a genius who got super successful and was willing to trust me.
Bill: That's wild. I had talked about our insurance company, the family's, a little while ago. When I talked to my grandma about where the inflection point in that insurance company really came was the Great Depression.
Moses: Really?
Bill: Yeah, people were afraid to underwrite. I guess he's what great-great-grandfather and his business partner just went ham, and they just captured a ton of market share.
Moses: Yeah. I mean, for us, I think a big part of why we were able to do that is we were so naive. First of all, a lot of professional investors were at that time dealing with problems in their own portfolios. They had bought stuff in 2005, 2006, and then these things are getting foreclosed on and they're underwater, and it's in there doing workouts and it's a disaster. A lot of the professionals were on the sidelines for that reason. Even the ones who had access to capital and could have bought, most of them had lived through the savings and loan meltdown and the RTC in the mid-90s when real estate got stupidly cheap. They were giving it away.
In 2008, 2009, 2010, those guys kept waiting for the same thing to happen, for the banks to capitulate and just blow out the commercial real estate. But the crucial difference this time was that the Fed stepped in and basically allowed the banks to extend and pretend the loans, to protect the banks, they basically made it so that the banks didn't have to recognize the loan losses. Just instead of foreclosing, the banks could just extend the loans out and pretend the borrowers were going to pay it. The result is that the pricing never went into the freefall that it did with the RTC in the mid-90s. The result of that was that even the professionals who were not hurting from the stakes that they had made, who the ones who had access to capital and absolutely could have gone on a buying tear, didn't because they kept waiting for things to get better, for prices to get even lower. We didn't know anything about the RTC. We didn’t know anything about anything. It was just like, “Okay, well, here's the rent we can--”
Bill: Yeah. [chuckles] You're like, “Let's go get it.” [laughs]
Moses: Yeah. I was like, “Here's the rent we can get for these units. Here's what it's going to cost to buy the building. Seems like a good deal. Let's buy it.” It was very fortuitous. It was that beginner mindset and naivete, honestly, that allowed us to jump in when everyone else was running away.
Bill: That's wild. That's super cool. It's interesting how a lack of knowledge maybe was your edge, at least behaviorally.
Moses: No question. Even with the second building, the first building that my friend capitalized, it's our second deal, when we were finishing the renovations on the first couple of units, we went around and we interviewed others management companies. We were like, “These are the rents that we want to get.” The management companies were like, “You guys are out of your minds.” It was the same beginner thing, we were just looking at what was available on Craigslist, we're like, “Our units are way better than that. This is a cool neighborhood, people are going to be willing to pay this rent,” but the management companies couldn't see it because they were used to dealing with their own shitty units, which would never have got those rents. When we said, “We want these rents,” they were like, “Forget it.” We were forced to do the leasing ourselves basically and we got the rents. I was like, “Okay, no one else knows anything. You can just look at the market and figure out what the rent should be.”
Bill: Yeah. Huh, that's wild. Have you stayed in pretty much the same asset class? Do you focus on a neighborhood? How's your career gone? It seems like it's mostly the same asset class.
Moses: Same. It's basically, we did some single-family flips in that first batch of deals that my friend capitalized and that just to be really clear, that first batch of deals was under a company called Better Dwellings. Within Better Dwellings, within that initial portfolio with my buddy, I think we did two or three single-family home flips, some small apartment buildings, and then some bigger ones. It's funny, we sold the single-family homes and the small apartment buildings, and then we actually sold the big apartment buildings too. My big takeaway from the whole thing-- I remembered, like, conceptually, I understood that selling real estate cost money. But I remember looking-- it's actually a very interesting experience. We sold everything, we very stupidly liquidated that entire initial portfolio in 2012. Very stupid.
Bill: Why?
Moses: My buddy was like, “Look, I've been your training wheels for a long time. You guys need to build a business.”
Bill: Yeah, that's cool of him, pushes you in an uncomfortable direction that ends up helping you long--[crosstalk]
Moses: Totally. It is a big lesson I learned and it's one that is absolutely relevant, I think, anyone who's in a professional money management business, is think long and hard before you become overly reliant on any one capital partner, because that person can just get out of bed one day and be like, “You know what? Actually not interested anymore.” If you haven't developed the fundraising muscle, and the network to go out and raise capital from other people, your career can come to an end for reasons that have nothing to do with your skill in investing.
Bill: Yeah, that makes sense.
Moses: He was like, “Look, I want my money back,” and we had done pretty well, so we sold everything. Then I remembered, there are a couple of really key insights that came from that experience of selling. The first one was, I knew before that intellectually that you could buy a building and fix it up, and then have the building be worth considerably more than you spent to do that. We can go through the math, but basically, let's say, just to go back to our unlevered yield example. If you create a 7% unlevered yield, you invest a million dollars, and it's generating 70k in net operating income, and it's a five-cap market where people are willing to buy at prices that reflect a 5% yield, the building is worth $70,000 divided by 0.5, which is more than a million, I don't know what it is off the top of my head. That delta is your profit. I mean, it sounds very obvious. Conceptually, I knew that. It's a different thing to actually sell the buildings. Someone came along-- we hired a broker and he advertised. A random person came along and was like, “This building that you invested $2 million in is worth $2.8 million. Here you go.” Okay, so that was awesome. I know it sounds lame, it's like--
Bill: It doesn't sound lame to me, man. I'm sitting here thinking the exact same thing happened to me. Real estate is what helped me capture it. I have an LP interest in a fund that targets cities, so it's apartment complexes, and they target cities that have tech influence. Our general exposure is some San Fran, not much because the cap rates are so tight. Austin, Denver. We have some stuff in LA, Seattle. I didn't really understand how it all worked until we were walking one of the properties, my buddy said-- he walked me into the common area. This is a place in Denver. He's like, “Okay, so we're going to invest this much in the common area. We're going to pull the leasing offices to the front. We're going to make it approachable. We're going to put amenities in here. We're going to invest in the pool, and then it's going to raise the value of all of our rents. Then, we're going to capitalize that, and this is how the math works.” I was just like, “Holy crap.”
It's silly to say, because this is back in the day when I was like, “Oh, deep value is the only investing strategy and I'm looking for 50-cent dollars.” Then, I started to think about, “Okay, well, if you can do that in real estate, what can you do in companies? If I can figure out how much more earnings this company is going to have in five years and then put a multiple on that.” I'm sure people who are listening are like, “How did you not understand that?” Well, the answer is I didn’t, but I do now. I'm less dumb than I used to be.
Moses: Well, it's just a different thing. It's such a simple observation or a simple understanding. For me, I think maybe if I had been from a more commercial family, it's like, I think if your family owns a little business, like a store, let's say. They like buy wholesale and sell retail, you're very used to the concept that you can buy something for $1 and sell it for $2. It's part of the life of your family. Our family, we owned some buildings, but we weren't that commercial. Maybe I had a lemonade stand once or something, but I wasn't one of these budding entrepreneur types who goes, and whatever. I didn't do that. I just was interested in history and reading and all kinds of other stuff.
Bill: Your dad was into art and you said your mom worked for what the--
Moses: New York State Government. Yeah, they owned some real estate, they're not naive, but the money is not the focus of their lives.
Bill: Yeah, that make sense.
Moses: It was really not until we sold that first building from that pool from Better Dwellings that we did with my friend, it was like, “Okay, this actually works. It's not just a theory that you read in a book. Some random person will come out and write a check.” Very helpful. Then the following realizations came immediately thereafter. One, if you look at the closing statement from the sale of real estate, what you see is a shitload of the gross purchase price gets vaporized in transaction costs.
Bill: Yeah, your fees are just garbage.
Moses: There's brokers, there's city and county transfer taxes, escrow, title, you name it.
Bill: [laughs] It's just a ton of leakage.
Moses: A deal in LA, depending on how much you negotiate the brokerage commission, you're probably talking 7% of the gross sale price leaks out.
Bill: People then don't think about, okay, well, this is an 80% or 60%, or whatever levered asset, so as a percentage of your equity slug, the fees are huge.
Moses: Huge. Then, okay, so you sell and you're like, “Ugh, alright, but at least I got my money. At least I got the net proceeds.” Then you file the tax return for the entity, and you realize that between federal and state taxes on your capital gains, you're vaporizing another big chunk of the remaining equity, and that experience of selling that whole portfolio in 2012-- Oh, sorry, one more thing. Then, okay, we sell this thing, get killed on the transaction costs, get killed on the taxes. Then, to add insult to injury, we have to watch as the rents keep running, and therefore the values of the buildings keep running. We sold stuff in 2012 to people who bought it from us and then just basically did no work, just sold it on again a year later, and made more money from holding it for a year and reselling it than we made from doing all the hard work of renovating the building.
Bill: Yeah, that’s brutal.
Moses: Yeah. Taking together the experience of selling a bunch of stuff and vaporizing bunch of value, then watching as the values of those sole buildings continued to soar, really drove home to me that selling real estate that if you have good renovator, or new real estate in improving areas in a good city, don't sell that. Then, the more that I started reading about it, and thinking about it, and meeting people everything, it's like we never sold the first building we bought, the one we own with my family, that we still own that building however many years it is later, we've refinanced it, we've pulled way more than the original equity that we invested out, it's worth more than double what we bought it for and it's still chunking out cash every month. When you have assets like that, don't sell them, hold them, manage them well-
Bill: Never sell.
Moses: -take care of them and refinance them and pull the capital out tax free and buy more. That experience of being forced by my buddy to liquidate that original portfolio really ended up being the impetus for the strategy that we still follow at Adaptive Realty. We sold that whole portfolio. My brother and I decided to stop working together, it was just too crazy. We had an employee and a junior partner at that time, this guy, John, who had been working for us, and then I decided to go-- at this point, I had a young child. I was married, I had a young kid. We didn't really have any money because we didn't really make that much. My friend did okay on the sale, we did okay, but not great. I'm sitting there and going, it's still 2012, it's not a great time to get a job. I have a young kid, the only thing. I know how to do is I've got my brokerage license because I had been representing us sometimes in buying buildings. My buddy, John, had got his contractor's license. All we knew how to do was do what we had been doing, which is buying and fixing up apartment buildings. We went into business together. That was the formation of the Adaptive Realty. John is my full partner.
Bill: That's cool, and that’s your partner that you're still with?
Moses: Yeah.
Bill: That's cool.
Moses: Yeah. I raised the capital and I find and buy the buildings. John does all of the design and construction management. It's just that's-- [crosstalk]
Bill: He does nice stuff.
Moses: He's great. He's not trained as an architect or anything, but he has good taste. He has extraordinarily good spatial reasoning skills. We've renovated 100 buildings over the last 12 years. He has laid out more small apartments in Los Angeles-- I bet there aren’t architects who-- he sits there with a paper and pen and moves walls. It's always like a game of Tetris, because you're trying to optimize the space usage, and he's just really good at it. Not only good at doing one building but doing 10 of them at a time. Imagine overseeing 10 gut renovations of different idiosyncratic apartment buildings at once with different contractors and different neighborhoods. It is a monumental logistical and operational challenge, and he's really good at it. It's been a very fruitful partnership in that way.
Bill: That's cool. It's nice to find somebody that complements your skill set.
Moses: The other thing to say, and this is maybe a little bit more subtle, is my background pre-real estate, was in banking. I did a couple years of like M&A banking. I went to Princeton. I like to read a lot. I'm not a hands dirty kind of guy. Anyone who knows me who's listening to this is laughing right now because I'm the opposite of a hands dirty kind of guy. I like to think about things and read and everything. John grew up in a family without any money. His parents wouldn't help him pay for college. They couldn’t. His stepfather loaned him enough money to buy a truck, and he bought one of those College Pro house painting franchises.
Bill: Oh, yeah. Yeah, I know College Pro.
Moses: Yeah, he put himself through college. Every summer, he would run painting crews in New England, hire a bunch of initially kids, but then eventually it was grown men. Go around and quote. As a real small business, hands dirty, working with blue collar guys, he was really good at it. He is just a scrappy person. He's not particularly interested in-- He could probably explain what a cap rate is. He's not an idiot, he went to Wesleyan. He's a smart dude. He hasn't read books about real estate, but what he does is know how to run construction projects. He's got a small business mentality about just being scrappy, like, “We're going to figure out how to get this done. When you do more, figure out how to say yes, when someone wants to do a project, we'll figure it out,” like that urgency and drive. The combination of that, he really taught me a lot about being scrappy. It's not just the intellectual and looking at the deals and running money. It's also almost more of a mindset thing. It was incredibly valuable for us. We built an asset management business from zero assets under management, we're $155 million or something now and growing really fast, but going something like that from zero with no fees, and no nothing coming in the door, and none of your own capital or very little of your own capital, that is really hard. We absolutely would not have been able to-- I would not have been able to do it on my own. It was John's scrappiness.
Bill: That's cool. Those College Pro guys are scrappy.
Moses: Yeah, he was climbing up on roofs and getting in fights with New Hampshire homeowners who want him to come back and paint it again. That is completely beyond my experience of the world. I was hanging out at fraternity parties at Princeton then, you know what I mean? It's just a completely different experience.
Bill: Yeah. The painting crews are a different level of-- I don't want to say unreliable but that's a word that's coming in--
Moses: Oh, no, well, he--
Bill: I have interacted with a lot of those College Pro guys, and the stories they have are pretty funny.
Moses: What happened with John is after a few years of doing the conventional College Pro thing, the College Pro company came to him and were like, “Listen, our problem is that we hire all these kids in the summer, and they fuck the jobs up. We need someone to go around and fix the jobs after they fuck them up.” He stopped having to go bid new jobs. The company would just pay him to go fix the jobs that the other people had screwed up all over New England in August and September. He was sleeping in his-- driving from Wesleyan and Connecticut up to New Hampshire, sleeping in his pickup truck for the weekend. Really crazy stuff.
Bill: Huh. That's cool. Did you guys know each other from back in the day or did you meet just by happenstance? [crosstalk]
Moses: He went to college with my brother.
Bill: Then what, was he part of the-- [crosstalk] were you, your brother and him all three in the business together?
Moses: Yeah. He was initially our employee and then we made him a very, very junior partner. That was the other thing, by the time that he and I founded Adaptive together, he had renovated 13 buildings or something. I'd been working with him for years and I knew that he was great. It was a very organic way to start a partnership.
Bill: Then when you founded Adaptive, did you go out and try to get one building and then raise the funds or did you try to raise a fund first to the--
Moses: Fund first.
Bill: [crosstalk] -to then close on a building quickly.
Moses: It was crazy.
Bill: It's a huge competitive advantage, closing, isn't it?
Moses: It is, but it's also very much harder to raise a fund than it is to raise it for an individual deal because you have to go to people and be like, “I would like to raise money to buy some buildings.” They'd be like, “What's buildings?” They're like, “I don't know.”
Bill: Yeah, and I need your capital for a time period.
Moses: Yeah, it's very hard. We didn't have that much of a-- we had a little bit of a track record. It was still crazy to try to raise a fund then, but we did it and it was tiny. I went out, I made a list of all of the rich people that I knew, and this included parents of friends, I didn't grow up going to Country Clubs, or whatever. The list wasn't that long. I was able to get-- I think I got 1.8 million bucks worth of commitments, which for a fund is ridiculously small. Then, as a last-ditch effort, I asked our CPA, if he knew anyone who might want to invest. He was like, “Well, there's this family, you should go meet them. Just tell them what you do, and we’ll see what happens.” I go to this office in Santa Monica. I was so green, I dressed up. It's funny, because I know these guys now and I can visualize now what I must have looked like to them then, they were so nice to me, but I was so green.
I go in there and I meet the senior nonfamily member, and I explained to him what we do. He's like, “Okay, if you just want a couple 100 grand, I'll write you a check right now. If you want a material amount of money, we're going to have to negotiate the docs.” I'm like, “What's material?” He's like, “Well, we'll match what everyone else has contributed.” I was like, “Okay.” It turned out that the negotiation that they wanted to do was not-- they didn't want to come after our money. It wasn't about the economics. They wanted some control rights. They wanted to be able to veto deals basically. That seemed reasonable.
Bill: To approve them? Did they want to just make sure that you were doing something that made sense?
Moses: Yeah, exactly. I was a little worried at the time going back to the other investors and saying, “Look, we brought in this big family, and they're going to have veto rights.” As I started talking to the other people who I had signed up, it occurred to me that having the whole thing blessed by this huge real estate family office, and these guys own an incredible amount of assets, they've been doing real estate in California for generations, they're huge. So, having them come in and take half the fund is an incredible endorsement of what we were doing and having them have veto rights over the deals, far from being something that's bad for the other investors is actually great for the other investors. The other investors are thrilled to have these experts reviewing everything. It was very easy. The other people were like, “Great, fantastic.” That was Adaptive Realty Fund One was, I think it was like $3.6 million, half from close friends and family and half from this family office.
Bill: Huh, that's cool. That's a good way to start. If I had told you then that you'd be here now, how many seeds of doubt did you have to get over before you got where you are at?
Moses: Oh, my God. I remember distinctly being like, “God, if we could get to $100 million of assets under management.” At this point, we probably had $12 million or something. I remember thinking, “God, if we can just get to 100.” Then I remember waking up a few years later, I think we were doing a personal financial statement or something for a bank as part of a refi. The bookkeeper, we have an awesome bookkeeper, and she's been with us since the beginning. She totals it all up, she's like, “These buildings are worth more than $100 million.” I was just like, “What the fuck?” It just happened.
[laughter]
Moses: I have doubt all the way through. We were broke. A $3.6 million fund is not enough for people to live. We had an employee-- so we were brokering, we were doing property management. We did tons of fee development. We scraped and clawed to survive as we grew the business. It was, in retrospect, an extraordinarily difficult time in my life, like, from when we found it Adaptive in 2012, through about-- things got easier probably in 2016 or something. But that first period, it was brutal. We were a subscale asset management business with a subscale property management business stapled to it. Then, a subscale brokerage that we started. It was really hard.
Bill: Yeah, that's wild. And you had a kid at home, right?
Moses: Then a second one.
Bill: Not the easiest thing to do.
Moses: No, it was terrible.
Bill: Yeah.
Moses: I mean, cards on the table, and I don't really want to talk too much about it. My first wife and I got divorced, it was not just because the money but it was a--
Bill: Geez.
Moses: I was really rough on her, and I was extremely rough on John, my partner, like, I was so consumed-- it was a couple things going on. One is, my friends from high school, including the guy who had staked us to our first deals, did incredibly well. I have friends who retired in their 30s. My friends had done so well. I'm here running this shitty little real estate business, I'm broke and driving my mom's old car that she gave me, going to real estate conferences in my mom's old Blue Audi and it's dirty, because I haven't washed it. I'm trying to make sure that people don't see me leaving the conference because I'm trying to present myself as this real estate expert, and I'm getting in a shitty car.
Bill: Then you get in that car. [laughs]
Moses: Yeah, it was terrible. I felt bad about myself. I was envious of my friends. I was consumed with this drive to try to make it. I put an enormous amount of strain on the relationships with people who love me and were around me and trying to help me. I was just a complete stress ball lunatic. It's classic allowing your net worth to be the center of your identity or whatever-- but that rage and anxiety and whatever, drove everything forward. Then by 2016 or so, 2017, that flywheel starts to spin, and we have more and more investors, and more and more deals, and the company's grown and it's not so subscale anymore, and then it got easier and I learned a lot about how to be a normal person. I don't know that my current wife would agree that I've quite got there yet, but--[laughs]
Bill: Well, mine wouldn’t think I am at all. And I don't think I am. I don’t think I actually want to be. I think that's interesting. I come from a way different place. I have not struggled financially, but I've had family and personal stuff that has been the card that I was dealt that wasn't super easy to deal with. As a kid saw some stuff that I probably shouldn't have, and for a while, it manifested itself in me by acting out in class a little bit. Then, I sort of got behind in some of the classes and then I was sort of told that I was stupid. I always ran from this fear of like, yeah, I have this money, but it's not a ton, but I'm also blessed at the same time. I'm not trying to-- but I had this shame of feeling that I wasn't worthy of it. Then, when I didn't do well in class, and then I had kids or friends, I felt like-- you know how guys would pick on each other's insecurity. They knew that that was the button that they could go out, like manifested itself. Man, I lived with that shit for a long time. Honestly, last year was probably the year that I kicked all that stuff, because I don't know, I feel I became a man.
Moses: Did you have help?
Bill: Oh, man. I've done a lot of therapy.
Moses: Me too.
Bill: A lot.
Moses: In two different chunks in my life, and both times were extremely helpful.
Bill: I've gotten to men's groups. I've screamed at a chair. I've done all kinds of weird shit.
[laughter]
Bill: You know what? I needed it, and it brought me through, but it definitely stunted me or I let it or whatever the hell, I don't know what the answer is.
Moses: Can I ask you? How much of the improvement do you think comes from the work that you did? How much comes from just maturing, just getting older and more fully inhabiting yourself?
Bill: I think that it's probably-- I guess, I don't know how to untangle those two things.
Moses: Yeah, it's a hard question.
Bill: I think the reason it's hard is-- I spent a lot of time on a couch as a kid. As a kid, I wasn't really willing to hear the conversation that was going on. My brain couldn't really comprehend what was happening. Then, I had a situation with my dad that I feel bad talking about it. I also think it's really important. I had to check him in to a hospital and he was going through actually a divorce in his life. It manifested, what that did to him was, he didn't sleep and he totally abused caffeine. Then it started to go to Red Bull. It was like 30 days, I think he only slept. I mean, he slept under 30 hours in 30 days, and he just lost it.
After that, I called the man and I apologized for what I thought my dad's behavior was, I don't know what's reality and what's not because I wasn't in the room. He said, “Why don't you come to this group that I'm involved in?” At the time I was probably 28-ish. I think that's when I was really actually ready to start to receive some of the messages and do some of the work that was really required. It's hard for me because I love Buffett and Munger, I don't think that they would approve of all the media that I do. You're not learning when you're talking. The other side of it is like, I left a job, and I didn't want to disappear. I have not disappeared. I think I get a lot of encouragement from people, and it's fulfilling to me, and it's manifested itself in ways that have made me money, and I'm trying to reciprocate and stuff and it's just-- I don't know, man, it took a long time. Finally, I'm like, “You know what, I am worthy of this.” I finally feel I could look at the guy that I owe all of it too, he'd be proud of me, but it took a long time.
Moses: Yeah. Obviously, there are taboos about talking about this stuff. One of the things that-- I am participate in Twitter and do podcasts and stuff, because there's material benefits me. I've met a bunch of capital providers. There's no question that it's helped my career in that way, but I'm not raising money for anything right now. The reason that I do this is that I didn't have a mentor going through that process of building a firm. I had investors who were pretty experienced, but when they're your investors, there's a little bit of a-- you can't be totally honest-- maybe honestly is the wrong one word, you can't be raw because if you're too raw, they're going to be like, “Whoa.” You know what I mean? Actually, with our biggest investor, I remember being like, “Look, I'm getting divorced from my wife.” That was a big moment, I have to tell them that and everything. My point is that I do this stuff to a large extent, because I didn't have that mentorship. I didn't have anyone telling me how this works, and helping me avoid mistakes and all that stuff. A big part of this, for me is just trying to be that mentor for people who are 3, 4, 10 years behind me on that journey.
Bill: Yeah, well, I appreciate you doing it, because I'm learning stuff, too. I guess that's how I've approached it as well. I didn't grow up around people that were money smart. I grew up around people that thought that money would just always be there. I love my family members. I think that if they want to argue that point with me, we can totally on that one. I watched my one uncle drank himself to death at 41. My other uncle took a long, long time before he got himself sober and a productive member of society. I don't know, man. For a long time, I just wish that I could find somebody, and part of the reason that I have so much love for Buffett and Munger is, like, those are actually the guys that I learned from. I know, it may sound really weird, but I don't think I'd be a man without them. Then I got involved in Twitter and the friends that I've made, and the true connections that I've gotten from that. It's been unbelievable, and a lot of them have been featured on this podcast and will be in the future. I'm just trying to live, what did Naval, “Wealth games, not status games.” It's worked out well.
Moses: Yeah. Amen.
Bill: The mental health part I'm particularly passionate about, because I just think it's total bullshit that people feel they have to hide from it or whatever. The amount of stress that you go through trying to build stuff is crazy.
Moses: Totally. I think in some ways the personality type that wants to go build something from scratch is often, very often, the personality type that puts a ton of pressure on him or herself, and also the people around them. That's exactly the person who needs some help and support and needs to know how to take care of him or herself. It's a really hard lonely road. Unless-- obviously, if someone-- if you have a dad, the business, they help you, or you're spinning off of a fund and you come out fully capitalized or something, it's a different story, but if you're trying to build something literally from scratch, it is just a long, lonely road.
Bill: Yeah, no doubt. I think that the other thing that's tough is everybody that-- at least I studied when I was younger, you look up to the people that have done it. It's like you're comparing yourself to the Tom Bradys of the world and you're still in high school pee wee league. It's like, “No, man, you got to put the reps in.” That’s interesting.
Moses: Yeah. For me, having my best friend basically shoot the moon in our, I guess late 20s, early 30s. Imagine that, this is a guy who I've been close with since we were 15, he's really smart dude. We're not in the same league intellectually, but still, this is someone who like I think of as a peer, who just goes out and fucking blows the doors off and is done by early 30s. I'm 31, I have $1,000 in my checking account, a young kid, and just the anger and the jealousy, but the thing is that-- I think another lesson that's important for people to understand is, he was putting the reps in high school, and in college. He was taking serious physics classes and math and everything, he worked really hard out of college. I was in a fraternity, I was drinking, I was smoking pot, I was like, a little bit lost. I was like a banker, but I didn't really know what I did. I basically screwed around for a lot of my 20s, and it turns out that, as with everything else, things compound. If you start killing yourself in high school and college, and you continue doing it through your 20s, you set yourself up for this life where, by the time you're entering your 30s, you are in a pretty amazing position, professionally. I didn't do that. I messed around and caught one of the last trains in my late 20s. My first real estate deal, I think I was 27 or 28, maybe 28.
Bill: We were talking about your friend that shot the moon out.
Moses: Yeah.
Bill: That happened to me as well. It was interesting to watch.
Moses: Yeah. He handled it incredibly well. Basically, he ended up setting up a whole bunch of us in business. In addition to what he did for me, he also angel invested in one guy's tech company that did well and started another company with another friend, and God knows, probably did the same thing for a bunch of other people too. His success really allowed a lot of us to get our start, maybe not just get our start, but maybe accelerate our careers in ways that would not have been possible otherwise.
Bill: That's cool.
Moses: Yeah.
Bill: Does that make you want to do it for somebody else, I guess? [crosstalk]
Moses: Oh, yeah. Of course. It's going to be a while before. I mean, part of the thing about not selling is that we're just not that liquid anytime. What we've done is created this machine for tax efficiently growing net worth. The machine is going, and it's gone pretty well and it's going to continue to do well and everything, but it doesn't result in like huge chunks of cash. I'm not in a position to write a $10 million check for someone's startup or whatever. It's definitely influenced my desire to mentor people and have interns and help people I meet through Twitter and that kind of stuff.
Bill: Well, I think one thing that you can do if you're not going to cut a check, which I think a lot of people can, I don't think there are that many people that are willing to come on a program like this and be raw and I think that's the way that you can help a lot more people than the check. Because, I don't know, I think money is-- it's a weird thing to say out loud, because I don't actually think it's a pretty abundant commodity, but I think that true mentorship is much more scarce than dollars.
Moses: Well, particularly now. The world is awash in capital.
[laughter]
Moses: There's capital coming out of everyone's ears right now.
Bill: Yeah. What has it done to your business? Are you seeing deals that are interesting at all right now or are you just sitting on your hands?
Moses: It's a mix.
Bill: Obviously, you never just sit, but I mean, like--
Moses: No, we're looking for stuff all the time. We have a couple of different pots of money that we invest out of and the fund that we just raised in the fall, we can't find anything that makes sense for that right now. That has very strict quantitative targets. We're not missing by a little bit. We're missing by a lot. We look every day, we make lowball offers sometimes, we we're trying to make things work, but it's just not working right now. We have an opportunity zone vehicle that is--
Bill: Oh. That’d be cool.
Moses: Yeah. It's actually funny. It's a guy who I met through Twitter, honestly, who wrote a very large check. He knew very well a guy who has been an LP of ours for a long time. It was a serendipitous meeting on Twitter, but it was not wholly unconnected, so there was--
Bill: Well, that's how the world works.
Moses: Yeah. We have pretty big opportunities on allocation. We've done, I don't know, I think three deals through that. That one, we can accept lower returns for those deals, obviously, because of the tax benefits. We've done a few of those. Those deals are closer to working right now than the fund deals are.
Bill: Well, that's what it's designed to do.
Moses: Yep. Exactly.
Bill: Hopefully, it spurs the investment in the innovation in those communities that can create the opportunity.
Moses: Yeah, the last one we bought, which I think we bought a month ago or something, is literally a building and a pretty good area that happens to be an opportunity zone, and it was effectively derelict.
Bill: Wow.
Moses: It's a great building, but it's going to cost a hell of a lot of money to return it to use. It would not have made-- given where construction prices and rents are right now, it absolutely would not have made sense if it weren't for the tax benefit.
Bill: We're talking about finance, so the money matters, but what a rewarding experience to be able to do that in a zone that needs the investment. That's really cool. I make fun of ESG a lot. I don't actually mean that I don't believe in making a difference with your money. I just don't believe in public market ESG, mostly because I don't trust the people marketing it, but to do it with your own dollars, that's something I can totally get down with.
Moses: This gets into some political stuff about-- well Los Angeles has rent control, and there's this question about, like, are you raising rents and therefore chasing people out of their neighborhoods, and there's a lot of validity to those arguments. One thing I'll say is that the majority of the housing stock in Los Angeles is really old. The city was developed in the teens and the 20s. A lot of those 20s buildings are still there. There's also a lot of 60s stuff. We are way past the useful life of those buildings. They need everything. They need new plumbing, electric, windows, there's lead paint in them, some of them have asbestos. They are not safe places for people to live to a large extent. Whatever you think of the politics around fixing up old buildings and raising the rent, which is what we do, the housing stock in Los Angeles is just unhealthy and requires investment, and that investment needs to get a return, otherwise, it will not happen. I'm not going to sit here and claim that it's ESG or something. I'm just a dumb real estate guy. You just have thousands of apartments that are not safe and become safe once we gut them and replace everything and put in modern insulation and energy-efficient appliances and water fixtures and everything, just like we're making them into places that will be safe for people to live for 50 or 100 years going forward.
Bill: I'm bidding out building a home right now.
Moses: I saw that tweet.
Bill: Dude, what I’ve realized is stuff here trades so far below replacement costs, because replacement cost is so high. It's crazy.
Moses: Yep. I think that's actually a very interesting observation that you made and I think it's not widely appreciated. First of all, you can see everyone in the multifamily space right now is obsessed with the fact that insurance quotes are going up. Everyone’s like, “The insurance quotes are going crazy. It keeps ruining my pro formas.” The reason the insurance quotes are going up is because the construction cost of repairing things that break is really way higher than the insurance companies had been previously underwriting. That's a symptom of it--
Bill: Is that a material issue or a labor issue? It's a material issue.
Moses: Both. It's material, but there's a lot of the boomer subcontractors and contractors aging out of the business.
Bill: Yes, scarcity of labor.
Moses: Yeah, well, and then on the labor labor side, there used to be pretty lax border enforcement. What would happen when there was a building boom is a lot of skilled workers would come over from Mexico and Central America. It's got tougher to cross the border. Also, there's just better economic opportunities, particularly in Mexico now, you can make a good living in Mexico. They're just, “I don't really need to go take my chances with ICE.” The guys running a little company, the contractors and subs are aging out retiring. But also, the guys who work for them are not being replaced by young people coming in. Yeah, labor's gone through the roof and materials.
Bill: Huh. That's wild. It's probably a combination of the four years of policy and COVID. All hitting together at the same time.
Moses: Well, and the Mexican economy improving. I don't know what it's like today, but over the last, like 20 years or whatever, you could have a better life, like staying and working in Mexico than you used to be able to. The interesting thing is, when you start to really think about the rapid escalation of construction costs, it starts to become a barrier to entry. For any given piece of existing real estate that you own, you're worried as an owner, is someone going to come and compete with me by building a building next door? [crosstalk]
Bill: Yeah. Now, they almost can.
Moses: Yeah, construction pricing escalating 10% a year or whatever, way in excess of rent growth, even with low interest rates, it becomes harder and harder to justify building anything. At least in places like Los Angeles, where there's high barriers to entry anyway and there's a lot of demand, you get the situation where you just-- there's a lot of people want to live here, but you still can't make the numbers work on construction to build more stuff. So, it's going to have the effect of shooting the rents up. It's partially a zoning issue. We have crazy zoning here, and that's a whole other conversation. It's also increasingly a construction cost issue. There's some advances in modular construction and stuff that might start to change that. But right now, man, it is-- I'll give you just an anecdote. There's a pair of partners who are contemporaries of mine. In the same neighborhood that we do our rehab projects, they do ground up. They're smart and scrappy, and they do their own GC and they're good at what they do, and they can't build anything now, and they really haven't been able to build anything for a couple years. The numbers just don't make sense. They couldn't get cheaper pricing. They are the guys who should be able to build in any market and they cannot build. I think that that is a very, very good sign for existing owners of apartment buildings, because it just means that there's going to be less supply.
Bill: Yeah. And arguably homes, I guess. [crosstalk]
Moses: Oh yeah.
Bill: Then you get into an affordability issue, where it's just like, “Well, how are you going to increase supply?” Because you can't.
Moses: Yeah. I think Los Angeles is a weird market in that there's a lot of people who make money in other places who come to Los Angeles. Even if they themselves didn't make money, a lot of our tenants, they'll be like graphic designers or whatever, they're doing okay. But it’s like their parents are cosigning on the lease for them. Their parents are making 500k in Cleveland or something, but the kid wants to live in LA, and the parents can afford it, so the parents just chip in on the rent. The affordability metrics that people use, they want to compare what the rents are to median incomes.
Bill: That's not really what’s going on anyway, right?
Moses: Yeah, you just have all these people who are making money, like I said, in Cleveland or wherever who are subsidizing their kids. So, it doesn't show up in that median income statistics, but they can pay the rents.
Bill: Yeah. Man. I don't know when it's ever been easy to look forward and be like, “Oh, America's setup, and everything's great.” It feels it's going to be really hard coming out of COVID for the wealth gap to close a little bit.
Moses: I have my reservations about the work from home and remote work stuff. It has not been great for our company. I know that other people have done really well with it or whatever. I think the most positive thing probably to come out of COVID is the realization that at least for some companies that you can do business remotely, means that a bunch of jobs and wealth creation will get redistributed back. Not just in San Francisco and New York and LA, but other cities and states will benefit too. That's both good for individual people, because it's more affordable and whatever. It's also just good for the country. It's totally fucked up that we have this winners and losers thing and the country is so bifurcated. It's just not good. You want to have people who can live in a small town and make a good living and raise their kids there and everything. I think work from home has the potential to do that.
Bill: Yeah. I've talked about it before on a previous episode, but my mom is looking to buy somewhere around here too. I don't know, it's tough. You might need to rent, I don't know what to tell you. The cost is just really, really high. If you're trying to live off what you have, to buy doesn't really make a ton of sense. It might be time to cash out the equity in the real estate-- [crosstalk]
Moses: Yeah, man. Starter homes in LA, like in LA proper, not the Valley. Starter starter homes, like 1.2.
Bill: Yeah, that’s crazy.
Moses: 1.3. Yeah, it's nuts. It's nuts. That’s amazing for us, because no one can afford-- Obviously, there are people with family money whose parents help them with the down payment, and then that's how they do it. There's a whole group of people who are successful, hardworking, people who are doing great in their careers that are responsible, and they want to live in a cool neighborhood in LA, but they just haven't saved up the $400,000 they need for down payment in a place that they would like to buy. Those people are awesome tenants. If you make a really nice apartment for them, they are happy to pay really high rent. They're making 150K or whatever. It's like an insanely good tenant demographic. Again, not great for the world. From a societal perspective, you want people to be able to see how they can buy a house and raise a family and all that stuff.
Bill: Yeah, I guess, it would be one thing if I had the answer, where I was like, “Well, stocks are really cheap, so if they can rent and they can invest, then they'll make a lot in the stock market.” Then, I look at stock market valuations, and I'm like, “Well, I can't confidently tell you that returns haven't been pulled forward a lot there.” If you get the combination of, I can't afford my house and I can't make money elsewhere-- which maybe that's not true. Maybe stocks aren't that expensive, but boy, it doesn't feel that way to me.
Moses: Let me know when you find the answer to this problem, because I certainly don't know what it is.
Bill: Yeah, that's right. I don't think the answer is trading GameStop or-- [crosstalk]
Moses: [laughs] No.
Bill: That I don't think is the answer.
Moses: There you go. We just timestamp the episode right there.
Bill: [laughs] That's exactly right. Yeah, that may not season very well. I don't know, man. I’ve got to get going here. I've had just a fantastic time talking to you. I hope you come back. I'll have you back on whenever you want, man. It's been great.
Moses: Likewise. I really enjoyed it. I'm going to have to go drink some water or something. I've never talked for this long in my life.
[laughter]
[crosstalk]
Bill: We didn’t even take a bathroom break.
Moses: I hope people have enjoyed it. I appreciate what you're doing. I think it's really cool. I look forward to connecting with you and other people on Twitter and everything.
Bill: Yeah, how can people find you?
Moses: Just add @moseskagan, all one word, and you'll be bored to tears by my incessant real estate chatter.
Bill: I don't think so. I think it's pretty good stuff, man. I enjoyed it.
Moses: Thank you. I appreciate that. Thanks for having me on.
Bill: Thanks very much and we'll talk soon.
Moses: Thanks, man.
