WS273: Repositioning 80 Apartment Buildings with Moses Kagan

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In the competitive world of real estate, it’s hard to stand out and find a niche where you can thrive. Moses Kagan, the Co-Founder of Adaptive Realty, a property management company, certainly succeeded when he grew Adaptive Realty from zero to $110 million of property under management. He credits this to the unique business model that they use where they buy beat-up, old apartment buildings and then renovate those into exceptional properties. They are now managing about 650 units, half of which are company-owned and half-owned by third parties. In this episode, Moses talks about how he was able to keep his focus while doing multiple projects simultaneously. He also touches on Beat the Streets, a program that provides wrestling coaching to disadvantaged middle school and high school kids, his way of giving back to the community that has been good to him.

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Repositioning 80 Apartment Buildings with Moses Kagan

Our guest is Moses Kagan. Thanks for being on the show, Moses.

Thanks for having me.

Moses is the Cofounder and Head of Adaptive Realty, the Los Angeles-based development and property management group. Since 2018, he has overseen the repositioning of 80 properties in Los Angeles and grown Adaptive from $0 to $110 million of property under management. He’s licensed as a real estate broker in California. Moses, I’m excited to have you on the show. I appreciate your time and sharing your expertise with the readers. Tell them who you are, a little more about where you’re at and what your focus is. Let’s dive into this different business model that you have and how you’re crushing it.

Thank you so much for having me here. I’m excited to talk to your audience. Our model is pretty unusual. We have renovated 80 buildings or so for the past few years in Los Angeles. We have nine projects under renovation. To give you a sense for the business, we’re around 115 million in assets under management. Our property management company manages about 650 units, half of which are ones that we own and half are owned by third parties. That gives you a sense for the scale. We have an unusual strategy. Our business model is to buy beat-up, old apartment buildings in about five or six neighborhoods in Los Angeles. We gut renovate the buildings. We vacate them entirely. We renovate them to the studs. We replace electric, plumbing, windows and roof, upgrade the foundation and move walls. We do everything to restore the building so that it lasts for a long time and also to optimize the square footage to maximize the rent per square foot.

The result of that process is we add a ton of value to the buildings. When the buildings are stabilized, we are able to refinance them using long-term bank debt and pull out anywhere between 80% and 100% of the capital employed. The result is we and our investors are earning in the low tens cash-on-cash returns on the capital that remains in the deal, all the way up to internet. We have plenty of deals where we’ve pulled out, in one case, 110% of the capital employed. Once you do that, you own the building, your investors have all their money back and you’re collecting cashflow forever. In a situation like that, why would you sell that? All of our capital is permanent capital. We don’t sell renovated buildings.

I’m excited about this model or learning a little more about it. You’re buying the buildings and they’re heavy renovations. I want to get into that a little bit. You’re increasing the value so much that you can return investor capital. You’re paying them off and they did with that deal and ready to invest in another deal with you or are they staying in the deal?

[bctt tweet=”You can get away with something once or twice, but when you’re busted, your relationship with that person is over. ” via=”no”]

They stay in the deal. They get their capital back but they retain an ownership stake in the building. The terms vary a little bit, but we use a relatively standard real estate private equity model where investors usually get a 6% pref. Once we return all their capital and the 6% pref we pay, they own 70% of the building and we own 30% of it.

You all have completed 80 properties in the past few years. That’s massive. Let’s back up a little bit to how you’ve done that. How have you successfully continued to keep doing that? Help us to get there?

The first thing to understand is Los Angeles real estate is extremely attractive, particularly multifamily. Particularly as you climb up the asset sizes, those buildings attract a lot of interest from players who have cheap capital, who have pension fund money or whatever. If you’re trying to generate supernormal returns, it made sense to us to focus on what I would call sub institutional scale deals. That’s in the range of $2 million, $2.5 million on the low-end up to around $10 million on the high-end. The nice thing is those deals are a little bit more complicated and capital intensive than what your standard dentist who wants to buy a building would do. They’re also way smaller than what an institutional real estate private equity fund would want to do. The result is you can generate super normal returns. The downside is it’s an inefficient way to place capital. You’re doing a $2.5 million deal here and a $5 million deal over there. It takes a long time to place material amounts of capital.

We wanted to be able to offer supernormal returns to our investors in order to justify the fee and ownership stake that we got. The question is, “How do you square that circle?” The answer is you figure out how to do a lot of projects at once. I have a partner, Jon Criss, who is licensed as a contractor. If there’s someone better at renovating small apartment buildings in Los Angeles, I’ve not met him. Jon is a wizard at running multiple construction projects at the same time. Because of that and because I love doing deals, we’ve evolved between the two of us and trained a bunch of employees who worked for us to be able to do a whole bunch of deals in parallel. We’re doing nine now. We’ve done as many as twenty at a time before. These are not like lipstick on a pig type deals. You don’t just paint them and change the carpet or whatever. We gut-renovate to the studs, its insulation, drywall, wiring and plumbing. You name it. It’s a thorough renovation.

Quickly go through that. You close on a deal. You’re gutting it down to the studs. On a per unit basis or the size of the property, how long does that take?

We always renovate the entire building. We don’t do unit by unit.

RES 274 | Standing Out In Business — Standing Out In Business: Renovating apartments is not just painting them and changing the carpet. It’s a thorough renovation.

Is every deal that way?

Yeah. That means negotiating with tenants often to vacate them from the building. Once the building is vacant, it generally takes us somewhere between nine and twelve months to go through the whole process. It’s longer if it’s a particularly large deal. Every once in a while, we get lucky on a smaller one. It takes six months or something like that. The whole process going from the day we buy it until the day that we refinance the building is on the order of eighteen months give or take.

It’s a major remodel. How did you grow teams to be able to do all this? Are you hiring out a lot of that work and managing other contractors or are you employing all of these people?

We don’t GC ourselves. In the beginning, I thought that we might. Jon got his license for that reason. It turns out that’s not a great model for us. We want to do a lot of projects at once and with the best in the world. No GC is going to oversee ten or twenty individual rehab projects. It’s not feasible. We are going to be forced to do some third party GC-ing anyway. GC-ing your own deals create some weird incentive misalignment. A contractor, almost by definition, is trying to do as little work as they can for whatever they’re getting paid.

The flip side is that the investors in a building want the most work that they can get after the month. We have found that it is better to set ourselves up as 100% pure advocates for the investors who are after all our partners and have true arms-length negotiations and relationships with the contractors. We have a guy who has been renovating buildings for us since 2009. To my knowledge, he has not worked for anyone else. He’s done 40 buildings or something. We have two other guys who have each done north of fifteen buildings for us. We have close contractor relationships. We can get into why that’s important. At the end of the day, it is an arms-length relationship. Our job on our side is to oversee the design. We do the materials purchasing. We hire the contractors and oversee them, but we are not ourselves the contractors.

It sounds like if somebody has done 40 remodels with you, even at fifteen, they’re a close part of your team.

[bctt tweet=”Once you realize that your relationship with investors is a permanent thing, it’s a different game. You’re playing a multi-iteration game. ” via=”no”]

They are. We do all kinds of things to try to help those guys out. We had one guy who had a worker accident on site. He had some workers comp issues. We cut them a check that had nothing to do with any contract we had or any deal that was going on at the time. He’s a guy who has done a lot of business with us. He’s an honorable guy. We cared about him and wanted him to stay in business and not go back to the country that he’s from. Jon and I wrote a big check out of our own pockets to make it okay for him. I’ve been to some of these guys’ family birthday parties and stuff. They don’t work for us. You could hear Jon screaming at them sometimes from the other side of the office. He’s super tough on them. At the end of the day, we depend on them to do good work quickly. Those are long-term relationships.

You and I were talking about that first deal to building that sustainable business. I appreciated some of the analogies you used as well. One of them was crawling through broken glass. I wanted you to share a little bit of that with the readers. It’s valuable because a lot of people see people in this business that seem very successful. It looks like it just happened in the last year. They think, “I’m going to go do that.” They don’t see all these hardships. Maybe you can elaborate on that first deal to building a great business as you have.

It is a hard slog. Probably twice a week, people come to me and ask me like, “I got my first deal,” or, “I’m about to do my first deal but I’ve run the numbers. My wife is telling me, “We’re going to make $40,000 in fees. We’ll sell this thing two years from now. I’m going to make another $70,000 but I’ve got two kids and a house payment, a rent or whatever. How do you do that? How do you build it into a full-time business?” For us, it was like scratching and climbing. I got my brokerage license. Before we started Adaptive, we had done some deals. We didn’t have any money when we started Adaptive. We had done some deals. I had my brokerage license. Jon had his contractor’s license. In addition to doing the small number of deals that we could do with the capital that we could raise in the beginning, I was brokering deals. I was representing buyers. I didn’t want to cold call and said I knew a lot about buying buildings. I ended up building a business representing buyers.

The problem was I would show these buyers a deal that was all beat up. I’d be like, “This is cheap on a per square foot basis per unit basis. You should buy this deal.” I don’t have the first idea of what I would do with that building if we bought it. It’s like, “Congratulations. You found me a cheap deal, but I don’t even know any contractors.” In the beginning, I would be like, “Here’s what we’ll do. I’ll bring Jon in and you pay him a consulting fee. He’ll oversee the renovations for you.” That worked. Jon and I decided like, “I’ll split my brokerage commission with you. You split your construction consulting fee with me.” What that evolved into was like a fee development business. There were all these deals that we could see that were good deals, but we didn’t have the capital to do them.

We found a bunch of clients who are willing to pay us $100,000, maybe $150,000 to do the whole process on these buildings and not have ownership. It was so awful. We’d renovated all these buildings for people, almost all of which we still manage. The buildings are great. The rents are way up. Our fee was effectively free by the time you take into account how much value we added to the project. What they were paying us was a rounding error. By stacking a bunch of those projects on top of each other, that allowed us to live while we were building up our capital base, the network of investors who would go on to capitalize our future deals.

You had a long-term in mind there. You’re building that investor base and putting in the time and making it happen.

That’s an important thing to understand about the business, at least with us. I don’t want to speak for other people. I am going to die behind a desk like this one if it’s not this one. I love this business. I will do this as long as I am able. Knowing that has been freeing in a way because what you should do is clear. You don’t cut corners. You put the investor’s interest before your own. I’ll give you an example. We bought a deal with this investor. We ended up getting an opportunity to buy the deal next door and the original deal. There were some reasons why it isn’t going to work out as well as we’d hoped. Luckily, the deal next door is going to be great. We’re going to offload the first one. It’s not a great result from our perspective. It happens infrequently, but bad luck happened on this one. Jon and I are going to eat the losses for that. The LLC is probably going to lose $50,000.

It’s not a huge deal in the grand scheme of things, that’s going to come out of Jon and my pocket. It’s not because the investor wouldn’t pay it or because it’s in the docs. It’s like, “This guy trusted us enough to buy the first deal. He trusted us enough to double down and buy the next deal. He’s in our funds. We want to have a lifelong relationship with this guy. We put him in a deal that didn’t work out great. We’re going to make it right for him.” Once you decide that you’re going to be doing it forever and that those investor relationships are going to be forever, it’s clear on how you should act. It’s the same with the city and tenants. You think about it like, “I’m going to be sitting here doing these deals with the same inspectors ten years and twenty years from now.” You can get away with something once or twice, but then you’re going to get busted. Your relationship with that person is over. You’re going to be seeing them again for the next three decades. We’ve always built the business from the perspective of like, “This is going to be a long-term thing.”

I’ll give you another example. We always wanted to be in a place where we didn’t have to do a deal and where we weren’t dependent on the fees from any particular deal so that if the market sucked, we could sit on our hands for a while. I knew that to do that, we were going to have to build a property management business because the property management fees are recurring smooth revenue stream that allows you to make payroll. We have ten employees now. In the beginning, when we were building the business, we kept the property management in-house, even though we only had 10, 20, 50 or 100 units. We would lose money on property management.

Every month, we would take those precious deal fees that were coming in from those deals where we didn’t even have ownership. We would use it to pay payroll for employees who are managing the buildings that we didn’t know. I was sitting there, Jon and I were broke and we were subsidizing property management for rich people, which did not feel great. Over time, as the size of the property management portfolio grew, both because we did a good job and the third parties referred to other people. They bought more buildings, etc. and because we were buying more and more of our own deals, the property management business became big enough to break even and be profitable. It was a long slog to get there. It’s one that we always knew we had to do. It’s paid off for us.

How did you stay motivated through the hard times? You referred to it as crawling through broken glass. How do you keep going when it’s that tough? A lot of the readers are even before that stage. They’re just seeing these other people with great success and are not anticipating in taking all that time or all those hours and that difficulty. How did you keep pushing?

I went to Princeton and London School of Economics. I got a ton of friends who were very successful out of the gate starting in their early twenties. We had done a few deals before Adaptive but we started Adaptive in 2012. I was already 32. I was pretty broke. My first kid was already born. It was terrible. It was not good. My best friends in the world were getting rich and I was broke. There’s this question of opportunity costs. People are like, “How did you stick by it? It was so hard.” It was 2012. What job was I going to get? There weren’t a ton of amazing jobs. I had washed out of investment banking and messed around with a tech start up. I didn’t want to work for anyone else. If I was willing to work for someone else, it would have been going and taking a job that I didn’t want, one that wouldn’t pay me as much.

[bctt tweet=”You got to do everything you can to deliver what you said you were going to do. ” via=”no”]

There wasn’t an option in my mind. It was like, “There’s a slog here. We’re just going to keep doing it.” We always had a long-term vision in mind, but it’s about doing the deal in front of you. Go sit there and look at every single deal that’s on the market until you find one that is good and then run like crazy with that one. As soon as that’s done, do that again and then do it again. Sit there and chop wood and don’t think too much. You’re making money in each deal. It’s going to take a long time to get it to promote. You’ve gotten some fees and you’re paying your bills. You keep doing it day after day. You’ll look up one day and it’s X number of years later. It’s like, “We have done a lot of buildings.”

I appreciate the mindset too that it wasn’t an option to quit. You mentioned, “It wasn’t an option. We had to keep going and doing the deal in front of you.” “Sit there and chop wood,” I like that analogy as well. Keep your head down and keep moving forward.

Jon is one of these people who needs action. He’s out at construction sites all day, arguing with people and driving around. I am fine to sit at my desk from whatever o’clock until whatever o’clock and look at every single deal. At this point, I can tell pretty quickly if we’re going to be willing to do something. There’s no substitute for that. Every once in a while, I don’t know when it’s going to happen but I know, because I’ve been doing it for a long time, that it will happen. You find stuff that’s mispriced. The more you do and the more confident you are in what the numbers look like, the quicker it jumps out at you that something is mispriced. You get where you start to see the matrix. You have to keep staring at deals after deals. Suddenly you’re like, “That’s a deal.” You run crazy to try to get it.

That also complements your team, your partnership and your different roles too. How do you all communicate within your team? How do you all keep all of this going? You’re focused over here and he’s focused on that. How do you all keep all the projects happening?

Our offices are next to each other. There’s a window separating them. We have it open most of the time. He’s not there all day. We have one big team meeting at 12:30 every Tuesday where the whole company gets together and talk through every single project that we have on. Jon and I probably have a morning catch up call. Probably once or twice a week, we have lunch together. We trust each other. Every once in awhile, there’s a decision that needs to get made. We’re each other’s best sounding board. I don’t need to hear the in’s and out’s of what’s going on with the contractors and stuff all day. That’s why I have a partner. I’m sure he feels the same way as me. We have to trust each other that we’re spending our time in a reasonable way. The results speak for themselves.

If you don’t have trust in one another, you shouldn’t be partners anyway.

Life is way too short to work with people you don’t trust.

In this business, this department, syndication raising capital and all these things that we have to do or know how to do and do well to be successful in this business, what’s been the hardest part for you?

In the beginning, it was the capital raising part. I used to have this mindset where I’d be like, “Our deals are so good. Why do I have to go and pitch people for capital? They should be banging down the door. The numbers are insane. Why aren’t they calling me?” I was resentful about that. That is a self-defeating and stupid way of looking at the world. I’m like, “I’m not a good capital raiser.” You’re in the most capital-intensive business in the world. You don’t get to be like, “I’m not a good capital raiser.” You need to figure out how to raise capital. That was a real process. I started writing a blog. I’ve been writing since 2011 or something. That brought capital partners in. I put my hand up and said, “I’m willing to speak at conferences.” I have participated in podcasts, followed up with people and ask for referrals. God knows how many meetings I’ve taken to try to raise money that didn’t work out.

If you know what you’re doing and you talk to enough people, not in a salesy obnoxious way but in a cut and dried, “Here’s what we do and we think you’re going to like it” way, you attract the investor base that you deserve. My approach is maybe a little bit more cerebral and a little less backslappy than most people. I don’t play golf. I’m not in a country club or whatever. What we have done is attracted an investor base that’s a bunch of partners at private equity funds and people who are themselves, particularly successful real estate investors. You get the investor base you deserve. That was a process of learning and growing.

If you’re too salesy, it pushes a lot of people away.

At every turn, you want to be like, “I’m okay with you not moving forward.” We’re talking about building for the long-term. When I was brokering, I would tell people not to do deals. Even when I was broke and I stood to get a $20,000 commission check, which I needed, if we found something in the diligence that would make me not want to buy the building, I made a point of telling my clients not to do it. I wouldn’t be like, “I’m on an apartment building X but I’m broke.” They didn’t know I was broke. You can’t be like, “I’m broke. I’m telling you not to do this deal.” It was painful inside, but you have to say, “What are people going to think of me?” I couldn’t imagine getting someone to buy a building that I knew had problems with it. They come back to me six months or a year later and say, “Why did you sell me that building?” Sales are very much about doing the opposite. It’s talking about the downside and making sure people understand what the risks are. Hopefully, the numbers are good enough that people, despite being fully informed of what the risks are, are willing to move forward.

[bctt tweet=”When you screw up, take responsibility for it to try to make it right. ” via=”no”]

It’s the relationships and having the long-term in mind. What’s a way that you all have improved your business that we could apply to ours?

Jon was the one who figured it out. We both want to punch ourselves in the face for not having done it until now. It’s a little esoteric. Anyone who does rehab deals is going to get it right away. We buy a building. We would negotiate with the tenants to move out however long later, a few months or whatever. Six months later, the tenants would move out. We would go in and start doing our design process. We’ll do the as-builts, get measurements of the building and start taking it through the city. That probably takes two, three months to permit it. It would sometimes be six months or even longer, from when we bought the building until we are ready to start our construction. At one point, Jon looks at me and he’s like, “Why don’t we just spend the $500 and have the drawings made while we’re doing our initial inspections?” You can run the city permitting process at the same time that you’re hoping to vacate the building, thereby saving yourself two, three months of screwing around with an empty building. It seems obvious in retrospect. We made that mistake over probably 70 buildings. I don’t know how much preferred return we ended up having to pay those investors for having each of those buildings sit there for two, three months and not earning any cashflow. It was super obvious and a small thing. Think about trying to organize your processes in parallel so you don’t waste time.

What’s your best advice for taking care of investors?

There’s a concept in game theory. It’s about the distinction between one-time games and multiple games. If you’re playing a game with someone once and it’s a win or lose, you do whatever you can to make sure you win and the other guy loses. Once you realize that your relationship with investors is a permanent thing, it’s a different game. You’re playing a multi-iteration game. In that game, it’s not trying to screw over the other guy so you win. It’s like, “How do we figure out how to make sure that we both win?” We’re going to keep doing this over and over. We could do better by collaborating. That’s what it comes down to. Think about those people who trust you with capital. Capital is precious in a world where income is a tax for your highest earners.

In California, high-earning people can pay north of 50% of their income to state and federal taxes. Think how hard it is to accumulate capital in that situation. That dentist who you’re talking to, who can write a $500,000 check or whatever for your deal, bled for that money. He had to earn a million. He had to have all of his other expenses taken care of. He had earned $1 million to pay $500,000 in taxes to have that $500,000 that he’s going to share with you. That capital is precious. Those relationships are precious. They’re not to be taken lightly. You’ve got to think of those investors and their capital as gold. You’ve got to do everything you can to deliver what you said you were going to do. When you screw up, you’ve got to take responsibility for it to try to make it right for them.

I appreciate you talking about how hard that person has worked for that money. That’s something we don’t think about sometimes or in the industry. That’s their hard-earned money and they’re trusting you with all that time they’ve spent and work to make that happen.

It’s later on in your career once you start to get a little bit more successful. You start to write those big checks to the IRS then you’re like, “Generating capital is hard. Maybe I ought to treat those people well.”

What’s been the number one thing that’s contributed to your success or something we haven’t talked about?

I have a network of friends and family of friends who I’ve met along the way in high school, college and a little bit after college. Those people were the ones, in the beginning, who were willing to back me to a greater or lesser extent when I didn’t have a track record. Many of them are still investors with us for the rest of time. Even when I have a $500,000 minimum fund, if one of those guys wants to write a $50,000 check, I’m taking it, even though $50,000 is not what I want to take. They trusted us from the beginning. We’re always going to take care of them. Most of our capital comes from people who write seven-figure checks. I’ll never forget those people. My friend, Courtney’s mom, wrote a $100,000 check to Adaptive Realty fund one when we didn’t have a track record. We didn’t know what we were doing. She wasn’t in Los Angeles. She didn’t have a view. I don’t think she read the documents. She knew me since I was fifteen years old. She knew that I was going to do everything possible not to screw up and lose her money. She trusted me. That goes for every one of those early investors. We’re smart. We try to be honest and do the right thing and everything, but it took a bunch of people in making a pretty big leap of faith with us in the beginning. We’ll never forget that.

How do you like to give back?

I raised a bunch of money for the wrestling program at the high school that I went to. Both Jon and I were wrestlers. A bunch of the money that helped us get started came from people who I met that way. That’s a financial thing that we did that I feel proud of. I’ve noticed among the youngest people who are in college or out of college that a lot of them are negative about capitalism in general. They’ve got a big student loan. They don’t feel like the world’s working for them. I get why they say that and everything, but when I look around at the real estate business and particularly in Los Angeles, it is bursting with opportunity. There are brokers making millions of dollars a year. You could start your own company. There’s a whole world of opportunity out there but these kids do not see it.

There’s a program called Beat the Streets, which is a program that provides wrestling coaching to disadvantaged middle school and high school kids. I know the guy who runs the program a little bit. I’ve had him refer kids to me who are pretty mature and self-started kids. I started to talk to them about what those opportunities are. What can you do? No one ever told them that when their apartment building or the one down the street gets sold, some broker made $50,000 for doing 60 days of work. No one ever told them that that world exists. What I’m trying to do is talk to them about that world and try to introduce whatever part of it they’re interested in, whether it’s property management, loans, brokerage or whatever. I’m trying to introduce them to people who are in the business, who can maybe give them a shot and take them under their wing. I’m trying to serve as a clearinghouse for the opportunity for kids like that.

Thank you for doing that, for sharing that and investing back into those kids. You’ve been an amazing guest. I appreciate your time in sharing your expertise, this business model that’s different than what we hear about most of the time and how you’ve been successful at it. Tell the readers how they can learn more about you and get in touch with you.

The easiest thing is to check out my blog. It’s KagansBlog.com. My contact information is on there. If any of your readers have sleeping problems, I can recommend going through a few hundred of my blog posts. It will knock them right out. It’s a journey. I’ve been writing it since I started Adaptive. You can see us learning and growing and all the numbers and pictures. It charts my education in the business as much as anything else. It’d be pretty interesting to some of your readers.

Thank you so much for sharing that. Thank you again for your time and being on the show. I appreciate the readers being with us every day. I hope you all will be with us in the next episode. I hope you’ll go to the Facebook group, The Real Estate Syndication Show. Go to Life Bridge Capital and connect with me. I’m happy to help you in any way I can. I hope you’ll connect with Moses as well. I look forward to speaking with you in the future. We’ll talk to you soon.