Scholastic Capital Update #3
Single Family Homes In Elite School Districts
Sean O'Dowd
October 06, 2023
Hi There,
Hope your October is off to a good start! With it being a new month, it’s time for a brief update from Scholastic Capital.
Today, we will cover:
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An Anecdote on Returns and Risk
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Re-Convene Reflections
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Fundraising Status
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Next Steps
Let’s get started.
An Anecdote on Returns and Risk
Under the 14-year leadership of David VanBenschoten, the General Mills Pension Fund never had a year where it performed better than the 27th percentile of the pension fund world or below the 47th percentile. (We were confused on this scale too….1st percentile is the best returns here.)
In other words, each year was slightly above average. Definitively second quartile.
However, over the 14 years, the General Mills pension fund returns were in the top 5 percentile overall!
Said differently: a consistent track record of slightly above-average returns on a yearly snapshot basis results in stellar returns in the aggregate.
We haven’t been able to stop thinking about David, because it ties in very well to how we think about risk/return at Scholastic.
“Swinging for the fences” may lead to exceptional returns. A fund manager could make a high-risk, high-reward bet that leads to a “home run” in one year.
However, the fund manager could just as quickly strike out the next year.
That’s the danger of swinging for the fences. Babe Ruth led the league in home runs in 1923.
He also led the league in strikeouts that year.
We have no interest in leading the league in either.
Instead, we want to hit singles or doubles consistently. We’re optimizing for stable, consistent returns over the long term.
Trying to do more than that can quickly lead to disaster. This leads us to the Reconvene Recap.
(If of interest, you can read the full write up that discusses General Mills here)
Reconvene Recap
We were at Re-Convene this past week, a real estate conference in Santa Monica. We met some existing investors in person for the first time, found new investors, and learned a lot.
On the whole, it was a fantastic use of time.
Nevertheless, the below tweet sums up the mood of at least some of the investors at the conference (albeit, the tweet is slightly sensationalized):
Why is there fear? Why are things “very bad?”
Let’s go back to the General Mills Pension fund.
It’s tempting to look at the General Mills story and say: “Protect your downside risk, optimize for the length of ownership, and the returns will be great! Obvious! We plan to do that.”
The hard part is re-commiting to that every single day.
General Mills had a 14-year timeline. You have to be OK with being second quartile for 5,110 days. (14 years x 365 days).
Contrast that with the type of people who become entrepreneurs and real estate sponsors. To a person, we’re competitive and believe we can build something beautiful. (If we didn’t believe that, we wouldn’t even get started as entrepreneurs!)
Naturally competitive sponsors could find it difficult to accept being the 27th-47th best investor in a room of 100 people every year.
Investors (LPs) may also find it challenging to see second-quartile returns every year.
So, sponsors and investors might take on a bit more risk to juice returns by a few percentage points.
It works.
So they take on a bit more risk for a bit more juice.
And then more. And more.
Before long, they’re taking risks they never planned to do.
It is extremely hard for a competitive person to actively decide to be “second quartile” 5,110 days in a row.
Based on Re-Convene, some sponsors and investors may run into this situation and have taken on too much risk to juice out better returns.
(To be clear: we are not being critical of that decision or them. Rather, we’re talking about how easy it is to slip into a risk-seeking, competitive approach!)
So, some may have taken too much risk. Who from Reconvene is doing extremely well in this market?
One of the most illuminating talks was from Matthew Gottesdiener, CEO of Northland. They own & operate a touch over $7B in real estate, typically Class A multifamily.
The firm has been around since the 1980s. They have weathered quite a few real estate market shocks.
In listening to Matthew's talk, it’s clear why: they are laser-focused on downside protection, even if it means forgoing the highest return in any given year.
For example, a popular real estate strategy is the “reposition.” That involves buying a distressed multi-family property, removing tenants, renovating, re-leasing at higher rents, and then selling the property as a stabilized asset.
From Matthew’s perspective, it’s better to buy an existing property that’s already great.
The significant increase in risk associated with repositioning is not worth the incremental improvement in return.
How can we apply this knowledge to Scholastic Capital?
First, we have to think long-term. We must measure ourselves based on what the scoreboard says at year 10, not at the end of each day.
By not measuring day-to-day swings, we can avoid the emotional urge to take risk for incremental return gain. We don’t want to have to actively decide each day to be OK with the second quartile returns.
Second, we’ll follow Matthew’s lead. We want to buy great assets, not “OK” assets we hope to make great.
We’re looking for investors excited about their monthly distributions but will “officially” check the scoreboard at year 10, too.
This is about building wealth for our investors and our kids, not chasing IRR.
Fundraising
Fundraising is a significant portion of our time right now! For that reason, we would be remiss not to provide an update.
Overall, things are still going better than forecasted. We have a significant amount of capital already signed on.
The most surprising element is the investor duality. Our investors are roughly 50-50 split into two cohorts.
Half are excited about the monthly distributions we plan but are also very excited about a sale of the portfolio in ~10 years to a larger institution.
(Simply put: Lots of smaller monthly checks and then a very large check in 10 years. This is what we assumed most investors would want.)
What surprised us was the other half of the investors. These investors do not want us to sell the portfolio in ~10 years. Instead, they want to receive a monthly check forever. Their goal is for that monthly check to get progressively larger as the rent increases and, eventually, the mortgage decreases.
The good news is that Scholastic Capital gives investors the choice of whether to exit the fund or stay committed for the long haul. It’s up to you. We’re planning to buy attractive assets with long-term staying power.
Finally, we’re in talks with a few parties that are interested in being our “anchor” investor – a limited partner that writes a large (several million dollar) check in exchange for preferential terms. If this is interesting to you, we’re open to having a discussion.
Next Steps
For next steps, we will continue to be largely focused on the fundraising process.
We’re in close communication with other funds that are currently raising. Most of those funds target 12-18 months to complete their raise.
With our timeline being dictated by the school year, we have closer to six months to raise our full $10M.
With that in mind, we need to keep up the momentum!
We’re a touch over a month into our raise, and we are on pace to reach $10M in less than six months.
As a reminder, the 80/20 profit split is available to LPs that are in the first $5M to commit. After that, it’s a 75/25 split (unless you commit at least $500k, in which case you can still get 80/20).
If you, or someone you know, might be interested in single-family homes in elite school districts + long term leases, we’d always be happy to chat!
Feel free to grab time HERE or reply back to this email with any questions!