Scholastic Capital Update #1

Hi there,

Sean here! This our first email update from Scholastic Capital!

We anticipate sending email updates every 60-90 days for the next 10+ years as the fund grows and matures.

These email updates will contain information about the homes, their performance, and our perspective on the market. We’ll also provide information for anyone looking to potentially invest in Scholastic Capital.

Today, we have an update on:

• What we're working on

• Key decisions we're thinking about

• Next steps for the fund!

What we’ve been working on

We’ve been working non-stop since beginning the newsletter. For that reason, we have quite a bit to update you on!

Here are some of the key things we’ve done:

Begin with the End in Mind

We anticipate owning 100+ homes through the life of the fund. One of our potential exit opportunities is a sale to a large asset manager that buys properties at scale.

With that in mind, we spoke with larger funds and asset managers. Our goal was to understand what their ideal package of homes would look like.

Armed with this knowledge, we can buy homes in elite school districts that a fund would find appealing.

Many large funds have told us their ideal package of homes in elite school districts is in the Upper Midwest.

Why? Insurance.

The funds have experienced significant increase in premiums this year across most of the country. Their insurance partners have indicated their insurance expense will continue to increase for the next decade.

The Upper Midwest (Minnesota, Wisconsin, Illinois, Indiana, and Michigan) are cold in the winter, but have less exposure to natural disasters like hurricanes, rising sea levels, earthquakes, forest fires, and flooding.

The funds we’ve met expect long term insurance prices to be lowest here.

As an example: here’s FEMAs map of all-in natural disaster risk:

For that reason, we now plan to focus on elite school districts in the Upper Midwest.

Status: Complete. We have decided to focus on the upper Midwest.

Zip Code Selection

The thesis is simple: investing in single family homes in elite, 10/10 high school districts.

There are ~500 of those in the country. We need to narrow it down, which we've done by looking at data points:

· Homes in the Upper Midwest (see, begin with the end in mind)

· The percentage of homes that are owner-occupied

· The median income (which informs what rent the median resident could afford)

· And 15 other datapoints that are similar!

Status: Completed. We've zeroed in on a target list of zip codes that fit exactly what we’re looking for. We’re now studying these zip codes in detail.

Here is our final list!

Rental Data Tracking:

Our target zip codes have limited rental home inventory. Most homes are owner-occupied due to the desirability of the school district.

Because of low rental stock, standard rental tools like Rentometer and Rentcast are unreliable. There is not enough data for them to accurately generate a rental forecast.

Instead, we are building a proprietary dataset of single-family homes in our target zip codes.

One data source includes Zillow Data.

Zillow shows you how many "contacts" a home has (e.g., this home is asking $3,500/month in rent, has been listed 6 days, and had 5 people reach out via Zillow to ask about renting it).

This is a velocity of 0.83 contacts per day. That is low rental activity.

Even worse, no one has applied to rent this home.

It tells me something about this home not being desirable at this price. I now need to figure out what the driver of low rental interest is. That will become an important data point.

Meanwhile, this home is just a few minutes away and is listed for $3,300.

This home has a much lower velocity of contacts but significant conversion (5 out of the 7 people who reach out about the home end up applying).

Again, there’s a data point here.

We’re utilizing these datapoints to help build a dataset to enable us to forecast optimal rents better.

Status: In progress

Vendor Selection

The fund will need, at a minimum:

• Fund administrator/accountant: Ensure the books are clean and investors are paid every dollar they deserve.

• Fund CPA: Prepare tax returns and K-1s each year.

• Fund Lawyer: Draft the fund documents.

• Insurance Expert: Ensure sufficient insurance coverage for all homes

• Fund Lender: Provide the fund attractive borrowing terms

We're stewarding other people's capital. We will only work with quality service providers we can trust (after speaking to references).

We spent a significant amount of time interviewing vendors. We have selected all our vendors and are confident they are the best in the business.

Status: Complete. We have all of our partners in place

 Legal Work

The fund will have a stack of carefully-drafted legal documentation that will take time to create. Our fund lawyer is working on this now.

 Status: Just about done. We anticipate these documents completed in less than 10 days. At that point, we can then sign on investors

Fund Model

We built a model to forecast investor returns.

Inputs for the model include data from all of the vendors. For example, our insurance broker shared insight into current pricing. Our lender shared insight on loan origination cost at scale.

These inputs allow our model to be more accurate. We can then be more accurate to investors when we share projected returns.

We have now finished the model. It currently forecasts investor returns as an 11.3% IRR over a 12-year hold period.

We also built a sensitivity analysis to demonstrate how returns might change based on different rental growth rates, appreciation, and interest rates.

Status: Complete

Fund Deck

Potential investors will want to see more information about the fund before investing.

To that end, we’ve spent a significant amount of time building a fund deck to share with investors.

We would love your feedback on the deck! You can click HERE to see it. Please reply directly to this email with any feedback.

Status: Soliciting Feedback

Advisor Selection

A fund is a significant undertaking, and we have built a fantastic list of advisors to assist us!

One of whom, Sean Sweeney, has publicly talked about how he’s joined the team!

The remaining advisors are all wildly credentialled and experienced in the single-family home space and will be huge assets to the fund. All three of whom are featured within our fund deck!

Status: Complete

The big decision: use of leverage

The ideal investment generates infinite return with no risk. In reality, that doesn’t exist. Risk and return are tradeoffs.  

We can increase the return to investors by buying property at a lower down payment. That means we’ll be borrowing more money, which increases risk.

Alternatively, we could minimize the risk by buying property all cash. In that situation, the return for investors is much lower.

Our job at the fund is the find the perfect intersection of maximum return at minimum risk.

At this time, we plan to generate an 11.3% IRR by:

• Buying 2/3 of the homes at 25% down, 75% LTV

• Buying 1/3 of the homes all cash

• Keep 15% of the purchase price in reserve to cover any market volatility

That should lead to:

• Aggregate down payment on the portfolio of 35%

• Aggregate reserve fund of 15%

At this time, we believe this is the right balance of risk/reward.

However, this is subject to change based on interest rates and market conditions. A material change in interest rates can change the math on how best to balance risk vs reward optimally.

Therefore, this decision will not be solved until we begin purchases.

Our base case involves beginning the bulk of our first tranche of purchasing in Spring 2024. However, we’re obsessively monitoring market conditions and may begin buying properties earlier. 

Next Steps for the Fund

There are several items we need to work on next.

Finalize Fund Documentation

Our fund documentation is just about ready. The last document we need is the “sub-docs”, which will enable us to sign on investors officially. We expect those to be ready next week!

Raise Capital

As we’ve finalized our offering, we’ll now officially reach out to investors to raise money.

Fortunately, we’re a bit ahead of schedule! Based on initial feedback, investors are excited about our thesis. Investing in homes within great school districts seems logical to many investors.

We now have $1.4M in verbal commitments over our first batch of meetings, and we plan to keep taking meetings until we reach $10M.

If you would be interested in speaking about the fund, please click HERE.

Build Operations

Managing a portfolio of single-family homes is largely an operations problem.

Fortunately, Sean has spent his career optimizing operations for private equity backed portfolio companies. He will spend a significant amount of time over the next year building out our operational playbook to ensure the assets are well-managed.

Here’s an example: filters within a furnace should be changed every 90 days. That will extend the life of the furnace.

We also believe the portfolio will be sold a higher price if we can document that a filter change was completed every 90 days for life of ownership. It will imply the furnace is in better condition and lower capital expense is required for the portfolio.

The operational requirements here are significant:

• We need to know the make, model, and serial number of every furnace in the portfolio

• We need to know the right filter model to fit with each furnace

• We need to ensure those filters are sent to tenants on a quarterly basis

• We need to ensure the tenants know how to change those filters

• We need to ensure the tenants provide documentation (e.g, a photo) that shows the filter has been changed

This one process is an example of the items we are thinking through to ensure successful long-term management of the portfolio.

What questions can we answer?

We are happy to answer any questions you might have. Please feel free to reply to this note and it will come directly to us.