Scholastic Capital Update #6: How We Identify School Districts

Hi There,

The extreme weather of the past week has been an interesting time to own a portfolio of single family homes.

On the plus side, the snowstorm here in Chicago has made for plenty of fun for our kids outside. Sean’s daughter made her first snowman!

On the negative, extreme weather can also result in significant property damage & lots of work for our maintenance teams.

Despite it snowing it 100% of the zip codes we buy property in, we haven’t heard from a single tenant.

Sean made that comment to a friend earlier in the week, who responded that our snow datapoint reveals where we buy homes!

So, we’re going to focus today’s update on that very foundational point to Scholastic: how we identify zip codes to buy homes in.

As always with our bi-weekly update, we’ll share a market update, fundraising update, and next steps.  

How we Identified Our Target States

When looking for new homes to add to the portfolio, we need to narrow it down. So the first step in our process was to eliminate states where we wouldn’t buy real estate.

There’s a concept in consulting called “begin with the end in mind” where you work backwards from the ideal outcome to reverse engineer it. 

In Scholastic’s case, one outcome could be a sale of the entire portfolio to a larger institution. Think American Homes 4 Rent, Tricon, etc.

We got on the phone with these institutions and asked them where in the country they would be most excited to buy a portfolio of high quality single family homes in elite school districts.

The unanimous answer here was Upper Midwest: Wisconsin, Illinois, Indiana, Michigan, Minnesota.

These locations were appealing for two reasons:

• The Institutions have enough exposure to the sunbelt & need exposure in the Midwest

• Rising insurance prices make the midwestern homes more profitable than sunbelt homes

While the “green” states were unanimously interesting to the institutions, some institutions also mentioned other areas. These are the yellow areas.

These locations share some, but not all, of the exposure & insurance advantages of the upper midwest.

How we Identified Our Target Zip Codes

There are 5,456 zip codes across the five states we target. We needed to get that list down.

To do that, we wanted to find a significant imbalance between demand & supply.

At its core, Scholastic’s entire thesis is a supply/demand imbalance in specific zip codes. 

Specifically, we need a massive amount of demand and very little rental supply. The resulting outcome is a significant rental premium that drives returns for our investors.

Demand

Our primary demand driver is the fantastic school system. We used both a qualitative & quantitative approach to identify massive demand. 

Quantitative Data

We found datasets that rank school districts. Some were well known, such as the Great Schools ranking.

Some are less known. For example, a dataset that shows what percentage of high school graduates go on to Harvard, MIT, or Stanford.

Others were self-created. Most high schools publish a list of colleges their graduates go to each year. With some research, you can calculate the percentage of graduates that go to an “elite” college.

Qualitative Perception

The perception of the school district is arguably more important than the data.

It’s not enough for the school’s data to say it is elite. We need local people to perceive it as elite as well. Otherwise, there will not be tenant demand to pay a premium to live in this school district.

To check perception, we:

• Spent a significant amount of time “on the ground” talking with locals

• Called real estate agents in the area

• Read every Reddit Forum, Blog Post, Google Review, Niche Post, etc. on the area

• Talked to parents in the area: parks, coffee shops, train stations, etc.

A poor perception eliminated many schools. One example is Evanston, Illinois. This is a nice suburb north of Chicago that is home to Northwestern University.

Evanston’s school system is quantitatively highly rated and sends a significant number of students to Northwestern.

However, the school is not perceived to be elite. We could not find any evidence that people would move solely to be within that school district.

For that reason, Evanston and many other similar zip codes were crossed off the list.

Durability

School districts are living organisms. They can improve, or decline, at any given point. To protect our source of demand, we want to minimize the chances a school could decline in quality. 

One way to do this is to find “durable” school districts that have been outstanding for 50+ years.

A great counter- example here is Maine South High School, also in Illinois. While always a “good” school, it very recently became “elite” and is now a newcomer on lists for “the top 10 high schools in Illinois.”

We anticipate holding this portfolio for at least 10 years. There’s a world where investors vote to hold this for much longer.

We cannot say in full confidence Maine South will still be viewed as “elite” in 10 years. A quick improvement in its rankings could also lead to a quick fall. 

For that reason, we had to cross Maine South, and similar schools, off the list. 

After analyzing these three factors of demand (quantitative data, qualitative perception, and durability), we eliminated 90% of the 5,456 zip codes in our target states, leaving us with

Supply

Now, let’s talk about the specific supply conditions we’re looking for.

Those conditions are simple:

• An area with very few rentals available

• No possibility of new rentals added in bulk.

How to find an area with very few rentals available

The first step here is to check IRS data.

The IRS has a surprisingly robust online portal with a significant amount of data attached to it.

We downloaded data on every remaining zip code.

Then, we compared the total number of tax returns filed per zip code to the number of them with the home-owners exemption.

We looked for a 90%+ home-owners exemption file rate. That meant almost everyone who lived in that town owned their home & lived in it themselves.

(For reference: the national average is about 65%.)

Said differently: the 90% home-owners exemption rate means there are no available rentals because people live in their own homes.

This datapoint confirms our first condition. Zillow rental listings are sometimes arbitrary, but a tax return is definite! 

How to ensure no possibility of new rentals added in bulk

The following would be a bad outcome for Scholastic:

• We buy 5-10 homes in a specific zip code

• Those homes rent for a premium due to the high rental demand and historically low rental supply

• A developer notices this trend 

• The developer buys a large tract of land & builds a BFR (build for rent) community of 50+ homes

• The zip code’s rental price plummets as an overabundance of supply pushes prices down

To defend against this outcome, we selected zip codes that did not have any buildable single family lots left in town. 

There are two ways to do this:

• Visual checks on drives through the town and/or Google Earth, cross referenced with property records

• Pull the addresses of all approved single family build permits for the last few years. 

The implications from these checks are:

• If you cannot identify any clear vacant lots, then the town might be out of land.

• If the build permits were for lots where the prior home was knocked down, then the net housing stock was flat

What about a zoning change?

One possible pushback here could be that a developer might buy a parking lot or strip center to redevelop into housing units. 

There are no guarantees, but residents in these zip codes are typically “the Final Boss of NIMBY.” They tend to be motivated to prevent new development and have the financial resources to make development unlikely.

We’ve found it worth the time to research the last few times a developer tried to get high-density housing developed in each town. 

We wanted to see strong opposition that successfully prevented past development. 

This allows us to feel comfortable that the zip has reached the maximum number of housing units it will ever have. 

“Red Flag” Overlay

Solving for supply & demand brought us from 5,456 zip codes across the Upper Midwest to approximately 50. 

We further refined the list down to 37 by looking for any of the red flags below.

• Household median income unable to support appropriate rental prices

• History of redistricting the school system

• Crime, especially violent crime 

• Presence of sexual predators 

• High flood area making insurance prohibitive

• Negative corporate signals (e.g: major chain like Starbucks closing locations in town)

• Lack of access to healthcare (far from major hospital)

Redistricting in particular was important. We did not want to see the town had redistricted previously since that could indicate a willingness to redistrict again in the future. 

The Outcome

After a year of work, we landed on the 37 specific zipcodes we are currently monitoring.

We likely won’t buy in all of these over 2024. We want at least 3 homes per zip we buy in. So, we expect to buy homes in approximately 15 of them.

However, we’re now collecting detailed data on every house & rental that hits the market in these zip codes. 

This added data will make us better at identifying the right homes. For example:

• We can better understand which homes will sell faster vs slower, and at what price

• We can better understand which rental homes rent faster vs slower, and why

When combined, we can:

• Bid on a home that we know will rent quickly at a great price

• At a purchase price that is profitable once rented

• While moving faster than other buyers (e.g: if we know a house will sell in 2 weeks, we’ll buy it faster)

The detail on how we identify homes will be the focus of our next update. 

Market Update

As of January 9th, we currently have:

• 1,955 homes on the market across our 37 target zip codes in Minnesota, Wisconsin, Illinois, Indiana & Michigan (up 7.4% from last update)

• Of those, 303 homes fit our binary buy box parameters. We call this check #1 (up 22% from last update)

• Of those, 153 homes passed manual underwriting and are at a quality level we would offer if the price is right. That’s check #2 (up 37% from last update)

• Of those, 49 homes passed financial underwriting and are at a price point where we believe we could profitably buy and rent these homes. That’s check #3. (up 75% from last update)

(For reference: our last update was December 12th.)

What is the implication for Scholastic?

We could be in a fortunate position this summer:

• Inventory is growing faster than expected

• Inventory is growing fastest at the “bottom of the funnel”, the 49 homes we could profitable buy

The implication is:

• We could have more profitable homes to choose from

• We could purchase homes at lower prices

Fundraising Update

We have closed on our first batch of investor capital. This means both investors and Scholastic have countersigned the documents and they are officially in the fund.

This is a big milestone in our history and we are excited to welcome 19 incredible investors into Scholastic.

Since that time, we’ve had an additional three investors verbally commit to join Scholastic.

We are still fundraising and are looking for an additional 15-25 investors interested in joining the Scholastic family.

If you’re interested in learning more & getting to know each other, feel free to grab time HERE or reply back to this email.

If you were forwarded this note and would like to join our email list for future updates, feel free to sign up HERE

Media Coverage

Much to our surprise, we’ve found that the Scholastic story is extremely interesting to the media. 

We had a second news outlet cover us, with this story coming from New York Magazine & Curbed.

The article, linked HERE, does a fantastic job of describing Scholastic.

One line in particular worth highlighting is:

"It’s a weird corner of the market where investor-owned single-family homes might create more affordable housing options in upscale towns, opening up elite school districts to the merely upper-middle class"

Some of our existing investors have made this point themselves: they see Scholastic as a way to invest their capital while also helping families access great schools.

It’s exciting to see NY Mag interpreted the Scholastic story the same way.

Next Steps

Our next steps are focused on finalizing key parts of our process.

That includes finalizing

• The raise

• Our operational onboarding

• Our debt partners (we’ve had a few approach us with some extremely interesting terms!)

All the best,

Sean & Michael