Scholastic Capital Update #8: Property Management

There’s a critical component in rockets called the attitude control thrusters. (We thought it was a typo too. Turns out they are "attitude" and not "altitude.")

Several aerospace and defense suppliers make them. Most suppliers sell a unit for $120,000 each.

One renegade company thought this price tag was ridiculous. As a result, they decided to build the thrusters in-house. So, their engineers figured out a design and began mass production.

The total cost: $3,500 per unit, or about 97% cheaper than the initial quote.

As you can likely guess, we're talking about SpaceX. This story is from the original Musk biography from Ashlee Vance.

This story also helps describe why Scholastic Capital does in-house property management.

Today's post will dive into more detail around why and how we keep property management within the family.

We’ll also share what we’re thinking about today, which includes an update on a vendor we might work with

Why we do property management in house

At the core of every vendor decision is a simple trade off:

• what you pay

• what you get

Let's talk about both of these in the context of property management for Scholastic.

What you pay

A standard property management contract for a single-family home has two components:

1. A leasing fee, typically 100% of the first month’s rent

2. A monthly management fee, typically 6-10% of rental income

Our target average rent is a little under $4,000 a month. Under this structure, Scholastic would pay in PM fees:

• $4,000 the first month

• $300 for the 12 months of management, or $3,600 total (assuming a 7.5% management fee)

All in, we would pay an average of roughly $7,600 per house in property management fees for the first year of renting the home, or about 16% of total yearly revenue.

(For subsequent years, fees would be roughly $3,600 per house, or 7.5% of total yearly revenue. Because we rent houses on three-year leases, the average weighted expenses over the lease would be $14,500, or roughly 11% of forecasted revenue.)

What you get

In some real estate asset classes, 16% of total revenue may be appropriate.

For example, some funds specialize in college student housing.

It's not uncommon for the cops to show up weekly due to out-of-control parties. Maintenance staff is on speed dial to fix party damage at the house.

In that case, 16% of revenue may be fair due to the time commitment necessary to run the homes.

For Scholastic, the time commitment is minimal.

Leasing a home can take less than an hour or two of work due to the significant tenant demand for these homes.

On the maintenance side, our data shows ~4.2 maintenance calls per property per year. Each call should take 1-2 hours of work for the property management company.

Total, that's 6-10 hours worth of work per year.

Evictions & Turns

Most property management companies also handle evictions and unit turns between tenants.

In our case, however, our needs are projected to be lower than most real estate owners.

On the eviction side, we screen our tenants extremely carefully using a software called Boom.

In addition to the standard credit check, Boom integrates with payroll processors to verify employment & connects to the tenant bank account to verify rolling bank balance average.

For unit turns, we typically sign 3+ year leases. When compared to the standard one-year lease, a smaller percentage of our portfolio is up for renewal in any given year.

That means we will likely have fewer turns at any given point in time, which simplifies the management burden.

The result for Scholastic

The trade off between what you get vs what you pay on property management is:

$7,600 in year 1 for 6-10 hours of PM work. Or, roughly $1,000 an hour.

With that in mind, we made the decision to build an affiliated, in-house property management firm.

We couldn’t reasonably say to our LPs that we were fiduciaries of their capital while spending 11% of the three year lease revenue on a task we believe we could do cheaper.

Let’s now talk about our property management process, with particular emphasis on the maintenance side of the equation.

How do we do property management?

This is the most important question to ask about Scholastic Capital.

The purchase of each individual home is expected to take 15-30 days.

We plan to own and manage the homes for 10+ years. Property management is what we will spend the vast majority of our time doing.

The way we think about this is a “hub and spoke” model, where our central office is the “hub” and our homes are the “spokes.”

Hub (Central Office)

Our job within the hub is to make things as simple as possible for the spokes.

The best way to do this is with data and software. Data is the lifeblood of our maintenance operation.

The single most important thing we do during pre-purchase inspection is to collect the make/model/year/serial number for every single major component in the house.

Think: fridge, HVAC, furnace, water heater, etc.

This information will now touch every single part of the operation.

Here’s an example.

Let’s say a maintenance request comes in for 123 Main Street. We’ll check our data and see it’s a Rheem Ruud AP 11828 water heater that is 6 years old.

Budget

We plan to adjust our maintenance spend forecast based on how many years the equipment has left. Older equipment needs a higher budget since it will be replaced sooner.

This water heater is still relatively young. We have some budget available, but we don’t expect a full replacement in the immediate future.

Recalls

Our process involves routine checks for open recalls on all equipment; if we find any, we get it fixed or replaced for free.

For a maintenance request, we’ll check again. In this example with the water heater, there are no recalls.

Warranty

Next, we’ll check the warranty on this particular Rheem water heater. If it’s under warranty, we’ll want the work performed under warranty so the manufacturer covers the cost.

Dispatch

After completing all of the above steps, we’ll dispatch our local vendor to handle the actual maintenance. This step, and all of the preceding ones, were entirely managed by software.

Spokes (Homes)

The Hub’s goal is to make the spoke’s life as simple as possible.

In this case, we have a preferred vendor in each location who is already familiar with the Scholastic process.

In most cases, the only information a vendor has for a service call is the address of the call itself.

In our case, the vendor gets a nice report that says:

• You’re going to 123 Main Street

• It’s a Rheem Ruud AP11828

• It’s only 6 years old, so we expect a repair instead of a replacement

• Make sure to bring the parts for this specific Rheem model

• This is not under warranty or recall 

We want to be the easiest calls the vendor ever gets. They can instead focus on getting the job done instead of driving to Home Depot to pick up the specific parts.

Payment Terms

A vendor who gets paid immediately is a vendor who quickly returns your next phone call.

For that reason, we use a payment solution that pays vendors immediately upon work completion. It’s the right thing to do, both from a human perspective & a relationship standpoint moving forward.

But what about other aspects of property management?

There are other important elements, such as leasing, turns, eviction, and preventative maintenance.

 We focused on one specific maintenance example here. However, this example should hopefully illustrate how we’ve designed the property management system.

The goal is to enable our team to do their specific jobs to the best of their ability without paying an external company $1,000/hour.

What we are thinking about

One interesting byproduct of our recent news coverage (both TV and print media) is we’ve heard from a variety of vendors interested in working with us.

One vendor has piqued our interest. They are another real estate fund that developed proprietary tools they offered to license them to us.

They would enable Scholastic to absorb already-rented homes that pass our strict investment criteria.

Here’s an example:

• Bob & Ann landlord own a $500,000 paid off home in one of our target zip codes

• This home has an in-place tenant and both the home & tenant pass Scholastic’s underwriting and inspection criteria

• Bob & Ann are tired from managing a rental, but don’t want to sell (capital gains taxes, plus they like the recurring income).

• They contribute their home over to Scholastic in exchange for LP units in the Fund, from which they’ll continue to receive cash flow distributions

Why are we interested in this strategy

For Scholastic, there are three main reasons we are interested in this:

First, the contributed homes may be entirely debt free. Adding them to Scholastic could lower our fund LTV, increasing overall safety within the fund. If we refinance some of these homes, we would expect to limit leverage on these homes to a maximum of ~50% LTV.

Second, we buy up our competition. We are explicitly looking for areas with very few rentals. If we buy out the few existing mom & pop landlords, Scholastic can increase market share in the area. That may provide significant pricing power in the market.

Third, and most important: this will dramatically expand our buying window.

Right now, we only buy homes from May-July. That enables us to lease the homes during the summer when most tenants are moving.

Since these homes already have tenants in place, we aren’t restricted to just summer months for acquisitions. That would simplify our operations.

Fundraising Implications

Our target raise for 2024 is $10 million. Thus far, our operating assumption has been to raise $10M solely from “cash” investors.

If we instead go down this path, we could instead allocate the $10M between “cash” investors and “contribution” investors, with a skew towards “cash” investors.

This is still a work in progress, but is an interesting concept. We’re dedicating a significant amount of time here.

Next Steps

We continue to monitor the market very closely as we approach the spring buying season. We have 58 homes on the market right now that we believe we could profitably buy and rent.

This number should climb over the next 45 days to approximately 80 homes.

In the interim, please feel free to reply to this email with any questions. Those replies come directly to us.

Alternatively, if you are interested in joining Scholastic as an investor, please feel free to book time HERE to speak with Sean