Scholastic Capital Update #9: Monthly Distributions

There’s a self-deprecating joke that entrepreneurs love to tell.

It goes something like this:

“I’m the owner of a business that employs 100 employees. All 100 employees have an easier time getting a mortgage than me.”

At face value, it looks like a backhanded way for the CEO to complement themselves. My college-aged brother in law would call this a "humble brag."

Yet, the entrepreneur is right. When I (Sean) took out a mortgage for my primary residence in 2019, the bank made the process a nightmare. The worst part: the total mortgage balance was less than our yearly household income!

On the other hand, the employees can readily get a mortgage because they haveW2 paychecks.

The question to ask is: why does this phenomenon exist?

The simplistic answer is that banks place significant monetary value on the reliability of a monthly paycheck. 

A $100K/year W2 employee getting a mortgage over a $300K/year business owner means the bank puts at least a $200K premium on the stability of the monthly paycheck.

At Scholastic, we spend a lot of time talking with bankers. (Fortunately, since we use commercial loans, we exempt from this mess).

But, once we realized this phenomenon exists for business owners buying personal residences, it led to another question: 

Since monthly direct deposits are clearly preferred, why don’t we do the same and pay our investors monthly?

That’s the focus of today’s newsletter. 

We’ll talk in more detail about how and why Scholastic Capital is designed to pay our investors a monthly check. There will also be a market and fundraising update

How many funds handle distributions

To begin, let’s briefly explain how most private funds handle distributions. 

Many funds pay their investors each quarter. 

There are several platforms (Appfolio, Juniper Square, InvestNext) that allow funds to securely direct deposit investment profits to their investor’s bank account. 

A fund admin team, which is a specialized accounting firm, will “do the math” on exactly how much each investor receives each quarter.

To be clear, we are not being critical of funds that pay quarterly. It is not a “bad” thing that many funds do this. 99.9% of investors won’t bat an eye at quarterly distributions

Scholastic is just a little unique.

Why Scholastic is different/why we can do monthly

At face value, Scholastic’s process is similar. We use Appfolio and work with a fantastic fund administrator named Fleming Fund Services.

The difference is we plan to pay distributions out each month to provide both monetary value and perceived monetary value that comes from the stability of distributions.

The reason why we can do this is our lease structure & renovation needs. 

First, our standard lease is 3 years long with annual rent escalators. That gives us more security in our cash flow planning than funds that deal with the traditional one year lease. 

Second, we don’t do major rehab work when we purchase homes. 

A home undergoing a rehab is not leased, and therefore not generating revenue. In that case, the fund has no rental proceeds that are able to be distributed until the rehab is finished and home rented.

Since homes like ours often rent ASAP after purchase, we expect to see rental income start immediately and have security that it will continue for the next 3 years.

How our monthly distributions work

We think of our distributions from a timeline perspective.

• Investors join Scholastic during Q1/Q2 2024

• Late April/early May, investors wire their investment to the fund

• We’ll use that investment capital to buy homes in May/June/July

• Upon purchasing homes, we’ll immediately list them for lease

• Once all our homes are leased up by the fall, we’ll start sending out our monthly distributions to our investors

The goal is for these monthly distributions to be at least 8% annually

An 8% annual return for a $250,000 investor would be $20,000. That’s $5,000 per quarter or $1,666 per month.

Our hope is by sending distributions each month, investors will view Scholastic as a “stable paycheck”, similar to how banks view W2 employees.  

How monthly distributions impacts our investor base

One thing we underestimated was how the monthly distribution would impact our investor base.

While LPs have joined Scholastic for a wide variety of reasons, the most common reason has been the monthly distributions.

We’ve been repeatedly described as a “high floor” or “tax sheltered dividend” investment. That framing appeals to some investors more than others. 

This is similar to stock market investor archetypes. Some investors are “growth” investors who prefer high upside stocks. Others are “cashflow” investors who prefer high dividend stocks.

The monthly distribution structure has naturally attracted the “cashflow” investors to Scholastic. 

How monthly distributions impacts a sale of the portfolio

Since Scholastic investors are, typically, attracted to the monthly distributions, they are hesitant to give them up.

That impacts our potential exit via a sale of the portfolio. 

Our best understanding is that Scholastic investors would be in support of a sale if there is a clear “overpay” number offered. 

If an offer presents that is not an overpay, our understanding is investors would prefer Scholastic to not sell the portfolio. 

We agree with this philosophy. Since we also have long term debt on the homes, we have the ability to be patient & collect monthly distributions until the right price presents itself. 

Market Update

As of 1:22pm on Feb 21th, we currently have:

• 1,969 homes on the market across our target zip codes in Minnesota, Wisconsin, Illinois, Indiana & Michigan 

• Of those, 538 homes fit our binary buy box parameters. We call this check #1 

• Of those, 148 homes passed manual underwriting and are at a quality level we would offer if the price is right. That’s check #2 

• Of those, 45 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. 

Importantly, the 45 homes are really good homes in great school districts. 

As a result, there is a lot of interest in them. It’s not uncommon for a home to go pending in 1-3 days. 

They’ll then be replaced by new inventory hitting the market during the summer rush. There is a significant amount of turnover in this inventory! 

Timing update

Based on current market conditions, we expect our initial capital call to be late April/early May.

We are in close communication with investors (they receive separate communication) about this. As we get more data on how the market develops, we’ll continue to follow up here with you too.  

Fundraising Update

Fundraising has taken an interesting turn. 

We’ve had three major real estate funds (one $10B AUM, one $50B AUM, and one $80B AUM) reach out to us.

We are in various stages of conversation with them about joining us as an LP.

Their process is very different from our existing investors. With our standard investor, typically a family, we usually need to meet with both spouses and have both spouses sign off on the investment.

With these larger funds, there are multiple rounds of approvals across different people in their organization.

Some people want to attach “strings” to the investment as well, while others do not. Almost everyone defines “strings” differently as well! Depending on what they are, these “strings” may make or break the investment.

We’ll continue discussing with these larger institutions and with new prospective investors who fit our historical buy-box. 

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

Alternatively, feel free to reply to this email. It will come directly to us!