Scholastic Capital Update #7: How We Identify Homes to Buy

Hi There,

A friend of mine (Sean) was an early employee at Uber.

He wasn't "private jet and an island in the Bahamas due to my equity" early. But, he was early enough that he has some incredible stories.

My favorites are about the launch of Uber Eats.

To hear him tell it, the story of Uber Eats is actually about Doordash.

Both Eats & Doordash had an unlimited budget. Both companies had employees with brand-name resumes. Those employees all worked 80+ hours a week.

They tried everything to gain market share, from hiring 100 Ph.Ds to "puppy promotions."

With competition this fierce, anything to stand out was worth a try.

I (Sean) think this is a perfect example of what not to do in real estate. 

Pick your competition

Real estate, maybe more than any other industry, allows you to pick who your competition is.

Let's say one invests in Class B, sunbelt multifamily between $10-30M.

In that particular asset class, you are choosing to compete against Blackstone. There are hundreds of sophisticated funds looking for these deals.

Some of these funds have infinite budgets. Their employees have brand-name resumes. They work 80+ hours a week to find deals. They have to, since everyone else is putting in that time.

It's an Uber Eats vs Doordash competition. It’s difficult to gain any edge. 

Almost every  multifamily building over $10M will have an institutional owner. The competition is fierce!

In our opinion at Scholastic, we want the exact opposite. 

Take this house as an example:

This home was listed for rent this week in one of target zip codes. 

It’s almost $5,000 a month. Yet the first photo of the house is an iPhone photo of the master bathroom.

Here’s the crazy thing: the mom & pop landlord who owns this home likely will rent it for $4,700 a month. 

The bar is that low in single family homes, because the competition level is that low. 

We are working tirelessly to ensure thatt Scholastic will be a top-tier operator in SFR. 

That’s not because we’re special, or incredible. 

It’s because we learned from the Eats vs Doordash example, and we chose a market with competitors we could beat. 

In today’s update, we’re going to talk about how we decide which homes to buy. 

We believe this six step process helps enable us to out-compete the mom & pop landlords we compete against.

Who we are

A brief intro if you were forwarded this email: great to meet you, we are Scholastic Capital. 

We buy single family homes in highly elite school districts. We rent those homes on 3+ year leases to tenants who want to be in these school districts but don’t want to buy.

We work on behalf of our own capital and the fantastic investors who have joined Scholastic with us! (more on these investors at the end of this update).

How we identify homes

There are six steps we follow to identify and purchase homes. 

These steps can be thought of as a funnel. Fewer homes reach each successive step. 

All of the numbers you’ll see in this example are real and accurate as of January 23rd at 4pm.

As a reminder, we only buy homes during the summer when our tenant archetype (families with school aged kids) moves between school years. The inventory numbers will increase during the summer due to regular seasonality seen in real estate.

Step #1: All Homes on the Market

We have a custom software tool built in Airtable. 

Every day, the software looks at all MLS listings across the 37 zip codes we focus on. (if you missed last week’s article on how we found the 37 zip codes we focus on, you can check it out HERE)

At this time, there 2,059 homes on the market we could buy. If you look at this data by state, there is a big concentration of homes in Indiana.

Step #2: Check 1

We don’t have the time to evaluate 2,059 homes individually. 

Therefore, we run a series of “binary” checks on each home. These checks are binary because they are not subjective. 

For example: a house either has more than three bedrooms or less than three bedrooms. It’s binary.

We use the binary checks to automatically eliminate any home we would never buy

Sticking with the bedroom example: our target tenant profile of a family with school-aged children needs space. They will not rent a home with 2 bedrooms.

For that reason, we eliminate any home that has 1 or 2 bedrooms.

Similarly, that family will strongly prefer a house with at least two bathrooms.

For that reason, we automatically eliminate any house that has 1 bathroom.

Once the binary checks are complete, we have 429 homes remaining.

Indiana still has the most remaining homes, but Michigan & Minnesota have the highest conversion rate from step #1 to step #2.

Step #3: Check 2

Every home now needs manual underwriting. The goal of this step is to determine if we would be able to rent, insure, and sell this home.

We have a long list of checks we need to do. Some examples include: 

Rent:

• The home needs to be on a 25 MPH road or less. Any faster, and it’s not a “neighborhood” feel, and we would struggle to rent the home

• The home is well located within town, close to both schools & points of interest

• The home is in good aesthetic shape. It looks like a nice place to live

Insure

• No pools, above or below ground

• No elevated cement steps up to back door (these often crumble and can result in lawsuits)

Sell

• No solar panels. Institutional SFR funds, the most likely buyer of our portfolio, don’t buy homes with solar panels

There are currently 158 homes that passed this step.

Step #4: Financial Underwriting

At the end of the day, we buy these homes to deliver a return for our investors.

That makes financial underwriting the most important step thus far. 

For every house that made it this far, we forecast:

• Rent

• All expenses

• Profit

A quick note on maintenance

Maintenance is often the biggest expense within single family rental homes. 

Fortunately, we have an absolute treasure trove of data here. One of our advisors has shared real maintenance spend data from a portfolio of 30,000+ homes. 

This data enables us to forecast, based on square footage and age of home, a very accurate maintenance number. We then use that number in our financial underwriting. 

Financial Underwriting Summary

All told, there are currently 56 homes that pass all steps, including financial underwriting

Across the board, roughly 2.75% of homes on the market make it this far. 

If we were buying homes now, we would start extended offers on the remaining homes.

If the offers are accepted, we then proceed to step #5.

Step #5: Offer Accepted

Once we have an accepted offer on the home, it’s time for deeper diligence on the home itself.

We can take our time and be thorough here. Since we are under contract, we have exclusivity on the home for 5-7 days. 

Some checks we do during this period include:

• Full house inspection by a licensed inspector, optimally one who is a retired General Contractor. They know where and how subcontractors cut corners

• We need to check the make/model/serial number of every major system in the house to ensure no open recalls or known issues. 

• Family Watchdog, to ensure that no sex offender lives near the property. Parents, especially moms, will do this check before renting the home. We therefore need to do it too

• Insurance sign off. We need to know the insurance company is going to be comfortable insuring this home before we are out of inspection period

• HOA check. We need to confirm with city records that the property is not in an HOA, and if it is, we need an attorney to review the HOA documents to ensure no rental restrictions or a path to rental restrictions 

One key element of this process is that Sean plans to be physically be at each home during the inspection process. 

As with before, the goal here is to ensure that we will be able to rent and profitably own each home.

We anticipate approximately 50% of homes of homes passing Step #5. For the 50% of homes that fail, we’ll terminate the contract and recover our earnest money.

Step #6: Inspection Passed

At this point, we’ll have passed inspection and will close on 95% of homes in this stage. 

(The 5% exception is for any home that does not appraise and the homeowner refuses to adjust price accordingly. This is rare, hence the low odds here).

This step is approximately 15 days long, which gives us a nice jump on renting the home.

That means we will:

• Ensure we have professional listing photos taken, edited, and uploaded into our leasing software 

• Ensure we have a floorplan sketch created and uploaded into leasing software

• Create a property record for this home within our property management, leasing, & tenant application software

• Ensure we have a listing description written for each property

• Ensure we have a “smart doorknob” on each home to enable self-guided tours

This entire stage is all about preparation. We would like to officially close on the purchase of the home at 9am and have the home on the rental market at 10am.

By preloading everything into our leasing software, we simply need to press a button to turn on the leasing process.

This is also how we out-compete the “bathroom photo” mom and pop landlords from before. 

No UberEats vs Doordash situation for us!

What we’re thinking about

There are two item’s we are thinking about today. 

#1: Blackstone & Tricon Deal

Blackstone recently purchased Tricon, a publicly traded single family rental institution with roughly 38,000 homes, for $3.5B.

This is a fascinating transaction, for a variety of reasons.

One clear trend here within the institutional SFR space is consolidation. We would not be surprised, especially after acquiring 250 homes, if there were significant interest in acquiring the homes owned by Scholastic.

#2: Sharing Home-Level Data

We want investors to be able to access information on all of the properties in the portfolio. 

For example:

• The addresses of all of the homes 

• The amount the homes are rented for 

• Photos of the homes

A few investors have specifically requested this level of information. For that reason, we’re looking into a few different solutions that would have a live feed of property information for investors to review.

Fundraising Update

We’ve seen a ton of interest from investors after our article in Curbed came out. It’s been a bit of a whirlwind.

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

All the best

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