How to underwrite core deals in this environment

[Dan Bowe]

Seeing the market in reading the big brokerages reports on the main metros I invest in, everyone estimate rent growth at 0% for at least a year or two. Expenses naturally rise with inflation - insurance, property tax, utilities...

Those two factors, by definition, result in lower NOI down the road than in-place/year 1 NOI. Meaning that even with cap rate expansion set to 0%, the sale price is lower than the going in purchase price. resulting in negative/low yields.

Am I missing something here? Do core deals not pencil in this environment at all?

[Kevin Sobilo]

@Dan Bowe, you are looking to broadly and thinking too narrowly IMO.

Rent growth: So, estimated rent growth in a given market is 0% for the next couple years.

1. First off that is "estimated" not what will actually happen.

2. Rent's can remain flat and you can still bring in more money! For example, you might reduce rent by 2% and cause your vacancy to dip to almost 0% causing your rent received to actually RISE!

3. Even for a buy & hold investor there are opportunities to make more money when rents are flat by attacking expenses. Activities such as appealing assessed values, shopping for cheaper utility providers, shopping for cheaper insurance, or even energy efficiency upgrades are all on the table.

Expenses naturally rise with inflation: True and also COMPLETELY FALSE!

1. Yes when you look at inflation prices are rising SOMEWHERE, but NOT equally everywhere! So, while ON AVERAGE prices are rising that does not mean YOUR expenses will or will at the same rate.

2. Inflation might cause prices to spike but some taxing bodies might not need to raise taxes for MANY reasons. For example, maybe the tax basis is growing because of industrial development or expiring tax breaks.

3. Insurance may go up, but if you haven't shopped it recently you might actually be able to reduce your expense at the same time prices are going up!

Other factors:

1. You have other factors in your rental business such as the cost of money. Rates are higher right now then they have been in recent history. A property purchased today might be able to be refinanced in a couple years for a rate reduction and corresponding reduction in expenses.

2. Deals are more about what YOU make of them then what the broad statistics say they are. The factors within your control/influence are much greater than some modest market environment headwinds.