Stretch your proforma till it snaps!!!

[Nick B.]

Hello BP,

I am struggling with my apartment underwriting standards. I use a set of conservative or semi-conservative rules that should keep me out of trouble if the market turns against me. What I keep finding out is that my target price is always at least 20% below seller's asking price.

Here are my rules/metrics:

• total economic loss after property is stable is 12% (15% in lower quality areas)
• incremental rent growth after the property is stable is 2%
• expenses grow by 2%/year
• property tax is 90% of the purchase price multiplied by a local tax rate (usually doubles tax from whatever seller pays)
• payroll $1000-1200/unit regardless of the property size (brokers claim that 30-units don't need payroll but I don't believe them :-) )
• reserves of $300/unit counted in expenses
• exit cap rate is 100 basis points higher than current cap rate (e.g. exit at 8% if current cap rate is 7%)
• cash-on-cash ROI 10%+ starting in the second year; first year may be lower if this is a value-add
• 5 years total ROI (assuming sale) is at least 100%
• IRR 15%+ over 5 years (al ROIs are net to investors after 20% sponsor override)

I can adjust may metrics to some degree but in order for me to get to the seller's acceptable price I have to adjust most or all of them to unsustainable levels.

So, what should I do other than keep underwriting and waiting until the market turns down and all of a sudden my numbers would make sense for a seller?

Thanks
Nick

[Joel Owens]

Honestly there are just a lot of people right now paying NUTSO prices for MF based on bubble numbers the last 12 months.

I saw this before in the last downturn of 2007. Those people if they can hold on through the down cycle until the next up cycle tend to be okay. Those that have to have the numbers meet or beat the bubble projections they bought on will likely lose money.

So just remember this. The best deal you have ever done might be the one you never do.

I have been going round and round with an off market value adds strip center deal for 4 months. We are almost at agreement but I will not waiver from my approach and underwriting. I have 2 other development deals in the works if this doesn't happen. I am doing the development deals even if this doesn't happen.

So stick to your numbers and only do what makes you comfortable with your capital.