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