KPIs for Deal Analysis

[Matt Shumate]

Fellow investors and syndicators, What are some of the core KPIs that you look at for benchmarking whether or not you'll move forward with a deal? Could be things like... Short term Cash on Cash return cash flow Deal size Price per unit Long term IRR Total equity increase Cap rate at resale Would love your insights on which ones are most important and what numbers you use as a minimum for each before you would consider moving forward on a deal. Thanks! Matt Shumate

[Tom Lafferty]

I suspect that is going to be a different answer for everyone, and a combination of several factors.  

For us its more of a total picture rather than one factor, although I guess I do focus on some more than others.  I am constantly trying to learn from those who have been through several RE Cycles (the more the better!), and one common thing I hear is that focusing on cash flow when buying will help you get through the downturns.  If (when) things change, if the value of your property drops because cap rates have increased, as long as it continues to cash flow and your debt isn't coming due then who cares?  Keep making money until things improve, and the value hopefully returns.  

So when analyzing a deal, I really try to look at the cash flow, but I also look at how aggressive our underwriting has to be in order to hit those numbers.  I've been to a few events where Ken McElroy was speaking, and at one of them he was going over how they analyzed a particular deal.  He made the comment that when evaluating a deal, whether you're buying it or investing with someone else, the pro forma rents are the most important thing to look at.  I put a ton of value on anything Ken says, so I always want to know how someone came up with their rents, how they compare to the comps, and whether they seem achievable.  

As far as cap rates, I don't focus much on the going-in rate.  If there is a clear value add to be done, and its being proven with a substantial number of units, or nearby properties are doing the same thing, then I'm fine with that.  You will hear a lot of people say NEVER to buy on pro forma, and only buy on actuals.  If you're buying in a competitive market, good luck with that.  Even off market stuff is getting a large premium over what the actual numbers warrant.  I'm mainly working in Dallas Ft. Worth, and I can tell you owners are getting an enormous amount of the upside right now, but there are still potential deals to be had.  

Reversion cap rates are another story.  We always want to use a higher rate than whats going on now since things are so overheated.  As an example, a C class deal in DFW may sell for a 7.0 or less, but we'll use 7.75 or 8 for a 5 yr sale.  That's just a guess anyway, but if the cash flow is good,  I feel ok about it.  

There are situations where we will put more emphasis on the value add potential than the cash flow.  I'm a year into a deal that we bought purely on pro forma, and had to give the owner FAR more than he deserved in order to win it.  It has not paid out anything to the investors yet, but will likely double their money at the 2 year mark.  The risk in that one is I had to use only 5 yr recourse debt, which I do not like doing right now, but the reward warranted the risk for me.  On just about any other deal we like to buy with 10-12 yr non-recourse fnma debt in order to have the flexibility to ride out a downturn as all the very experienced people are always telling me.  

So all in all, I just evaluate the whole picture.  If every factor has been pushed to the limit, I will not do the deal, or invest in it if its someone elses.  If one or two factors are aggressive, its a good (or great) area, and I trust the sponsor if making a passive investment, I'm ok with that.