Wow or Wait? Is it the right time to update rent projections?

[Sean Myers]

Should I update projections because two new lease exceeded our baseline? Even a little bit?

On Friday I received an update on 2 new leases for a property we're closing on soon. Our group is the contract purchaser and we're wrapping up due diligence in a week.

Earlier in the inspection process, we requested the Seller and Property Manager ask for rents at our Upside “rates” rather than our Base Case "market rates" on two units that are turning over. (Note: these are move-out, so not existing tenants that are renewing a prior lease.)

Results:

• Unit Type #1 went for list at $775 and the new residents moved in yesterday. The scheduled lease rates (rent roll) for these unit averages $697.
• Unit Type #2  was listed later in the week. It had several apps at the list of $925. PM is processing one of the tenant files right now at $925. The currently scheduled lease rates for these unit averages $814/month.

Comparing existing leases rates to our “Base Case Scenario” you can see how much the new lease rates are exceeding our baseline projections AND the average currently scheduled rents:

• 2/1 New Lease +$78/month                Our Base Case is +$53/month
• 2/2.5 New Lease +111/month             Our Base Case is +$71/month

I don't want to post the actual rent roll on here, but I can tell you that just from the wide spread in lease rates among unit of the same type that this property is carrying a big loss-to-lease.

So what do you think? After all, these two leases only make up 5% of the existing units.

Should I edge up my base case numbers a bit and redo my projections - or hold tight with my original numbers?

[Brian Burke]

Since you have gotten this far, I would assume that your deal underwrites attractively enough at your originally-projected rental rates, so I'd leave the projections alone.  If you are able to get the higher rates, that's your opportunity to outperform.

Two leases don't make a market.  Could be a fluke, or could be that there is enough demand to absorb a few at that rate.  Or it could be a sign that you are going to do very well on this deal, assuming that none of your other projections prove-out in the wrong direction.  

Too many syndication sponsors are "underwriting to perfection" these days.  Leave yourself some breathing room and that'll set you apart from those who are pushing the envelope too hard.

[Sean Myers]

Thanks @Brian Burke. The deal is working for us at our original numbers, so I'm inclined to follow your advice and not to make any adjustments upwards.

And I agree, two leases does not make prove a market. 

We're keeping LTV low, taking more term on our debt than we anticipate needing, and have a plan that focuses on bringing the old leases more in line with the current average rates.

We also run Downside scenarios to see what the numbers look like if we're wrong about room to increase or (worse) the market changes and results in vacancy going up and rates going down.

Those are not pretty of course, but a large part of winning is being able to stay in the game.

[Ben Leybovich]

If 2 leases are 5% of the rent-roll, we are talking about a 40-unit building. Right?

40 units is a small building. There are all kinds of inefficiencies inherent with the size, which leads to my perspective on your question:

1. This could be a fluke. The boutique nature of the size lends itself to all kinds of things.

2. More globally, if this sticks you'll just have more room than you thought to handle the inefficiencies, and potentially over-perform. I wouldn't change projections.

Good lcuk!