What are your top 3 metrics for evaluating a deal and why?

Question

I've noticed investors emphasize some metrics over others. Clearly it's best to look at as many as you can in any deal. But I'm just curious which ones are your favorites and why?

Brian Burke · Answer

The most important one is rent being achieved by nearby similar comps that are renovated to a similar level to which I would take the property. This allows me to compare the in-place rents to the potential future rents and calculate the lift I can achieve after making improvements. If the lift is small the deal is very unlikely to work. I need to be able to create a minimum of $150 in rent bump for most deals to pencil.The second most important is the IRR. Because my deals are syndicated to our client base of high-net-worth investors, there is a certain level where the IRR needs to be on any given deal to give me confidence that we can get it fully subscribed. This IRR varies depending on a lot of factors and is really a judgment call. It generally needs to be in the mid-teens for a typical B-Class value-add multifamily deal.Third is cash-on-cash return, for the same reason as IRR. I'm mostly looking at the average over the hold period and the CoC for each year of the hold. Those just need to be reasonable and sell-able. First year CoC is less important as people tend to understand that most value-add multifamily deals have low CoC in year 1 as the renovation plan is underway.That said, the ability to achieve the desired IRR and CoC is highly dependent on the first metric--rent bumps. Some might wonder why that is...well, the answer is that if you are underwriting properly, you are using conservative vacancy factors, decompressing cap rates, above-market debt interest rates, conservative property tax assumptions, etc...even if the property is performing better today. In order to counter-balance those negatives you need a hedge, and that hedge is higher rent.And those are only the top three. There are so many other metrics that I study on every acquisition. Here are a few (in no particular order):Exit ValueReplacement CostPortion of IRR attributable to cash flow versus reversion (sale)Unleveraged IRREquity MultipleDebt Coverage RatioLoan to Value (every year throughout the hold)Break Even OccupancyDefault RatioRevenue Stress TestA few others that are a bit obscure and not that importantYou might notice one metric that is conspicuously missing: Cap Rate. I don't care about cap rate. It just must be market for the type of property we are buying in the area in which we are buying it. The only thing I use cap rate for is predicting the future exit value of the property by using today's market cap rates and inflating them for a time adjustment. Outside of that, cap rate is of little value as a metric to predict investment outcomes.

Tyler Kastelberg · Answer

@Mike KriegAdding to @Brian Burke's answer, all metrics can and should be stress tested. You can run data tables in excel to see variation in IRR, equity multiple, debt service coverage, and other important metrics based on changes to operational metrics like rent growth, market vacancy, etc. Best of luck!

Theo Hicks · Answer

@Brian Burke selected the same top three that I would chose. (1) the future rents based on the rental comps, (2) the IRR based on my exit strategy, and (3) the CoC return to the LP.And I also agree in that I don't care about cap rate. The business plan is much more important.

Seth Williams · Answer

If you can get a real look at current rents and expenses, and also value what they would be under your management you can really get into value with cap rate, helps weed thru a lot of trash in my opinion.

Alina Trigub · Answer

@Mike Krieg It's hard to talk about only three metrics when there're so many of them. While @Brian Burke covered it nicely, I want to point out that there are different sides of the story.1) If you're looking at the three main metrics that passive investors are interested in, then it is Sponsor's track record, IRR, CoC, and (I'll break your rule and throw nu 4) Equity Multiple :).2) from a deal sponsor or an active investor perspective, I don't think one can name three metrics only because majority of them work in tandem with one another. So for instance, one must not look at the property location without reviewing the rents, or look at the IRR without evaluating the approximate ownership duration of an asset. And I cannot stress enough the importance of multiple exit strategies.

Anthony Wick · Answer

Location: I'm comfortable where I live. I know the rental market (buy and hold). Cash Flow: I'm in it for the money. Price: sort of goes along with cash flow; but also what is the overall price, is there some deferred maintenance to gain higher rents and equity?

Shmuel Waldman · Answer

A) LocationB) LocationC) LocationPounding pavement and knowing your location is the keyMy .02