How to analyze apartment syndication offer summary?

Question

Hi!

I've received an offer summary on an apartment syndication. There is a lot of information to dissect here. How do I determine if it is a good deal or not? After all, these are projected outcomes. Is 8% pref return the way to go on a 75/25 split with average annual return 17.56%?

In other words, what are the numerical criteria (or other parameters) that separate a deal into "yes" pile vs the "no" pile?

Also, I've been told to review the syndicator's track record of projections vs. actual numbers. How do I obtain that information?

Thank you!

Theo Hicks · Answer

Good vs. bad deal is subjective and is based on your return goals. Usually, there is a sample investment data table that shows how much money you would make if you invested $100,000. If those numbers meet or exceed your desired returns, it is a good deal for you.

In regard to their projections, a few things to look at:

• What are there annual income and expense growth assumptions (anything higher than 3% is a red flag)
• How are they calculating the exit cap rate (an exit cap rate is lower than the in-place cap rate is a red flag)
• What are the statuses of the major systems, like roofs, HVAC, windows, plumbing, etc.? If there are issues, is that accounted for in the capex budget?
• How to the year 1 income and expense projections compare to the T-12?
• Are taxes based on purchase price?
• How much money are they placing in reserves each year, and what is the upfront reserves balance?

In regard to the sponsor, you want to see a sponsor who successfully executed a similar business plan in the past (ideally, with the same team). Successful = met or exceeded investor return projections. To determine if they were successful, you should be able to get your hands on a profit and loss statement that includes the variance between actuals and projected.

Todd Dexheimer · Answer

The sponsor is the most important part of the deal. Are they trustworthy?

Beyond that, I would make sure they are conservative. Recently I saw a deal by a very respected sponsor that have thousands of units under his belt. This company was projecting 5% rent growth for the next 7 years. Even though I respect the sponsor, I would not consider putting money into that deal, as I felt he was being irresponsible with projections.

Nick B. · Answer

You need to start from the sponsor's proforma for the property and check if their projections are reasonable.

E.g., if they assume 3% rent growth, that's  normal. But if they think rents would grow at 10% rate in perpetuity, they and their investors will be disappointed.

Once you verified property-level numbers look at the deal structure. Something like 8% pref and 75/25 split afterwards is acceptable but 40/60 split in favor of a sponsor is way too greedy.

Last step is to look at the projected investor's return and decide if this return meets your objectives. This is a personal preference. Some people may be happy with 10% IRR and some won't settle for less than 30%.

As for track record, ask them to show a list of past projects and their performance on the project level and net to investors. Ask if they ever lost money and how they handled it.

Ask for contact information of current and past investors and talk to them about their experience but also pay attention to their level of sophistication. I once spoke with 3 investors of a prospective sponsor and all 3 could not tell me the numbers on the project they had just invested in. One told me that she simply trusted the guy with her money and did not bother with the details. I passed on that guy as he seemed to cater to clueless people.

Ask if sponsors are ok with you running a criminal and credit check on them. If they refuse, they may have something to hide.

Michael Bishop · Answer

@Rebecca Jackson, I 100% agree with Theo that the "numerical criteria" is really based on your desired returns. You need to determine at what return you're comfortable with assuming the built in risk that comes with real estate. Some folks might be okay with a 7% pref and a 15% IRR, for some that number may be higher or lower. It all depends on you.

One other thing I would mention is to look for the presence of a sensitivity analysis. This will show you what happens to your returns with a change in key metrics like vacancy, rent premium achieved, CAP rate, etc. If you don't see one in the offering, ask your contact if they have one available for you to review!

Scott Morongell · Answer

@Rebecca Jackson  Determining a good deal from a bad one is subjective in regards to the numbers. The first thing I would look at is the sponsor. Do you trust them? Track Record? Do a background search, etc. As far as vetting the deal, you want to be asking questions on

• rent growth projects 
• cap ex budget
• who the pm company is
• acquisition fee
• asset mgmt fee
• disposition fee
• construction fee
• taxes
• t-12 vs proforma year 1
• reserves

This will give you a pretty good start.

Mike Krieg · Answer

Here are questions I'd seek answers to either on the investor conference call (is there one? there should be) and the Investment Summary.

1- What is the justification for why this market makes sense?

2- What are the current and projected rents and thesis on why rents can be increased?

3- What are the projected jobs and population numbers over the hold period?

4- What is the experience level of the team running this deal? Do they have a website with bios of each team member and their experience?

5- How many deals has this team done? Have they had any bad deals? Are they conservative in their underwriting?

6- Has this team seen a full real estate cycle? Are they also investing in the deal?

7- How many exits has this team had? What have been the results? Avg return, IRR?

8- How quickly will this deal start paying distributions? (I want to see within 90 days)

9- Is the deal a standard 8% Preferred Return with a 70/30 split? If not, is the investor return a conservative number above 17%

10- Again back to rents. This is the whole deal. What are the rent comps of similar properties in the area that have been renovated. How likely is it that the operator will achieve targeted rents?

11- Is the cap rate at or better than market?

12 - What is the exit cap rate? Does it take into account rising interest rates? Is there a rate-sensitivity analysis provided with the exit projection?

13- How often will they communicate with investors?

14 - What is the Equity Multiple over the hold period? (I like seeing 2.0X over 5 years generally)

Just a few questions, not exhaustive though.

Jeff Kehl · Answer

@Rebecca Jackson just to be a bit of a cynic... Have you looked at the numbers with 0% rent growth for the 7 years? I know it's a bit heretical to say this but rents do not always go up.

Rebecca Graziano · Answer

Thanks Todd! I checked the rental projections and they stabilize at 2% years 4-7, with growth of 3-5% years 1-3. Based on commonsensical inclination I would think this is conservative and appropriate.

But absolutely I agree the sponsor is the one putting the deal together, and therefore the most important piece of the puzzle.

Thank you!

Rebecca Graziano · Answer

Thank you both. This is very useful advice to review the offer summary more specifically.

Thanks!

How to analyze apartment syndication offer summary?

Most Popular Reply