Syndication Question from Passive-investor standpoint

[Nik Batra]

I have been doing some due-diligence on apartment syndication deals. From what I have read and heard, a conservative underwriter should project the exit cap rate at least 50 to 200 bps higher than the purchase cap rate. I have however come across a few deals where the sponsor purchased the property at a much higher cap rate (around 7.3) than the market cap rate (around 6.4) and then projected the exit cap rate at around 6.8 (which is higher than the market cap rate but lower than the entry cap rate). Their strategy is mostly value-ad. Would you consider that conservative or aggressive when analyzing a deal from a passive investor standpoint? 

Hope that question made some sense.

Nik

[Taylor L.]

I would underwrite it with a higher exit cap rate. My assumption would be that the acquisition cap rate is the market cap rate for that property, unless I have a very good reason to believe otherwise. 

Reason being, we're in a seller's market and the seller has every reason to sell at the lowest cap rate they can. Additionally, lowering cap rate can make a marginal or bad deal look good. 200 bps is probably overly conservative, depending on the timeframe. I might do a schedule of 50 bp increase first year, 25 bp increase per year after that.

Other factors to consider:

- Does the sponsor have experience in this market?

- They're using comp properties for the value add strategy. Are those comps valid? i.e. similar vintage properties in the same submarket or a similar submarket

- What is the debt strategy? DSCR?

- How are the renovations being financed?