What IRR returns do you target?

Question

Hey everyone!

What IRR returns do you target when looking at acquiring an existing multi family property? Let's assume it's a class B property, 10 units, you plan to gut-renovate it, and then lease it out for 4 more years for cash flow.  Just want to get a sense of what other developers are targeting here.

Frank Gallinelli · Answer

We've had the opportunity to interact with thousands of investors and developers (been providing analysis software to those folks for 30+ years), and from that perspective I can agree completely with @Brian Burke.  The typical income-property investor we talk to is looking for an IRR in the mid-teens, and certainly won't object to pushing near 20%.

Also, and as Brian suggests, that expectation is typically risk-adjusted.  For example, when looking at a triple-net lease property with a credit tenant, most investors we encounter will accept a lower IRR; if the property presents some significant long-term risk, then they will generally expect higher -- and will generally be less tolerant of dicey cash flow projections.

Brian Burke · Answer

My properties are funded by private investors.  I aim to achieve an IRR in the high teens to the investors using very conservative and achievable assumptions, while leaving enough meat on the bone to carve out a promote for doing my part.  This means an IRR at 20% or higher at the asset level.  Of course, this return varies commensurate with the level of risk the specific deal presents.

If using your own funds, you don't have to generate the thicker returns required when partnering with investors.  In that case, it's just a question of risk vs. reward while being mindful of the IRR you can achieve in other investments in a similar risk class.

Jared Foster · Answer

Since it appears this post has stopped being added to, I thought I could pose a related question without hijacking the post.  I have no real estate investing experience, but reading learning etc.  I do have some transferable skills though.  I have built a proforma and started drafting up a business plan.  I figured if I can't get through the business plan, then I shouldn't be in the business.  Anyway, one of many things I am struggling with is that I don't have a ton of cash sitting around to put 20% down on a property (say I need 120K) and was thinking about looking into private investors.

I do have some questions related to investors and the type of funding.  Would investors typically provide funding to cover a portion of a down payment on a loan..etc..I think there are some legal issues associated with private investors that I need to be cautious of; however, related to IRR.  I am thinking that when modeling an opportunity we should be considering multiple IRRs.

Assume that I have (3) Investors and the property is sold after 5 years.

(2) Investors Put in 30K, (1) Investor puts in 40K, and the business puts in 20K.

1.  The property (call it the Project).  Accounts for all equity, cashflows, and sales proceeds.  Say IRR = 25%

2. It seems we should look at the IRR for each investor which would include their equity, some % of cashflow and some % of sales.

3.  Business IRR (ME).  Includes my 20K of equity, remainder of cashflows, and sale proceeds.

So in this example, it is not clear to me what should be paid to the investors.  Should they get a pro-rated portion of the cashflow and sale based on amount invested?  If one does this there wouldn't be enough for the business to reinvest.  I assume since I would be the one managing day to day stuff I should received the highest return.  Thoughts?  Also, how does this work if you wanted to hold on to the property.  From what I can tell the only way the investors will get paid is by the sale of the property.

Finally, on CAP RATE.  I am having a hard time seeing the usefulness of this number unless you are doing estimates in your head while looking at opportunities.  Seems to me the IRR is the more accurate way to value this.  Thoughts.  The reason I ask, is I am looking at at market that has a lot of 6% Cap Rates, might be able to move these up slightly during negotiations, but they are a lot lower than I was thinking my target should be (8-10%)

Thanks, also if you have any suggestions on other posts to read that would be great.  I am trying to learn anything I can.

Jared

Erik Drentlaw · Answer

I think it is less speculative than you think because these are multi family properties and their value is based on their income not appreciation as much.

Bryan Hancock · Answer

We're not asking the sellers to carry any paper either.  In situations where this would work the lender generally wants to cap the "CLTV" in the deal though such that you have some equity in the game.  Deals like this were more common before the crash, but I am sure there are still many of them out there.

Keep in mind that having the seller carry paper will increase the CLTV and thus decrease the potential lender pool.  Thus your rates are likely to be higher, your amortization period shorter, and you loan constant higher.

If you're competing in distressed product where equity is traded for peace of mind you're unlikely to get the seller to carry paper.  Like Brian mentioned if you're competing with other offers you're also likely to lose if you need the seller to carry paper.  If I was on the sell side of the transaction this would signal to me that the deal is less likely to close and I would likely accept other offers over yours if I had them.

Having said all of this I think if you're going to ask I'd ask for a 30-year amorization at close to market rates for first position notes.  That would be a good starting point in the negotiation if the seller is interested.  You could use the fact that you're going to have to pay higher first position note rates for the privilege of having the seller carry paper in a subordinate position.

Brian Burke · Answer

Paul Khazansky, in my experience, it's close to half and half but it depends on where you invest.  I think that coastal investors will see lower cash-on-cash portions and higher reversion value portions than investors in flyover states.  Since my objective is to provide meaningful cash flow to the investors, and also a meaningful IRR, I have to source assets in areas and of a class that provide good cash flow (higher cap rates), and good rent growth to drive the exit price.

My offerings are typically a 5 year hold with options to extend for up to two additional years.  Exit clauses are problematic because the investment entity doesn't typically have a bunch of idle cash sitting around to cash out an investor of an income property.  Of course they can sell their interest to someone else, but that can also be challenging because there is no secondary market for these types of securities.

Bryan Hancock · Answer

Great answers already.  Your target project-level numbers and deal structure really drive this decision.  If there are other investors to pay and you're trying to syndicate the deal your hurdle is likely to be a bit higher than if you have an abundance of personal cash that needs to be put to work.  If you're doing a turnaround project with greater uncertainty and skill required to achieve the upside that should command a premium when determining the yield required on the equity.

You don't generally want to syndicate deals that are 6-7 on a 10-point scale because there is not enough juice in them to pay the investors and yourself.  If, however, your equity doesn't have to work as hard you don't need a stellar deal to achieve your target numbers.

There are other things to consider too; like fees to the developer, other fees enumerated in your operating agreement, matching (or "make-up" returns), waterfall structures, etc.  How the capital is organized should drive what targets your project has to hit for you as the promoter to make the numbers you need to make for the effort exerted.

Our fund targets 18% at the project level.  The 18% is really meaningless without consideration for many other factors though.

John M. Pagli, Jr. · Answer

Student Housing JV Equity Investment Target IRRs - Sources of Information and Deal Comparables

I am interested in investing in the student housing sector, and I am hoping that you might direct me to sources of information and deal comparables for JV equity investments, deal structures and target IRRs.

Would you be able to guide me?

Thank you for your time and consideration.

Ziv Magen · Answer

@Erik  Drentlaw  - @Brian Burke  wrote "cashflow from the resale of the property, presumably at a higher price" - that's the speculation I was referring to.

Ziv Magen · Answer

thanks, @Brian Burke  - that explains it - the numbers you've all been discussing above are highly speculative, particularly in today's financial climate - I'll take the "low" (10-16% net pre-tax cashflow p/a) that we've been seeing in our condos over the risky potential discussed here any day of the week, but I do realise it takes all sorts. I'm just a scaredy cat like that ;)

Thanks for the clarification!

What IRR returns do you target?

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