All Forum Posts by: David Almeida

Congrats on the great deal! Impressive that your hurdle is a 30-40% IRR. Most investors who are honest with themselves aren't underwriting to anything better than 15% these days!

There are a number of programs out there, including a handful that teach you how to model deals in Excel.

Since it seems like you're newer to real estate itself, you should check out CCIM's 101 course. It teaches the fundamentals of real estate finance and analysis. CCIM is a very reputable organization, and you'll likely meet a lot of brokers along the way who can show you deals.

Investing other people's money is serious business, and you need to have a strong understanding of the fundamentals. Downloading someone's spreadsheet application will do little for you if you have no understanding of the concepts and what they mean. 

Best of luck!

It's true that the going-in cap rate is often meaningless. In general, however, cap rates are useful for gauging market sentiment, and they're most useful for determining exit prices. For example, seasoned investors usually underwrite ~10bps of cap rate expansion per year. So if you buy a property in 2019 and expect to sell it in 2024, you would assume that cap rates would be 0.50% higher. 

Even though you're hopefully adding value, the property is still 5 years older. And if you assume that things will always stay the same or get better then you will have no margin of safety. That being said, you don't want to lose out on a deal because of 10bps in your underwriting. 

It's been the goal of investors and developers of commercial properties for years. The market is competitive right now, so it's tough to find value-add deals by which you'll be able pull out all or most of your cash. I've done it, but haven't seen any deals lately that afford the same ability. 

Also, depending on the product type there will be some challenges with lenders. Last year I refinanced an apartment building I own and pulled out 100% of the invested equity. Regional lenders, however, were not happy with the strategy and would not give me credit for the value I created because they wanted me to have skin in the game. I did the refinance with Freddie Mac, and they required a write-up describing what the proceeds would be used for. Hint: the answer is not "I'm cashing out". So I'm reinvesting a portion of the proceeds back into the units and I'm allocating another portion towards future capex-- the rest went towards other investments.

Historically, developers of ground-up projects aimed for a "development spread" of 200 basis points, which would allow them to refinance and cash out all equity upon project completion. (A development spread is the difference between Yield-on-Cost and the Market Cap Rate). Today, spreads have compressed due to competition so it's difficult to find projects that produce those types of returns. It's still possible, however, to pull out a good chunk of capital upon stabilization.

I'm glad your first commercial transaction as a broker went well. Commercial sales are often nightmares in their own unique ways!

I've thought a lot about this topic. A few points to consider: (1) in commercial property investing, apartments are the least-risky asset, (2) while there's been an influx of institutional capital, there's also been an influx of uneducated sponsors who have taken a few online courses or followed a guru, and (3) why do investors think they deserve great returns for an asset class that's just not that risky? 

For B and C-class apartments, there is no new supply coming online. The supply is effectively capped in the near term, save for LIHTC housing. While not non-existent, the downside risk is low. The big risks, from a sponsor's point of view, are overpaying for the asset due to poor due diligence, not being able to cover capital calls in the future, and not being able to refinance if rates rise in the next 5 years. Also, there's operational risk: Can you manage the property effectively?

So the pricing for these assets should take risks into account. But if risks aren't anywhere comparable to new development--and I'd argue they're not--then why should investors be rewarded with 20% IRRs? I don't think they should be. Thus, capital will continue to flow into this asset class and continue to depress returns in any market with strong long-term growth prospects. Of course there's always the possibility of a black swan event. But even in a moderate recession most apartment investors won't lose their shirts.

Then the question becomes: How do you not overpay? First, do more due-diligence than you think you should. Second, sensitize rents for a downside case in which you need to modestly reduce rents to keep occupancy levels high. It sounds elementary, but most investors just plug in a 3% growth rate and call it a day. But if you know you can cover your mortgage if you drop your rents $50/mo and occupancy decreases by 5%-10%, then you should feel pretty comfortable.

In my opinion (which may not mean much), 5-year IRRs will settle in the low teens for light value-add assets, compared to many sponsors today pitching 20% deal-level IRRs. And by light value-add, I mean standard unit renovations and some general exterior capex. 

This strategy can only hurt the seller. If they provide wrong or incomplete information and you base your offer on that information, then you'll have grounds to re-trade the purchase price during the contract period. It's worth finding out if the seller is a mom-and-pop, in which case they may not understand that not providing financials could hurt their interests. It's also worth offering to sign an NDA, which often fleshes out whether or not they're serious about providing information.

Immigration is still a net positive for the country, and we expect population growth to continue. Birth rates are down but we can fill the gap and more overnight. It's not like there's a dearth of immigrants looking to become US citizens. 

Here's an article from Harvard's Joint Center for Housing Studies discussing the trends: 

https://www.jchs.harvard.edu/blog/number-of-u-s-households-projected-to-increase-by-12-2-million-in-the-next-decade/

And the trends seem to support multifamily ownership over the next decade even though they revised down the long-term population growth numbers. Realistically, it's going to be public policy dependent and how competent you feel our government will be over the long run.

I've used it to double-check value-add programs. In other words, if I feel like I'm being ambitious with my renovated-unit rent assumptions, I'll do some digging on home prices in the local market and determine the average monthly payment--including taxes, insurance, and utilities. 

I've never come up with a hard formula for the practice. If the numbers are too close for comfort, it makes me dig deeper. It's something to consider alongside the market's growth rate and the amount of new supply in development. Since all of the data should mix together to form your final analysis, it's a valuable metric that helps one understand the market.

Plenty of people have started where you're at, but it's risky. Having a trusted partner who won't cut you out of the deal is the best way to do it. If you don't have someone whom you can trust, then you'll need to get the property under contract and then shop it to partners. (Make sure there's a due-diligence period that allows you to get out of the deal and get your deposit back). 

If it's an off-market deal with good returns, you'll find a partner. Keep 5-10% of the GP, get a piece of the acquisition fee, and call it a win. You get to put the deal on your resume and learn from your partner. The first deal isn't about getting rich, and if you sign a partnership agreement, insert a condition that you get to be present at all operations meetings. 

Most great sponsors do not have podcasts or similar digital presences (that doesn't mean the ones who do aren't legitimate). The best sponsors are focused on running their real estate deals. It's an intense business. You want your sponsor operating real estate and finding good deals--that's a 60- to 80-hour per week job.

First, you should be comfortable doing due-diligence on the deals and verifying the sponsor's assumptions in the model. For some context: in deals with sophisticated LPs, sponsors will send their model and the LP will then pick apart that model. LPs often underwrite the deal with their own model. 

Underwriting takes practice. If you can, ask for trailing-12 expenses from a current property they own so you can verify that their model's projected operating expenses are in line with their current market operations. Sponsors are in the business of doing deals and they need those deals to look attractive to investors so they can get their fees. Thus, assumptions may get a little ambitious-- but that's for you, the LP, to determine. Some sponsors are conservative, some are aggressive.

Second, in respect to the sponsor as an individual or as a team of individuals, you want to see a track record of successful deals--and preferably successful exits. If they've just started but have 2-3 deals under their belt in the past year, it's too early to know if those deals are making money or will make money in the future. That's not to say you shouldn't invest with new sponsors, but it does mean that you need to spend more time diligence-ing the deal with your own assumptions and market research. Further, you need references--including character references--for newer sponsors.

Finally, and I've mentioned this in other posts, you want to make sure the sponsor has incentive to work hard to achieve outsize returns, but you don't want them taking too much of the deal. So, if a sponsor sends you a deal in which you're projecting an 18% IRR over 5 years to yourself, the sponsor shouldn't be receiving 50% of the total cash flows from that deal--that would be well-above market. You want a structure in which they're receiving 20-30% of the profits when you hit your 18% hurdle (as an engineer, you'll get this math relatively quickly). Structures in which the sponsor receives more than those percentages are often imbalanced and result in the sponsor making a lot of money even if the deal doesn't meet your return thresholds.

Understanding the fee structure dovetails with this: Sponsors can't be "feeing up the deal" so they get all their capital back before a check is delivered to the LPs. You also want the GP to have skin in the game until you get your initial invested capital back.

Regarding your returns: an 18% IRR over a 5-year hold period is not unreasonable but will take skill to achieve. It's a competitive market and sponsors can only achieve returns like that through heavy value-add programs. Make sure the construction budget reflects this. And if they're using bridge financing, make sure the deal isn't too risky because those are the first deals to go underwater when a market corrects.