Alright, mf’ers. Let's talk about underwriting. At its core, we want to understand what the real Net Operating Income (NOI) is today and how that number changes over time due to things we can and cannot control.
A few ground rules First, this is “a” way to look at deals, not “the only way.” If you’re a reply-guy looking to flex, understand two things. 1.) real estate is complex and nuanced; lots of ways to value property; I know this, and 2.) I do not know, or give a shit about you.
Second, this is only part of a complex process. You can’t just mirror these and be done. We look at a NOI as a story with 4 parts: buying, building, trending, and selling. How it moves through these phases matters. A lot.
Buying – Simply, what is the going-in cap rate? For the most part, this number doesn’t matter if we fully understand it. If the going in cap is higher than market, we better know why. Are we really getting a deal, or did we miss something?
If the going-in cap rate is lower than market, how confident are we in our business plan? You can buy 2 caps if you believe in your business plan 100%. If you buy 2 caps and don’t have a plan, well, you get the return on cost you deserve.
Building – Stabilized yield on cost, NOI when you finished your business plan. What 2 or 3 levers are we pulling to move NOI from X to Y? How confident are we in these levers? Our conviction allows us to buy value-add deals at low cap rates. Lack of levers, not a deal for us
How big is the lift, and is the spread between our going in cap and our stabilized NOI large enough to justify the risk involved? There’s no exact rule, but we aren’t doing value-add deals for less than 180bps in development spread.
Is our capex budget sufficient to execute the business plan, and how do we know? Can we address all deferred maint. while still having enough to fully upgrade the appearance of the units/common areas? Do not make trades here. Just don’t.
If you think tenants won’t notice that you spent 75% of the money you should have on upgrades, you’re wrong. Deliver comparable product or drop your rent assumptions. Fix your systems now, or credit the next buyer for the upgrades in your model.
Trending – What is our yield on cost when we sell? If the spread between stabilized and trended is too wide, our rent growth assumptions might be too aggressive. If it’s too tight, why are we investing in this market. Who’s our logical buyer?
You can’t get me to underwrite more than 3% growth on affordable deals. Because of this, we’ve missed a lot of deals. Deals that have performed well because of the market. But I’m not smart enough to make momentum bets, so we don’t make them.
If you do make aggressive rent growth assumptions in order to justify the purchase price, please DM me your lender's contact info. I’ll buy your deal back from the bank when you go bust and send you a pic of me on a date with your wife.
Unless you’re buying one of our deals. Then, obviously, you should underwrite 10% growth forever.
Selling – What is our exit cap? Is it far enough above our going-in cap, given the hold period? Does it reflect the product we will be putting on the market? If we renovate 100% of the units, people will not pay value-add cap rates.
There’s a lot of handwringing on Twitter about projecting exit caps and I promise I don’t care about your feelings on this. We project exit caps in our model because that’s part of how we pay dollars for buildings. Just how we work.
We look at historical averages, the length of our hold period, and property condition at sale, and try to make an educated guess about where cap rates will be down the road in a medium case scenario. We look at the downside scenario to stress test.
A note on exit NOI. Your buyer, if they aren’t a f’ing idiot, if going to reassess taxes at sale in their model. So, if you deliver a deal to market with 1M in NOI, but you haven’t reassessed taxes at the exit, your NOI isn’t 1M.
If the assessed value when you sell increases (it will) and the tax bill goes up 50k, then your exit NOI is 950k, not 1M, and you should factor that into your underwriting. We aren’t gonna have a vote on this, don’t tell me I’m wrong.
Resist the urge to nitpick; this is just our strategy. If you want to chime in with “well, you’re wrong about X” I gotta tell ya, the odds that’s true are very low. The odds I give a shit are even lower. -Marlo the analyst
@mu2myoc It's very concerning to me that the information in this thread might be news to a lot of GPs.
@resetbasis @twallyweb OG Classic!
@mu2myoc "If you're a reply-guy looking to flex...I do not know or give a shit about you". Lmao best thread opener I've seen on retwit
@mu2myoc Me: 😬😬😬 (resisting the urge to nitpick)