Multifamily Madness Case Study
Originally Posted April 2022
Recently I came across a deal that we previously offered on, but was awarded to another buyer.
I did a high level comparison where we differed in our underwriting and here are the results:
1) Rents: They projected over $300/unit rental gains, whereas we projected $140. The differential is due to the comp set. If you do not recognize the true comps to your property (ie. what prospective tenants consider when looking for a place to rent), you can put yourself in a precarious position; one in which you can never get ahead. The reason this is very dangerous is because not only does it impact your cashflow, but it also impacts your ability to exit as pricing is typically based off of the NOI approach.
2) Natural Appreciation: Currently there is some healthy appreciation in the market, however, is that going to continue at today's rate for the next three years? This sponsorship believes it will. In comparison, we underwrote appreciation for Y1, and then scaled back for the subsequent years.
3) Inflation: I have seen this on so many offerings and I am not sure why it is not being called out. If inflation impacts your income, it should impact your expenses. Too many times I have seen underwriting account for inflation in income but not in expenses. This was the case in this Sponsorship's underwriting too.
4) Economic Occupancy: Economic occupancy almost always is less than physical occupancy. The Sponsorship's model had economic stabilized occupancy greater than today's current, historic and future forecasted physical occupancy. Typically, the only way to achieve such high occupancy is when the rents are below market. I already mentioned how aggressive their rental gains are, so I am not sure how occupancy can keep up when the rents are so high.
So what does this all mean? When you are vetting an investment opportunity, I am a huge proponent for vetting the team first, the market second and the deal third. However, when the fundamentals of the underwriting do not make sense, that is more a reflection of the team than the deal itself. To translate everything above in an offer price, we offered only 83% of what this Sponsorship paid for the property. This is not the only deal that our offer has been off by ~20%. More and more deals are trading for insane prices. Some may argue we should just sit on the sidelines for a bit or change our underwriting, but we are not doing either. We are sticking to our fundamentals. While we may not get a lot of deals, the deals we do get will be worth the wait!