Value-Add Underwriting - How are you (acquisition analysts) accounting for the 'value' in OMs?
Hi acquistion folks, when you get an OM from a broker with an 'in-place' NOI and a 'pro forma' NOI, how do you go about properly underwriting this? Ideally sellers cannot price in the entirety of the upside. It's my time, money and risk that is involved.
To all the brokers out there also, how are you coming up with the asking price? What is the sweet spot?
To all the buyers, what have you been doing during diligence and or tactics to win deals in this environment? Are you losing out to buyers paying for the upside?
You take in-place and then add your own assumptions for capital improvements and the correlated increase in rents. Then project out with a DCF and see if the asking price yields an IRR you are comfortable with.
My team presents the in-place NOI as a picture of where the property is currently at. Very rarely we will include value-add income in the ‘in-place’ column as well, but we make it very obvious so that buyers can exclude those amounts if they’d like. Generally, though, we are only putting those drivers in year 1.
They take a return IRR or EM for the amount is needed to get there. Obviously most just slap a cap, and only use the cap rate method as opposed to the IRR and NPV, DCF method.
So you have the in place, noi, and stablized(proforma) noa, it is your job as an underwriter to back into the acq price based on the work the needs to be done to achieve your investment hurdles.
Sellers tell brokers the price they want, brokers back into the bullshit they spew in the OM. You and 5 sophisticated groups bid but some dumb wit syndicating capital for fees bids a 2.25% cap rate. Boom you’ve just wasted half a week.
Generally just try to ballpark the assumptions to comps. Like if seller is pitching a MF asset with 9% rent growth YoY in the model, but we already own an asset down the road getting 4.3% YoY growth, we know they’re full of shit (unless that asset has something specific to command higher rents, prob not)
Take haircuts accordingly
A lot of times if brokers know we're serious buyers we'll get financial statements from Yardi. It's crazy to see how far off NOI on OMs vs financial statements is.
In-place NOI is your starting point (always verify against the historical operating statements the broker provides - if none are provided request 1-2 years, if they refuse then run).
My advice? Completely ignore the broker's proforma NOI. 99% of the time there are sneaky assumptions getting them to that level. You need to underwrite your own assumptions based on your firm's market knowledge/research. Then once you've forecasted cash flows you can run a DCF to see what your maximum purchase price is based on your firm's returns criteria.
If you're in the ballpark relative to asking price, you're probably in a position to make an offer. If you're way off, it's always worth a conversation with the broker to say "here are the issues we saw with your assumptions and this is where we are coming out to price-wise - what are you hearing from other buyers and will we be competitive at this price?".
If you're in the ballpark, you can also always make your bid more competitive by being creative - you can have earn-outs based on achieving NOI hurdles, offer higher pricing upfront but require the buyer to hold cash in escrow to bridge NOI to an agreed upon proforma NOI while you integrate the value-add program, etc. etc.
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