How do you determine a cap rate for an acquisition of a mf property currently in lease up (14% leased)? Should you derive an NOI from annualized current income based on 100% of units and use stabilized expenses and debt?
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Are you buying the property as is, or is it a forward sale where you close once it is stabilized?
If the latter, just value at market cap rate based on stabilized income. If the former, you shouldn't be giving them a ton of value for empty units. You can value stabilized income at a significant cap rate premium to account for lease-up risk, or run a full DCF.
We are buying as is and taking responsibility for lease up.
I like the “value stabilized income at a cap rate premium.” Do you mean, take stabilized NOI / purchase price = cap rate + premium?
Ex. 4M NOI / 63M = 6.3% cap + -2% = 4.3% ???
Theres certainly value in the empty units… throw the cap rate approach out the window in this scenario. Use your market assumptions on the lease up and take NPV to get your purchase.
Take NPV of stabilized NOI?
Every outfit is different but typically you would value it on a reversionary basis and tailor your return to suit that of the market risk of leasing it up. Alternatively you could just value it as if it was 100% leased up then deduct any void/lease up costs associated and offset it against the purchase price.
Can you show this in a quick example?
Two metrics.
1) untrended return on cost. Let’s say the market cap rate is 5%. Developers will aim to built to a 6.5%. This is a lease up, so while risky, not quite as risky as development. So maybe your purchase price is a stabilized untrended return on cost of 6%-6.25%. Therefore, you’re making 100-125 bps for taking the risk.
Method 2: what’s a 5 and 10 year unlevered IRR? Speak with the brokerage community. See what buyers are underwriting to. (In a nutshell, this is the inverse of your discount rate for NPV). Are you happy with a market unlevered IRR (or hopefully it’s a good deal and doing better). The reason I say to look at unlevered IRR is because everyone gets different debt quotes. If you always look at unlevered IRR, you are looking at a deal apples to apples each time.
^^^^^
100-125 BPS seems like a hefty spread, I'm not sure just a lease-up is risky enough to warrant that high of a spread. Developers often look for 150-200 BPs of spread for entire projects, which can include entitlements, design, construction, AND lease-up. LMK if I'm off base here but that's the way I see it.
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