What are some asset level characteristics/parameters that you'd want to see in your ideal value-add property prior to acquisitions? Feel free to use any property type that you're familiar with.
I heard this question asked to an office investor. He said his ideal property would have (1) great location & market, (2) a building 60%-70% leased, (3) a capital impaired owner, (4) a cap rate of 6% or > on in-place NOI, and (5) a reasonable assumption that you can exit at a sale price 20%-30% below replacement cost. (there may have been more but I can't remember)
I thought this was really interesting so I wanted to make a thread to hear what other people this.
Think I heard this same conversation, can't remember the podcast. I think those are fair metrics for value-add aside from the cap rate which obviously is going to vary drastically depending on asset class. Right now if I was buying open-air grocery anchored retail I'd want 6.5%+, enclosed malls 10%+, and apartment at 5%+.
I do remember thinking about his comment regarding the deal working with an exit below replacement cost and it's something so obvious that I had never really considered actively in assessing deals before that. I don't think he said 20-30% below, but regardless it's a great sanity check. If my deal pencils but I'm exiting at greater than replacement cost then my assumptions probably aren't realistic - but that being said there's obviously exceptions to this. If it's exceptional, irreplaceable real estate that can't be replicated within that submarket, then its less of a concern because you CAN'T replace that asset.
Why is exiting below replacement cost important?
If I can build a brand new building for less than I can buy one that is going to require more capex over the same time horizon, assuming that new building can be sold at a premium over an older one, why would I choose to pay more for the older building?
In other words, is my exit assumption realistic if I'm exiting significantly above replacement cost for an asset? Will buyers down the line actually pay that much for something that will be 5-10 years older than when I'm buying it? Maybe, but it's just another element of risk.
Any apartment (in my market- tier 1-non NYC) needs to be at _>5.25% for us to seriously look at it
Lol it was probably from the same podcast! I listened to it on a flight but I can't remember the name of it. It was a great podcast though.
1) Strong market fundamentals 2) Below market rents 3) Vacancy 4) Short-term leases 5)Area that will experience population growth in the future 6) Poor physical condition
What do you mean by cap-rate of 6%? Like an in-place cap or an ideal exit cap? I am not on the acquisition side so I always assumed value-add and opportunistic deals are evaluated using DCFs because cap-rates signify bond-like returns.
Usually will look at 5-10 year cash flow and see where IRR stands with exit cap being determined by some expansion factor being applied to todays market cap rates. But what I and my shop prefer looking at is yield on cost for value add and dev. Get rid of all of the exit cap and rent growth noise and just really see where untrended YOC shakes out.
No I'd actually argue most value-add and opportunistic investors tend to evaluate on a direct cap valuation and keep things back of napkin. That type of risky deal needs to work at a high level analysis and if you can't make it pencil with handwritten numbers it's probably not worth the risk.
It's usually "can I buy this at a cap rate that is higher than what I think the asset is actually worth" and from there a lot of value add investors will actually assume some cap rate compression or at least keep it flat, whereas in a lot of other deal profiles you'd assume expansion.
Lot of good points here. I’ll add three items from recent deals: (1) property characteristic that scares off other buyers - structural repairs, asbestos, environmental issues, etc, (2) some market or zoning constraints limiting others from building similar product, and (3) most important to me is a lead on a new key tenant.
Lots of good stuff here - like most people, my shop tends to dedicate a lot of time in understanding why we think the the market is mispricing the asset and deciding for ourselves whether those reasons are legitimate or unwarranted
Common themes we like to see are: (1) is this a market where institutional capital can't play, but has strong fundamentals / is on a path of growth? (2) has the asset shown strong performance historically, but has been underperforming due to an unsophisticated or undercapitalized sponsor? (3) can we execute on the value add / business plan? does it align well with our core competencies as operators and do we have the track record to substantiate this?
Synthesizing all of this - it's really asking ourselves whether "the juice" is worth the squeeze? i.e. are we going to be well-compensated for the time / money / effort that this investment is going to require? are there better opportunities out there that require less? this is where risk/return comes in and understanding whether the range of outcomes are favorable for us
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