I'm curious what you guys are seeing/assuming in underwriting these days. My shop invests, develops and manages in tier II/III markets in the Northeast. We are seeing our actual expenses across our portfolio vary widely from what the market is assuming to get deals done. The biggest variance seems to be on taxes (no one pricing in potential for revaluation to chase sale price), R&M, Reserves and Value-Add per unit renovation costs. For example, we are looking at a deal now where the brokers are representing a $900/unit R&M figure where we are seeing closer to $1500/unit based on our contracts. Unfortunately this means our acquisition pipeline has been weak... our disposition valuations have been well above expectations for the same reason. Anyone else experiencing this? What are your per unit assumptions like for these variables?
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Underwriting assumptions vary shop to shop. The important thing is to keep those assumptions, or really the "philosophy," in line from deal to deal. Some shops slap 5% GV on every deal, some use current market in perpetuity, some use a reversion to mean GV. Some will underwrite assessed value to shoot to acquisition price on day 1 while others may allow a few years for the county to catch up. For MY replacement reserve some equity people use a flat 250/unit (and have for decades), while others use much much more.
I don't say this to be facetious but to highlight a point in that no one is working off the same numbers. The important part is comparing deal to deal keeping your underwriting philosophy relatively stable. It does management no good if an analyst is constantly changing how she underwrites deals. If you do, you're just tricking yourself into deals.
The market is aggressive but think of it this way, today to win deals you need to either under represent expenses, over represent revenues or settle for lower return, no one is feeling super comfortable with any deal they do today. If that's representative of three different types of shops in a vanilla deal they are all going after the same asset, with the same management plan. Their expectations are a little different but they will all ultimately end up in the same place. At the end of the day its just the justification for the deal that's different.
I guess what I'm trying to get at is if you've underwritten a lot of deals in a market using a certain set of assumptions and aren't winning deals no amount of assumptions from outsiders are going to help because you don't know to what return and holistic approach they are taking. It needs to be a much deeper discussion about philosophy with management. Should we be more aggressive in areas x,y and z even though that's not what our managed portfolio is telling us OR do you say look the last X number deals have traded y bps under our target, do we lower our target return to get these assets or move to lower quality product or lower tier markets to hit the same return.
But slapping on a lower replacement reserve without taking into account how you underwrite in totality will at best mislead management and at worst trick yourself into a deal you wouldn't have done otherwise.
This is less helpful guidance if you're a small owner who really doesn't look at the market often.
This is a pretty helpful framework. Thanks for sharing your insight on this.
250 a unit in reserves is typically a lender requirement
Assuming this is multi with the $/unit comments. What do you guys include within your UW R&M? $1,500/unit R&M very high. As a note, I’m on the debt side.
Agreed, $1,500/unit for R&M is high.
Depends on market and condition of the building, and planned capex.
If you're buying a MF building that was built in 1925 and hasn't had a serious renovation since the 70s, then 1,500/unit might actually be low. If you're putting a few million of capex in, then maybe it's too high.
I can tell you with confidence that older NYC housing stock can easily be $1,500/unit in R&M. Sure, slumlords get away with much lower, but even marginally responsible operators end up spending quite a bit. Just keeping building systems and envelope up to code can eat up a big chunk of that number, let alone maintaining the physical space. Doesn't even take into account contract maintenance (which I've occasionally seen as an R&M line item)
We include service contracts, turnover cost and general maintenance ie. hvac repair, plumbing, painting etc... Service contracts account for the majority of our R&M. Also as developer/owner/ operators we probably tend to over invest back into the property
And what’s your plug for payroll on a deal like this? These two spill into each other pretty often.
It’s kinda tough without knowing how many units, location, vintage, etc. That being said, if you’re talking about a 200 unit deal, and you’re UW R&M and Payroll at $1,500/unit and $1,000/unit respectively, I think it’ll be difficult for you to compete.
usually budget 250 a unit in ongoing R&M
R&M/Contracts/Turnover is typically below $1,000 per unit across our portfolio.
$1,500 seems really high, does that include and payroll?
That $1,500 does not include Payroll. What type of product do you own/manage? We are heavy in suburban garden style which could be a factor. Do you accrue for reserves?
our portfolio is mainly garden style 70s-90s product. Reserves are excluded from that number, we typically hold $250-300 per unit depending on vintage of property.
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