Might be a stupid question but acquisitions guys, how do you determine an offer you will make for an asset?
I understand all valuation methods but was curious on the UW process. So do you run a DCF, get your NPV, and then plug in that to see what your IRR would be?
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When underwriting and creating DCF, you're figuring out what price will satisfy your return parameters, which can vary based on buyers (some want a 7% average cash on cash, some want a 12% IRR, some want a 12% net IRR to the LP, etc)
you're also usually making sure the bid price makes sense vs. comps, broker guidance, debt guidance...
ETA: to address your question more specifically, all models are different, but generally yes you're usually ultimately either playing around with a price input or discount rate/IRR input to get the most competitive price that will still work for you
It's funny, most DCF's I've seen completely omit the NPV calc, and are more LBO model focused on IRR.
You should hopefully have credit memos where it spells out minimum returns either internally, or what an equity partner would expect to see.
Agreed, I've never ran an NPV calculation on a deal. Maybe on some specific aspect of the deal (usually a tax abatement or future capex cost), but never cared much about the deal's NPV. The problem with the NPV calculation is that return expectations, at least for a value-add/opportunistic investor, can fluctuate wildly based on risk/market/asset type/debt/etc. I know in theory you could have a discount rate for all of that, but that's really hard to do. A lot easier just to run a DCF and discuss if the IRR is adequate for the deal and risk.
Not sure I am following. So how do you solve for an IRR then? How are you coming up with what your outflow of cash will be at closing?
Say I have zero guidance on pricing from a broker.
At our shop, we have a dart board in the big conference room. During DD period, we take turns throwing darts on there and basically just pick a number.
It depends on return hurdles you need to meet. You'll see what broker guidance is and if you can hit your hurdles based upon that guidance. With that said, in the institutional space, you generally know, for instance, that pre-2020 (pre-pandemic), NYC core office, traded at a discount rate of approximately 6% over 10 years. So when underwriting core NYC office, you knew it would probably pencil to that. If it was less, that wasn't a surprise, if it was more, you were probably missing something, or underwriting aggressively. Although many firms don't necessarily look at real estate in this way, if your firm takes the 'academic' approach, investment committee will be asking the question of what are current market cap rates and discount rates. There is a market for this, and the institutional brokerage community releases reports on what IRR's people are underwriting to today. Appraisers track this information as well.
In terms of solving for NPV, one of the things I quickly learned was that many people don't underwrite to an NPV like you might learn about in school. However, when you think through it - underwriting to an IRR is effectively telling you what the NPV is. If you underwrite to an unleveraged 7% IRR, the discount rate is 7% at that purchase price. So it is effectively another way of getting to the same end goal - the NPV.
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