How do you think about % IRR from operations vs residual?
I’d be curious about how this is thought about from investors across property types and strategies. I work at a brokerage shop and we usually don’t think about this and the fact is our values are usually heavily weighted to residual even on stabilized core deals. For a stabilized core MF deal, what % of the IRR should come from residual / operations? Honestly any verbiage would be appreciated thanks!
Based on the most helpful WSO content, the split between IRR from operations versus residual value can vary significantly depending on the property type, strategy, and deal structure. However, here are some key insights:
Stabilized Core Multifamily (MF) Deals:
Value-Add or Opportunistic Strategies:
Investor Preferences:
General Observations:
If you're working in brokerage, it might be helpful to analyze past deals to see how the IRR components break down across different property types and strategies. This can provide a clearer picture of what investors in your market are targeting.
Realistically, as much as possible should be from CF than exit value - easy to see why, you have a lot better insight into cashflows especially if they're from contracted leases vs. cap rates that might blow out substantially as they have L5Y. For core deals it should be 50/50 from both, as you slide up the risk scale it can stretch closer to 85/15 exit/CF at the opportunistic level. Now obviously for core deals like the MF deal like you're describing, the IRR you arrive at to hit that 50/50 really only works for actual core buyers with low cost of capital, we're talking a 9%-11% on reasonable underwriting.
I would also say that the 50/50 applies across property types because it's a result of risk and how much work you're putting into the property. You'll obviously take more risk and need more return to do a half-empty office deal than fully-let industrial, and more of that return will come from the work you put in leasing the rest of the office and flipping it than collecting coupons from the industrial.
What also needs to be considered is hold period - a 10 year hold of a core asset with 50% of profit coming from cash flow pretty much means it’s an average 5% cash on cash. That’s pretty weak sauce.
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