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1. Only a fool would underwrite present inflation and submarket rent growth throughout a full hold period. The conservative way has and will always be to underwrite long-term CPI (~2%), maybe 3% at the top end. If you have supreme conviction you might push that a bit, but 7% would be suicide.
2. We get forecasts from several lenders and use those in conjunction with our own judgement.
3. Exit cap depends on asset class. Mostly focused on MF where we're just assuming exit caps at a 50-75bps spread over today's cap rates.
What about spiking rents up front, so say 7% year 1, 5% year 2, then 3% thereafter?
Do most lenders have these? Should I jsut reach out to our relationships to determine?
Aggressive year 1-2 inflation is how a lot of the big multifamily shops are competing for deals right now (along with their favorable lending terms due to the scale of their businesses), so that's not unreasonable. If you're going to do that though I would underwrite 2% into perpetuity and not 3% to be conservative.
Most (all) major banks will have an economics team that prepares regular rate forecasts, they're usually available to clients with strong relationships at no extra charge. Definitely worth asking your primary lenders.
What's the rationale for assuming exit cap rates are 50-75 bps higher in MF?
Because assuming they stay the same or compress is irresponsible underwriting regardless of asset class. We're mostly looking at long-term holds so we assume a larger spread over 10 years. If it was a 5-year project we'd probably use 25bps.
To clarify, it's irresponsible because nobody can predict where the market will be in 5+ years, all we can do is guess. A neutral guess, assuming nothing changes, would be that they stay the same. But things change, the property itself ages and begins to deteriorate, and will be less competitive with new product. Thus the applicable cap rate rises regardless of market conditions.
You’re rent growth goes up to 3% but also your expenses are rising at a clip of 3%. All relative. Although revenue is increasing in aggregate, is everyone matching expenses to their rent growth?
I've been pegging the two together, but if both revenue and expenses grow at the same rate, NOI will also grow at that rate, and NOI growth of 2% vs 3% definitely makes a difference in the model - expense growth of the same % doesn't always mean the assumptions are conservative.
Cap rates compress when the fed hikes (at least historically). Rents grow faster than trend as well. We are underwriting 50 bps over spot caps on exit for merchant deals and trending rents at 1-3% YOY.
Why do cap rates compress when the Fed hikes? Is this consistent across all asset classes?
LOL brokers underwrite 5% year 1-3 rent growth already before the inflation hit.
On a serious note, we are not buying anything right now. If you are disciplined you should underwrite a 25-50 bps cap rate expansion for a 5-7 year hold, but that won't win you any deals. There's always this guy who plans to hold the shit forever and doesn't give a cent about inflation. They really don't need to worry about what the next buyer will analyze the deal.
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