LP folks..how do you go about your UW?
Say you get a deal from a Sponsor for a development that is asking for X in LP Equity. They provide you their investment memo, underwriting, and maybe even their full model with all development budgets and projected CF and returns.
What do you do now? Do you do your own market research and validate their assumptions? Build your own model? Just tweak their model for different risk/downside scenarios?
Assuming I like the market and the returns being projected are in line with what I was looking for. I would do a quick return on cost analysis to validate it. Start with taxes (usually first deal killer), than check their expense assumptions. If I agree, and haven’t had to kill the deal yet, check revenue assumptions and see if I agree. If I still agree, and the ROC meets my needs to hit the returns I would want, I would next pop it into my model. I wouldn’t use their model as people sometimes calculate things, or look at things, differently, and I want to make sure I’m looking at things apples to apples. For example, my last firm (a PE firm), used to re calculate taxes on sale. But many people don’t do that. So if I just used the sponsor model, it wouldn’t be apples to apples how we looked at the deal.
The above process is what I used when I worked at a Life Co and the PE firm. Currently at a developer.
When you say pop into your model..would you have a full on development model or a more simpler model just mainly with the projected CFs and returns analysis?
By pop it into my model I meant put it into the firm template model. We had a development model for development and a non development model for the value add, core plus, and core investments.
Assuming it’s in a market I’m familiar with, I’ll check the value assumptions first. This kills a lot of deals straight away as it removes deals priced to perfection. Assuming the values stack up, I then compare costs and timelines to similar deals we’ve underwritten in detail or invested in. If these are noticeably different I’ll discuss with the Sponsor to understand them better and see if it’s justified or if they’re overly bullish.
If it’s a market I’m not familiar with, I’ll do my own market research to get a feel for the values and costs. It’s easy for a Sponsor to cherry pick comps to support their case, and there’s plenty of ways to support cost assumptions too. The vast majority of Sponsors are credible and transparent, but we also look at special sits and hairier deals so you do need to sift through materials from more questionable or less experienced Sponsors and validate their assumptions.
Ideally the Sponsor has a decent model which I can use to flex key assumptions for the initial screen. If they don’t I’ll quickly run the deal through my own screener model. If the deal looks good and we want to progress it to IC, I’ll then run my own model as it has all the outputs I want / I know how it all flows together reducing risk of unforeseen errors.
If they sent their model, mess with it as a quick screen if the returns are still there you do the usual underwriting 101 stuff
Then throw it in your model adjust accordingly to your assumptions in your own vacuum.
Often times my own model has more carry costs less aggressive lease up etc. and at this point if the deal still pencils you turn to what the GP is expecting in regards to terms in the deal. If they’re going to assume cost overruns etc it’s not as big of a deal you’re Golden.
Then convince a partner or IC member that this deal is amazing and they came up with the entire proposition boom you submit a term sheet and it all goes up in smoke cause the deal is actually in greentown khazikstan not greentown Kansas, get chewed out and move on to the next deal.
Yeah but did you share the potential for hard cost arbitrage (couple guys with AKs, nobody gets hurt) in Kazakstan with your IC?
“You didn’t you f’ing rtard, now find me an institutional developer in the sunbelt that want the same terms”
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