Rental Model - Value Creation (BTR, Senior Rental...)
Quick question regarding BTR and Senior Living (Rental only).
From a developer + operator perspective, how would you model the returns?
Struggling to understand the value creation here. Let's say company A develops a building thanks to equity provider + construction loan then once reaching a certain level of occupancy refinance with better terms (LTV vs. LTC and potential better rate let's say).
In a classic deal that refi would improve the IRR but this IRR would be awful without an exit event (sale). I've tried to model a quick BTR Development and I can't get any positive IRR without an Exit Event (Unless I keep the asset for like 25y).
As in this example the developer also operates this scheme. How does the Dev/Operator make money?
I get the idea of having stable inflation linked CF (in some cases much higher than typical rent in the same area) but without an exit, isn't it hard to make returns aligned with the development risk and as such reward the equity provider?
Is there an in-house sale? Is it only a long term game?
There must be an easy solution here I don't get, thanks in advance guys!
(More than happy to see any modeling test regarding BTR / Rental ideally including a refinancing, have several case study from different group to share as well (RE&Infra/Energy))
Not too familiar with BTR, but I would think it should be underwritten similar to any other development. Typical development underwriting would most likely assume a 3-7 year investment period with an exit at the end of the hold period. My current firm develops and holds long term, so the focus is more on ROC, but we still include IRR/EM metrics for a 5 year investment period.
Focus is more on annual yields with any type of holding strategy - ROC and cash on cash.. With a development you still want your stabilized development yield to have enough margin for the deal to make sense, but IRR and MOIC are less relevant. If you're building to hold, you're doing it because you want the cash flow.
That being said, I've never heard of someone NOT underwriting an exit event. Usually you'd use a 10 year model and assume an exit in 10 years to have an illustrative IRR.
Our development platform specializes in BTR so maybe I can provide some color on how we operate. We typically operate under the same assumptions as a general multifamily development in terms of construction loan to refi and then underwrite a sale event at year 10. However, since BTR doesn't need to be all delivered at once and THEN leased up, you can do a delivery schedule based lease up with leases coming online as units are built across the site (assuming your leasing team is able to lease up in pre leases and while units are being delivered). For instance, we have a only a few units online with most of the site still going vertical, including finishing clubhouse, but we still have some tenants moved in and quite a few others signed leases and even more applications. Because of this, you can have less capitalized interest as you are able to start paying the loan faster when tenants move in before the last unit is delivered.
Outside of that aspect, it's pretty standard with any other MF underwriting process. We go from construction loan and all that entails, then once we hit stabilization, usually around year 3, we refi into either HUD or traditional financing and pulling out a lot of capital then and start cash flowing. Then we underwrite an exit of the deal in year 10, but we typically like to hold onto our developments long term so that's merely a formality to show investors since we would, in a perfect world, refi the property endlessly until you pull out all your capital and just have "infinite" returns on the cash flow and capital events.
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