I thought this might be an interesting survey to see what the actual IRR for an investment was, versus what we underwrote that investment at. I imagine that many of us are underwriting with aggressive assumptions in order to justify the investment, but most of the time those assumptions will not materialize because otherwise in a competitive market one would never be able to win a bid. At least this is what I am observing in my market.
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I’ve found that our underwriting is always super conservative. 9 times out of 10 we’re crushing our UW returns for the sole reason that we’re super picky when it comes to acquisitions. If you only buy the needle in a haystack deals then the returns are always killer. If a team has to play with assumptions to ‘make the light turn green’ then are you really doing your fiduciary duty as an acquisition officer?
Feel this way about my shop as well - we look at a ton of deals but we only aggressively go after ones where there are no questions as to whether it’s a great deal vs just a good one.
Because of that we’ve historically absolutely demolished underwriting.
At a developer so a little different and longer time horizon than acquisitions but each everyone else saying you have to have conservative UW to be successful long term
For example we recently had an apartment deal stabilize and sell for around a 3.6% cap and we UW initially at 5.3% cap - blew it out of the water on that one but always need at least 50-75 bps spread between spot and exit cap rate to feel comfortable
why do you think it sold for a 3.6% cap when you assumed a 5.3% in your underwriting? cap rate compression has saved 80% of investors in the current cycle and with inflation or projected growth of ~6%, groups are forced to use 5-7% rent growth the first couple of years to buy deals. Even worse, groups are using bridge debt. Pretty soon, it will be multiple of revenue than NOI to buy multies. The market is on fire and groups buying in the south east, phoenix and certain coastal markets are getting extremely aggressive to buy deals. Not sure you can have 7% rent growth for the next 5 years and additional cap rate compression with a SHIT LOAD of new supply coming online across multi, SFR, and for sale product. In today's world, everyone is underwriting high 3's or low 4's exit cap.... if you are using 5% cap, that means you are assuming crazy YoY rent growth or it's a wealth preservation play with only 2-6% IRR on paper. I honestly don't know how some of the institional groups buying turn key assets are making money without making up BS in their presentation to limited partners who don't have a clue.
So there are a lot of different aspects to your post - I will try to break it up best I can
First - it was able to smell for a 3.6% cap just based on market dynamics and cap rate compression from when it was initially UW - however if this deal sold for a 5.3% cap we would have still hit our return thresholds - just a difference of making a 50% IRR compared to a 100%+ IRR (GP piece)
Second - I would have to disagree with you on cap rates not continuing to fall - there is so much capital chasing RE deals right and access to capital has always proved more important to cap rates than the Fed changing interest rates (in institutional RE at least, can’t comment on mom & pop and single family home purchases)
Definitely think in the next decade we could see a race to the bottom in cap rates and definitely room to move lower - if you just look at Europe a lot of deals in major cities over there sell for sub-2 caps. I still strongly believe you need to be UW at least a 50-75 bp buffer to spot cap rates in the current climate to feel conservative with your UW
You’re running development deals with a 50-75bps spread? Sheesh… we won’t even look at less than 100 unless we have an institutional partner that REALLY wants to do the deal.
So if you just sold a deal in the same city at a 3.75% cap when you UW another deal in that city that will stabilize within 4 years you are UW a 4.75-5% exit cap? Are you able to find deals using that range?
Deal 1 - UW/LIRR - 20.25% Actual - 0% (Shit Happens)
Deal 2 - UW/LIRR - 14% Actual - 9.8% (Current)
Deal 3 - UW/LIRR - 6% Actual 5.5%
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