Underwriting / Scenario Analysis
For those in underwriting / acquisition roles.. how much scenario analysis are you doing for a single deal? It seems like our team cranks out an unreasonable amount of scenarios and iterations of the model just to tweak a combination of assumptions that can't easily be set up in a data table. I get that running scenarios is part of the job and is crucial to understanding the different ways a deal may or may not work, but I can't tell if this is normal for everyone else or if our VPs and directors are just making extra work and missing the big picture
That's very normal, especially in a world that interest rates are changing constantly, costs changing constantly, purchase price changing, leverage changing, market rate rents fluctuating, and target returns for equity partners are a moving goal post. We might run several dozen models for a single deal. For example: if we see that market rent decreases month over month then we might run multiple scenarios including 1. Base model with the new rents 2. What opex do we need to be at to get the same returns assuming rents are not going up 3. What level of leverage can we be at given DSCR or debt yield constraints on deals 4. What the cap ex has to be at to get acceptable returns 5. What purchase price can we retrade at potentially to get back to acceptable returns.
Those are just the base 5 models that we might run given a simple change such as rents moving. We might also run different models for all of those if we are comparing debt quotes that vary slightly from different sources. I would say that in acquisitions and underwriting in general is better to run too many than not enough scenarios since you would rather have an idea of where your investment could be at any given point and make the most informed decision as possible. Is it fun? No. Do most scenarios ever happen/realistic? No. But without knowing all possible scenarios you might run head first into a deal and the worst possible scenario happens that you didn't model and all of a sudden your firm takes a massive hit both financially and reputation wise among capital allocators.
Less is more.
Too many scenarios and will be more difficult to compare various opportunities.
Typically before control:
1) As accurate of a pro-forma as you can and look at project level IRR / EM
2) Business plan — how much rehab if any, lease up tempo, etc. This will affect capital stack.
3) Distressed scenario - how bad can things get and still be able to refi if you have to hold?
4) If asset type or tenant replacement is more complex, need to model those out.
Post control
Additional scenarios are run to help with the equity raise and answer investor questions.
Some investors will care more about the downside; otherwise will care more about upside.
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