Unlevered IRR - Return Spectrum?
How do institutions/LPs look at returns from an unlevered IRR basis? I understand LPs generally target a net levered 6 to 9% for core, 9 to 11/12 for core plus, 13 to 16/17 for value add… and anything 18%+ for opportunistic, but are LPs also looking at it from an unlevered IRR basis? Are there similar goalposts for unlevered IRRs?
Thanks
Yes there are. Generally you’ll hear institutional investment sales brokers quoting 5 year and 10 year discount rates. Those will generally be the goal posts. As leverage is effectively financial engineering, and one firm may receive different debt quotes than another (leading to different return projections), unlevered IRR is actually how you should look at every deal. For instance, if a value add unlevered deal generally produces a 7-9% 10 year IRR, and you found one that produced a 10-11% 10 year IRR-you may have just found a mispricing and you should do the deal. However, your debt quote may only get you to an 17% levered IRR but your competitor gets a better quote getting them to a 18.5% IRR. Leverage is engineering. You should always look at unlevered.
Spot on.
Thanks! This is super helpful. Would you say unlevered returns for core/core+ is generally 4 to 6%? Value-add 7 to 9%? And anything above is opportunistic?
It's been getting higher, and that is really just a function of debt getting more expensive
Yes, it's often referred to as "Project Level Returns". In other words it tells you the actual projects return on a stand-alone basis, not accounting for gains from leverage or promote waterfalls.
It's a very important metric as you want to make sure your unlevered returns demonstrate a healthy spread to your debt interest rate, otherwise you're at risk of experiencing negative leverage and in extreme cases, default.
I think Project Level Returns are the levered returns prior to the waterfall. From my experience it’s usually still called the Unlevered Returns/ or Unlevered Project Level Returns. If it’s called the Project Level Returns by itself it’s usually the Levered. Agree on the rest of your points though
Thanks everyone for your input. My question still stands, what are the “goalposts” for what unlevered IRRs should be per core, core+, value-add, and opportunistic?
Thank you!
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