What are the most important aspects of an offering memorandum/offering memorandum?
To all the analysts/associates/VP's at debt and/or equity real estate investors, what are the most salient aspects of an offering/financing memorandum and which aspects are typically ignored?
To provide some context, I work as an analyst at a top capital markets shop in a major US market and a primary component of the job is to put together fancy OM's to present to prospective investors. However, a lot of the information--especially market and location overview section--in the books we create merely uses selective data/statistics to paint the opportunity in the best possible light. Granted, our job is to sell the opportunity so I get that part. But given that there is a clear conflict of interest when it comes to how we are presenting the data and investment opportunity, it seems that if I were an analyst/associate on the lending or principal side, I would take broker OM's information--especially the market overview sections--with a huge grain of salt and default to third-party data providers for primary market research.
Nevertheless, I also get the sense that the OM is more about making sure the client is happy rather than producing a book that investors are going to heavily rely on--again more from a market perspective--to determine how to underwrite a particular deal.
Therefore, I would just like to get a better sense of what parts of an OM actually matter to a lender or equity investor and which parts don't matter--or at least are not as important as the most important aspects of the OM. MonkeyWrench I'm particularly interested in your perspective given your experience on both the sell-side and principal side.
I pretty much look exclusively at the rent roll, physical characteristics of the building, executive summary, and the financials. A lot of the other stuff is unnecessary unless it is in a market that I am unfamiliar with. Even then I typically do my own research rather than just look at what the broker sent. The Argus model is helpful as well for reference, but I always build a new model as I don't trust brokers to not try to sneak something into their model that moves the needle. It is expected that the information coming from the brokers is biased.
financials and executive summary should give me a feel for the situation.
For a lender, tbh I really only need the rent roll, historical operating statements/proforma in excel (please no pdf). Thats it. I dont even need a proper OM most of the times in order to send you a quote. All the other market info, sponsor info is really fluff that can be summarized in a few sentences in an email. But I totally get that preparing a 30 page OM is one way you can justify value and show the sponsor that you have spent hours working on the deal, so its fine and we all have to do what is expected of us.
For equity investors, I would imagine you would need to send more comprehensive info and just the rent roll and the historicals is not going to cut it.
I want as many years of operating performance as you have, rent rolls, co-tenancy provisions, rent escalations, anything unusual in the leases, which tenants are credit tenants. If you provide market/demographic data then I want the sources so I can easily verify the information.
It really depends on the deal. If it's a stabilized core asset, for example, there will be different capital looking at it than a value-add / opportunistic deal profile, and therefore there will be different pain points/risk mitigating factors that an investor would look or would want to be addressed in the offering materials.
On the principal side from start to finish...
- Investment Highlights / Summary: I'm reading this to get a feel for the asset, size, submarket, class, finish, etc.
- Physical: I want to know the age of the property and all major systems to help determine what kind of deferred maintenance we need to consider.
- Comps: I typically breeze through these, but sometimes use them as a starting point. We play in markets that we know pretty well and some of the broker's suggested comparables are so far off you just have to laugh. Regardless, this can help us understand appraisal for tax purposes and other useful details.
-Financials: I spend a lot of time here, especially in due diligence. Also, I've found it helpful to take the broker's YR1 NOI and cap it where we've seen comps trade. Multifamily NOIs are always way off, but this gives us a good idea where pricing may end up if we haven't been given guidance.
I pay almost zero attention to what the broker says about rent growth potential, suggested value-add, submarket characteristics, top employers in the area, or what speculative development has been announced on a 15-year horizon with accompanying renderings. Unlike the above, we actually take the broker's Argus run and make our underwriting tweaks until money goes hard. If we find any trickery in DD, we have reasonable grounds for a retrade.
How long do those OMs take to pull together? just curious.
Never in a million years would i ever let an analyst put together an OM, though i do see it done on the debt side all the time.
If everything is done (UW, research, etc.), we typically spend 1.5 weeks on them. Couple hours on content and ship to graphics, they typically take about a week to format everything in ID. Usually stick with the same 3-5 templates for the year, and our marketing staff revamps every 6-12 months. We actually listened to the market though, and cut our books down to about 20 pages on average. I know firms that spend MUCH more time on them.
This is literally impossible to conceive if you work for a high producing team. Who in their right mine cares enough about the OM's if your sourcing deals and closing? My MD's would literally lock us in a room and say "see you in a few days have fun" and go heli-skiing with clients.
Question for everyone. I have a case study for an interview and the task is to compare two (real) offering memorandums and corresponding models and assuming I had to choose one of the development projects, which one and why? One page write up explaining my decision. How would you guys approach this? I'm planning on focusing more on the qualitative aspects of the OMs since models are mere projections however, also paying attention to projected IRRs and returns. Thoughts?
The answer might partially be determined by what kind of firm. Brokerage...acquisitions...development...debt...etc.
It would seem that the point is to choose the better investment. I would think that would require assessing the financials...potential risk factors...market...and overall business model. I would determine whether the models and projections seem plausible. And then note any items that seem out of place...and perhaps list some of the outstanding issues that were not adequately addressed in the OMs while selecting which investment seems the most prudent based on the information available.
In my mind...you would demonstrate your competency by not only pointing out what's right with the potential investments...but what's potentially wrong with the OMs. Are they overly optimistic and unreasonable in their projections (spoiler alert: that's often the case)?
They might be looking to see if you're able to pick apart and question the assumptions when vetting a potential deal. Again...the focus of your response is likely tied to what kind of gig you're trying to get.
Sell-side: suggest cranking rent growthBuy-side: shit all over rent growth
Speaking from the multifamily side, there are a handful of specific items that bug me:
Floorplan/Unit mix detail - when an OM says "X% of the units have been renovated and are achieving $Y premiums", without any breakout or direction as to which units in the rent roll have been renovated. I have seen some OM's that don't even have a unit mix. This should be standard. I find emailing the analyst and copying the MD results in quick turnaround.
Tax millage rate breakdown - providing a comprehensive list of each taxing authority and current millage rates helps tremendously. I don't see this often.
Data Sources- I typically like to use info from the OM for our internal writeups. If an OM says: "X submarket has created over 5,000 jobs in the past year", I would like to see the source footnoted for that statistic. Many buyers adhere to SEC regulations that require them to back up their assumptions with sources, and "taking the broker's word for it" is unfortunately not a source.
History of Asset - I've seen some OM's that have a brief section on the asset's developer and subsequent ownership history, and any major physical improvement projects. I wish more would do this.
Edit: another thing that just came to mind...if you are going to outline the property over an aerial, make sure you take a look at the survey and are reflecting the boundaries of the property correctly. Can't tell you how many times property outlines are inaccurate. Damn, it's a broker's business right now. We need a market correction to flush out this laziness.
Care to expand a little bit more about the SEC regulations for sources? Who has to abide by this? Where can I read more about the rule?
To manage investment vehicles of pooled investments you must register with the SEC as a Private Fund Advisor. Once this is done, you now have a fidiciary duty to your investors, and any documentation you send to your investors (including investment memos, quarterly reports, etc.) must be carefully vetted, "You must employ reasonable care to avoid misleading clients and you must provide full and fair disclosure of all material facts to your clients and prospective clients".
You hit on a key point...the information/data in OMs are selectively curated to make each investment seem like a complete homerun. People on the receiving end of OMs should always question and verify the information.
I am on the development side. So we prepare OMs to pitch investments to equity and debt providers. While those on the equity and debt side can offer better feedback on their preferences...in my opinion...the following info is the most helpful...
Brief executive summary that highlights the overall investment thesis with bullet points.
Aerials...site plan...renderings...pictures in order to get a sense of place and feel for the scope of the deal.
Land comps...sale comps...rent comps...and demographics (1 mile/3 mile/5 mile)
Full pro-forma...not just an overview...but one with line item costs that includes all of the assumptions...and shows two exit strategies.
Really...apart from visuals of the location/project...the pro forma is the only thing that is needed if it is comprehensive. We have a standard Excel template that includes 12 sheets of data. Since we do MF development...we do not use Argus.
All of the decision making information is really contained within the pro forma model. To that end...we will often just do an executive summary (with a few graphics) and send our Excel model.
As an FYI...our model includes comps...justification for tax projections and utility costs...FF&E breakdown...sensitivity analysis...justification for projected debt rates...breakdown of the cost of each employee (operations) and the phasing of each employee start date...absorption rates and turnover rates...closing costs...monthly construction draw schedule...project timeline...market capture rate...A&E breakdown...breakdown of permits/fees...justification for construction costs...etc.
Agree with everyone's responses. Pretty much cover it all.
Aerials and trade areas. Rent roll/lease abstracts. Financials/Argus.
We just need the broker's fluff to incorporate into our memo.
Everyone else will be tweaked and incorporated into our deal structure (debt/equity)/agreement.
As an underwriter at a Bank, the more info/color you can provide on the financials and operating history the better. I would assume most analysts would have access to CoStar or REIS for market data, or opt to wait for the appraisal to come in. Personally, I also like a nice comprehensive background on the sponsor(s) and management team. Any info on past/key projects always helps with the comfort factor.
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