Joining a New RE Shop- Evaluating Their Underwriting Practices
I am in lengthy discussions with a relatively new acquisitions and AM shop (towards the end of the process). I've asked to be walked through some deals they've done (10 so far). I'd be quite senior and handling a lot of the AM strategy.
I am curious what questions you'd ask to ascertain their underwriting behavior / their implementation of best investing practices you'd want to (ideally) see? What about their numbers, assumptions or what they say should raise a red flag?
I'd say I am most weary of joining a shop that employs ignorant investing behavior (nothing so far has sketched me out) so signs of that would be most helpful.
TL;DR - how to sus out bullshitters vs methodical investors
All insight is appreciated!
To evaluate the underwriting practices of a new acquisitions shop and identify potential red flags, here’s what you should focus on:
Assumptions in Underwriting:
Risk Assessment:
Deal Tracking and Feedback:
Diligence and Data Scrubbing:
Debt Strategy:
Investment Mindset:
Red Flags:
By asking these questions and observing their responses, you can gauge whether their underwriting practices align with best investing principles or if there are signs of ignorance or recklessness.
Sources: Acquisitions Analyst Advice - New Analysts, Contrarian Thesis: Acquisitions is the Least Interesting Job In Real Estate, Anatomy of the 10-K, Stuck at Current Firm, Moving from Appraisals to REPE Acquisitions?
I would ask about their due diligence process and how that translates into their acquisition underwriting. In my experience acquisition teams tend to underestimate opex / R&M and capex significantly, but that can be product type dependent.
Thanks, that’s helpful. Given they’re new & likely still establishing systems and processes, would you expect them to have strong / rigid process for creating a business plan for each asset? Is that something that’s typically baseline for a new shop to have? Trying to bifurcate what processes and behaviours a new shop should 100% have in place, without excuse, and items that come with time and aren’t particularly pressing up front.
I haven't worked at a new shop, but I would expect them to have the AM team (if they have one) involved in acquisition efforts. Too many times acquisition teams are pressured to push down costs to win a deal, and then AM is left holding the bag.
I’m curious - what would you consider “ignorant investing behavior” and what are the red flags you are looking for?
A lack of due diligence, emotional decision-making, or an overestimation of potential returns as examples. Suppose high level I am looking for signals of poor decision making that a seasoned investor would raise eyebrow to / asking what those signs may look like.
What asset class? Obviously the biggest things off the top of my head:
Hope this helps.
Thanks, very helpful. Multi-family and some student housing all in the NE. More value add than anything else. I come from a development background and therefore feel less privy to spotting underestimations, expense assumptions etc. that would be easily caught by a seasoned AM. Any good questions on how DD ties into their decision making and underwriting would be helpful.
You should be able to take a look at their underwritten capital budget done during DD and be able to compare it to what they've actually spent so far. Did they reserve the capital up front or are they pulling money out of cash flow to do renovations? How much did they budget per unit in renovation costs? Is it attainable? You used to be able to completely renovate a unit for ~$12,000/unit, but those costs have risen to upwards of $20,000/unit for a luxury renovation.
Other things - how do they look at concessions and vacancy? If they purchased a deal that has higher economic vacancy, are they appropriately burning off concessions? Are they factoring in higher vacancy while they complete unit renovations?
When it comes to asset managing - a lot of younger guys don't realize the amount of work involved and the AM can make or break a deal, as you can no longer rely on interest rates to bail you out. Operations are key. A good AM can tell you the 30, 60 and 90 day occupancy trend, what units lease out faster and which ones the slowest, what rent increases you're capturing on renewals, what on new leases, the overall resident retention rate, concessions offered in the submarket, the strenghts/weaknesses of the comp set, etc. They can also tell you how long its taking on unit renovations, how much they're costing, the timeline on major capital projects, etc.
When I was in asset management, I was constantly at the properties speaking with the leasing staff, walking the properties and inspecting them for any issues, anonymously chatting with residents, speaking with subcontractors.
Underwriting deals is the easy part. Execution the business plan effectively is a whole different story.
This right here is exactly what I was referring to above.
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