I'm doing a final project for a RE class and the assignment is to analyze the purchase of a grocery-anchored retail shopping center. The property isn't actually on the market yet, but our professor was able to get some materials from the broker who is working it.
Part of the material is an operating statement with projections for the next 10 years. There aren't any explicit assumptions (e.g., 2% rental esc for years x-y, 2% expense escl, or vacancy). They underwrote 0% vacancy for some later years in the projection, after several contract leases have expired (good location in Dallas, but seems pretty optimistic).
I'll probably just call the broker and use it as an opportunity to network, but I'm curious how monkeys in the real world like to go about sniffing out BS in a broker's pitch material.
I mean this is sort of where underwriting gets interesting - you have to almost make a bet on where you think rents/lease incentives/vacancy etc. are (or will be) in the market, and you have to have some sort of basis for these assumptions so that you can convince your capital they're true.
Personally I defer to the more senior members of my team on this type of stuff because they know the market better than me. We also have an internal leasing/management team that we'll consult because they have their ears more to the ground on the leasing market. Of course you can look at CoStar & broker market reports and whatnot, but a lot of it is future expectations which is harder to read.
You can use common sense to some degree. Like if a broker is uw rents that are way out of whack with in-place, you'll call him up and he better have a real answer, not just some generic "oh the market is picking up etc. etc." Or like in this case, 0% vacancy is kinda bs - frictional vacancy at the very least should be a factor. But keep in mind that if you're uw to 20% vacancy and the guy down the block is uw to 0%, you'll probably lose the deal to him. Sometimes you have to be aggressive within reason.
Yep. Therein lies the rub. You can be as hard-assed as you want in your underwriting, but at the end of the day your underwriting doesn't exist in a vacuum.
To the OP, you almost always underwrite vacancy when valuing a property, if for no other reason than to adjust for credit losses. With that said, in acquisitions (which is different than valuation), you have to use commonsense. If your tenant is McDonald's then you can go ahead and assume that the tenant will not fail to pay rent at any time in the next 10 years. On the other hand, if your tenant is a regular restaurant (even a very popular restaurant), you'd better darn well underwrite some vacancy. How much to underwrite? Well, that's more of an art than a science.
Awesome advice, thank you.
Checked Costar and the most optimistic vacancy that I could underwrite for the submarket was ~2.5%, which is even ignoring the fact that one of the anchors w/ 30% of the GLA is a large department store that has been having some major problems.
Broker packages have garbage assumptions, usually. Looking at a retail/office 10 I/O request right now in Austin where they underwrote 1-2% vacancy over the 10 year term, even though there's a few years of 30% roll.
You can UW 0%... but I imagine it's about as accurate as forecasting 3-4% GDP growth.. hint: your forecast will be wrong
by ignoring them
Green box got it right I think -- vetting a broker's assumptions is many parts: - Comparing it to your pro-forma U/W. If a broker is promising you the world on a golden platter compared to what you U/W the deal at, it's probably not right. Also keep in mind IC usually won't green light a deal unless it hits returns that are Accretive to the company and platform. Anything above that is just gravy. Me personally, I'd rather have a high probability of hitting U/W than a 50/50 of hitting some huge sale number, or missing and having to explain to the market - Talk with leasing/broker team. They will best help you on the MLA assumptions regarding rent, growth rates, etc - senior members of team as mentioned above...not so much for market fundamentals as much as the buyers that are out there. They know the other deal makers in the space, what they're looking for, and if the trading volume for your deal type is frothy enough - Trust the broker... I know this sounds crazy, so let me preface this with "in realistic terms". I mean after all, you ARE paying him to close the deal...
I've worked at a few different PE & REIT shops and each one views the disposition process differently. I've worked at sector agnostic PE firms where they'll place their kids' college fund in the DCF model. Worked at MF development firms where they just take the T12 and cap it (don't pay for NOI you don't have).. The current place I work at could care less about IRR or a DCF model. Their opinion is that it is largely bs because its so heavily based on assumptions. This type of shop places all of their eggs in the sales comp approach. Can't say I necessarily disagree with them, to an extent.
At the end of the day it comes down to the type of buyer you are selling to. If it's a large insurance GP player who needs to abide by compliance and stick to some sense of procedure, a DCF is probably your best bet for a valuation. If its a product specific REIT or PE player, a sales comp might be more favorable.
At the end of the day, it's going to sell for what someone will pay for it. I know this is stating the obvious, but you'd be surprised how many people I hear say "BUT BUT BUT MY DCF SAYS THIS VALUE! WE CCAANNTT SELL IT FOR ANYTHING LESS!". And the response is typically okay, well tough pal, if there's someone else out there who will pay that price, by all means....
that's my rant for the morning...
When I do my modeling I never trust what a broker says, or at the very least take it with a grain of salt. I trust my knowledge of a market and the ability of our firm to perform in line with pro forma > deterministic assumptions made by someone trying to make an OM attractive.
Suggestion would be to use broker's assumptions as base guidelines, but 0% vacancy is lunacy (5% vacancy is pretty standard - let it oscillate within a half of percent +/- if you want to get fancy with your model). Plus you'd rather be on the more conservative side when underwriting RE...that way there's always room to over perform, assuming your conservative model wins best and final.
Just to give a little bit of context on why not to trust brokers' numbers--it's not that they outright lie; it's that they cut out the fat. AvalonBay is an elite REIT with endless resources to manage a property at the absolute highest level of cost efficiency. A broker may adjust the actual numbers to reflect the management of, say, a highly efficient manager similar to AvalonBay. But what you may not realize as the buyer is that unless you have the same level of efficiency on your property management team you will not realize the listed return.
As a broker, my assumptions are for the most part based off of what the market will pay for it. We've basically got two sets of numbers, one that we show our client, and one that we show the world. The number my client gets is what it most likely will sell for, and the number the world gets is 5-15% above that. The number I tell my client has been about 1%+/- what the buyer actually paid on the past few deals I've sold.
EDIT: And the reason we do this, regardless of how good I am, half the sellers will pick a team based off of who tells them the highest number, regardless of if it's actually true, my 5-15% number is basically my way to keep them realistic while also trying to win the deal. Additionally, sellers think that if you put it up at 2mm, someone will offer 1.9mm, and if they list it at 2.1mm, someone will offer 2mm.
In MF, I've seen listings where the rent roll was made to the maximum legal rent you COULD charge each unit, which anyone who works in the field knows can be a completely irrelevant number. Then in very fine print, it gave what the actual unit rent was. Whether you used the fantasy or real rent roll worked out to something like a 30% difference in purchase price. Wild stuff. Worst part is that it'll go at that price, so even if you catch it all you've done was disqualify yourself.
Ipsam nihil inventore laborum sint ducimus. Nam reprehenderit earum ratione doloremque rerum sit nihil. Sint quaerat autem ab esse atque nam. Quibusdam animi laboriosam odio reprehenderit aliquam nobis. Reprehenderit eveniet dolorum et nemo. Voluptate ullam ut aut debitis non. Nulla nostrum amet aspernatur aut in qui consequuntur quisquam.
Ullam quia ea doloribus placeat et adipisci modi reprehenderit. Provident quisquam in similique magni nihil deleniti.
See All Comments - 100% Free
WSO depends on everyone being able to pitch in when they know something. Unlock with your email and get bonus: 6 financial modeling lessons free ($199 value)
or Unlock with your social account...