I feel like I'm trying to fit a round peg into a square hole. I've been getting blasted by emails from brokers in the last 8ish months with "amazing value add" etc opportunities. The problem is the brokers want first rounds of offers like a week or two after, and all that 'value add' they're talking about, amounts to sub 4 caps, weak coc, and unacceptable IRRs on 3-5 year exits.
Am I missing something? What have you guys been doing to make deals work, while staying based in reality, and also getting your capital partners to hop on board?
I know there is a lot of foreign capital floating around, but I feel like I'm copping out using that as an excuse for thinking every deal I see is weak, or when a decent one turns shitty BC the cost basis is now a 2 cap in New Mexico.
Lots of deal flow. You got to look at a lot of volume in my opinion to find good ones.
Definitely a lot of deal flow. Im curious though, what returns or metrics are you able to hit in terms of coc/year, irr, return on equity, etc?
Would love to get others insight into how they're underwriting, and what they're able to actually deliver on for investors. My group is active southwest and south east, and takes one offs in the north east and west. Maybe it's just the regions we look at, but it's getting more tough hitting a 20+% irr, or doubling investor money in two years. We have a good track record, and can get creative, but wanted to see what others on the site thought.
Yeah... we're in the part of the cycle where sellers bake all of the upside into their asking prices
I keep trying to explain to people that Legos are the only commodity where the BUYER pays the SELLER a premium for assuming the value-add execution risk. I don't think I'm getting through to anyone though
We are a build and hold developer and have had a horribly scary time meeting IRRs this year in our underwriting, and our target hurdles are relatively low (14-18%). When do find deals that could work we have been outbid every time by foreign capital. Not sure why the sudden increase in foreign money but I'm worried that it's here to stay.
We would love to be more active on the West Coast but those cap rates are so low they won't deliver the returns we require. South is still affordable in a lot of places though.
As a build-to-hold developer, what timeline are you underwriting those IRRs to? Also, those IRRs, unless over very long timelines, mean you are leaving some cash in when you put the permanent loan on?
10 year hold time. Those returns would be with cash in and not very leveraged, but in actuality we buy and hold on unlevered IRRs (500 bps lower) and don't put any debt on the property. (This policy comes from the CFO, and I don't know his logic behind this). Actually maybe that's what's made it difficult to do any deals rather than foreign money. 5 years ago we could hit the hurdles on an unlevered basis, but not any more.
There are four easy solutions--1) change your asset type; 2) change your geographic location; 3) use more leverage; 4) adaptive re-use.
Multifamily is the only asset type right now that should have utterly garbage returns. Retail, office (except in the best of the best locations), hotel, self-storage, and for-sale residential are all asset types where you can get strong leveraged yields. For example, stabilized cap rates on hotels in the Washington, D.C. metro area are 7.5%. That's actually really solid. Now imagine the return on cost for new construction. We're selling a nice chunk of residential land in a decent (not great, but decent) area to a homebuilder that is realizing 25% IRR in its underwriting.
Adaptive re-use allows you to realize outsized returns on asset pricing for a lower use. For example, turn an office building into a self-storage facility or into an apartment. Or turn apartments into condos. Or turn a hotel into student housing units or into micro-units. You have to be creative right now.
Yes, this. Thanks for the thoughtful response.
But regarding the broker asks. I mean, these bull shit deals are still selling to someone. Is anyone buying 'value add' deals from brokers, and hitting anything resembling a decent return? It makes me think capital should, in theory, be pulling out of multi family.. or no?
As you know, supply/demand is a balancing act. "No one invests in multifamily anymore because there is too much demand." That's what it feels like, right? But of course that's not the case in reality. Persistently low interest rates, foreign money and the rise of REITs are completely up-ending the market and expected returns, and I think it's basically a structural, more-or-less permanent change. Add in the strong increase in construction costs and returns kind of suck. And yeah, the sellers are getting close to what they want, usually.
I think multifamily feels like the only smart long-term bet because people will always need a place to live. Hotel, retail and office, however, are in process of structural shifts due to things such as Airbnb, internet shopping, and company "right-sizing," respectively. And all of those asset types could be upended in 20 years or in 2 years, so it's got people freaking out a bit and running toward multifamily "safety" (and, ironically, creating a glut in certain markets and increasing the risk profile of future multifamily investments). The upside to people being afraid of non-multifamily real estate is that it maintains demonstrably better upside.
Yep - shit returns in multifamily for sure. Anyone got any hotels for sale though?!
I think you should stop being a pussy. That, or build a secret back channel to communicate with the Kremlin to find some more attractive financing options for your next real estate project.
It's really hard to buy into the rent growth assumptions that some of these brokerage shops are spitting out. When we do get beat, I think that's where it happens, that and the capital assumptions. I've seen a lot of guys I know get beat up with that the last few months. They don't bake a bucket of capital into their UW or they turn a blind eye just so they get awarded the deal. They underwrite rents that are 30% off and then an LOI comes in on a vacancy that was way less favorable than what they originally anticipated while the DD period is ongoing.
On a base/obvious level, it's really hard to feel good about increasing your leverage at this point of the cycle when interest rates are increasing and the returns are decreasing...
Another point you mentioned is the foreign capital. I'd throw that, HNW, and trade buyers into the same category. When you don't have to worry about an IRR/EQM and all you have to do is cap the year 1 NOI or comp the PSF, the deal is a lot easier to pitch to capital partners/committees...
I see, and agree with your observations. by capital assumptions and bucket of capital Do you mean the capital being used to redevelop/update the property?
So what solutions are you seeing to these problems? As a different poster said, its about getting creative. Curious to hear some strategies others are executing or trying.
To MonkeyWrench's point, I think choosing capital partners who have more "realistic" return requirements will do a whole lot to move the needle on competing for and winning deals.
Yes, I mean the investor profile that you would partner with as the equity in the deal. Different types of firms have different expectations as Dances mentions below, which can make your life easier or harder, depending on a lot of variables.
Getting creative is great, but there's also such a thing as 'chasing yield'. There's nothing inherently wrong with it, but in a market like this, IMO if you have to do things that you normally wouldn't WANT to do just to get a return, you have to ask yourself why the return is so juicy in a market with otherwise anemic yield. We've looked at a lot of opportunities the last few months where I don't think we would have looked at it otherwise. Could mean we got 'creative' or that we looked at a bad opportunity in a strong market and branded it that way instead. Time will tell.
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