In the value add apartment space, seems like more and more deals are being floated where the typical bathroom/kitchen/flooring renovations have already been completed. Yes, there are other areas where improvements can be made, but my sense is that in many cases, unless you are comfortable underwriting rents that would be "setting the bar", you simply can't proforma these deals to make sense.
In supply constrained markets like LA, for example I'm seeing 80's vintage garden style deals in the Valley trading for north of $300,000/unit. Would need to exit close to $400,000/unit in 4-5 years to hit a high teens LIRR, which would ultimately mean setting a new price standard for that market/submarket. Generally, that means my exit cap can't be much higher than 5% (which seems insane in 4-5 years considering how many factors could push cap rates higher), and I need to assume some form of substantial rent growth during the hold. LP equity wants to see rent and sales comps that prove all this out, but in many cases they dont exist.
How are those in the value space justifying exit values and assuming the comps arent readily available, are you using other metrics to extrapolate values?
bumping.
I hate to say it - but your post echoes what I've been hearing from our partners/brokers for the past 6 months.
I work on the LP side of the value-add space and we are getting crushed by core buyers shifting to this strategy (with lower return thresholds) as well a family office buyers who can hold longer.
I'm starting to see our sponsors tightening exit cap rate assumptions and using rent growth assumptions as high as 5% year 1 and 2 (a year ago, everyone used 3% annually). Looks like people are pulling every lever to get a deal to make sense. Of the 3 deals we have closed this year, 2 have been off market and 1 was at a discount due to a botched marketing process.
To answer your question, we typically underwrite 15 bps cap rate for every year we hold. We consider our going-in basis compared to replacement costs today, as well as how much construction costs have risen over the past 5 years.
On a price per pound basis it may seem insane, but I personally do not see cap rates expanding past 5% in markets like LA, and if you are underwriting conservative rent and opex growth and achieving your NOI projections it does not seem that crazy. Most reports I read about these core markets show us that developers are far from keeping up with demand (long term).
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