Jan 28, 2019
What kind of returns are LPs targeting in opportunistic funds these days?
For those of you who are LP's, what kind of IRR's are you looking for? What would you actually expect to get in say a ground-up hotel property?
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Comments (41)
For development we are looking for 20%+ IRR. We would dip lower if the project was located in a true gateway city (NY, Boston, D.C, Chicago, LA, or SF). It's hard to justify going much below a 20% IRR when we have sponsors that average a 16% - 17% IRR on their value add deals. There is added risk with any development and that is something we need to be compensated for.
For opportunistic value add deals we would need to see at least a 15% IRR.
Core Plus can be in the 10% - 12% range depending on how heavy the lift is.
Curious if you've looked at any deals in Austin? If so, what would you say you guys would look for here?
Yes, I've looked at a lot of deals in Austin. We are getting close to selling 3 developments we completed there.
I'm not sure what you mean by "What you guys look for here". If you're talking about asset class we are open to pretty much anything. If you are talking about returns, see my response above. It's not a gateway market so we are pretty strict with out return metrics. Honestly, unless something changes dramatically I don't think we will do more deals in Austin anytime soon. There is a ton of capital flowing into that market and 80's vintage value add multifamily deals are only penciling to about a 12% - 13% IRR and newer vintage returns are even thinner than that.
Sorry for the ambiguity. I meant in terms of returns. Multifamily is incredibly tight here, especially downtown. Thanks for your input.
So you are looking at higher than 20% IRRs for a new development in Austin?
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Curious how you guys look at return multiples. Construction projects are shorter than typical CRE investments - developers get their capital back much faster, which boosts up IRR.
MOIC's and IRR are directly tied so it's something that is included in all of our committee memos and models. I don't want to list out the IRR/MOIC targets for all our investment strategies here, but you can do the math based on the guidance I provided above.
15% IRR for a 5 year hold is always a 2.0x MOIC
26% IRR for a 3 year hold is always a 2.0x MOIC
To clarify for anyone reading this, it is pretty intuitive to translate an IRR and a hold period into a MOIC assuming a significant majority of the equity is deployed day one. If there is a delayed equity funding schedule for deals with development or redevelopment components, than IRR to MOIC is NOT intuitive, particularly in instances where the equity funds pari passu with the debt.
Also important to note that these returns and MOIC's are on a LEVERED basis.... Should be pretty obvious, but just to be crystal clear...
What's definition of opportunity value added vs opportunistic?
IMO opportunistic deals do not have in place cash flow, generally when my firm talks about value add deals there is an existing stream of cash flows we are looking to grow through an infusion of capital. With "opportunistic" deals there usually is not any cash flow until improvements are completed.
This is just my/our fairly loose definition and I'm sure others would describe things differently.
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^^^ On the money... Although I've seen some brand name capital sources out there doing deals for -200bps on each range, respectively.
Edit: Looking back, I think I've confused some people with my comment. For clarification, I was responding to the...
20% IRR threshhold for development
15% for value-add
10%-12% for core plus
I'm saying I've seen sophisticated capital in secondary markets solve to returns at a 200bp discount to these ranges. For instance, a pure value-add deal (leasing and reno) we took a run at sponsoring was committee approved at an 11.5% IRR over 5 years.
I invest with taxable capital and I've seen tax exempt investors dip down to the ranges you've described. On an after tax basis we are hitting roughly the same returns.
Curious. What markets are you finding development deals with 200 bp spreads from build-to-exit?
For us, most markets are far tighter than that, but we've found a few markets in Northern Nevada, Washington, and Florida where those are achievable AND make sense from a risk-reward standpoint.
Sometimes hard to even pencil within 200 bps of those to be honest.
These days? Realistically? Opportunistic funds are chasing value add returns for opportunistic risk. Value add funds are chasing core plus returns for value add risk. Core plus funds are chasing core returns for core plus risk.
This is pretty spot on. From a multifamily perspective, no one will say it in their PPM, but we're all telegraphing lower return expectations to our LPs in the near term.
As a developer, I can tell you that most development deals (secondary markets) on sober underwriting are 15%-20% IRR. Would be very skeptical of anything too much in excess of that. Don't know a single value-add deal (office or multi) that fits the mid-teens return profile.
We've been doing a bunch of value-add multifamily in NYC and hitting (conservative) 13-14% returns. 5-7 yr hold.
I do some work in the NYC market and recently underwrote a few big multifamily developments on behalf of private owners. These developers are going forward with 30-50bps spreads (YoC) with ~55% LTC. They're projecting long-term holds and very ambitious rent growth.
Thus I'm curious how anyone is conservatively projecting 13-14% IRRs in NYC on value-add multifamily, especially with what's rumbling in Albany. Are your projects all market rate? Because it sounds like there's a greater than 50% probability that rent stabilized deals lose a lot of value this summer.
NY multi is a nightmare right now. Laughable returns. People are still trying to sell rent stabilized deals at 3.5% caps. Who is buying this shit?
If I had to guess? Mostly slumlords who will operate the buildings at an inhuman opex number, and people new to the business who think it's still possible to buy out tenants at low numbers and/or haven't caught on to the fact that L/T court is laughably biased in favor of tenants (partly from understaffing, I'll admit).
That being said, if you can buy for over a 4 cap you can make this stuff work and still hit mid-teens deal level IRRs. Just takes some creativity and not reading from the same book that everyone in Brooklyn was playing out of in 2010-2014. That is a large part of the problem; folks who did this back then are the people who are trying to exit out of MF in the Bronx, norther Manhattan, and parts of Queens now - they bought in 2015 after a truly massive wave of price increases and tenant displacement in western and central Brooklyn just before, and assumed the same tactics would work. Now they're stuck with an identical rent roll to 3 years ago and a short term, I/O mortgage coming due that they can't refinance due to rate increases. So they come out with the cap rate they bought at and get negotiated from a 3.5% to a 5% after 4 months on the market.
You hit the nail on the head with those 2015 buys in Northern Manhattan. We have mezz pieces on some of those buys and the picture is not pretty.
I've done some consulting for non-MF guys trying to break into that space and the underwriting assumptions I saw were jaw dropping, even in 2017 when the peak had obviously come and was beginning to pass. I'm starting to see real 4.5% caps (as in, real once you plug in some actual expenses and up the vacancy/bad debt expense past 2.5% or whatever brokers try and scam you with), so we're starting to see Seller expectations change.
People thinking that rent stabilized units have like a 20% turnover, or that you could buy out tenants in Central Harlem for $15,000.... just complete ignorance, and from extremely intelligent, well known people at major companies (just not MF focused).
Yeah, I looked at the sponsor UW from when we placed the mezz and I was straight up dumbfounded. Using 5% rent growth on top of IAI premiums is just one example of complete ignorance. Rent caps at the time were 0%. How did this get through layers of institutional stakeholders? Beats me. They're the ones losing their shirts.
Yeah that is crazy. We UW 2%, maybe 2.5% if we really need an extra few basis points in IRR to push something over the line. And no one ever remembers to build in the actual hard cost to achieve the IAI's or even MCIs. To get that $1,000 annual rent bump you're spending 40-60 grand! No one ever thinks that they need to build the cost of that capex into their model. If you're turning 20 units that's another million or so dollars in Yr 1, essentially!
People just don't understand the affordable space and don't understand that tenants are smart. They have more than a vague understanding of what a low rent is worth. They talk to each other. Unless you're willing to resort to downright criminal acts and pray you don't get caught, it's a very tough game
Very true and interesting points.
Are you referring that the 2014 playbook was buying out tenants and renovating?
What is something different that you can do today to add value if it's more expensive to remove tenants? Is it less attractive to buy RS buildings?
18% to 20% on opportunistic deals. We hardly ever do development.
So what do you think new development would generally require LP IRR targets of? 22-25%?
Totally depends on the LP's required return threshold. Our threshold IRR is higher than most.
With those of you assuming 20% IRR, what type of LTV are you talking about here?
Typically 65% LTC, but can range from 50% (if we can't get proceeds) up to 70% (our threshold).
60% - 65%, we might go higher leverage with some pref equity or mezz on deals in gateway markets.
Can you give an example on why you might choose pref equity over mezz or vice versa. Trying to understand the differences between the two. Thanks.
Mezz is usually structured as a loan which requires an inter-creditor agreement with the senior lender and is secured by an interest in the property. Many, but not all, lenders get weird about this and I have often found pref equity is an easier execution. Pref equity is just an equity position in the deal that is structured like debt. I think you can really achieve the same thing with either.
This is not my area of expertise so others may be able to provide more insight than I can.
Interesting.
Everyone is so focused on IRR at 15% for value add, what kind of leverage and growth do you hvae in that model? what is spread between going in and exit cap rate? There is a lot more to IRR. I have seen deals where brokers want some crazy price and solve to a 18 to 20% IRR. Unfortunately, once you look under the covers, it's easy to see these fucktards are using 4% growth in a market with 1 month rent concession and using 75% LTV. Well, no shit these dumbasses are getting a 18% IRR while I am getting 12% despite all over assumptions are relatively comparable.
Good point. On multi we're solving to 11-13% net to our investors (post acq fee, AM fee, partnership costs etc). We underwrite 65-70% debt, realistic growth (we would only u/w 3%+ in a strong market like phoenix for instance) and cap rate expansion of 5-10bp/year based on building vintage and general market macros.
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