Underwriting rents when there aren't any comps
All in the title. Also happens to be a popular interview question.
Thanks!
All in the title. Also happens to be a popular interview question.
Thanks!
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If its retail, underwrite to an occupancy cost based on estimated sales of the tenants. 5% for your anchors, 15% for the in lines.
Thanks, how about office or resi?
In reality, the way one does it is through intuition based on market knowledge. I know because we just went through these motions on a major renovation ($30 million) on a multifamily building that we own, and there were literally no comps--none--in which to base our underwriting on. So we sat knowledgeable market participants around the table and came to a consensus number on various rents.
If it's an out-of-market deal, well, you shouldn't be purchasing real estate in a market you don't know when there is no comparable information.
I would agree with above ^ but if you're being asked this in an interview, they're looking for you to use some wit and come up with a real answer.
Most places you wouldn't have a comp are in some tertiary market with limited tenant demand. Operating under that assumption...
For hotel, I would look at the flag's regional ADRs by MSA population, scale it downwards (obviously factoring in a floor with expenses). If it's unflagged, I would estimate the quality of the hotel (what Class), and choose a flag that is analogous, e.g. Holiday Inn Express for some average shitty limited service.
For multifamily, I would look at cost of living and income data. Look regionally (or nationally) for comparable cities, compare rent as a percentage of median income. Income data should be either available for your tertiary market or at the very least estimable.
For office, I would frankly look at cost of improvements / replacement cost. Based on that, you have a value. Estimate a cap rate, back into a net cash flow. Estimate an expense ratio. You now have EGI. Estimate a vacancy, get a GPR. Divide by square footage, you have a crude estimate of rents.
I'm really just soapboxing here as I've never done any of this (all deals I work on have full appraisals) and the accuracy of such methods is debateable.
Can you give an example of how you would back into the rent using TI ect?
TI being a percentage of income
great answers, much appreciated
For multifamily (occupied), look at the most recent new leases, maybe leave room for concessions. Shouldn't be your only method, but it's one indicator along with the above mentions.
No interviewer is going to ask a question "What do you when you don't have X?" where the answer they are going to be impressed by is "Nothing, you need X."
Nothing is not the answer. I clearly outlined the answer--you gather people (or yourself alone, depending on your level of experience and market knowledge) and you utilize intuition, past experience, different ideas, and rational thought (e.g. would a target tenant pay $30 PSF to put his office space 30 miles out from the city center when the the target tenant is likely employing largely millennial personnel, or would that tenant need a substantial economic benefit from city center--say, more than 25%--to relocate? What do you do think, Mary? You're 25 and work in that business and live in city center. What would you and your friends think about working in [said suburb]? Would you guys likely leave the company?).
Using a convoluted formula to back into a proper underwritten rent is as effective as utilizing a WACC formula to determine cap rate. If you don't have comps then you have to use intuition--there's no other correct way to underwrite rents without data.
If the interviewer is impressed with the following answer, then he's a fool: "You utilize a WACC formula to determine cap rate and multiply the implied cap rate by the property's assessed value to determine your rent." Why would the interviewer be a fool? Because there are about a thousand holes that could be poked in that answer. You don't invest using textbook formula's from Finance 101 sophomore year.
They aren't looking to use your answer to evaluate a potential investment idea. The amount of diligence that would go into the "real answer" would far eclipse anything one could detail in an interview, and I certainly agree, would involve some element of on-the-ground experience or investigation.
In the context of an interview, they are looking to gauge your critical-thinking ability and knowledge of RE fundamentals & valuation. If I were asked that, I would supply one of the jerry-rigged answers I mentioned before, or something analogous...in my view it's not too dissimilar from the "How many barbers are there in Chicago?" question that pops up in many finance interviews. The result is immaterial, it's the process they care about.
I have 8 years in this business and I've hired and interviewed numerous candidates and have been on maybe 40 interviews myself in the last decade. Who is this "they"? I'm stunned that you think the actual correct answer is somehow a de facto wrong answer. That literally makes no logical sense. I just laid out for you a rational process--investigation. It's not a mathematical formula but it takes orders of magnitude of more critical thought than anything you've put forth. If an interviewer rejects the correct answer then he/she is not worth working for.
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