A sample value-add apartment deal - how (un)realistic is this porforma?

[Nick B.]

Hello BP,

I put together a proforma for a fictitious 100-unit C-class apartment deal located in DFW, Texas.

Here is the link:

https://docs.google.com/spreadsheets/d/1_Dui4Fly69...

I used rents and expenses from the deals that I reviewed and from the one I am currently in.

I also used rather small assumptions for future rent and expenses growth (2% for rents and 1% for expenses).

Please tell me if these numbers are attainable or if I am totally off my rocker :-)

BTW, if someone wants to copy my spreadsheet, you are welcome to do so but use it at your own risk. There is no warranty implied or explicit that it works. The yellow areas are meant for the user input, the rest is calculated.

Thanks
Nick

[Steve Olafson]

Originally posted by @Nick B.:

Thank you @Steve Olafson. So, you were finding properties where rents could be doubled in a 1-2 years. Were these mostly smaller properties (less than 50 units) with out of town owners? I guess these "mom-and-pop" properties are prime candidates for value play.

Why do you budget 7% for the cost of sale? Is this because of a smaller transaction size or region-specific. I saw proformas for $10-30M projects and projected cost of sale there was 3-4%.

 Yes, mostly small mom and pop but not always.  I bought an 87 unit with partners from a non-profit that went belly up.  It was in bad shape.

For the most part, I pay 4-6% commission for the sale.  The larger the project, the smaller percentage for the commission.

[Dmitri L.]

Originally posted by @Tom Lafferty:

I definitely put reserves above the line for projections.  Its getting very common now for brokers to do the same, because they know we're all going to consider them an expense, so I'm seeing that a lot in their pro formas. 

 That's good to know, thank you!

[Dmitri L.]

Originally posted by @Hattie Dizmond:

@Nick B.

Your numbers make sense to me.  I've never done multi-family, but they follow the logic I have built into my MF analysis sheet for when I do get there!  I'm excited for you.  

@Dmitri L.

Nice picture!  Finally!  :)

Thanks!  Imperial Palace in the background and everything.. :)

[Brian Burke]

@Nick B. so far I buy in Austin, Dallas and Houston although I'm open to other markets as well.  Those just happen to be the three where I've actually bought deals.

The lowest econ vacancy I've achieved upon full stabilization is 6%, but I wouldn't EVER consider forecasting to that upon acquisition.  If you are buying based on a "perfection" level 6% econ vacancy you are playing way too close to the fence and there is no margin for error.  I don't forecast perfect econ vacancy and I don't sit on the edge of cliffs dangling my legs off the side.  I'd rather stand back and enjoy the view from a distance, so to speak, because achieving a 6% econ vacancy causes my investment to outperform my projections and there's nothing wrong with doing that.

The numbers for my latest deal forecast a 16% economic vacancy upon stabilization and MUCH higher than that in years 1 and 2, 39% and 27% respectively as the property is renovated and rental increases are implemented. The end result is a net IRR to investors (after all splits and fees) of over 17%. I know it's been said that you can't find deals in Texas with this type of conservative underwriting but I'm acquiring this property below my strike price. To be fair, I was outbid by over $400K...the only reason I got it was because of my track record and being known in the industry. A first-timer or unknown player wouldn't have been awarded the deal, they would have simply been outbid and then posted on BP that you can't find deals with this type of conservative underwriting! By and large, there is nothing wrong with saying that because the unfortunate reality of playing in the multifamily space is that it's a really tough business if you do it right. Besides, maybe they are right...my deal hasn't closed yet and I'm still in due diligence, something could pop up and reshape my opinion of how good of a deal this is. Time, and additional hard work, will tell.

[Nick B.]

That makes sense now, @Brian Burke! If you start with 39% vacancy you can use 16% as your stabilized target and if you achieve a national average of 8% you way over-delivered.

What happens though if current econ vacancy is 10-12%? Does such deal have any potential or it's a no deal at all?

Now, if your stabilized vacancy target is 16%, how do you refinance with Fannie Mae? They want 10% vacancy max. 

Thanks
Nick

[Brian Burke]

There's a big difference between physical vacancy and economic vacancy. The deal I'm buying is 99% occupied right now. I'll bump gross potential rent day 1, which just means that I'm setting a new asking rent.  None of the leases will be at the new asking rent so I've immediately created economic vacancy by manufacturing loss to lease (the difference between gross potential and actual lease rates).  When increases are implemented at lease renewals, some folks will move, so I've created physical vacancy.  I'll have a lot of turnover and will need to lease a lot of units so I might have to offer two weeks free, which creates concession losses.  I want the property to shine for the prospective tenants so I'll create a decorated and furnished model unit, creating a non-revenue loss. Some tenants won't be happy with rent increases so they'll stop paying rent and wait to get evicted,  this creates collection losses. 

All of those components are elements of economic vacancy.  The national average for physical vacancy might be 8% (is it?) but there's no way that the national average for economic vacancy is 8%. Most of the time owners, brokers and syndicators talk about physical vacancy and try to sweep the other components of economic vacancy under the rug.  Don't do that or you'll come to regret it later.

As to your second question, the current owner's economic vacancy doesn't tell me if it's a deal or no deal, it just provides clues to the real story behind the deal.  It confirms what the broker is telling me, disputes what the broker is telling me, or tells me something that the broker isn't telling me.

As to the FNMA refi...you are correct, they want 90% occupancy for 90 days trailing, but that's referring to physical vacancy, not economic.  You can run a deal with 8% physical vacancy, 2% loss to lease, 3% for concessions, 2% for credit loss, and 1% for non-revenue units and you meet the 90% physical target but have 16% economic vacancy.

[Marc A.]

@Nick B. Thanks for sharing the spreadsheet. Is there a problem with the formula for principal & interest for the first year? I think it is showing only one month payment instead of a full year.

[Nick B.]

@Brian Burke, I think I got it now. So, here is a simplified example of how I see it:

• Two 100-unit properties are located in the same neighborhood. One is nice and shiny and rents for $1000/unit. Another one is outdated and rents for $700/unit. This a property you're buying. Both properties are 100% occupied for the sake of simplicity.
• You take $1000/unit as your gross potential rent and that immediately creates 30% economic vacancy regardless of the physical vacancy.
• Then you renovate the property while rising rents. Some people move out, some get evicted, etc. and that deepens the vacancy in the first 6-12 months(?)
• At some point you reach 90% physical occupancy but not everyone pays $1000/mo. On average they pay $933/mo and that equates to $84K gross collected rent and 16% of economic vacancy. You treat it as your stabilized target.

Am I correct?

Thank you
Nick

[Nick B.]

@Marc A., I checked the formulas. They are correct. What specific row/cell do you think has an error? 

Thank you

[Brian Burke]

@Nick B., yeah, you got it!  The only addition to your scenario is that the tenants might pay more than $933 on average but there might be some collection losses, concessions, and non-revenue units that bring the collections down from the total lease rates to $84K. 

[Nick B.]

@Brian Burke, When I wrote "on average $933" I meant to include collection losses, concessions, etc. into it. Non-rev units are a part of 10% physical vacancy. So, if you have 1 demo unit on a 100-unit property and 99 units are occupied, that 1 unit represents 1% physical vacancy,  correct?

[Marc A.]

@Nick B., in cells F54 and F55 for year 1 it shows $10,625 and $4,282 for the interest and principal payments. However, those look like the first month payments instead. Then in cells G54 and G55 it jumps to $123,616 and $55,269 which looks correct for year 2.

[Brian Burke]

Originally posted by @Nick B.:

@Brian Burke, Non-rev units are a part of 10% physical vacancy. So, if you have 1 demo unit on a 100-unit property and 99 units are occupied, that 1 unit represents 1% physical vacancy,  correct?

Practically, yes, but it's bad practice to refer to it this way. Remember the FNMA 90% occupancy threshold?  You don't want your non-revenue counting as vacancy so you treat them separately. As another example, let's say you give an employee a free or discounted unit. That unit is non-revenue (or partial), not vacant. I treat our model units the same way. Non-revenue units are not listed as vacant on the rent roll, and the revenue loss is a separate line item from vacancy loss.

[Barbara G.]

I don't understand a word of this post,

Do you think I am in the wrong bussiness because I can not follow anything here?

[Nick B.]

@Mark A, F54 and F55 look the same as G55-55 for me. Must be something to do with your  browser. Try to create a copy and edit the formula.

[Marc A.]

@Nick B., ok thanks. I copied the formulas and fixed it in my excel.

[Seth C.]

A quick note on NAA numbers. Those are for very large properties (274 unit average), and are often owned by institutions big enough for in-house management, maintenance, and even rehab. Their numbers are much better than what one might do in the 20-100 unit space. Example: Good luck on finding 2.8% management that doesn't wind up 2.8% of nothing! The same is true for repairs, for insurance, utilities, etc. Even the numbers on this thread tend a bit to the larger complex economies of scale.