“There are three kinds of lies: lies, damned lies, and statistics”
- Benjamin Disraeli
The 50% rule is a great start for back of the envelope analysis for apartment investing, but what if you are seeking development capital for a project or private money? Will a wave of the hand and “oh the 50% rule says x” for your pro-forma suffice?
Pro-Forma’s Can Be a Dangerous Thing.
A recent horror story I heard is a prime example:
Allegedly, a group of doctors fresh from a famous apartment guru boot camp rushed right out to buy a property. As it turns out they relied on the pro-forma’s provided by the seller side. The actuals only supported a shocking 1% cap rate based on what was paid. OUCH! The end result is new buyer is ending up with a steal-of- a-deal based on their pain.
When dealing with the seller side in commercial and you need a friend: better to get a dog.
That being said, for a developer – I believe pro-forma’s are more dangerous. We are telling our own story. For me I am very concerned about “deal junky” syndrome. Are we lying to ourselves’ to justify our passion to build? Field of Dreams is a great movie but the SEC won’t let you off the hook based on that defense. Okay maybe if you did a séance and brought Johnny Cochrane…”the pro-forma didn’t fit so you must acquit”?
Are enforcement actions and civil litigation a pretty solid deterrent to the Field of Dream’s effect for you too?
To seek a reliable truth others have innovated a great data source. Two organizations that I have found infinite return from are Institute for Real Estate Management (IREM) and the (ULI) Urban Land Institute. The IREM is a great professional organization that focuses on continuing education for property managers and the ULI is the similar to the bar association for real estate developers.
Both organizations offer tremendous “cost to operate” surveys that can work to substantiate your expense pro-forma’s. The beauty of these reports is that they serve both in acquisition and development.
What’s This All Mean?
Imagine you are buying your first 20 Unit apartment. Your financial diligence can be checked against the cost survey from IREM or ULI. Perhaps you can get a great feel for whether the property has an inherent flaw or the management is incompetent? Opportunity and danger can be identified down to a line item to help you make a better decision on the expense side.
The crunchers in data crunching have tremendous choice over the quality of the research. GIGO (garbage in garbage out) is a chief concern. Cost-effective resources are available that go along way toward finding the truth.
Photo Credit: Mario InoportunoLies, Damn Lies and Proforma's by Douglas Dowell