Are institutional like returns possible with smaller assets?

Question

Hello BiggerPockets community,

As I begin underwriting smaller acquisitions targets in both Logan Square and Englewood, I find it hard to project anything beyond a 10% IRR, CoC above 3.5%, and an equity multiple north of 1.06.

At the moment, I lack the sufficient experience, net worth, and UNHW LP base to analyze larger apartment deals.

In my view, smaller apartments are ripe for acquisition (i.e market inefficiencies, etc.) since fewer shrewd, sophisticated GPs are available to make offers.

Hence, less competition.

However, the pro forma will not appeal to a more affluent LP pool outside of Chicago. And this is necessary before I can accrue the necessary equity to make an offer on a prime opportunity.

Any thought?

Greg Scott · Answer

"Institutional-like returns" to me is the same thing as saying "sub-par".

Large assets tend to attract big money. Many of the institutions out there are willing to accept much lower returns than I am, so they are willing to pay significantly more than I am for the same asset. While I prefer owning larger assets, the best total returns I've seen were on smaller assets, both single family and apartments.

Have you tried looking outside of Chicago?  You may find better returns elsewhere.

Brock Mogensen · Answer

I certainly do think there are opportunities to be had in the > $10M deal size.  But it is still very competitive and hard to find deals that pencil with interest rates where they are at.  It has to be a deal that has value add potential for it to work, in my opinion

Henry Lazerow · Answer

It's easy to find 15-20% IRR in Chicago. I sold 40 million of multi units here and happy to run through numbers (even if you aren't my client all good) feel free to shoot me a PM for my email. Nearly every deal I sell we drastically raise rents to market this is really the kicker that make the numbers work. Some basic numbers below on a typical deal, this does not include the equity made by raising rents just for simplicity...

$650k 4 unit Avondle/logan square. Rents $4000 at purchase. Raise them to $6000+ range with maybe $40k updates.

25% down + $40k updates is $202,500

You should get atleast a 6% COC at 25% down. Lots of my clients hit 8%+ though and if unzoned extra unit 10%+

Mortgage paydown will be $45,715 in first 10 years assuming 6.5% interest rate. This breaks down to a +2.2% annual return off your downpayment. I built an excel sheet that runs the amortization for me.

Appreciation even considering mild 2.5% appreciation off your money down it comes to a +8% return

Total project IRR = 6 + 2.2 + 8 = 16.2% and this doesn't even include the equity made by cosmetic updates and a higher rented building.

P.S. RUN from areas like Englewood unless you own the property management company you will get destroyed by all their maintenance calls and eviction processing costs etc. Some of those areas you have to repaint every turnover as the tenants just destroy your units. I relate these areas to junk bonds, they look good from yield on paper but that's it. On the northside all my clients self manage its very easy even the ones with 20+ units self manage the north side buildings.

Jonathan Klemm · Answer

Hey @Adriel Cisneros - This is a great question and I really appreciate you bringing it up.

First, I am interested to understand you decided on your two VERY different Chicago neighborhoods?

Second, if you are calculating an IRR that typically indicates a projected sale of the property, are these not going to be long term-holds?  We definitely see better returns in Chicago than you are projecting....maybe not so much in Logan Square, but honestly as the GP cash flow is only one of the five ways you build wealth through real estate.

Third, if you have the time and hustle to find/underwrite larger deals don't be afraid to go bigger NOW.......there are tons of us who have experience and looking for larger deals.

Lastly, if you are getting going typically your "LP's" are just your friends and family.....at that point at least in my experience, they aren't so much investing in the deal as they are in you.

Happy to connect to talk more about your plan and help out any way I can .

Jonathan R McLaughlin · Answer

@Adriel Cisneros the returns on smaller projects can be great, issue for institutional money is scale. They would eat up those returns with the opportunity cost of money sitting there.

Eliott Elias · Answer

Single family will give you these returns

John Warren · Answer

@Adriel Cisneros the main reason syndication doesn't work well for smaller deals isn't that you can't find some juicy deals. The main reason it doesn't work is that the cost of doing business in this structure is so high. Let's say you find a nice 4 unit for 400-500k. Ok cool, now you need to pay your attorney 10k to draft the legal paperwork for the syndication. You also need to give out K-1's at the end of the year and file a partnership tax return. You just burned another 2k or 3k there. At this point, even if the deal performs you are probably not making any money because the deal is too small.

In this scenario, I think your partnership is much better served just doing JV deals where you can have simpler structures. You will also have way more flexibility when you operate the deal too.

Paul Moore · Answer

Hi @Adriel Cisneros! I think you're looking for better returns than you will probably find in those suburbs and better returns that most institutional investors. Institutional investors sometimes have an extremely low cost of capital and expertise in due diligence that allows them to do well on much lower returns. Actually, they are smart about looking at risk adjusted returns which is what we all need to do anyway.

I recommend building up a stash of cash and equity lines and preparing for potential fallout in 1-3 years from now. It may not come, but like Warren Buffett says, you can't strike out by NOT swinging in investing. And you can actually get pretty good returns on T-bills now anyway. Good luck and happy investing!

Michael K. · Answer

@Adriel Cisneros I'd agree that when I hear the words "institutional" I generally think of a heavily managed, little personal involvement, and low return low-risk asset. Small deals are more likely to be mispriced and have room for operators to increase value - but are harder to consistently recreate.

Maybe look at bundling a couple of these higher yield multi-units into a portfolio, so that you have a larger asset but also the higher yields that B/C class multi-units deliver.

Paul De Luca · Answer

@Adriel Cisneros

I'm not surprised those are the returns you're projecting in Logan Square, but I would think that you could get a higher return in Englewood due to it being cheaper but also a D class area. I think targeting C class areas is the middle path that makes the most sense for returns. Fewer management headaches and higher cash flow & appreciation is attainable. CoC of 3.5% is very low.

I agree with @Greg Scott that "institutional returns" doesn't mean high or good returns for the reasons he mentioned. Those syndication investors are mostly looking to park their money somewhere and get a somewhat safe return.

Are institutional like returns possible with smaller assets?

Most Popular Reply