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

42 Replies

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

Nick,

I think the spreadsheet looks very good. (Disclaimer - I'm just in the middle of my first SFH deal, so all comments below are from book smarts not personal experience).

  • The expense ratio between 55-65% looks like a safe assumption.
  • Why are your property taxes so high though (12%??)
  • What you're essentially doing is showing that a 2% property is a good deal - assuming you ever see those scheduled rents in your account of course - by breaking out the individual elements :)
  • However - where are you going to find a 100 unit property with only 15% vacancy in DFW - at a 14 cap?? A bottom dollar deal like that would need to be significantly more distressed I'd think - which affects the initial vacancy and your expected turnaround budget. Or it could be in a war zone, in which case you may never see a good portion of that GSR
  • And one minor point - I don't believe that capital reserves are normally included as an operating expense, so this item would be "below the line" as far as NOI and cap rate is concerned.

So yeah on paper this looks like a great deal by the numbers. Of course, actually finding one of these in reality is the tricky part!

Would be awesome to read some feedback from someone who actually know what they are talking about!

Cheers

-D

Very doable if your projections are correct.  It takes time and effort to increase rents across the board.  You can expect vacancy to occur and people to be upset.  Plan on having some "churn" during the process.

If you can find a deal with a greater spread between the current income and future income, your results would clearly be better.  I tend to purchase properties with much lower cap rates and worse performance but much greater upside.  The drawback to these is finding financing but it is out there if you can show a track record.

I did not look through all your numbers but have a couple of comments.  The cost of sale will likely be higher once all is said and done.  If you are coming onto a property to turn it around, expect higher expenses.  Holding them to 1% annually would be tough if inflation is higher than that.  I usually target 3% growth in expenses.  Rent increases should be in line with your projections for the area.  I would not buy if the market would only dictate a potential for 2% increases.

btw... Your model here is one that I have been using successfully for years.  You are thinking along the right path for making millions!

@Dmitri L. , thank you for your comment. To address some of your questions/points:

  • I assumed property taxes to be 2.5% of 90% of the purchase price. 12% is the share of taxes in relation to gross income.
  • My initial cap rate is 8.48% based on projected first year performance. The "seller's" cap rate is 9.02% based on the sale price alone and last 12 months
  • Where do I find it? I have no idea but like I mentioned before the overall numbers are based on the project I am in. 
  • I used the same approach as banks do when they underwrite loans on these properties when I made reserves into a separate expense item. This makes the numbers more conservative and leaves more room for maneuver.

@Steve Olafson , thank you for your input. I do expect some churn in the beginning. First 3 months show 18% economic vacancy and rents still below the market. Average vacancy for the year 1 should be 10%. To compare, in the deal I am in we started with 18% vacancy and 6 months later it is 5%.

As for 2% rent increase, I used the low number to see if the numbers still make sense. Currently in DFW it is close to 4% but it's better to use lower numbers in underwriting.

Originally posted by @Steve Olafson :

btw... Your model here is one that I have been using successfully for years.  You are thinking along the right path for making millions!

 Thank you! You're very inspiring!

@Steve Olafson , I bumped expense growth rate to 3% while leaving rents growth at 2%. Still looks good. 121% total return, 24% IRR

Originally posted by @Nick B. :

@Steve Olafson, I bumped expense growth rate to 3% while leaving rents growth at 2%. Still looks good. 121% total return, 24% IRR

Is that 121% for 5 years?  My goal is usually a minimum of 300%  Most turn out to be greater than 500%. 

One of the problems right now is that these types of investments are too popular right now.  There are just too many buyers.  This makes it difficult to find deals that have enough upside.

I have told all my investors that we are not buying deals until some of the high desirability goes away.

That does not mean that you can't find something that fits your criteria.

@Steve Olafson

121% for 5 years. I can torture this spreadsheet to make it 300% but I feel it is unrealistic in today's market (2010-2012 is a different story). Do you mind sharing some of your 300% proformas and actual performance? 

Thanks
Nick

@Steve Olafson , you mentioned earlier that the cost of sale should be higher. I used 5% of the sale price and I saw other people used 4% in their projections. What were your percentages?

Originally posted by @Nick B. :

@Dmitri L. , thank you for your comment. To address some of your questions/points:

  • I assumed property taxes to be 2.5% of 90% of the purchase price. 12% is the share of taxes in relation to gross income.
  • My initial cap rate is 8.48% based on projected first year performance. The "seller's" cap rate is 9.02% based on the sale price alone and last 12 months
  • Where do I find it? I have no idea but like I mentioned before the overall numbers are based on the project I am in. 
  • I used the same approach as banks do when they underwrite loans on these properties when I made reserves into a separate expense item. This makes the numbers more conservative and leaves more room for maneuver.

@Steve Olafson , thank you for your input. I do expect some churn in the beginning. First 3 months show 18% economic vacancy and rents still below the market. Average vacancy for the year 1 should be 10%. To compare, in the deal I am in we started with 18% vacancy and 6 months later it is 5%.

As for 2% rent increase, I used the low number to see if the numbers still make sense. Currently in DFW it is close to 4% but it's better to use lower numbers in underwriting.

  •  Taxes - yes that makes sense. I missed the nuance of what isin the denominator :)
  • Cap rate- you're right, not sure where I got that number. Certainly seems more doable
  • If you do, give me a call! Lol.. This is the type of deal I want to work up to in the future
  • Yeah it's mostly semantics but I think the textbook definition of NOI excludes capital expenditures and reserves.

If you want to get more inspiration on how to present performance numbers to potential investors, check out the public disclosures docs that the REITs make available for investors (usually public on their website). A ton of interesting info, and super professional inspiration. Here's the link to one here in Japan (info is in English)

http://www.kdr-reit.com/english/

Check out "financial reports", "earnings for individual properties", and "IR presentation materials" [investor relations] - a ton of interesting stuff, the only difference is the number of zeros at the end. 

It's personally quite funny to me because I happen to live in one of their buildings.. Peeking into the financial statements reinforces the wisdom of renting in a high-priced area like central Tokyo (would apply just as well to SF, NYC, etc I'd think) - they are only making 4-5% net on their building!

Nick, you mentioned you're already involved in a deal like this? That's awesome! Are you the promoter or an investor? Would be quite keen to hear more details on an actual deal that you've done

Cheers,

-Dmitri

@Dmitri L. , I am a passive investor in the deal I mentioned. Hope to become a sponsor one day :-)

@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!  :)

Nick - nice job on the spreadsheet. You are off in several areas. We can't get into specifics here, as there are too many income/expense assumptions that are off a bit. Let me just paint the big picture...

You are re-positioning an asset that is currently running 18% economic loss. You are saying that you can get it to 10% in Year 1. How likely is that?

From T12 gross of $664,000, you are saying that in Year 1 you'll be at $775k. That is a lot of LTL that you are saying you'll burn IMMEDIATELY (you are not allowing any time). This LTL is not reflected in the economic loss...

In other words, even if we assume that your income and loss projection hold, and it's possible to achieve your Year 1 stabilized numbers, it will certainly take some time. 

What you used as Year 1 pro forma is your stabilized pro forma. It's wise to assume that you'll get there by year 3. Years 1 and 2 need to be discounted. 

Then, in year 4, you start growing. Use 2% expense growth - 1% is never enough. Keep in mind that unless you can project 3% growth, it is quite difficult for the IRR to work; you have to buy it on the front end. Finally, some of your expenses look too low, specifically pay roll and R&M.

It's a good spreadsheet. The story behind the numbers needs to be refined a bit. Your numbers seem as though they should work, but I think they are too aggressive in reality. 

A few comments, @Nick B. ,

Your spreadsheet is pretty good.  A bit basic but a lot better than many I've seen.

I wouldn't have the guts to forecast 5% stabilized vacancy. Even if market studies support it, it's bad practice to underwrite that aggressively.

6% economic vacancy is almost certainly unachievable. You're more likely off by half or more. I tend to underwrite between 14 and 18% depending on property class and submarket.

Asset management is a partnership expense not a property expense so it should be below the line--a component of cash flow but not NOI.

Your G&A is a bit low, you'll probably be closer to $250/unit.  $340/ unit for maintenance and make ready is light unless this is a new property.  

That's just a few of the basics but enough to keep you out of trouble.

@Ben Leybovich , thank you for your insight. 

The first year is modeled after a deal I am in. It went from 15% to 5% (I was wrong earlier stating that it went from 18% to 5%) vacancy in 6 months. Assuming it stays at 5% for another 6 months, it gives an average of 7% vacancy for the year. In the model I project to get from 18% to 10%. It is less of a distance :-)

On the expense side, I used numbers from my operating reports and averaged them with some other proformas. Then looked at this report for further guidance:

http://www.naahq.org/sites/default/files/naa-docum...

As you can see, the national average payroll expense is 10.4% of gross or $1178/unit. I used $1150/unit in my model. The actual number I have is $995/unit.

What should I budget for R&M? Mine is 5.17% (2.95% R&M + 2.22% for make-ready). National average is 5%. Your number?

Thank you
Nick

Hi @Nick B. , I like the spreadsheet!  You asked, so here are my thoughts.  They're based on experience in DFW, so others may have a broader scope of knowledge to play with...

I agree with @Ben Leybovich re economic loss... sort of. You're probably too low for year one. I think repositioning the property with a $5k/door rehab would easily get you to the pro forma rents you're using, but not in three months. I typically use about 15-20% for year one, but where I disagree is that you should be able to burn off the LTL by year 2. In a deal I put together, we projected about 15% loss for year 1, and by the end of the first year we were down to around 7%. I have grudgingly decided to start using 3% rent growth for years 1 and 2 only, due to the state of the DFW apt market, but I use 2% after that. I just don't feel its conservative enough to use 3% going forward. It can be difficult to compete in this environment using 2% rent growth as Ben mentioned, but I don't think it makes the IRR not work. I guess it all depends on what you are shooting for. You show 122%, which is very similar to what I look for. I would LOVE to find a deal that returned 100% every YEAR, like @Steve Olafson said he finds, but I cannot imagine where in the world I would ever find that.  Heck, I'd be thrilled with 30%/year at this point!  If I insisted on that though, there would be no deals for many years.  The network of investors I have built are completely fine with a 100% return after 5 years.  I use 2% rent growth and 2% expense growth because I feel that gives me some room to under promise and over deliver.  

On other income, $50,000 is a lot for 100 units unless you're implementing a RUBS.

Property management for 3.5% is going to be tough to find with 100 units.  I'd use 4%.

Ben mentioned that payroll was too low.  I think its a bit too high.  Since you're in the same market as I am, I can say with confidence that you can easily get multiple PM companies that will quote $1000-$1100/unit.  Some will quote less, but I'd be careful there.  I think he may be right on the R&M being low.  I noticed that you broke out make ready's and contract services, so you may be okay, but $200/door for maintenance is pushing it on an older property.  

Taxes look pretty good.  I have been using 80% of the purchase price for tax valuations, but we just got our 2015 appraisal on a Garland property, and its the full 100%.  Don't let anyone kid you with that "Texas is a non-disclosure state" nonsense.  Your loan is public, and they'll find out what you paid.  We will protest and hopefully get it down quite a bit, but best to be safe, which it looks like you were.  

Insurance is at $400/dr.  Thats pretty high.  Could happen, but $350 is probably pretty safe.  At least you'll have the previous years financials to go by.  If there's a loss history, aluminum wiring, electrical panels that are known to be bad, you may pay a lot more.  

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.  

On the rehab, $5000/dr is a significant number.  You should be able to cover interior upgrades,  and a few major projects too such as roofing, or parking lot repairs with that amount.   

@Brian Burke - wow...so that's what restraint looks like on you. Had I show you numbers like this, you'd have ripped me a new one..right there...on the spot...and you would have made it hurt too...

It's like there is a litmus test - is the name Leybovich? If not - be nice...just sayin'

Nick - $1,200 for 200 units might be ok on pay roll. For 100 doors you are likely at $1,300. Like Burke said - your economic numbers are just so aggressive. Perhaps possible, but you always want to under-promise and over-perform. This pro forma is not close to that ideal...

Rehab budget is not something you can fluctuate - **** costs what it costs, and $5,000 doesn't buy nearly as much as you think!

Just too aggressive, Nick. And proves why these are so damn hard to find!!!

LOL, yes, I only pick on you, @Ben Leybovich .  I'm nice to everyone else on BP.  Note to self:  be nicer to Ben. Wait...I was supposed to remember to do something, but forgot what it was. Oh well.  :)

@Nick B. , I should have been more specific on what use of property I'm talking about.  Based on your purchase price, your rehab budget, your rents, and previous conversations we've had, I assumed C class in a decent area of DFW.  Other areas and properties can obviously vary widely.  That may be the difference in the payroll numbers @Ben Leybovich used and what I use.   I have spoken to three PM companies this month regarding a 92 unit property.  One used $850/unit, and the other two are rt at $1100.  i think you and I are talking about the same type of property with the same demographic.  

I don't know where

@Brian Burke is buying, but 14-18% economic loss would make it nearly impossible to buy anything around us.  Not that conservatism is a bad thing!  

Originally posted by @Brian Burke :

LOL, yes, I only pick on you, @Ben Leybovich.  I'm nice to everyone else on BP.  Note to self:  be nicer to Ben. Wait...I was supposed to remember to do something, but forgot what it was. Oh well.  :)

 Oh, my...I bring it out - don't I? Have you stopped to internalize what this really means...scary!

I haven't, Ben, but it is funny. 

@Tom Lafferty is right, it isn't easy to buy with conservative underwriting, but if you are buying with investor money it's the only way to buy. I buy primarily in Texas markets and all of the properties I've purchased there, including one this week, has met that criteria as to economic vacancy. 

Here is the example that you asked for.....

So the properties that I look for would probably be next to impossible to find these days.  I have stated multiple times on this forum that I am not buying multi-family right now.  The switch was made to retail strip centers about a year ago.

Let me give an example though.  This is a deal that was purchased just over a year ago while the market was HOT.  I have other examples from a time when the market was not hot that made way more that 100% per year. 

So this is a 24 unit deal in an EXCELLENT location that was not making money for the long-time owner (about 20 years).  It was filled with tenants that did not make a lot of money.  The management company was charging a lot and it was costing the owner a lot to do repairs and maintenance.  I paid 50K/unit and it was around a 5 cap.

The initial rents were $460 for the 1 bedrooms and 550 for the 2's.  The initial goal was to upgrade the floors, paint, counter-tops, clean the outside, raise the rents up to 675 for the 2br's and sell it.  Since that time, I have seen other properties in the area that have had much more thorough upgrades selling for over 100K/unit.  I pulled it off of the market and talked to the investors about adding another 250K to the upgrades.  We are in process now and expect to get $1100 for rents.  Maybe even more.  We also expect to sell it for 110K per unit once we finish.  On top of this, the bank is going to give us the $250K and add it to the loan.

Anticipated proceeds after 7% cost of sale = $2,455,000

Loan outstanding = $1,100,000

Proceeds after loan is paid = $1,355,000

Original investment = $365,000

Anticipated hold time is 2.5-3 years.

This is about 300% after 3 years.

I have other examples of deals that have been completed and sold that were much greater than this.  It takes too much time to detail them all out.  The others were purchased during the downturn and I paid more like 18K per unit.  In some cases there was no money down at all.  Not even for fixup!  It was all included in the loan.

Create Lasting Wealth Through Real Estate

Join the millions of people achieving financial freedom through the power of real estate investing

Start here