How to Evaluate Key Aspects of a Deal

This is our last article in a series focused on identifying and understanding investment opportunities, as well as the underlying decisions that go into making these decisions.

Our first article focused on defining what a good return is and discussed comparing various risk profiles of seemingly similar opportunities and how that can impact our understanding of different potential returns. Two weeks ago we discussed how not all investment metrics are created equal and the importance of comparing various asset classes in a truly equivalent manner.

In this third and final article, we provide our perspective on how we evaluate investment opportunities. This comes from our experience as both a passive investor in non real estate assets in addition to how we are evaluated as an operator of value-add multifamily assets. These are elements of (mostly) private investment opportunities we would encourage you to investigate and discuss as you parse through whatever deals you may find.

• Know Your Industry
  You need to have a very good understanding of the industry you are investing in. Within real estate, understand the underlying asset class of each opportunity and what the macro forces are driving that industry. There are different factors driving multifamily growth vs self storage facilities, for example. You should be looking at demographic trends, historic performance of the industry (if it exists) and really understand what you are investing in.
  
  In our world of multifamily, we see demographic and financial data that shows there are more renters today than ever before. Millennials are set to be the largest generation for the long term future and have different financial realities, attitudes towards homeownership, and traditional triggers to buying a home (like marriage and having kids). That means they will rent longer than previous generations, increasing demand. On the flip side, the price of homes continues to increase, and many people are facing an affordability crisis that doesn’t allow them to afford a home, even if they wanted to. That also creates a larger renter demographic. In our core Texas markets, there is a clear need for more apartments to be built and an expectation that demand is going to outstrip supply over the next 5-10 years. Those are good industry trends to be tracking.
  
  But what about new industry’s without as much data? No doubt you’ve seen the news, and perhaps an investment prospectus, related to cannabis and it’s derivatives (CBD & THC marijuana). I know we have. It’s an industry that is seemingly exploding as legal status and general attitudinal changes alter the landscape of this what’s possible. In this instance, it’s an extremely new, burgeoning industry with very little track record. How do you evaluate an industry that is just beginning? It’s definitely harder to do, and we’d expect if we did make an investment in a new space the potential returns would be much higher to compensate.

• Team Performance
  No matter the industry, you need to look at the team you are investing with. Who are the operators that will be driving the ship and making daily decisions that affect your investment. In simple terms, make sure you know the horse you are betting on. Are they truly the operators behind the wheel? What is their track record in the industry? What is their background? What kind of person are they?
  
  In our view, this may be the single most important factor you look at when evaluating opportunities. First and foremost, we always make sure that we like the person we are investing with and they are someone we wouldn’t mind being delayed in an airport with. We want to know their character, ask them questions about difficult times they’ve gone through and the decisions made in those times. How consistent are they in their performance? Are they always executing similar plans in similar locations and industries?
  
  At Wildhorn, we try to make this easy for (potential) investors. We are always available for phone calls and face to face meetings. In fact, that’s our favorite part of this job. But we also stay narrowly focused on what we do-- B-Class assets in in-fill locations of major Texas markets. That’s a box we exclusively play in, which helps give us focus, but also allows investors to define us a little bit. If they see a C-class deal, or something in a tertiary market from us, they’d be right to question our plan and track record in that space.

• Know Your Market
  To us, this is different than industry, as this is geographically focused. Where is the investment opportunity you are looking at? When looking at private offerings, some investors want to be able to see what they’ve invested in--is it within a short drive of your home? Is that important to you?
  
  Even if proximity is not important, you obviously need to be comfortable with the location of the investment. In our world, “market” can be broken down into cities/MSA’s, but also into submarkets. First, you have to evaluate the city and what’s happening there. Austin has very different dynamics and trends right now than Amarillo, for example. Both could offer good investment opportunities, but understanding what is happening in each of those markets will help you make smart decisions.
  
  The next element of real estate opportunities is sub-market. What is happening in the neighborhood you are investing in? As you know, there can be vast differences between the north and south sides of town. You want to make sure you’re in the path of progress, and that you’re not buying the nicest asset in the area. But understanding the sub-market is critical.
  
  Outside of real estate, we’ll again use the example of cannabis since that space is attracting so much attention right now. Clearly, it is not legal in every state, so that will dictate the markets you can even consider. But if you were looking into that space, understanding the different regulations by state would be important. Do California and Colorado have all of the same laws? Do they have different requirements for investors? In this example, Market has the potential to make a huge difference in the investment opportunity and return profile.

• Business Plan Scrutiny
  Once you get past the other three elements, in our opinion, then it’s time to look at the business plan being presented. What assumptions is the sponsor putting into the proforma? Are they believable? What data do they have to support those? Does the financing structure align with the timeline?
  
  In an established industry like real estate, you can look at rent growth projections and compare those against the historical figures in that area. You can look at sales comps and cap rates to see if exit assumptions are conservative enough. You can dig into as much detail as you’d like to get comfortable with the business plan for that investment.

In our opinion, these four aspects are absolutely key to have locked down before you can make a decision about whether or not an investment is for you. If you’re ever looking at a Wildhorn deal, we make sure to cover all four elements of this approach in our investment prospectus.

We hope that the last few articles have been beneficial in peeling back our thought process when approaching an investment. You should be able to set your own definition of a “Good Return”, compare various investment opportunities apples to apples to ensure you’re meeting that good return and finally deep dive that opportunity to truly evaluate key deal aspects that ensure this is a sound investment. Like always we’d love to hear from you.