I see a lot of articles on the blog that I coin “guts and glory.” I am guilty of it, too. You know, the low hanging fruit all about how you must have guts to succeed, and you must have a strong “why,” and all the rest of this stuff… you know what I’m talking about?
This topic is easy to write about ’cause we all agree on it in principle, which makes this the easiest advice to give and receive. Be bold, we tell. Don’t let your fears control you.
I ask people a lot about fear; I want to know what people fear. And the number one answer I get reads something like this:
The biggest issue is finding the right deal and getting comfortable enough to proceed.
Do you feel this way?
The way I see it, there are two separate issues blended into one here: Defining what is a good deal is one, while getting comfortable to proceed is something else all together.
What is the “Right Deal?”
Well, this is the simple part (sorta) because it’s all about the math. If the numbers work, then the deal is right – agreed?
I wouldn’t be so fast to agree!
What numbers are you using? Don’t we have to qualify this in order to make the statement above…?
For instance, I’ve been rather absent last week from the Forums. Why? I was in the running for an apartment community in Ohio. My underwriting came in at about $4.1 million, and I had reason to believe that this was good enough to get the deal done — it was certainly close…
I began talking to the investors. The underwriting penciled to 15+% IRR to the limited partner. That’s 15% IRR after all of the syndication expenses and the GP split. Great!
I didn’t get it. In the end, $4.3 million ruled the day.
Underwriting to the IRR vs. the Cap Rate
I had a candid conversation with the broker in this deal. In so many words, he asked me why I underwrite to the IRR in a marketplace where everyone else underwrites to the Cap Rate. I explained that I work with sophisticated investors who understand that Cap Rate is a static metric, and in order to inject the element of time, they want me to underwrite to the IRR. Then, they take my projected IRR (if they agree with it) and underwrite it to their MIRR, which compares apples to apples all of the opportunities available to them.
If I try to bring my investors a deal underwritten to Cap Rate, they’ll just laugh me out of the room… 🙂
But others are comfortable doing it differently!
Sure, they are. Not everyone is as sophisticated as my investors. And not every syndicator wants to deal with sophisticated investors; most will take your money if all you know is cash on cash and Cap Rate. Many investors are less interested in driving returns and more concerned with protecting buying power. And in an environment with 10-year fixed rate GSE debt at under 5%, which is in many cases non-recourse, 12% CCR on paper looks real good.
They are comfortable; my guys are not!
You see what I mean? We all look at the same T12 numbers and market attitudes relative to Cap Rate, but these tell us a different story. One’s comfort level is a function of our capacity to read the numbers. What is good deal for them is not for me, at least not Ben Leybovich the syndicator…
I did not feel comfortable at $4.3. Am I a loser because I can’t “get comfortable?” Or am I wise for recognizing that it’s better not to take a deal than to expose and potentially lose investor money, get sued, and lose my house?
What do you think? Do you often come to a completely different conclusion than other investors on the same numbers?
Leave your comments below.