Three Factors to Consider During Real Estate Deal Analysis
As a passive investor in apartment syndications you rely heavily on the expertise of the general partners (GP) when it comes to real estate deal analysis, market selection and management of the asset. But, it never hurts to have a base level of knowledge about the criteria your general partner team uses when looking at a multifamily opportunity.
When it comes to investing your hard-earned money, investors have a number of questions to ask themselves. What is the investment amount? What are the expected returns? What is the project timeframe? When will I receive distributions?
General partners, on the other hand, are looking at the deal through an entirely different lens and asking different questions.
Here are the three primary categories we delve deep into when conducting real estate deal analysis.
Market Conditions
One of the key success drivers in a multifamily investment is the market(s) in which the sponsors choose to invest. Money can be made in any market, generally speaking, but accelerated growth and success can be achieved when markets are carefully selected based on economic growth at both the macro and micro economic level.
At the macro level, sponsors look for population growth, job growth, declines in crime rates and the average household income compared to the average home purchase price. In a real estate deal analysis these factors give a quick assessment of the overall stability of a market. Then, the sponsor can dig deeper into the micro or submarket level to find specific areas to invest. Just because a major city scores highly on the macro economic factors doesn’t mean that every submarket in that area will meet their investment criteria.
Understand the local economic drivers that can supply rental demand in particular. Is the property close to a university or a major hospital? Is there diversity of employment in the area? What are the potential dangers of the local economic drivers? Is there any possibility that the primary economic driver, such as a naval installation, may close down, and if so, what effect would this have on demand for this apartment building? The more diverse the local economic forces are, the better positioned the investment is to weather a downturn.
Projected Returns
If you’ve read several of our blog articles, you’ve probably heard us say that every deal is a little bit different in how it’s structured, the details of the business plan, returns it offers and exit plan for how the asset will be disposed when the project is complete. All these factors aside, investors expect a consistent range of returns for most real estate investments. This tends to be an easy qualifier for an investor to look at the returns offered and if it meets their criteria, then can look at other factors of the deal to ensure it aligns with their goals. Returns come in many ‘shapes and sizes’ but here are typical returns that can be expected from a value-add apartment syndication:
• Cash on Cash/Preferred return: 8-10%
• Internal Rate of Return (IRR): 15-20%
• Average Annual Return 14-18%
For a more detailed description of these return types, check out this article
Value-Add vs Turn Key Business Plan
A value-add business plan is a common strategy to increase the net operating income on an apartment community. Value add deals typically target B and C (and sometimes D) class properties that have been poorly managed, have higher than normal expenses, below market rents and deferred maintenance. While this strategy comes with some risk, there’s also a large upside potential if the sponsor team can meet or exceed the business plan. Because a multifamily asset is valued based on the income it generates, driving up income and lowering expenses on a value-add project can result in significant returns for investors that are able to weigh the risks against the potential gains.
This differs from a turnkey business plan in that these investments are typically A class assets that have great amenities, are at or near market rental rates and have been well maintained. These assets cash flow predictably and with less risk than value-add projects, but the returns are typically not as high. For investors looking for lower risk opportunities that still provide good returns, turnkey assets are a good investment strategy.
Investing with an experienced sponsor team is important for any real estate investment, but especially so when participating in a value-add opportunity. A sponsor team can make or break a deal, and with more at stake on a value-add project, ensure that you carefully vet the sponsors before deciding to commit to a deal.
Conclusion
A good multifamily syndication team considers many different factors during the real estate deal analysis process. And while a passive investor doesn’t need to be an expert in real estate deal analysis, it’s important to understand the fundamentals of how deals are analyzed and structured to ensure that it will align with your investment objectives.
Your sponsor team, on the other hand, should have in depth knowledge of these three elements and how each impacts the overall business plan of an apartment syndication project. Work with sponsors that are experienced in real estate deal analysis and will openly share their approach to evaluating new opportunities that they receive.
Ask about how we approach real estate deal analysis by scheduling a call or joining our investor club today.