Three Factors to Consider During Real Estate Deal Analysis
If you're a passive investor in apartment syndications, you're entrusting a lot of responsibility to the general partners (GPs). They're the ones with the expertise in real estate deal analysis, market selection, and asset management. However, having a foundational understanding of the criteria your GP team uses to evaluate multifamily opportunities can empower you as an investor.
When considering where to invest your hard-earned money, there are several important questions to ponder. These might include the investment amount, expected returns, project timeframe, and distribution schedules. On the other hand, GPs approach deals from a different angle, asking their own set of questions.
Here are the three primary categories that GPs dive into during real estate deal analysis:
1. Market Conditions: One of the critical drivers of success in multifamily investments is the market(s) in which the sponsors choose to invest. While it's possible to make money in any market, strategic selection of markets can lead to accelerated growth and success. GPs assess market conditions at both macro and microeconomic levels. At the macro level, they look for indicators such as population growth, job growth, declining crime rates, and the relationship between average household income and home purchase prices. These factors provide a quick assessment of a market's overall stability. However, GPs also delve deeper into the micro or submarket level to pinpoint specific areas for investment. Just because a major city shows promise on macroeconomic factors doesn't guarantee that every submarket within it meets investment criteria.
Understanding local economic drivers is crucial for assessing rental demand. Proximity to institutions like universities or hospitals, employment diversity, and potential risks associated with local economic drivers are all factors considered. For example, if a primary economic driver, such as a naval installation, were to shut down, how would it impact the demand for the apartment building? Diversification of local economic forces strengthens an investment's resilience during downturns.
2. Projected Returns: While each deal is unique in its structure, business plan details, offered returns, and exit strategies, investors generally expect a consistent range of returns from real estate investments. This serves as an initial qualifier for investors to gauge whether a deal aligns with their criteria before delving into its finer details. Returns can take various forms, but typical expectations for a value-add apartment syndication might include an 8-10% cash-on-cash/preferred return, a 15-20% internal rate of return (IRR), and an average annual return of 14-18%.
3. Value-Add vs. Turnkey Business Plans: GPs often pursue either a value-add or turnkey business plan. A value-add strategy aims to increase the net operating income of an apartment community by targeting B and C class properties with management issues, high expenses, below-market rents, and deferred maintenance. While this approach carries inherent risks, successful execution can yield significant returns. Turnkey plans, on the other hand, involve investing in A class assets with excellent amenities, market-rate rents, and meticulous maintenance. These assets offer predictable cash flow with lower risk but typically lower returns compared to value-add projects. For investors seeking lower-risk opportunities with solid returns, turnkey assets present an attractive option.
Investing in a value-add opportunity underscores the importance of partnering with an experienced sponsor team. The sponsor's expertise can significantly impact the success of the deal, making thorough vetting of sponsors essential before committing to an investment.
Conclusion: A competent multifamily syndication team considers numerous factors during the real estate deal analysis process. While passive investors need not become experts in deal analysis, understanding the fundamentals is crucial for aligning investments with objectives. Partnering with sponsors experienced in deal analysis ensures thorough evaluation of opportunities. Open communication with sponsors regarding their approach to assessing new opportunities is key for investors to make informed decisions.
Whether it's scheduling a call or joining an investor club, understanding how sponsors approach real estate deal analysis empowers investors to navigate the market confidently.
