Read on Twitter
Have had brokers wondering why my offer prices are down so much vs. pre-crisis.
After all, rents are only down, say, 15%.
So their intuition is that my offer prices should be down 15%, too.
To understand why they& #39;re wrong, we gotta do some math.
(1/n)
After all, rents are only down, say, 15%.
So their intuition is that my offer prices should be down 15%, too.
To understand why they& #39;re wrong, we gotta do some math.
(1/n)
2/n
Recall we underwrite every deal using unlevered yield:
(Forecast annual rents / forecast annual opex) / (acq price + rehab cost) = unlevered yield
Price and rents are important, but other things matter, too:
- projected opex; and
-rehab cost
Recall we underwrite every deal using unlevered yield:
(Forecast annual rents / forecast annual opex) / (acq price + rehab cost) = unlevered yield
Price and rents are important, but other things matter, too:
- projected opex; and
-rehab cost
3/n
Re opex:
Recall numerator of yield equation: (Ann. rent - ann. opex) ["net operating income"]
Just bc rents are
https://abs.twimg.com/emoji/v2/... draggable="false" alt="⬇️" title="Downwards arrow" aria-label="Emoji: Downwards arrow"> doesn& #39;t mean expenses are, too. Still need to pay prop tax, utilities, insurance, etc.
Assum. no chng in opex, 15% rent decrease equals ~20% decrease in NOI
Re opex:
Recall numerator of yield equation: (Ann. rent - ann. opex) ["net operating income"]
Just bc rents are
Assum. no chng in opex, 15% rent decrease equals ~20% decrease in NOI
4/n
But wait, there& #39;s more.
Remember denominator of unlevered yield calc: (acquisition price + rehab cost)
We expect construction to get cheaper, but we don& #39;t have proof yet, so we& #39;re not changing rehab cost under-writing.
So...
But wait, there& #39;s more.
Remember denominator of unlevered yield calc: (acquisition price + rehab cost)
We expect construction to get cheaper, but we don& #39;t have proof yet, so we& #39;re not changing rehab cost under-writing.
So...
5/n
If forecast rents are down 15%, forecast NOI is down 20%, and assuming rehab cost stays the same:
To get the same unlevered yield as before, you need to drop aquisition price by ~30%.
Ouch.
And it gets worse...
If forecast rents are down 15%, forecast NOI is down 20%, and assuming rehab cost stays the same:
To get the same unlevered yield as before, you need to drop aquisition price by ~30%.
Ouch.
And it gets worse...
6/6
If the present risk environment causes you to raise your go/no go yield hurdle by, say, 10%, then...
... that 15% drop in forecast rents requires a 40%(!!) drop in acq. price to get you the yield you need to move forward.
So, brokers: That& #39;s why my bids are way down.
If the present risk environment causes you to raise your go/no go yield hurdle by, say, 10%, then...
... that 15% drop in forecast rents requires a 40%(!!) drop in acq. price to get you the yield you need to move forward.
So, brokers: That& #39;s why my bids are way down.
Some notes
- my original equation assumed price is 2/3 of total capitalization, with rehab the other 1/3.
- for simplicity, have grouped holding cost into rehab... Don& #39;t forget about it!
- when rents drop, opex does actually drop a little, bc mgmt cost is pegged to rent
- my original equation assumed price is 2/3 of total capitalization, with rehab the other 1/3.
- for simplicity, have grouped holding cost into rehab... Don& #39;t forget about it!
- when rents drop, opex does actually drop a little, bc mgmt cost is pegged to rent
@mgirdley rightly points out the unlevered yield equation in 2 contains a typo ("/" instead of "-"):
Should be:
(Forecast annual rents *minus* forecast annual operating expenses) / (acquisition price + rehab cost)
Should be:
(Forecast annual rents *minus* forecast annual operating expenses) / (acquisition price + rehab cost)