Rent Roll Questions

[Anonymous]

I have a couple of questions on the Rent Roll analysis:

1. In the Rent Roll Summaries we used in this module we are working off of the ‘average market and average leased’ rents vs. modeling each unit individually for the actual rent info for that particular unit. I know this has been done to simplify the exercise. In the real world, do you work off of the averages or do you actual review/model each individual unit to be as accurate as possible?

2. I assume we should also confirm if we agree with the ‘average market’ rents show in the rent roll as well to agree if we agree or believe they should be higher or lower?

Thank you!

[Spencer Burton]

Thanks for the great questions.

1. In the real world, ideally you’d calculate the “average rent” yourself using the full rent roll. This allows you to make adjustments by individual unit and really dig into the rent roll. In lecture 1.4 of course 4d. Real Estate Income Statements – Multifamily, I show you how to work with full apartment rent rolls. At the end of the tutorial, I show you how to use the raw data from the rent roll, plus any adjustments you make to the data, to build a unit mix table like the one used in this course.

By the way, unit mix tables are also used in the real world, especially at the back-of-the-envelope stage. They generally will get you pretty close to your final underwritten gross rent, and they’re quick and easy to digest.

2. This is a really good point. While this is a modeling course and so I haven’t gotten into comp analysis much, ultimately all of the assumptions we make as real estate professionals must be supported. So the market rent you use in your analysis should be supported in some way. Ideally by looking at the experience of other comparable properties.

[Anonymous]

Thank you Spencer – I appreciate the quick yet thorough response.

I come from the affordable housing world and have been acquiring and renovating senior/multifamily apartments for about 10-years, working on about 2,500 units of housing. In my niche of the housing world, the developer/owner doesn’t really operate on an IRR, NPV or other conventional investment metrics I’d be happy to explain this further if you’re interested). I am taking this course to get a better sense of how conventional RE investors think and to get exposed to different RE asset type and their various models.

In the current market I find my of my competitors underwriting revenue/expense assumptions that are either wildly optimistic or frankly just not achievable in order to win deals. I also find the broker’s underwriting to also be very optimistic, which I understand. I know that you pay for poorly (i.e. overly optimistic) underwriting both upfront and over-time.

I am trying to enhance my underwriting skills and feel this course will help give me an underwriting perspective(s) that will help broaden my knowledge of the topic.

[Spencer Burton]

Hi Nick,

That’s interesting that you don’t see time value of money metrics used much in your niche of the housing world. In my experience, the return metrics a sponsor/GP uses is a function of what metric their investor partners require (and their lenders to a lesser extent). Thus, if their investor or lender partners aren’t requiring an IRR to fund the deal, why spend the time to learn to model an IRR!

I spent the first 10 years of my career in boutique residential development, and similar to your experience these metrics were rarely used in my sphere. I remember the first time I had to run an IRR for a real estate deal. We met with a potential investor who had been the CEO of a fortune 500 company. As we were nearing the end of the meeting we asked if he needed anything for him to make a decision, and he said “could you run me a DCF”. And I remember thinking, “what is a DCF!” Haha.

With that said, the industry is becoming increasingly more sophisticated and these metrics increasingly more important. While less than 40 years ago, large institutions (e.g. pension funds, sovereign wealth funds, life insurance companies, endowments, etc) didn’t even consider real estate a viable investment vehicle, today large institutions allocate nearly 11% of their portfolios to real estate, and that number is expected to continue to climb.

So I applaud you for putting in the effort to get exposed to different RE asset types and their various models.

Now, to your second point about deteriorating underwriting standards. That is a sign of a late cycle. When brokers and buyers have to stretch to make a deal work, you’re nearing the end. And that’s not specific to real estate. All asset bubbles are driven by crazy assumptions.

My advice is to have clear underwriting standards, and stick to them. It may mean fewer deals at certain points in the cycle, but it will keep you out of trouble. The firm I’m at right now is so very good at sticking to their underwriting standards, even if those of us on the front lines get frustrated at times when everyone else is loosening theirs to win more deals.

Anyway, thanks again for chiming in!

Spencer

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