Five Assumptions to Review Before Investing Passively in a Multifamily Syndication
Many passive investors mistakenly think that there is no work involved as limited partners in a multifamily syndication. This is simply not true. Passive investors must take the time to carefully vet deals before making an investment decision and then pay attention to the communication coming from that deal ongoing to ensure that their investment is performing as planned. There are many items that passive investors should be aware of before making an investment decision and today we will review the top 5.
Five Assumptions To Review
Exit Cap Rate
The exit cap rate assumed in underwriting has an enormous impact on the overall returns of a project. The standard underwriting assumption is to increase the cap rate by .1% from the current market cap rate for each year of ownership in the business plan. This means if the current cap rate is 5.5% and the business plan calls for a 5 year hold that the exit cap rate would be 6%. This assumption could of course warrant change depending on the current market conditions and other such considerations.
Rent growth has been at historical highs over the past few years. Many deal sponsors have underwritten for continued aggressive rent growth over the next several years in their business plans which is already presenting problems as rent growth has declined or even decreased in some markets. Understanding what is a reasonable projected rent growth for your market and making sure the sponsors assumption is not exceeding it is important when reviewing an investment summary.
The max possible income that a property can generate in rent is simply the sum of the market rent for all units added together and is commonly called gross potential rent. As the name implies, gross potential rent is the theoretical rent that a property could achieve when running perfectly, however a number of things play into the reduction of this amount to the amount actually collected by the property. The largest of these items is occupancy. In their underwriting, a sponsor will make an assumption for physical occupancy (number of units physically occupied by a tenant) and economic occupancy (accounts for non-paying tenants). These assumptions should be made based on information from norms for their market, historical norms for their property and feedback from their property management company.
Get a Free Multifamily Loan Quote
Access Non-Recourse, 10+ Year Fixed, 30-Year Amortization
Running an apartment complex is no different than running any business in that there is a certain amount of income each month and along with it a certain amount of expenses. Understanding each of these expenses and conservatively estimating what they will be is important when predicting cash flow for the property and NOI. Expenses should be corroborated by the property management company who will be running the property and executing on its business plan.
Tax and Insurance Increases
Speaking of expenses, the two most important to understand are taxes and insurance. Understanding how taxes and insurance will go up after a sale is crucial as they constitute such a large percentage of the expenses for a property and are uncontrollable. Ensuring that the projected taxes and insurance have been verified by a tax consultant and insurance broker is important to check before investing in any deal.
Source: Apogee Capital