May 1, 2019

JF1702: How To Underwrite A Value-add Apartment Deal Part 5 of 8 | Syndication School with Theo Hicks

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Syndication school is back! We’re just going to jump right back into it today. Theo will pick back up where he left off with underwriting. Specifically, today he’ll be talking about how to determine your asking price. If you enjoyed today’s episode remember to subscribe in iTunes and leave us a review!


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Joe Fairless: There needed to be a resource on apartment syndication that not only talked about each aspect of the syndication process, but how to actually do each of the things, and go into it in detail… And we thought “Hey, why not make it free, too?” That’s why we launched Syndication School.

Theo Hicks will go through a particular aspect of apartment syndication on today’s episode, and get into the details of how to do that particular thing. Enjoy this episode, and for more on apartment syndication and how to do things, go to, or to learn more about the Apartment Syndication School, go to, so you can listen to all the previous episodes.

Theo Hicks: Hi, Best Ever listeners. Welcome back to another episode of the Syndication School series, a free resource focused on the how-to’s of apartment syndication. As always, I’m the host, Theo Hicks. Each week, as you know, we air two podcast episodes that focus on a specific aspect of the apartment syndication investment strategy.

For the majority of these episodes, we offer a document, a spreadsheet, or some sort of resource that accompanies the episode, for free. All of these free resources, as well as the past Syndication School series can be found at

This episode is gonna be a continuation of the series we’ve been doing for (I guess now it’s been about) two months, since we took about a one-month break, because I’ve been off for the past month… But I’m back here, to talk more  apartment syndication. This is gonna be a continuation of the series entitled “How to underwrite a value-add apartment deal.” This is gonna be part five.

I highly recommend, if you haven’t so already, going back and listening to parts one through four; we might have a lot of new listeners since we haven’t recorded for about a month…

To start this episode off, I’m gonna quickly do a synopsis of steps one through four, just to give an idea of what we’ve discussed so far, because everything we’ve discussed so far is gonna be the foundation for specifically this episode; in this episode we’re gonna talk about how to actually set the offer price.

Once you’ve done parts one through four in the case of the seven-step underwriting process steps one through four, then we are going to be able to set an offer price, and see if we can actually get this deal under contract.

In part one we discussed what you actually need in order to underwrite a value-add apartment deal. That’s gonna be the T-12, which is gonna be that 12-month summary of the income and expenses at the property. You’re gonna need a rent roll, which is a summary of the units and the amount of money each of those units are bringing in.

Third is gonna be the offering memorandum, if the deal is on market. That’s that sales package put together by the listing broker. And then lastly, you’re gonna need some sort of financial model to input all of this information into. And being Syndication School and we give away free stuff on this podcast all the time, one of the free documents we gave away is that simplified cashflow calculator… So if you haven’t done so already, go to and make sure you download that model… Because a very common question I see is “Can I get my hands on the financial model you guys use to underwrite your deals?” This is not the model that we use, but is a simplified, condensed version of that model, that you can use to get started, that you can use to fully underwrite deals, and that hopefully you are able to customize as you get more familiar with the cashflow calculator, as well as the underwriting process, to make it a powerful tool based off of what you need and how well you are using Excel.

Also in part one we went ahead and introduced the seven-step underwriting process. To quickly review, step one is to read the offering memorandum, step two is to input the rent roll data into your cashflow calculator, step three is to input the T-12 information in your cashflow calculator, and step four is to set the underwriting assumptions. Step five is to determine the offer price. Step six is to perform an online rent comp analysis, and step seven is to visit the property in person.

Now, as I mentioned already, we’ve done steps one through four so far, and in this episode we’re gonna be talking about step number five. But in part one, if you listen to that, we discuss steps one through three, which is, again, read the OM, input the rent roll and input the T-12 data.

Then moving on to part two, the second episode in this series, we began setting our assumptions; so step four – setting the  underwriting assumptions. Specifically in that episode we focused on how to calculate how much money you need to raise in order to take down the deal. That requires knowing 1) what your acquisition fee is going to be; 2) how much you need to pay in closing costs; 3) how much you have to pay in financing fees; 4) how much money you’re going to raise for an operating account fund; 5) how much money you’re gonna need to raise in order to perform the interior and exterior renovations, and 6) how much money you need to put down in order to secure financing.

So we’ve reviewed how to calculate each of those factors… Then in step three we went into more detail on how to calculate those renovation, those capital expenditure costs, so those interior costs and those exterior costs, as well as a contingency budget… And to do so, we went over a list of 27 different ways that you can add value to apartment communities. Again, not every single way to add value, but these are some of the most popular and common ways to increase the value of your apartment community by performing those interior renovations or exterior renovations in order to demand more rent, or others sorts of income through fees.

Then the most recent Syndication School episode was part four, and that is where we finished up step four, setting the assumptions, and we discussed the remaining assumptions, which were those growth assumptions, from appreciation, how much is the income going to increase each year, how much are the expenses going to increase each year.

We talked about the various project assumptions – how long  do you think it’s gonna take in order to perform all the renovations and get those new, stabilized rents, how long do you plan on holding on to the property… And then we discussed the stabilized income and stabilized expense assumptions – that is what are going to be the income (loss to lease, vacancy, bad debt, concessions, things like that) as well as the expenses (payroll cost, insurance, taxes), what those are going to be once you actually take over the property.

The last set of assumptions we discussed were those debt assumptions – what type of loan are you getting, what’s the interest rate, what’s the amortization period, is there an interest-only period, how long is the loan… So we went ahead and discussed where to find that data and how to input that into the cashflow calculator.

Now, at this point, since we have all the information about how the property is currently operating, and we’ve inputted all the information about how we plan on operating the property, we’re able to go ahead and figure out how much money we can pay for the property; we can figure out how to set an offer price. That’s what  we’re gonna talk about for the remainder of this episode. Then in the next episode, as well as next week, we’re gonna finish off the seven-step underwriting process.

With that being said, let’s jump right into how to determine an offer price. If you listened to the episodes, typically for these larger apartment deals (100 units, 200 units, or more) whether it’s off-market or on-market, there’s likely not going to be a purchase price or a sales price listed.

Typically, if you read through an offering memorandum, it’s going to say that the price is going to be determined by the market. Or it’ll just be left blank, or they won’t even really address the sales price at all. Now, “determined by the market” means that they’re likely going to have some sort of bidding period, where all the people who are interested in buying the deal will do their analysis, submit their offers, and then once they collect all those offers, they’re going to pick the strongest offer; not necessarily the highest priced offer, but the strongest offer. We’ll discuss that most likely next week, how to create a  strong offer. But they’re gonna review all of those, and then sometimes they’ll have a best and final sellers call, where the seller and the broker will have a conversation with the top few buyers, to get an understanding of their ability to purchase, as well as what their business plan is going to be… And then they’ll pick the strongest offer to have a purchase and sales agreement signed for.

Typically, that number is going to be based on the buyer – what are the buyer’s return goals, and how much value can they add to the deal? The more value you can add, the more you can pay for the deal. Those are the two main factors that will determine the sales price.

When it relates to the return goals, because we’ve already talked about adding value when we discussed the 27 ways to add value – but the other one is the return goals… So what are the return goals that either you and/or your investors have for the apartment deals? So since we are raising money, the goals of our passive investors are gonna be pretty important, so you’re gonna want to know what returns they want.

For Joe’s business, when they’re analyzing deals, the two factors that they take into account when determining how much money to pay for a deal are gonna be the cash-on-cash return, and the internal rate of return.

When they’re underwriting deals, they wanna see a cash-on-cash return of at least 8% each year, and one of the reasons why is because the preferred return that they offer to their investors is 8%. So if the deal doesn’t cash-flow 8% each year, they’re not able to hit that preferred return, so the deal is not going to make sense.

Now, sometimes you don’t necessarily need to hit that 8% or whatever that factor is year one; you can make up for it in other ways. It can accrue, you can pay your investors in other ways… But ideally, you wanna see an average return of at least 8% each year, if that’s what your preferred return is going to be.

The other one is internal rate of return, which is gonna be based off of the hold period. For Joe’s business, they wanna see an IRR of around 13%-14% for a five-year hold.

Now, when you’re underwriting it, from a strictly analytical perspective, the way that you’re gonna figure out what the offer price is going to be is through an iterative process. So at this point, you fill out your entire cashflow calculator. You have all the formulas set up, and if you don’t input a purchase price, you’re gonna get some errors, you’re gonna get some zeroes, some undefined cells in your cashflow calculator, particularly when it comes to these return factors – the cash-on-cash return and the IRR. That’s because the cashflow calculator is waiting for you to input the last piece of information, which is what the purchase price is going to be, and then once you input a purchase price, it’ll go ahead and do his thing, run all these formulas and spit out a cash-on-cash return and an IRR.

So what you wanna do is you’re going to want to essentially just input a number, and see what the cash-on-cash return and the IRR is. If the cash-on-cash return is 50%, and the IRR is 100%, then you’re going to want to likely increase that number, because it’s not going to be a strong enough offer to the seller. If the cash-on-cash return is 1% and the internal rate of return is 3%, then you’re gonna want to go ahead and reduce that offer price.

You wanna keep messing around, inputting different numbers, until you get to the point where you’ve got a purchase price that results in the deal meeting or exceeding your return goals.

Now, one more thing that you’re gonna want to do before you get to this point, because the cash-on-cash return is not necessarily dependent on when you actually sell the property, because that’s just based off of the ongoing cashflow… But of course, once you actually sell the property, since you’ve added value, you’ve increased the income and/or decreased the expenses, then the value of the property is gonna go up, which means that you’re gonna have hopefully a large lump sum of cash to distribute at sale. The amount of money you’re able to distribute at sale affects the internal rate of return, so that’s why you want to input – if you remember back to step 4, one of the assumptions you inputted was your projected hold period; so five years, seven years, ten years, or how long you plan on holding on to the property. Once you input that, then you’re going to know “On this date in the future I plan on selling the property”, so based on that you can determine how much profit you’re going to make once you actually sell the property. These are what are known as disposition assumptions, or sales assumptions; it’s just a fancy way of saying sales assumptions. Once you set those, then you will have that IRR number populated.

Here’s a few things you need to know in order to set your dispositions assumptions. Number one is going to be what will be the exit cap rate? The value of the property, of multifamily, is based on the net operating income and the market cap rate. So you’re going to know what the exit net operating income is, because if you filled out your cashflow calculator properly, then every single year should have a total income, a total expense, subtract the two and you’ll have your net operating income. So if the goal is to sell a property after five years, then you can use the net operating income from month 60. Whatever the annualized net operating income in month 60 (which is five years) will likely be an estimate or an approximation of what the net operating income will be when you sell that property in five years. Of course, it’s not going to be perfect; that’s why we want to input conservative assumptions, and it’s why I said to input conservative assumptions. That way, you know that that net operating income is not necessarily a worst-case scenario, but it’s a conservative estimate, and not something that’s super-aggressive… And you’ll notice this when you have your cashflow calculator. Just the slightest change in that net operating income will impact the profits, as well as the ongoing cashflow. So if you’re super-aggressive and you don’t hit those numbers, then you’re not going to hit those return projections that you presented to your investors, and that’s gonna at the very least give your credibility a hit.

So in order to calculate that exit cap rate, this really depends on how you wanna do it. Different operators have different methods and strategies for determining what that exit cap rate is. For Joe’s business, they’ll typically assume that the exit cap rate is going to be 20 to 50 basis points worse than the in-place cap rate. What that means is they believe that the market is going to be worse when they sell than when they buy. Now, if that holds true – again, this is being conservative, and kind of going for that worst-case scenario – if the market is worse when they sell compared to when they buy, will they still be able to hit those return projections? If they do and the market remains the same or gets better, then they’re going to blow away their projections… But just to be safe, they assume that the market is going to be, in this case, 20 to 50 basis points worse at sale, compared to the purchase.

In mathematical terms, that means that the exit cap rate is going to be 0.2% to 0.5% higher than the in-place cap rate. So if the in-place net operating income divided by the offer price that you set – let’s say it’s 5%, and you plan on selling after five years, then the in-place cap rate being 5%, you’re going to assume an exit cap rate of 5.5%.

A few of the other strategies I’ve seen is ten basis points per year, so every year they hold the property, they assume the market cap rate is going to get worse by 0.1%. Some people just keep it the same. Again, it’s really up to you, but our recommendation is to assume, whether it’s 20, 50, 100, whatever you wanna do, but just assume that the market is going to be worse at sale than at the buy, just to keep everything conservative.

Once you have that exit cap rate and you’ve got your exit net operating income, you take the NOI and  divide it by that cap rate in order to determine what you’re likely going to be able to sell your property for after five years.

Of course, you didn’t buy this property all cash, and you likely didn’t pay off your entire loan. You might even refinance and have a larger loan on there now, so you’re gonna have to subtract the remaining debt from the sales price… And again, I’m just explaining how the math is working in the cashflow calculator; in the simplified cashflow calculator, all of this is already done for you. All you really need to do — well, actually, the cashflow calculator automatically assumes that the exit cap rate is 50 basis points worse… So I’m kind of just explaining what’s going on in the cashflow calculator, just in case you wanna tweak things.

So it’ll subtract the remaining debt, and that will be what your profits will be at sale. Then there’s also a few other things that need to come out of that before you’re able to distribute to investors. So you’re gonna have your closing costs – if you’re the seller and you’re paying the closing costs, you’re gonna have to take that into account. As the general partner, you might also charge a disposition fee, which is a percentage of the sale for essentially all the work you’ve done, from day one until you actually sell the property. Then you’re gonna take out some taxes, and really any other fees that are involved with the selling of property. That could be a broker’s commission… This really just depends on how you go about selling the property. Once all that money is taken out, the remaining profit is going to be your sales proceeds. That is going to be the money that is able to be distributed. Then based on how you’ve structured your agreement with your passive investors,  some of that money goes to them and some of that money goes to you.

For example, you’re likely going to need to distribute the remaining equity to investors. Let’s say for example you’re holding the property for five years, and the total investment is of a million dollars, and you’ve given that 8% preferred return, which is usually considered a return on capital; anything above that is considered a return of capital. So anything that was distributed above that preferred return will be get subtracted from their capital balance, and then whatever is remaining is owed back to them at sale. So you subtract that from the sales proceeds, and then the remaining profits are split between the GP and the LP based on whatever that profit split is  (a 50/50, 70/30), and that’s how much money is going to be going to your passive investors at the sale. At this point, in the cashflow calculator, it will automatically calculate that internal rate of return based on all the cashflow they’ve received from day one, plus that entire lump sum profit they receive at sale, plus how much money they invested initially, and it will calculate that internal rate of return for you.

So at that point, you will have the entire cashflow calculator filled out, you’ll have your disposition assumptions set, and you’ll go ahead and do that iterative process with the offer price. Once you’ve gotten to the point where you’ve gotten that cash-on-cash return and the internal rate of return to the point where it meets your investors’ goals or your goals if you’re buying this yourself, that is going to be what you can offer on the property.

At this point also, all the other cells that were undefined, or zeroes, will automatically populate. For example, the equity requirements, so how much money you need to raise, because that number is going to be based on the purchase price, because of the acquisition fee, the closing costs – all those are usually just a percentage of the purchase price, and that’s how it’s set up in the simplified cashflow calculator.

So you can go through and say “Okay, this is how much money I’m going to pay for the deal, this is how much money I need to raise, and here are going to be what the return factors are going to be.” Now, you’re not ready to submit an offer yet; there’s still a few more steps. But at this point, something that would be helpful for you, especially if you’re just starting out, is to go ahead and ask your mentor and/or your property management company to review your underwriting.

Now, depending on the expectations you set with your mentor or property management company during those conversations – that will determine how you have them analyze your underwriting. You probably don’t wanna just send them your cashflow calculator and that’s it. That’s just gonna be more work on their part, because just because you’re familiar with the cashflow calculator doesn’t mean that they’re necessarily familiar with the cashflow calculator… So anything that you have questions on or you’re not 100% sure on, just ask them.

For example, you can say “Hey, these are my stabilized expense assumptions. Here’s my payroll costs. Here’s my property management fee. Here’s my maintenance and repairs. Here’s my contract services. What are your thoughts on that? Here are my growth assumptions, here are my income assumptions. I think the vacancy is gonna be this, loss to lease is gonna be this; what are your thoughts on that? Here are the interior and exterior renovations I think are going to be needed at the property and here’s the cost associated with each of those. What are your thoughts on that?” Summarize your cashflow calculator in words, and then send them a few bullet points and ask them to give you their feedback based on that, instead of just sending them the entire Excel model… Because they probably wouldn’t appreciate that that much, but they’d appreciate you putting forth the effort to underwrite the deal, as well as you putting forth the effort to make your questions more clear and concise.

So at this point you’ve got your offer price. You’re gonna want to do steps six and sever concurrent with determining the offer price, because it really depends on how you are determining the stabilized rents, how much money you’re gonna be able to collect once you’ve actually done all of your exterior and interior renovations. This strategy is assuming that you’re buying a property that has the proven rent premiums. That means, as I’ve said in previous episodes, that the current owner has implemented a program already on maybe 20% of the units, and they’ve gotten a $25, $50 or whatever rental premium, and you’re going to assume that you’re going to get that same premium on the remaining units, and you’ve inputted that into your cashflow calculator.

If that’s not the case, then you’re gonna have to do steps six and seven first – that is the rent comp analysis and the in-person analysis. Just step by step, a seven-step process. Usually, you’ll follow it straight through, but sometimes you might have to do the rent comps first, before you’re able to set an offer price… But we’ll talk more about that in tomorrow’s episode, when we discuss how to perform the rent comp analysis.

That’s gonna conclude part five of how to underwrite a value-add apartment deal, as well as step five of the underwriting process, and that is how to determine that offer price. Again, this is gonna be based off of the return goals; once you know those and you’ve set your disposition assumptions, you’re gonna want to determine what the offer price is going to be through that iterative process, which means you change that input on the cashflow calculator until you are achieving those returns that are desired by you and/or your investors.

As I said, in part six tomorrow we’re gonna discuss step six, which is going to be the rent comp analysis. Until then, to listen to other Syndication School series about the how-to’s of apartment syndications and to download that free simplified cashflow calculator and other free documents, visit

Thank you for listening, and I will talk to you tomorrow.


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