December 12, 2019

JF1927: Everything You Need To Know About Sales Assumptions When Underwriting An Apartment Deal | Syndication School with Theo Hicks


When underwriting a potential deal, you’ll need to have set assumptions that will help you determine how much cash you will receive at sale. After investors are paid back, you’ll be splitting the profits with them according to how you structure the investment. Theo will break down how Joe and Frank underwrite their sales assumptions for Ashcroft Capital. 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 and welcome to another episode of the Syndication School series, a free resource focused on the how-to’s of apartment syndication. As always, I’m your host, Theo Hicks. Each week we air two podcast episodes; they are available on the best real estate investing advice ever show in podcast audio form, as well as available on our YouTube channel in video form.

These episodes focus on a specific aspect of the apartment syndication investment strategy. For the majority of these episodes we offer some sort of free resource. These are PowerPoint presentation templates, these are Excel calculators, these are PDF how-to guides, these are resources that will help you in your apartment syndication journey, that accompany the specific episode or series that we are discussing. Of course, these are free, just like the Syndication School episodes are free. Both of those are available to

In this episode we are going to talk about sales assumptions. This episode is entitled “Everything you need to know about sales assumptions when underwriting an apartment deal.” If you harken back to our discussion about underwriting value-add apartment deals or just underwriting really apartment deals in general, one of the many assumptions are going to be your sales assumptions. That is the assumptions the assumptions made about when you actually sell the deal on the back-end.

The purpose of this episode – it’s going to outline how to think about in more detail these assumptions that you’re setting when you are initially underwriting the apartment deal. So all of these assumptions are a part of the disposition summary that is outputted for you at the end of your underwriting process, which basically tells you how much cash you’re going to get at closing. That’s gonna be very important for you when you’re raising capital, because you’re obviously offering your investors some sort of ongoing return, whether it’s a preferred return, a profit split, or a combination of the two, class A, class B… But a large portion of the return – and maybe even a majority of the return – actually comes at sale. So you add value to the property, you force equity up and up and up, you sell the property for a large profit, and then after you have returned equity to your investors, the remaining profits are split between you the general partner, and the limited partner. The return goes from maybe 8% to 10% annualized, up to 20% plus annualized, once you take into account those profits at sale.

As we’ll dive deeper, the actual profit at sale calculation is very sensitive. So you could change the assumption just a little bit and it could increase your sales price, which would in return increase your profits. So it’s very important to be specific, to be conservative when you are making these underwriting assumptions on the back-end. Once I get to that part of this episode, I’ll explain what I’m talking about.

This disposition summary flows like this – so you decide to sell the property, you have a  net operating income at that date… So I guess going in you have in your mind a projected hold period of, say, five years, so in five years you plan on selling the property. In your model you have a year five ending net operating income, as well as the exit cap rate assumption that you think the cap rate will be at year five, and then you divide the net operating income by the cap rate to get the projected sales price of the property, the value of the property, which you assume is gonna be the sales price of the property.

Then you take the closing costs expense, as well as any debt that you still owe to your lender if you’ve got a mortgage on the property, and you subtract that from this projected sales price… Because those are gonna be expenses paid out at closing. And then you determine based off of that what the sales proceeds are going to be.

So the six assumptions here that we’re making is 1) the net operating income, 2) the exit cap rate, 3) the sales price, 4) the closing costs, 5) the remaining debt, and then 6) the sales proceeds. So we’re gonna go ahead and go through all six of those, and discuss (again) how to think about setting these assumptions.

First is the net operating income. As you know if you’ve been listening to the Syndication School – and I mentioned this a few seconds ago – the value of the apartment is based on the net operating income. That is one of the two factors that goes into the value of the apartment calculation.

The value of the apartment equals the net operating income, divided by the second factor, which is the cap rate. So to calculate the projected sales price, the first thing you need to do is determine what the net operating income is at the sale. So you’ve got your deal fully underwritten — this is assuming you’ve already underwritten the entire deal, and the last thing you need to do is set these last assumptions. In our underwriting process, this is actually one of the last things you do, because a lot of the formulas that are used in this disposition summary are tied to the five-year business plan, and things like that.

The first assumption that goes into your net operating income is obviously the hold period. So when you’re initially underwriting the deal, you need to know how long you plan on holding on to the property. Again, the profits at sale are going to be a large chunk of your investors’ profits, and if you don’t have an end in sight, you’re not gonna have that profit in sight, so you can’t just hold on to the deal for an indeterminate amount of time, unless of course that’s what your investors want… But most likely you’re gonna want to sell the property at some point, so you can return their equity, as well as give them that profit. So five years, six years, seven years, eight years, nine years, ten years – whatever you wanna do, but you need to set that assumption in your underwriting model.

Now, in the simplified cashflow calculator that is hardwired in, you can’t change it. It’s set at five years. But obviously, as I explained in those episodes, you wanna use this as a guide, and then from there using your Excel skills (if you have those) and making it more detailed.

So that’s one, the hold period. And then obviously, once you know the hold period, then you can pull that net operating income number and use that for your calculation. And of course, the net operating income calculation is based off of the income and the expenses, but usually, since it’s gonna be year five, it’s actually based off of the stabilized income and expenses that you underwrote, plus whatever annual income and annual expense growth that you assumed; your rental growth is gonna be based off of how quickly you do renovations… So obviously, there’s a lot that goes into the net operating income calculation. I’m not gonna go into extreme detail on that right now, because we’ve already talked about that a ton in our episodes on how to underwrite the deal.

The one thing that I did wanna stress is the hold period; the NOI at the end of year five is gonna be different than the NOI at the end of year three, which is gonna be different than the NOI at the end of year ten… And since those are all gonna be different numbers, the value of the apartment at year three, year five and year ten are also gonna be different. Hopefully, the NOI is higher at year three than it was in year five and year ten. So once you set that hold period assumption, then you can pull that NOI number from your five, ten-year projections. So that’s the first assumption.

The second one is the exit cap rate. That’s the other part of the value calculation to get that sales price. So in the simplified cashflow model, the assumption is that the exit cap rate is 50 basis points higher than the in-place cap rate at acquisition. So whatever you paid for the property and whatever the net operating income at the time was, is used to calculate the in-place cap rate. So it would be the NOI divided by the purchase price.

So the assumption is that the exit cap rate is going to be 50 basis points, which is 0.5% higher than that in-place cap rate… Which is assuming that the market is worse at sale than at purchase, which is a conservative assumption. Because if the market is the same or is better, then that’s just extra value that’s created. But if it’s worse, then you’ve already accounted for that. If it’s way worse, well then you’ve already accounted for at least some of that.

Now, this 50 basis points assumption that we use is based on a five-year exit. So if you want to have a lower one, if you’re gonna make the exit cap rate the exact same as it was in place, if you wanna make it less than, greater than, it’s really up to you. This is just what we do. But if you make that change, then you wanna make that change reflected in your cashflow calculator. So however you’re calculating your exit cap rate in your cashflow calculator… If it’s gonna be 50 basis points greater than the in-place cap rate, then the formula would be in-place cap rate plus 0.0005. If it’s something else, then you wanna change that plus number… And if you’re just inputting a different number entirely that’s not based on the in-place cap rate at all, then you’ll wanna just input that.

Now, there are a few scenarios where you can’t just base the exit cap rate on the in-place cap rate. There’s really two that come to mind. The first is if you bought the property below market value, and the second is if you are updating the property to such a degree – and this kind of ties into yesterday’s episode, or if you’re listening to this in the future, the Syndication School episode before this one, about underwriting a highly-distressed apartment deal… So if you’re adding  a ton of value to an apartment, that actually brings it from class B to class A, or class C to class B, or class D to class C, so it’s going up in class ranking – then you’re also gonna want to not base the cap rate on the in-place cap rate.

So in the first scenario, if you’re acquiring the property below market value, then the in-place cap rate is going to be a lot higher than what the actual market cap rate is… Because the value is lower, the NOI is the same, so therefore the cap rate is higher, since it’s in the denominator of that formula… So you need to figure out what the actual market cap rate is, because your transaction is not actually at market cap rate.

So this is speaking with your property management company, or your broker, and reading the various market cap rate reports by institutions such as CBRE, to help you determine based off of the stabilized product what is the market cap rate. And then you can base your exit assumption on that number, as opposed to the in-place cap rate.

The other time, again, is if you’re taking the apartment to a higher asset class. Generally, the cap rate of class A are less than the cap rates of class B, which are less than the cap rates of class C, which are less than the cap rates of class D. So if you are buying a class C at a higher cap rate, and you convert it to a class B, at that lower cap rate, well then you’re not gonna wanna base your exit cap rate on that class C cap rate; you’ll wanna base it on that class B cap rate. So again, where do you find that? Same place you find any market cap rate, which is your property management company, brokers, and the various commercial real estate reports. Once you find that number for the new asset class, then you can base your exit cap rate assumption on that number. So that’s assumption number two, exit cap rate.

Assumption number three is the sales price, which technically isn’t really an assumption. I mean, it is, but it is based off of two other assumptions. So it’s based off of your NOI at exit assumption and your exit cap rate assumption – again, NOI divided by cap rate gives you the value. In your cashflow calculator that’ll most likely be automatically calculated. It is in our simplified cashflow calculator that you can get at for free.

Number four is the closing costs. These are the expenses that are associated with selling the apartment, and in the simplified cashflow model we just have it set to 1% of the sales price. It’s not necessarily a placeholder, but it’s just assuming that all it is is these lending closing costs; the closing costs paid to the lender, which may be lower or higher than 1%.

So there are other expenses that might be incurred at sale, depending on your business plan, depending on the loan that you’ve got… So here’s a breakdown of some of those other potential expenses. If these are something that you believe might be incurred at sale, well, make sure you’re accounting for these in your disposition analysis.

First is the commission. If the deal on the back-end is listed for sale by a broker, they’re gonna take a percentage of that purchase price. That’s gonna be based on the sales price, so you need to account for that in your disposition analysis. So ask the broker you expect to use what they would charge to list the property on the back-end. Usually, it’s gonna be a percentage, but it might also be a flat fee, depending on if you’ve exceeded a certain dollar threshold… So it kind of varies, depending on the sales price of the deal. But you can get that information from the broker, whether it’s a flat fee or a percentage. That’s gonna be something else that’s subtracted from the sales price when making the sales proceeds calculation.

Two is a disposition fee, which is kind of like a back-end acquisition fee charged by you, the syndicator, for the process, the work involved in actually selling the deal. 1% of the purchase price is standard, but again, you may or may not charge this fee.

The pre-payment penalty and yield maintenance and defeasance are all kind of wrapped into one. If there is a yield maintenance, a defeasance, a pre-penalty clause in your mortgage, and you sell your property before that clause expires, well there’s gonna be some extra fees that are gonna be paid to the lender for exiting the deal. I’m just gonna leave that there, because we’ve talked about pre-payment penalty, yield maintenance and defeasance in the Syndication School episode “Everything you need to know about pre-payment penalties.” So for more information on that and what those numbers/costs might be, make sure you check out that episode.

Next are closing costs. And now I’m saying “Well, how is closing costs a category of closing costs?” Well, these are the costs that are associate with ending the mortgage that your lender charges. Whenever you sell a deal, there’s always closing costs; these are what’s associated with that. To get those numbers, talk with your mortgage broker or lender, to get an estimation of what those will be; is it a percentage of the purchase price, a flat fee? Things like that.

And then lastly, legal costs. Since you’re putting a syndication together, there is steps that need to be taken to end that syndication partnership, which requires the work of a real estate attorney or a securities attorney… So that’s also an extra cost you might have to pay, depending on your contract with them. So you’ll wanna also talk to them, your securities attorney and your real estate attorney, to determine what’s the process for ending the partnership and any costs associated with that.

All those combined add up to the closing costs expense, which is subtracted from the sales price. The last thing that’s subtracted from the sales price, or I guess the second thing that’s subtracted from the sales price is the remaining debt. So you secured a mortgage, and you paid a principal towards that mortgage, so the remaining debt is the initial loan balance minus all the principal payments. Maybe you had three years of interest-only and no principal was paid down, so maybe it’s like two years of principle; maybe it’s five years, maybe it’s ten years, maybe you paid extra, for some reason… Whatever that happens to be, there’s going to be an amount that you still owe to the lender to pay off that loan… And that also comes out of the sales price.

That is something that, again, is tied back to the holding period assumption. So if you plan on holding on to the property for 4-5 years, then based off of whatever the amortization schedule is, you will know how much of the loan you should have paid off, unless something crazy happened and you can’t pay the loan off. This is something that’s gonna be a maximally certain assumption, shall we say, that you should be able to know how much debt is gonna be remaining based on when I sell.

If I have three years of interest-only and I sell at year three, then I owe all of the debt back. If I sell at year ten and I have five years of interest-only, then those five years of principal paydown, which are gonna be on kind of a sliding scale, since you pay more interest upfront, and gradually pay off more principal over time, you can look at your amortization schedule and it’ll tell you “You’ve paid this much principal in year two, this much in year three, year four, year five”, therefore all those together have paid down the mortgage, so whatever is left over is what you owe. That is the remaining debt.

The last assumption, which again, is kind of like the sales price assumption, is actually based off of the previous two assumptions, or the previous three assumptions, or I guess all five assumptions, is the sales proceeds. So the sales proceeds is going to be the sales price minus the closing costs, minus the remaining debt. And again, in your cashflow calculator, this is most likely gonna be automatically calculated for you, if you set it up properly. And then whatever that number is, a portion of that is going to go to your investors…

So however much equity you owe them — it depends on how you structure it, but typically it’s either all of their equity, if you offered a preferred return,  or if you did a refinance, or if you had the partnership structured such that any profits above the preferred return are considered a return of capital, then those profits above the preferred return in addition to the refinance proceeds are typically considered a return of capital… So that’ll be subtracted from whatever equity is owed, and then the remaining balance will be owed, and the  rest of those sales proceeds that are remaining, the profits that are remaining are split amongst the GP and the LP based off of what was agreed to.

So overall, you need to know what the exit operating income and the exit cap rate is at your projected sales date, so those are two assumptions you set. Based on that,  you can determine what the projected sales price is gonna be. Then you also want to determine what the closing costs are going to be, as well as how much debt you’re going to owe based on that sales date… Subtract those two factors from the sales price and that gives you your profits at sale, which a portion goes back to paying your investors, and the rest is split as profit, and that will go into your IRR and cash-on-cash return calculations.

So that’s it for this episode… That is everything that you need to know about setting the sales assumptions when you’re underwriting an apartment deal. Until next week, check out some of the other Syndication School series episodes that we have about the how-to’s of apartment syndication. As I mentioned in the beginning, lots and lots of free documents as well. All of that is available at

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

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