Not all returns are “created” equal

 

Well DUH.

I am sure that is the first thing that comes to your mind.  But there is a word in that sentence that I am sure you really didn’t pay much attention to.  The word “created” because the thing is you are going to have to watch out because most of the returns that are being spouted by all the guru’s are…. Wait for it…… “Created” thats right,  how are they created you might ask.

1.  Most of these folks are making things work based on a flawed underwriting model.  The main flaw is they are basing most of their appreciated value through rent increases which is reflected in the IRR.  You may not remember it, but those of us that were in the real estate business aren’t that many years separated from the days of huge multi family complexes at 50% or less capacity.

2.  How deep have you looked at the individual underwriting?  I am not suggesting that anybody is making numbers up, but what if they are working with or have been given numbers that aren’t correct?  These are things that you should watch out for, if you don’t do anything just ask the questions, and if there is an answer given that satisfies you then move forward with your due diligence.

3.  The importance of making sure that the returns aren’t based on massive rent hikes is so imperative I am going to mention it again.  This should be your main question when doing your due diligence on an operator or discussing a deal with an operator.

Simply say: “What percentage of the IRR is going to come from rent increases?”

Other important points to bring up and discuss in this post are the fact that some operators are really good at marketing a “plan”… However implementing one is an entirely different subject and takes an entirely different skill set.  When you are looking around and weighing the differences between operators, it will be much to your detriment to simply look at the numbers that are full of glitz, such as the internal rate of return (Purely Subjective) and the Cash On Cash Return (Can Vary Wildly).  These percentages are thrown around and looked at differently by many people.

Although these are a few of the items you should be aware of from a due diligence standpoint you also need to know there right or wrong answers though, because ultimately the right or wrong answer is going to be market dependent, as well as operator dependent.  There are ways to mitigate your risks.  If you’d like to discuss these ways further schedule a call and we will be happy to discuss.