Been talking Opportunity Zone recently but tax benefits don’t save bad deals. I try to find a few heavy value add or ground-up apartment deals a year.
"Stabilized Unlevered Yield on Cost" is my most important underwriting metric. Super simple and often misunderstood.
Thread ⬇️
"Stabilized Unlevered Yield on Cost" is my most important underwriting metric. Super simple and often misunderstood.
Thread ⬇️
Like many things in business...part of the confusion comes from different people calling it different things.
I've heard “yield on cost”, “unlevered return on cost”, and several other variations. In school my professor just called it ROC.
As in: "What's the ROC?"
I've heard “yield on cost”, “unlevered return on cost”, and several other variations. In school my professor just called it ROC.
As in: "What's the ROC?"
Bottom line...it is simple "back of the envelope" math.
Numerator: NOI after you have done the rehab and leased up at market rents
Denominator: Purchase Price + Rehab, Carry, Closing Costs
Numerator: NOI after you have done the rehab and leased up at market rents
Denominator: Purchase Price + Rehab, Carry, Closing Costs
Notice a few things about the above calculation:
•No rent growth calculation into eternity
•No projection of exit cap rates
•Doesn't even look at interest rates
This truly allows you to compare apples-to-apples without getting distracted
•No rent growth calculation into eternity
•No projection of exit cap rates
•Doesn't even look at interest rates
This truly allows you to compare apples-to-apples without getting distracted
This also allows me to ignore current operations and the “Going-in Cap Rate”.
I do, however, rely heavily on my deep knowledge of my local markets for rent and CapEx info.
I do, however, rely heavily on my deep knowledge of my local markets for rent and CapEx info.
Simple math, but the output can be easily manipulated by overstating the stabilized rents or under-budgeting CapEx.
As a GP, you have to be honest with yourself or trust very experienced mgmt partners. As an LP, you have to really trust the GP or DYOR!!
As a GP, you have to be honest with yourself or trust very experienced mgmt partners. As an LP, you have to really trust the GP or DYOR!!
Since my first building in 2012, this has been my first screening method.
I want the ROC to be 150+ bps above the market cap rate for the asset I will own once I am done.
I want the ROC to be 150+ bps above the market cap rate for the asset I will own once I am done.
@moseskagan wants the ROC to be materially above the debt constant for the refinance loan that he will be seeking after stabilization.
This makes sense to me!
This makes sense to me!
You could also divide ROC by Exit Cap Rate rather than subtracting.
6% ROC with 4% market cap rate would be significantly better than 7% ROC with 5% market cap rates even though both have 200 bps of spread.
6% ROC with 4% market cap rate would be significantly better than 7% ROC with 5% market cap rates even though both have 200 bps of spread.
It is a basic check for “am I appropriately pricing in the risk?”.
In today’s market you may not win deals underwriting appropriately. That’s ok. The one that you do win will either be a homerun or have a nice cushion should something change in the market’s trajectory.
In today’s market you may not win deals underwriting appropriately. That’s ok. The one that you do win will either be a homerun or have a nice cushion should something change in the market’s trajectory.
Our OZ apartment rehab portfolio acquired in late 2020 had an underwritten ROC of 7.1% going in and we are getting rents now that are 35% over proforma
Our OZ development portfolio which will start later in Q1 had an underwritten ROC of 6.4%
Our OZ development portfolio which will start later in Q1 had an underwritten ROC of 6.4%
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