Columbia SC - Deal Lost!

In June, we wrote about the Columbia, SC market and how much we liked the area. We have pursued several deals but only made it to best in final in one. Today we are going to talk about this very attractive opportunity to acquire 165 units in a good location. Unfortunately, we didn't get the deal, and actually, no one did as the buyer decided not to sell at the offered prices. Below, we will detail how we underwrote the deal and contrast it to how the broker presented the opportunity. It is important to understand that the selling broker's Offering Memorandum (OM) is a sales tool with a mix of good nuggets of information and also large amounts of wishful thinking.

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The deal as presented:

?The property was built in 1970 and occupancy was good at 97%, with an average in place rent of $1,183 (avg for Columbia is $1,100), The current owners invested $6.5M over the past few years to renovate all the units and repair the exteriors. When you are evaluating a property that doesn't have upside from renovation, you have to focus on strategies to increase NOI from small value-added changes, organic rent growth and operational efficiency. In the T12, rents increased 8% YOY as a result of the ongoing renovations and organic rent growth. The whisper price on the property came in at $20.5M, which, based on the broker’s NOI, was a 5.97% purchase CAP rate. The broker claimed that the rents were significantly below the average comparable rents of $1,413. The OM listed 7 nearby apartment complexes that they were calling comparable to support their number. They also floated the idea that an additional $300K of CAPEX for modest interior upgrades could boost the rents by an additional $50, bringing the achievable rent to $1,463. In the OM, the broker claimed, "There is headroom to market of $475 per month per unit."

?CREE's sanitization of the numbers:

The first thing we focused on was market rents and the 7 properties listed as comparable. Three had average rents above our target, and four were below. The three properties with higher rents were significantly newer (2020, 2014,1993) and had average rents of $1,933, $1,856 and $1,661, respectively. Below are pictures of the property we were looking to buy (left) and the three newer properties.

Clearly, these newer properties shouldn't have been included in the comparable rental market, and they pulled the average market rent up significantly. The four properties with lower rents were all built in the late 1960s and early 1970s and were true rent comps. Our target property rents were about $50 higher than the true competitors already, which makes sense due to the recent renovations. The statement that there was "plenty of headroom" to raise rents was not valid. After studying the apartments and comparable properties, we did believe rents could be increased to $1,285 over time, a far cry from what the brokers were projecting, with improvements ($1M of CAPEX) and organic rent growth.

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The OM listed economic vacancy as 10.7% in year one, and we projected 19% and then moderating to around 10% for the balance of the hold period. We factored in more lost rent while renovating units and wanted to err on the side of caution.

After firming up our top-line assumptions, we moved on to the expenses. The T-12 as presented (remember you have to sanity check these numbers based on experience, industry averages, location and age of the property) listed operating expenses as $105K per month. The broker estimated that expenses could be reduced to $99K per month. The OM projected repairs, insurance and payroll could all be reduced, and taxes would remain flat. Given the uncertainty of inflation and the surge in insurance costs, this projection seemed wildly unrealistic. The OM listed turn costs of $300 per unit, which we also believed to be unrealistic. We adjusted each number based on our quotes and experience and underwrote to $117k per month of expenses.?

We ended up offering $18.7M in the best and final. With our numbers, we were buying the property at a 6.55% CAP rate. At this offer price, the deal would have generated 7.7% cash-on-cash return, a 16.7% IRR and an equity multiple of 2.05X. These numbers were based on conservative achievable assumptions, and we thought it would be attractive to investors. Unbeknownst to us or the seller's broker, the seller was not going to let the property go for less than $19.5M, so they walked away. In summary, if you are evaluating deals, you have to make sure the key assumptions as presented are correct and apply judgment and experience to come up with a realistic plan. You also have to be patient and understand that the process for acquiring properties can be long and frustrating.