Residential Lease Question

[Anonymous]

Hi Guys: In underwriting multifamily properties would there ever be an instance where you model each individual lease (like in the commercial example) or is the practice to always consolidate/roll-up the individual leases by unit type and size (as we did in the residential lease module)?

Cheers, Nick

[Spencer Burton]

Hi Nick,

Personally I’ve never come across a situation where the analysis of a larger residential building (i.e. 100+ units) would be appreciably benefited by detailing out each and every residential unit. On smaller buildings (e.g. 4 – 10 units) however, this is quite common.

With that said, you’ll often run into situations with larger buildings where creating a very detailed unit mix is important to the analysis. Take a high-rise apartment building as an example. There’s a big difference between what a particular floor plan rents for on a lower floor versus what that same floor plan rents for on an upper floor. Plus, many cities require some proportion of urban residential buildings to have a certain percentage of units as “affordable.”

Thus, you might have three floor plans that are physically (i.e. same dimensions, size, finishes, etc) the same but have very different economics. As a result, you’d want to detail out each of those three in your unit mix. Imagine you had 12 floor plan types, but detailed out each between market and affordable and between lower floor, mid-floor, or upper floor. You could end up with as many as 72 unit types (12 x 2 x 3) in your unit mix table.

Thanks for the great question! Happy to answer any follow up questions you might have.

Spencer

[Anonymous]

Thanks Spencer for the response and your example on the high-rise is helpful to demonstrate when a more complex lease modeling may be needed for residential. I am mostly dealing with Class C and B older multifamily properties. In the context of those assets, I am trying to sharpen my toolbox.

In our multifamily lease module, we rolled up the rent roll to what I think equated to a blended rent, between ‘market’ and the in-place leases. This effectively eliminated the need to make concessions or loss-to-lease assumptions. I have seen people model the 100% market potential rents then overlay a loss-to-lease or concessions and/or other adjustments to get to your effective (adjusted)gross rent. Do you think they way you had us model the blended rent is more accurate or is it really a matter of preference?

If I was repositioning a multifamily property that had under market rents and expected higher post-renovation rents to be phased in during future renewals, how would this change how you suggest I set up my underwriting in the model? If you cover this in a future module in the course just let me know.

Thanks! Nick

[Spencer Burton]

First to your question. It really is a matter of preference. I do think it’s important to understand the difference between effective and market rent in each period. And so, this generally means breaking out concessions, non-revenue units, loss-to-lease, etc. But how valuable this becomes to your analysis depends on the complexity of the deal and the stage of underwriting your at.

Adding specificity is more important when you’re executing on a value add strategy, since understanding where your rents are relative to market or knowing what % of your units have rolled to market helps you measure success. A value-add strategy, like development, has more margin for error and so adding specificity will help you make more informed decisions.

As an example, in my Value-Add Apartment Acquisition model, I use a ‘% Rolled to Market’ line rather than a loss-to-lease line. But than I include separate income and expense assumptions for pre-renovation and post-renovation units. Additionally, I include ‘Concessions’ and ‘Non-Revenue Units’ lines to arrive at an effective rent. At the BOE stage, this can feel like overkill. But as the deal becomes more real and you start to sharpen your pencil, it’s nice to have a model that allows you to really dig into the details.

[Anonymous]

Thanks, Spencer, I will download/purchase the ‘Value-Add Apartment Acquisition Model’ to dig into this concept further.

Are you guys working on a Sensitivity module for the Accelerator Course or can you direct me to where I could find an apartment model of yours with sensitivity analysis built in? To date, I have only used the data table function in Excel to build sensitivity analysis but I am always curious to learn how others model deal sensitivity, what tools they use and how they organize the sensitivity analysis within the model.

Cheers, Nick

[Spencer Burton]

Nick,

Yes, the Advanced Concepts in Real Estate Financial Modeling course has a module on doing sensitivity analysis in Excel:

Click here to view that module

Of course, the module teaches three methods to using Excel’s data table feature to perform scenario analysis. So it may be somewhat of a review for you. But I’d guess the “Use scenarios to effectively create unlimited variable, unlimited output data tables” part of the lecture will be new. That method is by far the most robust method I know of in Excel.

In terms of how others model deal sensitivity, what tools they use and how they organize the sensitivity analysis within the model. In my experience, sensitivity analysis is either done via Data Tables or via duplicate models with varying inputs for the base case, upside case, and downside case.

Check out the Scenario Analysis module and let me know if you have any other questions!

Spencer

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