Pretty spot on with this. YoC is clearly the best metric to sensitize, especially in today's environment. I have EM higher on the list; if you're comparing projects with similar deal profile and hold period, multiple is a simple and helpful metric to look at.
Thanks, Dude! I go much deeper with these metrics within the Tactica blog: www.tacticares.com/blog-feed Feel free to use the search function to find what you're looking for.
Hi Ike: Regarding Yield-on-Cost (also my favorite metric), I have a couple of questions I would like your opinion on 1.) You state the denominator in YoC as CAPEX + Purchase Price. Should you include all of your unlevered cost basis in this number (closing costs/reserves or carry costs)? I've also seen people use the total project basis (levered + unlevered cost basis) as the denominator for this calculation. Using this approach would create a more 'conservative' output on the YoC calculation, but I am curious about your thoughts on this. Second, I look at YoC at stabilization (annualized NOI at renovation completion month for a value-add project) and also look at the YoC at the exit month. In your opinion, what timeframe of the YoC is most relevant for value-add projects? Thanks!
Hey Nick, Great questions. #1 in Tactica's Redevelopment Model (for distressed/heavy value-add), I do include closing costs, reserves, fees, and even financing costs (as it's more conservative) in the denominator. You can see the logic in this video at the 12min mark: czcams.com/video/ddzjd-jckSY/video.html #2 In the same model, the YOC calculates the year after the renovation is complete. For example, if the renovation wraps up sometime in Year 2, the model would take the Year 3 NOI as the numerator. Rents, occupancy, and expenses (esp. property tax) should be stabilized by this juncture. I think it's wise to look at a residual spread too. This calculation is included in Tactica's Development Model. Obviously, it's important to escalate the cap rate annually to get a conservative feel for YOC/Cap spread at the exit. I think a YOC calc loses effectiveness the further you get out from the purchase date.
@@tacticares Thanks for the feedback. I also run an untrended YoC analysis as well in my value-add model as a double check to answer the question "does this business plan fundamentally create value" when you strip out any assumption around organic market growth and other trending. I like to see a residual spread on the untrended YoC above 100 bps from the exit cap and north of 125 bps on a trended YoC.
@@tacticares Getting an untrended spread at stabilization above 100bps is challenging, lots fall into the 50-75bps range. The position spread still means there is fundamental value creation; however, to get about 100bps (untrended) you really need to have a meaningful delta between in-place rents and the market, which can be closed through LTL burn-off (based on recent leasing) or renovation premiums achieved through capex infusion. I really think if there isn't at least a 20% delta between your in-place rents and the market, the deal probably doesn't have a fundamental rent growth story that is strong enough to produce compelling returns without financial engineering and/or optimistic market/organic rent growth assumptions. At the end of the day, the revenue story and opportunity are what make these value-add deals really work. Other Income and expense optimization help but rarely is there enough negligence in either of these categories there to create enough value on their own.
When using T3/T12 annualized to calculate a Cap Rate are you not concerned about seasonality? Or is it because these are assumed to be 12-month rental contracts so it doesn't matter? I come more from a hotel underwriting background so that is where this question comes from :) And great video by the way
I appreciate it! Yeah, generally, T3 is the industry-accepted revenue standard as leases tend to be longer term, and seasonality has less impact (unlike on expenses, especially in colder climates). But it's definitely worth comparing T3 revenue to T12 and making sure there are no anomalies, such as an upfront cable commission, that could skew the annualized revenue higher.
Love it, in your opinion how much of a higher YOC spread would you need for a ground up development vs a stabilized asset? Or what have you seen in as industry standard?
The spread will vary market by market. Pre-rate hikes, 1.50%, was a standard target spread in my neck of the woods. With the headwinds the MF sector faces, this spread should only increase.
To ensure that the investment is reasonably priced against other comparable properties that have sold. www.tacticares.com/blog-feed/determining-what-is-a-good-cap-rate
@@tacticares But what "purchase price" are you using, the asking price? Geez, this is backwards. If the market cap is 10% then anything over $10 is probably too much! Ignore the asking price. If the NOI is $100,000 and the market cap is 10% then the probable market value is $1,000,000. Compare that to the asking price!!
@@Walina-gv9ph Unfortunately, I've rarely encountered a deal with an "ask price." You're right that it would make things much easier than the typical "broker pricing guidance." Is the $100k NOI T12 NOI? T3/T12 NOI? An annualized rent roll? Are property taxes adjusted to post-sale amounts? Is non-recurring revenue stripped out? The point I intended to make in the video is that the variables in the cap rate calculation can be subjective and require more investigation. I think the cap rate is essential to vet, and that has always been an important component of my analysis (sell-side and buy-side). However, there are better metrics available to determine investment potential. I appreciate you watching!
The blog post I linked above details my thought process using an example property and reconfigures the cap rate formula to solve for 'value' in the "NOI Adjustment" section.
Pretty spot on with this. YoC is clearly the best metric to sensitize, especially in today's environment. I have EM higher on the list; if you're comparing projects with similar deal profile and hold period, multiple is a simple and helpful metric to look at.
Totally, with any of these metric, more volume = more insight. You can't deny the EM's simplicity and intuitiveness.
Excellent video! Any books or capital market websites you recommend to read more about this?
Thanks, Dude! I go much deeper with these metrics within the Tactica blog: www.tacticares.com/blog-feed
Feel free to use the search function to find what you're looking for.
Hi Ike: Regarding Yield-on-Cost (also my favorite metric), I have a couple of questions I would like your opinion on 1.) You state the denominator in YoC as CAPEX + Purchase Price. Should you include all of your unlevered cost basis in this number (closing costs/reserves or carry costs)? I've also seen people use the total project basis (levered + unlevered cost basis) as the denominator for this calculation. Using this approach would create a more 'conservative' output on the YoC calculation, but I am curious about your thoughts on this. Second, I look at YoC at stabilization (annualized NOI at renovation completion month for a value-add project) and also look at the YoC at the exit month. In your opinion, what timeframe of the YoC is most relevant for value-add projects? Thanks!
Hey Nick,
Great questions.
#1 in Tactica's Redevelopment Model (for distressed/heavy value-add), I do include closing costs, reserves, fees, and even financing costs (as it's more conservative) in the denominator.
You can see the logic in this video at the 12min mark: czcams.com/video/ddzjd-jckSY/video.html
#2 In the same model, the YOC calculates the year after the renovation is complete. For example, if the renovation wraps up sometime in Year 2, the model would take the Year 3 NOI as the numerator. Rents, occupancy, and expenses (esp. property tax) should be stabilized by this juncture.
I think it's wise to look at a residual spread too. This calculation is included in Tactica's Development Model. Obviously, it's important to escalate the cap rate annually to get a conservative feel for YOC/Cap spread at the exit. I think a YOC calc loses effectiveness the further you get out from the purchase date.
@@tacticares Thanks for the feedback. I also run an untrended YoC analysis as well in my value-add model as a double check to answer the question "does this business plan fundamentally create value" when you strip out any assumption around organic market growth and other trending. I like to see a residual spread on the untrended YoC above 100 bps from the exit cap and north of 125 bps on a trended YoC.
I love it! Have you been finding projects as of late checking 100/125 bp spread box?
@@tacticares Getting an untrended spread at stabilization above 100bps is challenging, lots fall into the 50-75bps range. The position spread still means there is fundamental value creation; however, to get about 100bps (untrended) you really need to have a meaningful delta between in-place rents and the market, which can be closed through LTL burn-off (based on recent leasing) or renovation premiums achieved through capex infusion. I really think if there isn't at least a 20% delta between your in-place rents and the market, the deal probably doesn't have a fundamental rent growth story that is strong enough to produce compelling returns without financial engineering and/or optimistic market/organic rent growth assumptions. At the end of the day, the revenue story and opportunity are what make these value-add deals really work. Other Income and expense optimization help but rarely is there enough negligence in either of these categories there to create enough value on their own.
This is gold for anyone reading the comments. I appreciate you sharing your thoughts.
When using T3/T12 annualized to calculate a Cap Rate are you not concerned about seasonality? Or is it because these are assumed to be 12-month rental contracts so it doesn't matter? I come more from a hotel underwriting background so that is where this question comes from :) And great video by the way
I appreciate it! Yeah, generally, T3 is the industry-accepted revenue standard as leases tend to be longer term, and seasonality has less impact (unlike on expenses, especially in colder climates). But it's definitely worth comparing T3 revenue to T12 and making sure there are no anomalies, such as an upfront cable commission, that could skew the annualized revenue higher.
Love it, in your opinion how much of a higher YOC spread would you need for a ground up development vs a stabilized asset? Or what have you seen in as industry standard?
The spread will vary market by market. Pre-rate hikes, 1.50%, was a standard target spread in my neck of the woods. With the headwinds the MF sector faces, this spread should only increase.
Good to know, thank you for taking the time to answer@@tacticares
A cap rate is not a return metric. If you have the purchase price why would you waste time trying to calculate a cap rate?
To ensure that the investment is reasonably priced against other comparable properties that have sold.
www.tacticares.com/blog-feed/determining-what-is-a-good-cap-rate
@@tacticares But what "purchase price" are you using, the asking price? Geez, this is backwards. If the market cap is 10% then anything over $10 is probably too much! Ignore the asking price. If the NOI is $100,000 and the market cap is 10% then the probable market value is $1,000,000. Compare that to the asking price!!
@@Walina-gv9ph Unfortunately, I've rarely encountered a deal with an "ask price." You're right that it would make things much easier than the typical "broker pricing guidance."
Is the $100k NOI T12 NOI? T3/T12 NOI? An annualized rent roll? Are property taxes adjusted to post-sale amounts? Is non-recurring revenue stripped out?
The point I intended to make in the video is that the variables in the cap rate calculation can be subjective and require more investigation.
I think the cap rate is essential to vet, and that has always been an important component of my analysis (sell-side and buy-side). However, there are better metrics available to determine investment potential.
I appreciate you watching!
@@tacticares What cap rate are you talking about? How are you getting the "V" in the direct capitalization formula of V=i/r ?
The blog post I linked above details my thought process using an example property and reconfigures the cap rate formula to solve for 'value' in the "NOI Adjustment" section.