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For ground-up development the "NOI Margin" & "Operating Expense Ratio" (mathematically related) are very important. In fact, other than the Return on Cost and the Rent/SF, it's probably the MOST important metric in your underwriting.
Here's the explanation (longer thread). https://twitter.com/moseskagan/status/1335587333228261379
Here's the explanation (longer thread). https://twitter.com/moseskagan/status/1335587333228261379
In ground up deals, the underwriting starts with "designing" the deal in excel. Zoning codes include max unit count (yield/acre), building size (max FAR) and a parking ratio dependent on unit mix (1:1 for Studio, 2:1 for 2BR etc). Every city has slightly different numbers.
After the unit mix is selected, this is where the most important thing occurs and it's based on standard underwriting protocol and not on "reality" per se.
Revenue is a multiple of $/SF
Operating Expenses are $/Unit
This is reasonable but has profound effects.
Revenue is a multiple of $/SF
Operating Expenses are $/Unit
This is reasonable but has profound effects.
For rent, $/SF is the best rough number for comparing units between buildings esp since they have different sizes. You can break out $/SF on unit type if you want.
For Op Ex, $/Unit is the best way to approximate insurance, cost of turns, real estate taxes, and even payroll.
For Op Ex, $/Unit is the best way to approximate insurance, cost of turns, real estate taxes, and even payroll.
With that process, here are 2 buildings with same size, construction cost, Rent/SF and "Operating Expenses."
A: 125 Units, $55MM, 6.15% ROC, 2x equity
B: 160 Units, $55MM, 5.75% ROC, 1.66x equity
Clearly A is the choice. Now add in Opex Ratio.
A = 32%
B = 25%
A: 125 Units, $55MM, 6.15% ROC, 2x equity
B: 160 Units, $55MM, 5.75% ROC, 1.66x equity
Clearly A is the choice. Now add in Opex Ratio.
A = 32%
B = 25%
As any operator will tell you 25% is crazy even for large bldgs. As an investor 25% tells me the developer is a noob or it's been "designed to work in Excel." I'd doubt all other assumptions -hard costs etc. On my projects it tells me, "Change the unit mix and your assumptions."
Now these are rough numbers, and development is inherently an an iterative process. Good developers can have their own successful methods.
But for me, I have 4 cells highlighted on the front page of my model, ROC, $/SF, Hard Costs, and Opex Ratio (dashboard from a live deal).
But for me, I have 4 cells highlighted on the front page of my model, ROC, $/SF, Hard Costs, and Opex Ratio (dashboard from a live deal).
And the first 3 questions I ask of any developer for an investment are:
1.What's the untrended ROC?
2. What are your rents?
3. What's your operating expense ratio?
1.What's the untrended ROC?
2. What are your rents?
3. What's your operating expense ratio?
