Many operators talk about “conservative underwriting” the same way brokers often market new construction as “value add.” Both terms can sound appealing but are frequently overused or misunderstood. So, what does conservative underwriting actually mean, and how does it look when applied to our deals? Let’s use Village Court Apartments, a property we recently purchased in Ortonville, MI, as an example to show how we put this principle into practice.

Rent Comp Achieved

At Village Court Apartments, we initially targeted $1,250 in our underwriting and our pitch to limited partners when raising capital for the deal. Like many of our other projects, this one was oversubscribed quickly. Upon closing, we were fortunate to have three vacant units right away. Although the seller claimed these were 'rent ready,' they weren’t, so we negotiated a $15,000 credit to cover our costs. We quickly cleaned up the units and leased them at our target rent of $1,250 within the first month.

Recently, a resident gave notice of their intention to move out at the end of their lease. We already have an approved application lined up to rent the unit as soon as it’s turned. Additionally, we’ve signed a renewal with an existing tenant at our full market rate, further confirming that our pricing expectations are on track.

Projected Returns

At the time of closing, Village Court was on track to generate gross annual rents of $198,720, assuming all units were occupied at the average rent of $1,035. With four units now moved to full market rent, our current rent roll is projected to bring in $210,624 annually. Using a market cap rate of 7%, this means we've already added $170,057 of value to the property in just 2.5 months.

When we achieve our increased rents across all 16 units, we’d be at a gross potential rental income of $240,000 annually. This would result in an estimated $589,000 increase in property value. While these calculations don't factor in vacancy and aren't perfectly linear, they highlight the significant value being created. On the surface, we are only adding $215 per unit of income, but when you multiply that across 16 units over 12 months and then apply the market cap rate, the value creation becomes clear. This increased value has a substantial impact on equity returns, making the growth potential even more exciting.

With four leases already signed at market rent and 12 more to go, we’re starting to see the business plan come to life. While there’s still work ahead, the early progress is a strong indicator that our underwriting was accurate, and our strategy is on track. Each new lease not only increases the property’s immediate cash flow but also adds long-term value, reinforcing the potential for significant equity growth. Though we're not celebrating prematurely, it’s exciting to witness the strategy unfold as anticipated.

Major Market News

Fed Lowers Interest Rates

According to an article by TheRealDeal, the Federal Reserve has announced a half-point interest rate cut, marking its first reduction since the pandemic, bringing the federal funds rate to between 4.75% and 5%. This decision comes in response to economic data showing inflation nearing the 2% target and unemployment rising to 4.3%. Anticipating the cut, mortgage rates fell to their lowest level in two years, with the average rate for a 30-year fixed mortgage dropping to 6.15%.

Source: TheRealDeal. (2024, September 18th) Fed slashes interest rates. https://therealdeal.com/national/2024/09/18/fed-announces-half-point-interest-rate-cut/

Tips & Tricks

Terms:

Gross Annual Rent- Gross annual rent is the total amount of rental income a property generates in a year, assuming full occupancy and no deductions for expenses such as maintenance, taxes, or vacancies. It represents the potential income from leasing all available units at their current rental rates over 12 months.

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