Given that we are in budgeting season, I thought it would be helpful to share some of our experiences having acquired and taken over two properties in the fourth quarter.
I particularly wanted to focus on the transition between your underwriting budget and the operating budget from your property management company (PM). Our internal underwriting process begins with our initial view of the opportunity based on our analysis of the T12 and Rent Roll using our proprietary models, due diligence, and comp analysis. We also draw from intel from properties we know in the immediate area that we either own, invest in, or have pursued.
To substantiate our underwriting, we have our property management company come up with their own budget for the property independently so we can compare them. Ideally, you’d want the property management budget to be more favorable to your underwriting so that you have a buffer to execute and achieve your returns to your investors. One issue that we have seen at this initial budget stage is that prospective PMs know this and will at times produce an aggressive budget so they can win your business. New sponsors entering a new market often fall prey to this, underwrite to an aggressive PM budget, and later are forced to reforecast their budget down after take over when they have a better feel for the property and submarket.
PM budgets are sometimes developed by the business development department with little or no feedback from the staff that end up managing the property. What we underwrite for our investors is typically a hybrid of our estimates and that of the PMs (whichever is more conservative).
Key Budget Process Takeaways
Engage your property management companies early in your process. We like to have a PM budget in hand before we put in an offer, specially if we’re in best and final.
Ask who was involved in developing the budget and ensure the folks spending your budget have bought into the numbers.
Don’t take the PM budget as gospel. Make sure to scrutinize their methodology and assumptions because at the end of the day, you will be held accountable by your investors for meeting that budget.
Confirm that a true market survey (physically shopping comps) is conducted. Don’t simply rely on local area market reports as they only tell part of the story.
Understand the feasibility of other income streams as they can add tremendous value or be overexaggerated and cause a large miss in revenues. This typically is uncovered through shopping comps and conducting a tenant survey.
Analyze how the property is currently being operated and be realistic about the improvements you underwrite. Often times, we see PM budgets showing vast improvement in operations even though the current manager is a highly professional and reputable PM company.
Income is important but focusing on expenses is what separates the great operators from the good. We see rule of thumbs (i.e. $300/unit for Contract Services) used too loosely for expenses. A deep dive into the specific line items on a T12 is a must as every property is different and may require a different expense profile.
Note that property management companies have their own approach to the budgeting process. Some PMs provide a preliminary budget during underwriting but will refine the budget after take over once things have settled. The issue with this approach is that the budget may come down depending on what is uncovered. We prefer to have a monthly detailed budget completed prior to take over so that we can ensure we have the optimal business plan and capex budget to hit the ground running the day after closing. This also ensures the PM is focused on our asset and a smooth takeover.
What are some budget process tips you have picked up in your experience?
About Us
Overland Capital Investments is a real estate investment company that focuses on acquiring multifamily apartment complexes in markets with solid fundamentals. We implement a disciplined and conservative approach to multifamily investing with a focus on capital preservation, cash flow generation and measured capital appreciation. Our mission is to provide passive income to our investors by buying underperforming multifamily apartments, partnering with good people, and impacting the communities we invest in.
To learn more, visit www.overlandcapitalinvestments.com.