Pricing and Dispositions: When 12-1 does not equal 11+0
by Donald Davidoff | Jan 15, 2013 12:00:00 AM
The deal world. Gotta love it. Smart people doing deals worth tens of millions. Even hundreds of millions of dollars. Surely with that much money at stake, processes are wired tightly and theres really no room for pricing shenanigans, right? Of course if you believe that, you probably thought sub-prime mortgages were a great investment back in 2007 as well.
Heres something that Ive wondered about for the 15 or so years Ive been doing pricing and revenue management in multi-family housing. Two different deal scenarios:
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Hey boss, Ive got this great deal we should take to under-writing. Were buying from XYZ Apartments, and theyre cutting back on this market. Theyve way under-managed the asset, and their team knew a sale was likely so theyve been in pretty poor morale. Theyre doing average rents of about $1200 a month with one month free. I know we can burn off that concession over the next year and really clean up.
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Hey boss, Ive got this great deal we should take to under-writing. Were buying from XYZ Apartments, and theyre cutting back on this market. Theyve way under-managed the asset, and their team knew a sale was likely so theyve been in pretty poor morale. Theyre doing average rents of about $1100 a month net. I know we can grow those rents to at least $1200 [ed. Note: thats an 8.33% increase] in the next year and really clean up.
Every acquisition guy (or gal) Ive talked to and presented these two scenarios tells me the same thing. The first scenario gets under-written without a second thought while second scenario doesnt have a chance of getting underwritten. BUT THEYRE IDENTICAL CASH FLOWS.
Why is that? I believe that the legacy of discounts being presented as concessions which are a bad thing to get rid of lends credence to the idea that surely you can burn off a 1-month concession in an under-managed asset. Meanwhile, rent growth of even 2-3% can be challenging to get, so an 8.33% growth in market rent (quotation marks intentional to mean alleged market rent) just seems too tall a hill to climb.
Yet from a pricing psychology perspective, people like to perceive theyre getting something for free. So if anything, removing a freebie might hurt demand MORE than just raising rents. Yet our deal guys and under-writers are more willing to do that than increase base rents. With tools like LRO and Yieldstar, operators have gotten use to looking at net cash flows in making their pricing decisions. What will it take for deal guys to catch up? Nows your chance to chime inam I missing something? Anyone out there have deal guys who would disagree with this? Join the discussiontheres literally tens of millions of dollars (or more) at stake!