Does conversion policy support belong in the model, or does the deal have to pencil without it?

Question

I've spent the last few months reading conversion pitches from the capital side and the split between them is sharper than I expected.

One group underwrites the building on its own economics. Acquisition, hard costs, soft costs, and market rents, with no credit, abatement, or program money in the base case. If something comes through it's upside. Their argument is that programs get oversubscribed, change between application and award, and arrive on a timeline that doesn't match a construction schedule. A deal that needs the incentive to clear the hurdle is a deal you're not really in control of.

The other group says that's a fantasy on office conversions specifically. The whole point is that the physical cost of converting these buildings runs at or above ground-up, and the reason cities and states are writing conversion incentives is that the pure private math doesn't clear on most candidate buildings. If public support is a structural feature of the strategy going forward, refusing to underwrite it means you never do a deal and someone less squeamish takes the building.

Specific programs vary a lot by city and state and they change, so anything anyone models here needs to be confirmed in writing with the actual administering body before it counts.

I don't know which discipline is the right one. Sponsors I respect are on both sides of it.

jordan_ellis2 · Answer

The middle position I've seen written into a couple of memos is that the incentive can be in the model but it can't be in the go/no-go. So you underwrite without it to decide whether to buy, then you show the incentive case separately as upside for investors. That's a reporting discipline more than an underwriting one, and it only works if the sponsor genuinely walks when the base case fails. Which, from outside, you can't verify.

luis_carrera · Answer

@pike, the version that worries me is timing rather than amount. A tax abatement that starts at occupancy is a hold-period benefit and does nothing for your construction budget, so a deal that needs it is a deal that still has to survive 20 months of carry before the benefit shows up. That distinction changed how I read two offerings last month. If it hits the operating side, it improves a hold. If it's a construction-period grant or credit, it changes whether the building gets built at all. Different animals, and the pitch decks blur them.

Does conversion policy support belong in the model, or does the deal have to pencil without it?

2 replies