240-unit value-add in a Sun Belt submarket, $185k a door against $260k replacement. What am I not seeing?

I'm new to this, so tell me if I'm off. If the going-in cap is 4.9 and the exit cap is 5.25, they're assuming they sell at a worse cap rate than they bought at, which means the price per dollar of income goes down? That reads conservative to me, which surprised me because I assumed sponsors always assume the rosy version. Or is 5.25 still optimistic for that vintage and location and I just don't have the reference points.

@ember has it on the mechanics. A higher exit cap than entry cap means each dollar of net operating income is worth less at sale than at purchase, so the model is not relying on cap rate compression to make the return. Whether 25 basis points of expansion is conservative depends entirely on where the entry cap sits relative to the debt cost. A 4.9 going-in cap with floating bridge debt priced above that is negative leverage, meaning the borrowed money costs more than the asset yields on day one. That is survivable only if the income actually rises on schedule.

Which puts the weight on one assumption, @canton, and it is the timing of the premium rather than its size. $175 on a renovated 2016 unit is not aggressive in absolute terms. Capturing it while the submarket is still clearing concessions of one to two months is the question. A month of free rent on a $1,700 unit is roughly $140 a month of effective rent given back over a twelve month lease. That is most of the premium, and it shows up in effective rent while the offered rent on the rent roll still looks fine.

So the diagnostic is not the renovation budget. Ask for the submarket delivery schedule by quarter, the sponsor's assumed concession burn-off quarter by quarter, and what the return looks like if concessions persist twelve months longer than modeled with everything else unchanged. National vacancy near 8.5 percent is widely believed to have peaked and the pipeline in many Sun Belt markets is contracting sharply, which supports the thesis. It does not tell you when your specific three-mile ring clears. Also confirm the rate cap covers the full period through stabilization, since it currently does not cover the extension years.

Five year hold with a three year loan and two extensions you have to qualify for. That's the part I'd sit with. I hold things for fifteen years and the reason is that I never want to be the seller on someone else's calendar. If the recovery arrives in 2027 and 2028 as everyone expects, a fund with a five year clock is selling into it rather than owning through it. Patient capital is the whole argument in this sector right now and a bridge loan is not patient.

Basic question since this thread is readable for once. When @canton says 65 percent loan, is that 65 percent of the purchase price or 65 percent of what it'll be worth after the renovation? I've seen both used and they're very different amounts of exposure.

@plumb it's usually stated as loan to cost on a bridge, so 65 percent of purchase plus budgeted capital, funded in draws as the work gets done. Ask which one the doc says, they are not interchangeable.

@canton, the line doing the most work is the year two cap of 5.6 percent. Back into it. To move from 4.9 to 5.6 on the same price you need net operating income up about 14 percent in year two. 140 units times $175 is $24,500 a month, $294k a year gross, and you will not get all of it in year two because you can only touch units as leases roll. Call it 60 percent of the units done and occupied at the new rent by the end of year two and you have maybe $170k. If the in-place NOI is around $2.2m at a 4.9 cap on $44.4m, you need $308k of growth. The renovation gets you half of it. The other half is coming from concession burn-off and organic rent growth in the same submarket where they just told you concessions are one to two months. That is the circularity I'd make them explain.

@sextant beat me to the NOI bridge, so I'll add the expense side because nobody models it honestly. Insurance in most Sun Belt coastal and hail-exposed metros has repriced hard over the last few years. Property taxes on a 2016 asset that trades get reassessed at the new basis in many jurisdictions, and how fast depends on the state. If the sponsor is showing taxes growing at 3 percent a year off the seller's assessed value, the year two NOI is overstated and the 5.6 goes away on its own. Ask for the actual trailing twelve, not the pro forma, and ask what they assumed for insurance renewal and for the reassessment. If those two lines are growing at 3 percent I'd stop reading.

Different angle. I read the LP agreement before the model.

Things I'd look for in yours: what happens on a capital call for the rate cap extension or a loan paydown at extension test, and what the dilution is if you don't fund. On a five year deal with a three year loan there is a real chance of a mid-life call, and the penalty for a small LP not funding is often a hard dilution or a conversion to a subordinated interest. Second, the promote structure and whether there's a clawback if early distributions get paid and the exit disappoints. Third, who controls the sale decision and whether there's any LP consent for a hold extension past the stated term. @orchard is right that the clock matters, and the clock is a document question rather than a market question.

@fathom that dilution clause is the one I'd read three times. I've seen versions where a non-funding LP goes from a 100 percent interest to a mid-double-digit percentage of what they had, and versions where the funding LPs get their money back at a preferred rate before anyone else sees a dollar. Those are wildly different outcomes for the same event.

@canton, one more document item. Ask what the loan says about the extension tests. Usually there's a debt yield or debt service coverage hurdle you have to hit to earn each extension, and if you miss it you either pay down principal or refinance into whatever the market gives you that year. That test is the actual maturity of your investment, and it is a number, so ask for it. A lawyer should look at the subscription docs with you before you sign anything, that part I won't guess at.