I'd wire $95k into a deal with management at 4% of collections on a 34-unit walkup

I sold my interest in a management book this spring, gain is about $95k, and I've got a QOF offering in front of me from a sponsor I've worked around for years. Reasonable people, decent construction record.

The operating budget is where I stopped. 34 units, 1920s walkup, gut rehab, and the stabilized pro forma runs property management at 4% of collections. On a building that size, in that condition, in a tract where the tenant base will turn more than average, nobody is managing that for 4%. I quote 8% on a 34-unit walkup and I lose money at 8% in year one. The fee is also going to an affiliate of the sponsor, so it's a related party line that's understated by roughly half.

Call it $340k in year one collections at their numbers. The difference between 4% and 8% is about $14k a year of NOI they've counted that isn't there, which at a 6 cap is a quarter million dollars of value in the exit assumption. Their projected sale is nine years out with a 5.75% exit cap, so the compounding on that error is worse than $14k a year suggests.

What I don't know is whether this is sloppiness or whether the affiliate really does intend to eat it as a marketing subsidy to make the fund look better, which would be a different kind of problem. I asked. Got told the affiliate has "efficiencies at scale," and they manage about 200 units total.

I've got until the end of next month. I don't want to walk away from a sponsor I actually respect over one line item, and I also can't unsee it.

2 replies

1laurenkim53Passive

In the small rural markets I look at, 4% doesn't exist at all, the floor is a per-unit minimum that works out to 9 or 10% on low rents. So your read matches mine. But I'd separate two questions. One is whether the pro forma is wrong, and you've shown it is. The other is whether the sponsor knows it's wrong. Ask them what the affiliate's actual charged rate is on the other 200 units they manage, with a statement to prove it. If they're charging 7% elsewhere and modeling 4% here, that's an answer. If they genuinely charge 4% across the portfolio and the portfolio is losing money on management, you've learned something else about them.

1nicole_adeyemiPassivePRO5

One line item is exactly what to walk over, because it's the one line you happen to know cold. Every other line in that budget has the same chance of being off and you can't see those. That's the actual information here. And on a nine year hold with a 5.75% exit cap on a 1920s walkup in a designated tract, I'd want to know what they think the roof and the boiler cost in year seven, because the sale assumes a buyer who has looked at those. Ask for the capital reserve per unit per year. If it's under $300 on that vintage, the exit number is decoration.

I'd wire $95k into a deal with management at 4% of collections on a 34-unit walkup

2 replies