You receive a call from your real estate broker about a hot apartment deal that they’ve just listed. You quickly review their offering memorandum and, using a current rent roll and T-12, you populate your underwriting model. Before you can calculate an offer price, you need to perform a rental comparable analysis to determine your stabilized market rents. Luckily, the real estate broker has already conducted the analysis, so you should just use their results, right?
You should never unquestionably use the information in a real estate broker’s offering memorandum. The offering memorandum is only to be used as a guide, and this applies to their rental comparable analysis as well.
I’ve reviewed my fair share of offering memorandums. As a result, I’ve developed a keen eye for identifying instances where a listing broker tricks a buyer with incorrect rent comp information (whether it is intentional or unintentional is up for debate). Since the results of rental comparable analysis will be used to calculate a stabilized market rent, which will have a direct effect on the cash flow, using the correct properties is a must.
Now, a good starting place for finding rental comps is the offering memorandum. But, there are three main things to look out for when reviewing the comps that the real estate broker provided.
#1 – How far are the rent comps from the subject property?
First, see how far the comps are from the subject property. Distance is important, because a rent comp that is 30-miles away will not give you accurate results. But the neighborhood in which the comp is located is even more important.
For example, I was looking at a property and the rent comps provided by the listing broker were nearby (within a few miles) but were in a completely different neighborhood. I was local, so I knew that the comp was located in a neighborhood of college graduates while the subject property was not. But if I wasn’t local, I’d have to investigate the neighborhoods in which the rent comps are located to confirm that they are similar, especially in regards to demographics. A neighborhood with college students will demand different rents than a neighborhood with young professionals or blue-collar workers.
Key takeaway: The rent comps need to be close enough to the subject property to be in the same or a very similar neighborhood with similar renter demographics.
#2 – When was the rent comp renovated?
The second thing to look out for is the year the property was renovated, over what period of time, and how that relates to your business plan. As a value-add investor, we will often purchase apartment deals from owners who have already initiated a renovation program. Maybe they’ve renovated 25% of the units over the last 6 months. In that case, our plan would be to upgrade the remaining 75% of the units over a 12 to 18 month period, projecting to demand the same rental premiums they received on the 25%. When that is our business plan, we need to find rental comps that were upgraded to a similar quality and with a similar renovation timeline.
For example, I was looking at another property that had proven rental premiums but the renovations had been performed over two years to only 25 units. That’s about one unit per month. Our renovation timeline moves faster than that, so that is not a good comparison, because the renovations were too slow. A better rent comp would have those 25 units renovated over a few months.
Another red flag would be if the units weren’t renovated recently. If the units were renovated over 6 months ago, you cannot trust the accuracy of their rental premiums, because they’ve likely changed.
Key takeaway: The rent comps need to be renovated recently and over a period of time that is similar to the speed at which you will perform your renovations.
#3 – Do the operations at the rent comp match those at the subject property?
Last, look at the operations of the property to see whether they match up with the subject property.
For example, I was reviewing an offering memorandum that had a mixture of rental comps where the owner paid for all of the utilities and rental comps where the owner paid for some of the utilities. If the subject property has the owner pay for all of the utilities, all of the rental comps need to be the same, because this impacts the rental rates.
Another example would be the rent specials offered. If a rental comp is offering concessions to new applicants, then they can likely demand a higher rent. Unless you plan on offering a similar amount of concessions, that rental comps should be eliminated (or the rents need to be adjusted downwards). If all of the rent comps provided by the listing broker are offering a lot of concessions, that may also indicate a market with low demand.
Key takeaway: The operations at the rent comp must match those at the subject property.
If the listing broker’s rent comps adhere to these three factors, great. But you should still verify that information provided is correct. If they don’t, however, you’ll need to find your own rental comps (and here’s how you do that).
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