Want to learn how to assess the risk of multifamily syndications beyond just the "big three" metrics? Tune in to this episode of the LSI Spotlight podcast as Steve Suh discusses six key risk metrics to evaluate, including exit cap rates, yield on cost, IRR partitioning, and more. Walk away with practical tools to perform more comprehensive due diligence on your next multifamily deal.

Here are some power takeaways from today’s conversation:

• Exploring risk metrics beyond the big three
• The exit cap rate structure
• The yield on cost
• Other metrics to assess the risk of multifamily syndication

Episode Highlights:

[01:55] Exploring Essential Risk Metrics: Beyond the Big Three

While the Internal Rate of Return (IRR), Average Annualized Return (AAR), and Equity Multiple are commonly used metrics to evaluate investment profitability, they may not provide a comprehensive picture of the risk involved. In this blog, we delve into lesser-known risk metrics that can offer valuable insights into investment decisions. By considering the pros and cons of different risk factors, we can make more informed choices to safeguard our investments. 

Let's dive into these intriguing risk metrics and uncover their significance in evaluating investment opportunities.

[03:59] The Exit Cap Rate Structure

The exit cap rate, also known as the terminal or reversion cap rate, is susceptible to manipulation by sponsors due to the uncertainty of future cap rates. It is preferable to have a higher exit cap rate compared to the entry cap rate, indicating a more conservative approach. When the exit cap rate equals the entry cap rate, it signifies a potential oversight of future conditions, which can artificially inflate returns. Understanding the relationship between the cap rate, net operating income, and purchase price helps evaluate investment performance.

[09:05] The Yield on Cost

The yield on cost is a measure of return that takes into account the stabilized net operating income (NOI) and total project costs, which may not be realized for a few years. It is calculated by dividing the stabilized NOI by the sum of purchase price, capital expenditures, closing costs, and fees. Comparing the yield on cost to the market cap rate reveals the development spread, a key indicator of deal riskiness, with Brian Burke suggesting a minimum spread of 1.5% to 2.5%.

[10:52] IRR Partitioning

IRR partitioning involves separating the total IRR of an investment into the portion from cash flows during the holding period and the portion from the sale proceeds at the end. For a typical 5 year multifamily deal, the IRR partitioning may be around 25% from cash flows during the holding period and 75% from the sale proceeds, indicating moderate risk. Ultimately, a higher percentage of the IRR coming from cash flows during the holding period indicates lower risk since those cash flows are more stable and predictable, while a higher percentage coming from the sale proceeds at the end carries more uncertainty and indicates higher risk.

The other metrics mentioned by Steve include the breakeven occupancy, default ratio, and debt service coverage ratio.

Resources Mentioned:

6 Metrics to Help Assess the Riskiness of a Multifamily Syndication

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