“What IRR are your investors seeking?”

I get this question a lot. But unfortunately, it’s really not the right place to start when pitching a deal to a large check writer. Sponsors come to me thinking that if their model shows a high IRR, it’ll improve the odds of their deal getting interest. I wish that were so.

Large check writers, like the kind we work with in our office, see the IRR as the final step in a long underwriting process. These check writers don’t start a deal by analyzing the IRR. They conclude their analysis by looking at the IRR.

Below is the typical exchange you could expect to have with a representative at a large check-writing group.

What asset class is the deal in question? “Multifamily”
When was the property built? “2014”
What market? “Southeast. Top 25 MSA”
What are you paying for the asset? “X/unit”
Do you have comps to support the purchase price? “yes”
What are your projected rents? “X/per foot or per unit”
Do you have comps? “Yes”
How’s your track record? “Solid”
“Ok, please send the deal over. We will take a look”

A week later… “We looked into your underwriting and think you are undershooting your operating expenses.

We especially think you are underestimating what your tax bill will look like upon getting reassessed.

In light of that, the IRR on the deal on our underwriting is 12% compared to your 22%.

Those returns won’t work for us. We are a pass.”

If you notice, the transaction needs to first fir a very tight box. Large check-writers, especially those working out of a fund, have very specific mandates for what they could and will invest in. They will not look at a deal outside that strike-box, no matter how good.

Today, many institutions happen to be looking for newer vintage multifamily assets. In the above example, everything checked out on the deal level. Only then did the representative at the institution even look at the deal.

The representative then went through an internal underwriting process to examine the sponsor’s assumptions, and in this case, as in very many cases, found them to be too aggressive.

A large check investor will NEVER take the sponsor’s word for the IRR. The lesson is that when you approach such a check writer, or even a middle-man like myself, presenting a high IRR does not help the cause.

Conservative underwriting and a popular asset class of choice will.