Sourcing and Underwriting the Calvera Way


Brian D. Milovich

Managing Principal, Calvera Partners

In a previous post, I discussed how to evaluate a real estate investment sponsor, also known as a syndicator. Here, I’m going to briefly outline how we find and underwrite what we believe are attractive multifamily investment opportunities.

Sourcing Deals

We uncover new investment opportunities many different ways—off-market, on-market, and limited market. Sourcing properties off-market gets all the attention. It’s what everybody wants, but it’s not always the best deal. As owners ourselves, we would only sell a property off-market if someone was willing to pay us a price that we couldn’t get through a competitively marketed process. In general, nobody wants to buy a deal that we’re selling off-market, unless they see something in the deal that we don’t. However, there are some unsophisticated sellers with no sense of value who do not understand the sales market, and every buyer (including us) hopes to find this owner. Sadly, that is the exception and not the rule.

Deals that are fully marketed often get a bad rap. In times of rationality (we’re getting there again), fully marketed deals work just fine: 1) the seller is real and will take a market price, 2) there’s a professional process with tours and due diligence materials, and 3) relationships with brokers can help position your offer amongst the pack. For much of the latter half of the most recent cycle, marketed deals were impossible to win and make sense of. The frenzied pace of acquisitions by large syndicators, numerous new entrants trying to get rich quick, and deals being preempted early in the marketing process made it difficult to compete. These events created market pricing that was so hard for us to rationalize that we leaned heavily on established relationships with brokers and sought out deals with special situations where we could be most competitive.

Finally, a limited marketing process is a hybrid of the off- and on-market process. This is when a broker (or seller) takes a potential deal to a select handful of qualified buyers. The good news for those buyers is that there’s a smaller pool of bidders to compete against and, generally, the seller is motivated to make a deal. The bad news is that everyone you’re competing against is qualified. This process usually eliminates the outlier offer as a group of “real buyers” tends to underwrite with more reasonable assumptions. If a broker knows someone will pay more than everyone else, they’re taking it to them directly anyway. This happened a lot in 2021 as brokers knew which syndicators were grossly overpaying…the path of least resistance for all involved. Those coveted “off-market” deals now look pretty terrible for the buyer.

At Calvera, we have acquired properties that fall under all of the above categories: off-market, on-market, and through a limited marketing process. There isn’t one type of acquisition that has outperformed the other. We’ve had great success in winning deals that sat on the market for too long and we were able to re-engage with the seller, where we were the runner up in the bidding and the property came back to us, and where a particular trait (i.e., loan assumption) significantly narrowed the bidder pool. The common theme is that we stuck to a specific underwriting process, which allows us to buy properties regardless of how they are sourced.

Underwriting Process

Every apartment investor is going to tell you their underwriting is conservative. If they said it was aggressive and the returns were 100% dependent on everything going right, you probably wouldn’t invest. We start the underwriting of each potential property by using anywhere from a 5- to 10-year holding period, based on the business plan for the asset. This shows that we’re not looking to flip a property. As a result, we must make longer-term assumptions for operating cash flows, capital expenditures, financing, and future values.

First, we scour the market for comparable properties to see what they’re charging for rent and what condition the units are in. This allows us to determine how far above or below market the subject property’s rents are. When we’re serious about acquiring an asset, we’ll even tour some of those properties in person to substantiate our analysis. Then, since we own apartment properties both large and small, we have a good handle on operating expenses to underwrite at realistic levels. If we know which property manager we’re going to use, oftentimes they will provide us with their analysis of expenses. The key number there is payroll expense, as it continues to move higher with wage growth and the immense competition for talent. Also, insurance expense can be a wild card, and we lean on our relationships to underwrite it at levels where a policy can actually be obtained.

Next, capital expenditures will have a significant impact on underwriting. With a longer hold outlook, we need to ensure the deal has adequate capital to address larger deferred maintenance items such as roofs, paint, systems upgrades, etc. If the business plan involves renovations, we must make our best estimation upfront based on previous projects. The timing of these capital expenditures can impact the financial return. Are these paid through future cash flow, or do we need to reserve funds upfront? We’ll never get the timing perfect, or the costs exact, but it’s important to have a plan and enough of the capital budgeted.

Then, even an aggressive underwriting of future cash flows can be tempered or undermined by financing and valuation forecasts. This is where we tend to diverge from our competition. We receive financing quotes from our network of reputable lenders who know Calvera and who we know can deliver on their guidance. The financing quotes match the expected hold period of the property. So, if we assume a 5-year hold, we will mostly evaluate 5-year loans. This way our business plan does not rely on a refinance, and we don’t have to guess where interest rates will be somewhere in the middle of our ownership period and be dependent on rates moving in our favor for the deal to work out. Many of the owners who took out short-term, floating rate bridge debt made this bet. We also make sure that the leverage is consistent with our fund restrictions—maximum of 75% at acquisition and 65% portfolio level; self-imposed levels to help safeguard the portfolio from the whims of the capital markets and economy.

Lastly, valuation assumptions can be tricky because, like prognosticating where interest rates are going, we all have to make an educated guess as to where the sales market will be in the future. A general rule that we use is to have a positive spread between the going-in cap rate and the exit cap rate. For example, if the going-in cap rate is 5.5%, we may use a 6.0% exit cap rate in 5 years. This means we assume the market will value real estate more conservatively in the future than today. That spread can widen or narrow based on market conditions, the hold period, and the business plan for the asset.

The most aggressive buyers from 2020-2022 assumed significant increases in rent from unit renovations, high leverage (80%+ LTV) debt, and needed cap rates to remain unchanged in 3 years to flip the property. Otherwise, the acquisition didn’t work. That’s precisely why we had difficulty finding suitable properties in this window.

This is a high-level view of how we source and underwrite apartment acquisitions. There is considerable nuance at every step of the process, and we do best when we operate within gray areas. That is where we found our most successful investment returns—by targeting out-of-favor properties or up-and-coming markets, under-marketed assets, or by being greedy when others are fearful. There is no one right way to acquire apartment properties and in a hyper bull market, we were left on the sidelines looking for the proverbial needle in a haystack. As the market now shifts back towards reality, thanks to higher interest rates, we’re confident in our approach to compile an attractive multifamily portfolio for the Calvera Income and Growth Fund using our conservative process.


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