Be careful when choosing Comps

When an apartment investor is evaluating a potential acquisition, the properties selected for comparison to the subject are critical to developing a proper understanding of the actual position of the acquisition target. The choice of inappropriate compositions can obviously lead to an inaccurate perception of both the property in question and the market as a whole. For the purposes of this discussion, we will focus on existing rental compensation and not comparable recent sales.

In most cases, larger rental assets will be marketed by one of the national or regional real estate brokerage firms. We all know who they are, so there is no need to list them.

In the prepared offering memorandum, in almost all cases, a detail of the rental premiums is provided. Since it is a real estate agent’s primary fiduciary duty to maximize the sale price of any asset being marketed, it makes sense for a savvy broker to select offsets that display their property in the most positive light. In some cases, the comps chosen by the broker are, in fact, the best true representatives. However, in most cases, I have found that they are not.

Obviously, location is a significant factor, with properties geographically close to the subject being important. However, simply choosing the closest five or six properties can lead to a distorted assessment of the acquisition target.

The critical characteristic that all compositions must have is that they must be a realistic alternative for the consumer to the property in question. In other words, you must see the advantages through the eyes of a potential future renter.

Of course, location will be a primary consideration. In most cases, potential renters identify their preferred location and then go about winning alternatives to a handful of properties that they can actually investigate further and/or visit. It is this “handful” of properties that will be most useful to an investor for comparison purposes during the due diligence period.

Of the remaining factors that a potential future renter will consider, price is possibly the most critical factor, even trumping location. After all, if a potential renter identifies a preferred location, but can’t find any that fit their budget, they’re likely to start researching secondary location options. When verifying current requested rents for these compositions, it is vital that current concessions or discounts are considered. In addition, the inclusion/exclusion of other items such as utilities, in-unit laundry, and parking must be considered.

Other items to be considered when selecting suitable compositions include; age/condition of property, building type (garden style, mid-rise, high-rise, etc.), utilities included, parking (street, surface, or gated), current tenant base (young professionals, family-oriented, housing for the elderly, etc.), as well as those factors that may be unique to the specific municipality or neighborhood.

Using the above guidelines should be helpful in putting together your preferred compensation set and will provide a more accurate view of the current competitive environment.

In a follow-up article, we will discuss the best methodology to use to determine how the property in question ranks relative to correctly chosen compositions. It will also include a background on why rent/square foot calculations can be very misleading and the proper way to avoid this potential pitfall.