Resisting magical thinking

Doing good deals is all about resisting magical thinking.

Hour after hour, you comb through possible acquisition targets, looking for the needle in the haystack that will allow you, if everything goes well, to deliver the kinds of out-sized return your investors expect.

When something looks like it might work, you build a model. You input the list price and a bunch of assumptions for how much the rehab will cost, what you’ll get in rent for the finished units, etc.

The model spits out a forecast unlevered yield, and, almost always, that number is too low.

Can you imagine how tempting it is to tweak one or two numbers and cause the forecast unlevered yield to rise above the target threshold, so that you can buy the deal?

After all, your investors trust you. They’ve learned to take your estimates as gospel, because you’ve delivered the forecast yield, over and over again, across many, many deals. So no one is going to bat an eye when you show them the model. They’ll just send in the capital.

And, the truth is, if you juice the numbers, it’s entirely possible no one will even care. Rents in the neighborhood might run, making your “actuals” look good. Or interest rates might come down, allowing you to do better than you should have on the refi.

So, in the end, it comes back to you. Do you have the will power to resist the magical thinking that will put hundreds of thousands of dollars of fees in your pocket, but at the expense of your integrity and, possibly, your fund’s returns?