Evaluating a Fractional Deal: The Numbers That Decide the Outcome

Start with net operating income

Net operating income is gross rent, less vacancy and credit loss, less all operating expenses, before any debt service or depreciation. Everything else in real estate underwriting is derived from it.

The two most manipulated inputs are the vacancy assumption and the maintenance line. A 3% vacancy assumption in a market averaging 8% quietly adds thousands to the projected income and to the implied value.

Core ratios and what they tell you

• Cap rate = NOI / purchase price. Compares this asset to the market, ignoring financing.
• Cash-on-cash = annual pre-tax cash flow / equity invested. What your money earns each year.
• DSCR = NOI / annual debt service. Below 1.25x, small setbacks threaten the payment.
• Operating expense ratio = operating expenses / gross rent. Residential typically 35% to 50%.
• Price per square foot and per unit. Sanity checks against recent comparable sales.

A comparison worth running

Take two offerings both quoting a 7% projected return. Offering A assumes 3% annual rent growth, 4% vacancy and 8% reserves. Offering B assumes 6% rent growth, 2% vacancy and 3% reserves.

Re-run B with A's assumptions and its projected return typically falls by several percentage points. The difference was never in the property; it was in the spreadsheet. Normalizing assumptions across offerings is the single highest-value hour an investor can spend.

Fees change the return more than most investors expect

Add all of these into a single all-in annual drag figure. A 2.5% total drag against a 7% gross return removes more than a third of the investor's outcome over a full hold period.

• Acquisition fee: charged on purchase, reduces the equity actually working for you.
• Asset management fee: ongoing, usually a percentage of assets or of collected rent.
• Property management fee: an operating expense, typically 8% to 10% of rent.
• Disposition fee: charged at sale, reduces the proceeds you receive.
• Promote or carried interest: the sponsor's share of profit above a hurdle.

Red flags in offering documents

• Projected rents materially above current in-place rents with no renovation plan.
• No named property manager, or a manager affiliated with the sponsor at above-market fees.
• Reserves below 5% of gross rent on a property older than twenty years.
• Broad manager authority to sell, refinance or dilute without a holder vote.
• Return figures presented without stating whether they are pre-fee or post-fee.

Location and demand fundamentals

Numbers describe the deal; the market decides whether the numbers hold. Look at job and population growth, permitting and new supply in the submarket, the ratio of median rent to median income, and the direction of insurance and property tax costs.

A submarket where rent already consumes more than 35% of median income has limited headroom for the rent growth many projections rely on.