What’s the point in Real Estate Financial Modeling?
A few definitions first We have defined “real estate” as land and structures which generate revenue or are able to generate revenue.
We concentrate specifically on commercial property (CRE) that is bought and then let to business or private individuals in contrast to residential real estate like single-family houses, which are owned by the owner and not rented to other people.
In CRE, people or companies, i.e., tenants make payments to the property owner who utilize their space.
The owners make a profit from the rent they collect and utilize a part of this to cover expenses like property taxes, utilities and insurance. In certain instances tenants are accountable for certain expenses in addition.
All this lets us develop the following definition for Real Financial Modeling of Real Estate (aka REFM):
In the field of real financial modeling of real estate (REFM) it is the process of analyzing the property from the viewpoint as the Equity Investor (owner) or Debt Investor (lender) within the property. You then decide whether or it is you as an Equity or Debt Investor should invest according to the risks and the potential return.
In other words If you purchase an “multifamily” home (i.e. an apartment structure) at a cost of $50 million and keep for five years, can you get an annualized 12% return for your money?
If you build an office building from scratch with a budget of $100 million for the construction and land, and then you locate tenants, lease the propertyand then offer it for sale, would you be able to make a 20% annual return?
If you can identify the most crucial assumptions and structure your analysis properly Financial modeling for real estate assists you in answering these kinds of questions.
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Every investment is a gamble Therefore, a simplistic model cannot determine if the property you purchase will yield an 11.2 percent or 13.5 percent annualized return.
However, a thorough analysis will help you determine if the range of returns, 10 percent to 15% is reasonable.
These are the kinds of questions private equity firms that specialize in real estate consider all day long and spend a lot of time conducting analysis prior to taking investment decision.
Real estate is a mix of fixed income and equity and offers an investment risk/return of a range that falls somewhere between.
For instance an example, for example, a Core real estate deal in which the firm buys stabilized property, makes changes little, then re-sells it, could provide risk and possible yields that are similar to an corporate bond that is investment grade.
However is an “Value-Added” arrangement where the firm purchases the property that has low occupancy and then makes major renovations to enhance it and then aims to sell the property at a greater price may offer more some risk and yields that are similar than stocks.
Also, and “Opportunistic” deal in which the company develops a new property from scratch (“development”) or totally transforms or rebuilds an existing property (“redevelopment”) may provide a higher risk than stocks, and more potential for returns.
These descriptions outline the three principal strategies as well as the three major kinds of financial modeling:
Modeling Real Estate Acquisition to: Purchase an existing property and then make a few changes and then Sell it.
Real Modeling for Renovation of Real Estate: Buy an existing property, modify It significantly, and then Sell It.
Real Modeling of Real Estate Development: Purchase Land, Build a New Property, Search for Tenants, and then Sell it After Stabilization.
There’s a fourth option to consider: build a brand new property, but you must pre-sell units prior to the completion of the project instead of leasing it out and then selling the entire property at closing.
This is one of the subsets of the real estate development modeling that is mostly applicable condos (residential property) and is not our primary focus.
The lease terms provide the main differences.
Retail, office industrial and office properties generally employ more detailed financial modeling, as lease terms differ significantly and there are less guests or tenants than hotels or multifamily properties.
In contrast, hotels employ the same drivers and assumptions that you would find in ordinary businesses, while multifamily properties (apartment structures) are in the middle.
The Step-by-Step Method to Real Estate Financial Modelling
The specific steps differ based on the kind of the financial plan, however they’ll be similar to this:
Step 1: Establish the Transaction Assumptions, which include the ones for the size of your property as well as the price of purchase or development cost, as well as the closing (i.e. what price you could be able to sell the property at the closing).
Step 2: In an development model, you will plan the construction Period typically in a month-long basis and draw down equity and debt over time , but not all at once for the construction.
Step 3: Develop the Operating Assumptions for your property. These can be extremely general (e.g. average rent per unit * Units) or very specific (revenue costs, expenses and concessions to individual tenants) dependent on the property’s type.
Step 4: Create the Pro-Forma. Include the revenue and expenses into the Net Operating Income (NOI) line Capital costs that are below that line to calculate Adjusted NOI, as well as the Debt Service (interest as well as principal payments) below that for the Cash Flows into Equity.
Step 5: Create the Returns Calculations, which includes the initial investment, and any additional investments made over time as well as the Cash Flows to Equity each year, as well as the profits from the sale, including the repayment of debt as well as transaction costs. The focus is upon the internal rate of return (IRR) and Cash-on Cash or Money-on-Money multipliers here.
Step 6: Take an investment decision based upon your preferences and the output of the model in various situations.
Real Property Financial Analysis To Buy or not to buy?
Real Financial Modeling for Real Estate is less complicated than standard model of finance… In many cases.
This is because the function is more restricted The reason is that we don’t need 3 statement models such as valuation models, credit models, DCF models, merger models or LBO models.
In addition, expense and revenue projections aren’t significantly from what they are for businesses in various industries.
The majority of financial models for real estate can be summarized in one slight modification of Shakespeare’s most famous line:
“To purchase or not to purchase?”
Do you want to acquire or develop a home at the conditions stated?
Does it seem feasible to earn the results you want or will that need completely untrue assumptions?
In the worst case scenario could you be losing funds, or be able to survive, even if returns are not as expected?
Real estate financial modeling offers you easy but efficient methods to answer these questions and making investment decision.