Final Exam Review Flashcards
Zoning Benefits
- Submarket consistency into the future so owners can project long-term value
- Avoid unfavorable or incompatible land use adjacencies
- Cities plan for municipal services based on anticipated density
- Density-based traffic management planning
- Assurance of what you can build “as of right” without deferring to arbitrary or political approvals
- Rational and even desirable or consistent urban form (form-based zoning)
- Can protect recreational and open space and conserve environmentally sensitive areas
- Even playing field for competition
Zoning Drawbacks
- Requires that all involved property owners relinquish some of their individual property freedoms for the common good
- Can discourage some development in some locations
- Can increase the cost of building new structures and reduce affordability
- Can work against historic mixed use neighborhoods in older communities
- Zoning limits the potential of previously existing land uses and structures that do not conform with zoning standards
- Properly enforcing a zoning ordinance involves a long-term commitment to a certain level of community spending
SFFA (Simple Financial Feasibility Analysis)
Computes whether it is possible to take out a permanent loan to finance most of the development costs. Traditional method for the financial feasibility analysis of a small development project based on the inputs utilized in commercial mortgage market.
Limitations of SFFA
- Assumes developer will take out largest possible loan upon completion of the building
- Assumes land + development costs = market value (ignores NPV and wealth maximization)
- Does not compute the value of the completed property.
Net Lease
Tenant pays base rent plus costs associated with operations of the building, landlord typically pays the actual expenses as due then bills tenants as a cost reimbursement
Single Net Lease
Base rent + pro-rated property taxes
Double Net Lease
Base rent + pro-rated property taxes and insurance
Triple Net Lease (NNN)
Base rent + pro-rated property taxes, insurance and operating expenses (OpEx)
Benefit of Net Lease for the Tenant
Removes the risk of the landlord overestimating operating expenses
Benefit of Net Lease for the Landlord
Offers landlords the ability to charge tenants for the actual costs of the building. Most common in markets high demand and high OpEx volatility
Gross Lease
Rents are all inclusive and the quoted rental rate does not change throughout the term of the lease
Graduated Rent
Lease includes specified step-ups in the rent amount that are determined up front in the contract
Revaluated Rent
Specifies in the lease contract the times when rental payments may change but exact change is based on property appraisal (in some leases rent can only increase and in others rent can increase or decrease based on appraisal)
Indexed Rent
Rent is adjusted according to some publicly observable and regularly reported index such as consumer price index (CPI) or producer price index (PPI)
Percentage Rent
Rent includes a base rent plus a monthly percentage of revenue above a predetermined breakpoint. Common in retail in highly desirable locations.
Benefits of Short-Term Leases
- More flexibility
- Fewer tenant concessions (TI, free rent)
- Landlords enjoy higher rates due to more frequent renegotiation of terms
Benefits of Long-Term Leases
- More concession options
- Landlords secure long-term cash flows
- Minimizes releasing costs to landlords
Recourse Debt
Holds the borrower personally liable; can either be full or limited, gives the lender the ability to take assets of the debtor, beyond any collateral, up to the full amount of the debt (less risk to lenders)
Non-Recourse Debt
Does not allow the lender to pursue anything other than collateral (lender can only foreclose on the property); even if the collateral value is less than the loan amount; higher rates than recourse debt
Non-Recourse Debt
Does not allow the lender to pursue anything other than collateral (lender can only foreclose on the property); even if the collateral value is less than the loan amount; higher rates than recourse debt
Loan to Value Ratio Formula
= loan amount/appraised property value OR 1 - (1/LR)
Debt Service Coverage Ratio Formula
= NOI/total debt service
Default Risk
Property returns need to exceed debt service; higher debt levels commit more cash flow to debt service; risk increases with leverage
Debt Service Coverage Ratio (DSCR)
Leverage risk ratio that measures current year cash flow available to cover current year debt payments (most lenders require 1.10 or higher).
Debt Yield Ratio Formula
NOI/Loan Amount
Debt Yield Ratio
Provides a measure of risk that is independent of interest rate, amoritization period and market value; lower debt yield = higher leverage and higher risk (riskier) and vice versa
Positive Leverage
Asset produces more income than the cost of borrowing; debt that increases overall rate of return
Negative Leverage
Cost of borrowing is greater than the investment return; debt that decreases rate of return; could occur in adjustable rate mortgages in a period of rising interest rates
Debt Capacity
The max amount of debt (and other fixed charge financing) that a firm can adequately service
Vacancy Allowance
(1-probability of renewal) x (market rent) x expected vacancy in months/12
Debt
Contractual interest payments that must be paid before any equity dividends can be issued; no ownership claims to profits beyond loan amount (exception is mezzanine financing); first to be repaid in the event of a default
ALV Calculation on HP12c
- Calculate cash flows
- Calculate lease present value (LPV) by solving for NPV
- Save lease present value as PV, enter i and n and solve for PMT = ALV
(Net rent = ALV when cash flows are the same)
Absorption Budget
- Marketing costs and advertising
- Leasing expenses (commissions)
- TI expenditures
- Working capital during lease-up until break-even
Gross Lease
Rent is all inclusive; quoted rental rate does not change throughout the term of the lease; landlord pays all or most property expenses, including expense increases over time
Full Service Lease
Generally, landlord is responsible for covering property’s OpEx up to a certain point (typically first year) then tenant pays for a portion of expenses above the base year expense amount
Construction Soft Costs
The portion of the investment other than the actual cost of improvements (loan fees, construction interest, legal fees, environmental studies, land planner fees, A/E fees, marketing and advertising costs, leasing and sales commissions)
Lease Goals - Landlord’s Perspective
- Maximize NPV
- Secure highest quality tenant credit
- Minimize parking required
- Synergize tenants to maximize productivity (retail)
- Shift OpEx to tenants
- Diversify expiration risk by term and tenant size as percentage of property
- Minimize interlease risk
- Renewals at market or close to it
- Local flavor and diversity (retail)
Lease Goals - Tenant’s Perspective
- Minimize NPV of lease
- Minimize total occupancy costs
- Minimize unexpected pass through expenses or significant increases
- Minimize upfront or releasing costs
- Maximize flexibility and the need to expand, downsize or exit with the least possible penalties
- Renew on favorable terms
Capital from an owner’s perspective - Debt
- Interest expense paid on borrowed capital
- Presents a contractual fixed expense
- Deductibility of interest expense from earnings
- Cost of debt typically has a lower cost than cost of equity
- Reduces financial flexibility and adds default risk
Capital from an owner’s perspective - Equity
- Claim on earnings of investment for ownership interest
- No obligation to make regular payments to equity holders
- Expected cost of equity is higher than expected cost of debt
- Offers more financial flexibility
Zoning Envelope
Use-specific and denominated in gross SF. Does not establish building envelope but does limit it (building configuration and design have to be based on it)
Mezzanine Financing
Senior to equity but subordinated to other debt that is senior to it hence the nickname “Middle” financing; can take the form of debt or equity including:
-Junior debt (such as a 2nd mortgage)
-Preferred equity
-Convertible debt
-Participating debt
Typically accounts for 10-15% of the funding and assumes medium/high risk and return
Parking Requirements
Ratio requirements delineated in spaces per 1,000 SF for commercial space or spaces per unit for residential
Capital Structure
The mix or proportion of a firm’s long-term financing represented by debt, preferred equity and common equity
Height Limitations
May limit the ability to build a tall building and will be different for different use types but does not exist in all markets (may be different for the building street-front areas versus a certain setback distance); max height density = FAR/site coverage ratio
Coverage Ratio Formula
Building footprint/site area
Coverage Ratio
How much of the site you can cover with your building footprint
Setbacks
The distance from the property line within which you cannot build
Easements
Covenants in the property title giving usage rights to portions of your property to others
Variations to the FAR Formula
- 1 acre = 43,560 SF = 4046.86 SM
- Site size = total lot area
- Total building area = floor area = gross floor area of building
Floor Area Ratio (FAR) Formula
Gross Floor Area/Total Lot Area
Floor Area Ratio
The ratio of floor area to lot area, metric regulating the number of SF that can be developed on a parcel
Potential Gross Income (PGI)
The sum of all rents assuming the property is 100% leased; price per SF x rentable SF + percentage rent (if applicable) + recoveries (if applicable)
Property Before Tax Cash Flow (PBTCF) Calculation
NOI - expenses - leasehold improvements - reserves -leasing commissions = PBTCF
Zoning Entitlements
What produces the most value has to be in compliance with zoning; the use you can build
Due-on-sale
Mortgage must be repaid in full upon sale
Public Market Equity Assets
Stocks, REITs, mutual funds, exchange-traded funds
Private Market Equity Assets
Real property, private equity, hedge funds, private REITs
Public Market Debt Assets
Bonds, mortgage-back securities, money instruments, mutual funds, exchange-traded funds, CMBS
Private Market Debt Assets
Bank loan, whole mortgages, venture debt/leveraged buyout
WACC Formula
(equity/value) x cost of equity + (debt/value) x cost of debt x (1 - effective tax rate)
Effective Rental Income Calculation
= GPI - vacancy - collections - concessions
Effective Gross Income Calculation
Effective Rental Income + Misc. Income
Proforma NOI Calculation
Effective Gross Income - Total Expenses
Reserves
Funds placed in reserves for unexpected expenses; would be treated as a deductible expense on taxes; below NOI is standard practice; if funds are considered as part of NOI, property price will be lower
Effective Rental Income Calculation
= PGI - vacancy - collections - concessions
Cash Flow from Operations
= NOI - TI - Capital Improvements - Leasing Commissions
NOI
Derived by subtracting all expenses from Effective Gross Income for a property; ignores irregular expenditures (leasing commissions, TI and larger capital expenditures)
Interim Cash Flows
A projection based on forecasted budget and escalation of revenues and expenses (can be estimated as historical or forecasted as % of NOI)
Terminal (Reversion) Value
Can be determined using: cap rate, comp value using price/SF or replacement cost
Reasons to Borrow
- Increased purchasing power
- Diversify assets
- Enhanced equity returns
- Tax benefits of interest payments
Leverage Ratio Formula
= Property value/equity or 1/(1-LTV)
Loan to Value
A lending risk ratio that lenders examine before approving a mortgage. Typically assessments with LTVs of 80% or more are seen as higher risk
Construction Hard Costs
Direct cost of the physical components of the construction project:
- Land cost
- Site prep
- Shell costs of existing structure in rehab projects
- Permits
- Contractor fees
- Overhead and project management
- Materials and labor
- Rental equipment
- Tenant finish
- Developer fees
Construction Loan
A short-term loan used to finance construction that does not requires repayment until the construction is complete; provided by a commercial bank; typically lender won’t approve construction loan until permanent lender has conditionally approved a “take-out” loan
Features of Predevelopment Phase
Land optioning and assembly, permitting, design; characterized by very high risk (40% OCC) and small investment; sources of financial capital include developers and other private entrepreneurial equity providers, including sometimes private equity funds of the opportunistic style
Features of Construction Phase
Includes land/site purchase (listed as Time 0) design completion and construction of shell; characterized by high risk (20% OCC) and bulk of the financial investment; sources of financial capital include commercial banks for the construction loan debt capital and the developer and/or joint venture partners for the equity, including private equity funds (opportunistic style), REITs, sometimes institutions such as pension or endowment funds or foreign investors
Features of Lease-Up Phase
Includes lease-up, TI, rent and escalations (listed as Time T1 at shell completion); characterized by moderate risk (10% OCC) and less capital; bridge loan; sources of financial capital are similar to the construction phase plus value-added funds
Features of Stabilized Operation
Includes property management and asset management, re-leasing, reposition and disposition (listed as Time T2 or Time T); characterized by low risk (8% OCC) and less capital; sources of financial capital include permanent mortgage financing life insurance companies, commercial mortgage-backed securities (CMBS), and other conservative institutions, REITs, pension funds, private equity core funds, foreign investors, and sometimes corporate end-users
Permanent Loan
Provide long-term debt financing of the property; traditionally made only on stabilized properties and face much less credit loss risk than construction loans, but more interest rate risk (if they are fixed-rate loans). Typical permanent lenders include life insurance companies or CMBS
Fixed Proforma Expenses
Remains the same regardless of occupancy; includes property taxes and insurance
Variable Proforma Expenses
Expenses vary with occupancy; includes janitorial and management fees
Capital Expenditures
Major expenditures that result in long-term improvements to the physical property (not specific to one tenant); typically expressed as a $/SF figure
Load Factor Calculation
= 1 - (USF/RSF)
Load Factor
AKA loss or core factor; ratio between usable and rentable square footage of a building expressed as a percentage
Add-On Factor
Common area calculated as a percentage of the usable area
Add-On Factor Calclulation
= (Rentable SF/Usable SF) - 1
Efficiency Reduction
Difference between gross building area and rentable area as a percentage; typically 94% in US; (GBA/RSF) - 1
Lease-Up Risk
Risk that forecasted absorption volume will not be realized
Interlease
Prior to or between lease signings the future rent is more uncertain or risky, hence, a higher “inter‐lease” discount rate is appropriate; rent may be expected to increase between leases, but not within
Intralease
Cash flows from the lease payments are relatively low risk, hence a low “intra‐lease” discount rate is appropriate
Gross Building Area
Total area of building’s footprint based on exterior dimensions excluding below-grade space; GBA = RSF x (1 + Efficiency Reduction); used for zoning, permitting, whole building construction contracts and pricing, RE tax assessments
Rentable Area (RSF)
The area of the enclosed interior space of the building other than holes in the floor, such as stairwells, and elevator and mechanical duct space. If it’s floor that you can stand on, it is rentable space; RSF = GBA/(1 + Efficiency Reduction); used for purchase, sale, leasing financing and partnership transactions
Usable Area (USF)
All floor area in a tenant space; USF = [RSF x (1-Load Factor)]; used for planning and TI construction pricing
3 Investment Objectives
- Growth (appreciation): relatively long-term horizon, no immediate need for cash, more risk tolerant
- Income or Yield (Current CF): Short-term, ongoing need for cash, risk averse
- Total return (hybrid of growth and income)
Advantages of RE in Balanced Portfolios
- Income producing asses with appreciation potential
- Provides diversification in a balanced portfolio with low correlations with other asset classes
- Lower volatility than marketable securities
- Potential inflation protection
- Cyclical hedge
- Tax shelter
Disadvantages of RE in Balanced Portfolios
- Illiquidity
- Long-term horizon
- Use of debt
- Rising interest rates
REIT Qualifications
Must be an entity that is taxable as a corporation, came out of a desire small investors access to the ownership of income producing assets, must pay at least 90% of taxable income to shareholders through dividends; more volatile on an interest rate level because of 90% payout
Core Strategy
Stable tenants; long-term holding period; 90-100% occupancy rate; buy and hold strategy; 7-10% return expectation; less than 50% leverage
Core Plus Strategy
Light renovations and release strategy, 80-95 % occupancy, 11-13% return expectation, low risk; 50-65% leverage
Value Add Strategy
Heavy renovations; medium risk; few stable tenants; less than 80% occupancy; 14-17% return expectation; 60-75% leverage
Opportunistic Strategy
Ground up development and/or major rehab; high risk’ ; no stable tenants; 0-50% occupancy; 18%+ return expectation; over 70% leverage
Investor Qualifications - Private Funds
Private funds are governed by a host of intersecting federal laws that impact who can invest in these fund, including the Securities Act of 1933, the Securities Exchange Act of 1934, the Investment Advisers Act of 1940, and the Investment Company Act of 1940. The type and character of each investor affect, among other things:
1) whether an investor qualifies to invest,
2) whether the fund would be required to register with the Securities and Exchange Commission
(SEC), and
3) the fee that can be charged
Regulation D - Rule 506
Provides exemptions from registration for companies when they offer and sell securities. Companies relying on the Rule 506 exemptions can raise an unlimited amount of money. Under Rule 506(c), a company can broadly solicit and generally advertise the offering and still be deemed to be in compliance with the exemption’s requirements if:
- The investors in the offering are all accredited investors; and
- The company takes reasonable steps to verify that investors are accredited investors
Accredited Investor
As defined in Regulation D under the 1933 Act:
• Net worth test ‐ A natural person whose individual net worth exceeds $1,000,000
• Income test ‐ A person who had an individual income in excess of $200,000 in each of the two most recent years or joint income with that person’s spouse in excess of $300,000 in each of those years
Requirements for Entities:
• An entity, owned exclusively by accredited investors; or
• is not formed for the specific purpose of acquiring the interest in the fund and has total assets in excess of $5,000,000.
Qualified Purchaser (QP)
An investor that meets any of the following criteria:
• an individual or family‐owned business not formed for the specific purpose of acquiring the interest in the fund that owns $5,000,000 or more in investments;
• a trust not formed for the specific purpose of acquiring the interest in the fund which is sponsored by and managed by qualified purchasers;
• an entity not formed for the specific purpose of acquiring the interest in the fund which owns and invests at least $25,000,000 in investments (or someone who is acting on account of such a person); or
• an entity, of which each beneficial owner is a qualified purchaser
Qualified Clients
An individual or entity is a qualified client if he, she, or it:
- Has $1M or more of assets under management with the investment advisory after the investment in the fund
- Has a net worth of $2.1M prior to the investment in the funds (excluding the value or his or her primary residence)
- Is a “qualified purchaser”
- Is an officer or director of the fund manager or is an employee who participates in the investment activities of the the investment adviser and has been doing so for 12 months
Typical Private Equity Fund Life Cycle - Investment Period
Returns are often negative in the early years as the funds call capital to make investments and charge management fees on the committed capital amount
Typical Private Equity Fund Life Cycle - Harvest Period
The period during which the investment is returned and profits are generated
J-Curve
Visual representation of the typical private equity fund life cycle depicting a downward curve during the investment period and the upward‐sloping part of the “J” comes later in the fund’s life as each of its investments are sold, ideally at a significant profit
Internal Rate of Return (IRR)
Returns consider time value of money, so timing of cash flows are important and assumes reinvestment at same discount rate
European (Global) Distribution Waterfall
LP friendly, GP receives carry only after LPs receive all contributed capital (plus preferred return if applicable) so GP receives carry later in the life of the fund
American (Deal by Deal) Distribution Waterfall
GP friendly, GP receive carry after each profitable investment is realized so GP receives funds earlier in the life of the fund; GP can be paid too much, which must be paid back to the fund (clawback clause)
Distribution Waterfall
The order in which a private equity fund makes distributions to limited (LP) and general partners (GPs); describes the method by which capital is distributed to a fund’s investors as underlying investments are sold
Carried Interest/Promote
Performance fee rewarding the manager for enhancing performance, typically ranges between 5‐30% of profits
Private Equity Structure - Single LLC
GP or Sponsor contributes its co‐investment into the same entity as all LPs; the sponsor’s co‐investment is treated equally to LP equity since it is contributed into
the same entity; helps to cleanly delineate what cash flows go to the sponsor as payment of its promote versus what cash flows go it as a co‐investor in the deal
Private Equity Structure - Class B Member
Sponsor contributes its co‐investment into the Class B Member entity instead of contributing it alongside LPs as an additional Class A Member; key distinction here is that the term “all equity” is no longer valid since now 90% of equity is contributed as Class A Members and 10% of the equity is contributed as Class B members with different treatment of those members; all equity is not treated equally and the differences are noted in the waterfall structure
Private Equity Structure - JV LLC
From a cashflow perspective, nearly identical to the Class B co‐investment contribution structure (previously outlined) but this structure employs a total of three LLCs with a JV LLC taking title to the property
- The GP and LP each join the JV LLC via its own LLC. LPs are now housed in their own distinct LLC
- All control provisions between GP’s and LP’s are now encased in the JV LLC Agreement. There are no longer Class A or Class B Members
Default
Occurs when borrower violates clause or covenant in the mortgage agreement
Workouts
Some, often creative, combination of rescheduling or forgiveness of debt; often results in higher long term yields or equity participation by lender
Foreclosure
Forced sale of collateral property. Proceeds used to satisfy loan obligation to lender; considered an action of last resort – expensive and slow process and a blemish to both parties; deficiency Judgement allows lender further payment by borrower if foreclosure sale does not provide sufficient funds (recourse loans)
Bankruptcy
Borrower protection where lenders are forced to accept a restructuring of debt (usually at a loss)
Exculpatory Clause
Limits lender liability to the property only; present in non-recourse loans
Promise to Pay
Borrower promises to pay the principal, interest and penalties in promissory note
Order of Application of Payments
The order payments will be applied to the various components of the debt
Borrrower’s Right to Reinstate
Allows borrower to stop the acceleration of the loan under default
Release Clause
Borrower is released from debt and lender returns mortgage deed and extinguishes lien on the property when the loan is paid off
Prepayment Clause
Gives the borrower the right to pay off the loan prior to maturity
