RE

Question 1

What is Real Estate Private Equity

Answer 1

REPE firms raise capital from outside investors called Limited Partners(LPs) and use that capital to acquire and develop, improve, and operate properties to eventually sell then and realize a return

Question 2

Who are Limited Partners

Answer 2

Pension funds, Endowments, insurance firms. family offices, funds, and high-net-worth individuals

Question 3

What type of real estate to REPE firms focus on?

Answer 3

Commercial real estate- offices, industrial ,retail, multifamily, and specialized properties like hotels - rather than residential real estate

Question 4

If REPE firms operate in residential real estate, what is their strategy?

Answer 4

To buy, hold, and rent out homes to individuals ( see: blackstone) (https://mergersandinquisitions.com/private-equity/)

Question 5

What do Real Estate Investment Trusts do?(REITs)

Answer 5

Raise debt and equity continuously in the publid market and then acquire, develop, operate, and sell properties.

Question 6

Why and how do REITs receive favorable tax treatment?

Answer 6

They comply to strict requirements about percentage of real estate-related assets they own, the percentage of net income they distribute in the form of dividends, and the percentage of their revenue that comes from RE sources

Question 7

What are the differences between Real Estate Operating Cmopaneis(REOCs) and REITs?

Answer 7

They are similar, but they do not face the same ristrictions and requirements and do not receive the same tax benefits

Question 8

How do Private equity firms differ?

Answer 8

1. Investors -
   REPE investors are the LP whose capital is locked up for a long period as the firm invests. REIT and REOC investors are public shareholders and lender, and their investments are highly liquid.
2. Holding period -
   REPE firms plan to acquire or develop properties, hold them for a few years, and then sell them; REITs and REOCs often hold properties indefinitely
3. Regulations - REPE firms, as private investment firms, are lightly regulated and not subject to the same requirements as REITs and REOCs

Question 9

What are the two distinct roles in REPE?

Answer 9

Acquisitions and Asset Management

Question 10

What does the Acquisitions team do?

Answer 10

They pursue and analyze deals, negotiates them, set up the financing, and convinces the decision-makers at the firm to invest in properties

Question 11

What does the Asset Management team do ?

Answer 11

They execute the busines plan once the firm has the property. They improve the property’s operation and financial performance and fix the problems that come up

Question 12

Why is the pay ceiling higher in Acquisitions?

Answer 12

the pay ceiling is higher because the perception is that it is harder to execute deals than it is to manage properties

Question 13

How does the Asset Management team differ in terms of compensation compared to Acquisitions?

Answer 13

The compensation is more stable and the career path as well because firms always need to mange their properties even if they’re not doing many deals

Question 14

How can you divide REPE groups?

Answer 14

1. Strategy -
   Does the firm acquire only stabilized, mature assets?(Core) Does it focus on major renovations or redevelopments?(Value-Added) Does it develop or redevelop properties?(Opportunistic) Does it buy distressed properties and attempt to turn them around?
2. Sector - Multifamily? Industrial? Office? Retail? Hotels? Something else?
3. Geography -
   Continental Europe? The U.K? U.S?
4. Capital Structure -
   Technically,”private equity” means “ Equity investments” , but some firms label themselves real estate private equity and still invest in Senior loans, bridge loans, mezzanine, and more?
   Deal Role -Does the firm operate as a General Partner or LP?. Does it contribute a small percentage of equity and run the deal execution and management or does it contribute most of the equity but take a hand-off role in the deal.

Question 15

What are senior loans?

Answer 15

A senior bank loan is a debt financing obligation issued by a financial institution and then repackaged and sold to investors. (Multiple loans.) senior bank loans hold legal claim to the borrower’s assets. Usually in case of bankruptcy, with senior bank loans lender/ investors can be paid back. Fluctuating interest rates.

Question 16

What is a Bridge Loan?

Answer 16

Short-term loan used until a company secures financing or pays existing obligation. Allows immediate cash flow. High interest rate and backed by collateral.

Question 17

Big REPE firms vs Small REPE firms

Answer 17

Big –> Highly diversified
Small –> focus on narrower markets

Question 18

What does a boutique REPE firms focus on?

Answer 18

They focus on value-added multifamily feals in medium-sized cities in the Midwest region of the U.S

Question 19

What does a huge firm like Blackstone focus on?

Answer 19

Potential Returns vs Risk
1 lowest risk lowest return
5 highest risk and highest return
1. Fixed income
2.Core real estate
3.Value-Added Real estate
4.Equities
5.Opportunistic real estate

Question 20

Highest REPE firms?

Answer 20

Blackstone, Starwood, and Brookfield are big in the US

Question 21

What does a REPE job entail?

Answer 21

Deal sourcing, analyzing investments, building models, conducting due diligence, monitoring the portfolio, fundraising, and preparing memos. Crunching numbers on excel for 10 hours; complete property tours, meet construction crew, set up conference calls to speak with the LPs

Question 22

Why do in-person and property tours matter a lot?

Answer 22

They give you the full picture and on-site maintenance matters

Question 23

What tool can you use to automate some of the process?

Answer 23

ARGUS - ARGUS Enterprise is a leading commercial property valuation and cash flow forecasting software trusted by CRE professionals worldwide

Question 24

Salaries in USD

Answer 24

Analyst : 100k-150K
Associate : 150k - 250K
VP : 300k - 500K
Director or SVP: 450K - 700K
Partner or MD : 750K - 1mil
pay at boutiques and family offices will be lower
Asset Management pay is lower by 10-20%

Question 25

Why real estate? OR Why would you invest in real estate?

Answer 25

It’s a very tangible asset class that’s rooted in real cash flows, not pie-in-the-sky future assumptions, and it combines financial analysis with real-life, on-the-ground knowledge.

Question 26

What are the main property types, and how do they differ from each other?

Answer 26

The main categories are office, industrial, retail, and multifamily properties.

Office, industrial, and retail properties have businesses as tenants and offer long-term leases of 5-10 years. The lease terms are highly variable and often include different rental rates, rental escalations, free months of rent, expense reimbursements, and tenant improvements.

Industrial properties can be built more quickly and cheaply and tend to have fewer tenants, while office and retail properties take more time and money and tend to have more tenants.

Multifamily properties have individuals as tenants and offer short-term leases (usually 1 year), with very similar terms for all tenants.

Question 27

What are the main strategies that private equity firms use to invest in real estate?

Answer 27

Core(buy an existing, stabilized property, change very little, and sell it again) lowest risk and return
Value-Added(acquire an existing property, renovate or greatly improve it, and then sell it again) higher risk and return
Opportunistic(develop or re-develop a property and then sell it)highest risk and return

Question 28

What is Net Operating Income (NOI)? What about Cap Rates?

Answer 28

Net Operating Income, or NOI, represents the property’s cash flow from operations on a capital structure-neutral basis before most of the capital costs
The Cap Rate equals the property’s stabilized forward NOI divided by its “price” (asking price or actual sale price); lower Cap Rates mean higher valuations, and higher Cap Rates mean lower valuations.

Question 29

Walk me through a property pro-forma and explain the main line items.

Answer 29

https://mergersandinquisitions.com/real-estate-pro-forma/

Question 30

How do Triple Net (NNN), Double Net (NN), Single Net (N), and Full-Service or “Gross” Leases differ?

Answer 30

With NNN leases, the tenant pay rent, plus its proportional share of Property Taxes + Insurance + Maintenance/ Utilities
With NN leases, its just Rent + Property Taxes + Insurance
N leases, its just Rent + Property Taxes

Full service Leases require Rent but no expense reimbursements. They ahave the highest rent since the tenant does not reimburse the owner directly for the other expenses

Question 31

How is Base Rental Income Calculated

Answer 31

Square footage occupied x rent per square footage
ex: occupies 5000 square feet and pays 50$ per square foot per year. 5000 x 50 = 250 000

Question 32

How is concession & free rent calculated ?

Answer 32

ex : 3 months = 25% x base rental income = 25% x 250 000 = 62 500

Question 33

How is Expense Reimbursement calculated?

Answer 33

Occupied space x Property tax per year=
ex 20% of total space x 500 000 tax for entire building = 100 000

Question 34

A tenant occupies 5,000 square feet of an office building (20% of total space) and pays rent of $50 per square foot per year, which is the same as market rates in the area.

This tenant receives 3 months of free rent upon move-in, it’s on a Triple Net Lease, and the total operating expenses and property taxes for the entire building are $500,000 per year.

Calculate the Year 1 Effective Gross Income for the tenant, assuming a January 1 move-in.

Answer 34

The Base Rental Income is 5,000 * $50 = $250,000. In Year 1, this tenant receives 3 months of free rent, which is 25% of the year, so the Concessions & Free Rent line is $250,000 * 25% = $62,500.

The Expense Reimbursements for this tenant are 20% * $500,000 = $100,000, so its EGI is ($250,000 – $62,500 + $100,000) = $287,500.
EGI = Base Rental Income - Concessions & Free Rent Line + Expense Reimbursements

Question 35

What are the main financial differences between multifamily properties and office, retail, or industrial properties?

Answer 35

Capital costs such as Leasing Commissions and Tenant Improvements are also far more significant, which reduces cash flow for these properties.

These items are much lower for multifamily properties, but unit turnover is much higher, and they may have more staffing and sales & marketing needs as a result.

Also, rent, occupancy rates, and expenses for multifamily properties tend to change much more quickly if there’s a downturn because the leases are short-term.

Question 36

What is a Construction Loan?

Answer 36

Short-term loan to build for RE. Covers the cost of project before long-term funding
Risky = high interest rates

Question 37

What is a Permanent Loan?

Answer 37

Loan with unusually long term.

Question 38

Walk me through a real estate development model

Answer 38

1. Assumptions for the land required, contruction costs, debt and equity
   2.project costs, draw from equity, switch to construction loan past a certain point
2. When construction finishes assume refinancing, project lease-up period for the individuals
3. Build a Pro-Forma with debt service based on the Permanent Loan
   5.Assume property is sold in the future based on its NOI and a range of Cap Rates
4. Calcualte the Internal Rate of Return(IRR)to Equity Investors

Question 39

Why do you assume that loan fees and interest are capitalized during the development period? Can’t you set aside a reserve for them in the beginning?

Answer 39

You assume they are capitalized because the property will not have cash flow to pay for them when construction is taking place.

You could pay extra for an upfront reserve, but doing so will reduce the IRR and multiple because the Equity Investors will have to contribute more in the beginning.

Question 40

Why do you assume that construction loans are refinanced and replaced with permanent loans when the construction finishes?

Answer 40

Construction loans are riskier. Lenders want underlying assets that match risk tolerance

Equity Investors like loan refinancing because it boosts the IRR

Property can take additional Debt once its stabilizes, so (Total New Debt - Old Repaid Debt) get distributed to Investors as cash inflow

Question 41

Walk me through a property acquisition model

Answer 41

You first assume a purchase price based on a Cap Rate and the property’s NOI, and you assume certain percentages of Debt and Equity to fund the deal.

You then make assumptions for the property’s revenue and expenses, sometimes projecting individual tenant leases (for office/retail/industrial properties) and sometimes using higher-level assumptions such as the average rent or ADR (multifamily and hotels).

You forecast the Pro-Forma over several years, project the Debt Service, and you assume an exit in the future based on a Cap Rate and the property’s stabilized forward NOI.

Finally, you calculate the returns based on the initial Equity contribution, the Cash Flows to Equity, and the Net Proceeds after Debt repayment upon exit.

Question 42

You acquire a multifamily property for $10 million at a Going-In Cap Rate of 5%, LTV of 70%, and Debt with a 5% Interest Rate and a 3-year interest-only period followed by 2 years of 2% principal repayments.
NOI stays the same throughout the holding period, but you sell the property for a Cap Rate of 4% in Year 5. What is the approximate IRR?

Answer 42

The NOI each year is $10 million * 5% = $500K, and you use $7 million of Debt and $3 million of Equity.

Assuming no capital costs, Cash Flow to Equity in Years 1 to 3 = $500K – $7 million * 5% = $150K.

In Years 4 and 5, Cash Flow to Equity is approximately $150K – $7 million * 2% = $10K.

In Year 5, you sell the property for $500K / 4% = $12.5 million and must repay ~$6.7 million of remaining Debt, resulting in just under $6 million in Equity Proceeds ($5.78 million exactly).

You invested $3 million and earned back around $6.2 million if you count the Cash Flow to Equity in Years 1 – 5 and the ~$5.8 million in Equity Proceeds at the end.

This is just over a 2x multiple over 5 years, so we’d approximate the IRR as “slightly above 15%” or “between 15% and 20%.”

If you run the numbers in Excel, the exact IRR is 17%.

Question 43

How do you value a property? What are the trade-offs of these methodologies?

Answer 43

Cap Rates, DCF Analysis, and the Replacement Cost methodology

Question 44

You are analyzing two office buildings on the same street in Chicago. The buildings have the same rentable square feet, are the same age, and are both “Class A.” Why might one building sell for a lower Cap Rate than the other?

Answer 44

The more valuable building, i.e., the one selling for a lower Cap Rate, might have higher-quality tenants, more favorable lease terms, a higher occupancy rate, or lower ongoing capital costs.

Question 45

How do you calculate the Discount Rate in a property DCF?

Answer 45

The Cost of Equity is based on the equity returns the investors are targeting in this “deal class” (e.g., Core vs. Core-Plus vs. Value-Added vs. Opportunistic), and the Cost of Debt is linked to the coupon rate on Debt. Discount Rate = Cost of Equity * % Equity + Cost of Debt * % Debt… and if there’s Preferred Stock or anything else, you also factor those in.

Question 46

What is the waterfall returns schedule, and why is it widely used in real estate?

Answer 46

https://breakingintowallstreet.com/kb/real-estate-modeling/real-estate-waterfall-model/?_ga=2.144358268.81131400.1708559983-1433123058.1708559982

The waterfall schedule allows the Equity Proceeds from a deal to be split up in a non-proportional way if the deal performs well enough.

For example, if the Developers contribute 20% of the Equity, normally they would receive 20% of the Equity Proceeds.

But a waterfall schedule lets them receive 20% up to a certain IRR and then 30% or 40% of the Equity Proceeds above that IRR if the deal performs well enough.

This structure incentivizes the Developers or Operators to perform while taking away little from the Investors or LPs.

Question 47

How do Preferred and Catch-Up Returns work in waterfall models?

Answer 47

Preferred Returns give one group, such as the Investors or Limited Partners, 100% of the positive cash flows from the property until they reach a specific Equity IRR or Multiple, such as 10% or 1.0x.

Then, the other group(s) may receive Catch-Up Returns that “catch them up” to that same Equity IRR or Multiple, which means that the other group(s) will receive 100% of the next available positive cash flows up to that level.

Once these thresholds are reached, the Equity Proceeds will be split based on percentages.

Question 48

How do Senior Loans and Mezzanine differ, and why do many deals use both?

Answer 48

Senior Loans are secured Debt where the property acts as collateral, they tend to have the lowest interest rates (either fixed or floating), and they often have amortization periods that far exceed their maturities (e.g., 30-year amortization vs. 10-year maturity).

Senior Loans fund property acquisitions up to a certain LTV that lenders will accept, such as 60% or 70%. If the sponsor wants to go beyond that, it will have to use Mezzanine, which is unsecured Debt that is junior to Senior Loans.

Mezzanine has higher, fixed interest rates, either paid in cash or accrued to the loan principal, amortization is rare, and the maturity is almost always shorter than the maturity of Senior Loans.

Question 49

What is LTV and LTC

Answer 49

Loan-to-cost (LTC) compares the financing amount of a commercial real estate project to its cost.

Loan to Cost=Loan Amount / Construction Cost

Loan-to-value (LTV) is an often used ratio in mortgage lending to determine the amount necessary to put in a down payment and whether a lender will extend credit to a borrower.

LTV ratio = MA / APV
MA = Mortgage Amount
APV = Appraised Property Value

Question 50

How can you determine the appropriate Loan-to-Value (LTV) or Loan-to-Cost (LTC) ratio for a deal?

Answer 50

You look at the LTV or LTC for similar, recent deals in the market and use something in that range.

You could also size the Debt based on the credit stats the lender is seeking, such as a minimum Debt Service Coverage Ratio of 1.2x and a minimum Interest Coverage Ratio of 2.0x.

Question 51

What is the Debt Service Coverage Ratio?

Answer 51

The debt-service coverage ratio (DSCR) is a measure of the cash flow available to pay current debt obligations.

DSCR = NOI / Total Debt service
Total Debt Service = Current debt obligations

Question 52

Suppose that the Debt Service Coverage Ratio (DSCR) is 1.1x, the Debt Yield is 8%, and the Going-In Cap Rate is 7%. What does this tell you about the deal?

Answer 52

The deal uses too much leverage because the DSCR is quite low – lenders usually want to see at least 1.2x to 1.4x so there’s enough “cushion” if something goes wrong.

Also, the Debt Yield (NOI / Initial Debt Balance) and Cap Rate (NOI / Initial Purchase Price) are very close, which means additional risk.

If the Cap Rate ever rises above the Debt Yield, you’re in trouble because then the Debt is worth more than the property itself (i.e., you’re “underwater”).