Technical Flashcards
How many black cabs do you think there are in London?
How many gas stations are there in London?
How many barbers are there in London?
How many piano tuners are there in London?
How many boxes of breakfast cereal are sold in London each year?
How many gold balls will fit inside a Boeing 747?
What is a Cap Rate
What are the main real estate asset classes and how do they differ?
Tell me about Eastdil and our investment strategy
Tell me about a deal Eastdil did recently that you find interesting
What asset classes have the biggest risk?
Describe an amortization schedule, or build one in excel?
An amortization schedule is a detailed table or chart that outlines the periodic payments, interest, principal repayment, and remaining loan balance over the life of a loan. This schedule is commonly used in the context of mortgage loans, where it helps borrowers and lenders understand how each payment contributes to the reduction of the outstanding loan amount.
Here’s a breakdown of the key components typically found in an amortization schedule:
Payment Number (Period): Each row represents a specific payment period, usually on a monthly basis.
Payment Amount: The total payment due for that period, which includes both principal and interest.
Principal Repayment: The portion of the payment that goes toward reducing the outstanding loan balance.
Interest Payment: The portion of the payment that covers the interest accrued on the remaining loan balance.
Total Interest Paid: The cumulative sum of all interest payments up to that point.
Total Principal Paid: The cumulative sum of all principal repayments up to that point.
Remaining Loan Balance: The outstanding amount of the loan yet to be repaid after each payment.
As the borrower makes payments over time, the proportion of the payment allocated to interest decreases, while the proportion applied to principal increases. This reflects the nature of amortizing loans, where a larger portion of the interest is paid early in the loan term.
Amortization schedules are useful for borrowers to understand how much of each payment goes toward reducing the loan balance and for lenders to track the repayment of the loan. Additionally, they can be beneficial for financial planning, as they provide a clear overview of the loan’s progress and the overall cost of borrowing.
Take me through a DCF in words?
How do you evaluate a REIT?
Walk me through an Income statement for a multi family building?
How would you value the building we are sitting in?
What are the main types of real estate loans?
What is a DCF?
What are the important numbers for valuing real estate?
Market Value:
Definition: The current fair market value of the property, representing the price at which a willing buyer and a willing seller would agree.
Comparable Sales (Comps):
Definition: The prices of recently sold properties that are similar to the subject property in terms of location, size, condition, and features.
Importance: Comparable sales help in determining a property’s value based on the prices achieved for similar properties in the same market.
Capitalization Rate (Cap Rate):
Definition: The ratio of a property’s net operating income (NOI) to its current market value or acquisition cost.
Importance: Cap rate is used to estimate the potential return on investment and is a key metric for income-producing properties.
Gross Rent Multiplier (GRM):
Definition: The ratio of the property’s sale price to its gross rental income.
Importance: GRM is a quick way to evaluate a property’s value based on its rental income, but it doesn’t consider operating expenses.
Net Operating Income (NOI):
Definition: The total income generated by a property minus operating expenses, excluding debt service.
Importance: NOI is a crucial metric for evaluating the property’s profitability and is often used in cap rate calculations.
Cash-on-Cash Return:
Definition: The ratio of annual before-tax cash flow to the total cash investment (including the down payment and closing costs).
Importance: Cash-on-cash return provides insight into the actual return on the cash invested in the property.
Debt Service Coverage Ratio (DSCR):
Definition: The ratio of a property’s net operating income to its debt service (mortgage principal and interest).
Importance: DSCR is important for assessing the property’s ability to cover its debt obligations.
Internal Rate of Return (IRR):
Definition: The discount rate that makes the net present value (NPV) of all cash flows from a particular investment equal to zero.
Importance: IRR provides a comprehensive measure of the property’s profitability, accounting for the time value of money.
Loan-to-Value Ratio (LTV):
Definition: The ratio of the loan amount to the property’s appraised value or purchase price.
Importance: LTV is crucial for lenders in assessing the risk associated with the loan and for investors in understanding the leverage used in the investment.
Vacancy Rate:
Definition: The percentage of vacant units in a rental property.
Importance: Vacancy rate affects rental income and overall property performance, influencing the property’s value.
What are the different types of Real Estate investment Firms?
Real Estate Private Equity (REPE) * REPEfirms raise capital from investors – i.e. the fund’s limited partners (LPs) – to deploy their capital contributions into real estate investments.
* The strategy of REPE firms is oriented around the acquisition and development of commercial properties like buildings, managing the properties, and selling the improved properties to realize a profit.
* The limited partners (LPs) of REPE firms include pension funds, university endowments, fund of funds (FOF), and insurance companies.
Real Estate Investment Trusts (REITs) * REITs are companies with ownership of a portfolio of income-generating real estate assets over a wide range of property sectors.
* If compliant with the relevant regulatory requirements, these investment vehicles are exempt from income taxes at the corporate level.
* However, the drawback to REITs is the obligation to issue 90% of their taxable income to shareholders (or unit-holders) as dividends.
* In effect, REITs rarely have cash on hand because of the dividend payments, and tend to fund their operations by raising debt and equity financing in public markets.
* Most REITs are publicly traded entities and subject to strict requirements on public filing disclosures.
Real Estate Development Firm * Real estate development firms, or “property developers”, construct properties from scratch.
* In contrast, most other investment firms acquire existing properties, such as office buildings.
* Therefore, development firms purchase land and build properties, while other firms participate in acquisitions.
* The life-cycle of development projects is substantially longer than acquisitions, as one might reasonably expect.
Real Estate Investment Management * Real estate investment management firms raise funding from limited partners (LPs) to acquire, develop, and manage commercial properties to later sell them at a profit.
* REPE firms are distinct from real estate investment firms because REPE firms are generally structured as closed-end funds (i.e. stated end date in fund life), while real estate investment management firms are most often open-end funds (i.e. with no end date in fund life).
Real Estate Operating Companies (REOCs) * Real estate operating companies (REOCs) purchase and manage real estate.
* Unlike REITs, REOCs are permitted to reinvest their earnings, rather than the mandatory obligation to distribute a significant portion of their earnings to shareholders.
* The drawback, however, is that REOCs face double taxation, i.e. taxed at the entity level and then the shareholder level.
Real Estate Brokerage Firms * Real estate brokerage firms serve as intermediaries in the real estate industry to facilitate transactions.
* A commercial broker is hired to protect their client’s interest in a purchase, sale, or lease transaction.
* Commercial real estate brokerage firms can help clients identify a new property to purchase, market, or sell a property on behalf of the client, as well as negotiate the terms of a lease as a formal “tenant representative”.
What are the Different Property Classes in Real Estate Investing?
Class A:
Description: Class A properties are considered high-end or luxury properties. They are usually in excellent condition and located in prime, desirable areas with strong economic fundamentals.
Characteristics:
Modern and well-maintained buildings.
High-quality amenities and finishes.
Located in affluent neighborhoods with low crime rates.
Attracts high-income tenants.
Investment Profile: Class A properties often come with higher purchase prices, lower cap rates, and lower potential for immediate value appreciation. They are considered more stable but may offer lower cash flow compared to other classes.
Class B:
Description: Class B properties are generally older than Class A properties but are still well-maintained. They are located in decent neighborhoods with moderate income levels.
Characteristics:
Solid construction and maintenance.
Good, but not top-tier, amenities and finishes.
Located in middle-income neighborhoods.
Attracts a mix of tenants.
Investment Profile: Class B properties may offer a balance between stability and potential for value appreciation. They often have a more moderate purchase price and may provide better cash flow compared to Class A properties.
Class C:
Description: Class C properties are older and may require more maintenance or renovations. They are often located in working-class or lower-income neighborhoods.
Characteristics:
Older buildings with some level of deferred maintenance.
Basic amenities and finishes.
Located in neighborhoods with mixed-income demographics.
May attract tenants seeking more affordable housing options.
Investment Profile: Class C properties can offer higher potential returns, but they come with increased management challenges and a higher level of risk. Investors may need to allocate funds for renovations and ongoing maintenance.
It’s important to note that these classifications are not universally standardized, and different regions or investors may have variations in how they define property classes. Additionally, within each class, there can be further subcategories and nuances based on local market conditions and investor preferences.
In the real estate industry, properties are commonly classified into different property classes based on the perceived risk of each property investment type.
* Class A→ Class A properties are the “premium” properties, most often the most modern or recently renovated properties located in prime locations with significant market demand (and anticipated near-term tailwinds). These types of properties are equipped with the highest-quality amenities and offerings for tenants, which are usually those that fall under the higher-income category and thus command the highest rent pricing in their respective markets. Class A properties are typically professionally managed and pose the lowest risk to investors, and lower risk corresponds with lower yields.
* Class B→ Class B properties tend to be more outdated (i.e. older), yet are still built with high-quality construction and well-maintained, although a tier below Class A properties. Class B properties can be less desirable to affluent tenants, and their locations have less demand from buyers in the market. Still, Class B properties offer higher yields and potential value-add opportunities, which attracts more middle-income tenants.
* Class C→ Class C properties are even more outdated and less modernized compared to Class B properties, and located in far less desirable locations relative to the prior two property classifications. Class C properties often need more renovations, and come with issues such as outdated infrastructure, sub-par amenities, and more maintenance issues that must be fixed or repaired. Hence, Class C usually attracts lower-income tenants and, given the higher risk profile, offers higher returns to investors to compensate for the higher risk.
* Class D→ Class D properties are the bottom-tier classification and consist of properties in poor condition, while located in areas with limited market demand. The Class D properties require substantial spending on renovations to modernize the property, and urgent repairs, such as leakages. The market demand primarily stems from lower-income tenants and presents the most risk to investors. Most institutional investors tend to avoid Class D properties because of the spending requirements and challenges in modernizing a property with exhaustive areas of improvement.
Q.What are the 4 Main Real Estate Investment Strategies?
Broadly speaking, the investment strategies in the real estate industry can be segmented into four distinct categories.
Real Estate Investment Strategy Description
Core * Core investments are recognized as the least risky strategy and involve modern properties in prime locations occupied by highly creditworthy, affluent tenants.
* The investor’s priority with core investments is stability in performance and limiting downside risk.
Core-Plus * Core-plus investments are marginally riskier than the core strategy, with several commonalities, aside from necessitating some capital improvements.
Value-Add * Value-add investments come with more risk, because the properties need considerable capital improvements, including the potential of collection issues from tenants with poor creditworthiness.
* Real estate investors implement significant improvements and renovations to existing properties to create incremental value, resulting in higher pricing and more market demand.
Opportunistic * Opportunistic investments are the riskiest strategy that entails new development or redevelopment projects that are not only time-consuming, but also require substantial spending on resources.
* Given the relationship between risk and return, investors who decide to pursue these projects expect to generate the highest rate of return
What is NOI in Real Estate?
The NOI, an abbreviation for “NetOperating Income,” measures theprofitabilityof income-generating properties before subtracting non-operating costs, such as financing costs and income taxes.
The net operating income (NOI) of a property is calculated by determining the sum of its rental income and ancillary income, followed by deducting any directoperating expenses.
Net Operating Income (NOI) =(Rental Income+Ancillary Income)–Direct Operating Expenses
The rental income component is the rent payments collected from tenants (i.e. the lessees), while ancillary income consists of any side income sources, such as parking fees, laundry fees, storage fees, late fees, and fees charged for amenities access (e.g. on-premise gym, pool).
The NOI formula neglectscapital expenditures(Capex),depreciation, financing costs (e.g. mortgage payments, interest), income taxes, and corporate-level SG&A expenses.
Since non-operating items are disregarded in the net operating income (NOI) metric, the NOI is the industry-standard measure of profitability to analyze property investments, particularly for comparability purposes.
Learn More →Net Operating Income (NOI)
What is the Difference Between NOI and EBITDA?
NOI measures the profitability of properties in the real estate industry, whereby the operating income generated by a property is reduced by direct operating expenses.
LikeEBITDA, NOI excludes depreciation andamortization(D&A), certain non-cash charges, income taxes, and financing costs like mortgage payments.
Net Operating Income (NOI) =(Rental Income+Ancillary Income)–Direct Operating Expenses
On the other hand, EBITDA stands for “Earnings Before Interest, Taxes, Depreciation, and Amortization” and is by far the most common measure of core profitability for corporations.
The calculation of EBITDA and NOI includes only operating items, causing the metrics to be suited for comparability, i.e. analyze the target company side-by-side with comparable peers.
EBITDA =Net Income+Taxes+Interest Expense+Depreciation+Amortization
EBITDA =Operating Income+D&A
The effects of financing costs, such as mortgage payments and interest, including discretionary management decisions like capital expenditures (and the depreciation method), are removed in both NOI and EBITDA.
The distinction between NOI and EBITDA boils down to industry classification, because the factors that constitute “operating” and “non-operating” items are contingent on the industry at hand.
* Operating Items→ The direct operating expenses subtracted in NOI include property management fees and maintenance fees, such as repairs and utilities. NOI neglects non-operating items like EBITDA, however, from the perspective of a real estate property, not a corporation. For instance, property insurance, property taxes, and property management fees are subtracted to calculate NOI, which are irrelevant costs to the calculation of EBITDA for non-real estate companies.
* Industry-Usage→ NOI is seldom recognized outside the real estate industry, whereas EBITDA is the most widely used measure of operating performance across a wide range of industries.
Therefore, NOI measures the profit potential of a property, whereas EBITDA reflects the operating profitability of an entire corporation.
Depreciation Concept – Real Estate vs. Corporations
The depreciation concept is nuanced in real estate because unlike standard circumstances – where depreciation reduces the carrying value of a fixed asset (PP&E) on the balance sheet to reflect deterioration (“wear and tear”) – properties such as homes can be priced and sold on the market at a premium to the original purchase price.
The recognition of depreciation in the real estate industry is more related to tax deductions, while depreciation is intended to match the purchase of a fixed asset (PP&E) with the timing of its economic utility for corporations.
How is the Cap Rate Calculated?
The cap rate, shorthand for “capitalization rate”, estimates the return that a real estate investor expects to earn on a property investment.
The cap rate is the ratio between a property’s net operating income (NOI) and its currentmarket value, expressed as a percentage.
Cap Rate (%) =Net Operating Income (NOI)÷Property Value
The primary use-case of the cap rate by real estate practitioners is to analyze a potential property investment side-by-side with comparable properties to determine if the property’s risk-return profile is worthy of an investment.
Learn More →Cap Rate Primer
Q.Explain the Relationship Between the Cap Rate and Risk.
Thecapitalizationrate, or cap rate, is a real estate metric that measures the return rate on a property investment based on the income that the property is expected to generate.
Since the cap rate is a measure of returns, the metric is also a measure of risk, since risk and return are two sides of the same coin.
In short, higher cap rates coincide with higher risk, while lower cap rates correspond with lower risk.
* Higher Cap Rates→ Properties with higher cap rates are implied to carry more investment risk. Why? Higher cap rates suggest property prices are low relative to the income generated. For instance, the underlying cause could be factors such as minimal market demand for the location, poor economic conditions in the location, and properties constructed using outdated materials.
* Lower Cap Rates→ On the other hand, properties with lower cap rates are perceived as lower risk. These properties are often in high-demand modern locations with more upside potential in rent prices. Properties with lower cap rates carry less risk and are more secure – resulting in reduced returns – which certain risk-averse investors are open to in exchange for mitigating potential capital losses.
What Does Funds from Operations (FFO) Measure?
The funds from operations (FFO) metric is used to analyze the operating performance of real estate investment trusts (REITs).
In practice, the funds from operations (FFO) metric is a method to estimate the capacity of a REIT to generate enough cash.
Funds from Operations (FFO) =Net Income+Depreciation–Gain on Sale
Contrary to a frequent misconception, the FFO metric is not a measure of cash flow.
What is the Difference Between FFO and AFFO?
Originally,Nareitcreated the funds from operations (FFO) metric because REITs could not be accurately analyzed using traditional U.S. GAAP metrics.
Hence, FFO reconciles net income – the accrual accounting-based profitability measure (the “bottom line”) – to measure the operating performance of REITs more accurately.
However, there are a few drawbacks to the funds from operations (FFO) metrics, such as the inclusion of numerous non-recurring items and omitting capital expenditures (Capex), the most significant cash outflow for most companies.
The adjusted funds from operations (AFFO) metric gained traction over time, as many REIT analysts and market participants perceived AFFO as the more intuitive method to measure operating performance.
The AFFO is simply FFO after applying further adjustments – as implied by the name – such as normalizing for items like non-cash rent (i.e. “straight-lined”) and subtracting the recurring maintenance capital expenditures (Capex).
Adjusted Funds from Operations (AFFO) =Funds from Operations (FFO)+Non-Recurring Items–Maintenance Capital Expenditures (Capex)
AFFO should theoretically reflect the operating performance of REITs more accurately, since the metric addresses the shortcomings of FFO. But the more pressing matter was the discretion given to management teams on the adjustments to apply, which turned out to be a “slippery slope” in which the absence of industry-wide standardization became an issue.
Like FFO, the AFFO metric also neglects the adjustments for working capital.
Learn More →Adjusted Funds from Operations (AFFO)
What are the 3 Methods of Appraising a Property?
Property Appraisal Method Description
Income Approach * The property value is estimated by dividing a property’s pro forma, stabilized net operating income (NOI) by the market cap rate.
* The market cap rate is determined by analyzing the cap rates of comparable properties to arrive at a benchmark to guide the pricing of the property.
* By dividing the property’s forward NOI by an appropriate cap rate, the income stream is effectively converted into a property value estimate.
Sales Comparison Approach * The sales comparison approach relies on the recent historical sales data (i.e. selling prices) of comparable properties to estimate the valuation of a property.
* The selected transactions provide insights regarding the price per unit or square foot valuations, including the current market cap rate.
* The sales comparison approach assumes that the attributes of each sold property contributed to its sale price.
* Factors such as the floor area, view, location, number of rooms (and bathrooms), property age, and property condition are considered.
* Based on the comparable property’s features relative standing to the target property, the appropriate adjustments are applied to determine the property value.
Cost Approach * Under the cost approach, or “replacement cost”, the property value is estimated based on the total cost of replacing the property.
* The estimated property value represents the total cost incurred if the property were hypothetically destroyed and had to be replaced.
* Unlike the income approach and sales comparison approach, the cost approach is the only method in which comparable properties are not part of the valuation.
Walk Me Through the Income Approach (or Direct Capitalization Method).
Under the income approach (ordirect capitalization), real estate appraisers can estimate property value based on the future income potential of the property.
The direct capitalization method estimates the value of a property based on the income expected to be generated in a one-year time horizon.
The initial step is to project theforward NOIon a twelve-month basis, in which the operating drivers are the vacancy and credit losses and operating expenses assumptions.
The forward NOI reflects the pro-forma, stabilized net operating income (NOI) of the property.
The estimated property value can then be determined by dividing themarket caprate by the rental property’s forward NOI.
Estimated Property Value =Forward NOI÷Market Cap Rate
Learn More →Income Approach (Direct Capitalization Method)
Q.What is the Intuition Behind the Cost Approach?
The basis of thecost approach(or “replacement cost”) is the principle of substitution, which states that no rationale investor would pay more for a property than the cost of constructing an equivalent substitute with similar utilities and amenities.
The cost approach to appraisal is grounded on the notion that the pricing of a property should be determined by the cost of the land and construction, net of depreciation.
Estimated Property Value =Land Value+(Cost New–Accumulated Depreciation)
General Rules of Thumb:
* Replacement Cost < Asking Price→ Current Pricing isPotentiallyReasonable
* Replacement Cost > Asking Price→ Current Pricing isNOTReasonable
Therefore, an investor should not purchase a property at a higher price, relative to the cost of reconstructing a similar property.
What Does the Cash on Cash Return Measure?
The cash on cash return, or “cash yield”, is a real estate metric that measures the annual pre-tax earnings on a property relative to the initial contribution to purchase the property itself.
The formula to calculate the cash-on-cash return is the ratio between the annual pre-tax cash flow and invested equity.
Cash on Cash Return (%) =Annual Pre-Tax Cash Flow÷Invested Equity
1. Annual Pre-Tax Cash Flow →The annual pre-tax cash flow generated by the property. The cash flow component is pre-tax, yet the metric is post-financing – i.e. the financing costs were deducted, such as mortgage payments andinterest expense– therefore, the annual pre-tax cash flow is a “levered” metric.
2. Invested Equity →The original equity contribution on the date of property purchase, i.e. the initial cash outlay.
Learn More →Cash-on-Cash Return
Q.What are Vacancy and Credit Losses in Real Estate?
The “Vacancy and Credit Losses” are a downward adjustment applied to thepotential gross income(PGI) of a property to arrive at the effectivegross income(EGI) metric.
* Vacancy Loss→ The term “Vacancy Loss” refers to the estimated losses incurred by property owners from rental properties (or units) left vacant, i.e. anoccupancy rateof 0%. Thevacancy lossis estimated using assumptions regarding the time between a rental unit remaining vacant and occupancy by a tenant, assuming the unit eventually becomes occupied. Usually, the vacancy loss is projected as a percentage of the potential gross income (PGI), which is the total gross income under the hypothetical scenario where all units available for rent are occupied.
* Credit Loss→ The “Credit Loss” component describes the losses incurred by the property owner from a tenant who is unable to fulfill their rent payment obligations on time. The tenant could request an extension on the due date – usually with fines attached – or default on the contractual rental obligation, resulting in an eviction process.
What is the Gross Rent Multiplier (GRM)?
The gross rent multiplier (GRM) is the ratio between the market value of a property and the property’s expected gross annual rental income.
By comparing the property investment’s currentfair market value(FMV) to its expected annual rental income, the number of years necessary for the property to break even and become profitable can be estimated.
Gross Rent Multiplier (GRM) =Market Value of Property÷Annual Gross Income
The gross rent multiplier (GRM) reflects the estimated number of years needed by a particular property’s gross rental income to pay for itself.
Generally speaking, the gross rent multiplier is more of a “quick and dirty” method to screen potential investments by evaluating the potential profit potential of property investments.
Learn More →Gross Rent Multiplier (GRM)
How is the Yield on Cost (YoC) Calculated?
The yield on cost, ordevelopment yield, is the ratio between a property’s stabilized net operating income (NOI) and the total project cost, expressed as a percentage.
Yield on Cost (%) =Stabilized Net Operating Income (NOI)÷Total Project Cost
Where:
* Stabilized Net Operating Income (NOI)→ The stabilized net operating income (NOI) of a property is the expected annual NOI after new construction and property development work is complete. A stabilized property is fully operational and generates income around the baseline level deemed sustainable, and a more accurate representation of its run-rate income (and performance is consistent with comparable properties).
* Total Project Cost→ The total cost component of the property depends on the real estate project type. For development projects, the total cost will be composed of the purchase price and the developmental costs. But for acquisition projects, the spending will predominately be related to maintenance, fixtures, renovations, and discretionary upgrades.
What is the Difference Between Effective Gross Income (EGI) and Net Operating Income (NOI)?
The difference between effective gross income (EGI) and net operating income (NOI) is as follows.
* Effective Gross Income (EGI)→ The EGI is the total income generated by a property after factoring in vacancy and credit losses. EGI not only includes the property’s rental income, but also other ancillary income sources, such as income from amenities, vending machines, laundry facilities, parking permits, etc. The EGI is calculated by taking the potential gross income (PGI), adding other ancillary sources of income, and then subtracting the estimated income lost from vacancies or credit losses (i.e. collection issues).
* Net Operating Income (NOI): The NOI is the remaining income upon subtracting direct operating expenses from the property’s effective gross income (EGI). Operating expenses include items such as property management fees, utilities, property taxes, property insurance, maintenance costs, and repairs. However, one notable type of cost excluded in the calculation is financing costs, like mortgage payments and interest, as well as income taxes paid to the government.
The formula to compute the effective gross income (EGI) and the net operating income (NOI) are as follows.
Effective Gross Income (EGI)= Potential Gross Income (PGI)–Vacancy and Credit Losses
Net Operating Income (NOI) =Effective Gross Income (EGI)–Direct Operating Expenses
hat is the Loan-to-Value Ratio (LTV)?
The loan-to-value ratio (LTV) measures the risk of a real estate lending proposal by comparing the requested loan amount to the appraised fair value of the property, securing the financing.
Loan-to-Value Ratio (LTV)= Loan Amount÷Appraised Property Fair Value
The loan amount is the size of the financing offered by the lender, while the appraised property value is the estimated fair market value (FMV) of the property as of the current date.
Generally, the lower the loan-to-value ratio (LTV), the more favorable lenders will perceive the financing request (and the more borrower-friendly the terms will be).
The maximum loan to value ratio (LTV) is usually in the proximity of 75%, which restricts the loan size, i.e. places a “ceiling” on the borrowing to minimize the risk associated with the financing.
What Does the Loan-to-Cost Ratio (LTC) Measure?
The loan-to-cost (LTC)underwritingmetric in the real estate industry is the ratio between the total size of a loan and the total development cost of a real estate project, expressed as a percentage.
The loan-to-cost ratio (LTC) formula divides the total loan amount by the total development project cost.
Loan to Cost Ratio (LTC) =Total Loan Amount÷Total Development Project Cost
The Loan-to-Cost ratio is a crucial metric for both lenders and borrowers, and it serves several purposes:
Risk Assessment: A higher LTC indicates that a larger portion of the project is funded through debt. Lenders use LTC to assess the level of risk associated with a particular project. Generally, lower LTC ratios may be perceived as less risky for lenders because there is a larger equity cushion.
Lending Decision: Lenders often have specific policies regarding the maximum LTC they are willing to finance. They use this ratio to determine the loan amount they are comfortable providing based on the total cost of the project.
Borrower’s Equity: For borrowers, the LTC ratio is a measure of how much equity they need to contribute to the project. A lower LTC implies that the borrower needs to inject a higher proportion of equity into the project.
Project Feasibility: The LTC ratio is also used to assess the feasibility of a real estate development project. It helps in evaluating whether the project is financially viable and whether the borrower has the capacity to cover the remaining costs after obtaining the loan.
How is the Debt Yield Calculated?
The debt yield is an underwriting metric that measures the risk associated with a real estate loan based on the estimated return received by the lender and the ability to recoup the original financing in the event of default.
To compute the debt yield, the net operating income (NOI) of the property is divided by the total loan amount.
Debt Yield (%) =Net Operating Income (NOI)÷Total Loan Amount
The debt yield can be considered the estimated return that a lender expects to earn relative to the original loan provided to the borrower under the hypothetical scenario of default, i.e. failure of the borrower to fulfill the agreed-upon lending obligations.
Since non-operating costs like financing costs (e.g. mortgage payments, interest) and income taxes paid to the government are not included in the net operating income (NOI) metric, the debt yield is an unlevered, pre-tax metric (and is capital structure neutral).
Learn More →DebtYield
What is the Operating Expense Ratio (OER)?
The operatingexpense ratio(OER) measures the percentage of a property investment’s gross income allocated to pay off its operating expenses.
To calculate the operating expense ratio, the property’s operating expenses are divided by itsgross operating income(GOI), and then multiplied by 100 to convert the output in decimal notation into a percentage.
Operating Expense Ratio (OER) =Total Operating Expenses÷Gross Operating Income (GOI)
Where:
* Operating Expenses (Opex)→ The property operating expenses include costs such as property management fees, maintenance fees, repairs, property insurance, property taxes, and other costs like utilities incurred from managing the property.
* Gross Operating Income (GOI)→ The gross operating income (GOI) is the total income generated by a property before deducting expenses. The GOI metric is composed mostly of rent payments collected from tenants, followed by other sources of income earned on the side, such as application fees, parking permits, amenities fees (e.g. gym access), and other on-premise services.
Generally speaking, a lower operating expense ratio (OER) implies the property is efficiently managed.
In contrast, properties with a high operating expense ratio (OER) often see a significant percentage of their income allocated toward operating expenses.
Learn More →Operating Expense Ratio (OER)
What is the Equity Multiple?
The equity multiple in real estate refers to the ratio between the total cash distribution collected from a particular property investment and the initial equity contribution.
Equity Multiple =Total Cash Distributions÷Total Equity Contribution
Where:
* Total Cash Distribution→ The cash “inflows” earned by the investor across the holding period of the property.
* Total Equity Contribution→ The cash “outflows” incurred by the real estate investor across the investment horizon, such as the land or property purchase price.
General Rules of Thumb:
* Equity Multiple = 1.0x→ If the equity multiple equals 1.0x, the investor is at thebreak-even pointregarding profitability (total cash distribution = total cash contribution).
* Equity Multiple < 1.0x→ If the equity multiple is sub-1.0x, that outcome is unfavorable because the investor received less cash than the initial investment amount (and thus incurred a loss).
* Equity Multiple > 1.0x→ If the equity multiple exceeds 1.0x, the investor recouped their original investment in full, and any incremental cash distributions beyond the breakeven represent “excess” returns.
The equity multiple answers the question,“How much in cash distributions was retrieved per dollar of equity invested?”
For instance, a 2.0x equity multiple implies the investor earned $2.00 per $1.00 of equity invested, i.e. the initial investment doubled in value.
Learn More →Equity Multiple
What is the Difference Between the Gross and Net Rental Yield?
The rental yield in real estate compares the rental income produced by a real estate property to its market value as of the present date, expressed in percentage form.
To calculate a property’s rental yield, a real estate investor must determine the property’s rental income, operating expenses, and appraised property value.
* Rental Income→ The rental income is the profits generated by a property per year that belong to the owner from renting out the property (or units) to tenants.
* Operating Expenses→ The ongoing operating expenses incurred by the property owner, such as property management fees, property insurance, property taxes, and repair costs.
* Property Value→ The property value refers to the current market value of the property, i.e. the fair value as of the present date.
There are two distinct types of rental yield metrics:
1. Gross Rental Yield→ Thegross rental yieldis the rental income of a property relative to its property value, without consideration toward operating expenses such as property management fees, repairs, or vacancies. While more convenient and less time-consuming to calculate, the gross rental yield is more of a quick method to estimate a property’s potential profitability, rather than to provide a comprehensive picture of the property’s profit potential on a more granular level.
2. Net Rental Yield→ In contrast, the net rental yield is virtually identical to the gross rental yield, except for accounting for the property expenses incurred in the day-to-day operations. The net rental yield, compared to the gross rental yield, offers a more accurate measure of a property’s true profitability.
To calculate the rental yield, a property’s rental income must be divided by its current property value.
Net Rental Yield (%) =(Annual Rental Income–Operating Expenses)÷Property Market Value
Gross Rental Yield (%) =Annual Rental Income÷Property Market Value
- If you buy a property at a 6 cap, using 60% Leverage (5% Interest only), what is the year 1 cash on cash return?
- $100 purchase price implies $6 of NOI
- $60 loan at 5% IO implies $3 of interest expenseand $3 ofCash flowafter debt service
- $60 Loan implies $40 of equity
- $3 of CFADS / $40 of equity = 3/40 CoC; (3/40)*2.5 = 7.5 / 100 = 7.5% Year one Cash on Cash
- Continuation of previous question, this is pen and paper question – if you hold this building for 10 years and NOI grows by 3% each year (compounding), what is your unlevered equitymultiple andIRR?
- For unlevered, you now that you’re starting year is $6 of NOI and given that 1.03^10 is 1.34, year 10 NOI will be approximately 1/3 higher so call it $8 of year 10 NOI. The trick here is to know 1.0x^10 for several numbers
- Because you hold for ten years and income increases from 6 to 8, you should assume that the average NOI level between years 1 and 10 is ~7. So 7 * 10 = 70 of income from life of project
- Then cap the Final year income of $8 at a 6 cap. 8 * 100 / 6 = 133 in proceeds from the sale. Income + proceeds from the sale = $200 and there was no leverage so equity multiple is around 2x
- ForIRRyou have to do some estimating. Given that Income trends from 6 to 8 you can assume that your average income over the 10 years is $7. If you had 10 years of $7 cash flows, and no principal appreciation (sell for $100), you’d have a 7%IRR. But given that you sold for an increased price in year 10,IRRwould have to be above 7%. If you took all of the profit you made ($200), and averaged it out between the 10 years and sold at $100, yourIRRwould be 10%. So given that the income is weighted more towards the end due to increasing NOI and the $133 sales price, you know theIRRis somewhere between 7% and 10% and you’d have to make a best guess. The actualIRRis 8.77%
- If you have $100 million of equity to invest where would you invest it and why? What type of returns could you expect?
- You can give a wide variety of answers here. Goal is to show that you’ve been reading the news and have your own view on the market
- Also know the types of returns you could expect from your investment idea. You don’t want to tell an interviewer that you think there is a good opportunity in Multifamily development in Austin and you’d look for deals with a 11% yield on cost
- Assume you buy a property, and the NOI grows 5% every year for 100 years. What are some reasons the property could still go bankrupt?
- Basically you need to point out items that are “below the line”. The answer is if you’re overleveraged and unable to refinance your debt or if you have significant deferred maintenance / largecapex projects
- A hotel and multifamily project are next to each other. Which one trades at a highercap rateand why?
- Hotels are a riskier / more volatile asset class
- Hotels require more capex on average
If you have two office buildings side by side that were identical in every way physically, why might one property be valued differently than the other?
qualityof tenants (financies, diversity), wacc - longer lease better, capital struture - no debt vs higly leveraged, occupancy rates, lease terms and rental income - lease escalation clause, long leases, zoning and land use,
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*
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* * Credit of the tenants
* Diversification of the tenants – if every tenant is in the financial services industry, that can be more risky than having a diverse tenant base from several industries
* Weighted average lease term – longer leases are better
* For expiring leases – if the rent is below market, that would make the building more attractive
* Capital structure- one is offered debt free and the other is encumbered with high leverage / high prepayment penalty debt
If you have $12 of NOI valued at an 8-cap, what is the property value?
- Trick is to remember that dividing by .08 is the same as multiplying by 100/8 which makes the mental math way easier
- Buy a property at a 5 cap and your expenses drop 20%. At what cap rate do you have to sell the property to maintain the same purchase price?
Assume property price at $100. 5 cap means the NOI would be 1005/100=5.
Expense dropping by 20% is equivalent to NOI increasing by 20%. This means new NOI is 51.2=6.
To hold the same purchase price of 100 with NOI of 6 means a cap rate of: 100/6= 16.67%
- Buy a property for $100m, 60% LTV, $0 NOI. What sale price do you need to get a 2x EM?
Buying at $100m with 60% LTV means $60m in debt and $40m in equity.
For an EM of 2x, cash distribution would need to be $80m.
So selling, at 60+80=$140m would yield 2x EM.
What are the different ways you can value a property? Walk me through aDCF.
Salescomps, income method (make sure to mention both direct cap and DCF), and replacement cost.
Always walk through the pro forma in detail when going through this (i.e. don’t just start at “so you take your NOI…”). I’ve heard of people being asked to build out a paperDCFwith some simple provided assumptions, but never run into it myself.
If you invest $100 in a property today and sell it four years later for double that, what is the property’sIRRassuming it was breaking even over the investment period?
Pretty easy one, but some people really stumble on it since you can’t actually just calculate theIRRon paper. The interviewer is really just testing the way you approach the question (i.e. are you just going to throw out a guess, or approach it logically).
The correct answer is “about 20%” - you would be shocked at how often people shout out 25% right away… You can just take a second to try out a few ballpark numbers mentally and compound it out over four years.
What do you think about the state of the market right now?
The interviewer might build on this by asking about specific types of assets or even sub-types. This is the gold standard question in addition to the hypothetical “where would you invest $100MM” to test if you’re genuinely interested in and keeping up with the market.
Be sure to explain the WHY and get in-depth.
What trends do you see impacting X asset class in the next 5-10 years?
Similar to the previous question in terms of what they’re digging for. For example, you might talk about how you think the increasing popularity of e-commerce and need for next-day and same-day delivery systems will be a huge benefit to industrial in the next decade.
At a retail-focused fund, maybe you’ll talk about how e-commerce and instant fulfillment are eating away at traditional retail, and you think there is an urgent need to change the tenant mix at malls and power centres to increase the entertainment and F&B allocation to increase foot traffic, and that retailers need to recognize the need to create an experiential, omnichannel experience to keep consumers engaged.
- All else equal, if your cap rate increases/decreases, what happens to price?
- If your cap rate goes from x to y, by how much does NOI need to grow/shrink for value to remain the same?
The answer is (y-x)/x. Typically asked where x is lower than y, probably followed by some ultra-dry conversation where you get to postulate on what will happen to real estate values if and whenFOMC everraises rates again.
- What is the most volatile product type?
Individual property idiosyncrasies aside, hotel generally displays the most volatility.
What is the least volatile product type?
Generally speaking, multifamily.
What product type is the best hedged against inflation?
Really what this gets at is, how fixed are your tenants’ rent commitments. Obviously hotels and apartments reprice daily and yearly, respectively. That said, maybe all your shopping center tenants have annual rent steps with aCPIfloor which might not be so bad. Maybe you worry about inflation if you have a single tenant, 15-year office lease with no rent steps; macro arguments aside.
Where do you see opportunities right now?
Assuming you’re interviewing for a national, product-agnostic platform, maybe cook up something like “I think assisted living currently presents an attractive investment opportunity for fundamental reasons, namely the huge aging demographic trend in the U.S. blah blah blah.” If you’re interviewing for a more local operator/developer, maybe it’s more like “my uncle works for Exxon and knows Sharif who owns the Mobil station at Santa Monica and Vine and my ex-girlfriend’s dad is a leasing rep forStarbucksand they want a drivethru there and blah blah blah”
If you had $100mm to invest in real estate, how would you invest it?
There is no 100% correct answer to this-just be mindful of macro trends and how they affect the real estate industry as a whole. Speak thoughtfully and knowledgeably about a particular asset class, market/submarket, and why you would put capital there (Your answer can involve equity and/or debt investments).
Walk me through a real estate pro forma
What is the value of a property with $10mm NOI at an 8 Cap?
NOI/Cap=Value, so $10mm/.08=$125mm (I was asked this in almost every acquisitions interviewat larger REPEfirms-Starwood,Blackstone, USAA
How do you calculate Debt Yield?
NOI/Loan amount
- Walk me through the purpose and mechanics of a waterfall distribution structure in a JVA
- If you were entering a JVA, what deal points would be important to you and why?
- If you have a property w/ $8M in NOI, senior debt of $40M,junior debtof $20M, and the cap-rate is 10%, what is your LTV? What if the cap-rate increases to 12%
- If the senior debt and junior debt in the last question are IO, with the senior debt at 5% and the junior debt at 10%, assuming you bought the property for $50M and there no cap-ex, what is your cash-on-cash return?
- What is an important point of diligence that should be done before acquiring any property?
What is the cap rate on the building were in/explain cap rate?
Explain why the terminal cap rate is higher than going-in?
What’s going on in the market? I’ve gotten both in the local sense ( speak on our markets rents, deals, etc.) and also more macro (nationwide RE trends, rates, etc.)… stuff like how foreign investors or oil affectCRE… or how the growth of tech hubs/widening of Panama Canal affectCRE. Stuff like that.
Pitch a market and/or asset type?
Where do you think we are in the cycle?
According to latest data from Nationwide, average UK house prices fell by 5.3% in the year to September, matching the decline recorded in August, which was the biggest annual drop since 2009.
we are past the peak and in the contraction phase - but not fully dropped yet i think there is more to go
The housing market remains in the late stages of a typical housing market cycle, Savills said. That suggests slightly greater house prices falls in London and the south-east next year, where buyers continue to need bigger deposits and borrow more relative to their income, and the strongest overall price growth in Wales and the north-east over the next five years.
Why would a sponsor take 12% mezz financing on a deal?
You have two buildings right next to each other they have the same everything includingirr. Why are themultiples on invested capitaldifferent?
How do you calculate the net operating income (NOI) of a commercial property?
In my experience, calculating the net operating income (NOI) of a commercial property is a crucial step in understanding its financial performance.The NOI represents the income generated by the property after accounting for operating expenses. To calculate the NOI, you need to follow these steps:
- First, start by determining the property’s gross income. This includes all the income generated from the property, such as rent, parking fees, and any other additional income sources.
- Next, deduct any vacancy or credit losses from the gross income. This will give you the effective gross income (EGI).
- Finally, subtract the property’s operating expenses from the EGI. Operating expenses include costs like property management fees, maintenance, insurance, property taxes, and utilities. It’s important to note thatdebt service or mortgage payments are not considered operating expensesand should not be included in this calculation.
The resulting figure is the net operating income. In a nutshell, NOI = Effective Gross Income - Operating Expenses.
Can you explain the difference between the income approach, sales comparison approach, and cost approach in real estate valuation?
Certainly! These three approaches are the main methods used in real estate valuation, and each has its unique strengths and weaknesses.
1.Income Approach: This method is most commonly used for income-producing properties, such as commercial and multifamily real estate. The income approach values a property based on the present value of its future cash flows, typically using the capitalization rate or a discounted cash flow analysis. In my experience, this approach is particularly useful when the property’s income generation potential is the primary driver of its value.
2.Sales Comparison Approach: This approach is widely used in residential real estate and involves comparing the subject property to similar properties that have recently sold in the area. Adjustments are made for differences in property features, size, location, and other factors to arrive at an estimated value for the subject property. The sales comparison approach is generally considered reliable when there is an active market with a sufficient number of comparable sales.
3.Cost Approach: The cost approach is based on the principle that a property’s value should not exceed the cost to build an equivalent property. This method involves estimating the cost to construct a similar building, including land, labor, and materials, and then subtracting any depreciation. The cost approach is often used for unique properties, such as industrial facilities or properties with limited comparable sales data.
Each of these approaches has its applications, and sometimes, more than one approach is used to get a more comprehensive understanding of a property’s value.
How do you determine the appropriate level of leverage for a real estate investment?
My go-to method for determining the right leverage level is to first consider thedebt service coverage ratio (DSCR), which is calculated by dividing the property’s net operating income (NOI) by the annual debt service. Lenders typically require a DSCR of at least 1.20 to 1.25, which means the property’s NOI should be 20-25% higher than the debt service. This helps ensure that the property generates enough cash flow to cover the debt payments.
Another factor I consider is theloan-to-value (LTV) ratio, which is calculated by dividing the loan amount by the property’s appraised value. Lenders usually require an LTV ratio of 65% to 80%, which means they will lend between 65% and 80% of the property’s value. A lower LTV ratio reduces the risk for the lender and can result in more favorable loan terms.
Lastly, I take into account theinvestor’s risk tolerance and investment objectives. Some investors are comfortable with higher levels of leverage to maximize returns, while others may prefer a more conservative approach to preserve capital. It’s essential to understand the investor’s preferences and align the leverage level accordingly.
How do you assess the risk associated with a real estate investment?
Assessing the risk associated with a real estate investment is a critical aspect of the investment process. In my experience, there are several factors to consider when evaluating the risk, including:
1.Market risk: This involves analyzing the local market’s supply and demand dynamics, economic trends, and potential changes in demographics. A healthy market with strong demand and limited supply can reduce the risk of the investment.
2.Property-specific risk: This includes evaluating the property’s age, condition, location, and tenant mix. Properties in prime locations with high-quality tenants and well-maintained facilities tend to have lower risks.
3.Financial risk: This involves analyzing the property’s cash flow, debt service coverage ratio, and loan-to-value ratio, as well as the investor’s equity contribution. A property with stable cash flows and conservative leverage levels can help mitigate financial risk.
4.Management risk: This requires assessing the competency of the property’s management team and their ability to execute the investment strategy. A strong management team with a proven track record can help reduce the risk associated with the investment.
5.Exit risk: Lastly, it’s important to consider the potential exit strategies and the liquidity of the investment. A property with multiple exit options and strong demand from buyers can help minimize exit risk.
By carefully examining these factors, I can better understand the potential risks associated with a real estate investment and make informed decisions accordingly.
Explain the concept of discounted cash flow (DCF) analysis and how it is applied in real estate.
The concept of discounted cash flow (DCF) analysis is a widely used valuation method in real estate and other industries. The main idea behind DCF is to estimate thepresent value of future cash flowsgenerated by an investment, taking into account thetime value of money. In simple terms, it’s based on the idea that a dollar received today is worth more than a dollar received in the future.
In real estate, DCF analysis is used to determine theintrinsic value of a propertybased on its projected cash flows. To perform a DCF analysis, you need to follow these steps:
- Forecast the property’snet operating income (NOI)for each year of the holding period, which is the rental income minus operating expenses.
- Estimate thereversion valueor terminal value of the property at the end of the holding period, typically based on a capitalization rate or by using the income approach.
3.Discount the future cash flows(NOI and reversion value) to their present value using an appropriate discount rate, which reflects the required rate of return for the investment. - Sum the present values of all discounted cash flows to obtain thetotal intrinsic valueof the property.
By comparing the intrinsic value to the property’s asking price, I can determine if the investment is overvalued or undervalued and make informed investment decisions.
Can you walk me through the process of creating a pro forma financial statement for a commercial property?
Certainly! Creating a pro forma financial statement is an essential step in evaluating a commercial property’s potential performance. It’s a forward-looking projection that helps you estimate the property’s cash flows, returns, and overall financial performance. Here’s a step-by-step process I follow to create a pro forma financial statement:
1.Estimate the property’s gross potential income (GPI): This includes the total rental income generated if the property were fully leased at market rates, plus any additional income from sources like parking, laundry facilities, or other on-site amenities.
2.Account for vacancy and credit loss: This involves estimating the potential loss in rental income due to vacancies and tenant defaults, typically expressed as a percentage of GPI.
3.Calculate the effective gross income (EGI): Subtract the vacancy and credit loss from the GPI to arrive at the EGI, which represents the actual income the property is expected to generate.
4.Estimate operating expenses: List and project all the property’s operating expenses, including property management fees, utilities, maintenance, insurance, and taxes.
5.Compute the net operating income (NOI): Subtract the operating expenses from the EGI to calculate the NOI, which represents the property’s income after covering all operating expenses.
6.Factor in financing costs: If the property is financed, include the annual debt service, which is the principal and interest payments on the loan.
7.Calculate the net cash flow: Subtract the debt service from the NOI to determine the property’s net cash flow, which represents the cash generated by the investment after all expenses and financing costs.
8.Project the property’s appreciation and exit value: Estimate the property’s potential appreciation over the holding period and its projected exit value based on market trends and capitalization rates.
9.Calculate key performance metrics: Using the pro forma financial statement, compute essential metrics such as cash-on-cash return, internal rate of return, and debt service coverage ratio to evaluate the investment’s performance.
By following this process, I can create a detailed pro forma financial statement that provides a comprehensive overview of a commercial property’s potential financial performance and helps me make informed investment decisions.
How do you keep up-to-date with trends and developments in the real estate market?
In my experience, staying up-to-date with the latest trends and developments in the real estate market is essential for a successful financial analyst. I like to think of it as a continuous learning process, and I employ several strategies to stay informed. Firstly, I subscribe toindustry publicationssuch as the National Real Estate Investor, Real Estate Forum, and the Urban Land Institute’s magazine. These sources provide valuable insights into market trends, investment opportunities, and regulatory changes. Secondly, I followreal estate news websitesand blogs, which offer timely updates on market movements and analysis. Some of my go-to sources include GlobeSt.com, Bisnow, and Curbed. Lastly, I attendindustry conferencesand network with professionals in the field, which helps me gain firsthand knowledge about the latest trends and developments in the market.
What sources do you use to gather information on a specific real estate market?
When it comes to gathering information on a specific real estate market, I rely on a combination ofprimary and secondary sourcesto get a comprehensive understanding. In my last role, I found that some of the most reliable primary sources include localgovernment websitesandplanning departments, which often provide data on zoning regulations, development plans, and demographic changes. Additionally, I reach out tolocal real estate brokersandproperty managerswho can provide insights into market trends, rental rates, and vacancy levels.
For secondary sources, I utilizemarket research reportsfrom firms like CBRE, JLL, and Cushman & Wakefield, which offer in-depth analyses of specific markets. Additionally, I consultonline databasessuch as CoStar, Real Capital Analytics, and REIS to access historical and current data on property sales, leasing activity, and construction projects. By analyzing these multiple sources, I can develop a well-rounded understanding of the market dynamics at play.
What are some common types of financing options available for commercial real estate projects?
There are several financing options available for commercial real estate projects, each with its own set of advantages and disadvantages. Some common options include:
1.Traditional Bank Loans: Banks and credit unions are the most common sources of financing for commercial real estate projects. These loans typically have fixed or adjustable interest rates and can be tailored to meet the specific needs of the project, such as construction, acquisition, or refinancing.
2.Small Business Administration (SBA) Loans: The SBA offers several loan programs designed to help small businesses finance commercial real estate projects. These loans typically come with favorable terms, such as lower down payments and longer repayment periods, but may have more stringent eligibility requirements.
3.Commercial Mortgage-Backed Securities (CMBS) Loans: CMBS loans are a type of commercial real estate financing that is pooled with other loans and securitized, creating a bond that is sold to investors. These loans often have lower interest rates and more flexible terms than traditional bank loans but may require a more complex application and closing process.
4.Real Estate Investment Trusts (REITs): REITs are companies that invest in commercial real estate properties and can provide financing for projects through equity investments or by purchasing the property directly.
5.Private Lenders and Hard Money Loans: Private lenders, such as individuals or investment groups, can provide short-term financing for commercial real estate projects at higher interest rates than traditional lenders. These loans can be useful for borrowers who need quick funding or do not meet the requirements for traditional financing.
In my experience, the best financing option for a commercial real estate project depends on factors such as the borrower’s creditworthiness, the project’s risk profile, and the specific needs of the project.
Can you discuss the role of real estate investment trusts (REITs) in the real estate finance landscape?
Real Estate Investment Trusts (REITs) play a significant role in the real estate finance landscape, providing investors with an opportunity to invest in large-scale, income-producing properties without directly owning or managing the properties themselves. REITs are companies that own, operate, or finance income-producing real estate assets and are required to distribute at least 90% of their taxable income to shareholders in the form of dividends.
There are two main types of REITs:Equity REITsandMortgage REITs. Equity REITs primarily own and manage income-producing properties, such as office buildings, shopping centers, or apartment complexes. Their income is generated mainly from rental income and property appreciation. Mortgage REITs, on the other hand, focus on providing financing for real estate projects by investing in mortgages or mortgage-backed securities. Their income is generated from the interest earned on these investments.
In the real estate finance landscape, REITs provide an important source of capital for property owners and developers by investing in new projects or acquiring existing properties. They also offer investors a relatively liquid and diversified investment option, as their shares can be bought and sold on major stock exchanges, and they typically invest in a diverse portfolio of properties.
From my perspective, REITs have a unique and valuable role in the real estate finance landscape, providing both financing options for property owners and investment opportunities for individual and institutional investors.
What software and tools do you use to analyze and forecast real estate investments?
In my experience, analyzing and forecasting real estate investments requires a combination of various software and tools. Some of the key tools I have used includeMicrosoft Excel, which is excellent for building financial models and conducting sensitivity analysis. Additionally, I have utilizedARGUS Enterprisefor commercial property valuation and cash flow projections. I also like to leverageCoStarfor market research and data analysis. In certain cases, I have usedgeographic information systems (GIS)to visualize and analyze location-based data to help with decision-making. Overall, I believe in using the right tool for the task to ensure accurate and efficient analysis of real estate investments.
Can you walk me through the steps you take to identify and analyze potential investment opportunities?
Here you have to answer according to your previous experience and how you manage your data. For example, how do you identify the potential market trends in commercial real estate? And how you use your data to analyze the potential investment opportunities in the market.
Here are some steps for your reference that you can use for identifying and analyzing the investment opportunities:
* Conduct thorough market research
* Identifying the potential investment opportunities
* Conductfinancial analysis
* Find the risk factors in the current market affairs
* Conduct site visits
* Try to connect with commercial real estate professionals
* Negotiate and close deals with clients
Can you walk me through the process of underwriting a commercial real estate loan?
A. Primary evaluation
The underwriting process initiates with a preliminary evaluation of the borrower and the property.
The lender typically evaluates the borrower’scredit score,financial statements, and other applicable documents toestablish their creditworthiness. They also scrutinize the property to determine its value, location, and capacity to generate income.
B. Preliminary approval
After primary evaluation comes preliminary approval. If the borrower and the property fulfill the lender’s initial requirements, they will typically be pre-approved for a loan. This indicates that the lender is willing to lend them a specified sum of money, subject to further scrutiny.
C. Scrutiny
The next stage is to perform a comprehensivedue diligencereview of the borrower and the property. This may involve an appraisal, a site inspection, and an examination of leases and other legal papers related to the property.
The lender may also run background checks on the borrower and their business partners.
D. Final approval
After completing the scrutiny, the lender assesses all the data they have gathered to decide on the loan. Then, they weigh factors such as the borrower’s creditworthiness, the property’s value and income potential, and any probable risks connected with the investment.
E. Closure
If the loan is authorized, the final phase is to conclude the loan. This involves signing all necessary legal papers and transferring funds to the borrower.
To sum up, underwriting a commercial real estate loan is a convoluted process that involves a meticulous appraisal of both the borrower and the property.
Lenders can make sound investments while minimizing risk by employing a systematic approach and conducting thorough due diligence.
Would IRR be higher for a property generating high cash flow, or one generating nothing at all?
Net Operating Income (NOI):
NOI is a key metric used in real estate that represents the total income generated by a property minus the operating expenses. The formula for
NOI=Total Income−Operating Expenses
Total income typically includes rental income and other sources of revenue, while operating expenses encompass costs such as property management fees, property taxes, insurance, maintenance, and utilities. NOI provides a snapshot of a property’s ability to generate income from its operations, excluding financing and income tax considerations.
Cash Flow:
Cash flow, on the other hand, is the amount of cash that is actually received or spent during a given period. It takes into account not only the income and expenses considered in NOI but also financing-related items such as loan payments and interest. The formula for cash flow is:
Cash Flow =NOI− Debt Service
What is the amortizing loan constant for a 6% 30-year mortgage on a $50 million dollar loan?
What are the lines in a hotel operating profit and loss statement.
Why might you want to invest in a project with a lower IRR?
Stability and Predictability:
Properties with lower IRRs may offer more stable and predictable cash flows. Investors who prioritize consistent income over high returns might find these properties appealing, especially in markets or economic conditions where stability is valued.
Risk Mitigation:
Lower IRRs may be associated with lower-risk investments. Properties with lower potential returns often come with less volatility and fewer uncertainties, making them more attractive to conservative investors who prioritize capital preservation and steady income.
Long-Term Appreciation:
Some investors prioritize long-term appreciation and value appreciation potential over immediate high returns. While the IRR may be lower in the short term, the property could appreciate over time, providing a solid return on investment in the future.
Portfolio Diversification:
Including properties with varying IRRs in a real estate portfolio can contribute to diversification. Lower IRR properties might offer stability and act as a counterbalance to higher-risk, higher-return assets in the portfolio, creating a more balanced investment strategy.
Cash Flow Requirements:
Investors who have specific cash flow requirements, such as those seeking regular income for retirement, might prioritize properties with lower IRRs that generate consistent cash flow. This is particularly relevant for income-oriented investment strategies.
If two neighboring buildings had the same cap rate but had different NOIs, what factors would cause those buildings to have the same cap rate?
Define IRR
Define NPV
Define 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.
Define NOI
represents the property’s cash flow from operations on a capital structure-neutral basis before most of the capital costs (disagreements over the Reserves).
Define GRM
What happens when interest rates go up?
How do Triple Net (NNN), Double Net (NN), Single Net (N), and Full-Service or “Gross” Leases differ?
With NNN leases, the tenant pays Rent, plus its proportional share of Property Taxes + Insurance + Maintenance/Utilities; with NN leases, it’s just Rent + Property Taxes + Insurance, and with N leases, it’s just Rent + Property Taxes.
Full-Service Leases require Rent but no expense reimbursements. They tend to have the highest rent since the tenant does not reimburse the owner directly for the other expenses.
What are the main financial differences between multifamily properties and office, retail, or industrial properties?
-pro-forma numbers tend to be “lumpier” for office, retail, and industrial properties because they have fewer tenants with more customized leases, and there are often long periods of downtime in between tenants and significant concessions when new tenants move in.
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.
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.
Walk me through a real estate development model.
First, you make assumptions for the land required, the construction costs, and the Debt and Equity to use. Then, you project the costs, initially draw on Equity to pay for them, switch to the Construction Loan past a certain point, and draw on the loan as needed, capitalizing the interest and loan fees.
When construction finishes, you assume a refinancing, project the lease-up period for individual tenants, and then build a Pro-Forma with debt service based on the Permanent Loan.
Then, you assume the property is sold in the future based on its NOI and a range of Cap Rates, and you calculate the IRR to Equity Investors.
How do you value a property? What are the trade-offs of these methodologies?
Cap Rates, DCF Analysis, and the Replacement Cost methodology.
Cap Rates are simple to apply, but they don’t work as well in smaller regions with more limited data; people also disagree about how to calculate NOI.
The DCF is the most theoretically correct methodology, but it’s based on far-in-the-future assumptions and is less useful for stabilized properties that don’t change much.
Replacement Cost estimates the cost of reconstructing the entire building from scratch today and compares it to the property’s asking price.
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?
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?
Explain this
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.
What is the waterfall returns schedule, and why is it widely used in real estate?
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.
How do Preferred and Catch-Up Returns work in waterfall models?
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.
How do Senior Loans and Mezzanine differ, and why do many deals use both?
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.
How can you determine the appropriate Loan-to-Value (LTV) or Loan-to-Cost (LTC) ratio for a deal?
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.
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?
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”).
Tell us about an article you read recently?
What is the investment strategy of the firm?
What types of properties does the firm invest in?
across the spectrum
What is the structure of the firm’s investments?” (i.e.equityor debt)
What are the investment criteria of the firm?” (e.g. geographical focus, transaction size, risk/return profile, etc.)
Explain one past transaction completed by the firm, and why you found it interesting?”
If you could invest in any property type right now what would it be?
We’re currently in a challenging macroeconomic environment, with reduced liquidity as a result of higher interest ratesand geopolitical tensions. In Europe we are also experiencing an energy crisis as well as uncertainty from the Ukraine war. Not to mention the foundational shift in the use of buildings since COVID-19.
However this environment offers many opportunities in the real estate markets. I would personally focus my investment allocation on sectors with strong secular tailwinds, such as multifamily residential real estate, logistics, and healthcare. For example, the logistics sector is placed to benefit from the growth of ecommerce Some analysts have suggested that the limited supply and outsize rental growth seen in this sector may result compression of capitalization rates.
Multifamily, logistics, and healthcare are considered to have strong secular tailwinds for various reasons, and these trends are likely to persist over the long term. Here’s a brief overview of the factors driving the growth in each of these sectors:
Multifamily (Residential Real Estate):
Population Growth and Urbanization: Increasing population, particularly in urban areas, drives demand for housing. Urbanization trends, coupled with lifestyle preferences and employment opportunities, contribute to a sustained demand for multifamily properties.
Changing Demographics: Shifting demographics, including a rise in single-person households and changing preferences among millennials and baby boomers, contribute to the demand for rental housing.
Affordability Concerns: In some markets, high home prices and the financial flexibility associated with renting make multifamily properties an attractive option for a significant portion of the population.
Logistics (Industrial Real Estate):
E-commerce Growth: The rise of e-commerce has led to an increased need for distribution centers and warehouses to facilitate the storage and transportation of goods. The demand for last-mile delivery locations has become particularly crucial.
Supply Chain Optimization: Companies are looking to optimize their supply chains, leading to a greater need for strategically located logistics facilities to improve efficiency and reduce transportation costs.
Technological Advancements: Automation and technology in logistics are driving the need for modern, tech-enabled warehouses that can handle advanced inventory management and fulfillment processes.
Healthcare:
Aging Population: As the global population ages, there is an increased demand for healthcare services and facilities. Older individuals typically require more medical attention, leading to a growing need for senior living facilities, assisted living, and healthcare services.
Advancements in Medical Technology: Advances in medical technology have increased the demand for specialized healthcare facilities, including research and development centers, outpatient clinics, and specialized treatment centers.
Healthcare Policy Changes: Changes in healthcare policies and an increased focus on preventative care contribute to the growth of healthcare-related real estate.
These sectors are often considered defensive investments because they are tied to fundamental and long-term trends that are less susceptible to short-term economic fluctuations. Investors often find them attractive for their stability, steady income streams, and potential for long-term capital appreciation. The strong secular tailwinds in these sectors are driven by societal, economic, and technological changes that are expected to persist, making them appealing for long-term real estate investment strategies.
I would also invest in a select number of office and retail properties in order to diversify my portfolio.
What is happening in the RE market?
What are your predictions for the RE market?
How would you value the property we are sitting in right now?
What is your favourite building and why?
What does Eastdil do?
Eastdil is a real estate investment banking company that provides a range of investment services covering three main areas: investment sales (brokerage), debt/equity origionation (mortgage origination), and investment banking servces (M&A, advisory).
What are some disruptive trends in the real estate market today?
Name a recent business story that interests you. How would that story affect the property owner?
What does a partnership offer over a public company?
What do you look for in an office building?
You invest $1,000,000 in two different projects. Project A produces $100,000 in operating cash flow every year for 5 years, and you sell the property at the end of year 5 for $1,500,000. Project B, on the other hand, produces $0 in operating cash flow every year for 5 years, but you sell at the end of year 5 for $2,000,000. At the end of 5 years, which project has the higher IRR?
Answer Q1:
A B
Acquisition (1,000,000.00) (1,000,000.00)
Year 1 100,000.00 -
Year 2 100,000.00 -
Year 3 100,000.00 -
Year 4 100,000.00 -
Year 5 1,600,000 2,000,000
IRR 17.1% 14.9%
For both projects in this example, the total profit on the deal is 1M. However, with all else being equal, the IRR of a project is going to be higher when the cash flows are received earlier in the hold period. This makes Project A the clear winner, with distributions starting a full 5 years before any cash flow is received in Project B.
Takeaway: If you’re asked to compare the IRR between two projects with identical or very similar total profit numbers, the project where cash flows are received earlier in the hold period is likely going to be the project with the highest IRR.
You make two real estate investments – Project A, where you purchase the property for $1,000,000 today and sell the property for $1,000,000 5 years from now, and Project B, where you purchase the property for $1,000,000 today and sell the property for $1,000,000 10 years from now. Which deal has the higher IRR?
A B
Acquisition (1,000,000.00) (1,000,000.00)
Year 1 - -
Year 2 - -
Year 3 - -
Year 4 - -
Year 5 1,000,000 -
Year 6 -
Year 7 -
Year 8 -
Year 9 -
Year 10 1,000,000
IRR 0.0% 0.0%
This is actually somewhat of a trick question, and the answer here is neither, because investments in both Project A and Project B just represent a return of capital, not a return on capital, resulting in a 0% IRR in both cases.
To explain this in a little bit more detail, let’s head back to the definition used earlier on in this article, that the IRR represents the time-weighted, annualized return on equity invested.
And this means that in order for the IRR to be a positive value, the investment needs to provide some sort of profit on the deal.
In both scenarios here, where $1,000,000 is invested up-front and $1,000,000 is received several years in the future, the total profit is $0. And this means that there is no profit in either scenario, an\d the IRR is going to be 0% regardless of the timing of that $1,000,000 distribution.
The bottom line on the IRR concept is to look for a return of capital first, and once that occurs and there is actual profit on the deal, then move into considering the timing of the cash flows.
Return of Capital: Investor receives their original investment back – whether partially or in full.
Return on Capital: Any amount you receive each year in exchange for making your initial investment.
: If you buy a property for $100 at a 5% cap rate, hold it for 4 years and then sell it for $120, what is the approximate IRR?
Total dollars returned are $120 + $5 x 4 years = $140 / $100 purchase price = 40% total return over 4 years; divide by 4 years and the IRR is a little less than 10% per year, or 9.4% to be exact.
2x in 3yrs
25%
2x in 5yrs
15%
3x in 3yrs:
45%
3x in 5yrs
25%
If cap rates rise from 5.0% to 6.0% in a market, by what percentage will the NOI of a property in that market have to increase for property values to stay the same?
It might seem like you need to bust out Excel or a financial calculator to solve a problem like this, but the solution here is actually pretty simple. For values to stay the same, the percentage changes in both cap rates and NOI values also need to be the same for both metrics, in either direction.
To use this case as an example, if cap rates rise from 5.0% to 6.0%, it might seem like cap rates have only risen by 1.0%.
However, when we look at that 1.0% change as a percentage of the original 5.0% cap rate value, cap rates have actually risen by 20.0%, not 1.0%.
This means that the NOI of properties in that market would also have to increase by exactly 20%, just to keep values where they were at the 5.0% cap rate figure.
To put this concept into practice using concrete numbers, we can use that same sample property mentioned above with $50,000 in annual NOI. If cap rates in the market are 5.0%, we know that our value is $1,000,000 in this scenario, since $50,000 / 5.0%, = $1,000,000.
However, if cap rates all of a sudden rise to 6.0% in the market, that $50,000 NOI would now only result in an $833,333 valuation. And to get that value back up to $1,000,000, the NOI on the deal would need to jump by 20%, or up from $50,000 to $60,000, since $60,000 / 6% = $1,000,000.
The question here is really looking to make sure that you know that NOI values and cap rates need to move in proportion to one another for values to stay constant, and if you can think of these changes as percentage increases or decreases within each variable, this will make the mental math of solving these types of problems significantly easier.
You purchase two properties for $1,000,000 each today, you receive $50,000 in annual cash flow for each year you hold each deal, and you sell each property for $2,000,000. You hold Property A for 7 years and hold Property B for 5 years. Which deal has the higher equity multiple?
With all else being equal, since the equity multiple is measuring the sum of all positive cash flows throughout the entire life of the deal, the answer here is Property A. And this is true even with the sale proceeds in this scenario not being received until a full 2 years after the scenario in Property B.
For the purposes of the IRR calculation, timing matters, and Property B would generate an 18.8% IRR, while Property A would generate just a 14.3% IRR (simply due to the timing of the sale).
However, the equity multiple is going to be highest for the deal that generates the most total cash flow in proportion to equity invested. And since Property A will have two more years of generating $50,000 in cash flow than Property B, Property A ends up winning out on this metric with an extra $100,000 in profit, at 2.35x, versus the 2.25x equity multiple for Property B.
The bottom line here is that the equity multiple will be highest for the deal that generates the most profit in relation to equity invested, regardless of when those cash flows are received.
If you buy a property for $100 at a 5% cap rate and finance it with 75% debt at 4%, what is the levered cash-on-cash return?
Answer (using shortcut): Unlevered yield (or cap rate) is 5%, then you add to it (unlevered yield - interest rate) x ($75 / $25), or (5% - 4%) x 3 = 3% additional return from leverage. So it’s 5% base unlevered return + 3% additional return from leverage = 8% cash-on-cash return.
If you buy a property for $100 at a 5% cap rate, hold it for 4 years and then sell it for $110, what is the approximate unlevered IRR?
Answer:
The Unlevered Internal Rate of Return (Unlevered IRR), also known as the “gross” or “pre-debt” IRR, is a financial metric used in real estate and investment analysis. It calculates the rate of return on an investment before factoring in the impact of financing or debt. In other words, it measures the expected return on an investment assuming it is entirely funded with equity, without considering the effects of any loans or leverage.
The cap rate is given (5%), so we just need to calculate the property appreciation CAGR, or ($110 / $100) ^ (0.25) - 1 ~ 2.5%. Then you add 5% and 2.5% to get 7.5% (pretty close to the exact answer of 7.2%).
Example: If you buy a property for $100 at a 5% cap rate and finance it with 75% debt at 4%, hold it for 4 years and then sell it for $110, what is the approximate levered IRR?
Answer: First we calculate the cash-on-cash return, or 8% (same approach as in #2 above). The equity value in year 4 is $110 - $75 = $35. The levered property CAGR is ($35 / $25) ^ (0.25) ~ 9%. Then you add 8% and 9% to get 17% levered IRR (pretty close to the exact answer of 15.9%).
