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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* * 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.
