Technicals Flashcards
Different property classes
Class A (premium); Class B (value add opp); Class C (30+yrs) ; Class D (Distressed Assets)
Main RE investment strategies: (know the diferentes)
Core, Core+, Value Add, Opportunistic
Capital Stack
Describes the diff sources of funding used to finance a project. High risk - low risk
Common Equity – opportunity to earn outsized returns
Preferred Equity – Hybrid security blends dent & common equity but only senior to common equity and subordinate to all debt, structure is flexible
Junior debt – bridges gap b/w senior debt & equity, lenders here posses the right to take control of a property in the events of default
Senior debt – interest rate at the lowest since is form of secured financing, these are first in priority of repayment
Phases of a RE cycle:
Recovery, Declining vacancy rates + no new construction
Expansion, Declining vacancy rates + new construction
Hyper supply, Increasing vacancy rates + new construction
Recession, Increasing vacancy rates + excessive supply
How is the cap rate used to value a property?
Cap rate = NOI/ Property Value
Cap rate = the expected rate of return on an income generating property
The primary shorthand of which different investment properties with comparables risk return profiles can be analyzed side by side
Credit losses:
monetary losses came from property owners pocket from inability to collect rent from tenants
NOI
Measure the profit potential of income generating properties before subtracting non operating costs
NOI = (Rental income + ancillary income) - direct operating expenses
Vacancy losses
% of units available for rent but left unoccupied
Effective gross income (EGI)
Potential gross income - vacancy & credit losses
Compare the cap rates for the main property types?
Hotels: Highest cap rates b/c cyclicality, demands fluctuates
Office sector: leases are renewed
Retail: Riskiest b/c secular shifts during the broader market (ecommerce)
Industrial: top performer
Multifamily sector: Most stable, but economic conditions can have material impact on demand that reduced occupancy rates
Cap rate and risk?
Cap rates measure of potential return so measure of risk, 2 sides of the same coin
High Cap rate = riskier = lower pricing & potential high return = lower property value = lower NOI multiple
Low cap rate = Low risk= low return = Negative growth in NOI = higher property value = higher NOI multiple
Cash on cash:
measure the annual pre-tax cash flow received per dollar invested
fund from operations (FFO) measure?
the operating performance of REITS by estimating a REITS capacity to continue to generate sufficient cash
Adjsuted FFO
FFO + Non recurring items - Maintenance capital expenditures
difference between NOI and EBITDA:
NOI measure the property profit potential, EBITDA reflects the operating profitability of an entire cooperation
methods of appraising a property?
1) Income approach; “Direct capitalization method” value = NOI / Market cap rate
2) Sales comparison approach: comps
** Assume all final sale recorded
3) Cost approach: “Replacement cost method” value is based on total costs of replacing the property
** Value = Land value + (cost new - accumulated depreciation)
Walk me through the income approach to a real estate valuation?
- Project forward NOI → must be stabilized (its fully functional)
- Determine market cap rate
- Estimate property value - NOI / Market cap rate
Difference b/w the Yield on cost and cap rate:
YoC is the forward looking cap rate
YOC = NOI/ Total project cost
Loan to value
LTV = loan amount/ Property Value
Measures the risk of real estate lending proposal
High LTV: Greater credit risk + higher interest rate
low LTV: less credit risk + lower interest rate
Distressed assets may have LTV ratios in the range of 50-60%, compared to 70-80% for stable assets.
Debt Yield
= NOI/ Total Loan
* Measures the riskiness of a real estate loan based on the estimated ROI
Lower yield = risk to the lender is higher because the property operating cash flows might not meet the mandatory debt service
Higher yield = The less risk it poses due to the reduced likelihood of the borrower defaulting on the obligation
( how quick a lender could recoup their original funds in the event of default)
Debt service coverage ratio
measure of cash flow available to pay current debt obligation.
DSCR = NOI/ Annual Debt Service
= 1.0x → break even point
<1.0x → insufficient income
>1.0x → sufficient income
How does Loan sizing work?
The process which lender perform diligence on the credit risk of a potential borrower and determine the appropriate debt burden than be supported by the NOI
Loan to value ratio (LTV) {70%}
DSCR {1.25x}
Debt yield{10%}
Difference between the going-in and terminal cap rate?
Going in = Stabilized NOI/ Purchase Price
Return on the date of property stabilization
Terminal= Expected NOI/ Anticipated Sale Price
Estimate return in the exit year
Timing:
The going-in cap rate is used at the time of acquisition, while the terminal cap rate is used at the time of sale.
Market Conditions:
Going-in cap rates reflect current market conditions when you acquire the asset.
Terminal cap rates reflect the anticipated market conditions, which may change over the holding period (e.g., rising interest rates, economic shifts, etc.).
When would you want each to be higher? (going-in and terminal cap rate)
You want a higher going-in cap rate when purchasing in a risky market or to ensure a favorable acquisition price.
You expect a higher terminal cap rate in markets with increasing risk or economic uncertainty that may result in lower property values at exit.
Lower intrest rates affect on cap rates
Lower interest rates typically lower cap rates because they reduce borrowing costs, increase property values, and reduce the return
- Lower borrowing costs: As interest rates drop, the cost of borrowing becomes cheaper, which encourages more investors to finance real estate purchases. This increased demand can drive up property prices, potentially lowering cap rates, as cap rates are inversely related to property values.
- Higher property values: Lower interest rates generally lead to higher property values because investors are willing to pay more for the same income stream, as they can finance the purchase at a lower cost. (lower cap rate)
Stabilization
- Occupancy rate: Property are fully leased or market occupancy
- Rent Pricing: Rent prices are at around market rat
Cap rate compression impacts property valuation?
inverse relationship, property prices tend to rise (higher purchase price)
Interest rate environment impact property values?
Interest rate reflects the cost of borrowing
High interest rate = high cost of financing + reduction in market demand, cap rates rise
Low interest rate = low cost of financing + rise in market demand, cap rates decrease
Development spread =
Development spread = Yield on Cost (YoC) - Terminal Cap rate
Estimates the financial feasibility of a real estate project, taking in the yield obtained
from undertaking a project to the yield earned of an acquisition of an existing property
3 common commercial lease structures?
- Triple Net (NNN): Most commonly, the tenant is responsible for all property operating expense on top of rent, so property taxes, maintenance, lowest rent.
- Full service lease (FS): landlord is responsible for paying all operating expenses of the property
3, Modified Gross lease (MG): Base rent contains portion of the operating expenses and other parties billed separately
Gross multiplier
GRM=Property Market ValueAnnual Gross Rent Income
The lower = the more profitable the investment
Bc the property generates more rental income to pay for itself at a faster pace
relative to comparable properties
Equity multiple:
Ratio b/w total cash distribution collected : the initial equity contribution
Total cash distribution: sum of cash inflows an investor earns
Equity contribution: size of initial investment by investor
= 1.0x → break even point (total cash distribution = equity distribution)
<1.0x → a loss (less cash than invested)
>1.0x → a + return
What is the difference between levered IRR and un levered IRR in real estate investing?
Internal rate of return measures the percent yield received on a property investment across a predefined period:
Levered IRR: expected rate of return after factoring the leverage used in fund the investment
{required equity distribution to investor reduces because of financing}
Unlevered IRR does: Neglects the effects of financing, it assumes no non-equity financing
2 sources of returns:
NOI growth & Capital appreciation
Calculate the unlevered FCF of a property:
NOI - Capital reserve - Capex - Tenant improvement - leasing commission
This is the remaining cash before deducting debt payments (like mortgages and interest)
Calculate the Levered FCF of a propert
= Unlevered Cash Flow - Debt service
Reflects net cash flow post financing
key factors that impact financing terms for different property types
nterest rates, property location, market demand, tenant quality, and property-specific risks. Diff asset classes attract varied financing terms due to their risk profiles and market liquidity.
types of real estate financing structures in the capital markets? structured finance viechles
- CMBS (Commercial Mortgage-Backed Securities):
This involves securitizing commercial real estate loans into bonds. These loans are pooled together, and the cash flows from these commercial mortgages are sold to investors as bonds. - SASB (Single-Asset, Single-Borrower Transactions):
SASB deals involve securitizing a single loan tied to one specific property. This structure is often used for significant assets like skyscrapers or high-value commercial buildings. - CRE CLO (Commercial Real Estate Collateralized Loan Obligations):
A CRE CLO product where loans made to borrowers are pooled and securitized into bonds. These loans are often short-term, floating-rate, and transitional (e.g., for properties in the process of being improved or repositioned). - Agency Deals:
Involve government-backed entities like Fannie Mae and Freddie Mac, which play a role in providing liquidity to the multifamily housing market by securitizing loans into mortgage-backed securities (MBS). a level of government guarantee, making these securities generally lower-risk compared to non-agency CMBS.
Determine the optimal financing structure for a commercial real estate acquisition?
Using LTV, DSCR and the property’s cash flow stability.
financing terms vary based on leverage levels, interest rates, and borrower creditworthiness.
Factors influence pricing and structuring of new loan originations?
interest rate environment, lender appetite, borrower creditworthiness, property type
Assess credit risk:
borrower’s financial strength, property income stability, market conditions, and collateral quality.
How does mezzanine financing work?
A hybrid debt and equity instrument used when a borrower requires more capital than senior debt allows.
It fills the capital gap b.w the senior loan and the borrower’s equity contribution.
Mezzanine loans often carry higher interest rates due to their subordinate position, but they offer lenders a claim on equity in case of default.
This financing can help increase a property’s leverage, thereby enhancing returns
LTV = loan amount (senior loan & mezzaine loan) / Property Value
Recourse vs. Non-Recourse Loans
Recourse loan: the lender can pursue the borrower’s personal assets beyond the collateral (property) in case of a default.
Non-recourse loan limits the lender to only the collateral → require stricter underwriting and lower loan-to-value (LTV) ratios to mitigate lender risk.
Explain the underwriting process for a commercial real estate loan
Steps to underwrite:
1. Gather Historical Financials T12)
* (income, expenses, NOI) to assess the property’s historical performance.
* Identify trends or discrepancies in income and expenses.
2. Analyze the Budget and adjust for market conditions (rent growth, inflation, capital reserves).
3. Project Future Income, (rental income/ parking based on market rents, vacancy rates)
4. Estimate Future Expenses - operating expenses
Include CapEx reserves for major repairs or renovations.
5. Calculate Net Operating Income (NOI)
NOI = Effective Gross Income −Operating Expenses
6. Determine Property Value
Apply a market Cap Rate to the NOI to determine the property value:
Property Value = NOI / Cap Rate
7. Estimate Debt Service
8. Calculate DSCR to assess loan feasibility:
DSCR = NOI / Annual Debt Service
9. Perform Sensitivity Analysis: Test different interest rates, rent growths to evaluate potential risks and returns
What are some strategies to manage refinancing risk in real estate debt portfolios?
Strategies include:
1. Maintaining low LTV ratios to allow easier access to refinancing even during volatile market conditions.
2. Staggering maturities to avoid having too many loans maturing simultaneously.
3. Extending loan terms or adding prepayment flexibility to take advantage of favorable refinancing conditions.
fair value of a loan
determined by discounting its future cash flows at the current market interest rate and credit spread. This accounts for the risk of default and the borrower’s ability to repay the loan.
What KPIs would you do DD on when investing in commercial real estate?
top 5
1. Net Operating Income (NOI):
Represents the cash flow the property generates from operations after operating expenses. It is a direct indicator of the property’s profitability and is the foundation for calculating other important metrics like the cap rate.
- Cap Rate:
helps you evaluate the relationship between the property’s NOI and its purchase price or market value. It is a key measure for comparing the relative return potential of different properties in the same market. - Internal Rate of Return (IRR):
critical for evaluating the total expected return on your investment over time, incorporating cash flows, time value of money, and the eventual sale of the property. It provides a comprehensive view of long-term profitability. - Debt Service Coverage Ratio (DSCR):
for assessing the property’s ability to meet its debt obligations. A healthy DSCR (above 1.25) indicates that the property generates enough income to cover its loan payments, reducing the risk of default. - Occupancy Rate:
drectly impacts the property’s revenue. Higher occupancy means more stable and predictable rental income, which is crucial for generating consistent cash flow and achieving your financial targets
Types of Mortgages
Zero Coupon Securities (ZCS)
1. Initial principal is distributed at period 0
2. No payment of loan until end of term period
3. Final payment of principal and interest at end of term period
a. FV = PV*(1+r)^N
Interest Only Mortgage (IOM)
1. Initial principal is distributed at period 0
2. Payment of interest only is made every period until the end of term
period
a. Interest Payment = Principal * r
i. r = Interest Rate
3. At final period, payment of full loan balance and interest is paid
a. FV = Principal + Interest Payment
i. or FV = Principal + (Principal * r)
Fixed-Rate Mortgage (FRM), also known as a Fully-Amortizing Loan
1. Initial principal is distributed at period 0
2. Fixed payment every period to expiration
3. Payment at period is identical at every period; hence the name “fixed rate mortgage”
Cash Flow After Debt Service
Cash Flow Before Debt Service - Debt Service = Cash Flow After Debt Service
i. Debt Service = (Interest + Principal) + Loan Distribution - Loan Repayment
1. Interest + Principal = Payment (we learned this earlier)
2. Loan Distribution = Principal amount of loan from borrowing. Think of
this as a cash inflow since the owner will be suddenly receiving
$xxx,xxx,xxx amount of cash from the bank.
3. Loan Repayment = Repayment of remaining balance on loan. Think of
this as a cash outflow since the owner will be repaying the remaining
balance that they owe to the bank at the final period.
3 C’s of Underwritting
Capacity
Collateral
creditworthiness
amortization
length of time it will take you to pay off your entire mortgage.
- The longer amortization period, reduces your monthly payments as you are paying your mortgage off over a greater number of years.
-However, you pay more interest over the life of the mortgage.
floating rate
type of debt instrument that does not have a fixed rate of interest over the life of the instrument (mortgage)
-also known as adjustable rate.
Cap rate
NOI/ property value
Pros: easy calculation
con: just one year snapshot in time.
-market cap rate can be difficult to determi
IRR
percentage rate earned on each dollar invested for each period it is invested.
-Measures profitability of potential investment
-A discount rate that makes the net present value of all cash flows from a particular project equal to zero.
Net present value
NPV of all future cash flows: saying present value.
=this would be the price you pay today to earn an 8% return with those expected future cash flows.
-THe value you would pay today to get an expected return in the future given the current cash flows.
intreviwer looks outside of the window, bring me through how you would value that office building over there
- I would look at the surrounding parcels and analyze the location and linkages around to estimate how much the land cost would be to have the area.
-I would consider what the zoning codes may be and how good of access the building has to traffic.
-I would consider the highest and best use for certain property types. - I would look for an opportunity to build up and onto the building for future projects.
why is going in cap rate usually lower than going out cap rate?
cap rate is a measure of risk.
-It is easier to predict what cap rates will be today, so going in is lower risk because you can forecast it.
-It is harder to predict the future because you don’t know what will happen, so it places it at a higher going out cap rate.
where do you want to buy and sell with cap rates?
you want to buy at a high cap rate and wait for it to stabilize, then sell at lower cap rates so you get more money.
walk me through a proforma
Potential gross income- vacancy allowance + other income to arrive at your gross income.
Then subtract your operating expenses from effective gross income to get NOI.
Once you have NOI, subtract capital improvement expenditures to arrive at property before tax cash flows.
major drawbacks of using IRR to evaluate investment
=IRR doesn’t explain whether the return is coming from operations or reversion. (your year zero cash flow is usually operating or reversion inflows/returns on property, expressed as negative)
-YOu don’t know where the returns are coming from.
-almost always the IRR is higher if you sell it earlier in the year.
If you want to optimize IRR, you sell after year one.
Name 3 regulations that REITS face
Need to have shares fully transferrable.
-have minimum of 100 shareholders after its firsts year as a REIT.
- have no more than 50% of its shares held by 5 or fewer individuals during the last half of the taxable year.
- derive at least 95% of its gross income from such real estate sources and dividends or interest from any source. -Have no more than 50% of shares held by 5 or fewer individuals during the last half of the taxable year.
Treasury bill impacts
If fed sells T-bills then there is less money supply in economy because people are giving their money to the fed and they are holding it.
-when the fed buys them, they’re putting more money into circulation and that causes inflation.
-to combat inflation the fed rises the interest rate to increase the incentive to buy and put money in banks.
5-9% in 1990’s, 3-6 2000’s`
low treasury rates mean?
mean people force little inflation. It means low cost government borrowing, meaning that the government is paying small amounts of interest on recently issued debt.
How oil prices impact commercial real estate
volatile commodity pieces like oil impact all elements of the U.S economy, both positively and negatively.
-For example, higher oil prices are good for some industries, and yet bad for others. same goes for lower prices.
-so overall, price fluctuations will affect different property types.
1.) Discuss what you view as some of the opportunities, risks, and challenges that investors face in today’s real estate market
risks: Retail is a risky market because of the collapse of brick and mortar with everyone moving to amazon to shop.
b. Opportunities
i. Raleigh Durham there is great opportunity to expand multi-family housing and rental properties because 23% of people living in the area are between ages 20-34 and are typically high paid professionals
ii. Texas shows great opportunity for businesses with there being no corporate income tax.
If you had to decide a project’s merit on basis of one performance indicator what would you use? (cap rate)
“Generally it would be cap rate. But thats only a general rule because you can very well have different cap rates based on many variables.”
-You could have a lower cap rate if the tenant is good.
-lower cap rate if there is a longer amortization period.
If you had to decide a project’s merit on basis of one performance indicator what would you use? (debt)
IRR
measures profitability of potential investments.
IRR is a discount rate that makes the NPV of all cash flows rom a particular period equal to zero.
If you had to decide a project’s merit on basis of one performance indicator what would you use? (lending)
debt service coverage ratio
- net operating income/ total debt service.
-measures of cash flow available to pay current debt obligation.
-good indicator for lending because you always need to know the risk that you are taking on with a loan.
You have two identical office buildings right next to each other; they were built at the same time, are the same size, and have the same specs. One is valued significantly higher than the other. What are some explanations for this?
The highest and best use could be different for the property. (may be profitable for some businesses and not for others).
one tenant could be of higher credit quality and because of that stye could get better loan ratings, which would lower the cap rate and riskiness (amazon versus a family business that is new). The lease discount would be based on what they can borrow.
-cap rates change based on lease terms (weighted average of 5 year lease versus 10 year lease would have different value, 10 year less risky).
-5 year would be have higher cap rate and be more risky than 10 year lease (less time to amortize out loan)
-could be zoning requirements. (what type of business can be there in those locations, highest and best use).
- what are there building codes, can you possibility build on or build up?
Walk me through a pro forma, ending at NOI
potential gross income- vacancy allowance+ other income to arrive at your effective gross income. then subtract your operating expenses from EGI to get NOI
Walk me through a pro forma, ending at after-tax cash flow
potential gross income- vacancy allowance+ other income to arrive at your effective gross income. then subtract your operating expenses to get your NOI.
b. Once a NOI you subtract off capital improvement expenditures to arrive at property before tax cash flows.
Over how many years do you depreciate multifamily assets? all other cre assets? land? what form?
27.5 years
39 years
land does not depreciate
straight line
LTV compared to DSCR
LTV: is more of a balance sheet thing.
ii. Measures your leverage on a property.
iii. Looks at your total assets and liabilities, which would impact how much you can put down on loan.
How much debt you are putting in versus equity
DSCR: Determines if you can pay off the debt over a certain amount of time.
2. you would first need to look at your debt coverage ratio before giving out a loan. (Your NOI/ debt).
3. Debt coverage ratio will be a better measure before giving out a loan. That will tell you based on your net operating income and debt what you are likely going to be able to pay off.
a. You want this number above one
CMBS Structure
a. underlying loans that get securitized into CMBS include loans for properties such as apartment complexes and buildings, factories, hotels, office buildings and shopping malls.
b. CMBSs are a group of commercial loans on these property types that are bucketed into various tranches. Though these securities are customized, generally they have three or four tranches.
i. tranches are typically ranked for senior, or highest quality, to lower quality.
1. Highest quality tranches will receive both interest and principal payments and have the lowest risk.
2. Securities are structured so as the tranches go down in rank, they take on more risk and are designed to absorb most of the potential losses that can occur over the life of the security.
3. Lowest tranche in a CMBS’s structure will contain the riskiest loans of the portfolio and possibly speculative loans.
Different between Effective Gross Income (EGI) and Net Operating Income (NOI)
EGI:
- total income generated by a property after factoring in vacancy and credit losses
- includes income from rent, amenities, vending machines, laundry facilities, parking permits
NOI:
- remaining income after subtracting direct operating expenses from property management fees, utilities, taxes, insurance, maintenance costs, and repairs
- excludes financing costs, mortgage payments and interest, and income taxes paid to the government
If you have $12 of NOI valued at an 8-cap, what is the property value?
noi/ cap rate ==> 12/0.08 = 150
What are the three major determinants of cap rate?
- opportunity cost of capital
- growth expectations in the property’s future cash flows
- specific risk of property
if a property has a low cap rate (3.0%) why could that be?
- the property is a very safe, core asset in a trophy location
- the asset is not stabilized with a very low NOI
What’s more important when evaluating a real estate investment - the cap rate or the price per square foot? Why?
a. Both are very important. Cap rates are based off NOI and help you generalize across assets. However, because it is applied to an NOI, it could be skewed (maybe if selling off an unstabilized NOI). Also, it is important to define what kind of cap rate you are using (e.g. gross or net, because sometimes people cap NOI at 100% occupancy, like in Europe). Cap rates
also don’t tell you much about the asset. It could be a very big building producing a low NOI, and so the cap rate is high.
b. Price per square foot helps you look at assets on a “pound for pound” basis. It ignores NOI and tells you about the building.
Explain the relationship between cap rates and interest rates.
as interest rates go up, the cost of capital becomes greater so debt becomes more expensive, therefore the values of buildings go down and the cap rates go up
Do you think real estate investors are justified in buying at lower cap rates? Why or why not?
a. A cap rate is not indicative of anything in isolation, as it depends on each investor’s objective and goal.
b. If the investor’s goal is to optimize NOI and IRR and there is room for rental reversion / growth, then a low cap rate is justified. The low cap rate could have been off a low NOI, which would imply that the price to purchase the asset is not high on a relative basis.
c. If the investor’s aim is to buy an ultra-core trophy asset for diversification / stable cash flow / capital protection purposes, then a low cap rate could be justified.
If I buy something at a 5% cap, put 50% debt on the property at a 4% interest rate, what is my cash on cash yield?
a. To make this easier, assume that you purchased the building for $100. That means that you bought the property with $5 of current income (5% cap). That also means that you only spent
$50 in equity and borrowed the other $50 from the bank (50% debt). If your debt cost 4%, you are paying $2 of interest (.04*$50). This means that your levered income is $3 (your $5 of
current income, less your $2 of debt). Your equity investment is $50. That means your cash on cash yield is 6% ($3/$50).
b. Please note that your unlevered yield is 5%. If they ask if you hold it for a year and sell at a 5% cap, your unlevered IRR is 5% and your levered IRR is 6% (assuming interim cash flows
are reinvested at the IRR rate).
Walk me through a DCF
This is a short answer, but basically a DCF is a way to project out future cash flows and discount those CF’s back to present value. You are saying that this property is something that
is going generate income (while having operating expenses) over some period of time fluctuating with market conditions, and that this potential needs to be taken into consideration
when valuing the building.
In trying to determine the value of an office building in downtown NYC: how would you value it and why? What questions do you need to ask?
a. First of all I would look at comps
i. Price per square foot comps and cap rate comparables
b. IRR analysis
i. I would determine a level of underwriting that I am comfortable with and determine what my expected return is, given the asset risk profile and envisaged business plan. Then I would see what price (benchmarked from the comps) would support those returns and not bid above that. I would need to take a view on exit as well
c. DCF
i. Similar to the above. I would underwrite the asset cash flows, and discount them back to today’s values. Would need to take a view on the exit as well as determine what the appropriate discount rate is.
d. Replacement cost
i. What would it cost to replace the building? Am I building at or near replacement cost?
Our firm wants to invest in an asset. If we give you the OM, what are the some of the things you’d do/look at?
a. Asset type: what kind of asset is this (resi, office, etc)? Then specifics (high rise, midrise, trophy, etc)?
b. Location: Country, city and then market
c. Parties involved: Who is the seller (more relevant if they are retaining a stake)?
d. Proposition / proposed capital structure: What kind of investment will this be (core building with 20 year lease, or value add residential refurbishment)? What is being sold and how much of it is being sold and to whom?
e. Building overview: size, floors, floorplates, refurbished recently?
f. Occupancy: leasing profile if office or retail, occupancy if multifamily
g. Cashflow: NOI (try and estimate going in cap), future capex requirements, etc
How do DSCRs vary by property type?
go from least to most risky:
i. Multifamily: 1.15 - 1.30
ii. Industrial: 1.2 - 1.3
iii. Office: 1.25 - 1.50
iv. Hotels: 1.35 - 2.25
What is one pro and one con about a building that has a ground lease (if you are going to buy the leasehold fee interest for the building only)?
A pro is that you don’t need as much capital to purchase the asset since you aren’t buying/paying for the land.
Some cons are that it can be difficult to obtain a loan if the ground lease will expire in the near future, that the ground lease rent can roll to market at lease expiration and substantially increase the ground rent expense, that the use and alterations to the property can be restrictive based on the ground lease covenants, and that the value of the asset continuously diminishes as the expiration of the ground lease approaches.
Discuss ground leases
Ground leases are like mortgages. The land belongs to someone other than the landlord of the building, and the landlord pays to lease it.
What is FAR? Why is it important?
a. FAR, otherwise known as the Floor Area Ratio, is calculated as the total/gross building area divided by the site’s size or square footage. It is a measure of a project/building’s density relative to the site upon which it is built.
b. So if you have a FAR restriction of 5x and a floorplate of 10 sqft, you can build one floor up thats 50 sqft or 5 floors up that are 10 sqft.
Explain the bottom up analysis of a market? Top down?
a. Bottom up is starting with a specific asset and looking at its drivers, then the submarket, then the market, then further on up into how it fits into its macroeconomic environment
b. Top down is the reverse. Start with macroeconomic factors and work your way down to the asset level.
What is the impact on rents, stock and asset prices from a 10% increase in population?
a. It impacts everything positively, generally.
b. Tracking the trends in population growth can provide an accurate prediction of which neighborhoods are likely to succeed and which ones are doomed to at least short term failure.
c. An increase in population results in an increase in households and so the housing sector is positively
impacted.
d. Similarly, employers and companies look to have operations in areas of high population density. Those employers will look for commercial space for their operations in these areas.
e. This drives up rents and higher rents (ie NOI) will ultimately drive up prices.
Why/how to exit a RE investment?
a. Why?
i. To free up capital.
ii. Risk profile is different to what you do (you’re a developer, and now your building is a core building).
iii. Fund life (usually 7-12 years).
iv. Human aspects (selling a building you inherited).
b. How?
i. Sale.
ii. 3-12 months.
iii. Must gather docs and contracts, prepare financial statements, get them audited, create marketing materials, hire lawyers to negotiate and structure, hire a broker, and negotiate with the buyer.
iv. All of this work cost fees and time. 2%-5% is a good estimate of sales costs (but this can be changed depending on value of asset - TW Center vs small building).
1. If you sell to a buyer who is levering, their lender will not lend until they get their lien on the property. But you already have a mortgage and so you need to pay that first, but you can’t do so until you sell the property. Get around this by simultaneously selling, paying your lender and transferring the first lien to the purchasers lender
2. Taxes: In the US you pay capital gains tax on the gain as well as tax on the accumulated depreciation.
v. Refinancing
1. Cheaper on costs than selling.
2. Postpone capital gains tax.
3. Allows you to take money out tax free.
4. Only works if you don’t mind holding the asset again for a while.
vi. Recapitalization
1. Letting in a partner in at higher than your basis.
vii. 1031 exchange
1. You can roll your sales proceeds into another building and defer your tax liability.
2. This also allows you to restart your depreciation schedule, which is very helpful if your current building is near the end of its depreciable life.
3. You defer your tax until you no longer own it.
4. Makes sense for personal people who are old and want to avoid the income tax.
5. You can do two things to create value with this:
a. Sell a stabilized asset for a value-add asset, and add value and get the return.
b. Sell stabilized and buy a more stabilized property which would offer better refinancing opportunities (allowing you to take money out tax free).
c. The problem with this is that others will be trying to do
Secured loan
secured by recourse to the assets of the property. If a borrower fails to repay, the lender is entitled to foreclose on the asset
Negative covenants (things the borrower cant do, otherwise the loan will accelerate) & Positive covenants (things the borrower must do)
negatives: Prepayment penalties / yield maintenance: make sure the borrower doesn’t refinance early if rates drop.
ii. Distribution: limiting distributions to equity, to provide cushion
positives: i. DSRA: you may have to maintain a minimum deposit in their bank accounts
ii. NOI minimum restrictions
iii. Leases: provide copies of all leases prior to execution, to check vs business plan
reasons to refinance
i. Property has risen in value. Allows you to lever more and take cash out (get equity windfall out).
ii. To get lower rates and better terms.
iii. Refinancing gives you a greater tax shield, as you will be in the early years of your amortization schedule and less principal (assuming not interest-only loan). But you may have prepayment penalties on your current loan. This makes sense if:
1. You manage to convince the lender to issue you a new loan and waive the prepayment fees. Do this only in a competitive market where the lender needs to get cash out.
2. If you think today’s rates are at all time lows.
3. If you really want to take some cash out.
4. If you are a new owner and can get debt at better rates due to your credit.
sweep
Taking all cash until loan is satisfied.
What is mezzanine debt?
Mezzanine capital, in finance, refers to a subordinated debt or preferred equity instrument that represents a claim on a company’s assets, which is senior only to that of the common shares. Mezzanine financings can be structured either as debt (typically an unsecured and subordinated note) or preferred stock.
Mezzanine capital often is a more expensive financing source for a company than secured debt or senior debt. The higher cost of capital associated with mezzanine financings is the
result of its location as an unsecured, subordinated (or junior) obligation in a company’s capital structure (i.e., in the event of default, the mezzanine financing is less likely to be repaid in full after all senior obligations have been satisfied). Additionally, mezzanine financings, which are usually private placements, are also often used by smaller companies and may also involve greater overall leverage levels than issuers in the high-yield market and as such involve additional risk. In compensation for the increased risk, mezzanine debt holders will require a higher return for their investment than secured or other more senior lenders.
