WSP RE Modelling Flashcards
What is Peak Equity
Represents the amount of equity capital required to be invested in the transaction
Common expenes to get from unlevered to levered cash flow
Interest expense: Floating rate loans are usually priced off LIBOR + a spread, so the LIBOR forecast (which usually comes from a LIBOR curve) is the moving variable in the forecast to arrive at interest expense. Note that interest expense is calculated off the beginning of the period debt balance in the model. In more complex models with cash sweeps, the approach of calculating interest expense from the beginning of period debt balances avoids a circular reference. We have written about how to handle model circularities due to cash sweeps in a separate post about the LBO modeling test.
Origination fee: The origination fee is paid upfront.
Principal amortization: Per the inputs section, 5% of the original debt balance must be paid back to the lender each year.
Loan funding and payoff: In the first year, the cash inflow from the loan is reflected, while in the exit year, the remaining principal balance on the loan is repaid.
What is the levered cash flow formula
Levered cash flow: unlevered cash flow – interest expense – amortization – origination fee (year 1 only) + loan funding (year 1 only) – loan payoff (exit year)
How does levered cash flow impact profit, multiple and IRR
Profit, multiple, and IRR:
Notice how profits are lower, while the multiple and IRR are higher than the unlevered returns. This should make sense – while the debt means lower profits in absolute dollars, the real estate private equity firm can write a much smaller equity check, such that returns are amplified.
Does Peak Equity include equity post acquisition
The peak equity represents the total amount of equity that must be put into the investment – not just the initial check – and is factored into the total sources of funds in the sources & uses of funds schedule (see below).
In this way, REPE models can differ slightly from regular LBO models, which predominantly rely on a revolving credit line and excess cash to fund cash shortfalls. The mechanics can differ deal by deal – some loans will include funding for capital expenditures, some will require the investor to set aside cash in Year 0 to cover capital expenditures. An investor may decide to spread the capital expenditures over time so that excess cash flows cover them.
in a multifamily acquisiiton model, what do we model net effective rent from
Net effective rent is driven from a per unit monthly rent assumption. Here, we assume that renovations immediately provide the rent premium benefits. This is a common simplifying assumption, because multifamily properties typically have ~50% annual turnover, and landlords can move rents overnight. In more complex models, unit renovations and the associated rent premiums will be integrated into the model using more specific assumptions.
what is the common structure of the sources & uses table for a real estate acquisition
Uses:
Buy the Real Estate Asset (i.e. the Property Purchase Price)
Pay the Origination Fee
Pay for Capital Expenditures (Capex)
‘Sources’ are:
Debt: summing the Loan Funding line in the Model section.
Equity in all years
Operating cash flows: This is the plug in the S&U table and represents how much of the planned capital expenditures are not going to be funded by additional equity checks but rather through the asset’s internal cash profits.
what is net effective rent
What is net effective rent
Monthly Net Effective Rent = [Gross Rent × (Lease Term – Free Months)] ÷ Lease Term
Net Effective Rent = Net Effective Rent Per Month × Number of Occupied Units × 12 Months
What is the difference between the gross rent and net effective rent
Gross Rent → The difference between the net effective rent and the gross rent is that the gross rent – as implied by the name – is the total rent before any adjustments related to concessions or discounts. When a one-year lease is signed, the gross rent represents the stated rental cost on the rental agreement, either on a monthly or annual basis.
Net Effective Rent → However, the actual rental cost (or net effective rent) can vary from the stated gross rent due to concessions, discounts, and promotions, which are generally offered during periods when tenant demand in the market is low. For example, the COVID-19 pandemic led to many rental apartments offering several months free for tenants, as trends such as “work-from-home” were unfavorable to the real estate market (and also as individuals temporarily moved away from cities).
What is prorated charge
Prorated Charge = Total Cost × (Number of Units Used ÷ Total Number of Units)
proration method is the process of adjusting costs, payments, or charges to reflect the actual amount of time or usage, ensuring fair and accurate billing to customers.
obligation to adjust the charge to reflect the time or usage rather than a fixed pricing rate for a given billing cycle
What is prorated rent
Prorated Rent = Total Cost × (Number of Active Days ÷ Total Number of Days in Month)
What is prorated salary
Prorated Salary = Total Salary × (Number of Hours Worked ÷ Total Number of Hours)
What is Before-Tax Cash Flow
Before-Tax Cash Flow = NOI - Annual Debt Service
Annual Debt Service = Principal + Interest
Used to calculate the cash on cash return. Cash on Cash Return (%) = Annual Before-Tax Cash Flow ÷ Equity Contribution
What is After-Tax Cash Flow
After-Tax Cash Flow = NOI - Annual Debt Service - Income Tax Liability
Net Operating Income (NOI) = (Rental Income + Ancillary Income) – Direct Operating Expenses
Annual Debt Service = Σ Current Principal Amortization + Interest Expense
Income Tax = Marginal Tax Rate (%) × (NOI – Annual Debt Service)
What is a sale leaseback
sale leaseback occurs when the seller of a property immediately commits to a leasing agreement with the buyer
Stage 1 → Property Sale Contract
Property is sold and ownership is transferred after the purchase is paid in full.
Stage 2 → Leasing Contract
Shortly afterward, the new owner (now the lessor) and the prior owner agree to a new leasing agreement that permits the seller (now the lessee) to remain in the space, but as a tenant.
What are the benefits received by the seller in a sale and leaseback?
Equity Injection and Capital to Reinvest in Business (e.g. Fund Working Capital Needs)
Discretionary Funds to Finance Growth Plans (Capital Expenditures, or “Capex”)
Capital to Right-Size Balance Sheet and Paydown Financial Obligations (i.e. Reduce Credit Risk)
Benefit from Tax Deductions (Transaction Must Quality as “Sale” under ASC 606 and “Operating Lease” under ASC 842)
explain the tax benefits from a sale leaseback
In a sale and leaseback transaction, the tax benefits generally arise when the transaction qualifies as a “sale” under ASC 606 (revenue recognition) and as an “operating lease” under ASC 842 (lease accounting). Here are the key tax-related benefits for the seller:
Immediate Cash Injection with Minimal Tax Implications: By selling the asset, the seller can realize a cash influx without triggering a substantial tax liability compared to a full asset sale, as they retain operational control through the lease.
Tax-Deductible Lease Payments: Lease payments made by the seller, now as a lessee, are often fully tax-deductible as a business expense, lowering taxable income. This is especially beneficial in jurisdictions with higher corporate tax rates.
Off-Balance Sheet Financing: If the lease qualifies as an operating lease, the asset and liability may not appear on the balance sheet, reducing the apparent debt load and potentially improving financial ratios. This can lead to better credit terms and lower financing costs elsewhere in the business.
Depreciation Recapture Mitigation: If the asset was previously owned and depreciated, a sale could trigger depreciation recapture taxes. However, by structuring it as a sale and leaseback, the business might defer or mitigate some recapture taxes due to the lease structure.
Flexibility in Asset Reacquisition: Sale and leasebacks can also include options to repurchase, allowing firms to maintain some flexibility in their control over the asset without the tax burden of full ownership.
For these tax benefits, it is crucial for the transaction to meet the specific guidelines under ASC 606 and ASC 842. If not, the seller might face unintended tax liabilities or reduced deductions.
What are the advantages and disadavtages of a leaseback transaction
How do you calculate Vacancy Loss
Vacancy Loss = Gross Scheduled Income (GSI) × Vacancy Rate
Gross Scheduled Income (GSI) → The gross scheduled income is the total amount of potential rental income that could be generated by commercial property, assuming the property is at full capacity, i.e., 100% occupancy.
What is economic vacancy
method to measure unrealized potential rental income attributable to property (or unit) vacancies
Economic Vacancy (%) = (Gross Potential Rent – Actual Rental Income) ÷ Gross Potential Rent
Gross Potential Rent (GPR) → maximum potential rental income that a rental property could generate
Actual Rental Income (ARI) → rent payments the property expects to collect based on recent leasing data and existing tenants.
Difference between physical and economic vacancy
low economic vacancy, the “fix” many property owners opt for is offering more concessions, reducing rent, and related tactics – which collectively contribute to a drop-off in the economic vacancy.
Economic vacancy provides more granular insights pertaining to the profitability of the rental property, while physical vacancy merely measures the percentage of unoccupied units.
What are the 4 different leasehold interests
The four types of leasehold interests are: 1) Tenancy for Years, 2) Periodic Tenancy, 3) Tenancy at Will, and 4) Tenancy at Sufferance.
