Basics of modelling and property cashflows Flashcards
What is financial modelling?
Modelling is a means of estimating the attractiveness of an investment
With any investment / finance decision it is important to look at overall financial impact and obligations over the period
Need to obtain all required information and build a financial model to look at the financial obligations and potential returns
What is a model sensitivity analysis?
As part of a financial model, sometimes a ‘sensitivity analysis’ = carried out to look at various scenarios / situations that could occur over a specified period and how this effects the investment
What is the most common type of financial model used in property?
The discounted cash flow (DCF) model
What is a DCF model?
Looks at future / expected income and cost projections over set period and discounts them back to today to get a ‘present value’ / what it is worth today based on the assumptions made
Plus an exit value at the end of that period, usually arrived at on a conventional ARY basis
In many cases an internal rate of return (IRR) is used to work out what the percentage return is over the period
Maps life of the appraisal, should show you full timeline through development process with sales at the end
What is the IRR?
The percentage return per period (usually annual) over the investment term with the assumed capital costs, income and discount rate ‘r’
A metric used to measure the profitability of a potential investment. It is the percentage discount rate that makes the net present value (NPV) of all cash flows equal to zero.
What is the NPV?
The net present value is today’s capital value of the cash flows after applying a required rate of return
How does the level of debt / leverage have an effect on the outcome of the investment?
When using the IRR as a performance measure, positive value addition along with leverage creates a higher return percentage than that of all equity. This is due to the investor being able to access positive returns with less of their own capital, i.e. making more money with putting less in.
The counter to this is when negative values are experienced the downside is also amplified and further capital may be required to avoid foreclosure from the lender.
What THREE questions should a financial manager consider in investing?
Choice of long-term investments?
Sources of long-term financing?
Working capital: short-term assets (income) and liabilities (outgoings)?
How does a DCF help in a property financial analysis?
Helps to understand cashflow of how the project will be financed, construction costs, funding income and
then sales at the end (or you might have to hold the asset for a certain / longer period of time)
What is an S-Curve?
Helps you understand when things need to be paid (construction costs typically follow an S-curve on a cumulative basis), helping you to make your cash flow
What are the TWO key Capital Budgeting outputs of DCF?
NET PRESENT VALUE ANALYSIS (NPV) - this provides a PV monetary sum: a positive NPV = a signal to proceed with a project
INTERNAL RATE OF RETURN (IRR) – this provides a % return – if the IRR% is sufficiently high
then the project should proceed
What factors should be considered when estimating the investment cashflow?
Need to capture all information relating to income and expenditure; rental growth taxation external financing / gearing tenure physical attributes lease / sublease arrangements rental values cost of ownership redev / refurb costs
What are the key RICS guides relating to financial analysis / DCF?
RICS GN; Discounted cash flow for commercial property investments
RICS 2019 professional standards and guidance; Financial viability in planning: conduct and reporting:
What is the YP?
The YP reflects the time value of money
Used to express the value of an investment in the number of years required for its income to yield its purchase price
What is the formula for YP(perp)?
YP(perp) = 1 / y
where;
y = yield or interest rate
