Wall Street Prep RE Qs + CRE Flashcards
(189 cards)
1
Q
What is the investment strategy of the firm?
A
2
Q
What types of properties does the firm invest in?
A
3
Q
What is the structure of the firm’s investments? (i.e. equity or debt)
A
4
Q
“What are the investment criteria of the firm?” (e.g. geographical focus, transaction size, risk/return profile, etc.)
A
5
Q
Explain one past transaction completed by the firm, and why you found it interesting?
A
6
Q
What is a Real Estate Private Equity (REPE)
A
REPE firms 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.
7
Q
Real Estate Investment Trusts (REITs)
A
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 are subject to strict requirements on public filing disclosures.
8
Q
Real Estate Development Firm
A
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.
9
Q
Real Estate Investment Management
A
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).
10
Q
Real Estate Operating Companies (REOCs)
A
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.
11
Q
Real Estate Brokerage Firms
A
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”.
12
Q
What are the Different Property Classes in Real Estate Investing?
A
Class A → “premium” properties, 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
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 D → Class D properties are the bottom-tier classification and consist of properties in poor condition, while located in areas with limited market demand.
13
Q
What are the 4 Main Real Estate Investment Strategies?
A
- Core - Core investments are recognized as the least risky strategy and involve modern properties priority with core investments is stability in performance .and limiting downside risk.
- Core Plus - marginally riskier than the core strategy aside from necessitating some capital improvements.
- Value-Add: More risk because the properties need considerable capital improvements. Real estate investors implement significant improvements resulting in higher pricing and more market demand.
- Opportunistic
riskiest strategy entails new development; time-consuming but also require substantial spending on resources.
14
Q
What is NOI in Real Estate?
A
Net Operating Income (NOI) = (Rental Income + Ancillary Income) – Direct Operating Expenses
NOI formula neglects non-operating items such as capital expenditures, depreciation, financing costs, income taxes, and corporate-level SG&A expenses.
industry-standard measure of profitability to analyze property investments, particularly for comparability purposes.
15
Q
What is the Difference Between NOI and EBITDA?
A
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 → NOI neglects non-operating items like EBITDA, however, from the perspective of a real estate property, not a corporation.
Industry-Usage → NOI is seldom recognized outside the real estate industry
Therefore, NOI measures the profit potential of a property, whereas EBITDA reflects the operating profitability of an entire corporation.
16
Q
Depreciation Concept Nuance | Real Estate vs. Corporations
A
The depreciation concept is nuanced in real estate because unlike standard circumstances, 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.
17
Q
How is the Cap Rate Calculated?
A
Cap Rate (%) = Net Operating Income (NOI) ÷ Property Value
18
Q
Explain the Relationship Between the Cap Rate and Risk.
A
higher cap rates coincide with higher risk, while lower cap rates correspond with lower risk.
Higher Cap Rates → Higher cap rates suggest property prices are low relative to the income generated.
Lower Cap Rates → 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.
19
Q
What Does Funds from Operations (FFO) Measure?
A
FFO used to analyse REIT; estimate the capacity of a REIT to generate enough cash.
Funds from Operations (FFO) = Net Income to Common + Depreciation – Gain on Sale, net
20
Q
What is the Difference Between FFO and AFFO?
A
normalising FFO for items like non-cash rent and subtracting the recurring maintenance capital expenditures
Adjusted Funds from Operations (AFFO) = Funds from Operations (FFO) + Non-Recurring Items – Maintenance Capital Expenditures (Capex)
21
Q
What are the 3 Methods of Appraising a Property?
A
Income Approach
property value = net operating income (NOI) / the market cap rate.
Sales Comparison Approach
Comparable properties to estimate the valuation of a property.
Cost Approach
“replacement cost”, the property value is estimated based on the total cost of replacing the property.
22
Q
Walk Me Through the Income Approach (or Direct Capitalization Method).
A
estimates the value of a property based on the income expected to be generated in a one-year time horizon.
Estimated Property Value = Forward NOI ÷ Market Cap Rate
23
Q
What is the Intuition Behind the Cost Approach?
A
no rational investor would pay more for a property than the cost of constructing an equivalent substitute with similar utilities and amenities.
Estimated Property Value = Land Value + (Cost New – Accumulated Depreciation)
24
Q
What Does the Cash on Cash Return Measure?
A
Cash on Cash Return (%) = Annual Pre-Tax Cash Flow ÷ Invested Equity
Annual Pre-Tax Cash Flow → metric is post-financing therefore is a “levered” metric.
Invested Equity → The original equity contribution on the date of property purchase, i.e. the initial cash outlay.
25
What are Vacancy and Credit Losses in Real Estate?
downward adjustment applied to the potential gross income (PGI) of a property to arrive at the effective gross income (EGI)
Vacancy Loss → estimated losses incurred by rental properties left vacant. Usually projected as a percentage of the (PGI)
Credit Loss → losses incurred from a tenant who is unable to fulfill their rent payment obligations on time.
26
What is the Gross Rent Multiplier (GRM)?
ratio between the market value of a property and the property’s expected gross annual rental income. Reflects the estimated number of years needed by a particular property’s gross rental income to pay for itself.
Gross Rent Multiplier (GRM) = Market Value of Property ÷ Annual Gross Income
27
How is the Yield on Cost (YoC) Calculated?
Yield on Cost (%) = Stabilized Net Operating Income (NOI) ÷ Total Project Cost
28
What is the Difference Between Effective Gross Income (EGI) and Net Operating Income (NOI)?
EGI = PGI + Ancilliary Income - Vacancy and Credit Losses
NOI = EGI - OpEx
29
What is the Loan-to-Value Ratio (LTV)?
Loan-to-Value Ratio (LTV) = Loan Amount ÷ Appraised Property Fair Value
30
What Does the Loan-to-Cost Ratio (LTC) Measure?
Loan to Cost Ratio (LTC) = Total Loan Amount ÷ Total Development Project Cost
Total Dev. Costs:
Hard Costs, Soft Costs, Property Purchase (or Acquisition Cost), Operating Expenses (Opex)
31
How is the Debt Yield Calculated?
Debt Yield (%) = Net Operating Income (NOI) ÷ Total Loan Amount
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. debt yield is an unlevered, pre-tax metric (and is capital structure neutral).
32
What is the Operating Expense Ratio (OER)?
measures the percentage of a property investment’s gross income allocated to pay off its operating expenses.
Operating Expense Ratio (OER) = Total Operating Expenses ÷ Gross Operating Income (GOI)
33
What is the Difference Between a Capital Lease and an Operating Lease?
Capital Lease → In a capital lease (or “finance lease”), the lease contract allows the lessee to acquire ownership of the leased asset. GAAP accounting standards mandate the recognition of the lease as an asset. On the other hand, a corresponding liability must be recorded on the balance sheet, and the interest expense tied to the lease is recognized on the income statement.
Operating Lease → In contrast, an operating lease is an agreement in which the ownership of the assets remains with the lessor. The lessor, rather than the lessee, is responsible for any asset-related costs, such as maintenance needs. Unlike a capital lease, an operating lease does not require the lessee to recognize the leased asset on the balance sheet.
34
What is the Equity Multiple?
Equity Multiple = Total Cash Distributions ÷ Total Equity Contribution
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.
35
What is a rental yield
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.
36
What is the Difference Between the Gross and Net Rental Yield?
Gross Rental Yield → The gross rental yield is the rental income of a property relative to its property value, without consideration toward operating expenses
Gross Rental Yield (%) = Annual Rental Income ÷ Property Market Value
Net Rental Yield → identical to the gross rental yield, except for accounting for the property expenses incurred in the day-to-day operations.
Net Rental Yield (%) = (Annual Rental Income – Operating Expenses) ÷ Property Market Value
37
What are Examples of Questions to Ask the Interviewer?
Q. “Could you tell me more about your career path?”
Q. “How has your time working in the real estate industry and this firm been to date?”
Q. “Which specific tasks or responsibilities of your job do you enjoy the most?”
Q. “If you don’t mind sharing, what are some of the near-term and long-term goals you hope to achieve?”
Q. “For which reasons did this firm and strategy appeal to you when recruiting?”
Q. “Which specific trends in the real estate industry are you most optimistic about?”
Q. “Do you have any contrarian predictions on the outlook of the real estate industry?”
Q. “Hypothetically, if you could go back to when you were still getting your undergraduate degree, which advice would you give yourself?”
Q. “Since joining the firm, what are some of the most valuable lessons you’ve learned since joining this firm?”
Q. “What do you credit your past achievements to?”
Q. “Given my past experiences, which areas would you recommend I spend more time on improving upon?”
38
What is the RE Capital Stack
1. Common Equity - riskiest but uncapped upside
2. Preferred Equity - hybrid. Option to include fixed interest and participate in equity upside
3. Mezzanine Debt: Higher interest rate but lower priority
4. Senior Debt: Lowest interest, most significant, first priority
39
What are the four phases of the real estate cycle?
40
What factors influence the real estate cycle?
1. Recovery → Declining Vacancy Rates + No New Construction
2. Expansion → Declining Vacancy Rates + New Construction
3. Hyper-Supply → Increasing Vacancy Rates + New Construction
4. Recession → Continued Increasing Vacancy Rates + Excessive Supply in Market
41
How is the vacancy rate of a commercial property determined?
High Vacancy Rate → Low Market Demand + High Attrition Rate in Existing Tenants
Low Vacancy Rate → High Market Demand + Low Attrition Rate in Existing Tenants
42
Why is the cap rate the inverse of a multiple?
Cap rate is the inverse of a multiple because the net income multiplier (NIM) is the reciprocal of the cap rate.
43
Compare the cap rates for the main property types
44
Explain the relationship between the cap rate and risk
High Cap Rate:
- Riskier, potential, lower price, positive NOI growth
Lower Cap Rate:
- Lower risk, unfavourable market conditions, more secure, lower return
45
What is the difference between the cap rate and cash-on-cash return?
Cap Rate: unlevered cash-on-cash return as of the original date of the acquisition. neglects the effects of financing.
Cash on Cash: levered metric as pre-tax cash flow affected by debt service as well as equity contribution
46
How are property values and NOI multiples affected if the market cap rate rises?
Higher cap rates coincide with lower property values
Higher Cap Rate → Lower Property Value + Lower NOI Multiple
Lower Cap Rate → Higher Property Value + Higher NOI Multiple
47
What are the 3 forms of depreciaiton recognised in RE appraisals
1. **Physical Deterioration**: Tangible wear and tear value loss
2. **Functional Obsoelence**: loss in value due to market shifts
3. **Economic Obsolesence**: loss in value due to external factors such as the local economy
48
What GRM is a good value and how can you use it to calculate property value
most real estate investors target a gross rent multiplier (GRM) around 4.0x to 7.0x.
Gross Rent Multiplier (GRM) approach estimates the value of a property by multiplying the annualized rental income of a property by the GRM ratio.
49
What is the difference between the yield on cost (YoC) and cap rate?
Yield on cost (YoC) is the forward-looking cap rate on property investments since the
computation divides the stabilized, “potential” NOI by the total project cost.
Stabilized NOI of a property is the pro forma NOI on an annualized basis after the new construction and property
development work is completed
50
How does the composition of the total project cost vary by type
The composition of the total project cost varies by the project type:
Development Projects → predominately the purchase price and the developmental costs
Acquisition Projects → On the other hand, the spending on acquisitions is mostly maintenance, fixtures, renovations, and discretionary upgrades since acquired properties can start operating and generating income relatively quickly
51
What are the common direct operating expenses deducted from the EGI
Property Management Fees
Property Taxes
Property Insurance
Maintenance Costs
Repairs
Utilities
52
What are the main costs that NOI neglects
financing costs, federal income taxes, and capital
expenditures (Capex
53
Difference between LTC and LTV
LTV compares to the property value
LTC compares to the total development cost
LTC typically preferred method for investing, LTV for acquisitions
54
From the perspective of a lender, is a higher or lower debt yield preferred?
Lower Debt Yield → If the debt yield is on the lower end, the implied risk to the lender is higher because the property’s
operating cash flows might not meet the mandatory debt service.
Higher Debt Yield → In contrast, the higher the debt yield, the less risk the financing poses due to the reduced likelihood of
the borrower defaulting on the obligation.
55
What does a higher or lower OER indicate
Lower Operating Expense Ratio (OER) → Higher Operating Profitability
Higher Operating Expense Ratio (OER) → Lower Operating Profitability
56
What is a capital lease
* Allows lessee to obtain full ownership of the leased assets
* PV of lease payments capitalised as a fixed asset
* Corresponding liability recording interest on the lease on the income statement
57
What is an Operating Lease
* Asset Ownership in lessor --> leased asset not on lessee's balanced sheet
* Lessor responsiblt for asset-related costs, lease recognised as a liability on the lessor's balance sheet
* Income statement recognises rental expense each period over the lease term
58
Common non-operating expenses in Real Estate
59
What is the IRR in RE investing?
Return that sets the NPV of Assets to 0, such that the PV of the intial investment is = the PV of the cash outflows
Main Sources are NOI Growth and Capital Appreciation
60
How is the IRR function actually calculated
In Excel, the IRR can be determined via the “XIRR” function, which is composed of two arrays:
1. Range of Cash Flow → The net difference between the cash “inflows” and cash “outflows” per period.
2. Range of Dates → The specific timing of each cash flow, formatted as a date
61
Difference between Levered and Unlevered IRR
levered IRR exceeds the unlevered IRR in practically all scenarios.
Greater the spread between the implied levered and unlevered IRR, the more reliant the returns are on debt to reach the target return.
62
What is the difference between the going-in and terminal cap rate?
Going In: expected return on date of property stabilisation
Terminal: estimated return based on projected NOI and sale in the exit year
exit cap rate uses far reaching assumptions
63
Ideal and conservative scenarios for the going in and terminal cap rates
Ideal: going in cap rate>terminal cap rate
Conservative: Terminal cap rate> going in cap rate
64
How does cap rate compression impact property valuation?
Cap Rate Compression → Increase in Property Value (Higher Purchase Price)
Cap Rate Expansion → Decrease in Property Value (Lower Purchase Price)
lower cap rate can signifiy lower risk, but increaess risk of overpayng.
Ideal scenario: cap rate compression + NOI growth
65
How does the interest rate environment impact property values?
Higher IR:
Higher cost of borrowing, reduction in demand, lower valuation --> cap rate expansion
one caveat would be if the supply remains insufficient to meet the current market demand, causing property prices to continue climbing upward even amid rising cap rates and in the face of rising interest rates.
66
What are the three common commercial lease structures?
Triple Net (NNN), Full Service Lease (FS), Modified Gross Lease (MG)
67
Describe the Triple Net (NNN)
* Tenant responsible for all prop. OpEx on top of base rent (incl. property taxes, insurance, maintenance and utilities)
* Rent is lowest
* Most common
68
What is the full service lease (FS)
* Landlord responsible for all OpEx
* Rent is fixed and all inclusive
* More expensive
69
What is the Modified Gross Lease (MG)
* Base rent has a prop. of OpEx while other relevant parties billed separately
* Limited standardisation
70
What does the term “stabilization” refer to in property development?
Meets following criteria:
1. Occupancy Rate → The property (or units) are fully leased or leased near market occupancy.
2. Rent Pricing → The property rent prices charged to tenants are around the market rate.
Most work complete or close to completion, minimial cap ex.
71
What is a good debt service coverage ratio (DSCR) in commercial real estate?
Therefore, real estate lenders often set a minimum DSCR covenant of around 1.2x to ensure the borrower is sufficient to service the debt burden, including a “cushion” to endure periods of underperformance.
The optimal debt service coverage ratio (DSCR) is widely recognized as 1.25x among industry practitioners.
The optimal DSCR ratio of 1.25x implies the property's net operating income (NOI) is 125% of the total debt service.
72
What is the net absorption rate?
measures the current supply and demand in the commercial real estate market (CRE).
The difference between the total amount of leased space, the amount of vacated space, and the amount of net space in a period is the net absorption rate.
Net Absorption = Total Space Leased – Vacated Space – New Space
Positive Net Absorption → more real estate was leased relative to the amount available on the market.
Negative Net Absorption → more real estate became vacant or was placed on the market relative to the amount leased.
73
How does loan sizing work?
Determining appropiate debt burden supported by NOI. 3 ratios:
LTV, DSCR, Debt Yield
LTV Ratio → 70.0%
DSCR → 1.25x
Debt Yield → 10.0%
74
What is the development spread used to determine?
compare the yield obtained from undertaking a real estate development
project to the yield earned on an acquisition of an existing property to determine if the development project is worth committing to from a monetary and time perspective
The greater the development spread, the more economically viable a proposed development project likely is
While there is no set industry benchmark for a “good” development spread, most property developers aim for a target development spread of 1.5% to 2.5% (or ~200 bps).
75
What is breakeven occupancy in commercial real estate?
property's minimum occupancy rate threshold to meet its Opex and DSCR, expressed as a percentage of occupied units.
occupancy rate at which a commercial property changes from an operating deficit to an operating surplus, i.e., the “inflection point.”
76
If a property is a breakeven occupancy, what two criteria are valid
1. EGI = OpEx + Debt Service → If a property is in a state of breakeven occupancy, its effective gross income (EGI) will be
equal to the sum of its total operating expenses (Opex) and debt service obligations.
2. DSCR = 1.0x → For properties at breakeven occupancy, their debt service coverage ratio (DSCR) will be precisely 1.0x.
a lower breakeven occupancy ratio is more favorable since there is
more of a “cushion” for unexpected underperformance.
standard range for the breakeven occupancy ratio in the commercial real estate market (CRE) is between 60% and 80%.
77
What are the step to calculate the unlevered free cash flow of a property?
Unlevered Cash Flow = NOI – Capital Reserves – Capex – Tenant Improvements – Leasing Commissions
Capital Reserves → funds set aside for future Capex requirements and
capital improvements
Tenant Improvements (TI) → property upgrades made to the landlord to accommodate the unique requests of a specific tenant.
Leasing Commissions → fees paid to real estate agents or brokers
78
What are the step to calculate the levered cash flow of a property?
Levered Cash Flow = Unlevered Cash Flow – Debt Service
Debt Service = Annual Mortgage Payments + Interest Expense
79
Suppose a rental property has 100 units available for rent in total, of which 16 are vacant.
What is the property’s vacancy rate (and occupancy rate)?
Vacancy Rate (%) = 16 Units ÷ 100 Units = 16.0%
Occupancy Rate (%) = 1 – 16.0% = 84.0%
80
Suppose a rental property generated $24 million in gross potential rent (GPR) and $1 million in ancillary income. If we assume vacancy and credit losses were 5% of potential gross income (PGI) while operating expenses were $3.75 million, what is the property’s net operating income (NOI)?
Potential Gross Income (PGI) = $24 million + $1 million = $25 million
Vacancy and Credit Losses = 5.0% × £25m = $1.25m
Effective Gross Income (EGI) = $25 million – $1.25 million = $23.75 million
The total direct operating expenses are $3.75 million, which we’ll deduct from effective gross income (EGI) to arrive at a net operating income (NOI) of $20 million.
Net Operating Income (NOI) = $23.75 million – $3.75 million = $20 million
81
Suppose a rental property generated $100k in NOI, and the market cap rate is 8%.
Estimate the market value of the property as of the present date.
Property Value = $100k ÷ 8.0% = $1.25 million
dividing the annual NOI by the market cap rate, we estimate the property's market value to be $1.25 million.
82
Suppose the forward NOI of a property is $420k while the market cap rate is 6%. What is the implied property value?
Forward NOI = $420k
Market Cap Rate = 6.0%
Property Value = $420k ÷ 6.0% = $7 million
83
Suppose a REIT reported $1.2 million in net income.
Calculate FFO given the following
adjustments: $800k D&A, $600k Gain on Asset Sale, $400k Loss on Asset Impairment, and
$200k in FFO Attributable to Non-Controlling Interest (NCI).
FFO = Net Income + D&A - Gain on Asset Sales + Loss on Asset Impairments - FFO attributable to NCI
Depreciation and Amortization (D&A) = $800k
Gain on Asset Sale, net = ($600k)
Loss on Asset Impairment, net = $400k
FFO Attributable to Non-Controlling Interest (NCI) = ($200k)
The “Gain on Asset Sale” and “Loss on Asset Impairment” are non-recurring so the gain is subtracted while the loss on asset impairment is added back to remove the effects
Funds from Operations (FFO) = $1.2 million + $800k – $600k + $400k – $200k = $1.6 million
84
Calculate the AFFO of the REIT from the prior example assuming $400k in maintenance Capex and a downward adjustment of $100k in straight-line rent.
Past: Suppose a REIT reported $1.2 million in net income.
Calculate FFO given the following
adjustments: $800k D&A, $600k Gain on Asset Sale, $400k Loss on Asset Impairment, and
$200k in FFO Attributable to Non-Controlling Interest (NCI).
$1.6 million in FFO
Maintenance Capital Expenditures (Capex) = ($400k)
Straight-Line Rent Adjustment = ($100k)
AFFO = FFO - Maintenance CapEx - Straight Line Rent Adjustment
Adjusted Funds from Operations (AFFO) = $1.6 million – $400k – $100k = $1.1 million
85
Estimate the value of an investment property expected to generate $200k in NOI at an 8% market cap rate.
Estimated Property Value = $200k ÷ 8.0% = $2.5 million
86
Suppose a property was acquired for $100k at a 10% cap rate using 75% leverage with a 5% interest rate. What is the cash-on-cash return?
Net Operating Income (NOI) = 10% × $100k = $10k
Interest Expense = (75% × $100k) × 5.0% = $4k
Deduct the interest expense from NOI to calculate the levered pre-tax cash flow. Since there is no principal
amortization, assuming the loan is non-amortizing (i.e., interest-only) is reasonable.
Levered Pre-Tax Cash Flow = $10k – $4k = $6k
Equity Contribution ($) = 25% × $100k = $25k
Determine the cash-on-cash return by dividing the levered pre-tax cash flow by the initial equity contribution.
Cash-on-Cash Return (%) = $6k ÷ $25k = 25.0%
87
Suppose a commercial building was purchased for $20 million using 80% leverage.
What is the required sale price to achieve an equity multiple of 2.0x?
Total Loan = $16 million
Initial Equity Contribution = $4 million
Required sale price is the sum of the exit equity value and total loan balance.
Sale Price = $8 million + $16 million = $24 million
88
Suppose a rental property is currently on the market with an asking price of $1 million. Given a 5% cap rate and 50% leverage ratio, calculate the interest rate at which the breakeven point is reached
Net Operating Income (NOI) = 5.0% × $1 million = $50k
Total Loan Balance = 50.0% × $1 million = $500k
breakeven point is where NOI equals the interest expense
$500k × Interest Rate (%) = $50k
Breakeven Interest Rate (%) = $50k ÷ $500k = 10.0%
89
Suppose a rental property generated $200k in potential gross income (PGI) with vacancy and credit losses expected to be 5.0% of PGI. If operating expenses are $90k while the annual
debt service is $40k, what is the cash-on-cash return if the equity investment is $750k?
Effective Gross Income (EGI) = $200k – $10k = $190k
Net Operating Income (NOI) = $190k – $90k = $100k
Annual pre-tax cash flow from NOI can be calculated by deducting the annual debt service
Annual Pre-Tax Cash Flow = $100k – $40k = $60k
Equity Invested = $750k
Cash-on-Cash Return (%) = $60k ÷ $750k = 8.0%
90
Suppose a residential building has 50 rental units, and the monthly market rate rent is $4k. If the property's market value is $12 million, what is the gross rent multiplier (GRM)?
Gross Rental Income = 50 Units × $4k × 12.0x = $2.4 million
(GRM) can be calculated by dividing the property value by the gross rental income
Gross Rent Multiplier (GRM) = $12 million ÷ $2.4 million = 5.0x
91
Suppose a commercial property is expected to generate $800k in EGI and $320k in direct operating expenses at stabilization.
If the total development cost is $4 million, calculate the yield on cost (YoC).
Stabilized NOI = $800k – $320k = $480k
divide the stabilized NOI by the total
development cost to arrive at a yield on cost (YoC
Yield on Cost (YoC) = $480k ÷ $4 million = 12.0%
92
Suppose a real estate investor acquired a property for $2 million that generated $300k in annual cash distributions for the next five years.
If the property is sold at the end of Year 5 at a sale price of $2.5 million, what is the equity multiple?
Property generates $300k in annual cash distribution from Year 1 to Year 5, which amounts to $1.5 million
Total cash distribution – the sum of each net cash flow (NCF), excluding Year 0 – is $4 million.
Equity Multiple = $4 million ÷ $2 million = 2.0x
93
Suppose a property appraised at a fair value of $600k is acquired using 75.0% leverage.
What is the implied down payment by the investor and loan-to-value ratio (LTV)?
Mortgage Loan = 75.0% × $600k = $450k
Implied Down Payment = $600k – $450k = $150k
75.0% loan-to-value ratio (LTV)
94
Suppose a commercial real estate investment firm is considering a potential development project to build an office building. The stabilized NOI is projected to be $5 million, while the
total development cost is around $47.5 million. What is the development spread if the market cap rate is 8%?
(YoC) by dividing the property’s stabilized NOI by the total development cost
Yield on Cost (YoC) = $5 million ÷ $47.5 million = 10.5%
Development Spread (%) = 10.5% – 8.0% = 2.5%
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Suppose a lender has set the maximum loan-to-cost ratio (LTC) at 80.0%. What is the required equity contribution if the total development cost is $40 million?
Equity Contribution = $40 million – $32 million = $8 million
Because there are no other funding sources, the $8 million represents the 20% equity investment necessary for the financing arrangement to be approved.
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Suppose a rental property has 40 units, and the current market rent is $4k monthly. What is the breakeven occupancy rate if the property’s total operating expenses and debt service
are $100k and $40k, respectively?
Potential Gross Income (PGI) = 40 Units × $4k × 12.0x = $160k
Total Opex + Debt Service = $100k + $40k = $140k
Dividing the total Opex and debt service by the PGI, breakeven occupancy ratio of 87.5%.
Breakeven Occupancy Ratio (%) = $140k ÷ $160k = 87.5%
Breakeven occupancy ratio multiplied by the total number of units to compute the number of occupied units
necessary for the property to reach its breakeven point.
Occupied Units = 87.5% × 40 Units = 35 Units
The product of the occupied units, market-rate rent, and annualization factor is $140k, equivalent to the total Opex and annual debt service, i.e., the property is at breakeven occupancy.
Effective Gross Income (EGI) = 35 Units × $4k × 12.0x = $140k
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Suppose a building expected to generate $10k in cash flow per year was acquired for $100k.
If the holding period was five years, after which the property was sold for $150k, what is the unlevered IRR?
e total cash distribution is $200k, while the equity contribution – assuming the purchase was funded using no debt – was $100k
MOIC is 2.0x
Since investment double in 5 years, estimated IRR is 15%
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If an investment doubles over 5 years, what is the IRR
15%
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If an investment doubles or triples in 1 year, what is the IRR
2.0x in 1 yr --> 100% IRR
3.0x in 1 Year --> 200% IRR
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If an investment doubles or triples in 2 years, what is the IRR
Doubles in 2 years --> 40% IRR
Triples in 2 years --> 75% iRR
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If an investment doubles or triples in 3 years, what is the IRR
Doubles in 3 yrs --> 25% IRR
Triples in 3 years --> 45% IRR
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If an investment doubles or triples in 4 years, what is the IRR
Doubles in 4 Years --> 20% IRR
Triples in 4 years --> 30% IRR
103
If an investment doubles or triples in 5 years, what is the IRR
Doubles in 5 years --> 15% IRR
Triples in 5 years --> 25% IRR
104
Suppose a property is purchased for $1 million at a 60% leverage ratio. The property generates
$50k in annual NOI across the 5-year holding period. If the investment is sold at the end of Year 5 at a
4% terminal cap rate. What is the equity multiple?
Cumulative NOI = $60k × 5 Years = $300k
Terminal Value = $60k ÷ 4.0% = $1.5 million
exit equity value determined by adjusting the terminal value by the debt paydown (“outflow”) and cumulative NOI (“inflow”).
Exit Equity Value = $1.5 million – $600k + $300k = $1.2 million
After dividing the exit equity value by the initial equity contribution, we arrive at an equity multiple of 3.0x, meaning that the investor’s equity tripled in size.
Equity Multiple = $1.2 million ÷ $400k = 3.0x
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Suppose a building was acquired at a 6% entry cap rate for $10 million. If the acquisition was funded using 60% leverage, priced at a 5% cost of debt, what is the DSCR in Year 1?
Net Operating Income (NOI) = $10 million × 6.0% = $600k
Annual Debt Service = 5.0% × $6 million = $300k
Debt Service Coverage Ratio (DSCR) = $600k ÷ $300k = 2.0x
106
Compare the cap rates and risk profiles for each of the main property types.
highest cap rate (most risky) to lowest cap rate (least risky) – hotel, retail, office, industrial, multifamily.
Hotels highest cap rates because cash flow is driven by nightly stays (extremely short-term leases) and more operationally intensive activities like restaurants and conferences.
The creditworthiness of retail tenants is increasingly in question due to trends in e-commerce.
The office sector is closely correlated to the broader economy but has longer-term leases.
The industrial sector benefits from e-commerce trends, longer-term leases, and simple operations.
Multifamily is thought of as the safest asset class because no matter how the economy is performing, people will need a place to live.
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Walk through a basic cash flow proforma for a real estate asset.
Top line is revenue which will be primarily rental income and other revenue lines. Include deductions for vacancy and leasing incentives like rent abatements and concessions.
After revenues, you subtract all operating expenses to get to NOI. After NOI, you subtract any capital expenditures and account for the purchase and sale of a property. This will get you to unlevered cash flow. To get from unlevered to levered cash flow, you subtract financing costs.
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What is Implied and Actual Cap Rate: What is the difference?
Implied Cap Rate reflects a pro-forma estimate
Implied Cap Rate = Stabilized NOI ÷ Purchase Price
Actual Cap Rate = NOI at Exit ÷ Sale Price
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Common CRE Appraisal Methods
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Property Value by GRM
Property Value, Gross Rent Multiplier (GRM) = Annual Gross Rental Income × Gross Rent Multiplier (GRM)
That said, the operating expenses incurred by the property – e.g. property taxes, insurance, repairs or renovations, and utility bills – are neglected.
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What affecrs CRE Valuations
112
Difference between Cash on Cash Return and ROI
Cash on Cash Return (%) = Annual Pre-Tax Cash Flow ÷ Invested Equity
ROI covers the entire holding period and accounts for debt and equity investments.
If debt financing was used as part of the transaction then the actual cash return on the investment diverges from the return on investment (ROI).
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Good Cash on Cash?
real estate market consensus is that a forecasted cash-on-cash return between 8% and 12% is considered a worthwhile investment.
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Optimal Capital Stack values of LTV, DY, DSCR
1. LTV - 75%
2. DY - 8 to 12%
3. DSCR -
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What is a Real Estate Waterfall
tier-based model for measuring the proper distribution of proceeds between a general partner (GP) and its limited partners (LPs).
pecking order via which the distributable proceeds of a fund (or “profits”) must be issued and the timing of each payoff is established by the equity waterfall.
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GP def.
General Partner (GP) → The general partner (GP), or “sponsor”, is the active manager of an investment fund responsible for deal origination (i.e. sourcing potential investments), performing diligence, and managing the properties post-acquisition
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LP Def.
Limited Partners (LPs) → The limited partners (LPs) are the capital providers of the fund. By committing capital to the fund, the LPs are passive investors, for whom the GP is investing.
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What is Preferred Return and Promote (Carried Interest)
Preferred Return (“Pref”) → Once the LPs are “made whole”, subsequent tier is the preferred return. Usually ranges between 6% to 8% on an annual basis
Promote (Carried Interest) → performance-based contingency payment and can be thought of as the reward earned by the general partner (GP) for meeting the pre-determined return target.
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Clawback Provision
The carried interest received by the General Partner (GP) that must be returned to the Limited Partners (LPs) from not meeting the minimum hurdle rate.
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Contribution
The distribution of capital by the Limited Partners (LPs) of the fund to fulfill a capital call request by the General Partner (GP) to fund an investment.
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American Waterfall (“Deal-by-Deal”)
The general partner (GP) receives carried interest on a per-investment basis, irrespective of the fund’s performance as a whole (or individual performance of other holdings).
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European Waterfall (“Whole Fund”)
The general partner (GP) collects carried interest only after the requirement for the original capital contributions, inclusive of fund fees and expenses, are returned in full to the limited partners (LPs) is met.
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Limited Partnership Agreement (LPA)
The contract between the general partner (GP) and limited partner (LP) to formalise the terms of the agreement, namely the profit share structure.
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What is the Catch-Up Provision
**Catch-up provision**:
investor receives 100% of all profit distributions until a predetermined rate of return is met. Once the investor attains the required return, all distributable proceeds are allocated to the sponsor. The investor (LP) receives a full share of the profit until a specified return is achieved under the catch-up provision, until the general partner (GP) reaches parity with the limited partners (LPs).
**Lookback Provision**:
The lookback provision provides a fund’s limited partners (LPs) with the right to “look back” and retrieve distributed profits back from the general partner (GP), even if the proceeds were issued to the GP. The rationale for the inclusion of the provision is that if the general partner (GP) is unable to generate a predetermined return for the limited partners, the LPs have the right to collect more proceeds to improve their poor returns.
The lookback provision offers sponsors with the option to allocate funds on investments, even if those proceeds must be returned later – hence, general partners (GPs) tend to view them favorably. In contrast, limited partners (LPs) prefer the catch-up provision, considering the receipt of an upfront payment without the need to request reimbursement from the sponsor at a later date.
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How to build a RE Waterfall
Step 1 → Quantify the Net Cash Flow (NCF) Available for Distribution (Sum of Levered Cash Flow, including the Purchase Outflow and Sale Proceeds)
Step 2 → Solve for the Minimum Cash Required to Meet Each Hurdle (Delta Between the Current and Prior Hurdle)
Step 3 → Input the Profit Split at Each Hurdle (Note: Profit Split ≠ Ownership Split)
Step 4 → Calculate the Cash Flow Attributable to Each Partner (Including Promote) at Each Hurdle
Step 5 → Multiply the Required Cash Balance at Each Hurdle by the Coinciding Profit Split
Step 6 → Reduce Net Cash Flow (NCF) Available for Distribution by the Cash Flow at Each Hurdle
If the model is adjusted properly, there should be no cash remaining to distribute after reaching the final hurdle.
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What is going in cap rate
Stabilised NOI / Total Project Cost
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What is Exit Cap Rate
Expected NOI / Terminal Value
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What is the Cap Rate Spread
Cap Rate Spread = Cap Rate (%) – 10-Year Treasury Yield (%)
Cap Rate comparable to expected return. Cap Rate (%) = Risk-Free Rate (rf) + Risk Premium
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Cap Rate Spreads Implications
High Cap Rate Spread → economy is likely underperforming, and will continue trending downward.
Low Cap Rate Spread → periods of economic stability, positive growth, and an optimistic near-term outlook among investors.
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How Do Rising Interest Rates Affect Cap Rates?
Rising Interest Rates → cost of borrowing increases in tandem, effectively reducing the purchasing power of market participants and the affordability of properties.
Declining Interest Rates → cost of borrowing declines, meaning there is more “cheap” capital readily available, which increases the purchasing power
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3 Fundamental components of cap rates
Risk-free rate
Change in NOI
Pure Risk Premium
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Definition of stabilised NOI
The stabilized NOI reflects a “steady state” level of operations.
property is fully operational, either in proximity or at its profit potential. Thus, stabilized properties are property investments in which the necessary (or discretionary) construction, repair, and renovation work is complete.
Stabilised property must exhibit an occupancy rate, indicative of the occupancy once the property is no longer under construction and fully operational.
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NOI vs EBITDA
NOI and EBITDA measure operating profitability
NOI intended for Real Estate properties --> add-backs to isolate real estate income generation such as excluding SG&A. NOI accounts for lost revenue caused by tenancy vacancies.
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What expenses does NOI eliminate
NOI eliminates the effects of these corporate-level expenses by isolating the core operating profits of the real asset in question, namely by excluding non-operating items such as depreciation, interest, taxes, corporate-level SG&A expenses, Capex, and financing payments.
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What is the NOI yield
NOI Yield (%) = Net Operating Income (NOI) ÷ Property Purchase Price
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What does the Purchase PRice in RE formulas include
The purchase price includes not only the cost of acquiring the property, but also any other transaction-related expenses like consulting fees, appraisal fees, etc.
137
What does NOI yield contain compared to the cap rate
The NOI yield represents the annual rate of return received by a real estate investor based on the income generated by the property and the purchase price paid to acquire the property.
Unlike the cap rate, which is usually computed as the NOI divided by the market value of the property, the NOI yield is the annual NOI divided by the total purchase price.
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What are CFADS
Cash Flow After Debt Service
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Is NOI Yield a levered or unlevered metric, if so why?
Since NOI is an unlevered metric (rather than CFADS), the output reflects the unlevered yield on property investments
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Whats the difference between NOI Yield vs Cap Rate
cap rate calculated by dividing the net operating income (NOI) of a property by its current market value, whereas the NOI yield divides NOI by the total purchase price
Priority of the NOI yield is to understand the return attributable to income, as opposed to capital appreciation --> cap rate fluctuates based on market value whereas NOI yield remains constant
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How does the income approach treat the NOI of a Property
Treats it as a perpetuity; constant stream of cash flows disocunted using a hurdle rate based on market (cap rate; rate of return used as of present to capitalise future income into a market value as of the present date)
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What are the 3 assumptions that underpin the income approach
Long-Term Investors → The market participants purchase properties for their potential to generate future income and provide long-term benefits.
Rational Market → The investors in the market are rational in that the quality and quantity of the property’s anticipated income stream are closely considered.
Time Value of Money (TVM) → The time value of money (TVM)—the premise of fundamental intrinsic value—states that “a dollar today is worth more than a dollar received on a future date”.
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What are the common operating expenses deducted from the NOI
Common operating expenses deducted from net operating income (NOI) include the following:
Property Insurance
Property Tax
Maintenance Costs
Repair Fees
Utilities
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What is the Yield Capitalisation Method
1. Long-term projection with pro-forma NOI adjusted for vaacancy losses, credit and oeprating expenses etc.
2. Project till adjusted NOI Metric in the final year of the pro forma forecast
3. Final Year NOI divided by terminal cap rate (from comps)
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What is the Direct Capitalisation Method and how does it differ to Yield Capitalisation
Direct estimates value based on NOI produced in a one year time horizon. Project stabilised NOI and divide by appropiate cap rate
Implicit assumption that income and costs remain stable over a year, best method for properties with a track record. Yield methjod is suitable for volatile investments.
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What is the equaiton for property valuation via the cost approach
Propetry Value = Land Cost + Cost New - Accumulate Depreciation
cost approach estimates the value of a property based on the value of the underlying land on which the property was constructed, the replacement (or reproduction) cost, and the accumulated depreciation of the improvements.
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When is the cost method most used
When there is limited or no market data on comparable properties
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Step by Step Property Valuation via the Cost Approach
Estimate Land Value → Estimate the value of the land by analyzing recent sale data on comparable, vacant land parcels. Make discretionary investments case by case.
Estimate Replacement Cost of Improvements → Estimate the cost to reconstruct the property and improvements, inclusive of direct and indirect costs, either the square foot method or the unit-in-place method is used here.
Estimate Accumulated Depreciation → Estimate the depreciation expense, which pertains to the losses in property value from age, wear and tear, deterioration in building components, functional obsolescence, and external obsolescence.
Calculate Sum of Land Value and Depreciated Improvement Cost → The implied property value under the cost approach method equals the estimated land value, net of the accumulated depreciation cost tied to the improvements.
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What type of depreciation does the accumulated depreciation in the cost valuation approach include
Physical Deterioration → The tangible losses in property value from the “wear and tear” starting from the initial date on which the construction was completed.
Functional Obsolescence → The losses in the market value of a property due to factors such as subjective consumer preferences, technological innovations, or unfavorable shifts in market standards.
Economic Obsolescence → The losses in property value caused by external factors that pertain to the property’s location, such as the local economy and environment.
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What are the 2 definition of the 'Cost New' in the Cost Valuation Formula
Replacement Cost New → The replacement cost is the current amount it would cost to rebuild a property using current standards for construction material, layout, and design.
Reproduction Cost New → In contrast, the reproduction cost is the cost to rebuild the property using identical materials, design, and standards that were in place on the date of the initial construction.
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When is the direct capitalisation approach used, and what are the main drawback
direct capitalization method is most reliable for stabilized, income-generating properties, where there is more than sufficient market data to support the validity of the cap rate assumption.
drawback to the direct capitalization method is the implicit assumption that NOI (and operating costs) will remain constant, i.e. the stabilized NOI reflects the income of the property going forward.
With that said, the direct capitalization method is thus most suitable for properties that generate consistent income, where the projected NOI at stabilization is not too far-fetched (and is backed by historical data).
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What is the ARV (After Repair Value)
ARV = Purchase Price + Renovation Costd
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In what context is ARV used and how does it show return
Used in a value-add strategy; acquiring a property to raise the rent of an existing property through tangible improvements
If the impact on the pricing rate increases while the occupancy rate remains stable (or improves), then the after-repair value (ARV) of the property increases – all else being equal.
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Why must a value add investor first implement tangible improvements before raising the rental price
Else the renewal rate and occupancy rate would reduce as existing tenants will sign elsewhere
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In the ARV Formula, what is the sign of Renovation Costs
The value of renovations, on the other hand, is the sum of all repair, renovation, and related spending activities.
Note: While the cost of renovation is a cash outflow, the value of the spending is input as a positive figure here, rather than a negative integer.
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How Do Existing Tenants Impact the After-Repair Value?
If there are existing tenants at the acquired rental property, the new owner must first strictly abide by the tenants’ leasing agreements with prior management until the lease terms come to an end.
The rental payments from the occupied units can offset some of the foregone rental income, contributing a stable stream of income for the property owner while changes are made elsewhere.
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Yield on Cost (Development Yield) Formula
NOI / Total Project Cost
NOI - Proforma Annual Stabilised
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What is the Yield on Cost and Cap Rate difference
Cap Rate uses FMV while YoC uses Total Development Cost
YoC is essentially a **forward looking cap rate**
YoC carries more uncertainty since NOI must be stabilised and development work has not yet started
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What is the development spread
Difference between YoC (Going In Cap Rate) and market cap rate (going-out cap rate)
Development Spread (%) = Yield on Cost (YoC) – Market Cap Rate
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What is Yield on Cost method
YoC Metric is a "back-of-the-envelope" method to determine the trade off for a potential property development investment
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What is a Good Development Spread?
While there is no set industry benchmark for what constitutes a “good” development spread, per se, most real estate developers target a development spread of around 1.5% to 2.5%.
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What is the development yield
Stabilised Annual NOI / Total Development Cost
Essentially the **potential ROI on a development project**
Total Development Cost includes the cost of acquisition and development
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What is a Good Development Yield?
contingent on the investment type and amount of development occuring
Higher development yield is more attractive generally
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What is the difference between Development Yield and Cap Rate
The cap rate is the ratio between the annual NOI and the fair market value (FMV) of the property, whereas the development yield is the ratio between the stabilized NOI and total development cost.
development yield concept can be thought of as the “forward-looking” cap rate
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What is Loss to Lease
difference between a unit’s market rental rate and the actual rent stated on the signed lease agreement.
Loss is nominal rather than monetary
Loss to Lease (LTL) = (Market Rental Rate ÷ Actual Rental Rate) – 1
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Loss to Lease (LTL) vs. Gain to Lease (GTL): What is the Difference?
inverse of the “loss to lease” is termed the “gain to lease”
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What is Equity Multiple?
Equity Multiple = Total Cash Distributions ÷ Equity Contribution
Total Cash Distributions (“Inflows”) → The cash retrieved from an investment over the holding period.
Equity Contribution (“Outflow”) → The total equity investment contributed by the investor on the original date of purchase.
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Equity Multiple vs. IRR: What is the Difference?
Equity Muiltiple neglects the time value of money whereas the IRR does to makje the NPV of a projects cash flow to be 0
High IRR + Low Equity Multiple → A property investment could yield a high IRR, but a sub-par equity multiple if the timing and cash proceeds were received earlier, i.e. the earlier receipt of cash distributions can distort the IRR metric.
Low IRR + High Equity Multiple → Conversely, a property investment could have a high equity multiple, but a lower IRR if the cash flows are spread across a longer time span.
170
What is a good Equity Multiple
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Equity Multiple vs. Cash on Cash Return: What is the Difference?
Cash on Cash Return – The cash on cash return is the ratio between the **annual pre-tax cash flow** the investor earns on property investment and the** invested equity in the coinciding period**, expressed as a percentage.
Equity Multiple – The equity multiple measures the **total return on the investment** and is calculated by dividing the **total cash received by the total equity invested** i.e. the cash received per dollar invested.
The cash-on-cash return offers a “snapshot” of the annualized return relative to the cash investment, with consideration toward only the cash income generated by the property.
On the other hand, the equity multiple is the ratio between the total return – from the initial purchase date to the exit date – relative to the equity invested.
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What is Net Rental Yield
Net Rental Yield (%) = (Annual Rental Income – Operating Expenses) ÷ Property Value
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Gross Rental Yield vs. Net Rental Yield: What is the Difference?
Gross Rental Yield → without consideration toward operating expenses such as property management fees, repairs or vacancies.
Net Rental Yield → accounting for the property expenses incurred as part of running the day-to-day operations.
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What is the implication of a higher rental yield
Generally speaking, a higher rental yield implies more profits and a better return on investment (ROI) in the property – all else being equal.
a rental yield between 5% to 8% is a decent starting point
175
Common OpEx that the net rental yield factors
Property Management Fees
Maintenance Costs (Repair, Renovation, etc.)
Building Inspection Fees
Property Taxes
Property Insurance
176
What is Levered IRR?
177
Difference between Levered and Unlevered IRR
178
Why does the levered IRR exceed the unlevered IRR in all cases
Debt financing means the equity contribution is lower thus a higher IRR
thus the return is lower for nearly any given investment
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What does the magnitude of the spread between levered and unlevered IRR signify
The greater the spread between the levered IRR and unlevered IRR, the more reliant the anticipated investment returns are on leverage.
Drawback to leverage is the potential downside risk created by placing a debt burden on the property.
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investment returns in cre come from which 2 sources
Cash Flow Growth → The growth in cash flow (or income) generated by a property stems from improvements in operating efficiency, in which more value is extracted from tenants (e.g. increase in rent prices). Further, there should be an expansion in the margin profile of the investment property, such as its NOI margin, from these initiatives to reduce costs.
Capital Appreciation → The capital appreciation concept refers to the value of an investment property increasing relative to the original purchase cost. Similar to achieving multiple expansion in LBOs, where the exit multiple is higher than the purchase multiple, the sale price at exit exceeds the acquisition price on the date of initial purchase.
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unlevered and levered cash flow formula
Unlevered Cash Flow (UCF) = Net Operating Income (NOI) – Capital Reserves – Capex – Tenant Improvements – Leasing Commissions
Levered Cash Flow (LCF) = Unlevered Cash Flow – Debt Service
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should you use leverage as a primariy investment strategy
If sufficiently meeting the minimum target return is contingent on the substantial use of leverage, the investment opportunity may be considered as riskier and might not be worth pursuing.
Simply put, using debt as a primary strategy to create value by itself is far riskier relative to plans to facilitate growth in net operating income (NOI) and capital appreciation from identifying favorable market trends or implementing improvements to properties.
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What is an Equity Dividend Rate
Equity Dividend Rate (EDR) = Before-Tax Cash Flow (BTCF) ÷ Initial Equity Contribution
annual cash yield received by an investor on a stabilized real estate property investment, after deducting financing costs.
Before-Tax Cash Flow (BTCF) → The pre-tax income of the property investment at stabilization. levered cash flow metric since the annual debt service, which includes principal amortization and interest, is accounted for.
Initial Equity Contribution → The equity investment on the date of the original property acquisition
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What is Real Estate Investment Payback Period?
Conceptually, the real estate payback period measures the recovery time in which the investment property remains unprofitable (and thus operates at a loss).
Investment Payback Period = Property Value ÷ Annual Return
Property Value → The property value, or total cost, is the total spend while completing the property investment, including the direct property-level expenses incurred across the holding period.
185
What is a Good Payback Period in Real Estate Investing?
186
What is GRM (Gross Rent Multiplier)
Gross Rent Multiplier (GRM) = Fair Market Value (FMV) ÷ Annual Gross Income
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What is Gross Income Multiplier?
Gross Income Multiplier (GIM) = Property Sale Price ÷ Effective Gross Income (EGI)
Property Sale Price → The stated selling price of the property that is currently on the market for sale.
Effective Gross Income (EGI) → The total income generated by the property across one year, prior to subtracting operating expenses.
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Gross Rent Multiplier (GRM) vs. Gross Income Multiplier (GIM)
Gross Income Multiplier (GIM) → In contrast, the gross income multiplier (GIM) is more inclusive since all forms of income generated by the property are factored into the metric rather than just rental income. Hence, the gross income multiplier is more frequently used in commercial properties with multiple streams of income.
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Net Income Multiplier (NIM)
Net Income Multiplier (NIM) = Property Purchase Price ÷ Net Operating Income (NOI)
