Commercial Real Estate Financial Analysis
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The document discusses analyzing value-added commercial real estate investments from both a debt and equity perspective. Value is increased by raising revenue through improving occupancy, lease rates, and tenant quality or lowering expenses. Key metrics for evaluating deals include increasing cash-on-cash returns, debt service coverage ratios, and gross profits to account for risk and time to complete improvements. Exit strategies like refinancing or sale require analyzing stabilized income and market conditions.
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Commercial Real Estate Financial Analysis
- 1. Financial Analysis of Value-Added Commercial Real Estate Projects
- 8. Underwriting the Value-Added Loan
- 10. The Capital Structure Based on Costs 20%-100% Sponsor Equity - Highest Risk - First Loss Piece - Profit Equals Difference in Cost and Value B 65%-80% 1 st Mezzanine - Current Yield/IRR: 8-12% - Typically pays current, but may accrue A 0%-65% Senior Debt - First Trust - Lower Rate/Lower Risk/Pays current - Required Yield: 6-8%
- 14. Exit Strategies
- 18. Value Added Investing: Metrics
Hinweis der Redaktion
- Introduce the module by first discussing the learning objectives. Essentials for the Development Process © NAIOP. Do not distribute or reproduce without permission.
- Discussion Question : Ask students to identify ways in which an investor can (1) increase the property’s net cash flow, (2) increase revenue, (3) decrease expenses, (4) and/or lower the risk of the cash flow stream. Essentials for the Development Process © NAIOP. Do not distribute or reproduce without permission.
- Discuss how each of the following increase revenue and/or lower the risk of the cash flow stream: Changing the Tenant Mix Generally, changing the tenant mix can increase value. By increasing the occupancy, rental income increases and the risk of losing existing tenants decreases. Increasing the lease rate to market levels may also increase rental income. Strengthening or lengthening lease terms provide the investor with a more certain stream of cash flow for a longer period of time. Rehabilitating the Asset Maintaining the asset and investing in capital improvements can increase the asset’s life and can attract new and better tenants, which can lead to higher occupancy, higher lease rate, longer lease term, and better tenant credit. Repositioning the Asset Additions to the asset or completely changing the asset’s use can reposition the asset in the market, and increase revenue or lower the risk of cash flows Essentials for the Development Process © NAIOP. Do not distribute or reproduce without permission.
- Discuss how each of the following increase revenue: Rolling Existing Leases – Changing the tenant mix can allow the investor to bring in new tenants at higher rents, thereby increasing rental income. Submarket Story – Activity in the area around the asset, such as new infrastructure, employment centers, etc., can increase demand for space in the asset. This increased demand will also drive rents higher, thus increasing rental income. Essentials for the Development Process © NAIOP. Do not distribute or reproduce without permission.
- Decreasing operating expenses can increase the revenue of an asset, and can be accomplished in several ways: Insurance – Maintenance – Routine property maintenance can reduce the risk of a much more costly improvement. Management – Reserves – Often difficult to achieve much of a decrease unless the property has been mismanaged. Essentials for the Development Process © NAIOP. Do not distribute or reproduce without permission.
- Discuss the examples of how value is added to each of the different types of commercial property. Essentials for the Development Process © NAIOP. Do not distribute or reproduce without permission.
- General Value Added Characteristics Value added assets assume that value can be increased by increasing the cash flow the asset generates. The Value Added Loan Because there is only a “bet” that value will be increased, the Value Added Loan is riskier and thus leveraged and priced higher than stabilized transactions and loans. Additionally, bridge financing, mezzanine debt, and equity joint ventures are more commonly used for these deals because of the added risk. Essentials for the Development Process © NAIOP. Do not distribute or reproduce without permission.
- Here is an example of a capital stack for an value-added investment. Notice each level of financing increases in risk, as seen in their increasing rate of returns, as we work our way up the stack. Essentials for the Development Process © NAIOP. Do not distribute or reproduce without permission.
- Explain why each piece of basic information is important to making an investment decision. Capital Structure – It is important for investors to know what they need and how the capital structure works to understand their stake in the investment, where he or she stands for recovery in line in the event of default or foreclosure, etc. Sources & Uses – Knowing where the capital is coming from and what it is going towards is also important. The capital should be coming from a reliable source and the borrower should be using the capital in such a way that it will add value to the asset. Capital Improvement Budget – Provides a framework for what improvements are planned to be made and how much will be spent on each improvement. Essentials for the Development Process © NAIOP. Do not distribute or reproduce without permission.
- Continue to explain why each piece of basic information is important to making an investment decision. Current & Historical Operating Statements – These statements provide a good reference point for the estimated value of the asset. Comparing the historical NOI and the Pro forma NOI can show the investor how accurate the estimated asset value is. Rent Roll – Knowing who the tenants are and the terms of their leases is also important because it can provide a better estimate of the rental income the property generates. Can allow for the analysis of leasing risk due to tenant lease expirations, estimated capex (TI and LC) Essentials for the Development Process © NAIOP. Do not distribute or reproduce without permission.
- Continue to explain why each piece of basic information is important to making an investment decision. Project Pro Forma – Viewing a project’s Pro Forma can provide an investor with a better idea of the potential cash inflows and thus the value of the asset. Exit Value – The exit value determines the value when the property is stabilized and sold or held by the equity investor. Other Helpful Information – Other information that might be helpful in making the underwriting decision include a site plan, aerial photos, an appraisal, market sale comps, and market lease comps. Essentials for the Development Process © NAIOP. Do not distribute or reproduce without permission.
- Refinancing is usually much cheaper than the sales process because you do not have to pay transfer taxes and you defer paying capital gains taxes; however, loan fees, lawyers’ fees, and accounting fees are likely to be realized. Source: Linneman, 2008 Essentials for the Development Process © NAIOP. Do not distribute or reproduce without permission.
- The Sale Exit strategy is more profitable than refinancing, but it is not without its taxes and fees. Finding a buyer can be difficult for which a broker’s services are solicited. Once a buyer has been found, the investor receives what is left after debt, fees, capital gains taxes, and depreciation taxes have all been repaid. Source: Linneman, 2008. Essentials for the Development Process © NAIOP. Do not distribute or reproduce without permission.
- These calculations will be covered in the case study Essentials for the Development Process © NAIOP. Do not distribute or reproduce without permission.
- These calculations will be covered in the case study Essentials for the Development Process © NAIOP. Do not distribute or reproduce without permission.
- These calculations will be covered in the case study Essentials for the Development Process © NAIOP. Do not distribute or reproduce without permission.
- These calculations will be covered in the case study Essentials for the Development Process © NAIOP. Do not distribute or reproduce without permission.
- Essentials for the Development Process © NAIOP. Do not distribute or reproduce without permission.