Real estate DCF question (interview is tomorrow pls help)
Hey guys I'm preparing for an interview and I'm just a little confused as to how you'd arrive at unlevered free cash flows and levered free cash flows.For unlevered free cash flows, would you take the NOI and then subtract out your total leasing and capital costs and then use the cash flow before debt as your ULFCF?And then for LFCF would you just use the cash flow after debt?I'm just a little confused here.
Would you also use cash flow before debt when calculating your terminal year value?
Yeah you have it right. Unlevered free cash flow is NOI subtracted by below the line capital items (leasing, tenant improvements, capex), while levered free cash flow is simply unlevered free cash flow minus debt service payments. You calculate unlevered and levered returns the same way by applying the IRR/XIRR formula.
For your unlevered terminal value you take forward 12 NOI (some people use LTM) and divide it by an exit cap assumption. For your levered terminal value you need to take your unlevered terminal value and subtract out the remaining debt balance at the time of exit. This is obviously part of your return calculations and for more value-add/opportunistic investments, the biggest driver of your returns.
Also, unlike a DCF on a company, does the discount rate stay constant regardless if youre calculating Levered free or Unlevered cash flows?
Just saw this - yeah in a RE model you're solving for a discount rate (rate of return) based on price, operating, and debt assumptions. In a DCF, you're solving for a price based on discount rate (WACC), operating, and debt assumptions. Both involve discounting cashflows - they're just solving for different variables.
A RE UW model is basically a simplified LBO - sponsors have a return target they're looking to hit, and if your discount rate exceeds that threshold, then in theory you do that investment. So yeah, your discount rate is constant because that's the one variable you're trying to solve.
Last questions here I really appreciate your help for this btw. It’s saving me for this interview.
In the practice model test it’s asking me to input the property valuation, would I use the unlevered result or the levered?
Also one question says “management is looking to apply leverage” and it provides me the following:
Existing/beginning financing of 40million
And ending mortgage balance of 30 million
And then it gives me a blank space where I would then fill in the “equity required using leverage”.
would I subtract the existing beginning financing of 40m by the property value?
And lastly for the irr, would I use the year 11 LTM cash flows in addition to my years 1 to 10 to calculate my irr or just the years 1 to 10?
These are my last questions I really really appreciate this man.
Hey no worries - I appreciate candidates asking questions (just finished interviewing candidates myself) but I would encourage you to think through these questions (because you're likely going to have to answer them during your interview tomorrow).
I'll help guide you by giving you a couple of pointers:
(1) What to input as property valuation - levered or unlevered result? -- think of it as buying a house. You're pre-approved for a mortgage and are required to put some amount of money down by the bank (this is the equity required). Is the value of the house only attributable to your down payment, or is it the equal to the down payment plus the mortgage amount?
(2) Equity required using leverage? -- related to question (1). If you know what the house is worth, then all you need to do is to subtract the house value with the beginning mortgage amount to solve for the equity required.
(3) Should I include Y11 cash flows in the IRR calculation? -- the returns of your investment are based on the cash flows you earn during your hold period. If Y11 is outside your hold period, would it be fair or accurate to include these cash flows in your return calculations?
Hope that makes sense!
IS forward 12 NOI the same as LTM?
Forward 12 = next 12 months, LTM = last 12 months
If you're given the information on a modelling test; and they say "assume a ten year holding period" but you're given years 1 to 11, but the eleventh year is highlighted Grey would you assume that year 11 is based on TTM figures and you'd still discount it by year 10? I also noticed on this one practice test that there is no service debt under the 11th year.
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