Underwriting a RE deal that is currently under development
Hello All - it's my first time posting but I would like to ask the forum about this question I have
If you have a development currently ongoing, but you are coming in to buy part of one of the investor's equity in the deal at cost base. My questions pertain to the following:
- How would you think about the equity? Would it be the current cost to date (capital stack) and essentially one would come in at the current equity base? For example, if the cost base is 100M (60% debt, 40% equity), current cost to date ~110M (due to cost overruns); if as a new investor, I'm buying out 20% of the initial equity, would the going in new capital stack, be 20% of the initial 40% or how would that work?
- Would modelling essentially be the same with looking at it from the point in time you as a new investor came in, and projecting the remaining costs to be spent and when the project will be leased up e.t.c?
Thanks and appreciate any insights!
Based on the most helpful WSO content, here’s how you might approach underwriting a real estate deal where you're buying into an ongoing development:
Equity Valuation and Cost Base:
Capital Stack Adjustment:
Modeling from the Point of Entry:
Key Considerations:
This approach ensures you have a clear understanding of your equity position, the project's financial health, and the potential risks and returns.
Sources: Real Estate Development Modeling, Equity is cheaper than debt, isn't it?, From Real Estate Finance to Founder of Development Company - Q&A, Great Deals You've Recently Done, What is PROPER underwriting process like for development projects
Hi! If the total investment of an ongoing project is 100% funded (the equity is committed and the debt is closed) you must think about any equity purchase / sell in terms of cash outs (for the existing equity investor). Considering your assumptions (40% equity, 60% LTV, 20% equity purchase), yes! the new equity will be 20% of the project's total equity (40% of the realized investment), since only a change of equity ownership has occurred. This is the simplest scenario, because it assumes that 100% of debt and equity has been called / paid (all the amounts are closed). On the other hand, (at cash basis) if the 100% of the equity has not been paid, your 20% purchase will be calculated pro-rata in terms of the executed equity, and since there's some amount to be allocated until reach the 100% (again 40% of the total investment), the new investor will have to pay the remaining part as the development requires, before debt is used. This scenario could end quite differently because debt tends to be locked at a certain amount, so any extra cost will be funded with equity resulting in +40% share (of the initial expected investment).
From a mechanics standpoint you've got it mostly right, but functionally it's fairly more complicated.
Look, a lot of the returns associated with development are related to the fact that new development is really risky. So how you think about the equity you're recapping out should depend a lot on where the sponsor is in the project. If they're just finishing up the SOE, then you're still stepping into a really uncertain situation, and I'd be really questioning why someone wants out of that deal and discounting accordingly. If they're basically about to start punch list work, then that risk profile contracts considerably.
I don't know whether you're asking in an academic sense or if you're actually looking at buying out an existing investor in a project, but there are a lot of other qualitative issues at play beyond accurately calculating the person's basis and how to build it into a model
Thank you! - this is talking in actuality and I agree on the risk factor; this project is actually currently ongoing and has started construction. The existing partner simply wants to reduce their equity piece due to internal allocations.
There are some free model templates in Adventures in CRE that could help you
Thank you for the reference - can you please direct me to which ones are relevant for situations like this?
Hi Just a follow up question, what would the return be for an analysis like this. For clarity, just to gut check, would there ever be a case where the investor who comes in after (at whatever negotiated price or pari passu) would have the same IRR as the project's levered return? Thanks in advance
Good question, this comes up more often than people realize.
If you’re buying into a development that’s already in progress, the cleanest way to look at it is from the current capitalization to date, not the original pro forma. In your example, total cost to date is 110M (with 60% debt, 40% equity planned), but the overrun has already changed that stack. So, your entry should reflect actual dollars spent and remaining costs not just the original equity share.
If you’re buying 20% of the original equity, you’ll need to clarify whether you’re paying based on the invested capital to date (what’s actually been funded so far) or on the total committed equity (including future draws). Usually, you’d come in at cost meaning you reimburse the outgoing investor their pro-rata share of what’s been funded, and then participate in future capital calls going forward.
When modeling, yes start at the point you enter. Build projections for the remaining construction spend, stabilization, and lease-up from today’s position, not from the project’s original start. Also, review the partnership agreement carefully to confirm how distributions, promote structures, and capital calls are handled. You don’t want to inherit hidden obligations or unequal terms. Also, consider bringing in R. E. Cost Seg or a similar group I’ve worked with them before, and they’re excellent at confirming true cost allocations and separating construction vs. capital expenses. That clarity helps protect you when negotiating entry value and gives you accurate depreciation data for tax planning later.
This comes up a lot in real estate deals with multiple investors. Typically, if you’re buying in at cost base, your entry value ties to the current equity invested to date, not the original pro forma stack. So, in your example, if total costs are now $110M and the original 40% equity has increased accordingly, your 20% buy-in would be priced on that updated equity portion.
You’d usually come in at the current equity cost to date, not the original base. From there, just model forward from your entry point with remaining costs and lease-up assumptions.
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