Value of Promote and IRR on Promote if hold post stablization
I am trying to model out how to best compare the returns of Promote/IRR for a long term real estate development investment that would be build for 2 years then stabilization in Year 3 then put on long term fix rate debt to hold forever vs the value of the same promote/IRR if at Stabilization we sold the property. How to best model out how to show the reinvestment capability of that (pre and post tax) promote and compare it to the long term hold?
My initial idea is to take the value of the promote in the year of stabilization and make that the new equity amount then run my long term hold model (CF and sale in Year 13), then compare that IRR. Next take the post tax promote amount and then model out assumptions (3x multiples + development fees) of what the next ten years of development deals I could do in a given ten years with that promote amount.
Your initial idea seems to be on the right track. Here's how you might want to approach it:
Calculate the value of the promote at the point of stabilization. This would be your new equity amount for the long-term hold scenario.
Run your long-term hold model with this new equity amount. This should include cash flows and a potential sale in Year 13.
Calculate the IRR for this scenario. This will give you a benchmark to compare against the reinvestment of the promote.
Next, calculate the post-tax promote amount. This will be the amount you have available to reinvest in new development deals.
Model out assumptions for the next ten years of development deals you could do with this post-tax promote amount. This could include assumptions about multiples and development fees.
Calculate the IRR for this reinvestment scenario.
Finally, compare the IRRs from the long-term hold scenario and the reinvestment scenario. This will give you a sense of which option might provide a higher return.
Remember, this is a simplified approach and there are many factors that could impact the actual returns, including market conditions, changes in property value, and more. It's always a good idea to run multiple scenarios and consider a range of potential outcomes.
Sources: Promote Structure Alternatives, Deal Structure For First Deals
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