So my background is M&A but have a real interest in RE.
I notice that in REPE interviews it seems to be common to give somebody an OM and ask them to model it and make a decision on wheter to invest. I went online and found the following OM for a retail asset.
www.cbre.us/o/oakland/assetlibrary/3250buskirk.pdf
I would love to hear from experienced folks how they would go about underwriting such an asset?
The OM gives cash flows so I am assuming you would model those out in excel (potentially making them a bit more conservative than provided), discount at some hurdle rate (how would you come up with this?) and then make assumptions on debt and equity based on DSCR and LTV ratios to come to an IRR by assuming a going-out cap rate?
You would then look at the more qualitative factors such as demographics, trends on the general market and quality of the tenants.
Like I said this is all new to me so would love to hear how experienced folks would approach this.
Is there anything I am missing in the model? Also how typical is the OM above of what you might get in a REPE interview? Is it pretty standard? I note that no guide price is given in the OM. I am assuming it would make the analysis easier if a guide price was given (no need for discount rate, just get IRR and comment if it is appropriate).
Thanks.
Interested as well
I'm sure you'll get some long, detailed responses here, but I'll give my usual fast, shitty but simple answer: 1. "model those out in excel" if you really wanted to be lazy, you could just use their cash flows (their assumptions). To keep it simple, before you even look at demographics (as you mentioned), just look up retail vacancy and absorption in the area. see if your lease-up is aggressive, try to keep it consistent with the area.
"discount at some hurdle rate" occupancy here is in the 60s, so you want a high return for adding so much value. just research what sort of levered return someone would want from developing or renovating a shopping center.
"make assumptions on debt and equity based on DSCR and LTV ratios" yes. ask a friend on the debt side. this would be recourse bank debt, again it's almost like a construction loan because you're over 40% vacant
"I note that no guide price is given in the OM." look up sale comps (cap rates and price PSF).
If you can't get your hands on seemingly "authoritative" research on any of the above, just ask a broker or two, and confidently state "i confirmed my assumptions with multiple brokers in that market."
Great stuff prospie. In terms of the debt on a deal like this how complex would the structuring get? Would it be a unitranche or could you have different levels in there? Any prospect of mezz on a deal like this? What determines the ultimate debt structure? Riskiness of the asset/quality of collateral?
Again, I'm giving quick answers here and I'm sure others are more educated on mezz than I am.
If you want to see a complicated debt structure, you're more likely to find that among the biggest deals: http://llenrock.com/blog/wp-content/uploads/2010/01/pyramid.bmp
An actual OM was given to me in all of my PE interviews. It is important that you do sensitivity and risk analysis as well. OMs are marketing books, and similar to annual reports, are known to be speculative and forward-looking. Show the project's risk in every aspect, aka timing risk, income risk, market risk, growth risk, etc.
What kind of product/asset type are we talking about here? The cheeky/smart ass answer is that no serious investor is going to underwrite something with an OM alone. To get a first run/ballpark value sure, but eventually you are going to have to dig in to the leases, budgets, CAM recs, operating statements, etc. Unless its multifamily, they would probably expect you to use Argus unless it is a single tenant deal. Expense reimbursements are a pain in the ass to model in Excel, especially if the expense pools are complex/nasty.
EDIT: I just saw the link to the OM, so given that its retail, I would definitely say you'd need Argus for this. Agree w/ comments above regarding the debt though.
Thanks for the responses guys. Some really helpful stuff in here.
MonkeyWrench, coming from a non-RE background I have no experience with Argus (do intend to get familiar in the near future). Given that do you thinK they would give a pass and let me do excel or is it a case of know your shit or GTFO?
Would also like to hear from those with direct experience of these tests in interviews...what was expected and how it went for you.
Cheers.
take it from a second year REPE analyst. get to know argus. while your market comments may be helpful to the higher-ups, what is needed out of you is model building. and then once you're an associate you'll need to be able to spot-check an analysts work or its your a** too.
PRO TIP: make sure you do a tax analysis. its common that in most counties, real estate taxes are reassessed upon sale (usually meaning they go up). all tax collector websites will spell out how taxes are calc'd. it helps to build a sheet that does the math with the mill rates to get your new tax expense. Then you'll need to plug in that new tax expense into the argus model so you can spit out another CF in excel to run your returns. Don't forget to do this. very important.
A few days late to the party here, but I agree with this comment. Even if you haven't had to build an Argus file or excel model from scratch, you should get comfortable with doing so. It is also a good idea to get comfortable with understanding where and how sell side RE analysts/brokers will tweak the cash flow to get some lift in the NOI, since your value add as a junior in acquisitions is basically how well you can find flaws in the broker models. It's extremely easy to manipulate MLA's and some of the more basic things in Argus, but if you really know what is going on in the back and (and can understand the math behind it) that is a huge value add as most senior people on both sides don't even have that detailed knowledge.
Not to hijack the thread but I would be curious to hear how many of you actually has to do a excel test for your interview. Also, can anyone provide an excel of what you put together? I work in acquisitions at a REIT and didn't have to do an excel test however I did run through a quick Argus test. Side note in my time in real estate I have never had to build a model from scratch...Argus..drop pro-forma into excel and tweak.
i agree with you comments on not really having to build a model from scratch but regardless, one needs to be ready for that juicy off market deal that comes along where there is no broker to put together a package (ie an OM and Argus file).
I work on acq team for an REPE fund. I had to do an excel test, but it was literally 3 tabs with simple questions:
Hi! I am just learning this stuff, I know how to calculate max loan amount (you said debt proceeds, do you mean the same thing?) based on certain parameters like debt yield of x percent, dscr of x and ltv of x percent. But, I am having difficulty trying to calculate the IRR when you only have purchase price, NOI and debt service. I can calculate cash flow from NOI and debt service, but dont I need the terminal value to calculate IRR? Thank you!
I've done some excel tests. In my experience, they're always easier than you think they will be, even at big name firms. Don't stress and don't overthink it.
One example is a single-tab 5 year cash flow and dispo in year 6 for a MF deal. This is at a place you would all recognize the name of immediately. You input all the numbers, make sure you grow them properly, and make sure you get the return metrics correct.
The entire test took less than 20 minutes. For comparisons sake, in grad school I could spend hours and hours building a model.
Agreed however even in that case (We deal in Office/Industrial) I would model it in Argus and drop it into our model? Do you guys do the same or would you try and build something in excel?
Impossible to model a complex office, retail or industrial deal in excel. Single tenant? Definitely. Just remember that the more leases/tenants/amendments, the messier the modeling gets. Modeling MG leases would be a nightmare. Even for an off market deal, you have the essentials (rent roll, expenses, leases, etc) to run a preliminary analysis in argus. Depending on the firm, you would then create a few sensitivities, highlight the return metrics, amortization table, etc.
I agree with Fez 100%. Argus is the only way to go when you're talking about anything but a single tenant NNN deal. While argus does a lot more that expense reimbursements, that is really its bread and butter. This way, when we think an asset is being mismanaged (think high expenses) or if we need to run sensitivity analysis against taxes/insurance, assuming your passthroughs are set up properly in argus, you'll be able to see how much of it could be billed back to the tenants. Very handy when you have certain tenant expense caps, varying expense pools, and denominators.
Interesting topic. I think it should have a model from market deal that comes along where there is no broker to put together a package. See how it works.
Hey everyone, I'm currently doing this myself so I thought I'd resurrect this post.
I have a question: I'm working on an OM for an office portfolio, and my Argus cash flows are off by a few hundred dollars from those in the OM.
Can you typically exactly replicate the cash flows from an OM, when building your Argus model from scratch? Or is it generally assumed that that is impossible and being within a rounding error is the best you can do?
For example, my one tenant, year 1 cash flow is off by $480 on a roughly $1 million base rent.
I'm potentially showing this OM and my model to an interviewer tomorrow, and need to know if I'm safe to do so or if it would be more of a negative to show that it isn't perfect.
Thanks for any advice,
Another Argus/underwriting question: what do you do when analyzing a property where a tenant has a 2011 base year for recoveries, but the only actuals provided are years 2015, 2016?
I assume the issue is that you're most likely putting rent PSF when the actual OM Argus model is calculation off of $XX,XXX per month. Not a big deal.
Hi Bert - OK, yes this could be the issue. Thanks!
For some reason, the rent roll provided in the OM lists rent on both monthly and annual basis, and the two don't match up very well, so I went with the psf which seemed to be closer.
I'll provide some color on this...
When modeling, the tough item is to arrive at accurate NOI figures. The only figure in an OM you can realistically rely on is the real estate taxes (and even that needs to be adjusted for re-assessment post closing).
Unless you know the numbers off the back of your hand (for example: $0.20/SF for insurance, maintenance is $0.30/SF, roof repairs is $0.20/roof SF, etc;) you need to take a comps set (hopefully the company is in the sector already and has P&Ls for similar properties, otherwise you need to get creative to find them) and then model the expenses out line item by line item on a de novo basis.
Revenue is easy you grab the leases, but you need to include realistic stabilized lease assumptions and their associated cost (TI/LC). The balance of the modeling simply falls into place (debt, exit, returns, waterfall, promote, sensitivity, etc;) and is similar to any M&A model.
The most important aspect of modeling (and what sets someone apart in the interview process) would be putting together accurate projections.
Thanks 81investment, this is very helpful.
I have a question for the boards: I'm building out a waterfall, and I noticed that the reference model I'm using doesn't build up any form of cash reserve meant to cover negative cash flows forecast for future months.
My model has several periods with negative cash flows, largely due to TIs and LCs. Do people: A) typically build up a cash reserve meant to cover those shortfalls? B) Do investors leave the cash that has been distributed to them in an account, from which the manager can pull cash for negative cash flow months? Or, C) do they withdraw cash monthly and the manager actually calls cash from each investor during that month of the shortfall?
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