Real Estate Private Equity Technical Qs

FalconPluse's picture
Rank: Baboon | 160

So I have been offered an interview with a top real estate private equity firm but don't know much about the technical side of it.

How do you calculate FCF when looking at real estate? I know the formula when analysing companies fcf =(1-t)EBIT+D&A- change in NWC -Capex.

As this is an internship straight out of undergrad , will I be expected to build an lbo model? I know the basic concept but can't actually do one. I've never studied real estate before.

Comments (32)

Sep 25, 2016

I think that you should do a little more research on what REPE actually does because, personally, I've never seen a LBO situation occur in REPE. You're talking acquisitions of real estate assets, not acquisitions of a corporation.

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Oct 1, 2016

I've had an LBO test for a REPE company before, so I am a little lost....

Oct 1, 2016

They buy hotels also, so surely they would use an LBO?

Oct 6, 2016

What about Lone Star taking Home Properties private last year? Or a PE group looking at a topping bid for Post? I guarantee someone has built that model recently. Or BX and Brixmor? Those seem a lot like lbo situations to me. Not saying that this is a common thing at your average REPE firm, but if you have an interview at a shop that plays at that level, they're going to want to know if you can build that kind of model.

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Sep 25, 2016

CRE SC is correct. You should think in terms of rents, expenses, debt service, NOI, etc. - NOT EBIT for sure.

It's a property acquisition, not a company with properties.

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Oct 4, 2016

They buy hotels.

Oct 6, 2016

AKA properties

Best Response
Sep 25, 2016

If you even mention EBITDA, you may get the stink eye. Quick rundown: Asset Level Revenues - Asset Level Expenses = Net Operating Income. Net Operating Income (NOI) less Capital Expenditures (Purchase Price, Closing Costs, Tenant Improvements, Leasing Commissions, Capital Reserves) = Unleveraged Cash Flow. Add Financing (Debt Proceeds, Lender Fees, Debt Service Expenses, and Loan Payoff) to your Unleveraged CF and you arrive at Leveraged CF. Think of Unleveraged CF as cash flow available to all positions in the capital stack (debt and equity). Leveraged CF is therefore cash flow available to equity investors. I've seen technicals ranging from brain teasers to IB-esque accounting questions; "walk me through how -$10 depreciation affects all three of the financial statements". You won't be expected to build a model but I can tell you that a REPE model is less complex than a lbo model. RE valuation is determined by a cap rate (what you would think of as an EBITDA multiple). To determine your asset value, divide your F12 NOI Sum by your exit cap rate. Cap rates differ throughout the country by location and product type. Core markets (gateway cities such as SF, LA, NYC, Chicago) typically have lower cap rates due to perceived stability by equity capital whereas secondary cities (the next tier) and tertiary markets (that next tier beyond secondary) are perceived to be of greater risk due to 1) less jobs 2) less growth 3) less population (in no particular order). Buying a building is like buying a business, levering it up, determining your investment strategy (is it a core play aka long term fixed income investment with minimal required improvements; value-add play, aka capital improvements required via aesthetic enhancement to the interior/exterior or operation efficiency improvement; opportunistic aka ground up development or extreme repositioning..btw those are ordered from least risk to greatest risk and as you can guess this translates to lowest returns to highest returns in order), and finally exiting the investment. Buy low, sell high. If cap rates compress (decrease) during your hold period, you can make a lot of money. Going the other direction can potentially destroy you. This is why so much emphasis is placed on buying at the right time (aka when cap rates are highest in the cycle and asset values are lowest). Good luck man.

Oct 1, 2016

Thank you so much!! I actually did mention EBITDA in the first round interview, but passed it lol . I'll be sure to use these in all future rounds. You honestly have helped me a lot!!

Oct 2, 2016

This is all correct, but I disagree with the idea that talking about EBITDA will get you the stinkeye or "pwn3d." It really depends what this REPE group does. For the overwhelming majority of shops, yeah, nobody cares about EBITDA because they are dealing with assets or portfolios of assets, not entire real estate operating companies.

If you are interviewing at a REPE firm that does have the size/scale to deal with real estate operating companies (hotel groups being a classic example) then you'll find that people do talk about EBITDA and it matters greatly. Why does it matter? Because corporate G&A is below NOI but captured in EBITDA. So if we are talking about a large operating company, you need to be considering that corp G&A.

This all said, there are only a few REPE groups in the world that have the scale to play on this level. And if you are lucky/good enough to be getting an interview with them, you damn well better be able to talk about EBITDA and do an LBO. They aren't asking you to do one as a thought exercise.

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Oct 2, 2016

Thanks. They do operate on that scale, they have about $6bn AUM

Oct 4, 2016
cpgame:

If you even mention EBITDA, you may get the stink eye. Quick rundown: Asset Level Revenues - Asset Level Expenses = Net Operating Income. Net Operating Income (NOI) less Capital Expenditures (Purchase Price, Closing Costs, Tenant Improvements, Leasing Commissions, Capital Reserves) = Unleveraged Cash Flow. Add Financing (Debt Proceeds, Lender Fees, Debt Service Expenses, and Loan Payoff) to your Unleveraged CF and you arrive at Leveraged CF. Think of Unleveraged CF as cash flow available to all positions in the capital stack (debt and equity). Leveraged CF is therefore cash flow available to equity investors. I've seen technicals ranging from brain teasers to IB-esque accounting questions; "walk me through how -$10 depreciation affects all three of the financial statements". You won't be expected to build a model but I can tell you that a REPE model is less complex than a lbo model. RE valuation is determined by a cap rate (what you would think of as an EBITDA multiple). To determine your asset value, divide your F12 NOI Sum by your exit cap rate. Cap rates differ throughout the country by location and product type. Core markets (gateway cities such as SF, LA, NYC, Chicago) typically have lower cap rates due to perceived stability by equity capital whereas secondary cities (the next tier) and tertiary markets (that next tier beyond secondary) are perceived to be of greater risk due to 1) less jobs 2) less growth 3) less population (in no particular order). Buying a building is like buying a business, levering it up, determining your investment strategy (is it a core play aka long term fixed income investment with minimal required improvements; value-add play, aka capital improvements required via aesthetic enhancement to the interior/exterior or operation efficiency improvement; opportunistic aka ground up development or extreme repositioning..btw those are ordered from least risk to greatest risk and as you can guess this translates to lowest returns to highest returns in order), and finally exiting the investment. Buy low, sell high. If cap rates compress (decrease) during your hold period, you can make a lot of money. Going the other direction can potentially destroy you. This is why so much emphasis is placed on buying at the right time (aka when cap rates are highest in the cycle and asset values are lowest). Good luck man.

This is hands down the single best explanation i've ever seen for real estate PE. Kudos.

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Oct 1, 2016

This thread is exactly why I think all of the IB analysts are completely worthless for real estate investment and why I would hire a guy from HFF or Eastdil every time over them

Oct 1, 2016

I haven't done IBD, I'm only trying to learn lol

Oct 1, 2016

Trolling on the IB threads and saying "LBO" and "EBITDA" will get you pwn3d by RE people.

Oct 6, 2016

It depends on the size/scale/sophistication of the shop. For most uses, yeah some analyst at HFF is going to be able to hit the ground running faster. I get it.

But if you are a large REPE firm, or a large REIT, or a large hotel operator, then you might think that analyst from HFF is just another fluffy-haired fuck from a SEC school with bad habits and subpar skills. You can get somebody from IB that knows general corporate finance better and teach them real estate. Real estate isn't hard. We all know this. There's a reason why it's common to go from general corporate finance to real estate but not vice-versa.

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Oct 3, 2016
pisgah:

[...] just another fluffy-haired fuck from a SEC school

He kids the brokers... we love your hair and your college football.

Oct 4, 2016

Hi,
I had to do a few of those excel tests, so I will try to help you out. From my experience, REPE excel tests always require you to calculate one or several of the following return indicators:

  • unlevered /levered IRR (usually pre-tax) -> most important
  • Cash-on-Cash Return
  • Equity multiple

This requires you to:

1) Arrive at NOI and the cash flow before debt service and taxes (unlevered cash flow). Note that NOI is not the bottom line unlevered cash flow because it NORMALLY excludes leasing and capital costs (tenant improvements, leasing commissions and CAPEX).

To understand real estate cash flows, I recommend taking a look at "Commercial Real Estate: Analysis and Investments" by David Geltner (you will probably find this book online). However, don't waste too much time on cash flows because, most likely, you won't have to set up a full blown cash flow statement.

2) Calculate the levered cash flow. It is helpful to know the formulas for debt financing (i.e. PMT, IPMT, PPMT) even though an interest only loan is most common in those test. Nevertheless, be able to apply the above excel formulas for non-interest only loans and for all cash flow intervals (monthly, quarterly semi-annually and yearly).

3) Calculate a terminal value by using an exit cap rate. When your holding period is 10 years, divide the year 11 NOI (HP+1year) by your exit cap rate. If no exit cap rate is given, just add 50 bps to 100 bps to your stabilized entry cap rate.

4) Finally calculate the above mentioned levered/unlevered return indicators.

A few more hints:
-It is important that you know how to calculate all financing formulas and the IRR for various cash flow intervals. Under time pressure, trial and error isn't an option.

-Difficult tests will ask you to calculate multi-tenant cash flows with various lease expiries, rent abatements and void periods. PM me if you want an example spread sheet.

-Some test also require you to extract some data from rent rolls. Important formulas are obviously sum product, sum if, subtotal, VLOOKUP index match etc.

-Know how to calculate the weighted avg. lease term (WALT)

Good luck!

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Oct 4, 2016

I have messaged you, thanks a lot!

Oct 4, 2016

If you're comfortable with it, it would be terrific if you put these in the shared drive that the forum has going for models and other innocuous excel files. Don't feel obligated, but I'm sure some of the college kids would appreciate it.

https://drive.google.com/open?id=0B5QD2Kz4n4a4UmlY...

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Oct 5, 2016

Why is this not a stickied item? Great link.

Oct 6, 2016

This is hands-down the most useful item on RE modelling I have seen on WSO. This should be a homepage post!

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Dec 7, 2016

thank you sir!

Dec 7, 2016

7.20%

Dec 7, 2016

Hi, did you get this by dividing the annual debt service $3,632,445 by the loan amount-$50,000,000?

Why is the loan constant a bigger number than the interest rate? Is this always the case? Thank you!!!

Dec 7, 2016

If you're interviewing with a REPE debt fund and don't understand why the debt constant is higher than the interest rate, do everyone on this forum a favor and tell us who it is that you're interviewing with.

Jokes aside - most debt service is either structured in one of two ways: (1) Interest-Only, meaning the debt service is the stated interest rate for a stated period of time or (2) Amortizing, in which debt service is comprised of interest and principal. Learn the key differences of these two or so help me g-d, I'm selling out of all my RE investments stat.

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Dec 7, 2016
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Oct 30, 2016
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