real estate private equity valuation techiniques

noobstar's picture
Rank: Senior Baboon | 213

does anyone have info on the type of valuation methods used in analyzing PE real estate investments?

the structure I am dealing with is one where a group of PE professionals raise money from investors, pool it into a fund, and use cash from the fund to acquire distressed real estate in development (commercial/residential). They acquire the properties through making a down payment (10-20%) using cash in the fund, and continually finance the development through pre-sales of the property. Entire property is sold within 6 months of project completion and money is returned to investors.

thanks in advance

Comments (13)

May 3, 2011

bump

May 3, 2011

PM international Pymp

If I had asked people what they wanted, they would have said faster horses - Henry Ford

May 3, 2011

Is this for work or is this something you are just curious about? Because if this is for work, you should know how to do this or your boss/coworkers can show you. It would be annoying and difficult to explain over the internet.

man made the money, money never made the man

May 4, 2011
mr1234:

Is this for work or is this something you are just curious about? Because if this is for work, you should know how to do this or your boss/coworkers can show you. It would be annoying and difficult to explain over the internet.

this is part of an interview case study

May 3, 2011

Check old threads. Evaluating a potential RE investment is pretty simple.

May 3, 2011

generally speaking, at least at my firm, when we're looking at a project that's already been started like that and that we're presumably buying a discount from market value, we pretty much rely on DCF as the primary valuation. The intrinsic value of the property is the future cash flows, and with a distressed property you typically aren't going to spend as much time on market comps. You're going to be looking at DCFs and also replacement cost (which will involve looking at land comps, perhaps), etc.... what you'll likely be responsible as an analyst for doing in that situation is all DCF related. Just know the basics there and you should be good for an interview. If you're buying individual assets, not companies, the modeling isn't as complex.

May 4, 2011
International Pymp:

generally speaking, at least at my firm, when we're looking at a project that's already been started like that and that we're presumably buying a discount from market value, we pretty much rely on DCF as the primary valuation. The intrinsic value of the property is the future cash flows, and with a distressed property you typically aren't going to spend as much time on market comps. You're going to be looking at DCFs and also replacement cost (which will involve looking at land comps, perhaps), etc.... what you'll likely be responsible as an analyst for doing in that situation is all DCF related. Just know the basics there and you should be good for an interview. If you're buying individual assets, not companies, the modeling isn't as complex.

yea i agree it doesnt seem so complex. they are mainly buying stalled developments and abandoned structures in prime locations to redevelop them from scratch, no companies involved.
thanks a lot this was really helpful

May 4, 2011
International Pymp:

generally speaking, at least at my firm, when we're looking at a project that's already been started like that and that we're presumably buying a discount from market value, we pretty much rely on DCF as the primary valuation. The intrinsic value of the property is the future cash flows, and with a distressed property you typically aren't going to spend as much time on market comps. You're going to be looking at DCFs and also replacement cost (which will involve looking at land comps, perhaps), etc.... what you'll likely be responsible as an analyst for doing in that situation is all DCF related. Just know the basics there and you should be good for an interview. If you're buying individual assets, not companies, the modeling isn't as complex.

This is right. One question that I have is: Why isn't the seller pre-selling units to finish the development. If a half completed building is in distress it is because they current owner has run out of bank financing. The seller then wouldn't be the equity holder, but the bank. So yes the bank could take a haircut on the debt and sell you the property at a distress price, but more financing will be needed because it will be difficult to execute on the business plan unless something materially changes (like a huge unit cost reduction). Adding debt into the mix will obviously change your valuation.

May 4, 2011
RE_Banker:
International Pymp:

generally speaking, at least at my firm, when we're looking at a project that's already been started like that and that we're presumably buying a discount from market value, we pretty much rely on DCF as the primary valuation. The intrinsic value of the property is the future cash flows, and with a distressed property you typically aren't going to spend as much time on market comps. You're going to be looking at DCFs and also replacement cost (which will involve looking at land comps, perhaps), etc.... what you'll likely be responsible as an analyst for doing in that situation is all DCF related. Just know the basics there and you should be good for an interview. If you're buying individual assets, not companies, the modeling isn't as complex.

This is right. One question that I have is: Why isn't the seller pre-selling units to finish the development. If a half completed building is in distress it is because they current owner has run out of bank financing. The seller then wouldn't be the equity holder, but the bank. So yes the bank could take a haircut on the debt and sell you the property at a distress price, but more financing will be needed because it will be difficult to execute on the business plan unless something materially changes (like a huge unit cost reduction). Adding debt into the mix will obviously change your valuation.

the seller is in fact the bank. and in several cases, the banks are in a bad financial situation as well (irish, greek banks) so there will be a significant discount. I am not sure what you mean by "more financing will be needed." The financing will be provided by the fund and pre sales. What type of debt would be added exactly? sorry I am not very familiar with the procedure, which is why Im asking you guys :)
thanks

May 5, 2011

^^

Let's say there is $100m of debt on the property and it required another $100m to finish development and the bank is willing to sell it to you at $0.5 on the $1. So you acquire the half finished building for $50m. The development will take 2 more years to complete.

Let's say there are 200 units that can be sold and each unit is now worth $1m. If you believe that you can achieve 50% pre-sales then you should be OK, but let's say for example your pre-sale profile is t1 = 10%, t2=30% t3=40%, t4=20%

Your cash flows would be as follows

t0 = -$50m (to buy the property)
t1 = -$50m (construction costs) + $20m (presales) = -$30m
t2 = -$50m (construction costs) + $60m (presales) = +$10m
t3 = +$80m (sales)
t4 = +$40m (sales)

you would needed extra financing for year 1 if you didn't want to add more equity than what was originally put in for the property purchase. That financing is usually debt. Based on this example, you would need $30m of debt to cover your shortfall and interest would accrue on that as well. That would affect your cash flow.

If you were working on an exercise to figure out what to pay, you would have t0 as your unknown and do a DCF on your unlevered and levered cash flows using your required rate of return. The npv would be what you are willing to pay.

    • 1
May 6, 2011
RE_Banker:

^^

Let's say there is $100m of debt on the property and it required another $100m to finish development and the bank is willing to sell it to you at $0.5 on the $1. So you acquire the half finished building for $50m. The development will take 2 more years to complete.

Let's say there are 200 units that can be sold and each unit is now worth $1m. If you believe that you can achieve 50% pre-sales then you should be OK, but let's say for example your pre-sale profile is t1 = 10%, t2=30% t3=40%, t4=20%

Your cash flows would be as follows

t0 = -$50m (to buy the property)
t1 = -$50m (construction costs) + $20m (presales) = -$30m
t2 = -$50m (construction costs) + $60m (presales) = +$10m
t3 = +$80m (sales)
t4 = +$40m (sales)

you would needed extra financing for year 1 if you didn't want to add more equity than what was originally put in for the property purchase. That financing is usually debt. Based on this example, you would need $30m of debt to cover your shortfall and interest would accrue on that as well. That would affect your cash flow.

If you were working on an exercise to figure out what to pay, you would have t0 as your unknown and do a DCF on your unlevered and levered cash flows using your required rate of return. The npv would be what you are willing to pay.

Ok I see what you mean now. Well I guess the good thing about the case I am looking at is that there is an agreement with the bank to put a 20% down-payment on the property, with the remainder due after the project is completed. I am not sure if this is a fictional situation or not, but it allows you to avoid taking out any debt since you dont have such a high upfront payment.
And yes, thats precisely what I am trying to do.

Thanks a lot for all this you've been a great help. I owe u like 20 SBs ill get you back one day :)

May 7, 2011
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