10/28/2013

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Welcome back! Best break story (within decency bounds)? Exams returned Reading Linneman chapters 8, 9 Eisenberg 11/11; Real estate round table 7:00, 11/14 in 141 DeBart; looking for questions for our speakers; reception to follow at Legends New Pro forma exercise assigned Wednesday; individual case study to be assigned next week In the news? From the animal stories file: http://www.mlive.com/news/grandrapids/index.ssf/2012/10/resident_using_torch_to_singe.html ; http://abclocal.go.com/wpvi/story?section=news/local&id=8854 977

Stabilized pro forma

Cash flow statement over typically a 5 or 10 year period

(for valuation); the process:

Extract current fundamentals from existing leases and

operating statements regarding current base rents, percentage rents, ancillary income, operating expenses, capital costs (TI and cap ex) and brokerage Use existing leases to forecast near-term rents and expense recovery (triple net versus gross, expense caps) based on forecast of operating expenses (usually current operating expenses grossed up by an estimated inflation rate; ) If there is vacant space (above equilibrium levels), forecast timing/structure of new leases

 Estimate major capital expenditures ($s and timing)

separately or use typical annualized reserve estimates (how to annualize?) As existing leases mature, forecast retention/new tenant scenarios including

Rents (at current market) Expense recovery TI expense (some $s will be given to retained tenants, less than new tenant TI) Rent abatement and lease lags for new tenants Brokerage fees some brokerage contracts call for (smaller) commissions when tenants retained Estimate likelihood of each scenario and compute expected cash flows

 A simple spreadsheet illustration simple valuation

model N:\Private\Fin 40710\Spring 2012\Simple valuation model.xlsx

Real estate development pro forma

Recall Dillingham - a stabilized property; its pro forma

is constructed based on existing tenant lease terms and assumptions regarding tenant turn over; If leases tend to be longer term (or contain extension options), the existing leases will control NOI for possibly several years Software such as Argus is used to track the cash flow consequences of the complex terms of lease contracts, and has much flexibility in modeling lease behavior over time in order to produce IRR and NPV values

 At the other end of the spectrum, development

projects represent facilities at the planning stage; lease contracts play at best a limited role
In the initial stages of a project (prior to land

acquisition, for instance) feasibility analysis will be carried out with no binding lessee commitment (although there may be letters of intent; non-binding) Some space will most likely be leased prior to construction (pre-leasing, agreements to lease) in order to satisfy the terms of construction lending

Development pro forma

Real estate development is a process: Site evaluation Entitlement (permitting) work Land acquisition Capital sourcing Site work Vertical construction Marketing/leasing Property management Property disposition

 In contrast to stabilized facility pro forma: Development involves construction and construction finance Development involves a leasing process Pro forma is used in project feasibility work that begins with site evaluation At project conception, development pro forma is based on a site plan, estimated development costs, and market rent estimates

 Starting from a site plan, development pro forma analysis involves the

categorical estimation of project costs:

Soft costs costs other than brick and mortar related including

engineering fees, architecture fees, developer fees, legal costs, leasing commissions, permitting fees, financial carrying costs (construction loan interest) etc. Hard costs land, site work (earth work), roads, building construction costs Development pro forma also requires estimates of NOI (at least first

year stabilized);

It is not unusual to forecast NOI out over a longer period (for

investment horizon IRR calculations), but most of the attention is on estimating market rents and computing a one year post-development NOI forecast (in order to value the stabilized property with direct capitalization)

Some development pro forma basics

Real estate development usually involves a developer with

expertise in managing the development process as well as capital partners who are responsible for the majority of the project equity (the developers portion of the equity interest typically will run from 0% - 10%) The developer profits from a (or several) fee(s) in addition to her/his return on equity Development usually involves construction debt of as much as 75% (at least when cash was easy!) of the cost of the project; the remaining 25% comes from the developer and capital partners; note that debt costs (interest) are included in the Overland pro forma, but there is no cost in the budget for the use of equity

 Note the debt cost (interest) is capitalized and

included as part of the total project costs; construction debt usually contains an interest reserve, which is a sum of funds used to pay accrued (capitalized) interest; It is probably simplest to think of the interest being funded as part of the construction debt so that other than the initial equity investment, the developer/capital partners have no developmentrelated cash out of pocket until the project stabilizes (and thus earns rent revenue)

 Most development pro forma contain a fairly detailed

construction cost analysis/schedule Capitalized interest depends on the timing of construction costs, because construction loan funds are paid out as construction proceeds (a process in which costs are submitted to the lender and then the lender allows a loan draw)

 Stabilized NOI constructed in the usual way; Potential income (0% vacancies) net of income loss from vacancies Rent, operating expense, and expense recovery assumptions (see spreadsheet); note the treatment of CAM and other expenses including management fees and structural expense Triple nets or gross lease assumptions are incorporated; under triple nets, fixed charges and CAM collected pro rata using leased footage relative to total leasable footage

 Development pro forma requires an estimate of NOI

(at least first year stabilized); it is not unusual to forecast NOI out over a longer period (for investment horizon IRR calculations), but most of the attention is on estimating market rents and computing a one year NOI forecast (in order to value the stabilized property with direct capitalization) Overland Park N:\Private\Fin 70710\OVERLAND MARKETPLACE P-1 101405 P-3.pdf ; N:\Private\Fin 70710\Overland Park Master Proforma 21407 B.xls