Proper real estate financial modeling is imperative when considering new assets for real estate investment. A successful real estate professional will have good processes for financial modeling that eventually become second nature once we find an asset worth looking at more deeply. Creating an accurate financial model will give you the confidence needed to make a sound investment. In the private equity commercial real estate space, we have our own specific model template we follow, but we are generally looking to understand the following items:
-What kind of Net Operating Income (NOI) and cash flow we can expect immediately
-What the Internal Rate of Return (IRR) is over a ten-year hold
-What the real estate valuation will be at various periods during the hold
To help us understand if a real estate deal is worthwhile, we’ll plug in the necessary information into a pro forma that we have created for our financial analysis. There are several tools online that do this very well, and you might say we’re boring, but good ol’ Microsoft excel has yet to fail us. Here is our core process:
- We start by inputting the general acquisition information into the model. The purchase price, acquisition cost and any debt information
- Then we’ll add all of the revenue into the model: Base rent, CAM recoverables, and any other income that the CRE asset throws off.
- We’ll factor in lease expiration information so we know when we can potentially lose a big chunk of our cash flow. Potentially losing a tenant also means we will need to budget for the capital costs involved in acquiring a new tenant, such as leasing commissions and tenant improvements. We like to use credit lines for these capital costs, but it is important to get the information into the model so we can see how it impacts our cash flow.
- Finally, we’ll factor in all of the operating expenses. Unfortunately, unlike gross revenue derived from leases that are written into a contract, you can’t calculate variable expenses to the penny, so it’s important to factor in annual increases into the expenses over time. We use at least 2%. (On a side note, this why it’s so important that all of your leases have annual increases in them)
The formula in your acquisition model will then do the rest and should give you a relatively close idea of what your investment return is going to be. If done properly, this step-by-step model or set of models will be the basis for your investment decisions. A great real estate model is what every financial analyst will use as a basis for their real estate acquisitions across any assets class. It may be valuable for you to take a financial modeling course if you plan on dealing with real estate finance regularly as the numbers are arguably the most important piece of this industry. This doesn’t just pertain to real estate transactions or real estate development, financial analysts working in investment banking on Wall Street in New York are following their own models as well – it is a must-have skill for real estate investors whether you are purchasing a huge multifamily complex or a single-family home.
If you have additional questions about the real estate pro forma that we use when qualifying a property, please reach out to us. First National Realty Partners is one of the country’s leading private equity commercial real estate investment firms. With an intentional focus on finding world-class, multi-tenanted assets – including middle-market service-oriented retail shopping centers – well below intrinsic value, we seek to create superior long-term, risk-adjusted returns for our investors while creating strong economic assets for the communities we invest in.
If you’d like to learn more about our middle market retail investment and lease opportunities, contact us at (800) 605-4966 or firstname.lastname@example.org for more information.
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