Foundations of real estate financial modeling

Overview of key concepts

What are the foundations of real estate financial modeling?

This guide will outline the foundations of real estate financial modeling and the key concepts you need to get started building your own models for development projects.

In order to get started, let’s define some of the key terms you’ll need to know before building your model.

 

real estate model

 

Real estate terms and definitions

LTV – “loan to value” – the amount of debt financing a lender will provide as a percent of the market value (i.e. 80%)

LTC – “loan to cost”  – the amount of debt financing a lender will provide as a percent of the cost of a development (i.e. 70%)

NOI – “net operating income” – gross rental revenue less operating expenses (property taxes, insurance, repairs & maintenance, capital expenditures)

Cap Rate – net operating income divided by the value of property expressed as a percent (i.e. 4.5%)

Amortization period – the number of months / years the principal repayments of a loan are spread over. The total length of time it will take you to pay off your mortgage (i.e. 30 years)

 

Structures and Joint Ventures (JVs)

Most developments structured as a joint venture between General Partners (GPs) and Limited Partners (LPs).

Key points about GPs:

  • Responsible for all management decisions
  • Fiduciary duty to act for the benefit of the limited partners
  • Fully liable for its actions
  • May have guarantees as security on borrowing

 

Key points about LPs:

  • Limited refers to “limited liability”
  • Have priority on liquidation, ahead of the GPs
  • Provide capital to fund the development project
  • Have no control over the management of the fund/project

 

Assumptions section of the financial model

As covered in CFI’s real estate financial modeling course, the key assumptions that will be input into the model include:

  • Schedule
  • Property Stats
  • Development Costs
  • Purchase and Sale

 

These are discussed in great detail in our actual course.

 

Development cash flow model

To set the foundations of real estate financial modeling it’s important to cover the key sections that will be built, based on project assumptions.

The key sections in the development model include:

  • Absorption (timing and pace of sales)
  • Revenue
  • Commissions
  • Warranty
  • Land acquisition (capital cost)
  • Pre-construction costs
  • Construction costs
  • Financing and interest expense
  • Levered Free Cash Flow

 

Output and Pro Forma

Once the model is built it’s important to create a one-page summary document or Pro Forma that can be shared with bankers, investors, partners, and anyone who needs to analyze the deal.

This output pro forma should include the following information:

  • Property stats
  • Schedule – summary key dates
  • Financing assumptions
  • Sales assumptions ($ total / per unit / per SF)
  • Budget ($ total / per unit / per SF)
  • Returns (IRRs)
  • Return on cost
  • Return on sales
  • Sensitivity analysis

 

Example of a real estate financial model

This is an example of the one-page output from our real estate financial modeling course.  As you can see, it clearly displays all the information listed above and makes it easy for someone to evaluate the deal.

 

real estate pro forma

 

Here is an example of the actual inner workings of the model, where you can see absorption by month for the development project, which builds up to revenue, and ultimately cash flow.

 

foundations of real estate financial modeling - model

 

These foundations of real estate financial modeling are covered along with much more detail in our online course.

 

Cap Rate and Net Operating Income (NOI) example

Net operating income, which is equal to gross rental revenue less operating expenses (property taxes, insurance, repairs & maintenance, capital expenditures) is the key profitability or cash flow measure used to evaluate real estate development transactions.

Cap rate, which is equal to net operating income divided by the value of the property is expressed as a percentage and used to value real estate.  The lower the cap rate, the more highly valued a piece of real estate is, and the higher the cap rate the less valued the real estate is.  Price and cap rate move in inverse directions to each other, just like a bond.  Learn more in our financial math course.

 

Financial modeling course

The best way to learn is by doing, and our real estate financial modeling course gives you the step by step instruction you need to build financial models on your own.  It comes with both a blank template and a completed version, so you can easily build it on your own, or just straight to the completed version.  Our high-quality video instruction will guide you every step of the way.

 

Additional resources

CFI’s mission is to help you advance your career. With that goal in mind, we’ve developed many more free resources to help you along your way.

To learn more about valuation, corporate finance, financial modeling and more, we highly recommend these additional free resources: