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The Foundations of Real Estate Financial Modeling

This guide will provide the fundamentals of real estate financial modeling and the essential concepts to help you begin developing your own models for development projects.

To get you started beginning, we’ll start by explaining some of the terms you’ll need to understand prior to building your model.

Definitions and Terms for Real Estate

LTV”loan to value “loan at a value” The amount of financing for debt that provided by a lender in percentage of marketplace value (e.g. 20%, 80%)

LTC”loan to cost “loan at cost” The amount of debt financing that a lender provides as a percentage of development cost (e.g. 70%, for example.)

NoI = “net operating earnings” Gross rental revenue less operating costs (property taxes as well as insurance, repairs and capital expenditures, maintenance, etc.)

Cap Rate is the net operational earnings divided by the amount of property. It is expressed in an amount (e.g., 4.5%)

Amortization period is the number of years or months the principal payments of the loan are spread over. The length of time it takes you to repay the mortgage (e.g. 30 years, for example).
Structures and Joint Ventures (JVs)

The majority of developments are arranged in a joint venture with General Partners (GPs) and Limited Partners (LPs).

Important points regarding GPs

Responsible for the management of all decisions
Fiduciary duty to act in the interest of the limited partner
Fully responsible for its actions
May have guarantees for security for borrowing

Important points about LPs

“Limited” refers”limited liability. “limited liability”
Priority on liquidation ahead of GPs
Fund the capital needed to finance the development of the project
You have no influence on the direction of the fund or project.

The Assumptions section within the Financial Model

In our financial modeling for real estate course, the main assumptions to be incorporated into the model are:

Schedule
Statistics on Property
Development Costs
Purchase and sale

These topics are discussed in greater depth in our current course.
Model of Development Cash Flow

To establish the basis for financial modeling for real estate it is crucial to include the most important parts that will be built upon the assumptions of the project.

The main components of the development model are:

Absorption (timing and rate of sales)
Revenue
Commissions
Warranty
Acquisition of land (capital cost)
Costs of pre-construction
Costs for construction
Cost of financing and interest
The Levered Free Cash Flow

Pro Forma and Output

After the model is constructed after which it is important to draft an overview document of one page or Pro Forma that could be sent to investors, bankers as well as partners and anyone else who wants to evaluate the deal.

The output pro forma needs to contain the following details:

Statisticians on properties
Summary of the schedule and key dates
The assumptions for financing
Sales assumptions ($ total / per unit / per SF)
Budget ($ total / per unit / per SF)
Returns (IRRs)
Cost of return
Return on sales
Analyzing the sensitivities

The Cap Rate as well as Net Operating Income (NOI) Example

Net operating earnings, equal to gross rental income less operating costs (property taxes and insurance, repairs, maintenance and capital expenditures) is the most important cash flow measure or profit that is used to assess real estate development deals.

Cap rate is the sum of the net operating profit divided by worth of the property is expressed in percentage and is used to evaluate real property. Lower the rate of cap, the higher valued an item of real estate is. Likewise, the more expensive the cap rate, the less valuable the property is. Cap rate and price change in opposite directions to one in the same way as the bond.

Financial Modeling Course

The most effective way to learn is to do taking an actual property financial modeling course will give you the step-by-step instructions to construct financial models of your own. It includes both an unfinished template as well as a fully-finished version, meaning you can build models on your own or simply go directly to the finished version. The instructional video will guide you through each step of the way while you complete the case study of townhouse real estate development.