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10/28/2013

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Admin 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 atLegends

New Pro forma exercise assigned Wednesday; individual casestudy to be assigned next week

In the news? From the animal stories file:http://www.mlive.com/news/grand-rapids/index.ssf/2012/10/resident_using_torch_to_singe.html ;http://abclocal.go.com/wpvi/story?section=news/local&id=8854977

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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 onforecast of operating expenses (usually current operatingexpenses grossed up by an estimated inflation rate; )

If there is vacant space (above equilibrium levels), forecasttiming/structure of new leases

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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, lessthan 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 expectedcash flows

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A simple spreadsheet illustration simple valuationmodel N:\Private\Fin 40710\Spring 2012\Simplevaluation model.xlsx

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Real estate development pro forma Recall Dillingham - a stabilized property; its pro forma

is constructed based on existing tenant lease termsand assumptions regarding tenant turn over;

If leases tend to be longer term (or contain extensionoptions), the existing leases will control NOI forpossibly several years

Software such as Argus is used to track the cash flowconsequences of the complex terms of lease contracts,and has much flexibility in modeling lease behaviorover time in order to produce IRR and NPV values

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At the other end of the spectrum, developmentprojects represent facilities at the planning stage;lease contracts play at best a limited role

In the initial stages of a project (prior to landacquisition, for instance) feasibility analysis will becarried out with no binding lessee commitment(although there may be letters of intent; non-binding)

Some space will most likely be leased prior toconstruction (pre-leasing, agreements to lease) inorder to satisfy the terms of construction lending

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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

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In contrast to stabilized facility pro forma:

Development involves construction and constructionfinance

Development involves a leasing process

Pro forma is used in project feasibility work that beginswith site evaluation

At project conception, development pro forma is basedon a site plan, estimated development costs, andmarket rent estimates

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Starting from a site plan, development pro forma analysis involves thecategorical estimation of project costs: Soft costs costs other than brick and mortar related including

engineering fees, architecture fees, developer fees, legal costs, leasingcommissions, permitting fees, financial carrying costs (constructionloan interest) etc.

Hard costs land, site work (earth work), roads, building constructioncosts

Development pro forma also requires estimates of NOI (at least firstyear 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 thestabilized property with direct capitalization)

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Some development

pro forma basics Real estate development usually involves a developer with

expertise in managing the development process as well ascapital partners who are responsible for the majority of theproject equity (the developers portion of the equity interesttypically will run from 0% - 10%)

The developer profits from a (or several) fee(s) in addition toher/his return on equity

Development usually involves construction debt of as muchas 75% (at least when cash was easy!) of the cost of theproject; the remaining 25% comes from the developer andcapital partners; note that debt costs (interest) are includedin the Overland pro forma, but there is no cost in the budgetfor the use of equity

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Note the debt cost (interest) is capitalized andincluded 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 beingfunded as part of the construction debt so that other

than the initial equity investment, thedeveloper/capital partners have no development-related cash out of pocket until the project stabilizes(and thus earns rent revenue)

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Most development pro forma contain a fairly detailedconstruction cost analysis/schedule

Capitalized interest depends on the timing ofconstruction costs, because construction loan fundsare paid out as construction proceeds (a process inwhich costs are submitted to the lender and then thelender allows a loan draw)

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Stabilized NOI constructed in the usual way;

Potential income (0% vacancies) net of income lossfrom vacancies

Rent, operating expense, and expense recoveryassumptions (see spreadsheet); note the treatment ofCAM and other expenses including management feesand structural expense

Triple nets or gross lease assumptions are incorporated;under triple nets, fixed charges and CAM collected prorata using leased footage relative to total leasablefootage

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Development pro forma requires an estimate of NOI(at least first year stabilized); it is not unusual toforecast NOI out over a longer period (for investmenthorizon IRR calculations), but most of the attention ison estimating market rents and computing a one yearNOI forecast (in order to value the stabilized propertywith direct capitalization)

Overland Park N:\Private\Fin 70710\OVERLANDMARKETPLACE P-1 101405 P-3.pdf; N:\Private\Fin70710\Overland Park Master Proforma 21407 B.xls