What's in a Real Estate Private Equity Case Study?

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• published: 22 Jul 2015
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In this tutorial video, you'll learn what to expect in real estate private equity case studies and you'll get an example of a real case study with the solution file and a walk-through of the key points. Please get all the files and the textual description and explanation here: http://www.mergersandinquisitions.com/real-estate-private-equity-case-study Table of Contents: 2:49 Part 1: The Types of RE PE Case Studies 7:59 Part 2: This Case Study and What Makes It Tricky 11:04 Part 3: How to Challenge the #s with Scenarios 15:56 Part 4: The Property Model 21:20 Part 5: The Investment Recommendation 23:26 Recap and Summary Part 1: The Types of RE PE Case Studies The 3 main types are core / core-plus, value-added, and opportunistic. In the first category, the property stays nearly the same over the holding period and the market analysis is more important than a complex model. In the second category, the property changes significantly (more tenants, higher rents, a renovation, etc.) and the models tend to be more complex. The modeling often gets the most complex in the third category because a new property is developed, an existing one is redeveloped, or the building changes massively (e.g., rescuing a distressed property). The complexity also depends on how granular the model is - modeling individual tenants with different lease terms always gets more complicated than a high-level model with average unit sizes, square feet or square meters, etc. Part 2: This Case Study and What Makes It Tricky The trick here is that the case study is more about figuring out the proper OPERATING scenarios, NOT modeling all the units in granular detail. The market will almost certainly experience a downturn and recovery at some point, so you must factor that into the 10-year model. Part 3: How to Challenge the #s with Scenarios We use an Immediate Downturn, Recovery, Stabilized scenario and then a High Growth, Downturn, Recovery, and Stabilized scenario in addition to the Base Case numbers. The importance of these scenarios is that the assumptions are all interrelated for real estate - if rents fall, the vacancy rate is almost certainly rising, as are tenant improvements and leasing commissions since landlords must pay more to win new tenants in a soft market. So you need to reflect those relationships in each phase of your model. Part 4: The Property Model We always start with the total potential rental income, add other income, subtract vacancies and collection losses, then subtract OpEx, Property Taxes, and Maintenance CapEx, and then subtract capital costs and debt service to determine the cash flow. We use IPMT and PPMT for the debt service calculations, and also look at the interest coverage ratio and debt service coverage ratio (DSCR). At the end, we also calculate the IRR and NPV and value the property with a DCF, ultimately concluding that we would be unlikely to realize a 10% IRR here. Part 5: The Investment Recommendation We recommend against acquiring the property because the numbers don't work, $120 million is too high an asking price, the DSCR requirements might be problematic, and the assumptions would have to be far more optimistic for the deal to work. http://www.mergersandinquisitions.com/real-estate-private-equity-case-study