In the fast-paced world of real estate investment you are sometimes only as good as your last deal. Why not make that deal count? At Finalyze CFO Services we can help you count your returns (and blessings) through an investment grade financial model.
Why should use a model for your next deal? Can’t you just rely on your gut? Read on to learn more!
A real estate financial model is a tool designed to produce an estimate of future cash flows and returns for owners, investors, and lenders in a deal. These models take a range of inputs including lending rates, building costs, rental income, operating expenses, and more! The type of inputs and complexity depending upon the investment type and strategy being applied.
After considering these inputs, the model generates a range of scenarios for the investment, usually in the form of return metrics and total costs of the project. Through changing different inputs known as sensitivity analysis, you are able to fine tune details on a close to real time basis to help predict and evaluate your investment options so you can make the most informed decisions. The financial model acts as your GPS as you evaluate investment opportunities.
If you are intending to bring outside capital into a deal whether through investors or lenders it is critical to have a working model which runs through potential scenarios. Lenders are looking to ensure there are safeguards in your expectations to provide security against their loan. In the case of investors they are looking to ensure there is not only downside protection for their investment but also an understanding of how the profits are split on the upside.
At Finalyze CFO Services we have expertise in real estate financial modelling with the ability to work with your project whether it is a value-add opportunity, development, or even launching a new fund!
From our extensive experience these are the top 5 principles that make a great financial model:
- Accuracy – A great model should always calculate accurate results even under complex scenarios. The mechanics of a model should be built with care and precision, so that key figures are never distorted, saving you a lot of trouble in front of investors or lenders! An inaccurate model can not only damage credibility if relied upon it provides an inaccurate benchmark or tool to manage performance.
- Flexibility – A great real estate financial model allows for evaluation of your project under any scenario. All critical assumptions should be an input marked clearly so that users can dynamically understand how cash flows and returns will look under different circumstances. When used properly, the changes should be reflected throughout the model, and new input figures must be well handled to not break or cause errors.
- Monthly versus Annual Cash Flows – To drive true precision a model should be projecting cash flows out using monthly versus annual figures and be as precise as possible in dates. When using Excel, specifying exact dates and cash flows in your XIRR calculation is critical to ensure accuracy. A few percentage point differences can significantly vary returns especially in situations with carried interest or promote waterfall structures.
- Dynamic Capital Stack – The capital stack which refers to the mix of debt and equity to fund a deal can vary significantly in different scenarios. On the debt side, changes in leverage can impact if a loan is even possible while meeting constraints such as the debt service coverage ratio (DSCR). On the equity side, the tables should factor in preferred equity and the complexities of a real estate private equity waterfall which can involve multiple IRR thresholds, equity multiples, and other features including a catch-up provision. The capital stack is the heart of the model and can be quite complex!
- Summarized Investment Analytics – Great models can have a lot of detail built into them, drilling into every single cost and forecasting revenue very robustly. Nevertheless, investors should always be easily able to follow the logic and understand the key takeaways of the model, even without any financial expertise. The Summary tab should be at the very first tab and provide a quick view of the deal, relevant return metrics, and include some sensitivity for key parameters such as interest rates, cap rates, and rent growth for example.
A great financial model is critical in determining the potential profitability of a real estate project while providing credibility to lenders and investors to raise capital. Building a financial model requires precise analytical skills paired with sound real estate investment financial and business acumen.
We’d love to help you make your next deal count. If you are evaluating a real estate investment opportunity, contemplating scenarios for a development, or launching a new real estate investment fund a financial model is a necessity. Such an undertaking isn’t for the faint of heart, choose our experienced team at Finalyze CFO Services to build you an investment grade financial models to help crush your goals!
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