Real Estate Interview Vocab
Annuity Formula
(1/r)*(1-(1/(1+r)^T)). T = number of perods and r = mortgage rate for one period
Return on Capital
6% is the CoC unlevered If interest is 4% at 50% LTC (2% of Delta to CapRate) You then weight an average (6% * .5 = 3%)+ (2% * .5 = 1% ) = 4% on half of the equity so 4% *2= 8% Levered Cash on Cash if it is interest only
Credit default swaps
A credit default swap (CDS) is a financial derivative or contract that allows an investor to "swap" or offset his or her credit risk with that of another investor. For example, if a lender is worried that a borrower is going to default on a loan, the lender could use a CDS to offset or swap that risk. To swap the risk of default, the lender buys a CDS from another investor who agrees to reimburse the lender in the case the borrower defaults. Most CDS will require an ongoing premium payment to maintain the contract, which is like an insurance policy.
Table Funding
A process in which a broker originates and closes a loan in his/her own name, then transfers the loan to a lender at closing. The lender provides funds for disbursement.
Repo Rates
A repurchase agreement (repo) is a form of short-term borrowing for dealers in government securities. In the case of a repo, a dealer sells government securities to investors, usually on an overnight basis, and buys them back the following day.
Stabilized cap rate
A stabilized cap rate is the ratio between the net operating income produced by a property upon achieving target occupancy, and its purchase value.
Debt Constant
Annual Debt Service/Original Loan Amount. Reflects total cash flow cost of a mortgage. Equals to inverse of the annuity factor
walk me through your deal
Background -Transaction type (refinance, acquisition, construction take-out, credit facility) -Borrower history -Property overview -Overview of City Financial and Demographic Metrics -LTV/DSCR/NOI/Cap Rate / Expense Ratio etc. - Median House Value / Median Income / Population Growth / Supply & Demand of Property Type - Compare the above metrics to Comparable properties Strengths and Weaknesses of Property -Highlight weaknesses and why your team was okay with them -Strengths are self explanatory Outcome of Transaction
Pro-forma income line items
Base rental income absorption and turn over vacancy -represents rental income lost when existing tenant leaves and time to take for new tenant concessions and free rent expense reimbursements: present the amount of property taxes, insurance, and maintenance/utilities for which the tenants are responsible for potential gross revenue = represents the cash revenue from all space in the building, ignoring permanently vacancy space (-)general vacancy effective gross income (similar to net sales) or net revenue for a normal company, but it's on a cash basis rather than accrual basis. egi representsthe cash revenue temporary and permanent vacancy and free months of rent interest expense on debt -IPMT function Debt principal repayment-use ppmt function since you ignore income taxes in most RE
CMBX
CMBX Indexes are a group of indexes that track the commercial mortgage-backed securities (CMBS) market
Purchase Price: $10M Loan Prinicpal: $7M Equity: $3M Cap Rate: 4.75% - $475,000 in NOI Debt Service: 4% * $7M = $280,000 Cash Flow after Debt Service? Cash on Cash Return? Levered return?
Cash flow after debt service: $475,000 - $280,000 = $195,000 Cash On Cash return: $195,000 (cash flow after debt service) / $3M (equity basis) = 6.5% So to summarize, your unlevered return is 4.75%. The lender is charging a 4% return to "own" the senior pice of the capital stack up to 70% LTV. After you pay the lender, your levered return is 6.5%
CMBS
Commercial Mortgage Backed Securities
3 approaches to value real estate
Comparables Sales Approach: start with value of comparison property and then adjust for differences in amenities, date of sale to determine the value of property we want to appraise Replacement Cost Approach: buyer won't pay more for property than what it would cost to rebuild somewhere else estimate cost of rebuilding the structure + value of land to get the value of total cost. Income Approach: value of an income producing property should equal PV of income produced by it.
DSCR
Debt Service Coverage Ratio Measurement of a property's ability to generate enough revenue to cover the cost of its mortgage payments. It is calculated by dividing the net operating income by the total debt service (interest + principal amortization)
Why Would Two Identical Properties Sell For Different Prices?
Different Tax Codes Different access points - turning lanes, street lights, traffic counts...etc One building can have much more attractive transferable debt Tenant Roster Space allocation Valuable/Less-Valuable lease structures (Reimbursements, tenant roll, termination rights) Leaner operations Walk able amenities - or even on-site amenities for an office building (cafe, gym, cleaners, day-care, etc...). The 'street' can be a freeway that you cannot really walk across Different Zoning Environmental - Cleaners and Gas Stations can play a role into this Parking can certainly come into play
What are common operating metrics and valuation multiples for REITS
Funds from Operations FFO Adjusted Funds from Operations AFFO FFO = Net Income to Common + Real Estate -Related Depreciation and Amortization - Gain/Loss on Sale of Depreciate Real Estate AFFO= FFO -Maintenance CapEx-Gain/Loss on Sale of Land+ Other Non Cash Charges
JBG Smith
JBG has substantial projects across multiple property classes (MF, office, retail, hotel) in three very different jurisdictions. (Think: Montgomery County=anti-growth; Fairfax County=pro-growth.) Know about the firm's largest development projects in the pipeline, such as its plans for L'Enfant Plaza
3 credit metrics
LTV DY DSCR
What are the key metrics you use to analyze and value a property?
NOI = Revenue - Operating Expenses - Property Taxes, so it excludes Interest, Corporate-Level Taxes, and D&A, just like EBITDA for normal companies A real estate investment trust (REIT) is a company that buys, sells, develops, and operates properties and/or real estate-related assets. REITs pay no corporate taxes if they distribute 90% of their taxable income as dividends, earn 75% of their gross income from real estate, have 75% of their total assets related to real estate, and have more than 100 shareholders (they also can't have fewer than 5 investors that own over 50% of the company). So you'd invest in a REIT if you want reliable, dividend income with the possibility of some stock price appreciation. The REIT itself saves on taxes, but you as the investor do not since you still pay taxes on those dividends.
How do you value a reit
Net Asset Value, DCF, Dividend Discount Model NAV is the most common method. It uses the REIT balance sheet and portfolio-wide NOI to value the firm. Assign a cap rate to the REIT's 12 month forward NOI to get true value of real estate assets, then you adjust and add in all their other Assets, subtract Liabilities and divide by the share count to get NAV per share DCF: use levered FCF
How do a REIT's 3 financial statements differ from those of a normal company?
No corporate taxes on the Income statement BS: Real Assets and non real assets Major Cash Flow Statement: acquiring, developing and disposing properties Discontinued operations on Income Statement Low on cash and need to issue Debt and Equity all the time because of high capital requirements and need to issue dividends constantly
Securitization
Securitization is the financial practice of pooling various types of contractual debt such as residential mortgages, commercial mortgages, auto loans or credit card debt obligations (or other non-debt assets which generate receivables) and selling their related cash flows to third party investors as securities, which may be described as bonds, pass-through securities, or collateralized debt obligations (CDOs). Investors are repaid from the principal and interest cash flows collected from the underlying debt and redistributed through the capital structure of the new financing. Securities backed by mortgage receivables are called mortgage-backed securities (MBS), while those backed by other types of receivables are asset-backed securities (ABS)
What would you do with $100 Mn
The first words out of my mouth would be to diversify the money. I'd make the claim that I know xyz market the best so I'd focus my active investments there. I'd also put 20 million in a core office/lab/development REIT that I am extremely familiar with (this would be my only passive investment). I'd put 30 million in acquiring multifam buildings on the outskirts of the CBD (secondary downtown multifam market). I'd take 20 million and develop a multifamily residential project on the waterfront of a long forgotten area within the CBD that I'm bullish on. I'd then use 10 million to develop single family houses in 2 suburban towns that I'm also bullish on--I have had access to successful single fam projects and have seen the numbers/time constraints/risks associated with this type of play. I'd use the remaining 20 million to buy a moderately sized class B office/retail building in the dead center of my CBD.
Going in cap rate
The overall capitalization rate; the ratio of the first-year net operating income to the overall value (or purchase price) of the property. Can be misleading because expenses are very high in the first year)
Value X building
What is it? Multifamily, mixed use multifamily with retail? Rent control? Rent stabilize? How many units Cash Flow limit by rent roll Tax abatement? environmental issue
Walk me through a DCF valuation on an asset.....How do you find an appropriate discount rate?
Your discount rate is the return of the next best deal you could undertake. So a good starting point is the unlevered IRR your could achieve on a comparable deal. For a database of discount rates, look at IRR's annual Viewpoint publication. Discount rate is your total return (income plus appreciation). Cap rate is the income component of your total return. Said another way, the discount rate = cap rate + long term growth rate On a high level, I find it helpful to think of discount rate (in any asset class) as compensation for the risk you are taking. As mentioned, you may look at comparable deals to get a sense of what a similar asset is yielding (or has been sold / traded for, and thus what someone else views as an appropriate yield / return for that asset) and establish a starting point for how to think about your deal. This is true across all asset classes. When you get into the practical side of it, it becomes asset class specific, because different assets have different risks and different ways to look at that risk. So as mentioned, you can break down discount rate for a real estate asset into income + growth (or WACC for a company, or risk free rate + credit spread for a bond, or risk free rate plus beta * market risk premium for a stock), but idea is the same and they all attempt to capture the same thing: the value of the risk. Something that is riskier will have a higher discount rate (or higher required yield) resulting in a lower price to reach that yield, and something less risky (like treasury bonds) will have a lower discount rate rate (or lower required yield, higher price). Coming up with your discount rate is ultimately how you come up with the price you are willing to pay for the asset. In your hotel example, if you've come up with reasonable assumptions on rent (income) and sale (growth / appreciation), then those two components will give you a sense of what your required discount rate should be. Also, I find for these interview types, it is more about showing you understand the big picture than the specific answers, so for #1 emphasize risk / yield and #2 highlight that you understand you can think critically through various reasons why two assets might be different besides what's on the surface or despite being told the easier variables are the same (similar tenants, similar size, similar location etc)
Real Estate Mortgage Investment Conduit (REMIC)
a vehicle for restructuring the cash flow of mortgage pools
why two identical properties have different values
any cash flow inhibiting or enhancing tax abatement rent control lease control rent stabilization
Property Prices and Cap Rates in a Rising Interest Rate Environment
as the spread between cap rates and Treasury yields has been much wider than normal, giving the real estate market a healthy cushion against rising interest rates. Spreads remain wide, but there is less margin than there was six months ago. We expect future increases in interest rates to be gradual but steady, which will likely be accompanied by some further narrowing of cap rate spreads. A sharper increase in interest rates, while unlikely, could lead to some disruption in cap rates, including a reversal of some or all of the recent increases in property prices.
Why FFO
because FFO excludes D&A (which is more correct as including D&A assumes that real estate assets diminish value over time. FFO is different from CFO
Cap Rate: NOI/Property Value
capitalization rates are an investor's way of converting expected cash flows from real estate into an estimate of today's value. They can be thought of as an investor's expected rate of return given assumptions about future net operating income (NOI) over a specific holding period. For any given cap rate, higher expected NOI will result in higher real estate valuations. However, cap rates and real estate valuations are inversely related, meaning higher cap rates result in lower valuations for any given level of NOI. As cap rates fall, real estate valuations rise, and vice versa. The yields investors can "lock in" by investing in U.S. Treasury bonds provide a benchmark that can be useful when assessing the cap rates currently observed in real estate markets. Using the yields on 10-year Treasury bonds as a starting point, we can estimate a "spread" or the incremental difference in returns expected from an investment in commercial real estate over returns from risk-free bonds. This spread should compensate investors for the additional risk that real estate investors assume with real estate investments, and must include some incremental reward for holding a less liquid financial asset such as nontraded REIT shares. Unlike a government bond with fixed interest payments, cash flows from real estate are typically expected to grow. Therefore, an investor's required rate of return will include future growth rates as an important component. Other things equal, the expected growth rate in NOI will show up in spreads as a downward adjustment. Higher expected growth in NOI from today's level means investors can accept a lower capitalization rate for current NOI. The cap rate/Treasury yield spread thus becomes a barometer of investor sentiment as it mathematically explains the trade-off in returns that investors are willing to accept for higher risk versus low-risk investments. Beyond estimating the return for an individual property or a portfolio of real estate assets, are there additional insights we can glean when it comes to valuations and the investment cycle in commercial real estate if we monitor the changes in spreads between capitalization rates and the yields on government bonds? The answer is yes. And in fact, cap rates and cap rate spreads are a valuable gauge of investor preferences for real estate versus other investments over time. By observing the spreads between yields on 10-year Treasury bonds and cap rates for commercial real estate, we can gain insights into the ever-changing investment environment. NCREIF publishes quarterly average cap rates for all classes of commercial real estate reported by fiduciary transactions and appraisals. As the chart illustrates, during 2Q 2007, the overheated and overpriced real estate market is quite evident as spreads declined while real estate asset values were increasing. Stating it differently, inflated real estate values resulted in historically low spreads between cap rates and Treasury yields (0.29%). Later, as spreads between capitalization rates and bond yields increased as we saw in 3Q 2010, investors were demanding higher rates of return as a risk premium for holding real estate and the spread increased to 4.42%. Over the last 10 years, the average spread between cap rates and 10-year Treasury bond yields has been 2.7%. Using these historical markers as our guide, is it possible to predict future real estate values and market trends? By applying the average spread to 10-Year Treasury yields in 2Q 2013, we could expect to see an average NCREIF cap rate of 5.27% which suggests that real estate values are improving because this new estimate is lower than the observed cap rate of 5.87% during 4Q 2012. John Maynard Keynes compared successful investing to judging a beauty contest in which the object was not to pick the most beautiful contestant, but to pick the contestant which the other judges would believe was most beautiful. Applied to real estate investing, today's valuation depends not just upon our estimates of future values, but upon the present and future return estimates of other investors both at the individual property level and the sector level. And by monitoring the change in both cap rates and cap rate spreads, we are able to create a valuable barometer of investor preferences for real estate versus other investments.
CDOs
collateralized debt obligations; financial investments based on mortgages; investment banks sell; values collapsed which created an inflated credit market because banks without capital funds
Exist value question
if I want to achieve X% return and this is my income, how much you pay to achieve IRR
"If You Had $100M, Where Would You Invest It?
if i had $100M of my own money to invest (and obviously for the purposes of this discussion as it relates to real estate investing), I would be putting it into core plus investments in stable markets. Investments that are at (or near) a stabilized occupancy containing tenants with good credit. Investments that might have a little meat left on the bone (minor lease-up, revenue enhancing opportunities to explore at the right time, etc.). There's an over saturation of value add investors chasing a story. In my market, I'm seeing vacant buildings trade at a higher price PSF than that of more stabilized investments containing strong yields, literally a block down the street with the same deal profile, with the exception of occupancy and a re positioning story. Especially when you take a step back and understand where we are at in this cycle, it really makes you question how these groups are making these deals pencil. When you couple this with the historically low debt capital markets environment... This is why I would be placing my $100M into core plus deals in core markets. This is an interesting argument, which type of investment will perform better in a downturn, core or value-add. Argument for Value Add: You can eat more of a cap rate increase because ideally you have a decent spread between your yield on cost and exit cap. A cap rate increase will crush core assets as there is limited ability to increase NOI and you'll never be able to get out for what you paid. If your compelled to sell before the market recovers (fund life, liquidity crisis, etc) you're going to take a bath. Argument for Core: Trophy assets will be the first to rebound in a recovery, and are inherently more valuable due to barriers to entry. The thesis of value add investments are unlikely to be realized in a recession. If you can hold through the downturn they will bounce back. While I think the above is a great answer, I believe in an interview context, this question is poised as a proxy to your knowledge of the basics of managing risk in a portfolio. My answer is always: "Keep ~$10M in cash for liquidity purposes, investment $15M in government securities for guaranteed coupon, invest the rest in equity in asset type xyz in market abc. Just my personal take from the feedback I have received when asked this question
Debt service schedule question
if you borrow a loan at 6.5% at 4.5% cap rate, what is your return? Model your expenses and revenue when you pay. What is the amortized balance
DY
noi/loan amount
proforma expenses line items
property management fees operating expenses real estate & property taxes Cap Ex, Ti and LC Reserve NOI: a capital structure neutral approximation of core business cash flows (-)cap ex, TIs, LCs (+) capital costs paid from reserves Adjusted NO: NOI -capital costs not covered by reserves. Similar to unlevered cash flow -the cash generated by core business operations, ignoring capital structure interest expense on deby
Why do investors bother to refinance loans
same as pe investors pursue dividend recapitalizations in LBOs: to boost their returns by making the company or property take on more debt and then distributing the net proceeds to themselves OR take advantage of lower interest rates if rates have been failing
Key Leases Term
start date and end date Monthly Rate and Step-ups Months of free rent expense reimbursements percentage rent tenant improvements TIs NNN: tenant pay for everytithing NN: tenantpayfor tax and insurace but not maintainance/utilities N: tenants pay for tax only
Credit Enhancement
the process whereby the issuer of a mortgage-related security adds support to the underlying assets by contributing capital or overcollateralizing the assets
