Blackstone BREP

IRR: Double Your Money in 5 Years = ?

= ~15% IRR

IRR: Double Your Money in 3 Years = ?

= ~25% IRR

IRR: Triple Your Money in 5 Years = ?

= ~25% IRR

IRR: Triple Your Money in 3 Years = ?

= ~45% IRR

what is the difference between enterprise value and equity value?

Enterprise Value = Market value of operating assets Equity Value = Market value of shareholders' equity

Both FFO and AFFO are based on Net Income, so they are...

Equity Value-based multiples.

What is the most volatile product type?

Individual property idiosyncrasies aside, hotel generally displays the most volatility.

what is the advantage of using a build-up method?

it attempts to define and accurately measure individual components of a discount rate.

what is the advantage of using the band-of-investment method?

it is the most appropriate capitalization rate for financed real estate investments

advantages to replacement cost method?

its grounded in fundamental construction costs as opposed to the prevailing Cap Rates in the market - so it's less subject to fluctuations in the real estate prices.

explain to me senior notes

less risky type of Debt than mezzanine, with lower interest rates; it may also be secured by collateral (the building).

explain the PE exit strategy for doing a secondary buyout. pros/cons

less than ideal exit as financial buyers cannot pay a premium for synergies

higher Cap Rates mean...

lower valuations

How do you estimate a property's revenue? What are the main revenue categories?

main revenue category is rental income. Here's how you calculate it for a few different building types: - Offices / Retail / Industrial: $ Per Square Foot or Square Meter - Apartments: $ Per Unit - Hotels: Based on the Average Daily Rate (ADR), the total # of rooms, and the Occupancy Rate

A lower Cap Rate (e.g. 5%) means the property is _________, and a higher Cap Rate (e.g. 10%) means that it's ____________

more expensive; less expensive

Amazon bond vs Amazon lease ware, which is more liquid?

typically, bonds are more liquid than lease ware as there is a marketplace for bonds

explain what multiple expansion is

when a financial sponsor acquires a company at a low entry multiple ("getting in cheap") and then exits at a higher multiple

if the NOI is $10 million and the building costs $100 million, the Cap Rate is...

$10m/$100m = 10%

if you've received over $240,000 over a 5 year investment and your total investment was $80,000, what is your equity multiple?

$240k/$80k = 3.0x

what is the AUM of Blackstone Real Estate Debt Strategies?

$26 billion as of 2020 2nd quarter, from $10 billion AUM only five years ago

BREDS during COVID?

- COVID crisis amplified significant shifts already underway in real estate and created market dislocation that should result in attractive opportunities for BREDS

explain the risk/return of the different strategies

- Core real estate offers lowest risk and potential returns - Core-Plus is slightly higher Value-Added is higher Opportunistic offers the highest risk and potential returns

How does the treatment of financing fees differ from transaction fees in an LBO model?

- Financing fees are related to raising debt or the issuance of equity and can be capitalized and be amortized over the tenor of the debt (~5-7 years). - On the other hand, transaction fees refer to the M&A advisory fees paid to investment banks or business brokers, as well as the legal fees paid to lawyers. Transaction fees cannot be amortized and are classified as one-time expenses that are deducted from a companies' retained earnings.

Do you think a hotel would be valued at a higher or lower Cap Rate than an apartment complex?

- Generally, hotels will be valued at higher Cap Rates, meaning they're less valuable, and apartment and office complexes will be valued at lower Cap Rates. - That happens because revenue is much more stable and predictable with offices and apartments since they use 1-year or multi-year leases.

why is rollover equity viewed as a positive sign?

- Generally, if a management team is willing to roll over some equity into the new entity, it implies the team is doing so under the belief that the risk they are undertaking is worth the potential upside in it for them - overall beneficial for all parties involved in deal for the management team to have "skin in the game" and altogether have closely aligned incentives.

Two companies are identical in earnings, growth prospects, leverage, returns on capital, and risk. Company A is trading at a 15 P/E multiple, while the other - Company B trades at 10 P/E Which would you prefer as an investment?

- In most cases, people choose to invest in undervalued companies over overvalued companies. In this case, two firms have homogenous earnings, growth prospects, leverage, returns on capital ad risk - You should choose Company B because its P/E multiple is lower than that of company A, it means the company B is undervalued in the market. You can have more handsome returns in future compared with holding a portion of company A.

example of replacement cost method

- Let's say you call several developers and they estimate that they could construct it for $95 million, which comes to $950 / square foot. - In this case, the asking price is above the Replacement Cost so you're buying the building at a premium. - That's not necessarily "bad," but it might mean the building is overvalued - or it might just mean it's a normal market price if everything else in the area also sells at a premium to the Replacement Cost.

what's the loan-to-cost ratio?

- Loan-to-Cost ratio tells you how much Debt vs. Equity you're using to finance the development - For example, if the Total Development Costs are $100 million and the LTC ratio is 80%, you would use $80 million of Debt and $20 million of Equity.

what are some of Blackstone's high conviction themes?

- Logistics: the sector continues to benefit from strong tailwinds driven by e-commerce - Life sciences: unprecedented innovation driven by rapid advancements in science and technology - digital transformation & growth equity

what is NOI? (what does it stand for and what does it mean)

- Net Operating Income - NOI determines the revenue and profitability of invested real estate property after subtracting necessary operating expenses.

explain what debt paydown and cash generation is and how it drives returns

- Over time the cash flows of the business pay down the debt, creating equity value to the equity owners

How do you determine the total square meters or square feet in a building?

- Property size is based on the size of the lot you acquire and what percentage the building can take up - For example, if the lot size is 10,000 square meters and Allowable Lot Coverage is 80%, you can use 8,000 square meters for the building's footprint. This number is determined by local zoning requirements. - to determine the total allowable square meters for the building you need to use the FAR and multiply that by the lot square meters - Then you can divide by the building footprint area to get the number of floors in the building, using a partial floor at the top in case it's not evenly divisible.

what are REITs?

- Real Estate Investment Trusts

recent news on the BREDS team:

- September 2020: Blackstone's final close of its most recent real estate debt strategies fund, BREDS IV

What attributes make a business an ideal LBO candidate?

- Steady, Predictable Cash Flow Generation - Operates in Mature Industry - Business Model with Recurring Revenue Component - Diversified Revenue Streams with Minimal Cyclicality - Low CAPEX & Working Capital Needs - Currently Undervalued by Market (i.e. Low-Purchase Multiple)

Blackstone Real Estate Debt Strategies ("BREDS") was formed in what year?

2008

if the lot is 10,000 square meters and the FAR is 10, your building can take up...

100,000 square meters across all the floors.

for an LBO, the financial sponsor usually targets an IRR of what range?

20-25%

Real estate debt funds make money through...

interest payments

If you buy a property at a 6 cap, using 60% Leverage (5% Interest only), what is the year 1 cash on cash return?

$100 purchase price implies $6 of NOI $60 loan at 5% IO implies $3 of interest expense and $3 of Cash flow after debt service $60 Loan implies $40 of equity $3 of CFADS / $40 of equity = 3/40 CoC; (3/40)*2.5 = 7.5 / 100 = 7.5% Year one Cash on Cash

if you earn $80,000 in one year and your equity investment is $1,000,000, what is your cash-on-cash return for that year?

$80,000/$1,000,000 = 8%

What are the most common operating metrics and valuation multiples for REITs?

(1) Funds from Operations (FFO) and (2) Adjusted Funds from Operations (AFFO)

downsides to investing in real estate debt funds

- Although your risk is mitigated, there is still some risk of investing in a real estate debt fund. - possibility that borrower defaults on one of the properties that you invest in

What is a leveraged buyout (LBO)?

- An LBO is the acquisition of another company using a significant amount of borrowed money to meet the cost of acquisition - purpose of LBO: allow companies to make large acquisitions without having to commit a lot of capital.

what does the BREDS team do?

- BREDS Residential team oversees residential credit investments across the capital structure - investor in whole loan residential mortgages as well as an active participant in securitized markets

why do you want to join BREDS?

- BREDS utilizes its breadth, scale and deep knowledge, to deliver differentiated investment solutions and results for LPs, as they seek new ways to deploy capital beyond the business's opportunistic vehicles - presence in diverse geographies and asset classes gives us the perspective to find the safest opportunities that meet our return targets - draws from the team's global real estate expertise

why Blackstone?

- Blackstone invests in high conviction thematic opportunities - firm's culture and commitment to being both a leader and a pioneer - thematic investment approaches: life sciences, growth equity, and digital transformation. For example, with Life Sciences, the firm brings vital, but underfunded medicines and technologies to market. Blackstone helps to improve the quality of life of patients around the world. - I want to work at a firm where I am truly emboldened by the firm's values in bettering the place - I believe my values and beliefs align well with Blackstone - Blackstone's company culture stands out, which I was able to quickly experience at my time at O4U

Amazon bond vs Amazon lease ware, which would you invest in?

- Bonds are relatively safe, but the safer the bond investment, the lower the interest rate of return - Bonds pay a fixed rate of interest over the life of the investment, so purchasing power with that interest drops with inflation over time. - Rental property investing consistently yields in the high single digits and often results in double-digit returns. - Rental property can generate higher rents in periods of inflation.

Factors for valuing a cap rate

- Building age - Length of the lease - tenant size and creditworthiness - general diversification

what are the limitations of cash-on-cash return?

- COC return metric averages distributions over the underlying asset's ordinary period of operation - an asset's cash flow can vary wildly from month to month and year to year

walk me through the three financial statements

- The balance sheet shows a company's assets, liabilities, and shareholders' equity - The income statement outlines the company's revenues, expenses, and net income - The cash flow statement shows cash inflows and outflows from three areas: operating activities, investing activities, and financing activities

how do the three financial statements link together?

- The bottom line of the income statement is net income. Net income links to both the balance sheet and cash flow statement. - In terms of the balance sheet, net income flows into stockholder's equity via retained earnings (RE = previous period's RE + this period's NI - this period's dividends) - In terms of the cash flow statement, net income is the first line as it is used to calculate cash flows from operations - Any balance sheet items that have a cash impact (i.e., working capital, financing, PP&E, etc.) are linked to the cash flow statement since it is either a source or use of cash. The net change in cash on the cash flow statement and cash from the previous period's balance sheet comprise cash for this period.

If you had to choose two variables to sensitize in an LBO model, which ones would you pick?

- The entry and exit multiples would have the most significant impact on the returns in an LBO. - The ideal scenario for a financial sponsor is to purchase the target at a lower multiple and then exit at a higher multiple, as this results in the most profitable returns. While the revenue growth, profit margins, and other operational improvements will all have an impact on the returns, it is to a much lesser degree than the purchase and exit assumptions.

What types of industries attract the most LBO deal flow?

- The industries that are mature, growing at a moderate rate, and non-cyclical - companies found in these types of industries are more likely to generate predictable revenue with less disruption risks

walk me through your resume

- USC: started out as music major, but now a double major in Economics and also pursuing a masters in Economics - introduced to buy-side and asset management during my internship at Oaktree doing corporate finance - knew I wanted to be on the buy-side at asset man. - last summer, worked as a data science research assistant at USC SPEC Lab: detail-oriented and technical skills in Python/Excel - this summer, interned at BlackRock in their ETF & Index Investing division - Currently, interested in careers in real estate

what is an UPREIT structure?

- Umbrella Partnership REIT; - property owners contribute property but get Operating Partnership Units that represent ownership in the REIT rather than cash, so they don't get taxed immediately.

Could you use a DCF to value a property? What are some problems involved with DCF?

- You could, but not recommended real estate; everyone mostly uses Cap Rates - The DCF for real estate has too much reliance on future assumptions, etc

How does an add-on acquisition add value?

- add-on helps to complement the platform companies' existing product/service offerings - thus, enabling the company to realize synergies, as well as enter new end markets. - Also allows platform companies to better compete with strategic buyers in sale processes

in an LBO, how can I buy at $100M & sell at $100M in 5 years but still double my money?

- all depends on how the purchase was financed on the outset - for example, let's say in Year 1, 75% of purchase was debt ($75M) and 25% equity ($25M) - after paying off all your expenses, let's say you generate a cash flow of $25M - that $25M can be used to pay off debt, so now debt is $50M - you keep the remainder ($50M) we started with $25M, ended with $50M, which generates a 2x return

what is a reason for why add-on acquisition is a common strategy employed in PE?

- because the acquisition target will more often than not be valued at a lower multiple than the acquirer (and thus be an accretive transaction). - For example, if a company valued at 15.0x EBITDA purchases a smaller company for 7.5x EBITDA, the earnings of the add-on target will automatically be priced at 15.0x post-closing in theory. Once the transaction has successfully closed, the cash flows of the newly acquired company will immediately be valued at the multiple of the platform company - instantly creating value for the combined entity.

what are the most significant usage of funds in an LBO that you normally see on the "Sources & Uses" section?

- buyout of equity from the targets' existing shareholders - transaction fees paid to M&A advisors - financing fees - refinancing of existing debt (i.e. replacing the debt).

what does the acquisitions team do?

- pursues and analyzes deals, negotiates them, set up the financing, and convinces the decision-makers at the firm to invest in properties.

why is going in cap rate usually lower than going out cap rate?

- cap rate is a measure of risk - It is easier to predict what cap rates will be today, so going in is lower risk because you can forecast it - It is harder to predict the future because you don't know what will happen, so it places it at a higher going out cap rate

What is the typical capital structure prevalent in LBO transactions?

- capital structure in an LBO tends to be cyclical and fluctuates depending on the financing environment, but there has been a structural shift from Debt to Equity ratios of 80/20 in the 1980s to around 60/40 in more recent years.

what are some tasks you would be doing in REPE?

- deal sourcing, analyzing potential investments, building financial models, conducting due diligence, monitoring the portfolio, fundraising, and preparing investment committee memos

what is real estate debt?

- debt instrument that the borrower is obliged to pay back with a predetermined set of payments - debt instrument is secured by a specified real estate property as collateral

why is the cost of debt lower than cost of equity? list some other benefits of cost of debt.

- debt is higher up on the capital structure - advantageous "tax shield" - increased leverage enables firm to reach returns threshold easier

what is an opportunistic strategy?

- develop or re-develop a property and then sell it

How is modeling a property development different then what you see for a normal 3-statement model or LBO model?

- different from normal 3-statement models because you start with no revenue and no expenses initially, and then scale them up over time - it's not a pure LBO model because you're using Debt and Equity to fund the development of a new asset rather than the purchase of an existing asset

what are the limitations of equity multiple?

- does not discount to present value; does not account for how long the investor's money is tied up, nor does it say anything about the distribution of cash flow throughout a project's lifetime

what does the asset management team do?

- executes business plan that is put in place once the REPE firm has acquired a property - Team members improve the property's operations and financial performance and fix problems that come up

if cap rates rise from 5.0% to 6.0% in a market, by what % will a property's NOI need to increase for values to stay the same?

- for values to remain constant, % change in CAP rate must equal % change in NOI 1% nominal increase/5.0% base = 20% - increases by 20%

explain to me the office property type.

- have businesses as tenants - offer long-term leases of 5-10 years

explain to me the retail property type.

- have businesses as tenants - retail properties take more time and money and tend to have more tenants

explain to me the multifamily property type.

- have individuals as tenants and offer short-term leases (usually 1 year), with very similar terms for all tenants

why are real estate debt funds helpful?

- help connect borrowers with short-term capital for commercial real estate projects like multifamily buildings, shopping centers, construction loans, and many other property types

why would you invest in a REIT?

- if you want reliable, dividend income with the possibility of some stock price appreciation - REIT itself saves on taxes, but you as the investor do not since you still pay taxes on those dividends

why would one choose to invest in debt as opposed to equity

- minimize risk whenever possible - even though the potential for high returns is greater with equity investors, debt investors generally benefit from receiving consistent payments

explain the PE exit strategy for doing an IPO. pros/cons

- monetize its profits is for the portfolio company to undergo an IPO and sell its shares in the public market - however, this is an option exclusive to firms of larger-size (i.e. mega-funds) or club-deals

explain the PE exit strategy for doing a sale to a strategic buyer. pros/cons

- most convenient method - fetches higher valuations as strategics are willing to pay a premium for the potential synergies

what are the limitations of IRR?

- not the best gauge of an investment's overall profit potential - IRR alone also says little about the distribution of cash flow throughout a project

You have two identical office buildings right next to each other; they were built at the same time, are the same size, and have the same specs. One is valued significantly higher than the other. What are some explanations for this?

- one tenant could be of higher credit quality, which would lower the cap rate and riskiness - differing zoning laws -cap rates change based on lease terms - 5 year would be have higher cap rate and be more risky than 10 year lease (less time to amortize out loan)

pros/cons of cap rates?

- pro: Cap Rates are simple to apply - con: people disagree about how to calculate NOI

benefits of investing in real estate debt fund

- provide stable returns and consistent payments - payments you receive are usually provided on a monthly or quarterly basis - provides you with security within the capital stack - backed by collateral

what makes BREDS an attractive product?

- provided capital at scale to our borrowers who are investing in major real estate markets around the world. - the capital and liquidity we provide ultimately stimulates economic growth in these markets - delivering current income and equity-like returns with downside protection to our investors, which include retirement systems for teachers, nurses, firefighters and other pensioners

What is the "Sources & Uses" section of an LBO model?

- provides a summary of where the capital used to fund an acquisition will come from (the sources), what this capital will purchase (the uses) - both sources and the uses must equal each other, and they must total the total purchase price + transaction costs

What are the major segments of the real estate industry?

- real estate can be divided into (1) individual properties and (2) REITs - (3) can divide properties by sector: industrial, offices, hotels, multi-family, retail, storage, and healthcare are a few examples - (4) REITs divided into equity REITs, mortgage REITs, and hybrid REITs - (5) can divide REITs according to the property sectors above as well as the geographies they focus on

how do real estate debt funds work?

- real estate debt fund consists of private equity-backed capital that lends money to prospective real estate buyers or current owners of real estate assets - Investors in these funds receive periodic payments for the interest charged against loaned capital, and security charged against property assets, which takes the form of a mortgage - These funds offer loans collateralized by senior real estate assets to borrowers for a wide range of commercial and business real estate needs.

why is NOI helpful?

- similar to EBITDA metric - NOI helps to determine the cap rate, which in turn helps them calculate a property's value, thus allowing them to compare different properties they may be considering buying or selling.

Walk me through how the Replacement Cost (AKA Replacement Value) method works.

- start by calculating the Asking Price per Square Foot or Square Meter for a property you're considering buying - Then, you would call a developer to look at the property and estimate how much it would cost to build it yourself - the Land Acquisition Costs, Hard Costs, Soft Costs, and so on

what essentially is cap rate? explain.

- the required rate of return on real estate - used to estimate the investor's potential return on their investment in the real estate market

explain to me in detail what REITs do

- they buy, sell, develop, and operate properties - They're like private equity firms, but for buildings rather than companies.

what is a core strategy?

- when a firm acquires only stabilized, mature assets - buy an existing, stabilized property, change very little, and sell it again

List some of the red flags you would look out for when assessing a potential investment opportunity?

1) Industry Cyclicality 2) Customer Concentration 3) Customer/Employee Churn

Which credit ratios would you look at when assessing the financial health of a borrower?

1) Leverage Ratios 2) Interest Coverage Ratios

Within real estate PE, there are 2 distinct roles:

1. Acquisitions 2. Asset Management

there are three main methods that investors can use to find an appropriate capitalization rate:

1. Build-up method 2. Market-extraction method 3. Band-of-investment method

The key steps to modeling a property development:

1. Determine the size, parameters, and Construction Timeline. 2. Estimate the eventual financial profile - revenue, expenses, and NOI 3. Estimate development costs for the building. 4. Create a Sources & Uses schedule and determine the amount of Debt and Equity to use. 5. Construct IS down to NOI, and bring in revenue and expenses over time as tenants move in. 6. Distribute development costs over the Construction Timeline, drawing on Equity and Debt as required. 7. Assume an exit price (based on Cap Rate) and calculate net sale proceeds and IRR

What are the four main levers in an LBO that drive returns?

1. Leverage / debt paydown with the use of cash flows 2. EBITDA growth 3. Margin expansion 4. Multiple expansion

walk me through an LBO (high level)

1. Purchase a business based on a multiple of EBITDA 2. We fund the purchase with a combination of debt and equity 3. We collect cash flows, and those cash flows can be used to paid down debt 4. we sell the business as a multiple of EBITDA (hopefully EBITDA has grown) 5. we pay off lenders and keep the remainder 6. we assess the returns, look at IRR

What are the most common REIT corporate structures?

1. Traditional, 2. UPREIT, and 3. DownREIT.

walk me through an LBO (detailed)

1. assumptions around the EBITDA multiple paid 2. sources/uses to fund the acquisition 3. Project out three statements over 5-10 years 4. make assumptions around debt paydown and equity distributions to the sponsor in any given year 5. assume some terminal value based on EBITDA exit multiple 6. calculate IRR based on the cash flows remaining to equity holders

walk me through a DCF.

1. build forecast of 3 financial statements, based on assumptions about how the business will perform in the future (typically 5 years) 2. Calculate unlevered free cash flow: EBIT - taxes, less CAPEX + D&A - Δ in NWC 3. Calculate terminal value: perpetual growth rate or exit multiple Terminal Value = (FCF X [1 + g]) / (WACC - g) 4. Discount forecast period and terminal value back to PV using discount rate (WACC) WACC = (E/V x Re) + ((D/V x Rd) x (1 - T)) 5. At this point, you get EV. To get equity value, subtract debt and add cash from EV

what are the 3 common Real Estate Return Metrics?

1. cash-on-cash return 2. equity multiple 3. internal rate of return, or IRR.

What are the different Strategies within Blackstone Real Estate

1. core+ 2. opportunistic 3. debt

What are the different ways to value a company?

1. discounted cash flow analysis (DCF) - intrinsic valuation method used to estimate the value of an investment based on its expected future cash flows 2. comparable comp analysis - relative valuation - used to evaluate the value of a company using the metrics of other businesses of similar size in the same industry.(EV/EBITDA) 3. precedent transactions - valuation method in which the price paid for similar companies in the past is considered an indicator of a company's value - creates an estimate of what a share of stock would be worth in the case of an acquisition.

The three key real estate valuation methods include...

1. discounting future NOI 2. the gross income multiplier model 3. cost approach

Blackstone Real Estate Debt Strategies and has three platforms: what are they?

1. drawdown funds 2. liquids funds 3. public mortgage REIT

what are the three factors that are used to choose comparable companies

1. industry classification 2. financial criteria (look at revenue, EBITDA, EBITDAR, EBIT, etc) 3. geography

what did Jonathan Pollack say were the two key factors which would help drive our capital deployment?

1. this unique economic environment: COVID-19 is shaping real estate markets in ways that are still evolving, and that sort of transition and uncertainty is what our capital is built for 2. the broad opportunity set we can address: breadth, and the size and expertise of our team

You buy a $100 EBITDA business for a 10x EBITDA multiple, and you believe you can sell it in 5 years for a 10x multiple.You use 5x Debt / EBITDA to fund the deal, and the company repays 50% of that Debt over 5 years.By how much does EBITDA need to grow over 5 years for you to realize a 20% IRR?

A 2x multiple in 5 years is a 15% IRR, while a 3x multiple is a 25% IRR, so a 20% IRR should be right in between: A 2.5x multiple.Initially, we buy the business for an Enterprise Value of $1,000, using $500 of Investor Equity and $500 of Debt.We need to earn back $1,250 in proceeds at the end, since 2.5 * $500 = $1,250.The company repays $250 in Debt, which means that $250 in Debt remains at the end.Therefore, we need to sell the company for an Exit Enterprise Value of $1,250 + $250 = $1,500.Since the Exit Multiple stays the same at 10x, EBITDA must grow to $150 over 5 years.

what is a downREIT structure?

A DownREIT is a partnership agreement between an REIT and a real estate owner that enables deferring of tax on sale of appreciated real estate.

how do you calculate AFFO?

AFFO = FFO - Recurring CAPEX - Straight-lined Rents

ffo and affo, which is better?

AFFO is a better measure of the financial performance of a REIT bc it takes into account recurring CAPEX

what is an add-on acquisition?

An add-on acquisition is when a portfolio company of a private equity firm (called the "platform") acquires a smaller company.

how does FAR impact the property size and other parameters?

Based on the FAR, the lot size, and the ground floor footprint, you can determine the number of floors in the building and the total rentable area inside.

how do you calculate cap rate?

Cap Rate = NOI / property value

explain what margin expansion is

businesses usually aren't run as efficiently as they can be. PE firms like to cut costs and drive synergies from M&A

_________________ for real estate is similar to discounted cash flow (DCF) valuations for stock

Discounting future NOI by the appropriate discount rate

What is the FAR?

FAR stands for Floor Area Ratio and tells you the maximum allowable square meters or square feet per square meter or square foot in the lot.

how do you calculate unlevered free cash flow?

FCFF = EBIT less taxes plus Depreciation less Changes in working capital less CAPEX

how do you calculate FFO?

FFO = Net Income - Gains on Sales of Underlying Assets + D&A

how do you calculate GIM?

GIM = property's sale price/gross annual rental income

What is the least volatile product type?

Generally speaking, multifamily

what is gross area?

Gross Area is how much space the entire building takes up, including walls, elevators, lobby areas, and so on.

how to calculate NOI?

Gross income - operating expenses EBITDA and NOI are pretty much the same things

explain what EBITDA Growth is and how it drives returns

Growth in EBITDA can be achieved by making operational improvements to the business's margin profile (e.g. cost-cutting, raising prices), implementing new growth strategies to increase revenue, and making accretive add-on acquisitions.

why is IRR so helpful/useful?

IRR factors in the time value of money - it's the effective, compounded interest rate on an investment

IRR is higher when cash flows are...

IRR is higher when cash flows are received earlier

other than the equity contribution by financial sponsor, what else could happen?

In some cases, the existing management team will roll over a portion of their equity to participate in the potential upside alongside the sponsor (rollover equity)

A private equity firm acquires a $200 EBITDA company for an 8x EBITDA multiple using 50% Debt.It wants to sell the company in 3 years, but it's difficult to find buyers, so the firm decides to take the company public instead.If this company's EBITDA increases to $240, and it repays ALL the Debt over 3 years, and the PE firm takes it public and sells off its stake evenly in Years 3 - 5 at a 10x EBITDA multiple, what's the approximate IRR?

Initially, the PE firm pays $1,600 for this company and uses $800 in Investor Equity and $800 in Debt.The PE firm sells its stake in the company for an Exit Enterprise Value of $240 * 10x = $2,400, and all the Debt has been repaid by this point, so the Proceeds to the PE Firm are $2,400.Tripling our money in 3 years would be a 45% IRR, and tripling it in 5 years would be a 25% IRR.Since this is an IPO and the stake is gradually sold off between Year 3 and Year 5, the "Average Year #" for receiving the proceeds is 4.As a result, the IRR is somewhere in between these figures - we could approximate it as a 35% IRR (it's actually 32%).

A PE firm acquires a $100 million EBITDA company for a 10x purchase multiple and funds the deal with 60% Debt. The company's EBITDA grows to $150 million by Year 5, but the exit multiple drops to 9x. The company repays $250 million of Debt in this time and generates no extra Cash. What's the IRR?

Initially, the PE firm uses 40% Equity, which means $100 million * 10x * 40% = $400 million. The Exit Enterprise Value = $150 million * 9x = $1,350 million (Mental Math: $150 million * 10x = $1.5 billion, and subtract $150 million). The initial Debt amount was $600 million, and the company repaid $250 million, so $350 million of Debt remains upon exit. The Equity Proceeds to the PE firm are $1,350 million - $350 million = $1 billion. $1 billion / $400 million = 2.5x, which is in between 2x and 3x over 5 years; since 2x over 5 years is 15% and 3x is 25%, this IRR is approximately 20%.

A PE firm acquires a business for a 12x EBITDA multiple, using 5x Debt / EBITDA, and plans to sell it in 5 years. The company's initial EBITDA is $100, and it grows to $200 by Year 5.If there's no Debt repayment and no additional Cash generation, what exit multiple do we need for a 25% IRR?

Initially, we buy the company for an Enterprise Value of $1,200 using Debt of $500 and Investor Equity of $700.To realize a 25% IRR over 5 years, we need to triple our money by earning $2,100 in proceeds at the end.No Debt is repaid, so we need to sell the company for an Exit Enterprise Value of $2,600.Therefore, if EBITDA grows to $200 by Year 5, we need an exit multiple of $2,600 / $200 = 13x.

why would you look at interest coverage ratios when assessing the financial health of a borrower?

Interest coverage ratios examine a companies' ability to cover their interest payments using their cash flows. As a general rule of thumb: the higher the interest coverage ratio, the better (ideally >2.0x)

Why is an LBO analysis often referred to as a "floor valuation"?

LBO analysis is often used to determine the floor value for a company since it represents what a financial buyer would be willing to pay.

How can you tell whether the Cap Rate is too low or too high?

It is very arbitrary, but Cap Rates are the universal method in real estate - just like you always use EBITDA Exit Multiples for LBOs of normal companies.

who is the Global Head of the Blackstone Real Estate Debt Strategies?

Jonathan Pollack

why would you look at leverage ratios when assessing the financial health of a borrower?

Leverage ratios compare the amount of debt held by a company to a specific cash flow metric, most often EBITDA

What is the difference between levered and unlevered cash flows?

Levered free cash flow is how much you have after you've met your debt obligations, unlevered is before you've met your debt obligations

Two analysts are looking at the same property and the same financial information, but one analyst says the Net Operating Income is $10 million, and one says that it's $9.5 million. Why is there a discrepancy?

Most likely, the discrepancy is because of Maintenance Capital Expenditures (Maintenance CapEx) - the annual cost required to maintain a building, replace parts that are wearing down, and so on.

what is adjusted NOI?

NOI - interest expense on debt.

If I buy a building with $60M NTM NOI at a 4.0% cap rate, what value does that imply?

NOI / Cap Rate = Value. So, this building is worth $1.5B.

You purchase a property for $100million at a 5% cap rate. To do this transaction, you spend 50% on debt, and 3% is interest rate. Calculate the cash on cash return

NOI = cap rate * Property value NOI = 5% * 100 = $5 0.5 * $100 = $50 equity 3% interest rate * $50 = $1.5 ($5 - $1.5) / $50 = $3.5/50 = 7%

What is the value of a property with $10mm NOI at an 8 Cap?

NOI/Cap=Value, so $10mm/.08=$125mm

How do you calculate Debt Yield?

NOI/Loan amount

how do you calculate property price?

NOI/cap rate

The ______________ is the return metric most investors rely on for equity real estate investments

internal rate of return (IRR)

What are the levers for a private equity investor to increase the IRR on an investment?

Positive IRR Levers - Earlier Receiver of Proceeds: e.g. dividend recapitalization, sooner than anticipated exit, opted for cash interest (as opposed to PIK interest), annual consulting fees paid to the sponsor - Increased FCFs Generation: achieved through revenue and EBITDA growth, better margin profile. Read more: EBITDA vs FCFs. - Multiple Expansion: exiting at a higher multiple than the initial purchase multiple (i.e. "buy low, sell high")

walk me through a pro forma

Potential gross income - vacancy allowance + other income = gross income Gross income - operating expenses = NOI NOI - capital improvement expenditures = property before tax cash flows

you invest $1 million in 2 different projects Project A produces $100k in operating cash flow every year for 5 years, and you sell at the end of 5 years for $1.5 million Project B produces $0 in operating cash flow every year for 5 years, and you sell at the end of 5 years for $2.0 million At the end of 5 years, which project has the higher IRR?

Project A wins because of the timing of the cash flows for each and every year, and IRR is higher when cash flows are received earlier

you purchase 2 properties for $1million today you receive $50k in annual cash flow for each year you hold each deal you sell each property for $2 million Property A held for 7 years Property B held for 5 years which deal has the higher equity multiple?

Property A, because equity multiple is not a time-weighted metric and Property A has a higher sum of all positive cash flows

what is the formula for the cost approach?

Property Value = Replacement/Reproduction Cost - Depreciation + Land Value

what is a traditional REIT corporate structure?

REIT owns the real estate (hotels, apartments, and office buildings), and these are then leased to a lessee, who arranges management and franchise agreements with third parties

what is rentable area?

Rentable Area is how much space can actually be rented out to tenants, so it excludes walls, elevators, lobbies, and anything else that cannot generate rental income.

how do you calculate RevPAR?

RevPAR = Occupancy Rate * ADR

The vacancy rate for a hotel is 25% and the Average Daily Rate (ADR) is $500. What is its RevPAR?

RevPAR = Occupancy Rate * ADR In this case, they've given us the Vacancy Rate, which is the opposite of the Occupancy Rate. So the Occupancy Rate would be 1 - 25%, or 75%. RevPAR = 75% * $500 = $375

what is RevPAR?

RevPAR means "Revenue Per Available Room" - it tells you how much revenue each room actually results in each night.

what is rollover equity?

Rollover equity is an additional source of funds and it reduces the amount of leverage necessary and the equity contribution from the financial sponsor to complete the deal.

what are hybrid REITs?

they invest in both properties and loans

what are mortgage REITs?

they invest in mortgages and loans rather than properties themselves

A PE firm acquires a $200 million EBITDA company using 50% Debt, at an EBITDA purchase multiple of 6x. The company's EBITDA grows to $300 million by Year 3, and the exit multiple stays the same. Assuming the company pays its interest and required Debt principal but generates no additional Cash, what is the MINIMUM IRR?

The Purchase Enterprise Value is $200 million * 6x = $1.2 billion, and the PE firm uses $600 million of Investor Equity and $600 million of Debt. The Exit Enterprise Value in Year 3 is $300 million * 6x = $1.8 billion. The PE firm realizes the minimum IRR when the Equity Proceeds are at their minimum level. For that to happen, the company must repay no Debt and generate no additional Cash. We already know the company generates no additional Cash, so we have to calculate the Equity Proceeds under the assumption that the company repays no Debt. $1.8 billion - $600 million = $1.2 billion, which is a 2x multiple over 3 years. That corresponds to a ~25% IRR (technically, 26%), so that is the minimum in this scenario.

you make 2 real estate investments Project A is purchased for $1 million today and sold for $1 million 5 years from now Project B is purchased for $1 million today and sold for $1 million ten years from now Which deal has the higher IRR?

The answer is neither, because investments in both Project A and Project B just represent a return of capital, not a return on capital - in both cases, profits are 0, so the answer is neither

When measuring returns, why it is necessary to look at both the IRR and cash-on-cash return?

The cash-on-cash multiple cannot be a standalone metric as it does not consider the time value of money, unlike the IRR calculation. IRR is an imperfect standalone measure because it is highly sensitive to timing. these two metrics are interlinked and both are widely used amongst investors to accurately assess returns

What are the main property types?

The main categories are (1) office, (2) industrial, (3) retail, and (4) multifamily properties, and (5) other

How do you estimate the Total Development Costs? What are the main categories?

The main categories are Land Acquisition Costs; Hard Costs (materials and constructing the building); Soft Costs (design, accounting, legal, permits); Furniture, Fixtures & Equipment (FF&E); and Tenant Improvements (TIs).

How do private equity firms exit their investment?

The most common ways for a PE firm to monetize its investment are: 1) Sale to a Strategic Buyer 2) Secondary Buyout (aka Sponsor-to-Sponsor Deal) 3) Initial Public Offering (IPO)

how would you categorize the main investing strategies in terms of risk and potential returns?

fixed income --> core RE --> value-added RE --> equities --> opportunistic RE

Let's say I want to acquire and renovate a hotel - how do I determine the appropriate purchase price?

The same as with any other type of real estate: the going Cap Rates for similar properties in the region.

what is the sponsor's typical holding period for an LBO?

The sponsor will typically hold onto the investment between 5 to 7 years

What is the basic intuition underlying the usage of debt in an LBO?

The typical transaction structure in an LBO is financed using a high percentage of borrowed funds, with a relatively small equity contribution from the private equity sponsor. As the principal of the debt is paid down throughout the holding period, the sponsor will be able to realize greater returns upon exiting the investment.

explain to me mezzanine

This is a riskier type of Debt with higher interest rates than senior notes; it's in between Equity and senior notes in the capital structure.

why were REITs created?

They were created to give average people the ability to invest in property without having to come up with $100 million to buy an entire building.

what is a sinking fund factor (SFF)?

This is the percentage that must be set aside each period to have a certain amount at a future point in time.

if your IRR is 18%, what is your equity multiple?

Trick question; not enough information

If an LBO target had no existing debt on its closing balance sheet, would this increase the returns to the financial buyer?

Upon the completion of an LBO, the firm has essentially wiped out the existing capital structure and recapitalized it using the sources of funds that were raised. When calculating the IRR and cash-on-cash returns, the companies' debt balance pre-investment does NOT have a direct impact on returns.

what is WACC?

WACC = [(% Equity) * (Cost of Equity)] + [(% Debt) * (Cost of Debt)(1-tax rate)]

Explain the relationship between "IRR", "NPV" and the "discount rate."

When IRR is equal to the discount rate, NPV is zero

how do you define working capital?

Working capital = current assets - current liabilities

Do you think NOI accurately describes the cash flow that a property can generate? Why or why not?

Yes and no - it's better than Net Income since it excludes Depreciation, but it also excludes Interest and possibly CapEx, so it doesn't represent a property's true cash flow. NOI tends to be more accurate for established properties where there's no Debt and where CapEx is minimal.

- Normally, you assume that the Rentable Area is...

a % of the Gross Area - values in the 70-90% range are common, depending on the building type A higher percentage means that the income potential is higher.

discounting future NOI is what type of a valuation method?

absolute valuation

what is a value-added strategy?

acquire an existing property, renovate or greatly improve it, and then sell it again

NOI approximates... what exactly?

approximates how much in cash earnings the property is generating each month or each year

what is the underlying assumption for the gross income multiplier model valuation method?

assumes that properties in the same area will be valued proportionally to the gross income that they help generate

what is the market-extraction method?

assumes that there is current, readily available NOI and sale price information on comparable income-generating properties.

One of the most important assumptions a real estate investor makes when performing real estate valuations is to choose an appropriate...

cap rate

what is the build-up method? (calculate)

cap rate = interest rate + Appropriate liquidity premium + Recapture premium + Risk premium

The _______________ is a key metric for valuing an income-producing property.

capitalization rate

Over shorter time frames, ____________ is more important than _____________

cash on cash multiple is more important than IRR

what does unsecured debt consist of? explain in detail

consists of Subordinated Notes and Mezzanine, and is NOT backed by collateral; interest rates tend to be higher and fixed rather than floating, there is no amortization, and it uses incurrence covenants (e.g., The company can't sell Assets above a certain dollar amount).

what does secured debt consist of? explain in detail

consists of Term Loans and Revolvers, is backed by collateral, tends to have lower, floating interest rates, may have amortization, and uses maintenance covenants such as restrictions on the company's EBITDA, Debt / EBITDA, and EBITDA / Interest.

what is an equity waterfall structure?

describes how cash flows are distributed between partners/owners of the real estate

disadvantages to replacement cost method?

determining accurate values is close to impossible - ask 10 different developers and they'll give you 10 different answers. Especially for large and complex properties, estimates vary widely and are still highly dependent on assumptions.

REITs with low cap rates tend to trade at a ___________ (discount or premium to NAV)

discount: Low cap rate means the real estate is expensive for an investor. Investors also generally have a multiple ceiling for real estate that that don't want to pass.

Discounting future NOI by the appropriate discount rate for real estate is similar to ______________ for stock

discounted cash flow (DCF) valuations

why is equity multiple helpful/useful?

equity multiple provides a nice snapshot of an investment's overall profitability - multiple is simpler and ignores timing (e.g., $1000 / $100 = 10x multiple)

what is the replacement cost method?

estimates the cost of reconstructing the entire building from scratch today and compares it to the property's asking price

In terms of equity, the contribution from the ____________ represents the largest source of LBO equity

financial sponsor

integrating the _________________ in real estate is comparable to relative value valuations with stocks

gross income multiplier model

what is a dividend recapitalization?

happens when a company takes on new debt in order to pay a special dividend to private investors or shareholders.

however, over longer time frames, it is better to achieve a...

higher IRR

Simply put, the smaller the equity check the financial sponsor has to write towards the transaction, the....

higher the returns to the firm.

lower Cap Rates mean...

higher valuations

If accounts receivable/inventory increases, how does that impact working capital and free cash flow?

if AR/inventory goes up, then current assets increase, and that is an overall cash outflow

If accounts payable increases, how does that impact working capital and free cash flow?

if AR/inventory goes up, then current liabilities increase, and that is an overall cash inflow

Assume you buy a property, and the NOI grows 5% every year for 100 years. What are some reasons the property could still go bankrupt?

if you're overleveraged and unable to refinance your debt or if you have significant deferred maintenance / large capex projects

what consists of "other" property type?

include hotels, storage, data centers, healthcare facilities, condominiums, and more; they also differ based on the tenants and leases or ownership

what is a debt strategy?

originate loans and invest in debt securities underpinned by high-quality real estate

what happens to property values when cap rates increase/decrease?

property value = NOI/cap rate increase in cap rate = decrease in property value decrease in cap rate = increase in property value

pros/cons of DCF?

pros: - accuracy and realism of the estimate as it takes into account the time value of money cons: - based on far-in-the-future assumptions - less useful for stabilized properties that don't change much

In the context of an LBO, what does the "tax shield" refer to?

refers to the reduction in taxable income from the highly levered capital structure. As interest payments on debt are tax-deductible, the tax savings provides an additional incentive for private equity firms to maximize the amount of leverage they can obtain for their transactions.

gross income multiplier model is what type of a valuation method?

relative valuation

integrating the gross income multiplier model in real estate is comparable to ______________ with stocks

relative value valuations

Discuss what you view as some of the opportunities, risks, and challenges that investors face in today's real estate market

risks: Retail is a risky market because of the collapse of brick and mortar with everyone moving to amazon to shop Opportunities: - industrials with rise of e-commerce - Texas shows great opportunity for businesses with there being no corporate income tax.

what are the different tranches of debt?

senior notes (revolver, term loans), subordinated debt (mezzanine), and equity

The vast majority of the debt raised in LBO transactions will be what type of debt...

senior, secured loans by banks and institutional investors before riskier types of debt are used.

why is cash-on-cash return helpful/useful?

this return metric provides a quick way to assess the magnitude of cash distributions throughout a project's lifetime

what is a core-plus strategy?

similar to core strategy (buy an existing, stabilized property, change very little, and sell it again) but make minor upgrades

What are two key metrics you use to analyze and value a property?

the 2 most important metrics for properties are Net Operating Income (NOI) and the Capitalization Rate (Cap Rate)

Real estate debt funds rose to prominence in the wake of...

the 2008 crash

cap rate is set by...

the area

what is the advantage of using a market-extraction method?

the cap rate makes the direct income capitalization more meaningful.

what is IRR?

the internal rate of return is an annualized, time weighted rate of return that investors can use to compare real estate investments to other potential investment vehicles like stocks, bonds, and other PE investments

holding all else constant, the more time periods the investment comprises, the _____________ the IRR.

the lower the IRR

what are equity REITs?

they invest directly in properties

is a dividend recap often considered a risky action?

yes; As a company increases its leverage, there is a higher probability of default on its financial obligations

where do you want to buy and sell with cap rates?

you want to buy at a high cap rate and wait for it to stabilize, then sell at lower cap rates so you get more money.