In this Opportunistic Real Estate Private Equity Case Study tutorial video, you'll learn what to expect in real estate private equity case studies, and you'll get an example of a real opportunistic RE PE case study with the solution file and a walk-through of the key points.
Get all the files and the textual description and explanation here:
Table of Contents:
2:41 Part 1: The Types of RE PE Case Studies, and Where This One Fits In
4:30 Part 2: This Case Study and What Makes It Tricky
10:47 Part 3: Doing the Quick Math on This Deal
13:12 Part 4: The Assumptions and Construction Timeline
20:12 Part 5: Expenses, Equity and Debt Draws, the Waterfall, and Sensitivities
27:08 Part 6: The Investment Recommendation
29:13 Recap and Summary
Part 1: The Types of RE PE Case Studies, and Where This One Fits In
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, and the models tend to be more complex.
In the third category, a new property is developed or an existing one is redeveloped.
This case study is in the third category, but the modeling is a bit simpler than what we showcased in the second RE PE case study here.
Part 2: This Case Study and What Makes It Tricky
A few points make this case study tricky:
Problem #1: Timing of Unit Sales – You tend to sell units in phases, and after a certain percentage of units are sold, construction begins, you start selling units in the next phase, construction there begins, and so on.
Problem #2: Variable Debt and Equity – You can't just assume a certain % of debt to use because you’re not allowed to draw on debt until a certain percentage (40%) of units have been pre-sold – so debt and equity will differ based on the timing of pre-sales.
Problem #3: Multiple Payment Phases – When condos are pre-sold, typically there’s an upfront deposit and then a final deposit when the construction is complete.
Part 3: Doing the Quick Math on This Deal
If you do the quick math here and simply sum up the total square meters across all the units, multiply by the average selling price per square meter, and then subtract the Hard Costs, Land Acquisition Costs, Soft Costs, Developer Fees, and other expenses...
...You'll see that the unleveraged cash-on-cash multiple is around 1.0 - 1.2x.
Even when we use leverage, it won't boost this multiple up to 2x - we might get to around 1.5-1.6x, and maybe a bit higher with inflation factored in, but that's about it.
Therefore, we're already leaning *against* this deal before opening Excel and creating a real model.
Part 4: The Assumptions and Construction Timeline
We tweak the provided figures a bit to get more reasonable numbers for the Hard Costs in each case.
The construction timeline takes some time and effort to set up, because you have to pre-sell either the targeted # of units in each month, OR the total remaining units in that phase (whichever one is less).
And then when the required percentage are sold (60% here), you move onto the next phase.
Then, you have to split up the sales into initial, construction-phase, and final deposits; multiply the value of units sold each month by the appropriate percentage and distribute them to do this.
The Final Deposit number must be equal to the total value of units sold minus cumulative initial and construction-phase deposits so far, since it only happens once (in the final construction month).
Part 5: Expenses, Equity and Debt Draws, the Waterfall, and Sensitivities
Expenses are quite straightforward - they are percentages of sales, or they're linked to the total gross square meters of the property.
For the equity and debt draws, draw on equity if monthly gross income is negative and less than 40% of total units in the building have been sold.
Also draw on equity if you're in the final month or final construction month and need to repay debt.
Draw on debt if you're past the 40% of all units sold threshold.
Pay interest on debt in cash if you can do so with positive gross income, and accrue it otherwise.
Repay debt if there's positive cash flow to do so.
Part 6: The Investment Recommendation
We recommend AGAINST this deal because it’s too hard to achieve the targeted 2x cash-on-cash multiple.
We do get there in the Upside case, but not the Base case; and the Downside case is admittedly closer to the 1.2x target.
There are also other problems: lack of good market data, results that are incredibly sensitive to small changes in Hard Costs, and an inability to mitigate key risks.