Real Estate Financial Modeling
Questions and answers
why does real estate trade with positive pricing - correct answer-due to real estates ability to
attract cash flows, the value of real estate is not the physical structure itself, but rather the
net rents (leases) the structure attracts or has the ability to attract
generalised risk structures in real estate - correct answer-1. Single Assets (MF, Office, retail,
hotel)
single asset with single tenant
single asset with multiple tenants
2. Multi-asset (marginal contribution to portfolio
3. Derivative product of FRA
Net Income formula - correct answer-Revenues - Expenses = NOI
NOI-Debt Expense= NET INCOME
NPV - correct answer-the sum of present values for all future cash flows discounted at the
appropriate market rate
an investment is worth pursuing when the NPV is positive
the major strength is the simplicity to calculate, the major weakness is the application of risk
to each period
NPV timing example - correct answer-1
CF0 -100; CF1 80; CF2 20; CF3; 20 == NPV 105.67
2
CF0 -100; CF1 20; CF2 20; CF3 80 ==NPV 96.96
IRR - correct answer-the discount rate calculated by setting the NPV equation to ) for a
series of cash flows
It provides an intrinsic value of a project, expressing the realized rate of return for future
cash flows
if IRR exceeds discount rate, generally the project adds value.
pitfalls of IRR - correct answer-IRR does not quantify risk
by design everytime the NPV goes negative to positive (vice versa) a new IRR is made
IRR also assumes the reinvestment rates=discount rate
, IRR/NPV Example of riskiness - correct answer-Project A
CF0= -$100
CF1= $130
Project B
CF0= $100
CF1= -$130
IRR for each project = 30%, project A has a 18.20 NPV & project B has a -18.20 NPV
IRR/NPV Example of riskiness 2 - correct answer-Project A
CF0= -$50
CF1= $100
Project B
CF0= -$1000
CF1= $1100
Project A
NPV = $50 & IRR =100%
Project B
NPV = $100 & IRR = 10%
modified internal rate of return - correct answer-adjusts for some of the pitfalls of traditional
IRR which assumes all cash flows are reinvested at the calculated IRR rate
traditional IRR may mistate the implicit return for a project by failing to quantify the effect that
earned cash flows during the project are not reinvested at a project's IRR but rather at a
corporate or market reinvestment rate
Modified IRR corrects this misstatement by converting a project's cash flows to a zero
coupon security. the projects future cash flows are compounded to the final period at the
reinvestment rate
how does a physical real estate purchase expose the owner to risk - correct answer-the total
loss could be unlimited
10 m property, leveraged 80% (8m)
if property disappeared the 8m debt is still owed, if the project disappeared and the soils are
toxic the loss can be worse than original purchase price
how is a project best described - correct answer-most often project is described by the yield,
but yield fails to answer "will I get my money back"
the question yield answers is how much money a project is expected to realize, yield if
essentially the return on capital
Questions and answers
why does real estate trade with positive pricing - correct answer-due to real estates ability to
attract cash flows, the value of real estate is not the physical structure itself, but rather the
net rents (leases) the structure attracts or has the ability to attract
generalised risk structures in real estate - correct answer-1. Single Assets (MF, Office, retail,
hotel)
single asset with single tenant
single asset with multiple tenants
2. Multi-asset (marginal contribution to portfolio
3. Derivative product of FRA
Net Income formula - correct answer-Revenues - Expenses = NOI
NOI-Debt Expense= NET INCOME
NPV - correct answer-the sum of present values for all future cash flows discounted at the
appropriate market rate
an investment is worth pursuing when the NPV is positive
the major strength is the simplicity to calculate, the major weakness is the application of risk
to each period
NPV timing example - correct answer-1
CF0 -100; CF1 80; CF2 20; CF3; 20 == NPV 105.67
2
CF0 -100; CF1 20; CF2 20; CF3 80 ==NPV 96.96
IRR - correct answer-the discount rate calculated by setting the NPV equation to ) for a
series of cash flows
It provides an intrinsic value of a project, expressing the realized rate of return for future
cash flows
if IRR exceeds discount rate, generally the project adds value.
pitfalls of IRR - correct answer-IRR does not quantify risk
by design everytime the NPV goes negative to positive (vice versa) a new IRR is made
IRR also assumes the reinvestment rates=discount rate
, IRR/NPV Example of riskiness - correct answer-Project A
CF0= -$100
CF1= $130
Project B
CF0= $100
CF1= -$130
IRR for each project = 30%, project A has a 18.20 NPV & project B has a -18.20 NPV
IRR/NPV Example of riskiness 2 - correct answer-Project A
CF0= -$50
CF1= $100
Project B
CF0= -$1000
CF1= $1100
Project A
NPV = $50 & IRR =100%
Project B
NPV = $100 & IRR = 10%
modified internal rate of return - correct answer-adjusts for some of the pitfalls of traditional
IRR which assumes all cash flows are reinvested at the calculated IRR rate
traditional IRR may mistate the implicit return for a project by failing to quantify the effect that
earned cash flows during the project are not reinvested at a project's IRR but rather at a
corporate or market reinvestment rate
Modified IRR corrects this misstatement by converting a project's cash flows to a zero
coupon security. the projects future cash flows are compounded to the final period at the
reinvestment rate
how does a physical real estate purchase expose the owner to risk - correct answer-the total
loss could be unlimited
10 m property, leveraged 80% (8m)
if property disappeared the 8m debt is still owed, if the project disappeared and the soils are
toxic the loss can be worse than original purchase price
how is a project best described - correct answer-most often project is described by the yield,
but yield fails to answer "will I get my money back"
the question yield answers is how much money a project is expected to realize, yield if
essentially the return on capital
