Recently, as I rewatched Game of Thrones, I found an analogy that illustrates the significance of an investment scorecard. Think of Melisandre from the series, an enigmatic Priestess of Light, a stunning figure aiding the Baratheons in their pursuit of the Seven Kingdoms. Today's video is titled "Game of Deals: Hidden Hags," drawing parallels between Melisandre and the realm of real estate investing. You guessed it, some real estate deals are just like the Priestess of Light - pretty on the outside, but once the choker comes off, an ugly hag emerges.
When it comes to evaluating real estate projects, having a structured system is paramount regardless of the property type. Whether it's a single-family home, a multifamily complex, or a retail power center, as I'll delve into today, emotions need to take the back seat replaced by a steadfast franchise system. If you include five crucial factors when evaluating a deal, you can uncover any hidden hags.
The Five Crucial Factors When Evaluating A Project
- Cash on Cash Return
- Internal Rate of Return (IRR)
- Debt Service Coverage Ratios
- Equity Multiples
- Going-Out Cap Rate
While these might seem daunting, I'll simplify them shortly using software.
Why Investors Need Good Financial Modeling
Attending a recent capital investment event reinforced a crucial point: solid financial modeling is non-negotiable. Not only is it almost required by lenders, it is also key to bigger pockets and better investing.
The Project: Retail Power Center
Let's dive into a current evaluation—an offer memorandum for a retail power center. Fully leased, except for a 1,500ft² space, this 164,000ft² center appears promising with big-name tenants and stable leases. Despite the $24 million price tag, understanding this evaluation is vital, irrespective of property size preferences. Mastery of the scorecard system translates to a universal understanding of financial modeling in both smaller and larger investments. Now, onto the metrics: cash on cash return, internal rate of return, equity multiple, debt service coverage ratio, and going-out cap rate.
The Real Estate Financial Modeling Tool
I'll be using PerformaPlus, a real estate financial modeling platform, to streamline the initial financial modeling process. I've preloaded essential data—building income, operating expenses, and utilities estimates. Examining an unlevered project initially (sans debt) it appears promising, boasting a decent cash on cash return. However, introducing leverage alters this outlook. With a senior debt of around $112,800 yearly at 55% loan to cost and 8% interest, the cash on cash return dips below a risk-free rate.
Despite falling short on this metric, let's explore further. Introducing debt service coverage ratios and going-out cap rates, this project continues to disappoint, failing to meet the required thresholds. Calculations demonstrate a significant impact—incremental increases in cap rate values drastically affect the going-out internal rate of return. Ultimately, this investment, intended for all-cash transactions with stable leases, falls short on various scorecard parameters.
In Summary
In this "Game of Deals," the evaluation doesn't pass muster for me, steering clear of a potential partnership. These evaluations are indispensable. I urge you to employ this scorecard diligently in your real estate ventures, using software tools like PerformaPlus for efficient evaluations.
In summary, this deal is a hidden hag.
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