Every investor can benefit from a clear understanding of the various stages of a commercial real estate investment, and the Forbury Finance model has been created to analyze buy, hold, sell scenarios.
When you buy an asset, you run a valuation on acquisition. When you hold, you operate the asset. When you sell, you run a valuation or value on exit.
During each stage of the property lifecycle, asset managers have different priorities and responsibilities to ensure the deal goes smoothly, and generally the goal of the asset manager is to maximise the value of the property, maximise returns and minimize risk.
The Forbury Finance model can be used to value the asset and structure the finance; size the debt, maximise the bank’s line of credit, analyze the cash flow, check you can meet the cash flow shortfalls over the hold period and see how much equity you need before you decide to buy the property.
Once you’ve bought the property, you're now in the operating section of the model and in the hold period.
Now every month you’ll have income coming in from rent, other income (signage or storage etc.) and recoveries (see here for more info on recoveries <link>). You may also have some costs to cover, such as statutory expenses (rates, water), operating costs (insurance, air conditioning, maintenance), ground rent and other costs (promotions and advertising etc.). This will give you a net property income, which is used as a valuation metric for assets.
After net property income, you may also have fund operating costs and other costs that aren't directly attributable to the asset but are attributable to somebody else managing the asset from an investment perspective, e.g., a guy that comes in and fixes stuff is part of the operations cost (cost of running the investment). We also must consider any interest or principal costs. Most commercial loans don't have repayment of principal.
What are the options when there is cash left over every month?
Option 1: Collect the cash and save it (no distributions) Option 2: Spend the cash to make the asset better, but usually it should have already been factored into your property cash flows for your capex, when you were coming up with your property income. Option 3: The most likely thing to do is to distribute the cash to your investors. Particularly if it's a single property investment asset, where the Investors only invested in one asset. If the property is a single asset, and if you only have one investor, you will distribute the whole lot, all the cash to the investor. Distribution type: target yield or all cash available (max cash payout all the cash to the investors). Option 4: But if the property sits as part of a portfolio, distribute all the cash available to the fund. Distribution type: net cash as it assumes you have a shortfall, so you can draw it back down from the fund.
Why do we need to look at distributions?
We need to look at the distributions to determine the investor IRR (investor returns). An IRR stands for the internal rate of return, which is the return on the cash flows based on the acquisition price, the exit price and all the cash flows and distributions in between. It is the rate of return that you would need to get on your money, say in the bank, to get the same equivalent return. It’s a metric used in financial analysis to estimate the profitability of potential investments. IRR is a discount rate that makes the NPV (net present value) of all cash flows equal to 0 in a DCF (discounted cash flow) analysis. Most often, the higher the IRR, the more desirable the investment is.
An investor would use our Forbury Finance model to analyze what they put in on acquisition and see what they get out, and they would get two things: a stream of distributions, and the proceeds on the sale of the asset.
Sell Most of the value comes from the sale of the asset and the growth of the asset over the hold period, in terms of capital valuation. You can use the Forbury Model to work out a good value on day one and add in metrics around what this asset could be worth in 10 years’ time, based on a set of assumptions.
Investor IRR vs Asset IRR An important thing to know is that the investor IRR is different to the asset IRR. Asset IRR: when you look at the property value, and you determine that the return from this asset is 8% and the asset is worth $100 million.
An Investor can use debt to fund the asset, and they don't have to put in $100 million, they only put in $30 million on acquisition, they may get some distributions during the hold period and then on exit, when they sell, they also get the capital uplift on the equity side. Say the asset is now worth $120 million, the difference of $20 million falls to the equity holder, and add in the $30 million initial investment, they get $50 million back from the $30 million investment.
Which means that their IRR is different to the asset IRR. In our model, the investor IRR comes out from the Finance sheet, and the asset IRR comes out of the Property model.
When considering a commercial real estate investment, it’s necessary to run a financial analysis to model the asset’s cash flow and IRR for the investment holding period. Forbury Finance enables accurate financial analysis information, so you can better identify the risk-return profile of the various stages of an asset's lifecycle.
Do you need more information on Forbury Finance?
Over the years, more features and functionality have progressively been added into Forbury's software. We are continuously thinking of better ways to leverage our property valuation tech for the benefit of our customers. Property professionals using Forbury gain increased accuracy and speed, empowering them to cover more of the market without additional resources and expense.
To learn more about how Forbury can transform your business, book a free demo at the link below.