Underwriting of Property to Sell

Underwriting is an extension of Property valuation. A Property is evaluated for multiple purposes and the valuation method varies depending on the purpose.  A Seller would evaluate a Property to arrive at a Price, which is called as “Offer” or “Asking Price”. Based on the Price quoted by the Seller, the Buyer performs Underwriting to evaluate and forecast the performance of Subject Property to negotiate the Deal. Underwriting Analysis is done based on historical data and Assumptions. We explain some of the key terms, and jargons that are distinctive to this industry in this blog.

Assumptions / Past Analysis:

1. Reports:
   • Rent Roll Statement: List of all the rentals, Unit-wise, in a specific Property
   • T12 Income Statement: Trailing twelve months statement of Income pertaining to the Property
2. Price or Value of Property:
   • Offer / Asking Price: It’s the Price quoted by a Seller after performing Property Valuation
   • Whisper Price: It’s the price as per Broker at which if we bid, we can secure the Deal
   • Sale Price: It’s the price at which we, as a Buyer, shall quote to the Seller for negotiation
   • Appraisal Review Board (ARB) Value: It’s the aggregate Market value of Land and Building as per the County’s Central Appraisal District (CAD) on which Property Tax is calculated
3. Forms of Capital:
   • Sponsor Equity: Capital that is raised by the Promoters or General Partners (GP)
   • Investor Equity: Capital that is raised by the Investors or Limited Partners (LP)
   • Debt: Capital that is borrowed from a Financial Institution
   • Working Capital: Capital that is required for running the day to day operations in a business, it can either be raised or borrowed
4. Financial Obligations:
   • Cost of Equity: Dividend that is paid to the Equity holders
   • Cost of Debt:  Interest that is paid to the Financial Institutions
5. Replacement Reserve: Portion of Profits that is set aside to provide for the periodic replacement of building components that wear out more rapidly than the building itself
6. Capital Improvements or Rehabilitation Cost: The average cost at which Units of the property are expected to be renovated during the holding period
7. Loan-To-Value or Debt-Equity ratio: The percentage or ratio at which Equity & Debt is preferred to be maintained for arriving at Sale Price
8. Growth Rates: These can be applied on any item of Income Statement in order to forecast, they can be arrived at either based on past trend or industry norms or market comps
   • Rent
   • Other Income
   • Opex
   • Vacancy Rate
   • Bad Debt
   • Tax Growth
   • Loss to Lease
   • Concessions
   • Capital Expense
9. Assets Under Management (AUM) Fee: A fee that is collected by the Sponsors for managing the Asset which in this case is a Property, generally its paid out as salary or fee to the employees of Sponsors or Vendors
10. Acquisition or Disposition Fee: The cost incurred to sell the property mainly consisting of Sales Commission
11. Closing Costs: The Processing fee for closing a Deal
12. Hurdles: These can be set for any of the KPIs that are listed under Financial Analysis to perform Waterfall analysis

Analysis:

• Financial Analysis:
  1. Cap Rate: The property’s one-year rate of ROI
     • Going-in: Property’s projected first-year NOI divided by the purchase price of the property
     • Terminal / Exit / Reversionary: Property’s projected first-year NOI divided by the sale price of the property
  2. Return on Equity: Percentage of Return (i.e., Capital Gains plus Net Cash Flow) on Equity portion of capital
  3. Return on Investment (ROI): Percentage of Return (i.e., Capital Gains plus Net Cash Flow) on Initial Investment
  4. Capital Gains Yield: Percentage of Return (i.e., Capital Gains) on Offer Price
  5. Net Present Value (NPV): The difference between present (discounted) value of cash inflows and present (discounted) value of cash outflows
  6. Internal Rate of Return (IRR): A discount rate that makes the NPV of cash flows equal to zero
  7. Equity Multiple: The number of times Return (i.e., Capital Gains plus Net Cash Flow) over & above Equity portion of capital
  8. Debt-Service Coverage Ratio: A measurement of NOI available to pay Debt obligations
  9. Cash on Cash returns: Percentage of Return (Net Cash Flow or Net Income) on Opening Balance of Equity for a particular year
  10. Preferred Return or Hurdle Rate:  A minimum threshold return that LPs must receive before the GP can receive from the balance interest
• Non-Financial Analysis:
  1. Demographics
  2. Flood Hazard Zone
  3. Crime Stats
  4. Market Comps (Amenities, Rent etc.)
  5. Accessibility to Restaurants, Schools / Colleges, Hospitals, Entertainment, Retail, Transport (Bus / Train / Airport)
  6. Vehicles Per Day (VPD)