Underwriting Commercial Real Estate in a Dynamic Market

Case Studies

Christian Redfearn

• Publisher: Academic Press
• Year: 2019
• Print ISBN: 9780128159897
• eBook ISBN: 9780128159903
• Topic: Economics
• Subtopic: Development Economics
• Index: Economics

A recurrent theme in Underwriting Commercial Real Estate in a Dynamic Market is that good thinking and good underwriting go together. This stands in contrast with "getting an answer" or even worse "reverse engineering" – getting to a solution by assuming that current trends in market pricing is best. The cases in Underwriting Commercial Real Estate in a Dynamic Market will force readers to recognize that there is no single answer, but rather a range of answers that will depend on numerous perspectives. And, in order to make valuation decisions, they will have to undertake a rich conversation about what constitutes a good trade-off and what does not. Cases can be structured for use with introductory material as well as advanced topics.- Encourages readers to think about alternatives and their viability- Addresses real world variations and concentrates on large urban economic forces and their implications for real estate valuation- Presents case studies that vary significantly in length and specificity- Includes pedagogical materials such as case introductions and exhibits

Part I

Developing a Framework

Introduction

One major theme for this book is that context matters for underwriting real estate. This is obvious, but can be difficult to fully grasp while focusing on the basics. The first five cases in this book include multifamily properties because I wanted to allow students to focus on developing their frameworks for underwriting while holding as much constant as possible. In these cases, the lease terms are not explicitly defined because they are so broadly standardized that 1-year leases are generally implied when month-to-month leases are not called out. This has several important implications for underwriting. The property must be retenanted every year so that changing fundamentals in the apartment market will constantly be transmitted into the value of the asset. This contrasts with longer-term commercial real estate leases, which can cause distortions between the leased value of a property from what short term fundamentals might otherwise suggest. The five cases in the next section focus on the multiple impacts of long-term commercial leases. Across the cases in this section there is more than enough variation to start developing a framework that would allow a common approach to underwriting.

Beginning with apartments is also helpful because many students are familiar with them. Other product types are introduced after students begin mastering other sources of variation. The cases in this section span metropolitan areas and the submarkets within them. They include old and new properties, institutional investors and first time entrepreneurs, as well as numerous different protagonists. The contrasts are instructive. In each of the cases there are ample opportunities to explore market analysis, model building, debt and equity options, and scenario analysis, with each challenging the students to grapple with a key strategic decision facing the protagonist. Across these cases, it will become abundantly clear that one-size-fits-all underwriting will lead to mistakes. As such, students will have to learn which valuation tool is most appropriate given the circumstances and given the questions being asked. This is what I mean by “framework”: a systematic approach to underwriting that is rigorous but not formulaic. In some cases, quick and dirty valuations are best, being effective enough and inexpensive in terms of time and data. In other cases, full-blown pro formas will be required and employed in multiple scenarios in order to get a sense risks and opportunities. The first three cases are terrific examples of how professional real estate investment in multifamily can work in practice—an important point being that there is no one “best” way. I included the last two cases to stretch people’s thinking about multifamily underwriting. The case in Detroit represented a novel and courageous bit of entrepreneurial inspiration that outperformed many other real estate investments over this horizon. Finally, the fifth case on “Little Data” was borne out of an undergraduate class and a simple offering memorandum. It started as a pro forma building exercise, but quickly spiraled out into a richer conversation about how to choose both the tools of valuation and the data used in them. While holding much constant, these five cases should help students build intuition as to how context matters and how it might influence their approaches to underwriting.

Case 1

Vista View and a Second Shot at Ownership

Abstract

Real estate deals late in a cycle are often challenging. Prices may be high, but short-term momentum and strong long-term fundamentals can be used to argue for “one more deal.” After being selected for a final round of bidding on a value-added apartment project in Mission Viejo, California, Gil Herron is stuck. He opened a West Coast office for a large and long-established apartment owner in Boston with the goal of placing capital and making good risk/return trade-offs. While Gil and his firm are enthusiastic about the property, they are not happy about the prospect of raising their bid to win it. The fundamentals of the deal are strong, but Gil needs to figure out if he should urge his firm to bid m...

Table of contents

• Cover image
• Title page
• Table of Contents
• Copyright
• Dedication
• Acknowledgments
• Introduction: The Returns to Effort and Expertise
• Part I: Developing a Framework
• Part II: Extending the Framework: Commercial Leases
• Part III: Framework, Deal Structure, and Risk and Return
• Part IV: Iteration and Integration: Development and Redevelopment
• Index