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Commercial Real Estate Valuation and Financial Feasibility

Author

1759 Avenida del Sol


Boca Raton, FL 33432

Phone: (561) 417-5515


Email: info@questorconsulting.com
www.questorconsulting.com

Summary
The purpose of this spreadsheet model is twofold: 1) to estimate the valuation of commercial property and
2) to determine the financial feasibility of an investment in the subject property for a 10 year holding
period. The uncertainty in this model lies in the many economic factors to be input as assumptions by the
user. The most important assumptions in this analysis are the Net Operating Income assumptions (Annual
Gross Rent, Vacany and Collection Loss Factor, and Operating Expenses) and the Cap Rate at Purchase.
Special attention should be given to these assumptions.

Keywords: Real Estate, Property Valuation

Discussion
Commercial property valuation is estimated using 2 factors: 1) The current Net Operating Income (NOI -
Gross Rent Roll minus vacancy and collection losses and operating expenses) and 2) The Cap Rate. The
Cap Rate for the property is best estimated by analyzing comparables. The Market Value and Cap Rate
can be calculated using the following formulas:

Cap Rate = NOI / Sale Price

Market Value = (NOI / (Cap Rate (%) * 100)) * 100

The financial feasibility of the investment is expressed in two factors: 1) The Net Present Value of Real
Cash Flow and 2) the After Tax Real Rate of Return. The model calculates these values automatically by
creating Pro Forma statements based on the assumptions input by the user.

Risk Analysis with Crystal Ball


Crystal Ball enhances your Excel model by letting you create probability distributions that describe the
uncertainty surrounding specific input variables. This model includes multiple probability distributions,
which all vary based on market conditions. These distributions are referred to in Crystal Ball as
"assumptions." Each assumption cell is colored green and is marked by an Excel note (mouse over the
cell to view the note). To view the details of an assumption, highlight the cell and either select Define
Assumption from the Define menu or click on the Define Assumption button on the Crystal Ball toolbar.

This model also includes several Crystal Ball forecasts: Property Valuation, NPV of Real Cash Flow, and
After Tax IRR, all shown in light blue. Forecasts are equations, or outputs, that you want to analyze after a
simulation. During a simulation, Crystal Ball saves the values in the forecast cells and displays them in a
Forecast Chart, which is a histogram of the simulated values. To view the forecast with Crystal Ball,
highlight the cell and either select Define Forecast from the Define menu or click on the Define Forecast
button on the toolbar.

When you run a simulation, Crystal Ball generates a random number for each assumption (based on how
the assumption has been defined) and places that new value in the cell. Excel then recalculates the
model. You can test this by selecting Single Step from the Run menu or clicking on the Single Step button
"assumptions." Each assumption cell is colored green and is marked by an Excel note (mouse over the
cell to view the note). To view the details of an assumption, highlight the cell and either select Define
Assumption from the Define menu or click on the Define Assumption button on the Crystal Ball toolbar.

This model also includes several Crystal Ball forecasts: Property Valuation, NPV of Real Cash Flow, and
After Tax IRR, all shown in light blue. Forecasts are equations, or outputs, that you want to analyze after a
simulation. During a simulation, Crystal Ball saves the values in the forecast cells and displays them in a
Forecast Chart, which is a histogram of the simulated values. To view the forecast with Crystal Ball,
highlight the cell and either select Define Forecast from the Define menu or click on the Define Forecast
button on the toolbar.

When you run a simulation, Crystal Ball generates a random number for each assumption (based on how
the assumption has been defined) and places that new value in the cell. Excel then recalculates the
model. You can test this by selecting Single Step from the Run menu or clicking on the Single Step button
on the toolbar.

After you run a simulation, you will see the Property Valuation, NPV of Real Cash Flow, and After Tax IRR
forecast charts. You can view the statistics or percentile values of the run, or you can enter values into the
input fields on the frequency chart view. What is the chance that you will breakeven, i.e. have a NPV of
zero? What is the chance you will lose money? (Hint: enter a number into the lower left field and use the
Enter button on your keyboard to accept the value.)

To view which of the two assumptions had the greatest impact on the forecast, use the Sensitivity Chart.
Which variable causes the most variation in the target forecast? Can you somehow reduce this source of
uncertainty and improve your overall forecast? Change the assumption parameters or the assumption
types, run a new simulation (hint: don't forget to hit the reset button before beginning a new simulation!),
and compare the results. You can also generate a report by selecting Create Report from the Run menu or
clicking on the Create Report button on the toolbar.
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Commercial Real Estate Valuation and Financial Feasibility
ASSUMPTIONS Commercial Real Estate Valuation and Financial Feasibility
Annual Gross Rent, first year 182,400
NOI
Vacancy and Collection factor 5% Assumptions
Operating Expenses, first year 55,540 INSTRUCTIONS:
Annual % change in rent 3.0%
Annual % change in expenses 3.0% 1.) Conduct comparables analysis of similar properties to estimate the cap rate at purchase.
Loan to Value ratio 75.0% 2.) Define all assumption distributions to reflect current and local market conditions.
Stated Annual Interest rate 6.0% 3.) Run simulation.
Loan Term (years) 25 4.) Analyze results.
Percent of price in improvements 85.0%
CPI Annual Increase 3.0%
After tax, Real Discount rate 8.0% Model developed by Questor Consulting LLC, Better Analysis. Better Decisions.
Cap Rate assumed at date of sale 8.0% For information regarding this model or for requests, please call us at (561) 417-5515.
Transaction costs as % of sales price 9.0%
Cap Rate at Purchase 9.1%

DEFINED VARIABLES Source


Recovery period (years) 39 Omnibus Budget Reconciliation Act of 1993
Income tax rate (Corporate) 15.0% IRS - Varies based on taxable income
Capital Gains tax rate 5.0% IRS - Varies based on income tax bracket

Property Valuation: $1,299,558.50

ECONOMIC VALUES, CALCULATED BY MODEL


Loan Amount 974,669
Equity Required 324,890
Mortgage Loan Constant 7.82%

DECISION ANALYSIS FACTORS


year 0 1 2 3 4 5 6 7 8 9 10 11
Real Cash Flow to Owner (324,890) 35,781 204,398 195,471 192,448 189,509 186,650 183,870 181,165 178,535 935,104 0
Present Value of Real Cash Flow (324,890) 33,131 175,238 155,171 141,455 128,977 117,621 107,286 97,878 89,312 433,134 0

NPV of Real Cash Flow: $1,154,313.90


After Tax Real Internal Rate of Return: 45.71%

PROFORMA INCOME STATEMENT


year 0 1 2 3 4 5 6 7 8 9 10 11
Annual Gross Rental Income na 182,400 187,872 193,508 199,313 205,293 211,452 217,795 224,329 231,059 237,991 245,130
Vacancy and Collection Losses na (9,120) (9,394) (9,675) (9,966) (10,265) (10,573) (10,890) (11,216) (11,553) (11,900) (12,257)
Effective Rental na 173,280 178,478 183,833 189,348 195,028 200,879 206,905 213,113 219,506 226,091 232,874
Operating Expenses na (55,540) (57,206) (58,922) (60,690) (62,511) (64,386) (66,318) (68,307) (70,356) (72,467) (74,641)
Net Operating Income na 117,740 121,272 124,910 128,658 132,517 136,493 140,588 144,805 149,150 153,624 158,233
Interest Expense na (58,480) (57,414) (56,284) (55,087) (53,817) (52,472) (51,045) (49,533) (47,930) (46,232) (44,431)
Depreciation (cost recovery) na (28,324) (28,324) (28,324) (28,324) (28,324) (28,324) (28,324) (28,324) (28,324) (28,324) (28,324)
Taxable Income na 30,936 35,534 40,302 45,247 50,376 55,698 61,219 66,949 72,895 79,069 85,478
Income Tax Liability na (4,640) (5,330) (6,045) (6,787) (7,556) (8,355) (9,183) (10,042) (10,934) (11,860) (12,822)
Net Income After Tax na 26,296 30,204 34,257 38,460 42,820 47,343 52,036 56,906 61,961 67,208 72,657

PROFORMA CASH FLOW STATEMENT


year 0 1 2 3 4 5 6 7 8 9 10 11
Annual Gross Rental Income na 182,400 187,872 193,508 199,313 205,293 211,452 217,795 224,329 231,059 237,991 245,130
Vacancy and Collection Loses na (9,120) (9,394) (9,675) (9,966) (10,265) (10,573) (10,890) (11,216) (11,553) (11,900) (12,257)

Developed by Questor Consulting LLC (561) 417-5515


Effective Rental na 173,280 178,478 183,833 189,348 195,028 200,879 206,905 213,113 219,506 226,091 232,874
Operating Expenses na (55,540) (57,206) (58,922) (60,690) (62,511) (64,386) (66,318) (68,307) (70,356) (72,467) (74,641)
Net Operating Income na 117,740 127,444 124,910 128,658 132,517 136,493 140,588 144,805 149,150 153,624 158,233
Debt Service na (76,245) 94,732 94,732 94,732 94,732 94,732 94,732 94,732 94,732 94,732 na
Income Tax Liability na (4,640) (5,330) (6,045) (6,787) (7,556) (8,355) (9,183) (10,042) (10,934) (11,860) na
Equity Dividend (cash to owner) na 36,854 216,845 213,597 216,602 219,693 222,870 226,137 229,495 232,947 236,496 na
Down Payment/Reversion (324,890) na na na na na na na na na 1,020,206 na
Total Cash Flow to Owner (324,890) 36,854 216,845 213,597 216,602 219,693 222,870 226,137 229,495 232,947 1,256,702 na
Purchasing Power Adjustment na 103% 106% 109% 113% 116% 119% 123% 127% 130% 134% na
Real Cash Flow to Owner (324,890) 35,781 204,398 195,471 192,448 189,509 186,650 183,870 181,165 178,535 935,104 na

MORTGAGE LOAN AMORTIZATION SCHEDULE


year 0 1 2 3 4 5 6 7 8 9 10 11
Balance Owed, beginning of year 974,669 956,904 938,073 918,112 896,954 874,526 850,752 825,552 798,840 770,525 740,512
Annual Mortgage Payment 76,245 76,245 76,245 76,245 76,245 76,245 76,245 76,245 76,245 76,245 76,245
Interest Portion of Payment (58,480) (57,414) (56,284) (55,087) (53,817) (52,472) (51,045) (49,533) (47,930) (46,232) (44,431)
Amortization of principal 17,765 18,831 19,961 21,158 22,428 23,774 25,200 26,712 28,315 30,014 31,814
Balance Owed, end of year 956,904 938,073 918,112 896,954 874,526 850,752 825,552 798,840 770,525 740,512 708,697

ANALYSIS OF REVERSION ON SALE


Net Operating Income Projected, Year After Sale (Year 11) 158,233
Cap Rate At Sale Date 8.00%
Capitalized Value (Sale Price) 1,977,909
Transaction Cost (178,012)
Net Sales Price 1,799,897
Book Value At Sales Date (cost-dep) (1,016,321)
Capital Gain ( Net Price - BV) 783,576
Capital Gains Tax 39,179
Mortgage Balance Owed 740,512
Reversion in nominal dollars to owner at sales date 1,020,206

Developed by Questor Consulting LLC (561) 417-5515