Real Estate Financial Modeling: Avoid Costly Mistakes

The combination of inflation and rising interest rates makes houses not only more expensive to buy, but also more expensive to build. According to an ongoing count by the US Federal Reserve, the producer price index for building materials increased from 235 in June 2020 to 350 in June 2022, an increase of 49% in just two years. Consumer price inflation is also rising at rates of 5% to 9% in most developed countries, prompting central banks to raise interest rates in response.

I have worked in real estate financing for over 15 years and have received funding for over 100 commercial real estate projects, including houses, hotels and commercial real estate. I have noticed that many developers turn their attention to daily requirements and have less experience in evaluating important financing decisions and understanding all the nuances HAI have worked in real estate financing for over 15 years and received funding for over 100 commercial real estate projects, including houses, hotels and commercial real estate. I noticed that many developers turn their attention to daily requirements and have less experience in evaluating important financing decisions and understanding all the nuances. You may not benefit from a real estate development financing model at all, or you may not be trying to benefit from a real estate development financing model at all, or you may be trying to do it yourself instead of hiring a financial modeling expert.

How Real estate projects Are financed

A real estate development project is usually financed with a combination of senior debt and equity of third parties. It is also customary to allocate additional funds from junior debt securities and/or third-party equity investors when the project costs increase.

Preferred lenders take a ” last-in-first-out” approach to financing projects. This means that they expect all subordinated financing to be invested before releasing funds. The main lender then finances the costs of completing the project, in which matter it will be repaid first.

As in most financing structures, senior debts provide the strongest security and are in the first place in the capital pile, as a result of which the most cost-effective burden is borne: a relatively low interest rate and low costs. JuWie in most financing structures, senior debts provide the strongest security and are in the first place in the capital pile, as a result of which the most cost-effective burden is borne: a relatively low interest rate and low costs. Junior debt carries a higher interest rate, and equity contributes to the profits of the project, and sometimes also carries a priority return.

Mistake 1: Misuse of the WACC to determine the best mix

A key indicator for determining the breakeven point of a project is the weighted average cost of capital (WACC).

I have seen how many real estate developers and even some lenders have made the mistake of choosing the most favorable mixed interest rate based on the WACC when the senior loan is fully exhausted and before the sale begins to pay off debts. This is a proven method for optimizing financing in certain financial areas, for example, in the matter of structured corporate acquisitions. However, for a construction project, this abbreviation can lead to the fact that you significantly underestimate the cost of financing.

Mistake 2: Neglecting the interest deduction

If you are considering options for senior debt, the lenders you turn to have their own models and methods of structuring loans. Most offer leverage as a percentage of the cost and/or the final value. They will then break down the loan to cover the construction costs and the accumulated interest, with the remaining amount being used to purchase the site. Even if two lenders have the same total loan amount, the distribution of financing and assumptions may be different—uif you are considering options for senior debt, the lenders you turn to have their own models and methods of structuring loans. Most offer leverage as a percentage of the cost and/or the final value. They will then break down the loan to cover the construction costs and the accumulated interest, with the remaining amount being used to purchase the site. Even if two lenders have the same total loan amount, the distribution of financing and assumptions may be different—and this affects the final result.

Let’s look back at Project 50 and focus on a scenario in which two competing banks offer senior debt at the same level of leverage: 60% of GDP.

Mistake 3: not modeling exit strategy

When evaluating a real estate project, the funders want to know the exit strategy of the developer. Construction financing is usually short-term (from one to four years), and solwhen evaluating a real estate project, the funders want to know the exit strategy of the developer. The construction financing is usually short-term (one to four years) and is to be repaid after the completion of the construction work. Even if a developer keeps the completed project for a longer period of time, he refinances the financial