How to Build Scenarios into a Real Estate Pro-Forma for a Multifamily Property
Raja Maan / Commercial Finance
PRIVATE DEBT & EQUITY | SBA | USDA : Hotels, Gas Stations, Car Wash, Truck Stops, Multifamily, Mixed Use, Retail, Office, Self-Storage
Follow us at ACOM Capital
All investing is probabilistic, so you need to consider what happens if the deal goes very well, average, or very poorly.
Typically, you create Base, Upside, and Downside cases with differences in Rent, Vacancy, Bad Debt, Expenses, TIs, and LCs.
In credit analysis, you focus on the Base, Downside and Extreme Downside cases since the upside is extremely limited for lenders.
Everything must be connected in these scenarios – if there’s a recession, rents will fall, the vacancy rate will rise, and TIs and LCs will also rise because it will be more difficult to find tenants.
In our multifamily example here, the Base Case represents steady, uninterrupted growth in Market Rents (3-5%), the same 3% Vacancy Rate, the same 3% Bad Debt, 2-4% Expense Growth, and TIs grow at 2-4% with LCs remaining at 3% of Effective Rent.
The Downside Case represents a mild recession over ~2 years, so Market Rents fall, Vacancy and Bad Debt rise to ~6%, Expenses fall, TIs grow at 10%, and LCs jump to 8% of Effective Rent.
And the Extreme Downside Case is similar but has even worse numbers, based on the most severe recession from the past few decades.
You can see how some of the assumptions differ in these scenarios below:
Taken together, all these differences create substantially different outcomes for Effective Gross Income (EGI) and Net Operating Income (NOI) in the final year of the model:
Recommended by LinkedIn
Base Case:
Downside Case:
Extreme Downside Case:
The scenarios also tell us that the proposed financing for this deal, with 85% leverage, won’t work because some of the lenders lose money in the Extreme Downside Case, and the equity investors also get wiped out.
We can see that by looking at some of the sensitivities for the returns to different investor groups here:
Follow us at ACOM Capital
PRIVATE DEBT & EQUITY | SBA | USDA : Hotels, Gas Stations, Car Wash, Truck Stops, Multifamily, Mixed Use, Retail, Office, Self-Storage
4moScenarios are crucial in a Real Estate Pro-Forma, especially for multifamily properties. They allow investors to prepare for various outcomes by considering different rent, vacancy rates, and economic conditions. This approach helps in making informed decisions and managing risks effectively.