This is the second part of the real estate private equity interview prep series focusing on property pro formas. The first part of this series can be found here. You must understand these questions cold before beginning any real estate private equity interview process.
Walk me through an office pro-forma
The revenue side of an office pro forma will recognize rent from multiple tenants. Then under your rent line will be a “free rent” contra-revenue line, which new tenants often receive for the first few months of their lease. Another major revenue item is tenant reimbursements, which represents the operating expenses that tenants must cover since most office leases are triple-net. Generally, tenants pro-rate their share of reimbursements based on their proportionate occupied square footage.
Operating expenses on an office pro forma comprise the usual suspects: property taxes, insurance, utilities, repairs and maintenance, landscaping, and so on. The key fact to consider is that most of these expenses are reimbursed to the landlord by the tenants because office leases are often triple-net. Thus, your tenant reimbursements revenue line should mostly negate your operating expense line.
At move-in, new tenants often receive a capital expenditure allowance called “tenant improvements.” These tenant improvements allow the new tenant to outfit their space to their taste. Tenant improvement allowances vary by market; brokers usually know the typical TI allowance for their markets.
The net operating income, then, flows to the cash flow statement to repay debt and then pay investors.
Walk me through an industrial pro-forma
The revenue line of an industrial pro-forma is less complicated than that of an office or mall, and especially less so than a multifamily apartment building or hotel. This is because most industrial leases are single tenant. For example, a distribution center on the south corridor of I-95 that is completely leased by Amazon.
On the expense side, expect lower repairs and maintenance costs. This is because warehouses do not need to be as pretty as a class A office or mall. On the other end, the utilities expense is higher because industrial buildings rely much more heavily on electricity. Thus, the landlord must ensure that those costs are either billed directly to the tenant or properly attributed to each tenant for reimbursement is key.
The rest of the pro forma is typical, with net operating income servicing the debt and then repaying investors.
Walk me through a seniors housing pro forma.
Seniors housing projects tend to fall into one of two categories- a straight lease of the facility by the operator, which would then underwrite like a single-asset deal, or an investment where the operator is simply under contract to provide day-to-day care and management for a fee, but the operator doesn’t take the risk of profit and loss in operations. In the latter scenario, the investor has operating risk, and the pro forma will incorporate the full schedule of operating expenses associated with care for the residents.
On the revenue side there is rent from the residents, but then there are revenues associated with levels of care or with spouses. Levels of care may include assistance with bathing or dressing, therapy services, medications, and so on.
On the expense side, there are costs for housekeeping, meals and meal prep, nursing, compliance, medications, and marketing. Net operating income, then, services the debt and then what remains is paid to the investors.
Want to learn more?
The concepts herein will be tested throughout the entire real estate private equity interview process. You should expect them during an introductory screener call as much as a final round with a senior managing partner. But, real estate private equity interviews require much more hands-on preparation than reading articles. That’s why we developed Breaking Down Real Estate Private Equity and the REPE Intro Guide. These two courses teach you the hard technical skills necessary to develop mental fluency with these fundamental concepts.