One of the key pieces to investing and developing commercial real estate is to have solid underwriting processes when looking at potential deals. Our team has worked for years to adapt and modify our pro forma modeling processes to reduce the risk in our projects to a minimum. I thought I'd share some tips from what we have learned as a team when modeling and looking at potential deals.
Breakdown and Organize Your Potential Costs
When working on a development project there are a wide variety of costs that come up from site work costs to city fees for submitting a site plan. It's a lot to keep track of we know. To keep the costs organized we typically break everything down into three groups: Hard Costs, Soft Costs, and Financing Costs. From there smaller categories are made like "Site Work" under Hard Costs or "Impact Fees" under Soft Costs. You can see our template Pro Forma below to see exactly how we breakdown our typical costs for a retail development. The categories change between deals but, separating out the costs into buckets like this make keeping the model organized a much easier task and also keeps the model easy to understand and track down specific costs.
Keep Your Pro Forma Alive
People often think that a Pro Forma is built at the beginning of a project and there isn't any need to look at it after it answers if the project is feasible or not. In the past we have found that when investors have questions, which they often do, it makes a world of difference to have an up to date PF to reference. Our team has gotten in the habit of treating our model like a living document. Every time we get an updated bid on work from a GC it goes directly into the model so we can see how our exit changes. Pay a fee to the city? That cost gets entered directly into the model. When we say exit that could mean we either sell the asset to an investor or get permanent financing in place to collect cashflow for our investors. The metrics we track depend on the exit plan we have in place but, consistently updating the PF always keeps those metrics fresh in mind for our team. This also makes it much easier to avoid unexpected issues when exiting a project. It gives a very clear accounting for the current status of the project and where it is compared to our original budget.
Set Strick Metric Goals
Last bit of advice about modeling a PF, set clear goals for what a deal you are willing to do looks like and stick to those guidelines. In the past our team has been a little too excited to get moving on a deal that we pushed forward with deals that maybe don't fit our set guidelines that we have today. For example if you are looking for a deal that reaches 18% annual return over the course of the investment be sure to have a cell that shows that calculation and stick to that goal. We have had deals that we pass on because they pencil in 1% lower than our set goals. There are constantly more opportunities coming into reach and it wouldn't make sense to dedicate so much time to a deal that doesn't reach our minimum goal.
Modeling a PF is something that is completely up to the individual on how they want it to look. There is no one correct way to model an investment so find something that works for you and stick with it. I do highly recommend following our tips above because they are changes we have made to our process in the past few years that have helped us maintain solid returns over this tumultuous time in the market. They have also helped keep our team much more organized and reduced the amount of headaches.
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