1. Introducing the Case
To begin, we'll learn about real estate asset we're going to value. We'll also meet the investor and his expectations for the investment.
Introducing our case
- The case study in question is a residential real estate asset for sale
- We chose a real estate asset for a number of reasons:
1 Real estate assets tend to have more predicatable cash flows and are easier to model
2 The apartment is a straightforward, single asset valuation
3 Most of us will buy a real estate asset during our lifetime so it's a relevant case to most people
Frame the problem
- Our client requires an IRR of >15%
- The asset in question is available for $1.4m
- The client is assuming that we sell the asset in 6-9 years
Question: Given these constraints, should our client buy the asset?
In this course, we’re going to build a full valuation model for a Real Estate asset.
Why did I choose a Real Estate asset? Well for a number of reasons.
Firstly, because of its relevance.
Most people during their life time will buy a property, and so the concepts and terms I use in this case study will be very familiar.
Also, given that it’s a single asset, the valuation process will be much easier to understand, and safer value in your company, which might contain multiple business units and many different types of assets.
The real estate asset in question is a 3-bedroomed apartment in a downtown US city that’s currently for sale for $1,400,000.
In valuing this asset, I’m going to assume that you have a basic understanding of valuation theory, including concepts such as discount cash flow, net present value, and Internal rate of return.
Now let’s meet our client who’s Joe Calatrava, an experienced Real Estate Investor.
He plans to buy the apartment as an investment and rent it to tenants in the near to medium term.
He wants a minimum 15% IRR on the investment, and plans to sell on the asset in six to nine years.
And he has asked us to advise him on a decision on whether he should buy the apartment.
For this case study we’ll be using Powell & Batt’s four stage modeling process to help structure our approach and eventually reach a decision.
Let’s start off in step one by framing the problem.
Given that Joe knows the purchase price, his estimated holding period and the target rate of return, the problem statement for this case is quite straightforward.
Will the asset yield an IRR of greater than 15% if we buy for $1,400,000 and sell in the next six to nine years? With this introduction out of the way, and our problem statement confirmed, let’s move on to defining the model structure in the next lesson.