Class A Office Property Acquisition Case Study
Pre-Acquisition Financial Analysis and Due Diligence
A New York-based real estate investor required time-critical financial analysis and due diligence in connection with its acquisition of a Class A office building in West Palm Beach, FL. The client retained Situs to perform pre-acquisition financial modeling, cash flow projections and a deep-dive analysis of property operations.
Reaching out to the existing owner, Situs obtained essential property-level information, including the current rent roll and budget as well as historical occupancy reports, property operating statements and supporting schedules and documents. These included leases for the more than two dozen tenants, operating expense recovery reconciliations, property tax bills, insurance invoices and a schedule of historical capital expenditures.
Next, Situs built out a ground-up cash flow and asset valuation model – which reflected both base-case and upside scenarios – utilizing ARGUS, the recognized industry standard for developing commercial real estate cash flow projections, transaction analysis and asset valuation. Situs worked closely with the client to adjust and update the model to achieve optimal results.
At the same time, Situs created an Agreed Upon Procedures (“AUP”) model with which it tested and verified various revenue and expense line items, reviewed and confirmed cash flow assumptions and prepared multiple analyses. For example, tying to the Argus model, Situs produced a complex analysis of tenant expense recoveries that required multiple expense line items to be reviewed and tested one-by-one. As part of the AUP process, Situs also reviewed the Argus model prepared by the property appraiser. Situs identified several modeling errors that, when corrected, resulted in a higher asset valuation and lower loan-to-value (“LTV”).
At the client’s request, Situs also designed a custom-built equity valuation/joint venture (“JV”) model. The model, which the client utilized to present the deal structure and underlying assumptions to its preferred equity partner, is fully scalable and can be used by the client for future transactions.
Situs’s equity valuation/JV model provided extreme flexibility: Referencing monthly cash flows generated in the Argus model, all calculations are done month-by-month and then rolled up for annual presentation. Multiple options were built in to allow for various desired hold periods and for modeling debt on both an interest-only and amortizing basis with either floating- or fixed-rate terms. The model also provides options for modeling mezzanine debt, with the ability to reflect both current and accrual pay loan terms. The equity JV model features a multi-tiered waterfall, or distribution, structure to reflect typical JV transaction terms, including three internal rate of return (“IRR”) look-backs, the option to bring in a JV partner at any time during the hold period and the ability to calculate implied equity value for partner contribution amounts. Lastly, the model was designed to allow for multiple exit pricing assumptions and sensitivity analyses.
Commercial real estate acquisitions demand thorough due diligence and rigorous pre-acquisition analysis. Purchase and sale contracts typically contain a “Time is of the Essence” clause; all work must be completed and vetted within a tight time frame so there are no speed bumps prior to closing.
By managing pre-acquisition due diligence, financial modeling, cash flow projections and equity valuation/joint venture modeling, Situs allowed the client to focus on negotiating the deal terms and getting to the finish line.