A Note About The Limitations of Microsoft Excel in Modeling Real Estate
I think its important to point out that my All-in-One (Ai1) Underwriting Model for Real Estate Development and Acquisition is not a surefire replacement for your non-Excel valuation/underwriting solutions. In fact, it’s likely you (or your employer) chose to use another tool in large part because of the limitations of Excel. And Excel certainly has its limitations!
An Example of its Limitations
Take for example modeling expense reimbursement. It would be virtually impossible to model in Excel (or in any other tool for that matter) the almost infinite variations of expense reimbursement arrangements in retail, office, and industrial leases. Other solutions likewise come up short in this area, but come a lot closer than any Excel model ever could.
So in this Excel-based All-in-One Underwriting Tool, I use an annual expense recovery by tenant method to calculate expense reimbursement rather than attempting to model every possible scenario. Less precise? Sure. Good enough? In my experience, the buy/sell decision/outcome does not hinge on what the exact amount of reimbursement income a property might throwoff is – a figure, by the way, no software can predict with 100% certainty.
Note on Limitations in the ORI Module
While the All-in-One is meant to handle more complex lease scenarios and therefore can do a lot of the things that people turn to non-Excel solutions for, it still has Excel-specific limitations that it’s important to be aware of.
First, the ORI module does not support reimbursement of management fees. The complexity of handling the circular nature of reimbursing management fees outweighs the benefit. As a workaround, we’ve included an Admin Fee that when modeled as approximately the same amount as the management fee gets you to approximately the same outcome.
Second, the ORI module is limited to three generations of leases. This is to avoid exceeding Excel’s memory capacity. Given that the max analysis period in the All-in-One is 10 years, and most long-term leases are 3+ years long with downtime between leases, this limitation shouldn’t affect most people. But if your scenario includes leases shorter than three years, you’ll likely need to use a different solution or shorten your analysis period.
Third, the model simplifies calculation of leasing commissions and free rent. Leasing commissions are calculated on the base rent without bumps and free rent is charged at the beginning of the lease (rather than spread over the expected free rent period).
Lastly, the lease reimbursement module in the All-in-One has limitations. While NNN and Gross leases generally model well, when you get into gross modified/base year type leases, the reimbursement amounts are more approximations than an accurate forecast of the reimbursements. This again is due to the limitations of Excel. If you need an exact forecast of future reimbursement cash flows, you’ll need to use a non-Excel solution.
Conclusion
So, it really comes down to this. Excel is inexpensive, widely used, and offers customization on the fly but lacks the super-precision of its non-Excel counterparts. It’s up to you to perform your own cost-benefit analysis to decide which tool best suits your purpose.
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Frequently Asked Questions about the Limitations of Excel in Real Estate Modeling
Why does the Ai1 model use a simplified approach for expense reimbursements?
Because of Excel’s limitations, modeling every possible variation of expense reimbursement is virtually impossible. Instead, the Ai1 model uses an annual expense recovery by tenant method, which is “less precise” but “good enough” since “the buy/sell decision/outcome does not hinge on what the exact amount of reimbursement income a property might throwoff is.”
What are the specific limitations of the ORI module in the Ai1 model?
The ORI module:
Does not support reimbursement of management fees due to complexity.
Is limited to three generations of leases to avoid exceeding Excel’s memory.
Simplifies leasing commission and free rent calculations, e.g., commissions are based only on base rent and free rent is charged upfront.
Provides approximate reimbursements for modified gross/base year leases rather than precise forecasts.
Can the Ai1 model handle more complex lease scenarios like NNN and Gross leases?
Yes, NNN and Gross leases generally “model well” in the Ai1 model. However, when it comes to base year or modified gross leases, the tool produces more of an approximation rather than a highly accurate reimbursement forecast.
Why is the model limited to three generations of leases?
This limitation helps avoid surpassing Excel’s memory capacity. Given the 10-year max analysis period and the typical lease duration of 3+ years, this constraint “shouldn’t affect most people,” unless analyzing shorter-term leases.
What is the workaround for not modeling management fee reimbursement?
The model includes an Admin Fee input that, when set approximately equal to the management fee, “gets you to approximately the same outcome.” This workaround addresses the circular nature of reimbursing management fees.
Is the Ai1 model meant to replace non-Excel tools?
No. The Ai1 model is not a “surefire replacement” for non-Excel valuation/underwriting solutions. It is meant to be a flexible, Excel-based alternative but lacks the precision and full functionality of dedicated non-Excel tools.
What’s the key trade-off of using Excel for real estate modeling?
Excel offers affordability, flexibility, and customization “on the fly,” but it lacks the “super-precision” and scalability of non-Excel tools. Users must decide what tool best fits their needs based on cost-benefit analysis.
