Returns Video

[Anonymous]

Hi Spencer,

Under Real Estate DCF, 2.8 Returns video, seems the GMV should be a -ve number in the spreadsheet?

AE

[Spencer Burton]

Hi AE,

Thanks for the comment. Unfortunately, I don’t quite understand the question.

When you say GMV, are you referring to Gross Reversion Value? And what do you mean by “should be a -ve number in the spreadsheet?”

Also, are you referring to the lecture 2.8 ‘From Theory to an Excel Workbook’? If so, what part of that lecture?

If you wouldn’t mind rephrasing the question that will help me get a good answer for you.

Thanks!

Spencer

[Anonymous]

In Course 3. Anatomy of The Real Estate DCF, under Lecture 2.8 From Theory to Excel Workbook, there are a number of videos. The last video on the page is a video named Returns. In that video, wouldn’t the Gross Market Value be a negative -ve number as it is also a cash outflow? The Net Market Value is the Gross Market Value less selling costs, though both the Gross Market Value and the Acquisition Costs are cash outflows, shouldn’t the cash outflow used to calculate the IRR be -$26,250,000?

[Spencer Burton]

Okay, now I understand what you’re referring to. Thanks for the clarification.

You are correct that the Gross Market Value and subsequent Net Market Value are negative (i.e. outflows) when calculating the returns. In this particular case, I intentionally leave the Net Market Value positive within the Investment Cash Flow section but make the Net Market Value negative when building the Net Unlevered Cash Flow line (see time 1:38 in last ‘Returns’ video at the very bottom of Lecture 2.8).

With that said, I understand the confusion and I think comes in both how I present the Investment Cash Flow section and in how the Selling Costs in the Investment Cash Flow calculation are uniquely handled in hold/sell analysis. Let me tackle both one by one.

First, why did I leave Gross Market Value and Net Market Value positive within the Investment Cash Flow section? I do this for visualization purposes; or in other words to make it easier to understand the calculation that’s going on. For example, when modeling development cash flows I always model them as positive values within the Investment Cash Flow section even though they’re negative cash flows at the Net Cash Flow line. In my opinion it’s just easier to work with positive values. In this particular case (the hold scenario analysis), the selling costs are actually adjustments to the Market Value rather than additions to it. So modeling the Market Value as positive values within the Investment Cash Flow section, and then setting them as negative when calculating the returns in my mind made it easier to understand.

The second piece, and I think the main element of confusion, is why the selling costs are an adjustment, rather than an addition to Market Value. In a typical acquisition, Investment Cash Flow is made up of the sum of Purchase Price, Acquisition Cost, and Closing Costs. The sum of those cash flows is Total Acquisition Cost which flows into the returns as a negative value. If this example were an acquisition, you’d be right that the calculation would look something like this:

Purchase Price: 25,000,000
+ Acquisition and Selling Costs: 1,250,000
Total Acquisition Cost: 26,250,000

However in the case of the hold scenario, the selling costs portion of the Investment Cash Flow calculation is actually an inflow. This is because in the hold scenario, the Investment Cash Flow represents the opportunity cost of not selling. Or what we would be missing out on if we didn’t sell the property. And how do we calculate that opportunity cost? We take what we could sell the property for (i.e. Gross Market Value) and we subtract any selling costs to arrive at a Net Market Value (i.e. the net proceeds from selling).

Gross Market Value: 25,000,000
– Selling Costs: 1,250,000
Net Market Value: 23,750,000

Then in the Hold scenario DCF, that Net Market Value flows to the Net Unlevered Cash Flow line (i.e. the returns) as one big negative cash flow in time zero.

Hope that clears up the confusion! Happy to answer any follow up questions you might have.

Spencer

[Anonymous]

Thanks Spencer, very clearly explained.

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