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The Fundamentals of Real Estate Financial Modeling in Excel

Several people have asked me recently how I learned to be proficient in real estate financial modeling. The questions stemmed from an interest to learn, and a desire to work in real estate finance or investment. I struggled to provide straightforward advice to what seemed a fairly straightforward question, largely because my career path has been unconventional. So rather than describe, step-by-step, the process I’ve gone through, I thought I’d share what I consider to be the three pillars of knowledge one must possess to be considered proficient in modeling real estate. I’ll also offer some suggestions, some free and some paid, for how to obtain this knowledge.

real estate modeling

Proficiency in real estate modeling requires mastering the principles of finance, real estate, and Microsoft Excel.


I. A Sound Understanding of Finance

Modeling real estate is fundamentally about ascertaining the present value of a future stream of cash flows – cash flows that just so happen come from a real estate asset. In other words, if you are considering buying an apartment building today, how much do you value the future cash flows that the apartment building is likely to generate? If you project the cash flows to be more volatile (e.g. the apartment building is not yet built), the value of those less-than-certain future cash flows are worth less to you than were the future cash flows more certain (e.g. the apartment building is completed and 97% occupied).

Consequently, mastering real estate modeling requires a sound grasp of basic finance principles. You must understand finance concepts such as the time value of money, risk and return and different methods for calculating risk and return, the various types of rates including interest rate and discount rate, the corporate capital structure, how to calculate a firm’s cost of capital, etc.

There are several options, some more obvious than others, to gain the finance knowledge you need to model real estate. Many of us learned finance in either undergraduate or graduate school – I took more than my fair share of finance courses during my graduate real estate studies at the Baker Program in Real Estate at Cornell University – and most universities offer finance courses. If taking a university finance course doesn’t fit your budget or schedule, another great option is to take a free MOOC course.

Two finance related MOOC courses I recommend are the Principles of Valuation course taught by Gautam Kaul of the University of Michigan’s Ross School of Business and the Introduction to Corporate Finance course taught by Franklin Allen of the Wharton School of the University of Pennsylvania. With these courses, not only will you be taking quality finance courses taught by professors from two of the top business schools in the world, but the courses are open and free too all!

II. A Mastery of Real Estate Principles

The second pillar of modeling real estate in Excel, is mastering the principles of real estate. The models you build are only as good as the assumptions you make. If your assumptions are weak, the results will likewise be weak. Hence the saying in modeling: “garbage in, garbage out.” Many of us learned real estate principles through some combination of education and real world experience. Of course, many real estate modelers who lack a seasoned mastery of real estate principles rely on others to feed them assumptions – this is common with newly hired analysts fresh out of school. Still, even newly hired analysts come into their position knowing the terminology, and understanding how real estate works.

Some of the indispensable real estate specific concepts and vocabulary you have to know include: debt vs equity, types of spreads, risk and return metrics (e.g. IRR, equity multiple, DSCR, mortgage yield, LTV), setting up a pro forma operating statement (PGI –> EGR –> NOI –> CFAF), market leasing assumptions (rent, vacancy, TIs, LCs), the fundamental value equation (value = NOI ÷ cap rate), public real estate vs. private real estate (REITs vs private equity funds), the real estate investment process, different valuation methods (comparable sales, replacement cost, discounted cash flow), real estate taxes, etc, etc etc.

The challenge with mastering real estate is that, as an academic study, real estate is relatively young. Even today, most universities don’t teach real estate principles, and consequently, real estate customs and conventions vary from region to region and from company to company. Despite this challenge, there are places to go to learn the principles of real estate.

Undergraduate degrees in real estate are far and few between and a quick search of free MOOC courses in real estate yielded similarly scarce results. There are quite a few graduate programs in real estate, Wikipedia has a comprehensive list here, but many people don’t have the time and/or resources to complete a graduate degree in real estate.

I’m sorry to say, there aren’t any quick and simple answers to where to turn for real estate education. Consider grabbing a book (you might check out this or this), or searching online for free or low-cost commercial real estate education. Short of attending a quality graduate program in real estate, I think the best way to learn is to leverage your finance and Excel skills to get hired on at a real estate investment firm and learn real estate from others around you.

You might also check out this paid Real Estate Financial Modeling course on Udemy.

III. Advanced Proficiency in Microsoft Excel

Modeling real estate requires an advanced proficiency working with Microsoft Excel (if you don’t have Excel 2016, get an Office 365 monthly subscription, or student license now). Of course there are other valuation tools used in the industry such as ARGUS DCF (I posted earlier on some free ARGUS training resources I’ve used), but Excel is used universally and is the most important software program to master.

I learned Excel through a combination of online courses, self-study books, Excel courses during my undergrad and grad years, Excel Q&A forums, YouTube tutorials, and good old fashioned learn by trial and error. In addition to the free Excel models, tools, and resources found on our blog, I’ve compiled a list of free Excel training materials online that I’ve found to be useful in mastering Excel. Given that we are all at different stages of Excel proficiency, I’ve organized the list by beginner, intermediate, and advanced levels.

Beginner
Intermediate
Advanced
All Levels

Two other options, one free and one paid that you might consider regardless of your skill level:

Becoming a great real estate excel modeler takes time, dedication, and a commitment to mastering the three pillars of real estate financial modeling: finance, real estate principles, and Microsoft Excel. I’ve found many of the resources I’ve just mentioned helpful as I continue to improve my mastery of real estate modeling, and I hope these resources and our blog are likewise beneficial to you.

As always, if you have any comments or just want to say hello, please don’t hesitate to reach out. You can find my contact details over at my personal website.

Disclaimer: This post contains affiliate links, which means we may receive a commission if you make a purchase using the links labeled (paid) within this post.

About the Author: Born and raised in the Northwest United States, Spencer Burton has over 15 years of real estate investment and development experience. In his current position, Spencer assesses new investments for a $40bn real estate fund. He resides in Dallas, TX.