Real Estate Financial Models: Key Differences of Acquisition vs. Development Excel Models
In the realm of real estate, there are a number of real estate financial models that can be used to analyze and predict the profitability of different deals. Two of the most common models used are the acquisition model and the development model.
Both models are used to determine whether or not a potential real estate deal could be financially profitable, but despite their similar purposes, these two models use different methodologies and principles, thus are applied in different scenarios based on the nature of the real estate project.
This article will provide a comprehensive comparison of these two financial models.
Acquisition Real Estate Financial Models
An acquisition real estate financial model is essentially the calculus used when an investor is planning to purchase an existing property. This model considers the property's current cash flows, potential for rent increases, and other factors to predict financial returns. The basic idea is to calculate the purchase price and operation costs, against the projected return on capital investments over a certain timeframe.
The analysis accompanying this financial model includes vetting of key parameters such as tenant leases, operational costs, capital and renovation requirements, market realities, demographic trends, historical rates, comparables etc. Determining your going-in, stabilized, and exit cap rates, as well as other metrics such as your IRR, Cash-on-Cash, and Equity Multiple, play a key part in acquisition modelling as it is used to value income-generating properties.
Development Real Estate Financial Models
Unlike the acquisition model, the development model is used when an investor or developer is constructing a new property or significantly renovating an existing one. This model is significantly more complex because there are many more variables to consider, such as construction costs, absorption rates, financing terms (construction loan, permanent loan, and potentially a refinance later on), pre-leasing, and the capitalization of costs.
The development model considers not just the projected income from the completed property, but also the costs and timing of the construction, planning and design, land purchase, permitting, and more. Risk factors also get heightened due to the longer time frames and completion risks compared to the acquisition model.
Key Differences
Purpose: The acquisition model calculates the value of an existing income-generating property, whereas the development model projects the profitability from a project that requires construction or significant renovation.
Risk Factors: With the acquisition model, investors typically deal with known cash flows and can therefore make more accurate projections, reducing the degree of risk. The development model, conversely, deals with many unknown factors like construction delays, pre-leasing rates, and cost overruns, increasing the risk factor.
Complexity: Due to the added variables to consider, especially the uncertainties surrounding construction, planning, design and permitting, the development model is generally more complex than the acquisition model.
Conclusion
While both acquisition and development real estate financial models work towards assessing the potential profitability of real estate ventures, they are employed under different circumstances with differing degrees of risk and complexity. An understanding of both models is crucial for any investor in real estate to make informed, financially sound decisions. Regardless of the model used, it's essential to conduct meticulous due diligence and maintain a broad understanding of the local property market to ensure accuracy in projections.