1. ERES 2011 Giacomo Morri - Paolo Benedetto Teaching real estate finance with cases: SUNLIGHT VILLAGE case study Giacomo Morri - Paolo Benedetto presented at the 18 th Annual ERES Conference June 15th - 18th, 2011 Eindhoven

2. ERES 2011 Giacomo Morri - Paolo Benedetto Introduction Purpose of the work Industry needs –Real estate & Finance –Computer skills –Team working From theory to practice –Learning by doing –Problem solving skills –Presentation skills 2

3. ERES 2011 Giacomo Morri - Paolo Benedetto Use of Sunlight Village case study Different RE finance courses –Master of Science –Master in Real Estate (post experience) –Executive courses for practitioners Presentation tool only –Class presentation –Spreadsheet creation by the teacher Exercise & Examination tool –Initial presentation by the teacher –Spreadsheet creation by students –Final class presentation & discussion by students –Valuation by the teacher –Delivery of spreadsheet & PPT solution files for self-assessment 3

4. ERES 2011 Giacomo Morri - Paolo Benedetto Example of a case study SUNLIGHT VILLAGE 4

5. ERES 2011 Giacomo Morri - Paolo Benedetto The role of the story The topic: –Land development, financing & acquisition Players involved: –Mary Watson  attorney, land owner & seller –Julie Holmes  MD real estate development company & buyer “Mary Watson, a well reputed attorney in a top legal firm, and Julie Holmes, managing director of an international real estate development company, have been friends since they were children. They attended the same schools and they have been playing volleyball in the same team for many years. Later on, even if they went to different universities, respectively studying law and finance, they have always kept in touch and now, that they are older, their daughters are best friends at primary school.” 5

6. ERES 2011 Giacomo Morri - Paolo Benedetto The object 6 Seller: Land 10,000sqm plot of land The bid  €5 million “A few years ago, Mary’s family purchased a 10,000sqm plot of land for €2 million that has recently obtained a building permit for 5,000sqm for residential from the municipality. The family accountant has suggested selling the property for not less than €5 million, but Mary doesn’t trust him too much and she has therefore proposed the deal to Julie, knowing that they might find an agreement which can satisfy both of them.”

7. ERES 2011 Giacomo Morri - Paolo Benedetto Input data – development Direct construction costs €1,100/sqm Land drainage€400,000 Urban land development costs 12% of direct building costs Other costs as % of the direct building costs: –designing costs 3% –project management 2% –contingency5% Development Timing  3 years from 2011 Sales €3,500/sqm  3 years from 2012 (preliminary contract) 7

8. ERES 2011 Giacomo Morri - Paolo Benedetto Input data – development Additional operating costs Annual development management fee: 5% of the GAV  WARNING Marketing fees to enhance the sales: €30,000/year General administrative costs: €5,000/year (from 2011) Selling brokerage fees: 2% on the sale price (to be paid at the notary’s deed) WARNING Annual development management fee: 5% of the GAV as % of the GAV is calculated as the sum of all direct and indirect construction costs from the beginning of the project until the end of the construction phase The model has to be set up in order to consider both production and sale phases 8

9. ERES 2011 Giacomo Morri - Paolo Benedetto Input data – funding issues Expected equity return 15% Corporate tax rate 35% No constant cap capital structure, but structured finance approach: –purchase of the land without recurring to bank debt –capital expenditures financed with debt –no VAT financing Construction facility financing –loan to cost on CAPEX: 80% –interest rate: 5% –upfront fee: 0.60% over the total amount –Bullet financing with repayment accordingly to the notary’s deed sales (release price 1.00) VAT rate –10% on sales and on capex –20% on all services 9

10. ERES 2011 Giacomo Morri - Paolo Benedetto Problem solving – investment decisions Two questions arise Would you buy the land @ €5,000,000? –Just yes or no… and why? Offering €3,000,000 fixed payment at the beginning, what is the maximum amount of extra return (in %) above a 10% hurdle rate (levered IRR) that can be granted to the seller as deferral payment at the end of the project? –Calculating earn-out without any previous explanation:  Knowledge of financial models  Use of IRR  but no previous theory about earn-out scheme construction 10

11. ERES 2011 Giacomo Morri - Paolo Benedetto Use of the case study SUNLIGHT VILLAGE 11

12. ERES 2011 Giacomo Morri - Paolo Benedetto Use of SUNLIGHT VILLAGE case study Task: Investment valuation, financing & negotiation Object: Residential development scheme Main issues: –Investment spreadsheet model for DCF investment Analysis –Project financing approach (equity side) Students’ task –Case Study Requested Output  Take decisions!  Yes or no  Earn out –Complete land development report using DCF (formula working spreadsheet) –Power point presentation –Class presentation 12

13. ERES 2011 Giacomo Morri - Paolo Benedetto Use of SUNLIGHT VILLAGE case study Team working –Group composition –Working hours decision (When? Where? How?...) Data selection –What is really useful? –What is sensitive for the final decision? Application of finance to real estate –Accounting (P&L - Balance sheet) –Cash flow models (investment, financing, covenants etc.) –Investment criteria (IRR, NPV, PBP etc.) Practical skills –Use of spreadsheet –Power point presentation –Class presentation & Communication 13

14. ERES 2011 Giacomo Morri - Paolo Benedetto Use of spreadsheet Not only finance, but also practical skills with daily tool –more and more companies require people already able to create and properly manage DCF models & presentations Some major tips to use spreadsheet for case solution –Colors –Cell (data or formula) –Data input & calculation sheet –Output data sheets (for presentation and print) –Data analysis tools: Sensitivity & Goal seek Tips related to Power Point presentation –Executive summary –Use of attachments –Public speech presentation and complete document 14

15. ERES 2011 Giacomo Morri - Paolo Benedetto Use of spreadsheet – colors & cells 15 Yellow cells with blue writing  input data (numbers to be plugged in) White cells with black writing  calculation (formulas) or output data

16. ERES 2011 Giacomo Morri - Paolo Benedetto Use of spreadsheet – data input & calculation 16 Data input and calculation formulas all in the same sheet to facilitate computations and links

17. ERES 2011 Giacomo Morri - Paolo Benedetto Use of spreadsheet – output data sheets 17 Output data separate from input and calculation sheet  If input data changes, output tables and graphs are always ready to be copy- pasted in presentations and reports

18. ERES 2011 Giacomo Morri - Paolo Benedetto Use of spreadsheet – data analysis tools 18 Tables (1 or 2 entries) –Sensitivity analysis Graphs

19. ERES 2011 Giacomo Morri - Paolo Benedetto Solving a case study SUNLIGHT VILLAGE example 19

20. ERES 2011 Giacomo Morri - Paolo Benedetto Solution: main steps Analysis of the problem Data preparation –Building, operating and company costs –Work in progress: investment Accounting –Profit & loss statement – without debt –Unlevered cash flow statement –VAT flows Bank Financing –Profit & loss statement – with debt –Levered cash flow statement & Investment criteria Balance sheet Sensitivity analysis Deferral payment 20

21. ERES 2011 Giacomo Morri - Paolo Benedetto Solution – building, operating & company costs 21 DATA PREPARATION

22. ERES 2011 Giacomo Morri - Paolo Benedetto Solution – work in progress: investment 22 DATA PREPARATION

23. ERES 2011 Giacomo Morri - Paolo Benedetto Solution – P&L statement (without debt) 23 Accounting

24. ERES 2011 Giacomo Morri - Paolo Benedetto Solution – unlevered cash flow statement 24 Accounting

25. ERES 2011 Giacomo Morri - Paolo Benedetto Solution – cash in & cash out 25 CHECK

26. ERES 2011 Giacomo Morri - Paolo Benedetto Solution – VAT 26 Accounting

27. ERES 2011 Giacomo Morri - Paolo Benedetto Solution – capex financing 27 FINANCING

28. ERES 2011 Giacomo Morri - Paolo Benedetto Solution – P&L statement (with debt) 28 FINANCING

29. ERES 2011 Giacomo Morri - Paolo Benedetto Solution – levered cash flow statement 29 FINANCING

30. ERES 2011 Giacomo Morri - Paolo Benedetto Solution – cash in & cash out 30 CHECK

31. ERES 2011 Giacomo Morri - Paolo Benedetto Solution – balance sheet 31 BALANCE SHEET

32. ERES 2011 Giacomo Morri - Paolo Benedetto Solution – sensitivity analysis 32 SENSITIVITY ANALYSIS

33. ERES 2011 Giacomo Morri - Paolo Benedetto Solution – deferral payment 33 DEFERRAL PAYMENT Offering €3,000,000 fixed payment at the beginning, what is the maximum amount of extra return (in %) above a 10% hurdle rate (levered IRR) that can be granted to the seller at the end of the project? The maximum amount that can be granted to the seller at the end of the project is €1,352,287, i.e. 62% extra return

34. ERES 2011 Giacomo Morri - Paolo Benedetto 34 "In theory, there is no difference between theory and practice. But, in practice, there is." Johannes Lambertus Adriana van de Snepscheut (computer scientist and educator) Giacomo MorriPaolo Benedetto Contacting Author Giacomo Morri, PhD SDA Professor & Director Master in Real Estate Accounting, Control, Corporate Finance & Real Estate Department SDA Bocconi School of Management Milan – Italy giacomo.morri@sdabocconi.it giacomo.morri@sdabocconi.it www.propertyfinance.it www.sdabocconi.it/mre