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What should you include in your pro-forma when doing a real estate development? Renat Yusufov, Managing Partner at Bullpen shares his detailed pro-forma, how should you think about it, and why.

Watch this deep dive here:

Tell us a little bit about you and Bullpen.
I’m based in New York and worked in several capacities across real estate on the private equity side, asset management side, as well as on the capital markets advisory side. Somewhere around 2018, I met my partner Tyler Kastelberg, who was at that point, starting Bullpen. The strategy really aligned between us two, both of us had real estate investment experience, and we both ran into the same problem both as an employee and an employer in the industry, we found that a lot of talent is frankly misplaced. And what that does is a lot of employers end up not being able to find the right talent for the project. And a lot of the employed professionals end up being in capacities or in jobs that don’t necessarily fit their career goals. Real estate itself is a project based business. So it’s not something you necessarily need to be doing the same thing every day. Most investment funds will probably do a few deals a year. In today’s environment, large or small, you’re probably looking for a specific team even if you’re at Blackstone, you’re doing what like four to eight deals a year, depending on the kind of deals you do. Most investors do less than that. Any kind of mid sized private equity fund today is probably doing anywhere between two to four deals ideally.

With that in mind, we realized that if you’re looking for higher end professionals, or any kind of talent that has experience in what you’re looking into, you’re probably not interested in paying the full salary, medical benefits and any other kind of payroll costs to have somebody staff full time if you’re only going to be using them for two projects a year. Both Tyler and I have been running into this issue professionally on both sides of the table. And this is how the concept of Bullpen came about. Bullpen is a freelance marketplace, where experienced talent, our average is about 10 years plus in terms of experience, are able to be connected with employers who are willing to hire on a project basis, whether that’s on an hourly basis, on a monthly basis or any other kind of an enterprise solution that an employer would be looking for. The services and the skill sets range pretty widely. We started with the bread and butter of financial analysis and investment analysis, and now anything from web creation, marketing, investor relations, asset management, and any other facet of real estate.

This is a much needed type of service, at least for me when I came across a potential project in San Francisco to convert retail to office. And that’s how I came across you guys because there are a billion moving parts, especially when you’re planning on developing and building a few more floors. Why don’t we dive into an example of what you guys are doing for this particular side of the business.
I created a template so to speak for an office development of what it would look like in today’s day and age, I come from the philosophy that no two deals are ever going to be the same. Naturally, you will have certain changes. But the core of the model should more or less look alike, it’s not just a financial model, it’s really a weapon for when you go into battle for a project. So it should be flexible, it should be something that you can present relatively simply to either your lender or any kind of investors or limited partners, etc. It should be able to adapt to whoever your audience is, the structure of a model, in my opinion, regardless of what asset class, regardless of what the business plan is, I like to always start with the dashboard. The dashboard is really where most of the toggles will be, anything that’s an input. And the reason for this is as you’re going through the project, regardless of where the onset underwriting starts, along the way as you’re talking to GC’s, as you’re talking to other contractors, architects, lenders, investors, business plans will be adjusted, they will be tweaked, they might be entirely revised, so it’s easier for any kind of user, whether it’s the partner, the principal, all the way down to the analyst, and company, or even if it’s a third party looking at this, to be able to see it all in one place, which I call the dashboard or the Summary tab.

The three big items that go into this are any kind of capital assumptions. This includes any kind of loans, you may have construction loans, perm loans, any kind of recapitalizations, refinancings, as well as anything that happens on the equity side. Any kind of splits you may have between the general partner and limited partner, if you have a co-GP and a sponsor, and they’re in the waterfall, having it here means you don’t always have to go through the entire end of the model every time you want to update something.

The second item usually ends up being its own tab, the budget. The start of the budget and the beginning of the project is usually ballpark, sometimes you’re going to do this as dollars per foot on hard costs, soft costs, many kind of architectural costs, etc. Chances are as you’re moving through the project, especially for development projects, as more and more parties look at it, GC’s, architects, any other kind of designers, etc, you’re probably going to have a little more detail built out into line items. I like to create a budget usually with additional rows, or in a way where the formula for the sums or the subtotals, calculates in a way that you can always add an extra row if you need it, but this can get complicated, obviously, the only choice of preference is, are you looking at things on a dollar per foot for certain line items? Or if it’s a fixed cost? Regardless of how big you build it, it’s really dealer’s choice when it comes to that.

And the third big bucket of assumptions is the operating assumptions. This is your expected revenues, expected expenses and anything else in terms of trends, inflation trends, how fast you’re going to grow your revenue. In the case of an office development, what are your tenant improvement costs? What are your leasing commissions, and will it be involved in terms of your monthly or annual operation for the pro-forma. These are your inputs. And then below that, these are what I call supporting and receiving to the dashboard, this is really the engine, everything here is automated, theoretically, somebody who is a high level user doesn’t ever need to go into these rows, they never need to go into these tabs. You just have to trust that it happens correctly. Outside of that, anything beyond monthly cash flows onwards, in terms of my model, is all automated.

The funding schedule is really the main engine, it’s all the money that goes in, all the money that goes out on a monthly basis, the numbers themselves aren’t really important. Starting with month zero all the way through the construction, the lease up, etc, all the associated costs, all the associated leasing and financing, all the money that goes to fund it, to match it, and then all the operating cash flows that go into it. This is all really an engine, and it pulls from the Summary tab. The same thing goes for the source and uses, the same thing goes for any kind of monthly or annual cash flows. That’s as far as the bones of the model, I always think this is the best way to build it. You’re going to end up having to do something in terms of flexibility, things always change as we know in the real world. I don’t think I’ve ever worked on a project where whatever was in the original pro-forma, was the business plan that ended up getting done, things change pretty rapidly, especially in today’s environment. The goal is to build it where you can quickly tweak it.

One place where a lot of things might be hidden or misinterpreted, is any kind of capital expenses. People underestimate what it costs to repair or repaint the hallway, or common space in an office building, if they’re buying it already built. The best way to go about this, whether you’re just in the beginning of building your model, or you’re trying to flesh out your business plan and get it to market, I would say is contact as many professional as possible. This is obviously a networking business, talk to the brokers about the rents, what can they reasonably achieve, as you’re going through your process of selecting a broker, talk to several GC’s about your costs, what they can reasonably get you as far as a budget, and where you could reasonably land in terms of your total construction costs.

One thing about that, as we all know, this year has been crazy, especially with regards to wood and metal’s skyrocketing costs. It really does a number on anything that has been underwritten on Q4 of last year, Q1 of this year, and they’re just now beginning construction, they just got all their permits, etc, and the budget is 40% higher. It’s no one’s fault, nobody maliciously decided to increase costs, you just never know, the goal from the underwriting, or the model point of view is, this is your weapon, you want it to be adaptable, and as soon as you find out we adjust the construction costs, and then look at the returns, what it does to them, if that is an output. I guess that was a very long answer to the question about where does the beginning business plan start? I would say you most likely will see it to be more aggressive than usual.

I would have imagined that. I’m curious to see how you account for that on your model.
My viewpoint is whichever role you play on a project, let’s say somebody first presents this to you. And you want to take a deal. Let’s say you’re an investor, a limited partner. Someone says, I have a great deal for you. I just need X amount of dollars. You take a look at this, right? And they say, Okay, these look like great construction returns, as you can see over here. This is project level unlevered and levered. For construction, 30% IRR is probably a great deal in today’s environment. Is it true? If I’m an investor, I don’t want to go through all these tabs. I don’t necessarily want to go through the Argus, I look at summaries, the untrended stabilized performance financing assumptions for the construction loan, the total sources and use of all the money that goes in, and all the associated costs, construction costs, everything is summed up here, so I can go through this and look at this.

Now, do I believe these rents, for example, $70/foot? It could be yes, it can be a no. If I’ve experienced with any kind of management of offices, I looked at the expenses, regardless of what you’re building, dollar per foot tends to be on a net square foot basis, it tends to be a pretty consistent metric. As you can see, this specific business plan is for one of those nice office buildings built in this environment, with co use of amenities, larger floor layout, so they can be a little more flexible in terms of partitioning for multiple tenants. You would go through what numbers you do believe or don’t believe. I from my experience of doing any kind of deals, lean on experts a lot, whatever I think I know about rents I will inevitably go through a process of talking to multiple brokers personally, that’s my favorite part of this business, my phone battery dies maybe three or four times a day. Maybe I just have an old phone but it a the fact that I’m on a call pretty much all day with contractors, brokers, just trying to figure out where the market is on any specific deal. Because every deal is custom, but it’s the fun part of the business. You’re always learning, always hearing new things. And you shouldn’t be expected to know everything yourself as far as these numbers.

So, to answer your question, I would go row by row what I believe, but I would be more interested in the deal if it was presented to me this way. If not, I’m probably going to have to spend four hours looking through this whole model to learn it. This is more of a here’s my rents, here’s my expenses, here’s where the loan is underwritten, do I believe this rate? Do I believe this leverage, etc. The more experience you have, the quicker you can get through something like this, but at least it’s all on a single page that you can even print if you need to take it on the go.

Exactly. And that goes back to your building, and the south side of a certain city and state, you’ll talk to the brokers who have experience there, and they’ll tell you what the rents will be, they’ll tell you how long it’ll be on the market before you’ll find a tenant, what the terms are, and the big terms being free rent, TILC, so that’s tenant improvement leasing commissions, and the time it’ll take to find a tenant, as well as the credit. This is really a summary. You’ll have different audiences for this model, it’s better to have it here than for them to have to run around the tab looking for the specific month, when you stabilize, and what the rent looks like then. I show it as a total dollars per net square foot, and dollars per gross square foot, because this is a construction project. You’re building grows, regardless. But you want to show how that rent looks both net and gross.

Opportunity, in my opinion.
I agree. I think when people leave is when you want to get in. All that is to say the cap rate is going to be a very contentious topic with pretty much every party involved. Nobody is necessarily wrong or right. Keep in mind that this is six years from now that you’re estimating what this property will be worth, what buyers will want, where buyers will want to put their money. And the best way to portray this is if you go back six years and read the best of the best. You read the CBRE, the Newmark reports, I will guarantee you most of them are wrong. And that’s not because they don’t know what they’re doing, because that’s life. Six years from now, who knows where we’ll be, who knows where the Fed will put interest rates, who knows where money will be coming from, if I told you six years ago that most of the world will have negative rates and you can get a mortgage for under 3%, that would be insane. But that’s the world we live in today.

And that drives cap rate compression, because people are trying to park their money somewhere. If I tell you to give me $100 and I’ll give you $6 a year, that’s it. And it’s an office product, it’s stabilized. You might do it even today, depending on the market. This is where you’ll have a conversation about, Look, I stabilize at 21 million NOI this specific one has rent abatements, any other kind of tax rebates, etc. You’ll have a conversation about what your NOI looks like. You’re always looking at deals on the forward NOI, so that’s basically the next 12 months. And you want to buy that profit at 6% yield, because you’re comparing it to a bond, you’re comparing it to other investments. That’s where the cap rate driver comes in, and you cap your gross value, you take out the sale costs, I put them tentatively at 3%. And then you get to your total net sale proceeds in this case. This is your total cost that you built to, and this is what you’re exiting for. You want to exit at a higher valuation than you built it for.

How are you 100% sure that someone didn’t mess up one little formula that could derail the entire thing?
You want to make sure that the analysts or professional that you have, or contractor, knows what they’re doing, and has experience of doing this. As a sponsor you are the one responsible for it. If you’re the one presenting this, you are the one that should walk through this whenever you have your first model, or if you build it out, walk through it, and review it, check your work. This is true for any business, any aspect of any business. I will note one thing if you’re an investor, or a lender, or another third party that receives this model, you aren’t the initial owner or the initial builder of it. The goal here is as you’re going through the deal, and this is true for lenders specifically. The way a lender works is once they’re serious about the deal, about underwriting it, they’ll pass it off to an analyst within their own company who will vet this, in sometimes aggressive calls, and sometimes, less aggressive calls, but a complete vetting of the entire engine that I’ve mentioned. The onus is on everyone that’s involved in the deal to take a look and make sure it’s accurate. I don’t think there’s any shortcuts to that. Checking your work goes back to relationships, trusting that the people you’re going into business with are professional and accurate about what they do.

If someone wanted to work with you guys on a project, what would they need to provide you? What kind of numbers and information?
The process is we have an employer reach out, our sales representative works with them to take down their initial scope, understanding the kind of product they work, because we don’t just do office, whether it’s residential, industrial, land use, single family rentals, pretty much all the food groups, location, geographically, what specific skill sets they’re looking for outside of underwriting, whether you need leasing skills, you need asset management skills, you need somebody who will be able to be on site. They take down the scope, we go through our pool of freelancers to see who has the skill set, who’s available and within the rate that the employer wants to pay. And we make that introduction, there’s an interview to make sure that everyone understands the scope, and everyone’s comfortable with it. If the relationship is okay, we create a contract and then you can work directly with the freelancer from then on.

In terms of what gets provided to the freelancer, or the professional, if I were the underwriter and if somebody asked me to underwrite this deal for them, the big things I would ask are the location, what they’re trying to build, construction costs usually get provided by a client, however, we have some clients that say, Look, I also need help with finding bids from general contractors, can you provide me a shortlist of the best job contractors for this market? Or that you know of, and we can schedule calls with them? So it’s really a white glove employee service that you don’t have to pay full time. Some employers asked me to help them gather this information, help them understand what the land actually cost on a per foot basis? What should they be willing to pay for it? Generally speaking, high level, this usually gets provided by the employer. Chances are they should know more or less what they’re building. It’s fine if they don’t.


Renat Yusufov

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