Avoiding Circular References When Modeling Real Estate Development Transactions - Real Estate Financial Modeling

5/19/2019 Avoiding Circular References When Modeling Real Estate Development Transactions | Real Estate Financial Modeling
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BRUCE KIRSCH | 3 COMMENTS | CONSTRUCTION, DEVELOPMENT, FINANCING, LENDERS, MODEL FOR SUCCESS
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Modeling development transactions can be tricky if you want to avoid allowing circular references in
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your spreadsheets. Circular references can distort your calculations dangerously in that they mislead
your expectations for your cash equity requirements.
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The primary driver of development pro-forma circular references is the fact that construction loans (a Source
of Funds) accrue interest, which itself is a Financing Cost (a Use of Funds). In other words, construction loans
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“fund their own interest” (i.e., they are “self- nancing”) (See this post for more basics on construction loans).
Since Financing Costs are part of the Total Development Cost, and the Total Development Cost is funded by
both Equity and Debt, one cannot help but refer to the Debt size (the dollar amount) in its own calculation.
This causes the circular reference.
For example, if in our model we state that the Debt amount is to be 65.00% of Total Development Cost, then
the calculation of the actual dollar amount of the loan rests on the inclusion of the loan’s interest cost as part
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of the Total Development Cost. Register now to get FREE e-Books, Excel tools and access to Valuate software 
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Matters are often compounded with secondary circular references that are
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created when soft cost items such
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as Insurance and Developer Fee (each of which are part of the Total Development Cost) are calculated as a %
of Total Development Cost.
Here’s one way to avoid allowing circular references:
We know in retrospect that Total Sources of Funds and Uses of Funds are equal.
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This is what we know once the transaction has been Valuate, our web-based software 
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completed.
When forecasting, if we assume the Equity amount in whole dollars as opposed to as a % of Total
Development Cost, then we can backsolve for the Total Debt dollar amount (which is composed of both
Principal and Interest), because we know that the Total Uses of Funds and Sources of Funds are equal. Refer
to the graphic below when reading the backsolving logic below the graphic.
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The set-up to backsolve for x, y and z.

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The backsolving logic and algebra are Register
as follows:
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If: $30 + x + y = $90 + z = $100
And: x = z
Then: $30 + y = $90 = $100 – z LOGIN TO VALUATE NOW
Therefore: y = $60
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And consequently: x = z = $10, as driven by the interest cost associated with the loan draws as they are
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necessitated by the Uses of Funds in each month and accumulated over the entire loan period.
Monthly IRR Formula And Other
Every dollar of Interest generated on the construction loan (technically interest dollars are “Sources of Funds”) Non-Annual Cash Flow Increments
is carried in the Uses of Funds as a Financing Cost to match the Sources of Funds interest amount in that As a follow-on to last week's post on
period. NPV, we note here...
All The IRR Files: What Constitutes A 

 of REFM’s Excel Model Templates use this backsolving methodology to avoid distortion of line item 
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values and resulting equity and debt requirements. We also build these dynamics into consulting
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3 Comments
Gabriel Denis
 October 8, 2014 at 7:14 AM · Log in to Reply 
Ok but how can you know that the total use/source of fund =100$
amelia
July 28, 2018 at 10:01 AM · Log in to Reply
How can you know that the total use/source of fund =100$?
amelia
July 28, 2018 at 10:04 AM · Log in to Reply
I have the exact same question as Gabriel Denis. How do you gure that the Project cost is
$100.
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5/19/2019 Avoiding Circular References When Modeling Real Estate Development Transactions | Real Estate Financial Modeling

Here’s one way to avoid allowing circular references:

Looking for the future of investment

Click the logo below to check out

Learn about Valuate’s bene ts in 30

The set-up to backsolve for x, y and z.

Then: $30 + y = $90 = $100 – z LOGIN TO VALUATE NOW

period. NPV, we note here...

All The IRR Files: What Constitutes A 

60-Second Skills: Annual vs. Monthly 

Get REFM blog posts, news and NPV Formulas

Enter Email How To Select A Discount Rate For A 

What Is A Preferred Return? 

Preferred Return De nition And An

Guide: Getting started with Valuate

Leave a reply Get Free Tools from REFM

REFM Training Course Catalog

Other Blogs to Visit

A Student of the Real Estate Game 

Select Leaders (RE Job Board) 

The Fundrise Blog 

The Tenant Advisor 

REGISTER FOR VALUATE >

LOGIN TO VALUATE NOW

REFM Legal Valuate Customer Support

510, Decatur, GA 30030

 hello@getrefm.com Login  Become an A liate 

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