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Real Estate Case Study – 60-Minute Pre-Sold Condo Development Modeling Test

The Nan Fung Group, a leading property developer in Hong Kong, has recently announced plans
to develop three towers consisting of 470 luxury flats (condominiums) in the Shau Kei Wan
district (33 Chai Wan Road). Your firm, Jade Sea Partners, is considering funding the
development as a 3rd party investor.

The finished property will have 25 floors, with 34,010 rentable square meters and 42,512 gross
square meters of space. The developers plan to begin pre-construction in January 2015, finish
construction in December 2018, and open the property for move-ins in June 2019.

The land will cost approximately HK $1.4 billion, with total Hard Costs, Soft Costs, and FF&E and
Move-In Costs of approximately HK $4.4 billion. Equity will cover half the costs of the land
acquisition and operating deficit, with a Construction Loan covering the remaining half.

In Hong Kong, pre-sales of flats are allowed to begin 30 months before construction finishes, so
Phase I of pre-sales, consisting of 148 flats, will begin in June 2016. Phase II, consisting of the
remaining 322 flats, will begin in December 2016.

Clients will make an upfront deposit for 30% each flat’s value, pay 40% when construction ends
in December 2018, and pay the remaining 30% upon move-in in June 2019.

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Your firm plans to contribute 80% of the required Equity, with the Nan Fung Group contributing
the rest; returns will be split pari passu up to a 20% IRR. Between a 20% IRR and 3.0x equity
multiple, returns will be split 70 / 30, and above a 3.0x multiple, they will be split 60 / 40.

Please use the following assumptions to complete the provided Excel template. You have 60
minutes to make the calculations and respond to the case study questions:

Part 1 – Construction, Timeline, and Financing Assumptions

Use the following figures to set up the key model assumptions:

• Development Start Date: 2015-01-31 (i.e., “within the month of January”)

• Pre-Sales Phase I – Units: 148 (average size of 50 square meters)
• Pre-Sales Phase II – Units: 322 (average size of 82.63945 square meters)
• Rentable to Gross Square Meters: 80%

• Plot Ratio (PR) or Floor Area Ratio (FAR): 5.0

• Land Price per Lot Square Meter: HK$ 170,000
• Lot Upfront Deposit: 50%, paid in Month #1
• Remaining Lot Payment: Paid in Month #6

• Hard Costs per Gross Square Meter: HK $55,000

• Soft Costs per Gross Square Meter: HK $15,000
• FF&E and Move-In Costs % Monthly Sales: 10.0%
• Annual Expense Inflation: 5.0%

• Flat Selling Price per Rentable Square Meter: HK$ 250,000

• Upfront Client Payment: 30%
• Client Payment Upon Construction End: 30%
• Client Payment Upon Move-In: 40%
• Pre-Sales Start Date: 30 months before the construction phase ends
• Sales Velocity per Month: 14
• Annual Sale Price Inflation: 7.0%

You may assume that the Maximum Equity Draw is 50% of the Total Operating Deficit over the
project, where Total Operating Deficit equals the sum of all negative monthly Gross Incomes.

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Investors will contribute 80% of the Equity, and the Developers will contribute the remaining
20%. The Equity must be drawn before any Debt can be drawn.

The Construction Loan will fund the remaining 50% of this Total Operating Deficit, and it will
carry a 10.0% fixed interest rate. Interest will be capitalized when there is insufficient cash flow
to pay for it.

You may assume that positive cash flows generated during the project are used to repay the
Construction Loan. The entire remaining Loan balance must be repaid in June 2019.

Use the following IRR and equity multiple hurdles to distribute the cash flows:

• Equity IRR Below 20%: 80% Investors / 20% Developers

• Equity IRR Above 20% But Multiple Below 3.0x: 70% Investors / 30% Developers
• Equity Multiple Above 3.0x: 60% Investors / 40% Developers

For the Construction Timeline, please use the following assumptions:

• Pre-Construction # of Months: 6 (End date of June 2015)

• Construction # of Months: 42 (End date of December 2018)
• Post-Construction # of Months: 6 (End date of June 2019)
• Phase II Pre-Sales Start Date: 6 months after Phase I begins

For the Hard Costs, use a normal distribution with a mean based on the midpoint month of the
Construction Period and a standard deviation of 5 months.

For the Soft Costs, use the monthly percentages that have been entered into the Excel template
(these expenses are not incurred on a predictable schedule).

Part 2 – Monthly Cash Flows

Start by projecting the # of monthly flats sold and the total value of flats sold in each phase, and
calculate everything down to Gross Income in the Monthly Cash Flows schedule.

The Construction-End Deposits and Final Deposits will be paid on the same dates for all flats
sold in both phases, while the Initial Deposits will be paid throughout the pre-sales period for
each phase.

Part 3 – Equity & Debt Draws

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Use the monthly interest rate to calculate the interest expense and use the beginning balance
to avoid circular references. “Cash Flow After Interest, Before Draws” should pay for the
monthly interest. Any interest it cannot cover will accrue to the Construction Loan.

Assume that Equity is drawn first, up to the Maximum Equity Draw, to cover the operating
deficit during development (and make sure you draw on Equity to repay any remaining Loan
balance in the final month of the model).

Construction Loan draws will begin once the Maximum Equity has been drawn. No loan draws
are allowed in the final month of the model.

If “Cash Generated After Equity & Debt Draws” is positive, assume repayment of the
Construction Loan principal.

Part 4 – Waterfall Returns Schedule

Distribute the cash flows according to the instructions above, and make sure that you use
either IRR hurdles or equity multiple hurdles depending on the tier.

Hint: The “Investor Accruals” formula will change for tiers based on equity multiple hurdles, but
the other formulas will be the same or nearly the same.

Part 5 – Case Study Questions

Once you’ve completed the model, please respond to the following questions:

1) What are the IRRs for the Investors and Developers, and why are they different?

2) Why might you use equity multiple-based hurdles instead of IRR-based hurdles for a
waterfall schedule in a pre-sold development project like this one?

3) If you had more time, for which assumptions would you create sensitivities or
scenarios?

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