Friday, June 25, 2010

A Different Perspective

Posted by: Scott Beggs
Investment Specialist
775 336 4644

Scott joined NAI Alliance in March 2008 to assist the company with investment sales. Previously, Beggs spent over seven years with Dermody Properties as Vice President of Acquisitions and Port Management.

Investors are often presented commercial real estate investment opportunities that have either significant vacancy or significant near term roll-over of existing tenants, or both. In looking at these types of projects, investors make assumptions about the likely outcome for these uncertain situations. The application of these uncertain assumptions is both art and science. Using the best information available, investors forecast the cash flows for an asset. In economics, the term used for the forecasting of returns is “ex-ante”

Ex-ante is Latin for "beforehand". In models where there is uncertainty that is resolved during the course of events, the ex-ante values are those that are calculated in advance of the resolution of uncertainty. The opposite of “ex-ante” is “ex-post”. Ex-post is the calculation of returns based on the full knowledge of the actual events and cash flows.

I know what you are thinking, “Who cares?” The reality is that the distinction between “ex-ante” and “ex-post” has a very real implication to commercial real estate investing in today’s market. The value of real estate is the nothing more than the present value of the future cash flows that an asset will generate. But as we sit here today trying to forecast those cash flows, there is considerable uncertainty as to what those cash flows will actually be due to the uncertain economic times that we live in. Investors are forced into taking a conservative view as to the future because the consequences of being overly optimistic could lead to considerable losses for the investor.

So what can a current owner do to address this situation? First and foremost, try to eliminate the uncertainty of those cash flows by getting leases signed on vacant units and extend the lease terms for tenants currently in occupancy. Both of these actions provide the potential buyer of a property with a contractual legal commitment from the tenant. This reduces the near-term uncertainty of the building’s cash flows.

Apart from bringing certainty to uncertain situations, there is another strategy that owners can employ to address the issue of ex-ante return calculations. The owner can retain a “promoted interest” in the project. What this structure will do is provide the current owner the ability to capture a portion of the profits that are created above the conservative assumptions employed by the buyer. In the event that “ex-post,” the property does materially better than the buyer had assumed, then the original owner would be eligible to re-capture some of that value. The amount of the “promote” is based on how the property actually performed and thus can be calculated with exact certainty.

This structure does not work for everyone, but where there is a need to sell and there is a high degree of uncertainty associated with a project, this is one methodology to bridge the gap between the buyer’s uncertainty and seller’s expectations. The NAI Alliance Investments Team would be happy to explain how this structure can be used to the benefit of both buyers and sellers. Email any questions you have to me at

1 comment:

Real Estate Hanoi said...

Very interesting perspective in writing this article. This proves to us that overtime, the policies can develop more into a better one or it dramatically fails such as in a crisis. Thank you for sharing this. We saw another perspective.