What's the best way to forecast real estate cash flows and returns?

1 Define your assumptions

The first step in forecasting real estate cash flows and returns is to define your assumptions. These are the inputs that will drive your projections, such as market rents, vacancy rates, operating expenses, capital expenditures, financing terms, exit cap rates, and discount rates. You should base your assumptions on reliable data sources, such as market reports, comparable transactions, historical trends, and industry benchmarks. You should also document and justify your assumptions, and test their sensitivity to different scenarios and risks.

2 Build your cash flow model

The next step is to build your cash flow model. This tool will calculate forecasted cash flows and returns based on your assumptions. You can use a spreadsheet software, such as Excel, or a specialized software, like Argus, to create your cash flow model. It should include a rent roll that lists tenants, lease terms, and rental income, an income statement that summarizes revenue and expenses, a cash flow statement with net operating income, debt service, capital expenditures, and net cash flow, a valuation section to estimate the value of your property at the end of the holding period with the exit cap rate or terminal value method, and a return section that calculates key metrics of your investment performance like the internal rate of return (IRR), net present value (NPV), equity multiple, and cash-on-cash return.

3 Adjust for property type and scenario

The final step is to adjust your cash flow model for the specific property type and scenario that you are forecasting. Different property types have different characteristics and drivers that affect their cash flows and returns, such as lease structure, tenant mix, operating costs, and demand cycles. For example, an office property may have longer lease terms, higher tenant improvements, and more cyclical demand than a multifamily property. You should tailor your assumptions and calculations to reflect the nuances of each property type and market.

Similarly, different scenarios may require different approaches and assumptions for forecasting cash flows and returns. For example, if you are forecasting for a development project, you may need to include pre-development costs, construction costs, lease-up assumptions, and stabilization assumptions. If you are forecasting for a lease negotiation, you may need to compare different lease options, such as gross vs net, fixed vs variable, or short-term vs long-term. You should adapt your cash flow model to suit the purpose and scope of your forecast.

Forecasting real estate cash flows and returns is not an exact science, but a skill that can be honed with practice and experience. By following these best practices and methods, you can improve your accuracy and confidence in your forecasts, and make better decisions for your corporate real estate strategy.

4 Here’s what else to consider

This is a space to share examples, stories, or insights that don’t fit into any of the previous sections. What else would you like to add?