How To Become Your Fund’s Favorite Real Estate Private Equity Analyst

This post examines the single most important real estate private equity skill. Mastering this skill will help you become your fund’s favorite real analyst. What is the skill? Simply put, you must learn how to convey information faster and more accurately than anybody else. You do that by building clean and flexible real estate LBO models. This post lays out the case for style and readability at every step of the modeling process.

Information is The Lifeblood of Real Estate Investing

Real Estate LBO models are the nexus of information. Every important piece of data is consolidated inside the model. When lawyers negotiate ground rent, the end goal is to load it into the model to see how their terms impact returns. When negotiating an affordability program with the local government, the financial model is used to understand which program is most accretive to the investment. Anything and everything that your fund considers about an investment winds up in the model. And yet, too many analysts make one critical mistake that renders their models borderline worthless.

Don’t Do This If You Want To Build Readable Models

Don’t focus exclusively on the output. Too many analysts make the mistake of focusing only on the final output of their model: the return. Unskilled analysts think that their work is done once they bang out a return. They cut through the backend of their model, building unsustainable shortcuts, making undocumented decisions, and hardcoding important figures without footnotes or links to the source documents. The analyst who built the model is comfortable navigating its sheets because they built it. But if anybody else enters their model, it looks like a bunch of untraceable nightmare spaghetti formulas.

Don’t Make Black Box Models

If your model is difficult for a complete outsider to read and understand in one take, then your model is a black box. Most analysts build black box models. This is bad because black box models are worthless and cause massive financial losses.

How do you avoid making black box models? Every step of the way, model with a bit of empathy. How would you feel if the critical input for your operating expenses was a hardcoded value that was impossible to trace? What would be your initial reaction to a tax formula that is five lines deep and requires ten minutes to untangle each nested if statement? In the world of real estate financial modeling, clarity is king. Break out your steps, document your decisions, and clearly state and tie back to your source for all hardcoded inputs.

Your Model is Worthless If It Doesn’t Inspire Confidence -- Follow These Tips To Build Clean Models

First, write simple formulas. As a rule of thumb, each row in your model should perform one piece of logic. List your rental rate in one line, list your growth rate in another line, and list your hold period cutoff in another line. Don’t do it all in one line. If everything is tangled together, it gets very difficult to trace and modify formulas down the line without unintended consequences elsewhere in the model.

Second, develop clean style and arrangement. Create different tiers of headers, color them sparingly but purposefully. Also, meaningfully color your cell font colors to represent hardcodes (blue), external links (green), or formulas (black).

Third, build as many checks as you can and aggregate them in their own tab. If all of your checks live in a global check tab, you can sum everything into one master check cell. You can link to this cell at the top of every page. That way, anyone auditing your model can start by auditing the checks. If they want to audit further, they just need to build more checks until something breaks or they can’t find anything broken.

Fourth, make a model that is correct. You can prove correctness through checks and clear documentation of your logic. If your logic is easy to follow, then it is easy to prove correctness. If you can’t prove correctness quickly, then nobody should trust your model.

Ready To Put This Knowledge To Work?

Modeling with clarity and confidence is an essential real estate private equity skills. Fortunately, Leveraged Breakdowns has created a free case study challenge that allows you to practice with a realistic interview prompt. Once finished, you can download our free solution to compare your model against ours. Finally, you can always ask us follow-up questions in our forums.