Real Estate PE Technical Interview Questions I Ask at My Megafund
This post includes technical questions that I ask when interviewing candidates at my real estate private equity megafund. These questions are softballs meant to test your basic grasp of easy concepts. If you struggle with these real estate PE interview questions to any degree, then you’re not yet up to par. If you need to brush up, I highly recommend you check out Leveraged Breakdowns, the premier resource for real estate private equity education.
Your interviewer considers the following technical real estate private equity interview questions to be easy, baseline checks of your skill. Practice until you’re comfortable in a high-stress interview. Also, make sure your mental math skills are tight. If not, there’s plenty of basic apps and websites out there that will help you practice.
Question: What is NOI? What are the most common items included in NOI?
Answer: Net operating income (“NOI”) is the standard metric that investors use to measure the profitability of real estate investments. NOI reflects the sum total of all reasonably recurring operating revenues and expenses. Investors generally calculate asset value by dividing pro-forma NOI by a market cap rate. Read more about NOI and T12 financials in this blog post.
Question: Why would a seasoned multifamily investor consider capital maintenance to be an operating expense rather than a capital event? What impact does this distinction have on valuation?
Answer: Capital maintenance expenditures keep the roof from caving in. These expenses are guaranteed to recur every year, thus they’re as much of an operating expense as others such as utilities, insurance, and property taxes. Unsophisticated investors often forget to include a capital maintenance reserve in their NOI, thus their valuation is inflated. This mistake often leads to an erroneously high valuation.
Question: Assuming your fund has a 20.0% hurdle rate, would you invest $5.5M in an investment you know will sell for $6.5M in exactly one year?
Answer: This is an example of a simple discount rate question. In this particular example, your fund would pass on this investment because the 14.0% return does not hit your 20.0% hurdle rate. If you’re not familiar with basic discount rate math, check out Leveraged Breakdowns’ REPE starter kit.
Question: What is the difference between levered and unlevered cash flows?
Answer: Unlevered cash flows represent the intrinsic value generated by a property exclusive from the impact of financing. Unlevered cash flow items typically include NOI, purchase price, sales price, unlevered transaction costs, and value add capex. Beyond that, investors then layer on leverage forecasts such as debt issuance, amortization, interest expense, and debt paydown to arrive at their levered cash flows. Levered cash flows will always produce a higher projected return than unlevered cash flows during initial underwriting. This fact may change if the investment goes south after purchase. Learn to manipulate the nuances of leverage in Leveraged Breakdowns’ flagship course, Breaking Down Real Estate Private Equity.
Question: If I buy a building with $60M NTM NOI at a 4.0% cap rate, what value does that imply?
Answer: NOI / Cap Rate = Value. So, this building is worth $1.5B. Common mistakes interview candidates make are: they say million instead of billion, they can’t quickly divide 6 by 4, and they freeze up. If you stall on this question, use the pen and paper that you always bring to your interview to do the math. Remember that cap rates are just inverse multiples, so you can arrive at the same answer by understanding that a 4% cap rate equals a 25x multiple on $60M of NOI.
Question: For that same building with $50M NOI at a 4.0% cap, what’s my Y1 cash on cash yield if I issue 50% leverage at a 5.0% fixed cost?
Answer: Cash on cash = (pro forma levered cash flow) / (equity invested). In this example, the building is worth $1.5B and you issue $750M of debt, so you invest $750M of equity. You know NOI is $60M and your interest expense is $37.5M, so your Y1 LCF is $22.5M. $22.5M LCF over $750M equity is a 3.0% Y1 cash on cash.
Confused? Follow up with us in the Leveraged Breakdowns forums, we’re happy to answer your questions. There are plenty of small nuances involved with these real estate private equity interview questions. Our team of megafund investors is happy to share its deep experience with anybody looking to break into the industry.
Leveraged Breakdowns is the premier resource for real estate private equity outsiders. We understand the frustration that non-traditional candidates feel when competing against pedigreed insiders. Without proper mentorship, hard work can only get you so far. Leveraged Breakdowns shows you exactly what you need to know if you want to break into the exclusive world of real estate private equity. We provide all the resources you need to grasp real estate private equity including model walkthroughs, interview prep materials, and interviews with outsiders that broke into the industry.
Practice Until These Technical Questions Feel Like Baby Math
Your interviewer considers the following technical real estate private equity interview questions to be easy, baseline checks of your skill. Practice until you’re comfortable in a high-stress interview. Also, make sure your mental math skills are tight. If not, there’s plenty of basic apps and websites out there that will help you practice.
What is NOI?
Question: What is NOI? What are the most common items included in NOI?
Answer: Net operating income (“NOI”) is the standard metric that investors use to measure the profitability of real estate investments. NOI reflects the sum total of all reasonably recurring operating revenues and expenses. Investors generally calculate asset value by dividing pro-forma NOI by a market cap rate. Read more about NOI and T12 financials in this blog post.
Distinguish Between Capital Maintenance vs. Value-Add Capital
Question: Why would a seasoned multifamily investor consider capital maintenance to be an operating expense rather than a capital event? What impact does this distinction have on valuation?
Answer: Capital maintenance expenditures keep the roof from caving in. These expenses are guaranteed to recur every year, thus they’re as much of an operating expense as others such as utilities, insurance, and property taxes. Unsophisticated investors often forget to include a capital maintenance reserve in their NOI, thus their valuation is inflated. This mistake often leads to an erroneously high valuation.
Learn to Mentally Manipulate Basic Discount Rate Math
Question: Assuming your fund has a 20.0% hurdle rate, would you invest $5.5M in an investment you know will sell for $6.5M in exactly one year?
Answer: This is an example of a simple discount rate question. In this particular example, your fund would pass on this investment because the 14.0% return does not hit your 20.0% hurdle rate. If you’re not familiar with basic discount rate math, check out Leveraged Breakdowns’ REPE starter kit.
Understand How Capital Structure Impacts Cash Flows
Question: What is the difference between levered and unlevered cash flows?
Answer: Unlevered cash flows represent the intrinsic value generated by a property exclusive from the impact of financing. Unlevered cash flow items typically include NOI, purchase price, sales price, unlevered transaction costs, and value add capex. Beyond that, investors then layer on leverage forecasts such as debt issuance, amortization, interest expense, and debt paydown to arrive at their levered cash flows. Levered cash flows will always produce a higher projected return than unlevered cash flows during initial underwriting. This fact may change if the investment goes south after purchase. Learn to manipulate the nuances of leverage in Leveraged Breakdowns’ flagship course, Breaking Down Real Estate Private Equity.
Value Buildings with Quick Mental Math
Question: If I buy a building with $60M NTM NOI at a 4.0% cap rate, what value does that imply?
Answer: NOI / Cap Rate = Value. So, this building is worth $1.5B. Common mistakes interview candidates make are: they say million instead of billion, they can’t quickly divide 6 by 4, and they freeze up. If you stall on this question, use the pen and paper that you always bring to your interview to do the math. Remember that cap rates are just inverse multiples, so you can arrive at the same answer by understanding that a 4% cap rate equals a 25x multiple on $60M of NOI.
Memorize Important Real Estate Underwriting Metrics Such as Cash on Cash
Question: For that same building with $50M NOI at a 4.0% cap, what’s my Y1 cash on cash yield if I issue 50% leverage at a 5.0% fixed cost?
Answer: Cash on cash = (pro forma levered cash flow) / (equity invested). In this example, the building is worth $1.5B and you issue $750M of debt, so you invest $750M of equity. You know NOI is $60M and your interest expense is $37.5M, so your Y1 LCF is $22.5M. $22.5M LCF over $750M equity is a 3.0% Y1 cash on cash.
Ask Questions in the Leveraged Breakdowns Forums
Confused? Follow up with us in the Leveraged Breakdowns forums, we’re happy to answer your questions. There are plenty of small nuances involved with these real estate private equity interview questions. Our team of megafund investors is happy to share its deep experience with anybody looking to break into the industry.
Dive Deeper and Conquer your Real Estate Private Equity Career
Leveraged Breakdowns is the premier resource for real estate private equity outsiders. We understand the frustration that non-traditional candidates feel when competing against pedigreed insiders. Without proper mentorship, hard work can only get you so far. Leveraged Breakdowns shows you exactly what you need to know if you want to break into the exclusive world of real estate private equity. We provide all the resources you need to grasp real estate private equity including model walkthroughs, interview prep materials, and interviews with outsiders that broke into the industry.
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