Real Estate Private Equity Model: Integrating a Cost Segregation Study

-
As an REPE analyst, you will build very complex real estate private equity models and be responsible for their accuracy and completeness. Depending on the firm you work for, your model may take into account the tax effects on investment returns. If so, you may want to consider a cost segregation study for property acquisitions.

What is a Cost Segregation Study?


A cost segregation study is a detailed analysis of a property that breaks down the value of a building into different components in order to apply various GAAP or Tax depreciation schedules. As a quick real estate investment case study, if your firm purchased a stabilized office property for $20,000,000, a cost segregation study might break down that value into several components, as follows:
  • Land Value: $2,500,000
  • Parking Lot: $500,000
  • Building Structure: $13,000,000
  • Heating and Cooling System: $1,500,000
  • Conveying Systems: $250,000
  • Tenant Finishes: $2,250,000
Breaking the purchase price down into the different component values allows each to be depreciated differently. Using our example, the components could be depreciated as follows: Land Value (not depreciable), Parking Lot (15 years), Building Structure (39 years), Heating and Cooling Systems (10 years), Conveying Systems (20 years), Tenant Finishes (remaining lease term).

Why This Matters to Your Model


In most cases your model (and likely your accounting department) will simply make a blanket assumption on how to depreciate an asset. Often times the land is assumed to make up 10-20% of the purchase price, and the remaining 80-90% is simply depreciated over 39 years. You can quickly do the math and see that a shorter depreciation schedule results in less tax liability. In fact, do the math, head over to the Forum at LeveragedBreakdowns.com, and share your results with the community!

When initially modeling an acquisition, you will not have the cost segregation report in order to create your first run. If your firm typically utilizes cost segregation, you can use the reports from similar properties to make assumptions for your model. If your firm does not typically use them, but you want to recommend it, you will have to make some assumptions on your own, based on a little research. Much of the information you will need on the cost of different building components can be found in the Cost Approach of an appraisal. You can then cross-reference that with GAAP or Tax depreciation schedules to make an educated guess for your model.

Who Can Prepare A Cost Segregation Study?


These studies are performed by qualified firms or individuals who meet the requirements stipulated by the IRS. These individuals often have property appraisal experience, or most importantly, an engineering background. Many of the larger accounting firms have specialists that can complete such a study, but there are many independent contractors or boutique firms that specialize in it as well.

Building a great real estate private equity investment model takes practice and patience. You can find plenty of opportunities to learn more about building models at LeveragedBreakdowns.com. You will find courses, forums, articles, and actual real estate investment case studies to help you on your journey to a REPE career. Check it out today!
Location: United States

Comments

Post a Comment

Popular posts from this blog

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. 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 st...
Read more

Why Asset Underwriting Skills Are Necessary For Real Estate Private Equity Interviews?

-
Why are asset underwriting skills necessary for a real estate private equity career? Real estate private equity interviews demand serious preparation. Although no two funds are the same, each will expect a strong understanding of real estate underwriting. Traditionally, real estate underwriting has been hard to learn outside of a real estate private equity career. Thus, industry outsiders have struggled to acquire the basic investments skills necessary to underwrite even a simple single-asset acquisition. This post details why asset underwriting skills are beneficial and how Leveraged Breakdowns’ real estate private equity course will help you ace your next REPE interview . How asset underwriting helps you better understand real estate private equity funds? No two real estate private equity funds are the same, each varies across countless factors. Some of the most important factors to understand when searching for your real estate private equity career are: Size Sector Focus...
Read more

Cap Rates - Wicked Simple or Wicked Complicated?

-
Are cap rates wicked simple or wicked complicated? The snarky answer is “Yes.” What we mean is cap rates have an “everyday” application that is intuitive and simple. Its foundation, however, is much more complicated. As you move toward a career in a real estate private equity firm, you will need to learn to use cap rates in their simple form. But it never hurts to understand the origins of the concept.   What is a Cap Rate? To begin, the term “cap rate” is shorthand for “capitalization rate.” The term is well-defined in real estate appraisals, and is aimed at determining a market rate of return for the property being appraised (see more on appraisals here ). The appraisal breaks the cap rate down into three component parts: the risk free rate, the equity rate, and the debt rate. The sum of these three rates becomes the capitalization rate used to arrive at the property value based on the income approach (specifically, net operating income divided by the cap rate equals th...
Read more