Real Estate Due Diligence

Financial Due Diligence (FDD) involves collecting and preparing all relevant financial data:

• Income
• Expenditure
• Opportunities
• Risks
• Assessment of the real estate (asset deal) or the real estate in the form of a company limited by shares (share deal), usually based on the discounted cash flow method

The FDD is the basis for

• the purchasing decision by the investor and
• the financing decision by banks and other financial backers

• Investment case and
• bank case

Procedural steps

• Cash flow projection or cash flow analysis
  • Planning horizon (5 – 15 years)
  • Assessment of the project’s periodic net returns
• Real estate assessment
  • Commercial value
  • Taxable value
  • Insured value
  • Collateral value
  • Real estate transaction (market value / current market price)
• Rating
  • Credit rating (buyer)
  • Market and property rating
    • MoriX market and property rating

Group of Criteria	Weighting
Real estate market	20%
Location	30%
Property	20%
Quality of the property cash flow	30%
The ten-point rating scale ranges from 1 = excellent to 10 = disastrous

• Risks from the perspective of the financial backers
  • Cost uncertainties
  • Profit uncertainties
• Borrowed capital
  • How much is possible?
  • How much is appropriate?
• Costs of capital
  • Serviceability of the costs of equity capital, mezzanine and borrowed capital

(Serviceability of the borrowed capital alone does not suffice)

• The costs of capital are calculated as the weighted average cost of borrowed, mezzanine and equity capital (weighted average cost of capital)
• The greater the risk, the higher the costs of the equity capital
• Amount of equity capital costs: 1% to 20%
• The capital costs are the minimum required rate of return
• Calculation of the rate of return is usually based on the internal rate of return method
• Internal rate of returns through the costs of borrowed and mezzanine capital enables additional borrowed or mezzanine capital to be leveraged and increased
• Internal rates of return of 20% and more require a high leverage
• Leverage is based on the ratio of borrowed capital to the financing of overheads (loan to cost)
• The internal rate of return (IRR) is contingent on the deadline and amount of the repayments » the faster and + higher the amortization, the lower the internal rate of return
• Equity capital investors use high leverage and deferred amortization to increase the internal rate of return!

Structured Financing Concepts

Capital Structure	Range
Equity capital	10 to 20%
Mezzanine capital	10% to 20%
Borrowed capital	60% to 80%

Other areas of structured financing are:

• Commitment to lend
• Syndication
• Placement (borrowed capital)
• Equity capital placement / involvement of additional investors (mezzanine)

• Types of credit (according to security)
  • Mortgage loan
  • Chattel mortgage
  • Transfer of ownership by way of security
  • Terms and conditions of loan
  • Interest rate instruments (swap, forward swap, swap option, currency interest rate swap, cap, floor, collar, forward rate agreement)
  • Collateral value
• Types of credit (according to term)
  • Interim financing
  • Long-term financing

Financing of leasing transactions is characterised as follows:

• High demands on marketable financing
• Timely initiation of the financing plan
• Involvement of a financial advisor who is thoroughly acquainted with the following aspects of the financing requirements:
  • Location
  • Layout of property
  • Lease
  • Various options

Traditional holding structures are broken up as result of privatisation or concentration on the core business and so on and entire portfolios are sold. The vendor transfers the real estate in its entirety to a single buyer by means of a so-called portfolio sale and the buyer has to refinance the entire purchase price (portfolio financing).

If real estate which is essential for the business is sold together with non-essential real estate, it is normally separated and handled in sale & lease back transactions as it is not possible to include non-essential real estate in the portfolio financing.