Kurt: When it comes to financial projections and exit strategy, how do you vet the numbers?
Rupy Cheema: A financial review starts with a review of the market feasibility report (if available). Most large deals have an extensive, say 200-page, market feasibility report prepared to help the developer assess the viability of the project. When we review a third-party report from an industry expert, what we're really looking into are the assumptions they're using and the competitive analysis, or the demand generators being used. We're looking for reasonableness and that income projections do not seem to be overstated and that expenses do not appear to be understated.
With small projects we might get a 5-page report prepared from a marketing firm or we may only receive internally prepared financial projections. In those cases we really have to do some independent research. We'll look for publicly available information or research reports, depending on the industry and the project. The bottom line is that if we don’t have a good market feasibility report to work with we tend to have to do a lot more digging.
The market feasibility and appraisal will go into calculating the sale price of the project upon stabilization. We review the inputs being used such as capitalization rates to project the sales price and compare these to industry averages for similar projects. The projected sale price of a project allows us to calculate the expected return for the equity holders.
Most private equity holders expect to receive a 20% to 25% return on their investment. If the numbers show that after all debt is paid off, the equity holders will earn an IRR of say 5%, this would be of concern because if the NCE is a preferred equity investor or an unsecured lender, there is a possibility that the developer does not have enough cushion to pay back the unsecured investors.