From managing portfolios to developing new properties, real estate developers face a variety of risk factors that can either help or hinder projects or investments. Overall market volatility, delays in approvals, variability in interest rates, regulatory hurdles, and general macroeconomic conditions can all have impacts on the feasibility of a project. Despite the wide range of risks, these factors really boil down one question: how do they affect the timing and amount of my cash flows?
As a group of wise philosophers once stated, “Cash rules everything around me.” If we take that statement to heart (which we should), then one of the best ways to effectively manage risk is to effectively manage and forecast cash flow. With the numerous inputs and outputs we have to consider in forecasting, this can seem a daunting task; compounded by the number of properties and projects current under management or in the pipeline.
A functional cash flow forecasting model can:
- Identify upfront identification of risks to highlight shortfalls before they become critical issues.
- Improve decision making to adjust project scope and timeline.
- Improve confidence and feedback for investors and management.
An effective model can be key in determining capital requirements for pre-build, construction, development fees, and working capital needs until the project is in service. A model doesn’t have to be extremely complicated, but those looking to construct a cash flow model should consider the following:
Effectively Choosing Inputs
The inputs to your cash flow forecast are the basis for all its future calculations. It’s important to establish benchmarks accurately and consistently for these inputs, whether thru market studies or comparative properties/projects. Inputs to consider include, but aren’t limited to, the following:
- Revenue forecasting (e.g., rental income, sales proceeds).
- Expense tracking (e.g., construction costs, operating expenses).
- Financing requirements, sources and repayment schedules.
- Refinancing opportunities for other portfolio properties
It’s important to be realistic in developing input assumptions. Overly optimistic inflows and outflows will only lead to future negative revisions and potential shortfalls in investor returns.
Scenario Based Planning
Scenario planning can be as simple as asking yourself “what keeps me up at night when thinking about this project/investment?” What if interest rates fall/rise? What if material/labor costs suddenly rise? What if there are significant delays? How much of a cash flow deficit cushion can we absorb without additional capital requirements? What will each of those capital choices cost my project?
Building moveable assumptions and sensitivity analyses can create various levers to pull in difference scenarios – if interest rates increase by 25 basis points, what does that do to my break-even point? If construction is delayed by three months, how much more upfront capital do I need to continue until my project is in service?
Looking Ahead
As the real estate landscape continues to evolve, staying ahead of the curve with accurate forecasting and adaptable strategies can make all the difference in the success of a project. With a strong foundation in cash flow management, developers can seize opportunities, mitigate challenges, and build for a more resilient and prosperous future.
If you need further guidance or have any questions on this topic, we are here to help. Please do not hesitate to reach out to discuss your specific situation.
This material has been prepared for general, informational purposes only and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. Should you require any such advice, please contact us directly. The information contained herein does not create, and your review or use of the information does not constitute, an accountant-client relationship.
