Real Estate Interview Questions
These are some of the most common — and most challenging — questions (and answers, of course) you’ll encounter when interviewing for junior roles at real estate private equity funds, development firms, operators, and more. Schedule a 1-on-1 with us if you need additional clarity on any of these topics.
Some Sound Advice for You
A lot of people stress over technical questions — and yes, they matter a lot. But you don’t need to memorize every real estate term, master lightning-fast mental math, or know the CEO’s favorite color. What you do need to know is what the job actually involves, day to day. If you’re interviewing for an acquisitions role, focus on valuation and what makes a deal worth pursuing. If it’s a development shop, you should understand how to evaluate a site, how zoning and construction costs impact feasibility, and how to assess whether the end product will perform as a stabilized asset. For debt roles, pay close attention to how loans are sized, what makes a strong borrower, and how monetary policy plays into underwriting. And if the firm focuses on multifamily, your prep should be centered on that asset class — not office or industrial. The point is: interviewers want to see that you can hit the ground running. That means showing you're already thinking the way someone in the role would — not just memorizing technical terms, but preparing with intention and relevance.
Finance Fundamentals
Walk me through a discounted cash flow (DCF) analysis.
A discounted cash flow (DCF) analysis is a method used to estimate the present value of a real estate investment based on its projected future cash flows. The process involves several key steps.
First, you forecast the property’s annual net cash flows over a holding period, typically 5 to 10 years. These include net operating income (NOI), less any capital expenditures, leasing costs, and debt service if using a levered model.
Second, you estimate the property’s exit value at the end of the hold period. This is usually done by applying an exit cap rate to the projected final year’s NOI. From this amount, you subtract selling costs to arrive at the net sale proceeds.
Next, you discount all future cash flows, including the annual income and the net sale proceeds, back to present value using a discount rate that reflects the investor’s required return. This accounts for the time value of money and investment risk.
Finally, you sum the present values of all cash flows to determine and subtract the initial investment amount to arrive at the NPV. This figure helps investors decide whether the investment meets their return expectations relative to its risk.
What is IRR, and how do you interpret it in real estate?
IRR is the annualized return a real estate investment is expected to generate, factoring in the time value of money. It is the discount rate that makes the NPV of all projected cash flows equal zero.
IRR helps investors evaluate the efficiency of an investment by accounting for both the size and timing of returns. A higher IRR indicates a potentially more attractive deal, especially if it exceeds the investor’s target return. However, it should be considered alongside other metrics, as it can be sensitive to assumptions and the timing of cash flows.
Read more about this here.
What’s the difference between IRR and NPV?
IRR and NPV are both methods used to evaluate the financial performance of a real estate investment, but they serve different purposes. IRR measures the annualized percentage return an investment is expected to generate over time. It reflects the time value of money by accounting for the timing and size of all future cash flows. In essence, IRR is the rate at which the net present value of those cash flows equals zero. NPV calculates the total value created by an investment in today’s dollars. It does this by discounting all future cash flows back to the present using a chosen discount rate and subtracting the initial investment. A positive NPV indicates that the investment is expected to generate value above the required return. IRR provides a rate of return and is useful for comparing deals and NPV gives a concrete measure of how much value an investment adds.
Read more about this here.
What’s the difference between unlevered and levered cash flows?
Unlevered cash flows exclude debt and show how the asset performs on its own. Levered cash flows reflect debt payments and show what the equity investor receives after financing. Unlevered cash flows are used to evaluate the asset’s fundamental income-generating ability, independent of capital structure, and are typically used to calculate the unlevered IRR. Levered cash flows incorporate interest and principal payments, making them useful for analyzing equity returns and risk based on a specific financing strategy.
What is an equity multiple?
An equity multiple is a real estate investment metric that measures the total return on equity over the life of a deal. It shows how much cash an investor receives in relation to the amount they initially invested.
The formula is: Equity Multiple = Total Distributions to Equity / Total Equity Invested
For example, an equity multiple of 2.00x means the investor doubled their money—receiving $2 for every $1 invested. This includes both cash flow during the hold period and proceeds from the sale or refinance. Unlike IRR, which measures the time value of money, the equity multiple is a straightforward measure of total return. It’s useful for understanding overall profitability, especially when compared across deals with similar hold periods.
What happens to real estate values when interest rates rise?
When interest rates rise, real estate values typically decline. This occurs for several reasons.
First, higher interest rates increase borrowing costs, which reduces the amount buyers can afford to pay while still meeting return thresholds. As debt becomes more expensive, leveraged returns decline, making deals less attractive at current prices.
Second, rising interest rates tend to increase capitalization rates (cap rates), which are used to value properties. Since value is calculated as net operating income divided by the cap rate, an increase in the cap rate leads to a lower valuation, all else equal.
Third, higher rates often are a result of contractionary monetary policy, which can slow economic growth, reduce tenant demand, and put downward pressure on rents and occupancy. This further impacts projected cash flows and investor demand, causing property values to decline.
Overall, rising interest rates create both financial and market-driven pressures for real estate, generally leading to lower asset values.
What is the time value of money and why does it matter in real estate?
The time value of money is the principle that a dollar today is worth more than a dollar in the future because of its earning potential. This concept is foundational in real estate finance, where investments are evaluated based on projected future cash flows.
TVM matters in real estate because properties generate income over time, and investors must assess whether those future cash flows justify the initial investment. Tools like NPV and IRR are used to discount future cash flows back to their present value, allowing for apples-to-apples comparisons.
Discounting future income reflects the risks of time, such as inflation, uncertainty, and opportunity cost. For example, $100,000 in rental income five years from now is worth less than $100,000 today because that money could be invested elsewhere or may be exposed to risk.
Walk me through the capital stack.
The capital stack refers to the structure of funding sources used in a real estate deal, organized by priority of repayment and risk exposure. It consists of four tranches: senior debt, mezzanine debt, preferred equity, and common equity.
Senior debt is the first and largest piece, secured by the property and first in line for repayment. It carries the lowest risk and the lowest return.
Mezzanine debt comes next; it is subordinate to senior debt and may be secured by an ownership interest in the property. It carries higher risk and typically commands a higher interest rate.
Preferred equity is subordinate to all debt but senior to common equity. It often provides a fixed or preferred return but has limited upside. It may be structured to behave like debt or equity, depending on the deal.
Common equity sits at the bottom of the stack. It is the riskiest capital but has the greatest potential upside. Common equity holders receive residual cash flows after all other obligations are met and may participate in profit-sharing through promoted interest structures.
What is a sensitivity analysis? What variables might you sensitize in an acquisition deal?
A sensitivity analysis is a tool used in real estate financial modeling to test how changes in key assumptions affect investment outcomes. It helps investors understand the potential risks and variability of a deal by measuring the impact of different inputs on metrics such as IRR, NPV, or equity multiple.
In an acquisition deal, common variables to sensitize include the exit cap rate, rent growth, operating expenses, vacancy rate, interest rate, and renovation costs. For example, increasing the exit cap rate or decreasing rent growth assumptions can show how sensitive the returns are to market conditions.
By adjusting one variable at a time (or multiple variables together), a sensitivity analysis highlights the range of possible outcomes and helps identify which assumptions have the greatest influence on returns.
What is the effect of leverage on returns?
Leverage, the use of borrowed capital in a real estate investment, magnifies both potential returns and potential losses. When a property performs well and generates returns that exceed the cost of debt, leverage magnifies the investor’s gains by allowing them to control a larger asset with less of their own capital.
However, leverage also magnifies downside risk. If the property underperforms or if expenses, including interest payments, increase, the impact on the investor’s equity is more severe than it would be without leverage. In this case, even small declines in income or value can significantly reduce or eliminate returns to equity.
Leverage introduces financial risk and increases the sensitivity of an investment to changes in operating performance, interest rates, and market conditions. While it can enhance returns in favorable scenarios, it requires careful structuring and risk management to avoid magnifying losses in adverse situations.
Real Estate Fundamentals
What are some key assumptions you need to build a real estate model?
To build a real estate financial model, you need assumptions in five core areas. First are purchase assumptions, including acquisition price, closing costs, and initial capital expenditures, which establish the total cost basis. Second are revenue assumptions, such as rental income, lease terms, vacancy, rent growth, and other income sources. Third are operating expenses, covering taxes, insurance, maintenance, management fees, and expense growth. Fourth are financing assumptions, including loan terms, interest rates, amortization, and any equity structures or waterfalls. Fifth are exit assumptions, such as the hold period, exit cap rate, and selling costs, which impact projected sale proceeds. Together, these inputs form the foundation of the pro forma and drive key return metrics like IRR, equity multiple, and cash-on-cash return.
What are the four main real estate investment strategies? How do they differ?
The four main real estate investment strategies are core, core-plus, value-add, and opportunistic. They differ in terms of risk, return potential, and the level of active management required.
Core: This is the lowest-risk strategy. Core properties are fully stabilized, high-quality assets in prime locations with strong tenants and predictable income. Returns are mostly from cash flow, with limited upside.
Core-Plus: Slightly higher risk than core, core-plus properties are mostly stabilized but may have minor operational or physical improvements needed. Investors seek both steady cash flow and modest value growth.
Value-Add: This strategy involves buying underperforming properties and improving them through renovations, lease-ups, or management changes. It carries moderate to high risk but offers higher return potential through both income growth and appreciation.
Opportunistic: The highest-risk, highest-return strategy. Opportunistic deals include ground-up development, major repositioning, or distressed assets. These projects typically have little to no initial cash flow and rely heavily on execution to create value.
Each strategy aligns with different investor profiles and market conditions, depending on risk tolerance and return objectives.
What is stabilization?
Stabilization is the point when a property reaches consistent occupancy and cash flow, typically after lease-up, renovation, or development. A stabilized asset has minimal leasing risk, predictable expenses, and is often 90–95% occupied. It marks the transition to steady operations and is key for refinancing, valuation, and investor returns.
How do you analyze market demand for a multifamily property?
To analyze market demand for a multifamily property, you evaluate current performance indicators and future trends affecting tenant demand and income potential. Net absorption is a key metric, measuring the number of units leased minus those vacated over a period. Positive net absorption indicates growing demand and the market’s ability to support new supply, while negative absorption suggests weakening demand or oversupply. Concessions, such as free rent or move-in incentives, reveal market softness. Widespread concessions often mean landlords are competing for tenants in an oversupplied or unaffordable market. Rent growth is another core indicator. Rising rents suggest strong demand and landlord pricing power, while flat or declining rents point to competitive pressure or limited renter income. Vacancy rates help gauge supply-demand balance. Low vacancy typically reflects a tight market, whereas high vacancy can signal oversupply. Finally, comparing historical cap rates to projected exit cap rates provides insight into investor expectations. If projected cap rates are higher than historical norms, it may indicate concerns about future performance or rising risk. Together, these metrics offer a clear picture of market demand and whether conditions support a new or existing multifamily investment.
Walk me through a pro forma statement for a commercial property.
A pro forma statement for a commercial property starts with potential gross income, which includes base rent, expense reimbursements (for taxes, insurance, and maintenance, depending on the lease type), and other income such as parking or signage fees. Subtract a vacancy and credit loss allowance to arrive at effective gross income—the expected income actually collected. Then, deduct operating expenses, including property taxes, insurance, repairs and maintenance, utilities, and management fees. These may be offset by tenant reimbursements, again depending on the lease structure. The result is NOI—the property's income before debt service, capital expenditures, or leasing costs.
Explain how expense responsibilities differ under single net (N), double net (NN), triple net (NNN), and full-service or gross leases.
Lease structures define how operating expenses are shared between landlord and tenant. In a single net (N) lease, the tenant pays base rent plus property taxes, while the landlord covers insurance and maintenance. A double net (NN) lease requires the tenant to pay property taxes and insurance, with the landlord responsible for maintenance and repairs. In a triple net (NNN) lease, the tenant pays all three major expenses: property taxes, insurance, and maintenance (plus utilities at times), in addition to base rent. This shifts most financial responsibility to the tenant, providing the landlord with more predictable net income. A full-service or gross lease, on the other hand, includes all operating expenses in the rent. The landlord covers property taxes, insurance, maintenance, and utilities, making it easier for tenants to budget but requiring landlords to manage cost fluctuations.
What does pro rata mean and what is its implication in commercial leases?
Pro rata means “in proportion” and refers to how costs or benefits are allocated based on a party’s share of the whole. In commercial leases, it typically applies to a tenant’s share of operating expenses—such as property taxes, insurance, and maintenance. The pro rata share is usually based on the tenant’s leased square footage divided by the total leasable square footage of the building. For example, if a tenant leases 5,000 square feet in a 50,000-square-foot building, they would be responsible for 10% of shared expenses. This ensures costs are distributed fairly among all tenants based on their occupancy size.
What are replacement reserves? How are they used in managing in real estate?
Replacement reserves are funds set aside regularly to cover the future cost of major capital improvements or replacements, such as roofs, HVAC systems, or plumbing. Unlike routine operating expenses, these costs are non-recurring but necessary to maintain the property's long-term value and functionality. In real estate management, replacement reserves are used for budgeting and underwriting purposes. Lenders and investors often include a reserve allowance in pro formas to account for long-term capital needs and to ensure the property remains in good condition without relying solely on operating income when major repairs are required.
How do you calculate net operating income?
A pro forma statement begins with potential gross income, which includes all projected rental income and other revenue sources like parking or reimbursements. From this, you subtract a vacancy and credit loss allowance to calculate effective gross income. Next, you deduct operating expenses, such as property taxes, insurance, utilities, repairs, and management fees. After subtracting these from effective gross income, you arrive at NOI.
What is a rent roll?
A rent roll is a summary of all tenants in a property, detailing unit numbers, lease terms, rent amounts, start and end dates, and other charges. It provides a snapshot of current rental income and lease expiration risk. Rent rolls are essential for underwriting, as they help evaluate the property’s cash flow, occupancy, and income stability. Investors and lenders use them to assess revenue and support valuation.
What are the key differences between gross potential income and effective gross income?
Gross Potential Income (GPI) is the total income a property could generate if all units are fully leased at market or contract rent, with no vacancy or credit loss. It represents the maximum possible revenue under ideal conditions. Effective Gross Income (EGI) is GPI minus vacancy and credit loss, and plus any additional income, such as reimbursements, parking, or storage fees. EGI reflects the realistic income the property is expected to generate. The key difference is that GPI assumes full occupancy with no losses, while EGI accounts for the operational realities of leasing and collections.
What are the different property classes in real estate?
Property classes help categorize real estate based on quality, location, and risk.
Class A properties are newer, in prime locations, and attract high-income tenants. They require little to no renovation and are considered low-risk.
Class B properties are slightly older, may need light upgrades, and are typically in good — but not top-tier — locations.
Class C properties are aging assets in less desirable areas and often need significant capital improvements.
Class D (used less formally) refers to distressed or functionally obsolete properties in high-risk locations.
Investors use property classes to compare deals, assess risk, and align investment strategies with return expectations.
Why might two identical buildings on the same block have different values?
Even if two buildings are physically identical, their income streams, lease terms, and tenant quality can vary. One might have higher rents, lower vacancy, or a stronger tenant roster with long-term leases, which increases its net operating income (NOI) and justifies a higher value. Differences in operating expenses, capital needs, or debt structure can also impact value. And from a market perspective, investor perception of risk — like lease rollover exposure or tenant credit — can influence the cap rate applied, leading to different valuations.
What are tenant improvements (TIs) and leasing commissions (LCs)?
Tenant improvements (TIs) are custom renovations or buildouts made to a rental space to meet the specific needs of a tenant. These can include installing walls, lighting, flooring, or specialized fixtures. TIs are typically negotiated as part of a lease and are often paid for, in whole or in part, by the landlord as an incentive to attract or retain tenants. Leasing commissions (LCs) are fees paid to brokers for securing a new lease or renewing an existing one. These are usually calculated as a percentage of the total lease value or on a per-square-foot basis and are paid upfront when the lease is executed. Both TIs and LCs are considered leasing costs and are capitalized in financial models. They are important in underwriting because they directly impact cash flow, especially in value-add or office deals with frequent tenant turnover.
Valuation
How do you value a property?
There are three primary methods for valuing real estate: the Income Approach, the Sales Comparison Approach, and the Cost Approach. Each is used based on the property type, purpose of the valuation, and available data.
The Income Approach is most commonly used for income-producing properties such as apartments, office buildings, and retail centers. It estimates value based on the property's ability to generate income. This method includes techniques like direct capitalization, where the net operating income is divided by a market-derived cap rate, and DCF analysis, which projects future cash flows and discounts them to present value.
The Sales Comparison Approach is widely used for residential properties and assets with reliable comparable sales data. This method involves analyzing recent sales of similar properties and adjusting for differences in features, location, size, and condition to estimate value.
The Cost Approach is used when a property is unique or income and comparable sales data are limited. It estimates value by calculating the cost to replace or reproduce the property, subtracting depreciation, and adding land value.
Each method provides a different perspective on value and may be applied individually or in combination, depending on the context of the valuation.
How do you use a cap rate to value a real estate property?
To value a real estate property using a cap rate, divide the property’s net operating income (NOI) by the market cap rate:
Property Value = NOI / Cap Rate.
This method reflects what an investor would pay based on the property’s income and market return expectations. A lower cap rate implies a higher value, and vice versa.
Read more about this here.
How would you determine if a property is overvalued?
To determine if a property is overvalued, compare its price to key market benchmarks. Start with the cap rate—if it’s lower than similar properties without strong justification, the pricing may be too aggressive. Analyze the NOI relative to the purchase price to see if the income supports the valuation. Check comparable sales on a per-square-foot or per-unit basis. A significant premium without clear advantages may signal overpricing. Finally, compare the price to replacement cost. If the property costs significantly more than what it would take to build new, it may be overvalued. Looking at these factors together helps assess whether the price is supported by market fundamentals.
Walk me through the process for finding a comparable set for a property.
To identify a comparable set for a property, begin by selecting recent sales or listings within the same submarket or neighborhood, as location is a key driver of value. Next, filter for properties with similar physical and operational characteristics, including asset type, size, age, building class, and condition. Comparable properties should appeal to a similar pool of tenants or investors. Focus on transactions that occurred recently to ensure relevance to current market conditions. Once a set is established, compare metrics such as price per square foot, cap rate, and occupancy, adjusting for any differences. This process helps support accurate valuation and informed investment decisions.
How do you determine an appropriate discount rate for a DCF?
To determine an appropriate discount rate for a real estate DCF model, start with a baseline that reflects the investor’s required rate of return for the specific asset class and investment strategy. For example, core assets in primary markets generally warrant lower discount rates, while value-add or opportunistic deals require higher ones.
From that baseline, you make adjustments based on asset-specific risks. These can include factors such as lease rollover exposure, tenant credit quality, vacancy risk, capital expenditure needs, and overall cash flow stability. The greater the uncertainty around the timing or reliability of future cash flows, the higher the discount rate should be.
In short, the discount rate begins with an investor’s target return for the asset type and strategy, then increases or decreases depending on the unique risk characteristics of the deal.
How would a change in interest rates effect property values?
A change in interest rates affects real estate valuations primarily through borrowing costs. When interest rates rise, debt becomes more expensive, which increases monthly payments and reduces the amount investors can afford to borrow. As a result, properties become less affordable, and buyers often lower their offer prices to maintain target returns. This puts downward pressure on property values.
Higher rates can also reduce investor demand, especially in highly leveraged deals, further reducing pricing. On the other hand, when interest rates fall, borrowing becomes cheaper, improving affordability and allowing buyers to pay more while still meeting return thresholds. This generally supports higher property values.
How would you assess if an implied cap rate is reasonable for a given asset in a specific market?
To assess if a cap rate is reasonable, start by comparing it to recent sales of similar properties in the same submarket. These comps provide a baseline for what investors are currently paying. Next, consider market conditions, including interest rates, supply and demand, and overall investor sentiment. Strong markets tend to support lower cap rates, while higher-risk or slowing markets demand higher ones. Evaluate property-specific factors like lease terms, tenant quality, and occupancy. Stable income or credit tenants can justify lower cap rates; vacancy or short leases typically require higher ones. Lastly, compare the cap rate to historical norms for similar assets in that market. Any meaningful difference should be backed by a clear rationale. Together, these checks help determine if the cap rate reflects both market trends and the asset’s risk profile.
What’s the impact of lease structure (e.g., NNN vs. gross) on valuation?
Lease structure has a significant impact on real estate valuation because it determines who is responsible for operating expenses and how predictable the cash flows are.
In a NNN lease, the tenant pays property taxes, insurance, and maintenance costs in addition to rent. This reduces the landlord’s expenses and makes net operating income more stable and predictable, which can lead to a higher valuation, especially for creditworthy tenants and long-term leases.
In contrast, a gross lease includes all operating expenses in the rent paid by the tenant. The landlord bears the risk of rising expenses, which can reduce NOI over time. As a result, gross-leased properties may trade at lower prices or higher cap rates to reflect that added risk.
Investors generally favor NNN leases for their lower risk and more passive income stream, while gross leases require more active management and carry greater expense uncertainty, both of which can impact how a property is priced.
What role does replacement cost play in valuing a property?
Replacement cost is the estimated cost to rebuild a property at current construction prices. It serves as a benchmark in valuation—if a property trades well above replacement cost, it may be overvalued; if below, it could signal a value opportunity or underlying issues. Investors and lenders use it to assess risk, compare buy vs. build options, and gauge long-term competitiveness.
Development
How does yield-on-cost relate to market cap rates, and how do you use that spread?
Yield-on-cost = Stabilized NOI ÷ Total Project Cost. Yield-on-cost measures the return based on the project’s stabilized NOI divided by total development or acquisition cost. To evaluate whether a deal creates value, you compare the yield-on-cost to the prevailing market cap rate for similar stabilized properties. If your yield-on-cost is higher than the market cap rate, it suggests you're creating value — the spread indicates you could sell the asset at a profit. But if your yield-on-cost is equal to or below the market cap rate, the return may not justify the development or repositioning risk.
Walk me through a typical financing structure for a development deal.
A construction loan typically provides 65% of the total development cost and is usually interest-only during the construction period. It is secured by the property and funded in draws as work progresses. The loan may also include an interest reserve to cover payments while the project is not yet generating income. The remaining 35% is equity, contributed by the sponsor and investors. This equity is often split into common equity, which bears the most risk and shares in the upside, and potentially preferred equity, which receives a fixed return before common equity profits are distributed. This structure ensures the project is properly capitalized while allocating risk and return appropriately among lenders, preferred investors, and the sponsor.
How would rising interest rates affect a development project’s feasibility?
Rising interest rates can significantly impact a development project's feasibility by increasing borrowing costs and reducing investor returns. Higher interest rates raise construction loan interest payments, which increases the project's overall cost and lowers projected cash flow and profit margins. This can make it harder to meet lender requirements such as DSCR, debt yield, or IRR hurdles. Additionally, rising rates may lead to higher cap rates at exit, which would lower the projected sale price and reduce total returns. At the same time, demand may soften if higher rates affect tenant affordability or slow the broader economy. As a result, developers may need to lower their land basis, reduce construction costs, or increase equity contributions to keep the project viable.
Explain how the treatment of interest differs in a construction loan versus a permanent loan? What is the intuition for this?
In a construction loan, interest is typically capitalized, meaning it's added to the loan balance rather than paid monthly. The loan is often interest-only and disbursed in stages, so the borrower pays interest only on the drawn amount. This structure preserves cash flow during the development period when the property isn’t yet generating income. In a permanent loan, interest is usually paid monthly from operating income, alongside principal payments if amortizing. The property is expected to be stabilized and income-producing. The intuition is that during construction, the project can't support regular payments, so interest is deferred. Once stabilized, the property can service debt normally from its cash flow.
How do land plot size, Floor Area Ratio (FAR), and gross versus rentable area relate to one another in a development project?
In a development project, land plot size, Floor Area Ratio (FAR), and gross vs. rentable area are all connected in determining the project's scale and income potential. FAR defines how much total buildable floor area is allowed relative to the land size. For example, a 20,000 SF lot with a 3.0 FAR allows up to 60,000 SF of total building area. That 60,000 SF represents the gross building area, which includes rentable space plus common areas like hallways, lobbies, and mechanical rooms. The rentable area is a portion of the gross area—typically 80% to 90%—and represents the space that can generate income through leasing. In short, land size and FAR determine the maximum gross buildable area, while the rentable area is a fraction of that total and directly affects projected revenue.
What are the main categories of a construction budget?
The main categories of a construction budget typically include:
Hard Costs – Direct construction expenses like labor, materials, site work, and contractor fees (e.g., foundation, framing, MEP systems).
Soft Costs – Indirect costs such as architecture, engineering, permits, legal fees, insurance, and development management.
Contingency – A reserve for unexpected cost overruns or design changes, often 5–10% of hard and soft costs.
Financing Costs – Expenses related to borrowing, including loan fees, interest during construction (capitalized interest), and lender-required reserves.
Developer Fee – Compensation to the developer for managing the project, often expressed as a percentage of total costs.
Land Cost – The acquisition cost of the development site.
Together, these categories form the total development budget and are critical for underwriting and securing financing.
What is SOFR?
SOFR (Secured Overnight Financing Rate) is a benchmark interest rate that shows the cost of borrowing money overnight using U.S. Treasury bonds as collateral. It’s based on real transactions and is considered more reliable than LIBOR, which it replaced. In real estate, SOFR is often used in floating-rate loans like construction or bridge loans. The lender adds a spread on top of SOFR to set the total interest rate the borrower pays.
What is the difference between a GP and LP? What is a typical equity split between the two?
In a real estate partnership, the General Partner (GP) is the sponsor or managing party responsible for sourcing the deal, securing financing, overseeing development or operations, and managing the asset. The Limited Partners (LPs) are passive investors who provide most of the equity but have limited control and liability. The GP typically contributes a small portion of the total equity—often 5% to 10%—while LPs contribute the remaining 90% to 95%. In return, the GP may earn a promote or carried interest—a disproportionate share of profits if the investment exceeds certain return thresholds—on top of their pro rata equity share.
How would you value a land parcel with development potential?
To value a land parcel with development potential, you typically use a residual land value approach. This method starts with the projected value of the completed development (based on market rents, cap rates, or sale comps), then subtracts all development costs, including construction, soft costs, financing, and developer profit.
The formula is: Residual Land Value = Total Project Value - Total Development Costs
This approach helps determine what a developer can afford to pay for the land while still achieving a target return.
Walk me through how to determine the appropriate exit cap rate for a five-year hold period on a development multifamily deal in a secondary market.
To determine an appropriate exit cap rate for a multifamily development in a secondary market with a five-year hold, start with the current cap rate for stabilized Class A assets in that market.
Then adjust upward—typically by 25 to 50 basis points—to reflect the fact that today’s new construction may no longer be considered Class A at exit and just for sound conservative modeling practices. Over time, properties tend to shift from Class A to Class B due to aging, changing design standards, and less competitive building efficiency or amenities.
This adjustment helps account for both market conditions and asset depreciation over the hold period. Use sensitivity analysis to test how different exit cap rates impact investor returns.
Debt / Credit / Risk Analysis
What’s the difference between LTV and LTC? What are the typical ratios that lenders use to size loans based on these metrics?
Loan-to-Value (LTV) is loan amount ÷ property value. Loan-to-Cost (LTC) is loan amount ÷ total project cost. LTV is used in acquisitions; LTC is more common in development projects.
What is the difference between amortization and maturity?
Amortization refers to the schedule by which a loan is repaid through regular payments of principal and interest over time. Maturity is the date when the loan term ends and the remaining balance is due. If the amortization period is longer than the maturity, the loan will not be fully paid off by the maturity date, resulting in a balloon payment. In fully amortizing loans, the loan balance reaches zero by maturity.
What are the three metrics lenders use to size a permanent loan?
The three primary metrics lenders use to size a permanent loan are:
Loan-to-Value (LTV): Measures the loan amount as a percentage of the property's appraised value. It helps assess collateral risk. Lenders typically limit LTV to 60–75% for stabilized assets.
Debt Service Coverage Ratio (DSCR): Compares NOI to annual debt service. It shows the property’s ability to cover loan payments. A minimum DSCR of 1.20x is common.
Debt Yield: Calculated as NOI divided by the loan amount. It reflects the lender’s return in a foreclosure scenario, independent of interest rate or amortization. Most lenders require a debt yield of at least 8–10%.
These metrics ensure that the loan is supported by both the property’s income and value, while also managing risk to the lender.
How do you calculate the DSCR?
The Debt Service Coverage Ratio (DSCR) is calculated by dividing a property’s Net Operating Income (NOI) by its annual debt service (total principal and interest payments):
DSCR = NOI / Annual Debt Service
A DSCR greater than 1.00 means the property generates more income than needed to cover debt payments. For example, a DSCR of 1.20 means the property produces 20% more income than required to service the debt. Lenders typically look for a minimum DSCR of 1.20 to ensure a margin of safety.
What’s the difference between recourse and non-recourse debt?
The difference between recourse and non-recourse debt lies in the lender’s ability to pursue the borrower personally if the loan goes into default. With recourse debt, the lender can go after the borrower’s personal assets to recover any unpaid balance after foreclosure and sale of the property. This gives the lender an added layer of protection and places more risk on the borrower. With non-recourse debt, the lender’s recovery is limited to the collateral property itself. If the sale doesn’t cover the outstanding loan balance, the borrower is not personally liable—except in certain cases of fraud or negligence, often outlined in “bad boy” carve-outs. Non-recourse loans are common in commercial real estate, especially for stabilized, income-producing properties.
What does “principal” and “interest” mean in a real estate loan?
In a real estate loan, principal refers to the original amount borrowed, while interest is the cost paid to the lender for borrowing that money. Each loan payment typically includes both principal and interest. The principal portion reduces the outstanding loan balance over time, and the interest portion compensates the lender for the time and risk of lending. Early in the loan term, a larger share of the payment goes toward interest, while later payments apply more toward principal.
Why are lenders willing to originate interest-only loans? Why do borrowers like this?
Lenders are willing to offer interest-only loans because they can still earn steady interest income while supporting deals with strong underlying fundamentals or short-term business plans, such as lease-up, renovation, or development. These loans are often used in lower-risk, transitional, or well-capitalized projects where the borrower has a clear exit or refinancing strategy. Borrowers like interest-only loans because they reduce initial debt service, improving early cash flow and equity returns. This flexibility is especially valuable during periods of lease-up or repositioning, when income may be limited.
In a fixed-rate loan, on a 30-year amortization schedule, how does the payment differ month to month?
In a fixed-rate loan with a 30-year amortization schedule, the monthly payment remains the same throughout the life of the loan. However, the composition of each payment changes over time. Early in the loan term, a larger portion of the payment goes toward interest, while a smaller portion goes toward principal. As the loan progresses, the interest portion gradually decreases, and the principal portion increases. By the end of the loan, most of the payment is applied toward reducing the principal balance. This shifting balance of interest and principal is a key feature of amortizing loans.
What is an amortizing loan? How is it different from an interest-only loan?
An amortizing loan requires the borrower to make regular payments that cover both interest and principal, gradually reducing the loan balance over time. In contrast, an interest-only loan requires payments that cover only the interest for a set period, with no reduction in principal. As a result, the full loan amount remains outstanding until the end of the interest-only term or maturity.
What is a balloon payment? When does it occur?
A balloon payment occurs when the loan’s amortization period is longer than its maturity. In this case, the borrower makes smaller payments based on a long-term schedule (e.g., 30 years) but the loan matures earlier (e.g., after 5 or 10 years), leaving a large unpaid balance due at maturity. This final lump sum is the balloon payment, often requiring refinance or sale of the property.
How does leverage affect returns?
Leverage increases potential returns by reducing the equity required. But it also amplifies risk—if income drops or costs rise, the fixed loan payments can reduce or eliminate profit.
What is prepayment, and why might a lender charge a penalty for it?
Prepayment occurs when a borrower pays off all or part of a loan before its scheduled maturity date. While this reduces interest expense for the borrower, it can be unfavorable for the lender, who expected to earn interest over the full term. To compensate for this lost income, a lender may charge a prepayment penalty. This penalty protects the lender’s expected return and discourages early refinancing, especially in a declining interest rate environment where the borrower could replace the loan with cheaper debt.
What happens if a borrower defaults on a loan?
If a borrower defaults on a loan, the lender can initiate foreclosure to seize and sell the property to recover the outstanding balance. In a recourse loan, the lender may also pursue the borrower’s personal assets; in a non-recourse loan, recovery is limited to the property. Default can lead to penalties, accelerated repayment, and harm to the borrower’s credit.
What’s the difference between preferred equity and mezzanine debt?
Preferred equity is junior to debt but senior to common equity and receives fixed or structured returns. Mezzanine debt is structured like a loan and typically secured by equity pledges, with more downside protection than equity.
How would you account for lease-up risk in a development or value-add model?
To account for lease-up risk in a development or value-add model, you adjust both timing and revenue assumptions to reflect the uncertainty of achieving full occupancy and market rents. Start by incorporating a lease-up period after construction or renovation, during which occupancy ramps up gradually rather than assuming immediate stabilization. You can model this with absorption rates (e.g., leasing 10% of units per month) and apply concessions or discounted rents to reflect the competitive efforts needed to attract tenants. During this phase, expected vacancy losses and operating inefficiencies should be included, and NOI will be lower than in stabilized years. You may also include additional leasing costs, such as broker commissions and tenant improvements. Lease-up risk impacts cash flow timing and can delay or reduce investor returns. Sensitivity analysis on absorption speed and achieved rents can help evaluate the impact of slower lease-up on overall performance.
What is capitalized interest?
Capitalized interest is interest expense that is not paid currently but instead added to the loan balance or project cost during a construction or development period. It is commonly used when a property is not yet generating income, such as during ground-up development. Rather than making monthly interest payments, the borrower accrues interest, which is "capitalized" into the total cost of the project. Once the project is completed and stabilized, regular interest payments typically begin. This approach helps preserve cash flow during early phases of a project.
Waterfall
Walk me through a typical equity waterfall IRR return schedule.
In a typical equity waterfall with pari passu distributions, all investors receive their capital back and an 8% preferred IRR in proportion to their ownership. Once that hurdle is met, promote tiers begin, shifting a larger share of profits to the general partner (GP). For example, profits may be split 80/20 (LP/GP) up to a 12% IRR, then 70/30 or 60/40 at higher return levels. This structure rewards the GP for exceeding return targets while protecting the LP’s downside.
What is a typical preferred return in a real estate waterfall distribution structure?
8%.
What is promoted interest? What is the logic behind it?
Promoted interest, also called promote, is the share of profits a general partner (GP) earns above their ownership percentage once certain performance benchmarks, usually IRR, are met in a real estate deal.
For example, a GP may contribute 10% of the equity but receive 30% of profits above an 8% IRR hurdle. The promote kicks in only after limited partners (LPs) have received their capital back and a preferred return.
The logic behind promoted interest is to align incentives. It rewards the GP for strong performance and motivates them to maximize the project’s returns. LPs benefit by receiving a preferred return before the GP shares in profits, and the GP is compensated for taking on greater responsibility, including sourcing the deal, managing the asset, and executing the business plan.
What does pari passu mean?
In the context of an equity waterfall, pari passu means that profits or distributions are shared proportionally based on ownership percentages between the general partner (GP) and limited partners (LPs), with no preferential treatment.
For example, if the GP owns 10% and the LPs own 90%, a pari passu distribution means 10% of the cash flow goes to the GP and 90% to the LPs—regardless of the tier in the waterfall. This structure is often used in the early stages of a waterfall, such as during the return of capital and preferred return phases, ensuring that all investors are paid in line with their contributions before any promote or profit-sharing tiers are applied.
Pari passu treatment provides alignment and fairness among investors until performance-based splits are triggered.
What is a GP catch up provision?
A GP catch-up provision is a feature in an equity waterfall that allows the general partner (GP) to receive 100% of profits for a period after the limited partners (LPs) have received their preferred return, until the agreed profit split between LP and GP is balanced.
For example, after the LPs receive an 8% preferred return, the GP may receive all additional distributions until they “catch up” to, say, a 20% share of total profits—matching a 20/80 GP/LP split. Once the catch-up is satisfied, remaining profits are split according to the agreed promote tiers (e.g., 80/20, 70/30, etc.).
The catch-up ensures that the GP is fully compensated for their share of profits before moving into the higher performance-based promote tiers. It’s a common way to align incentives and reward the GP for meeting baseline return expectations.