How to Increase Your CRE IQ with Corporate Finance

WALNUT CREEK, CA—As CRE becomes more institutionalized, especially with the growth of REITs, the lines between real estate and corporate finance valuation are blurring. That is according to Joseph Ori, executive managing director of Paramount Capital Corp. In the exclusive commentary below, Ori talks about how one way to increase your CRE acumen is to understand and apply corporate valuation and analysis to CRE.

The views expressed below are the Ori's own.

If you look at any Wall Street REIT analysis, cap rates are rarely used or mentioned in the valuation analysis process. Instead, analysts site metrics like funds from operation multiples, adjusted funds from operations, cash available for distribution, EBITDA margins and debt to EBITDA. Although the metrics and even terminology between CRE and corporate finance seem different, they are very similar. One way to increase your CRE acumen is to understand and apply corporate valuation and analysis to CRE.

First off, EBITDA, which is earnings before interest, taxes, depreciation and amortization, is a common cash flow measure that is used in corporate finance for company valuation purposes. Typically, a company is valued at a certain multiple of EBITDA. This is the enterprise value (EV) or the market value of the company's long term debt plus market capitalization of common stock less cash/marketable securities divided by its EBITDA. EBITDA multiples for a company typically range from 8 to 15 times. As an example, if the EV of a company is $10B and its EBITDA is $800M, the multiple is 12.5 times ($10B/$800M). This company trades at an EBITDA multiple 12.5x.

EBITDA in corporate finance is equivalent to net operating income (NOI) in CRE. Both are cash flow measures that exclude depreciation, amortization, capital improvements and interest and are used in valuation. The cap rate is the NOI divided by a property's value and is shown below:

Cap Rate = NOI/Property Value

The EBITDA Multiple formula is shown below:

EBITDA Multiple = EV/EBITDA

The inverse of the EBITDA multiple is equivalent to the cap rate formula as follows:

EV/EBITDA is the inverse of NOI/Property Value and,

EBITDA/EV = NOI/Property Value

An EBITDA multiple of 12 times is equal to a cap rate of 8.33% (100 divided by 12) or a cap rate of 4% is equal to an EBITDA multiple of 25 times (1 divided by 4%). If the average EBITDA multiple is 8x-15x, this means that operating companies trade at cap rates ranging from 6.7% to 12.5%. Another way to look at the low cap rates being paid today on core properties is to convert the cap rate to an earnings multiple as shown above. A 4% cap rate on a Class A office building in San Francisco is equal to an EBITDA multiple of 25x, which is unheard of in corporate finance circles. Investments in operating companies have higher risk than commercial real estate due to the quasi guarantee of income derived from tenant leases on real estate properties. Therefore, CRE investments should trade and be valued at higher cap rates than corporate investments, however, it's just the opposite today.

WALNUT CREEK, CA—As CRE becomes more institutionalized, especially with the growth of REITs, the lines between real estate and corporate finance valuation are blurring. That is according to Joseph Ori, executive managing director of Paramount Capital Corp. In the exclusive commentary below, Ori talks about how one way to increase your CRE acumen is to understand and apply corporate valuation and analysis to CRE.

The views expressed below are the Ori's own.

If you look at any Wall Street REIT analysis, cap rates are rarely used or mentioned in the valuation analysis process. Instead, analysts site metrics like funds from operation multiples, adjusted funds from operations, cash available for distribution, EBITDA margins and debt to EBITDA. Although the metrics and even terminology between CRE and corporate finance seem different, they are very similar. One way to increase your CRE acumen is to understand and apply corporate valuation and analysis to CRE.

First off, EBITDA, which is earnings before interest, taxes, depreciation and amortization, is a common cash flow measure that is used in corporate finance for company valuation purposes. Typically, a company is valued at a certain multiple of EBITDA. This is the enterprise value (EV) or the market value of the company's long term debt plus market capitalization of common stock less cash/marketable securities divided by its EBITDA. EBITDA multiples for a company typically range from 8 to 15 times. As an example, if the EV of a company is $10B and its EBITDA is $800M, the multiple is 12.5 times ($10B/$800M). This company trades at an EBITDA multiple 12.5x.

EBITDA in corporate finance is equivalent to net operating income (NOI) in CRE. Both are cash flow measures that exclude depreciation, amortization, capital improvements and interest and are used in valuation. The cap rate is the NOI divided by a property's value and is shown below:

Cap Rate = NOI/Property Value

The EBITDA Multiple formula is shown below:

EBITDA Multiple = EV/EBITDA

The inverse of the EBITDA multiple is equivalent to the cap rate formula as follows:

EV/EBITDA is the inverse of NOI/Property Value and,

EBITDA/EV = NOI/Property Value

An EBITDA multiple of 12 times is equal to a cap rate of 8.33% (100 divided by 12) or a cap rate of 4% is equal to an EBITDA multiple of 25 times (1 divided by 4%). If the average EBITDA multiple is 8x-15x, this means that operating companies trade at cap rates ranging from 6.7% to 12.5%. Another way to look at the low cap rates being paid today on core properties is to convert the cap rate to an earnings multiple as shown above. A 4% cap rate on a Class A office building in San Francisco is equal to an EBITDA multiple of 25x, which is unheard of in corporate finance circles. Investments in operating companies have higher risk than commercial real estate due to the quasi guarantee of income derived from tenant leases on real estate properties. Therefore, CRE investments should trade and be valued at higher cap rates than corporate investments, however, it's just the opposite today.