Real Estate Private Equity Technical Interview Questions To Prepare For

Technical questions during the interview process are becoming more and more common in commercial real estate, and these can be extremely difficult to answer if you don’t come in prepared.

And while these questions usually don’t require complex mental math, there are a few concepts and key terms you’ll want to make sure to go in being aware of.

So make sure you’re ready in case these questions come up during the process, this post walks through a few of the most common technical interview questions I’ve seen asked in commercial real estate interviews, and how you might want to think through the answers to each.

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Question #1: “Which of Two Identical Properties Would You Pay More For?”

The first type of question that I’ve heard a lot over the years tests a candidate’s knowledge of what drives property values.

This often shows up as a question along the lines of:

“If you have two identical properties, both in the same location, generating the same income, which one of those properties would you pay more for?”

When this question is asked, interviewers are usually looking to assess your understanding of the quality of income that each property generates, and how much certainty you can have that this income will continue.

Factor #1: Credit Quality

The first factor to consider (and often what interviewers are looking for most in your answer) is the difference in credit quality between the two buildings, with the property with stronger credit tenants commanding a higher price point.

Credit quality measures how likely it is that a tenant will pay all of its lease obligations over the entire term of the lease, and the more certainty an investor has that this will be the case, the more they’re going to be willing to pay to acquire that property.

Factor #2: Length of Lease Term

The term of the lease itself can also be really important, and this will directly factor into the value of each property. Assuming credit quality is equal between the two buildings, the longer the lease term, the more income certainty an investor has over a longer period of time, and the higher the property value is typically going to be.

Factor #3: Assumable Financing

If credit quality and lease term are both identical, another thing that might cause a difference in value is any attractive financing that might be assumable on either property. If this is the case, the buyer could step in and assume an existing below-market interest rate, which could allow them to pay more and still hit their target returns.

Other Potential Factors

Other things that could play into value differences could be below-market rents at one property (that would lead to higher upside for a buyer when leases turn over) or above-market expenses at one property that an investor could quickly bring down. However, when you’re asked this question, interviewers are usually going to be looking most for your understanding of credit quality and the certainty of income that each property will generate.

Question #2: “When Inflation Is High, Which Types of Properties Would You Want to Own?”

The next type of question you’ll want to prepare for is related to real estate product types and what types of properties are most attractive in certain market conditions.

A common question here goes something along the lines of:

“When inflation is high, which types of properties would you want to own?”

Short-Term Leases

When this is the case and costs are increasing, property owners usually want to be able to raise rents as quickly as possible. This makes hotels (where rates change daily), self-storage properties (where rates often change monthly), and multifamily properties (where rates often change yearly) the typical go-to product types in these market conditions.

Commercial Leases

Retail, office, and industrial leases often have lease terms that range from anywhere between about 5-10 years or more (with fixed rent escalation schedules), which means that a property owner can easily fall behind if market rents are rising quickly.

With that said, one redeeming quality of commercial property types is that, unlike hotels, self-storage, and multifamily properties, some commercial leases call for the tenants to reimburse the property owner for their pro rata share of the operating expenses incurred by the property. And when this is the case, this can be really helpful to smooth out net operating income when prices are rising across the board.

CPI Escalations and Percentage Rent

Some commercial leases will also have rent escalations that are directly tied to changes to the Consumer Price Index (CPI), which can be really helpful in an inflationary environment. On retail leases specifically, you may also see what’s referred to as a percentage rent clause, which allows a property owner to receive a percentage of the overall sales generated by a tenant as prices rise over time.

The Bottom Line

In general, the more quickly a property can benefit from higher rents or protect itself from expense increases, the more attractive that property is going to be when inflation is high. And because of this, answers related to hotels, self-storage, or multifamily are all usually safe bets if you’re asked this question.

Question #3: “How Do Interest Rates Affect Cap Rates and Property Values?”

The next type of question you’ll want to prepare for tests your knowledge of the relationship between interest rates and cap rates, and this often goes something along the lines of:

“How do changes in interest rates affect cap rates and property values?”

Because rising interest rates cause borrowing costs to increase, this reduces cash flows available to distribute, which means that investors will typically need to pay less for the same properties to hit their target returns.

When this happens, the NOI of a property ends up being a larger percentage of the overall purchase price that investors are willing to pay, and since cap rates are calculated by dividing the NOI of a property by the purchase price, this results in higher cap rates throughout the real estate market.

The Risk-Free Rate

Part of the reason this relationship also tends to exist is that higher interest rates also produce a higher risk-free rate of return, which can incentivize investors to put their money in safer, more liquid assets that offer similar yields.

The Bottom Line

The key thing to know when thinking through your answer here is that when interest rates rise, cap rates also tend to rise, leading to real estate values falling. When interest rates fall, cap rates also tend to fall, leading to real estate values rising. This is typically a result of a mixture of increased borrowing costs that reduce investor cash flow and other more attractive opportunities that come up in safer, more liquid investment vehicles.

Don’t Forget About Mental Math and Excel Skills

It’s worth noting that these are all qualitative questions that require a candidate to apply their knowledge in a more open-ended format, but if you want to make sure you’re prepared for some more quantitative mental math questions related to metrics like the IRR, equity multiple, or cap rate, you may also want to watch this video. This goes over some of the most common mental math questions that come up during the real estate interview process, and how you might want to answer each.

It’s also important to note that technical questions like these are still relatively rare in commercial real estate interviews, and in the vast majority of cases, CRE firms will rely almost exclusively on an Excel modeling exam to test a candidate’s technical knowledge.

How To Prepare For Technical Interviews

If you want to make sure you have the technical skills you’ll need to pass an Excel modeling exam that might be given to you during the interview process at commercial real estate firms, make sure to check out our all-in-one membership training platform, Break Into CRE Academy.

A membership to the Academy will give you instant access to over 120 hours of video training on real estate financial modeling and analysis, you’ll get access to hundreds of practice Excel interview exam questions, sample acquisition case studies, and you’ll also get access to the Break Into CRE Analyst Certification Exam, which covers topics like real estate pro forma and development modeling, commercial real estate lease modeling, equity waterfall modeling, and many other real estate financial analysis concepts that will help you prove to employers that you have what it takes to tackle the responsibilities of an analyst or associate at a top real estate firm.