class powerpoint2: cash flow modeling Flashcards
what does the income statement of the cash flow of a property look like?
Rental Income + Ancillary Income - operating expenses = NOI (Net Operating Income)
- Selling, general and administrative expenses
= earnings before interest, taxes, depreciation and amortization (EBITDA)
- interest and financing expenses
- depreciation and amortization
= earnings before taxes
- income taxes
=Net Income
Why is the NOI (net Operating Income) the most crucial component if the income statement?
it is used as an approximation of the cash flow generated by the property
are interest and financing expenses, and depreciation and amortization part of cash flow?
naaah
why are income taxes not part of what influences cash flow?
These do not reflect operations of a building, only the tax position of the owner
are expense recoveries part of rent?
yeee
what are major exclusions from the NOI (Net Operating income)?
debt service
depreciation
income taxes
capital expenditures
tenant improvements (most of the time)
Leasing commissions (really depends)
why is debt service not part of NOI?
Financing costs are specific to the owner/investor
not included in calculating NOI
why is depreciation not part of NOI?
Depreciation is not an actual cash outflow, but rather an accounting entry
why are income taxes not part of NOI?
income taxes are specific to the owner/investor
why are tenant improvements most of the time not part of NOI?
Tenant improvements include construction within a tenant’susable spaceto make the space viable for the tenant’s specific use
Tenants are paid for the improvements to make but if they it cost more than the cheque they are given, tant pis
Its more of an investment as an expense so not day to day operation expense
why leasing commissions sometimes not part of NOI?
Commissions are the fees paid to real estate agents/brokers involved in leasing the space
why capital expenditures not part of NOI?
Capital expenditures are expenses that occur irregularly for major repairs and replacements
expenses that occur from time to time
Ex: elevator repair, redoing the roof, etc
You have enhanced the value of your building
Not a day to day operating expense
do capital expenditures include minor repairs and maintenance?
naaah boy
those would be considered operating expenses
rent
periodic payment received from tenants for the use of real property
how is rent expressed in commercial leases?
usually expressed as a dollar amount per square foot per year
Usually expressed on annual basis, if you want to find per month divide by 12
how is rent expressed in commercial leases?
usually expressed as a dollar amount per square foot per year
Usually expressed on annual basis, if you want to find per month divide by 12
Example: a 5,000 square foot space has a rent of $30/sq. ft. The tenant will pay rent of $12,500 per month
(5,000 ∗$30)/(12 𝑚𝑜𝑛𝑡ℎ𝑠)
= $12,500
are commercial leases usually long term or short term?
long term
why will rent generally increase during the term of the lease by a set amount or some other adjustment factor like inflation (CPI)?
because leases are more long term
In the long term, you want to rent revenue to be adaptable to inflation
what is it that defines the total rent?
Base rent
Percentage rent
Expense recovery
Rent free period
where are all elements of the rent be documented?
in the lease
why is it important to read all leases?
Cant afford to make mistakes, especially for larger properties such as malls
percentage rent
a rental payment that is based on the sales or income earned by the tenant
percentage rent breakpoint
certain level of sales or income over which percentage rent will begin
why would landlords include percentage rent in a lease?
Protection against high inflation
To attract or keep tenants
how does percentage rent protect landlords against inflation?
Inflation would make the sales go above the breakpoint more recurrently so they can get more and more cash each year
how does percentage rent attract or keep tenants?
It lowers their risk by lowering the base rent, so if they mess sup, they don’t pay much rent, but if they succeed, as a landlord your cashflow is still there
The most common formula for percentage rent is:
𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑟𝑒𝑛𝑡 =
(𝑎𝑐𝑡𝑢𝑎𝑙 𝑠𝑎𝑙𝑒𝑠 𝑏𝑟𝑒𝑎𝑘𝑝𝑜𝑖𝑛𝑡)
∗ 𝑝𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑓𝑎𝑐𝑡𝑜𝑟
Expense participation
when a tenant pays their proportionate share of certain operating expenses of the property
on which basis is the proportionate share of an expense participation calculated?
calculated as leased area/total leasable area
which are the most common expense participation clauses?
Gross Lease
Single Net Lease
Double Net Lease
Triple Net Lease
Gross Lease
rent is all-inclusive
landlord pays all or most expenses associated with the property, including taxes, insurance and maintenance out of the rents received from tenants
single net lease
the tenant pays base rent plus a pro-rata share of the building’s property taxes
double net lease
the tenant is responsible for base rent plus a pro-rata share of property taxes and property insurance
triple net lease
the tenant is responsible for base rent plus a pro-rata share of property taxes, property insurance and all other property operating expenses
which is the most popular type of expense participation in retail RE? why?
triple net lease
favors the landlord as it protects him against rising expenses
what is the use of True-Ups or CAM adjustments?
These are used to get the real year expenses and then either bill or refund the tenants
Expenses are estimated at the start of the year and adjusted to actuals at the end of the year
why do tenants hate True-Ups or CAM adjustments?
this because they do not know what to expect and they rarely get refunded
why will a landlord will often offer a rent-free period at the beginning of the lease?
as an incentive to the tenant
how is a rent free period beneficial to the tenant?
At the beginning of a lease the tenant often has expenses related to moving or starting-up his business
The rent-free period will help offset these costs
how are rent free periods accounted for?
accounted for on a straight-line basis
must be adjusted for when calculating cash flows
what are the steps of the cash flow modeling?
- Model each leasable space separately
- Consider any leases expiring during the forecasted period
- Forecast expenses for the period under consideration
- Estimate any non-revenue-generating capital expenditures
- Estimate any financing costs
- Estimate income taxes to be paid
- Prepare different scenarios by varying certain key assumptions: tenant retention, market rates, CPI, interest rate, economic conditions, etc.
what must you consider when you model each leasable space separately (1)?
Consider any rent adjustments or escalations under the lease
This may necessitate estimating CPI over a number of years
how can you estimate future percentage rent when modeling each leasable space separately?
looking at historical sales figures and growth
applying certain assumptions for their future growth (economic outlook, CPI, etc.)
how do you estimate expense recoveries (expense participation) when modeling each leasable space separately?
recoveries a forecast of expenses must be established
any changes to the leasable areas must be taken into consideration
when considering any leases expiring during the forecasted period (2), what must be considered?
Consider any renewal options the tenant has
the likelihood of them renewing the lease
the new rent
when considering any leases expiring during the forecasted period (2), what must be forecasted if there is a lease termination expectation?
Period of vacancy
New rent levels considering current market rents
Any rent-free periods that are likely to be offered
Leasing commissions on the new lease
Tenant allowances to prepare the space for the new tenant
what must taken under consideration when forecasting expenses (3)?
historical costs in order to identify all relevant expenses
Consider and adjust for any non-recurring items
Increasing historical costs by applying an escalation factor (CPI is the most widely used basis)
any new costs that are likely to arise
when estimating any non-revenue-generating capital expenditures (4), what can historical trends maybe indicate?
may indicate a certain level of capital expenditure is required to replace and adjust the structure and its mechanical systems
what must be considered when estimating financial ring costs (5)?
Consider in place financing or any future financing
May require forecasting of interest rates
what are the different scnerios when preparing different scenarios by varying certain key assumptions: tenant retention, market rates, CPI, interest rate, economic conditions, etc. (7)?
Most likely
Optimistic
Pessimistic
what does the cost of bringing new commercial space to the market include?
development
construction costs
when do development costs usually begin?
will start before construction begins
how are development costs also known as?
soft costs
what costs do development costs include’
professional services
environmental studies and land remediation
land acquisition (sometimes included as a hard cost)
permits and zoning
project management costs
lease-up and operating costs to bring a property to a stabilized level
financing costs
what do professional services in development costs usually include?
legal
architecture
engineering
surveyors
can land acquisition sometimes be considered a hard cost?
ye boooy
what do the construction costs or hard cost consist of?
site preparation
actual building costs
building access roads and ramps, landscaping
what is site preparation
leveling
demolition
clearing
how do construction companies operate?
will often give a fixed price contract based on the approved building plans
where can average constructions costs be obtained?
third party sources in the market
once more, are capital expenses part of operating expenses?
nah boy
what is an expense stop?
an expense stop is a certain level of participation expense where anything under the stop will be paid by landlord
tenant will pay any expenses that go over the stop
for ex: if expense stop is $10 per square foot and expenses are $12.00 per square foot, then tenant will pay $2.00 of participation expense per square foot
