I'm analyzing a property that has a large special tax assessment tied to it, with the option to prepay the assessment now and never have to pay the yearly expense amount again.
The prepayment amount now is $2MM and the yearly assessment is $110,000, growing at 2% over the course of the hold period. So spend $2MM now or pay ($110K*1.02) for n number of years.
My main question is: at the end of the hold period, should I be capitalizing the assessment expense in Year n+1 at the cap rate we're disposing the property at, in the same manner you'd cap Year n+1 NOI to arrive at a sales price? Or should I only be taking into account the stream of potential expenses/savings less prepay amount?
I would say base the NVP solely on cash flow savings, since disposition variables are so, well, variable. It will be considered in your analysis anyway in the disposition price because you'll be capping the NOI in year n+1 without that additional tax expense.
Don't overthink the model. You have 2 basic scenarios.
Option 1: $-2M in time 0, CF1, CF2...CFn + terminal value (where you cap the time n NOI--with no taxes--by your disposition cap rate). Discount your cash flows by your discount rate and you get your NPV.
Option 2: CF1, CF2...CFn + terminal value (where you cap the time n NOI--WITH taxes--by your disposition cap rate). Discount your cash flows by your discount rate to get your NPV.
Higher NPV = "right" answer
Simple, simple.
Thanks, I realized after I posted that it's pretty simple. Was just having one of those moments where you overthink things. I blame it on it being Friday.
I disagree to an extent. This would be true if the payments went into perpetuity, but there's a strong likelihood that given what you've outlined above, the payments have a finite period. If they provided a payoff value, that most likely means they've done an amortization table of some kind, implying an end date. I doubt they would do this if the payment period was indefinite. The reason that's relevant is that most investors wouldn't cap the decreased NOI on the residual unless it was many years into the future (multiple hold periods), since whatever you cap implies that that cash flow/income more or less extends into perpetuity.
With the 2% increases, this thing gets paid off in full in less than 18 years if you assume a straight line. Is this a voter-indebted bond? If so they usually have the phone number on the tax bill of the gov. authority you can call to get the exact pay-down schedule and the details. I've seen this a lot in several markets. You could value it the way mentioned in the other post and it's not wrong, but you might lose the deal since some other people looking at the investment may look at it the way I outlined above, which would probably get you to a higher value/return up front.
If you think about the converse, in a lot of the deals I've seen where there is a tax abatement/credit, if it lasts 12 years let's say, and your hold period is 10 years, most investors wouldn't buy into the logic that you cap the year 11 NOI with the lower tax base/higher margin since it's going to burn off a year or two after that, and you wouldn't get credit for it when you go to sell if trying to sell to an IRR buyer. You would just take the NPV of whatever the cost savings is over 12 years, add that to your purchase price, and then cap the adjusted NOI on the front end for the purchase price and the back end for the residual.
big question here is what is the discount rate you would use. Heard many different theories on the subject, but most often from the best tax-deal shops I've worked with use the deal's cap rate. Think most of the other points have been discussed here.
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