Cash on cash if operating shortfall is capitalized
Hey all - thinking through some conceptual questions when it comes to modeling. If you end up taking any operating shortfall (including NOI shortfall, capitalized interest, and other capitalized capex) and add those to your starting basis, when you are rolling up monthly cash flows to annual to calculate cash on cash, you wouldn't "count" or add in the negative cash flows right? Otherwise, you would be both adding to your basis and being punitive to your annual cash flow. In reality, I guess you would have a contra "negative" item that would cover these deficits as you are raising debt/equity upfront and can cover these.
Thanks!
Cash on cash by definition has total equity investment in the denominator so you would incorporate those. If you have an operating shortfall your cash on cash return will be negative for that period and that negative has to come from somewhere (equity or debt).
Okay, so little difference between capitalizing an expense on an operating property vs expensing. What you are referring to is for an acquisition, and you want to "capitalize" this long term expense. Which it really isn't an operating expense, but it does add to the equity, which is how capex is shown.
-Capitlize the short fall. Recover that in a below the line "reserve" account, which should net out the negatives. This is easier in a fund, and takes some finesse, but if the carry is small in an operating company that doesn't have mandated distributions to LPs or other investors, then you can choose to carry negative. But don't do a monthly, I would look at the carry costs on a quarterly basis, or whenever the JV docs have you distributing cash.
If you're putting it in your initial cost basis then yes. The way we usually underwrite this is to include any shortfall as an operating reserve in our acquisition costs (i.e. increased basis) then offset the negative cash flows with money from the reserve as needed so there's no double counting.
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