This may be a stupid question but if you are using operating cash flow from a property to pay for capital expenditures (leasing commissions, TI allowance, etc.) in any given year, should that in turn affect your future cash on cash return by increasing your equity in the project by the amount contributed from operating cash flow? Or, should the cost simply be added as part of the total project cost without affecting your equity basis? Hope my question makes sense and would appreciate the help.
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Cash on Cash Return - CF for capex? (Originally Posted: 01/31/2015)
This may be a stupid question but if you are using operating cash flow from a property to pay for capital expenditures (leasing commissions, TI allowance, etc.) in any given year, should that in turn affect your future cash on cash return by increasing your equity in the project by the amount contributed from operating cash flow? Or, should the cost simply be added as part of the total project cost without affecting your equity basis? Hope my question makes sense and would appreciate the help.
I think you would add it to the cost basis (debt/equity of the project depending on how it is financed). I think core guys would tend not to worry so much about the impact of capex on cash on cash returns, but on the opportunistic side, capex can have significant impact on your all in basis. This is just my opinion on the matter from my experience in the industry. Take it with a grain of salt.
You can either a deduct it from the numerator (i.e. operating cash flow) or b add it to the denominator (i.e. equity basis). I've seen it done both ways (but not both at the same time, since that would understate returns). In my opinion, the decision should depend upon whether the TI/LC/capex work is expected to be x capitalized (reserved for) upfront, which can be required by lenders, or y actually paid for with future operating cash flow. Hope this helps.
Thanks for the input. Thinking about points a and b - it seems that if you include capex in a you would only be reducing that year's operating cash flow by the capex amount and there would actually be positive movements on the c-on-c return in the future due to a new tenant rent coming in if the capex was for leasing activities. However, if you include it in b then your equity basis would increase and all things constant for the next 3,5,10 years, the equity basis would stay at that higher level and consequently reduce your cash-on-cash all those years. I edited my original post and attached a PDF of what I mean by the aforementioned.
The answer is that it entirely depends upon timing, which will be impacted by various factors, such as lender requirements (i.e. repairing maintenance items) and project requirements (i.e. do the expenditures need to occur immediately in order to realize new rents?).
This depends on the lender. Some lenders will finance the TI and LC as long as the LTV is still within their parameters. If it isn't then it will be out of pocket for you. Also going forward, their are reserves that are factored into your cash flow. So you'll have reserves for TI and LC, similar to replacement reserves. This allows you to see a smoother cash on cash return over a course of time rather than volatile returns each time a tenant leaves. Hope this helps.
Cash on Cash Return (Originally Posted: 06/26/2013)
A popular metric funds use to evaluate the performance of a CRE proeprty is Cash-on-Cash Return, or Cash Yield, which can be viewed on an unlevered (no debt, just cash flow) or levered (cash flow minus debt Service costs) basis. My understanding of COC is simply:
COC = Cash Flow Year-X (numerator) / Equity Invested (basis/denominator)
My question, should you choose to answer it, is how Capital Expenses factor into the basis. Typically, I've kept the basis the same (Purchase Price + Closing Cost + Upfront Capital) throughout the analysis period, but using GAAP shouldn't one add to the basis if one is spending money to "improve" the property?
This formula gets tricky because you are then double-counting the capital expense (i.e. $500K Roof Repair in Year 2) above the line - as you subtract $500K from NOI, as well as adding to Equity Basis (adding $500K to formula above PP + CC + Upfront Capital).
If the basis (denominator) changes year over year I think it makes more sense to use NOI as the numerator, which is formally known as Income Yield.
LIY = NOI Year-X (numerator) / Total Capital Invested (basis/denominator)
Where Total Capital Invested = Purchase Price + Closing Costs + Upfront Capital b + TI's + LC's + Capital Expenditures [/b]
Really it's just different ways to skin a cat, wondering if any the vets would like to opine on the subject.
I've always used the following: Return on Cost = NOI/Total Costs (PP, TI's, LC's, Reno, CC's, fees, etc.) Cash on Cash (Equity) = NOI-Debt Service/Equity And your Cash on Cash Unlevered is a CAP Rate = NOI/PP
Cap rates are not a net number so they cannot be used as cash on cash returns, they ignore taxes and captial expenditures. Your cash on cash should be PP/(NOI-Debt service-Taxes-CapEx).
Thoughts from experts?
correct. at least, that is how i've always done it. i've never worked anywhere that included taxes in the model, though.
i would assume taxes are already accounted for in the NOI
I am going to have to disagree with you maddux. As kmzz said, taxes are already accounted for on the property level. The income tax burden is a separate matter. As for your Cash on Cash formula, I don't believe that is correct (and the PP or Equity should be in the denominator).
Cash on Cash Returns for RE deals (Originally Posted: 09/27/2013)
Question for you RE modelers and junkies...
How would you calculate COC return for a development deal, where I need an annual COC return calc?
The two issues I am having are:
1) What is the value of the development as it is being constructed (2-3 year window)
2) What is the best method to determine a terminal value in RE modeling?
Unlevered CoC is NOI / Total Development Cost (including land if not a sunk cost)
Levered CoC is FCF / Equity Investment
Generally the value of a construction site is Land + construction costs (ie replacement value)
Terminal value is generally calculated with a Cap out rate (NOI/cap rate in terminal year)
Awesome. SB for the help. Thx.
Sounds like doing a sensitivity analysis there.
I'm pretty sure unlevered cash on cash is NOI/Equity, not NOI/Total Development cost. TDC would more than likely include a mix of debt/equity.
Its unlevered so equity = cost.
In general, your terminal cap rate should be 50-100 or more basis points higher than your going-in or "current" day cap rate as well.
can someone comment on this? i was under the impression that cap rates fall as a property appreciates in value due to increased rents and stabilized operations.
Your cap rate or yield on cost obviously increases as income increases. Market cap rate is dictated by the market - supply/demand for that property type in that location.
So if i build into a 7 cap, my year 2 cap/yoc may be 8, then 9, and so on until it stabilizes, at which point if you wanted to sell, cap rate would be dictated by the market at the time - maybe buyers are paying a 6 cap for that type of property, maybe an 8...
However, in real life there is no "other things constant", because supply/demand and market conditions are changing all the time. If interest rates are lowered during your holding period, it will cause cap rates to decrease, progressing inflation causes cap rates to increase, overdevelopment of the region (i.e. exessive supply) causes cap rates to increase, etc. And you never now how all these market factors will result on a "net" basis - maybe they will accelerate your property value appreciation (expressed in cap rate), maybe slower it down or maybe outweight it and cause the increase in cap rates (depreciation from certain perspective).
@positive In an unlevered development the total development costs would be all equity anyways...
Cap rates are market driven and among dozens of factors very closely correlated to the treasury and expected inflation. common practice is to cap out at a higher rate than your cap in.
One more question... to get the terminal cash flow/value, it would be (NOI/cap rate) - net debt, right?
you might include a deduction for closing costs, but generally speaking, yes. typically, you will cap your forward year NOI
Right, but is that net of remaining net debt? Assuming you sell for NOI/cap, you still have to pay off the debt obligations with anything beyond existing cash, no?
Obviously...
meaning the terminal year cash flow should be the sale price + fcf - debt balance
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