Technical Question - Until Today / Forward Looking Returns
Hi all,
Technical question:
I am asked to calculate forward looking returns for an investment.
Situation:
Building value today 10m USD
Loan Amount 25m USD
Loan is recourse, so has to be paid back fully by the fund if we sell.
For forward looking returns, building value - loan = NAV is usually the starting point, however here we have a negative NAV.
Until today returns are clear in my opinion, returns would take into account the expected loss of the sale which is 15m USD.
However, what about forward looking returns. I would argue that the loss of the higher-than-building value loan is already incurred until today in the returns and should be ignored forward looking. Then the basis for the forward looking returns would simply be -10m USD. Others argue, the basis for the forward looking returns should be loan minus value = -15m USD (as that is the amout of money for us to get the building unencumbered) I find this hard to accept as forward looking returns are done usually on a positive NAV and Ive never seen them for negative NAV.
I think the tricky part of this exercise is that the loan is still taken over into the forward looking segment of returns, but the loss already occured.
Best,
Frank
Based on the most helpful WSO content, here's how you can approach this:
The crux of the issue lies in how you define the starting point for forward-looking returns when dealing with a negative NAV. Here's a breakdown of the perspectives:
Your Argument (-10m USD Basis):
You argue that the loss from the higher-than-building-value loan has already been incurred and reflected in the "until today" returns. Therefore, forward-looking returns should exclude this loss and start with the remaining NAV, which is -10m USD. This approach assumes that the forward-looking returns are based on the current state of the investment, ignoring past losses.
Counter Argument (-15m USD Basis):
Others argue that the forward-looking returns should account for the full loan amount relative to the building value, as the loan must still be repaid to unencumber the building. This would set the starting point at -15m USD, reflecting the total liability that needs to be addressed moving forward.
Key Considerations:
Forward-Looking Returns on Negative NAV:
While it's uncommon to calculate forward-looking returns on a negative NAV, it is not impossible. The key is to clearly define the assumptions and methodology. If the loan is recourse and must be repaid, the -15m USD basis might be more accurate as it reflects the true financial position moving forward.
Treatment of Past Losses:
If you exclude the past loss (15m USD) from forward-looking returns, you risk understating the financial burden of the investment. Forward-looking returns should ideally reflect the full scope of obligations, including the loan repayment.
Suggested Approach:
To reconcile these perspectives, you could calculate forward-looking returns under both scenarios (-10m USD and -15m USD) and clearly disclose the assumptions behind each. This would provide a comprehensive view and allow stakeholders to interpret the results based on their preferred methodology.
In summary, while your argument (-10m USD) simplifies the calculation by excluding past losses, the counterargument (-15m USD) provides a more conservative and realistic view of the financial position.
Sources: Working in FIG (Financial Institutions Group) - An Overview., Multi-Family Acquisitions Excel Test, Difficult Accounting Technical - IBD, Specialty Lending (GS/TPG) - Any insights?, How do you compute IRR without any negative cash flows?
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