Chapter 14 Cash Flow Analysis. Major Topics How to develop a multiyear proforma that estimates cash...
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Transcript of Chapter 14 Cash Flow Analysis. Major Topics How to develop a multiyear proforma that estimates cash...
Chapter 14
Cash Flow Analysis
Major Topics
How to develop a multiyear proforma that estimates cash flows from real estate investment
How to estimate the revenues, expenses and debt service that feed into a proforma
Important financial ratios such as the debt service coverage ratio
Key financial return and ratio measures
Introduction
Cash flow drives values for income property
Current and future returns are a based upon cash flow estimates
Appreciation is driven by increases in the cash flow
Development, acquisition, leasing, marketing and management decisions are all driven by or intended to influence cash flows
Value of any asset equals…
“Reconstructed Operating Statement”
Appraiser estimates “stabilized” revenues and expenses
Potential Gross Income = Market rent * Space available
Effective Gross Income = PGI – Vacancy Allowance Vacancy Allowance estimated as a % of PGI
Miscellaneous Income Parking, laundry, etc.
PGI and EGI
Apartment rent = $1/SF/month80,000 SF apartment complexVacancy rate = 5%PGI = $1*80,000 = $80,000EGI Vacancy allowance = 5% * $80K =
$4,000
EGI = $80,000 - $4,000 = $76,000
Expenses
Operating Expenses Fixed Property taxes, hazard insurance Variable Utilities, maintenance,
supplies Capital Expenditures ( “replacement
reserve”) = allowances for replacements and alterations that increase asset life/value
New roof, new fridge, new AC Prorated as a constant annual
“expenditure”
Reconstructed Operating Statement
PGI Potential Gross Income- Vac Vacancy Allowance+ MI Miscellaneous Income= EGI Effective Gross Income- OE Operating Expenses= NOI Net Operating Income
NOI ≈ EBITDA
Getting to CF’s
NOI ≈ EBITDA Depreciation expense Interest expense, Debt PMT Taxes
Getting to CF’s
Depreciation Allowances:
Assets Class Depreciable LifeNon-Residential 39 yearsResidential 27.5 yearsLand Improvements 15 years
All done straight-linePersonal property MACRS life
Depreciation
Value: Reduces taxable income, reduces taxes,increases CF
$100K NOI, t = 30%, Debt PMT = $0CF with and without $60K depreciation
expense?
Depreciation
NOI $100K-Depr 0Taxable Inc $100K-Taxes $ 30KNI $ 70KDebtPMT 0CF = (NOI-Tax-PMT)$ 70K
$100K$ 60K$ 40K$ 12K$ 28K 0$ 88K
Depreciation
Value of $60K Depreciation = $18K
Depreciation Expense * tax rate = $18K
Value of Depreciation = DeprExpense * t
Finally, Operating CF’s
NOI-Depreciation-Interest ExpenseTaxable Income-Taxes Net Income
Why is NI CF?
Operating CF
1. NI includes Depreciation Expense2. NI includes Interest Expense, but not
Principal Repayment
Operating CF = NOI – DebtPMT – Taxes
Operating CF Example
Year 1:$200K NOI30% tax rateYearly Depreciation = $30KFinanced by 30-year, 7%, $1M loan
Operating CF Example
Monthly Loan PMT = $6,653Yearly Loan PMT = $6,653 * 12 = $79,8361st year’s Interest Expense=CUMIPMT(7%/12,360,1000000,1,12,0)or1 Input 12 AMORT = $69,678
2nd year’s Interest Expense=CUMIPMT(7%/12,360,1000000,13,24,0)13 Input 24 AMORT = $68,944
Operating CF Example
Year 1 2NOI $200,000 $200,000-Interest $69,678 $68,944-Depreciation $30,000 $30,000Taxable $100,322 $101,056-Taxes $30,097 $30,317Net Income $70,255 $70,739
Operating CF Example
Year 1 2NOI $200,000 $200,000-DebtPMT $79,836 $79,836-Taxes $30,097 $30,317Operating CF $90,067 $89,847
Leverage ratios
Loan to Value Ratio = Loan ÷ Price “Equity buffer”
Debt Coverage Ratio = NOI1 ÷ Yearly PMT “Income buffer”
Breakeven Point = (OpExp + PMTs) ÷ PGI OpExp Ratio = OpExp ÷ EGI
Value Ratios
“Going-in” Cap Rate = NOI1 ÷ Price0
-- invert to get --
Price0 = NOI1 ÷ Cap Rate
-- generalize to get --
Pricet = NOIt+1 ÷ Cap Rate
Capitalization Rate
If we know market Cap Rate, and we estimate NOI1, we have an estimate of
market value of property. Buying apartment complex:
Cap Rate on San Marcos apartments = 8% Expect NOI1 to be $85,000.
How much to bid?
Capitalization Rate
Cap Rate = NOI1 P0
P0 = NOI1 Cap Rate P0 = $85,000 0.08 P0 = $1,062,500
Capitalization Rate
Apartment Valuation Example again We expect to hold for 10 years, then sell P10 = NOI11 Cap Rate Assume NOI grows 3% per year
P10 = ($85K * (1.03)10) 0.08 P10 = $1.428M
Terminal CF
CF’s realized from selling property 1. Selling P received 2. Loan repayment 3a. Capital Gains Tax
= CG Tax rate * Gain Gain = Selling P – Original Basis
3b. Depreciation Recapture Tax = Ordinary Income Tax r * Total Depr taken
Terminal CF Example
5 years ago, bought $2M property -- warehouse ($1.8M) & land ($200K) -- financed by $1.6M 30-year 7% loan
Today, selling for $2.4M Tax rates = 25% Ordinary, 15% CG
CF’s:1. +$2.4M (Selling P)
Terminal CF Example
2. Loan Repayment:Original: 360 N, 7 I/YR, 1.6M PV PMT =
10645Now 60 N, FV =???
Loan Repayment CF = -$1,506,105
Terminal CF Example
3. Capital Gain Tax CF: Original Basis Yearly DeprLand = $200K $0Warehouse = $1.8M 39 years = $46,154
Total Depr = 5 years * $46,154 = $230,770
Gain = Selling P – Original BasisGain = $2.4M -$2M = $400K
Terminal CF Example
3. Capital Gain Tax CF Continued:Gain Tax = Gain * 15% = $400K * 15% = $60KRecapture Tax = $230,770 * 25% = $57,693
CG Tax = $60K + $57,693CF = - $117,693
Terminal CF Example
Net Terminal CF:1. Selling P = +$2,400,0002. Loan Repayment = -$1,506,1053. CG Tax = -$ 117,693Net Terminal CF = +$ 776,202
END