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Chapter 14 Cash Flow Analysis

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

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Chapter 14 Cash Flow Analysis

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  1. Chapter 14Cash Flow Analysis

  2. 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

  3. 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…

  4. “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.

  5. PGI and EGI Apartment rent = $1/SF/month 80,000 SF apartment complex Vacancy rate = 5% PGI = $1*80,000 = $80,000 EGI  Vacancy allowance = 5% * $80K = $4,000 EGI = $80,000 - $4,000 = $76,000

  6. 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”

  7. 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

  8. Getting to CF’s • NOI ≈ EBITDA • Depreciation expense • Interest expense, Debt PMT • Taxes

  9. Getting to CF’s Depreciation Allowances: Assets Class Depreciable Life Non-Residential 39 years Residential 27.5 years Land Improvements 15 years All done straight-line Personal property MACRS life

  10. Depreciation Value: Reduces taxable income, reduces taxes, increases CF $100K NOI, t = 30%, Debt PMT = $0 CF with and without $60K depreciation expense?

  11. NOI $100K -Depr 0 Taxable Inc $100K -Taxes $ 30K NI $ 70K DebtPMT 0 CF = (NOI-Tax-PMT) $ 70K $100K $ 60K $ 40K $ 12K $ 28K 0 $ 88K Depreciation

  12. Depreciation Value of $60K Depreciation = $18K Depreciation Expense * tax rate = $18K Value of Depreciation = DeprExpense * t

  13. Finally, Operating CF’s NOI -Depreciation -Interest Expense Taxable Income -Taxes Net Income Why is NI  CF?

  14. Operating CF • NI includes Depreciation Expense • NI includes Interest Expense, but not Principal Repayment Operating CF = NOI – DebtPMT – Taxes

  15. Operating CF Example Year 1: $200K NOI 30% tax rate Yearly Depreciation = $30K Financed by 30-year, 7%, $1M loan

  16. Operating CF Example Monthly Loan PMT = $6,653 Yearly Loan PMT = $6,653 * 12 = $79,836 1st year’s Interest Expense =CUMIPMT(7%/12,360,1000000,1,12,0) or 1 Input 12 AMORT = $69,678 2nd year’s Interest Expense =CUMIPMT(7%/12,360,1000000,13,24,0) 13 Input 24 AMORT = $68,944

  17. Operating CF Example Year 1 2 NOI $200,000 $200,000 -Interest $69,678 $68,944 -Depreciation $30,000 $30,000 Taxable $100,322 $101,056 -Taxes $30,097 $30,317 Net Income $70,255 $70,739

  18. Operating CF Example Year 1 2 NOI $200,000 $200,000 -DebtPMT $79,836 $79,836 -Taxes $30,097 $30,317 Operating CF $90,067 $89,847

  19. 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

  20. Value Ratios • “Going-in” Cap Rate = NOI1÷ Price0 -- invert to get -- • Price0 = NOI1 ÷ Cap Rate -- generalize to get -- • Pricet = NOIt+1 ÷ Cap Rate

  21. 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?

  22. Capitalization Rate • Cap Rate = NOI1 P0 • P0 = NOI1 Cap Rate • P0 = $85,000  0.08 • P0 = $1,062,500

  23. 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

  24. 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

  25. 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: • +$2.4M (Selling P)

  26. Terminal CF Example • Loan Repayment: Original: 360 N, 7 I/YR, 1.6M PV  PMT = 10645 Now  60 N, FV =??? Loan Repayment CF = -$1,506,105

  27. Terminal CF Example • Capital Gain Tax CF: Original Basis Yearly Depr Land = $200K $0 Warehouse = $1.8M  39 years = $46,154 Total Depr = 5 years * $46,154 = $230,770 Gain = Selling P – Original Basis Gain = $2.4M -$2M = $400K

  28. Terminal CF Example • Capital Gain Tax CF Continued: Gain Tax = Gain * 15% = $400K * 15% = $60K Recapture Tax = $230,770 * 25% = $57,693 CG Tax = $60K + $57,693 CF = - $117,693

  29. Terminal CF Example Net Terminal CF: • Selling P = +$2,400,000 • Loan Repayment = -$1,506,105 • CG Tax = -$ 117,693 Net Terminal CF = +$ 776,202

  30. END

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