class powerpoint2: cash flow modeling

Question 1

what does the income statement of the cash flow of a property look like?

Answer 1

Rental Income + Ancillary Income - operating expenses = NOI (Net Operating Income)

• Selling, general and administrative expenses

= earnings before interest, taxes, depreciation and amortization (EBITDA)

• interest and financing expenses
• depreciation and amortization

= earnings before taxes

• income taxes

=Net Income

Question 2

Why is the NOI (net Operating Income) the most crucial component if the income statement?

Answer 2

it is used as an approximation of the cash flow generated by the property

Question 3

are interest and financing expenses, and depreciation and amortization part of cash flow?

Answer 3

naaah

Question 4

why are income taxes not part of what influences cash flow?

Answer 4

These do not reflect operations of a building, only the tax position of the owner

Question 5

are expense recoveries part of rent?

Answer 5

yeee

Question 6

what are major exclusions from the NOI (Net Operating income)?

Answer 6

debt service

depreciation

income taxes

capital expenditures

tenant improvements (most of the time)

Leasing commissions (really depends)

Question 7

why is debt service not part of NOI?

Answer 7

Financing costs are specific to the owner/investor

not included in calculating NOI

Question 8

why is depreciation not part of NOI?

Answer 8

Depreciation is not an actual cash outflow, but rather an accounting entry

Question 9

why are income taxes not part of NOI?

Answer 9

income taxes are specific to the owner/investor

Question 10

why are tenant improvements most of the time not part of NOI?

Answer 10

Tenant improvements include construction within a tenant’susable spaceto make the space viable for the tenant’s specific use

Tenants are paid for the improvements to make but if they it cost more than the cheque they are given, tant pis

Its more of an investment as an expense so not day to day operation expense

Question 11

why leasing commissions sometimes not part of NOI?

Answer 11

Commissions are the fees paid to real estate agents/brokers involved in leasing the space

Question 12

why capital expenditures not part of NOI?

Answer 12

Capital expenditures are expenses that occur irregularly for major repairs and replacements

expenses that occur from time to time

Ex: elevator repair, redoing the roof, etc

You have enhanced the value of your building

Not a day to day operating expense

Question 13

do capital expenditures include minor repairs and maintenance?

Answer 13

naaah boy

those would be considered operating expenses

Question 14

rent

Answer 14

periodic payment received from tenants for the use of real property

Question 15

how is rent expressed in commercial leases?

Answer 15

usually expressed as a dollar amount per square foot per year

Usually expressed on annual basis, if you want to find per month divide by 12

Question 16

how is rent expressed in commercial leases?

Answer 16

usually expressed as a dollar amount per square foot per year

Usually expressed on annual basis, if you want to find per month divide by 12

Example: a 5,000 square foot space has a rent of $30/sq. ft. The tenant will pay rent of $12,500 per month

(5,000 ∗$30)/(12 𝑚𝑜𝑛𝑡ℎ𝑠)

= $12,500

Question 17

are commercial leases usually long term or short term?

Answer 17

long term

Question 18

why will rent generally increase during the term of the lease by a set amount or some other adjustment factor like inflation (CPI)?

Answer 18

because leases are more long term

In the long term, you want to rent revenue to be adaptable to inflation

Question 19

what is it that defines the total rent?

Answer 19

Base rent

Percentage rent

Expense recovery

Rent free period

Question 20

where are all elements of the rent be documented?

Answer 20

in the lease

Question 21

why is it important to read all leases?

Answer 21

Cant afford to make mistakes, especially for larger properties such as malls

Question 22

percentage rent

Answer 22

a rental payment that is based on the sales or income earned by the tenant

Question 23

percentage rent breakpoint

Answer 23

certain level of sales or income over which percentage rent will begin

Question 24

why would landlords include percentage rent in a lease?

Answer 24

Protection against high inflation

To attract or keep tenants

Question 25

how does percentage rent protect landlords against inflation?

Answer 25

Inflation would make the sales go above the breakpoint more recurrently so they can get more and more cash each year

Question 26

how does percentage rent attract or keep tenants?

Answer 26

It lowers their risk by lowering the base rent, so if they mess sup, they don’t pay much rent, but if they succeed, as a landlord your cashflow is still there

Question 27

The most common formula for percentage rent is:

Answer 27

𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑟𝑒𝑛𝑡 =
(𝑎𝑐𝑡𝑢𝑎𝑙 𝑠𝑎𝑙𝑒𝑠 𝑏𝑟𝑒𝑎𝑘𝑝𝑜𝑖𝑛𝑡)
∗ 𝑝𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑓𝑎𝑐𝑡𝑜𝑟

Question 28

Expense participation

Answer 28

when a tenant pays their proportionate share of certain operating expenses of the property

Question 29

on which basis is the proportionate share of an expense participation calculated?

Answer 29

calculated as leased area/total leasable area

Question 30

which are the most common expense participation clauses?

Answer 30

Gross Lease

Single Net Lease

Double Net Lease

Triple Net Lease

Question 31

Gross Lease

Answer 31

rent is all-inclusive

landlord pays all or most expenses associated with the property, including taxes, insurance and maintenance out of the rents received from tenants

Question 32

single net lease

Answer 32

the tenant pays base rent plus a pro-rata share of the building’s property taxes

Question 33

double net lease

Answer 33

the tenant is responsible for base rent plus a pro-rata share of property taxes and property insurance

Question 34

triple net lease

Answer 34

the tenant is responsible for base rent plus a pro-rata share of property taxes, property insurance and all other property operating expenses

Question 35

which is the most popular type of expense participation in retail RE? why?

Answer 35

triple net lease

favors the landlord as it protects him against rising expenses

Question 36

what is the use of True-Ups or CAM adjustments?

Answer 36

These are used to get the real year expenses and then either bill or refund the tenants

Expenses are estimated at the start of the year and adjusted to actuals at the end of the year

Question 37

why do tenants hate True-Ups or CAM adjustments?

Answer 37

this because they do not know what to expect and they rarely get refunded

Question 38

why will a landlord will often offer a rent-free period at the beginning of the lease?

Answer 38

as an incentive to the tenant

Question 39

how is a rent free period beneficial to the tenant?

Answer 39

At the beginning of a lease the tenant often has expenses related to moving or starting-up his business

The rent-free period will help offset these costs

Question 40

how are rent free periods accounted for?

Answer 40

accounted for on a straight-line basis

must be adjusted for when calculating cash flows

Question 41

what are the steps of the cash flow modeling?

Answer 41

1. Model each leasable space separately
2. Consider any leases expiring during the forecasted period
3. Forecast expenses for the period under consideration
4. Estimate any non-revenue-generating capital expenditures
5. Estimate any financing costs
6. Estimate income taxes to be paid
7. Prepare different scenarios by varying certain key assumptions: tenant retention, market rates, CPI, interest rate, economic conditions, etc.

Question 42

what must you consider when you model each leasable space separately (1)?

Answer 42

Consider any rent adjustments or escalations under the lease

This may necessitate estimating CPI over a number of years

Question 43

how can you estimate future percentage rent when modeling each leasable space separately?

Answer 43

looking at historical sales figures and growth

applying certain assumptions for their future growth (economic outlook, CPI, etc.)

Question 44

how do you estimate expense recoveries (expense participation) when modeling each leasable space separately?

Answer 44

recoveries a forecast of expenses must be established

any changes to the leasable areas must be taken into consideration

Question 45

when considering any leases expiring during the forecasted period (2), what must be considered?

Answer 45

Consider any renewal options the tenant has

the likelihood of them renewing the lease

the new rent

Question 46

when considering any leases expiring during the forecasted period (2), what must be forecasted if there is a lease termination expectation?

Answer 46

Period of vacancy

New rent levels considering current market rents

Any rent-free periods that are likely to be offered

Leasing commissions on the new lease

Tenant allowances to prepare the space for the new tenant

Question 47

what must taken under consideration when forecasting expenses (3)?

Answer 47

historical costs in order to identify all relevant expenses

Consider and adjust for any non-recurring items

Increasing historical costs by applying an escalation factor (CPI is the most widely used basis)

any new costs that are likely to arise

Question 48

when estimating any non-revenue-generating capital expenditures (4), what can historical trends maybe indicate?

Answer 48

may indicate a certain level of capital expenditure is required to replace and adjust the structure and its mechanical systems

Question 49

what must be considered when estimating financial ring costs (5)?

Answer 49

Consider in place financing or any future financing

May require forecasting of interest rates

Question 50

what are the different scnerios when preparing different scenarios by varying certain key assumptions: tenant retention, market rates, CPI, interest rate, economic conditions, etc. (7)?

Answer 50

Most likely

Optimistic

Pessimistic

Question 51

what does the cost of bringing new commercial space to the market include?

Answer 51

development

construction costs

Question 52

when do development costs usually begin?

Answer 52

will start before construction begins

Question 53

how are development costs also known as?

Answer 53

soft costs

Question 54

what costs do development costs include’

Answer 54

professional services

environmental studies and land remediation

land acquisition (sometimes included as a hard cost)

permits and zoning

project management costs

lease-up and operating costs to bring a property to a stabilized level

financing costs

Question 55

what do professional services in development costs usually include?

Answer 55

legal

architecture

engineering

surveyors

Question 56

can land acquisition sometimes be considered a hard cost?

Answer 56

ye boooy

Question 57

what do the construction costs or hard cost consist of?

Answer 57

site preparation

actual building costs

building access roads and ramps, landscaping

Question 58

what is site preparation

Answer 58

leveling

demolition

clearing

Question 59

how do construction companies operate?

Answer 59

will often give a fixed price contract based on the approved building plans

Question 60

where can average constructions costs be obtained?

Answer 60

third party sources in the market

Question 61

once more, are capital expenses part of operating expenses?

Answer 61

nah boy

Question 62

what is an expense stop?

Answer 62

an expense stop is a certain level of participation expense where anything under the stop will be paid by landlord

tenant will pay any expenses that go over the stop

for ex: if expense stop is $10 per square foot and expenses are $12.00 per square foot, then tenant will pay $2.00 of participation expense per square foot