CapEx Below NOI

[Lizzie Boyer]

7 years, 9 months ago #2610

I am seeing that you have the CapEx below the NOI line on your all in one template. Does you valuation when using cap rate take into consideration the CapEx? If I have a large CapEx project planned for the first two years and I will not fund it from operating expenses how to I account for it without throwing off my cash on cash return?

[Spencer Burton]

7 years, 9 months ago #3092

Thanks for reaching out and two very good questions.

To your first question. By default, the model’s direct capitalization valuation method uses NOI (before CapEx). However, the user also has the option to cap CFO (after CapEx). This option can be selected by changing cell B8 on the Property CF tab.

In terms of how to fund a large CapEx project without throwing off the cash-on-cash return. I would suggest modeling the deal using the Development module. The module was intended to be used both for development, and value-add opportunities – this scenario falls within that second category. To do this:
1) Set the development length on the Summary tab to 24 months
2) Set the operations begin date on the Summary tab to be equal to the analysis start date
3) Enter the purchase price together with the large CapEx project items on the budget tab

A couple things to keep in mind. If you intend to use a bridge loan to finance the purchase and CapEx project, use the Construction Financing assumptions on the Sources and Uses tab. Set the Stabilization date on the Summary tab to be equal to the date when you intend to refinance the bridge loan. If you plan only to use permanent financing, set the stabilization date equal to the analysis start date, and set the construction financing interest rate and LTC to 0 on the Sources and Uses tab. Then make sure to set a permanent debt loan amount on the Perm. Debt tab.

[Lizzie Boyer]

7 years, 9 months ago #3094

Okay that makes sense. Thanks for taking the time to explain.

I was playing with the Equity CF tab and I think I found an issue with the calculations.
I set my sponsor equity to 6.19% and pre hurdle 1 to 8%.
Sponsor 172,315
LP 2,612,685

Then the split is 70/30% to the LP after the hurdle is met

Cash flow for distribution in year 3 is 415,544
Req’d return by LP to hit hurdle 1 is 201,053
Req’d return Sponsor to hit hurdle 1 is 13,260

So the remaining to be split 70/30% should be 237,230

30% to Sponsor 71,169
70% to LP 166,061

[Spencer Burton]

7 years, 9 months ago #3096

Great question!

The model is working correctly, but perhaps not treating the cash flows as you’d expect. I think the difference is, you’re expecting a distribution based on cash-on-cash return (6/94 to a 8% CoC, then promoted above that) and prior to the LP’s return of capital. However, the model distributes purely based on IRR – which would require a full return of the LP’s capital plus a return on top of that before hitting a hurdle. This typically doesn’t happen until a capital event occurs.

To illustrate using your investment as an example, the LP contributes $2,615,685 in time 0. In period 1, the partnership distributes to the LP $244,453 (its pro rata share). If we were to do an IRR calculation based on those two cash flows (-2,615,685, 244,453) the LP’s IRR at the end of period 1 is -90.6% and the LP’s capital account stands at $2,577,247 – thus no hurdles have been hit.

Hope that answers your question! Let me know if you have any other questions.

[Lizzie Boyer]

7 years, 9 months ago #3098

Oh okay that makes sense why the sponsor’s return would only adjust if the property was sold. Thanks again for the explanation.