Stabilized Year, DCF and Direct Capitalization

[Anonymous]

7 years, 8 months ago #2628

Hi Spencer,

Really enjoying the model so far, just had a couple of questions:

1. Changing the Stabilized Year on the OpSt tab changes the DCF value. Was this intentional? For instance, if Year 3 is chosen as the Stabilized Year, the model seems to discount certain items such as Parking Income and Operating Expenses from Years 1-2, until it reaches the stabilized amount that was input manually. However, other items such as Gross Potential Rent and Expense Recovery Income aren’t getting the same treatment – should the model be discounting these items as well, perhaps at a rate of market inflation?

2. Choosing a year other than Year 1 for the Stabilized Year seems to lead to inflated values using the Direct capitalization method. Going back to the example of Year 3 Stabilized Income, how would the model account for income loss if there was excessive absorption vacancy in Years 1-2?

Hopefully I am understanding the model correctly. Thanks for your time!

[Spencer Burton]

7 years, 8 months ago #3130

Great question! I had put a lot of thought into the OpSt tabs – not to say that means the logic is necessarily right! – so your question allows me to delve deeper into what’s going on there.

To answer your first question, yes that was intentional. That is a byproduct of the logic behind the “Stabilized Pro Forma” and the “Residual Pro Forma” idea. Let me explain further, and that should hopefully answer your subsequent question(s).

Rental income is driven by the assumptions on the MF/ORI-RR tabs, and inflated by growth factors entered on the MF/ORI-tabs. When those growth factors kick in, is determined by the “Growth Begin” date in the Timing section of the Summary tab.

Leasing costs (ORI), make ready costs (MF), expense recovery (ORI), and utility reimbursement (MF) are also driven by assumptions on the relevant RR tab, but are inflated by a growth factor entered on the relevant OpSt tab (column H).

The confusion I believe lies in the concept of the “Stabilized” and “Residual” Pro Forma and how they fit into the DCF. When building the model, I wanted three valuations to occur. 1) A DCF valuation (for acquisition purposes only), a direct capitalization valuation at “stabilization”, and a direct capitalization residual valuation at sale. The first two could be used, in combination with other metrics, to assess an appropriate present value with the third being used to determined the residual sale price for DCF purposes.

So if you look at the OpSt tab, the numbers in columns K:T are the operating cash flows that flow into the actual DCF. The figures entered into column J (Stabilized Pro Forma) constitute the baseline Other Income, Operating Expenses, and Capital Expenditures assumptions, as of the stabilized year, and flow into columns K:T. The Stabilized Pro Forma is also capped (see Property CF row E) to arrive at a “Stabilized Value” as reported in cell U10 of the Summary tab. The Residual Pro Forma values are calculated by default using last year of the hold period grown by the various growth assumptions but are blue font cells, thus alerting the user to the fact that additional thought should be given to what Pro Forma a future purchaser would use to arrive at a value. The resulting value, capped at the terminal cap rate (see column Q of the Property CF tab), flows into the DCF as the residual value.

However, there are a few nuances to the OpSt tab. The first is, stabilized year is not always year 1 and so Other Income, OpExp, and CapEx cash flows had to be treated differently in these unstabilized years. So how it works is, the values in blue you enter in the Stabilized Pro Forma constitute the values as of the stabilized year. An ‘Operation Begin’ date is set on the Summary tab, before which date all values are set to zero. Once operations begin, if a cash flow occurs before the stabilized year, the model deflates/discounts that cash flow by the CAGR (row H of the OpSt tab) to reflect that the stabilized numbers are X years into the future. Thus, if you open the model anew, go to an OpSt tab, and change the default Stabilized Year (J7) from Year 1 to Year 3, you’ll see the values in Year 3 will now match the values in the Stabilized Pro Forma and the values in year 1 and 2 are 2% per year less than the stabilized year.

The second nuance is that, leasing costs, concessions, and make ready costs are lumpy and don’t necessarily always represent a “stabilized” value. Thus, if you use an inflated concessions number in your stabilized pro forma, you’ll get a less-than-market valuation. Likewise, if you use $0 Make Ready costs in your stabilized pro forma because no MF units rolled in the previous 12 months, you’ll get a greater-than-market valuation. So, while concessions, leasing costs, and make ready costs are automatically calculated for DCF purposes, they are marked with an orange (optional input) font in the Stabilized Pro Forma so that the user can adjust the default calculations to something more appropriate. The default formula (in orange) essentially takes the average of the hold period, but that may or may not be true of a particular investment – thus the optional nature of those inputs.

Let me know if that answered all of your questions!