fundamentos para el armado de flujo de fondos miguel pato

Cash Flow Fundamentals Cash Flow Fundamentals

Miguel [email protected]

mailto:[email protected]

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Agenda

• Model Setup and Proforma • Assumptions of Modeling• Financial Rates of Return• Completeness and Reasonableness

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Learning Objectives

At the end of this program, you will be able to: • Describe the key users, uses, and components of a proforma cash

flow• Understand the relationship between the various components that

make up a proforma cash flow• Understand the next steps of how to model the components to vary

in future cash flow years• Recognize and understand the different categories in which to

make assumptions• Identify key financial rates of return used to assess cash flows • Verify cash flow analysis mechanics and assumptions for

completeness and reasonableness• Discuss how to test DCF via logic and a variety of ratios

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Cash Flow Overview

What are cash flow models? • Cash flow models are used to convert future income into a

value estimate based upon current facts and future assumptions

What are cash flow models used for?• Budgeting • Valuation• Investment• Finance • Accounting/Auditing

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Cash Flow Overview (Cont.)

Who uses cash flow models?

Audience Possible Uses• Buyers/Sellers ?

• Developers ?

• Lenders ?

• Landlords ?

• Regulators or Public Agencies ?

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Direct capitalization– Relationship between one year’s income and value is reflected in

either a capitalization rate or an income multiplier– Capitalized by applying appropriate rate or factor

ü Discounted cash flow (DCF)– Relationship between several years of cash flows and reversionary

value in either a capitalization rate or an income multiplier – Converted into present value through discounting

Which methods are typically used?

q

q

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Cash Flow Overview (Cont.)Direct Capitalization • Single-tenant properties• Apartment buildings

Discounted Cash Flow• Multi-tenanted properties• Office• Retail• Hotel• Land development• Mixed-use projects

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How does an analyst build a cash flow model?• Set up the analysis and develop a proforma• Apply future assumptions• Select and apply the proper financial rates of return

to conclude a value estimate• Review the model for reasonableness and

completeness

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Elements of a Cash Flow Model

Model Setup and Proforma

Completeness and

Reasonableness

Assumptions of Modeling

Financial Rates of Return

Assumptions of ModelingModel Setup and Proforma

Financial Rates of ReturnCompleteness and Reasonableness

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Model Setup • Determine the computer model

– Argus, Dyna-Lease, Pro-Ject, Excel, etc.

• Set up the analysis– Effective start date and frequency of cash flows

(monthly, quarterly, yearly) – Property size (square feet) – Holding or projection period (length) – Base rent– Concessions– Rent steps– Base year

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What Is a Proforma?

• A real estate proforma is a forecast of the income and expenses that are associated with a subject property.

• A proforma is usually accompanied by financial ratios that help indicate the financial soundness of the property.

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Key Components of a Proforma

Potential Gross Income (PGI)Vacancy / Collection Loss (VC)

Miscellaneous Income (MI)

Effective Gross Income (EGI)Fixed Operating Expenses (FOE)

Variable Operating Expenses (VOE)

Net Operating Income (NOI)Capital Expenditures (CAPEX)

Debt Service (DS)

Before Tax Net Cash Flow (BTNCF)

(-)

=(-)

=(-)(-)

=

+

(-)

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Review: Where Do These Items Fit?

1. Base rent

2. Real estate taxes

3. Bad debt

4. Tenant improvements

5. Trash removal

6. Percentage rent

7. Depreciation

8. Mortgage interest

PGIVCMI

EGIFOEVOENOI

CAP EXDS

BTNCF

(-)

=(-)

=(-)(-)=

+

(-)

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Exercise 1: Effective Rents Analysis

Stay in place

Scenario 1 Scenario 2 Scenario 3

Scenario: You and your team need to evaluate three different leasing options (from the tenant’s point of view) and recommend the best option to the client.

Move to Bldg. A Move to Bldg. B

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Key Concepts• Anticipation and change – The need to develop

procedures to attempt to consider the anticipated future benefits of an asset and estimate it into a present value

• Supply and demand – The need to analyze the present and future demand for a property and how its demand relates to current and proposed supply

• Time value of money - Investors are concerned with the amount and timing of the expected cash flows

• Risk – The possibility of suffering adverse consequences resulting from an investment

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Current Information to Collect and Analyze

• Leases in place – current rents and reimbursed expenses, escalations, concessions

• Market rents, renewal probabilities, downtime between leases, vacancy and credit loss estimates, etc.

• Operating expenses• Leasing costs – broker’s commissions, tenant

improvements (TIs), etc.

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Future Assumptions to Apply

• Growth rates – rent, expenses, overage rents

• Turnover scenarios – amount and length of lag vacancy, TIs, leasing commissions, etc.

• Expense – estimates considered for fixed, variable, and capital expenditures

• Capital expenditures – when, how much

• Investment rates – capitalization, discount rates

• Sale of property – when, how much, associated sales costs

• Debt or leverage – impact on the investment

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Growth RatesMarket Rent• Rate at which market rent is expected to increase or

decrease over the projection period• Depends largely on factors of supply and demand, not simply

inflationExpenses• Rate at which operating expenses and real estate taxes are

expected to grow over the projection period• Operating expense growth rates may correlate to inflation

rates• Real estate tax growth rates vary by local municipalities

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Goals of Financial ProjectionsTo provide an analytical basis for decision making regarding real estate investment and finance through the use of such tools as DCF models.

Examples• Determine how much to pay for a particular property given its

underlying income and overall market conditions/trends.• Test and establish the highest and best use of a particular site.• Compute the rate of return on an investment.• Assess the sensitivity of the DCF to changes in investment

assumptions.• Consider the impact of debt leverage and/or taxation.

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Exercise 2: Review a Cash Flow Model

Review the “Cash Flow – Sample A” Excel file and discuss the following:

– How effective is the model?

– What is ineffective about the model? Is anything missing?

– What would you change about the model?

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Going In Capitalization Rate - Ro

• First-year net operating income (NOI1) divided by the present value (or purchase price) of the asset

• Commonly used as a measure of risk in real estate—the higher the cap rate, the higher the perceived risk to the investor/lender. Cap rates represent required returns by investors.

• Cap rates can vary because of a variety of factors.

NOI1Stabilized Value

= Going-In Cap Rate

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Build-up of Going-In Cap Rate - Example

3.12

2.12

4.27

Real Rate

Risk Premium

InflationRate

9.51%

2.12 + 3.12 = 5.24% (Treasury Bond Rate)

5.24%Treasury

Bond Rate

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Going In Cap Rate: Direct Capitalization Example

Scenario: A property has a stable NOI of $27,500. Several comparable sales have been investigated, and the going-in capitalization rates show a range of 9.78% to 10.39%, with a median of 10.13%.

Task: • Develop a range of prices given the extracted market

capitalization rates.

Answer:• At 9.78% = $281,186 ($27,500 / 9.78%) • At 10.39% = 264,678 ($27,500 / 10.39%)

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Exercise 3: Direct Capitalization

Review the scenario facts and calculate a value range for the subject property.

• Individual exercise • Five minutes

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Terminal Capitalization Rate – Rt

• The rate applied to convert future cash flows into an estimate of value in the last year of a cash flow projection

• The Net Operating Income (NOI11) of the year following the end of the holding/projection period is capitalized into value

• Reflects the resale of the property and a lump-sum benefit that an investor receives at the termination of an investment less any sales costs

NOI11

Terminal Cap Rate= Terminal Value10

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Discount Rate - Yo

• The rate that reflects compensation necessary to attract an investor to give up liquidity, to defer consumption, and to assume the risk of investing

• It is the rate used to calculate the net present value (NPV) and is typically the rate of return offered by comparable investment alternatives

• Also called the hurdle rate or opportunity cost of capital

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Build-up of Discount Rate - Example

3.12

2.12

4.27

3

Real Rate

Risk Premium

InflationRate

Growth Rate

2.12 +3.12 = 5.24 (Treasury Bond Rate)

12.51%

5.24%Treasury

Bond Rate

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Discount Rate - ExampleTask: • What is the present value of a property that can

command a net annual rental of $10,000 for five years and can be resold for $100,000 at the end of the fifth year, assuming a discount rate of 12 percent?

Answer:• Total present value = $92,790

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Exercise 4: Discount Rate

Review the scenario facts and calculate the discount rate for the subject property.


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Internal Rate of Return (IRR)• The discount rate that makes the NPV of the investment

series of cash flows equal to zero

• The true annual rate of return on an investment

• A profitability measure which depends on the amount and timing of the project cash flows

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Financial Ratios and Multipliers• Operating Expense Ratio (OER) = Operating Expenses / EGI

• Debt Coverage Ratio (DCR) = NOI / Debt Service

• Breakeven Ratio (BER) = Operating Expenses + Debt Service / EGI

• Gross Income Multiplier (GIM) = Market Value / PGI

• Net Income Multiplier (NIM) = Market Value / NOI

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Interrelationship of Rates

• NOI / Ro = Value• Loan amount (M) x Rm = Debt service• NOI / DCR = Debt service• Ro = (M x Rm) + ((1-M) x Re)• Ro = DCR x Rm x M• Ro = (1 – OER) / EGIM• Ro = Yo – NOI Δ

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Financial Rates of Return - ExampleTask: • Review the “Cash Flow – Sample B” Excel worksheet. • If you assume a 10 percent going-in capitalization rate,

what is the value estimate for the property?

Answer:• $12,509,750, rounded to $12.5 million

(first-year NOI of $1,250,975 / cap of 10%)

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Exercise 5: Financial Rates of Return

• Review the “Cash Flow – Sample B” Excel worksheet.

• Calculate the maximum amount of debt service the property can support.

• Determine the annual debt service payment.


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• Revenue and expenses• Space absorption• Market lease terms• Concessions/abatements • Vacancy and collection loss• Building area, calculations for reimbursements • Debt service• TIs, leasing commissions, replacement reserves• Growth rates• Rates of returns (capitalization rates, discount rates, etc.)

Projected DCF Model Considerations

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Assumption Testing

Support for Projections• Market vs. contract rents• Vacancy or absorption of space• Concessions • Timing of the cash flow stream • Financial rate of return assumptions and

interrelationships

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Assumption Testing (Cont.)

Relationship Congruency• Are mechanics auditable?

• Is the model flexible?

• Can the differences between the contract vs. market rents be reconciled?

• Is the rationale for the growth assumptions supportable?

• Do the income, variable expense, and capital expense figures correlate to the changes in occupancy over the holding period?

• Are the financial rate interrelationships logical?

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Exercise 6: Completeness & Reasonableness

• Review the “Cash Flow –Sample B” Excel worksheet.

• Answer the questions on the “Exercise 6: Completeness and Reasonableness” document.

• Individual exercise • Twenty-five minutes

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Completeness and Reasonableness Checklist

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Program Debrief

• What lessons did you learn by reviewing the “Sample A and Sample B” Excel worksheets?

• Which cash flow concepts and/or procedures did you find most helpful?

• What was the most challenging aspect of today’s session? Why?

• As a result of the skills/knowledge gained during this training, what will you do differently in the future?

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Summary • Cash flows are use to convert future income into an

estimate of value. • The discounted cash flow (DCF) technique provides

greater flexibility to incorporate more precisely the expectations of market forces, vacancy periods, and varying income/expense growth rates.

• Assumptions are the rationale upon which data, input into a proforma, is based.

• Financial rates of return help express the relationship between income and value.

• Testing or “auditing” a cash flow model is critical to making certain the model is logical, sound, and complete.

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Course Evaluations

• Please complete your course evaluation before you leave

• Give the evaluations to your instructor

Real Estate Advisory Services All- Hands Meeting EvaluationJuly 10–12, 2003; Colorado Springs, Colorado

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DisagreeNot

ApplicableI clearly understood the program objectives. 5 4 3 2 1 N/A

The knowledge and/or skills gained through this program are directly applicable to my job. 5 4 3 2 1 N/A

This program was appropriate for me given my knowledge,level, and experience.

5 4 3 2 1 N/A

The knowledge gained through this program has increased my confidence in my ability to perform. 5 4 3 2 1 N/A

Program DesignThe program content was logically organized. 5 4 3 2 1 N/A

The delivery method(s) used in this program was an effective way for me to learn the subject. 5 4 3 2 1 N/A

The program materials were useful. 5 4 3 2 1 N/A

The length of the program was … Too long Just Right Too Short

PresentationsOverall, the … segment was an effective learning experience.

Opening General Session July 10 5 4 3 2 1 N/A

Team Building July 10 5 4 3 2 1 N/A

Product Fair July 11 5 4 3 2 1 N/A

Closing General Session July 12 5 4 3 2 1 N/A

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fundamentos para el armado de flujo de fondos miguel pato

Economy & Finance