Re: Ray or Somebody - Posted by ray@lcorn

Posted by ray@lcorn on August 01, 2005 at 17:22:50:

Lynn,

I think the confusion here is more of semantics and the fact there is no universally mandated format for analytical spreadsheets. I wonder if you are using a spreadsheet that calculates your return for you, hence the question of where to account for the Deferred Maintenance (DM).

If so, then I understand your confusion. We’re not all looking at the same spreadsheet, and different vendors do it different ways.

Typically, the APOD calculates NOI, then subtracts debt service, and the remaining funds (if any) are considered pre-tax cash flow. The spreadsheet may have separate entries on the APOD or a separate sheet for the purchase price, loan amount and down payment as the basis for calculating the various measures of return. Regardless of where it is entered, the math is the same.

Cap rates are figured on the NOI as if the investment were bought for all cash. And yes, the acquisition costs and any capital improvements performed in the first year (including DM, carry costs, closing costs, etc.) should be added to the purchase price. If so, then the cap rate and the CoC will be the same.

But we use leverage, and that’s where consistent methodology is important. NOI (used for the cap rate) does not include debt service, so the CoC cannot be calculated until the debt service is subtracted from NOI to determine cash flow.

Your question is whether to count the $60T DM as part of the initial investment comes down to which accounting method you use after the NOI line. Understand that the CoC return is an analytical tool and not used for bookkeeping or tax purposes.

For analytical purposes, I figure returns the way Thad outlined above. If the DM must be expended in the first year of ownership, then I include it as part of my initial cash investment, or perhaps seek a reduction in the purchase price if that’s the only way to make the deal fit my criteria. I want to know the the total cash in (NOI) divided by the total cash out, and don’t care about accounting classifications.

For your scenario, the deal would pencil out this way:

Price- $166,000

NOI- $20,000

Cap Rate - 12%

Then to figure CoC you have to know the terms of the deal. I’ll assume you are putting some amount down, plus the DM and acquisition costs?the sum of which is considered your Total Cash Invested?and the balance is coming from one or more loans:

Price - Total Cash Invested = loan amount(s)

Then you have to know the total debt service (DS) required for the loan(s) to calculate casf flow (CF) and the CoC return.

NOI - DS = CF (pre-tax)

CF / Total Cash Invested = CoC return (after conversion to a percentage)

The actual accounting may differ depending on how the DM is classified (i.e. expensed vs. capitalized) and what method of accounting is used (i.e. accrual vs. cash basis). But the cash flow is what it is, and that’s what I want to know in order to compare apples to apples between deals or to evaluate whether my goals are being met by a particular deal.

Now, did I put that in terms no one can understand? (smile)

ray