Real Estate Finance Cash flow modeling in Excel

Periodic cash flows (CFVal1 pp , 29-32)  Net operating income Revenues Expenses Cash flow projections (CFVal2 pp. 4-5, 10-13, 14-27)  Net operating income Existing lease agreements Lease renewal and vacancy  Reversion value  Capital expenditures Overview

NOI is total operating income less total operating expenses  Income: Rent Percentage rent Ancillary income Collection losses Expense reimbursements (recoveries)  Expenses: Common area expenses (CAM) Utilities Property tax Insurance General and administrative (G&A), property management fees NOI

Derivation of NOI: Potential gross Income - Vacancy adjustment = Effective gross income Effective gross income + Percentage rent + Expense reimbursements + Ancillary income - Collection losses - Concessions = Total operating income Total operating income - Operating expenses = Net operating income (NOI) NOI

A property’s potential gross income (PGI) is the rental income that would be received if the rentable area within the building was fully occupied  For occupied space, rental income is determined by the rent determined by the lease provisions of current tenants For multifamily, PGI is based on current market rent even if it exceeds the actual rent paid by existing tenants – the difference between market and contract rents can be used to estimate future rent growth  For vacant space, rental income is determined by the current market rent on comparable space NOI: Potential gross income

Effective gross income (EGI) is the rental income generated by all physically occupied space before adjustments EGI = PGI – vacancy  For vacant space, subtract the rental income associated with the amount included in determining PGI  For occupied space associated with PGI determined by market rents, adjust for difference in market rent above current lease terms NOI: Effective gross income

Total operating income equals EGI plus expense reimbursements, ancillary income, percentage rent and less collection losses and concessions  Expense reimbursements (recoveries) represent tenant repayment for expenses paid by the owner on their behalf  Ancillary income is income from sources other than the rent generated by the space occupied by tenants - parking, vending, antenna, signage  Percentage rents are based on a percent of a tenant’s chargeable sales Percent of sale Breakpoint  Collection losses are associated with the non-payment or late payment of rent or other revenues  Rent concessions reflect loss of revenue due to free-rent periods NOI: Total operating income

Example: What is the percentage rent paid by a tenant occupying 1500 sf of space with a base rent of $16/sf if they earn $925,000 in total sales for the year and a sales percentage of 3% percent of their chargeable sales?  Chargeable sales = Total sales Percentage rent =.03(925,000) = $27,750  Chargeable sales = Total sales above $750,000 Percentage rent =.03(925,000 – 750,000) = $5,250  Chargeable sales = Total sales above the tenant’s natural breakpoint Natural breakpoint = 16(1500)/.03 = 800,000 Percentage rent =.03(925,000 – 800,000) = $3,750 NOI: Total operating income

Depending on lease terms, tenants may be required to reimburse property owners for operating expenses  Total operating expenses equal the sum of reimbursable and non-reimbursable expenses Reimbursable expenses: CAM Utilities Property taxes Insurance Non-reimbursable expenses: Property management fee General and administrative expenses NOI: Expenses

Operating expenses are either fixed or variable  Fixed expenses are independent of the occupation rate Property taxes Casualty insurance  Variable expenses depend on the building’s physical occupation rate Utilities Common area maintenance (CAM) Property management fee General and administrative (G&A) NOI: Expenses

Example: What is the annual utility expense for a property with 30,000 sf of rentable space and utilities are $1.50/sf and 40% fixed…  If the building is 100% occupied? Utility expense = 1.50(30,000) = 45,000  If the building is 85% occupied? Utility expense = 1.50(30,000)(.4 +.6(.85)) = 40,950 NOI: Expenses

In a modified gross lease, tenants reimburse property owners on a pro-rata basis for any reimbursable expenses above a tenant’s expense stop  A tenant’s base year expense stop is by the reimbursable expense per square foot that sets the reimbursement in the initial year of their lease to zero Example: Total reimbursable operating expenses for a 60,000 sf building were 120,000, or 2.00/sf during the past leasing period A tenant with an expense stop of 1.75/sf occupies 3,000 sf of rentable space, the reimbursement paid by the tenant equals 3000(2.00 – 1.75) = 750 A new or renewing tenant in the building in that year will have an expense stop equal to 2.00/sf for the term of their lease NOI: Expenses

Example: Office Chilltown Plaza is a mid-size office building in Jersey City, NJ  45,000 sf of rentable space Sixth Borough Bank, 30,000 sf, 10-year lease signed 1/2014 Green Leaf Publishing, 10,000 sf, 5-year lease signed 1/2015 Goodman and Associates Law Firm, 5,000 sf, 5-year lease to be signed 1/2018  Ancillary income Roof rental/antenna, $24,000/year  Expenses Insurance, $27,500/year, 100% recoverable Property taxes, $105,000/year, 100% recoverable Utilities $1.65/sf/year, 35% fixed, 100% recoverable CAM, 5% of EGI, 100% recoverable Management, 3% of EGI, 0% recoverable

Example: Office Chilltown Plaza General data:Lease renewal: Price$9.5M9,500, Renewal probability75%75.00% Required return (unlevered)10%10.00% Months vacant8 months8.00 Property typeOffice Expected months 100% occupancy10.00 Rentable SF45,00045, Tenant improvements - New$15/sf15.00Inflation Number of tenants3 Tenant improvements - Renewal$5/sf5.00Inflation Lease termFive years5.00 Leasing commisions - New25% of base rent in initial year25.00% Leasing commisions - Renewal15% of base rent in initial year15.00% Market and economic data: Reserves$0.25/sf0.25Inflation Market rent$23.50/SF23.50 Market inflation3%3.00%Disposition: Inflation2%2.00% Market capitalization rate7%7.00% Sale commissions3% of sale price3.00% Income: Sixth Borough BankMortgage financing: SF30,00030, Principal amount borrowed$6.0M6,000, Base rent$19.50/SF19.50 Interest rate6.00% Rent escalation$.50/SF/YR0.50 Amortization period25 years25.00 Expense stop$4.50/SF4.50 Maturity10 years10.00 Remaining lease term7 years Payment frequencyAnnual Greenleaf Publishing Origination fee1.5% of initial balance1.50% SF10,00010, Base rent$22.00/SF22.00 Rent escalation$.50/SF/YR0.50 Expense stop$4.75/SF4.75 Remaining lease term3 years Goodman and Associates SF5,0005, Base rent$23.50/SF (beginning Y2)23.50 Rent escalation$.50/SF/YR0.50 Expense stopTBD Remaining lease term5 years (beginning Y2) AncillaryAntenna, $24,000/YR24,000.00Inflation ReimbursementsBase stop Collection losses2% of tenant revenue2.00% Operating expenses: CAM5% of EGI5% Utilities1.65/sf, 35% fixed1.65Inflation % fixed0.35 Real estate taxes$105,000105,000.00Inflation Insurance$27,50027,500.00Inflation Management (Non-reimbursable)3% of EGI3%

Example: Office 1 Jan-17 Utilities/sf1.65 TI/sf, New15.00 TI/sf, Renew5.00 Market Rent23.50 SBB19.50 GL22.00 G+A-- Potential rental income: SBB585, GL220, G+A117, Potential gross income (PGI)922, Vacancy allowance: SBB0.00 GL0.00 G+A117, Total allowance117, Occupancy88.89% Effective gross income (EGI)805,000.00

Example: Office 1 Jan-17 Effective gross income (EGI)805, Reimbursements: SBB Base stop4.50 Reimbursement26, GL Base stop4.75 Reimbursement6, G+A Base stop Reimbursement Total reimbursements32, Tenant revenue837, Collection losses(16,745.78) Antenna rental24, Total operating income844, Expense information: CAM40, Utilities68, Real estate taxes105, Insurance27, Reimbursable expenses241, Reimbursable exp/sf5.37 Management expenses24, Total operating expenses265, Net operating income (NOI)578,755.61

Existing tenants: Remaining term on existing leases Occupied space Base rents and base rent escalators Expense stops Vacant space: Market rent Leasehold agreements under current market conditions Property data: Operating expenses Ancillary income Collection losses Market data: Market rent growth Expected inflation rate Cash flow projections

Active lease agreements:  Income growth is determined by the terms dictated by the lease agreement along with expectations concerning the growth (or decline) of other variables Rental income: Base rent plus escalators Expenses: Expected growth Lease expirations:  If the space is re-leased after expiration, unless specified otherwise, the base rent equals the projected market rent and the lease terms present in the prior agreement are present in the new lease The space may be assumed to be vacant for a pre-specified period of time referred to as months vacant Cash flow projections

The property’s sale price at the end of the holding period can be estimated by dividing NOI from the year following the sale by a capitalization rate, c  The capitalization rate, more commonly referred to the cap rate, relates asset-level income to asset prices and is used to estimate value in real estate markets Value is inversely related to the cap rate The going-in cap rate is the cap rate at the time of purchase and is given by the purchase price divided by NOI in first year The terminal, or going-out, cap rate is the cap rate used to estimate reversion value at the end of the holding period Cash flow projections

What cap rate should be used to estimate reversion value?  Convention: Older properties tend to have higher cap rates, unless extensive renovations or major capital expenditures are undertaken during the holding period, terminal > going-in The current market cap rate is determined by transaction prices and incomes of comparable property sales, terminal > current market cap Cash flow projections

A capital expenditure is an expense that generates benefits or costs over an extended period of time  The equity investor’s cash flows before debt service are given by NOI less capital expenditures, tenant improvements and lease commissions  Capital expenditures in real estate: Capital improvements/reserves Tenant improvements (TI): Allowances paid to tenants to customize the space to their needs Leasing commissions: Payments to a broker or leasing company for leasing space Cash flow projections

What happens when an existing tenant’s lease matures?  When an existing tenant’s lease expires, the tenant is assumed to either renew or vacate… if the space is renewed, the existing tenant signs a new lease and pays rent R 1 if the space is vacated, then it is expected to be vacant for a given number of months and then is leased to a new tenant at rent R 2 with lease conditions similar to what is offered currently to new tenants. Cash flow projections

How do we use this to determine rental income for the space?  PGI per square foot for the space is given by the expected rent evaluated at MV = 0  EGI is given by the expected rent evaluated at the given MV which implies that the vacancy adjustment equals the difference between PGI and EGI Cash flow projections

If the rent for a renewing tenant is $18/sf and the rent for a new tenant is $20/sf, what is the projected PGI and EGI per square foot if the probability of the current tenant renewing their space is.75 and months vacant is 6?  PGI:  EGI:  Vacancy adjustment: Cash flow projections

Example: Office Chilltown Plaza is a mid-size office building in Jersey City, NJ  45,000 sf of rentable space  Ancillary income Roof rental/antenna, $24,000/year, general inflation  Expenses Insurance, $27,500/year, general inflation Property taxes, $105,000/year, general inflation Utilities $1.65/sf/year, 35% fixed, general inflation CAM, 5% of EGI Management, 3% of EGI  Capital expenditures $0.25/sf, general inflation

Tenants:  SBB 30,000 sf 7 years remaining lease term Base rent $19.50/sf, $0.50/sf/year escalation Expense stop $4.50/sf  GL Publishing 10,000 sf Base rent $22.00/sf, $0.50/sf/year escalation Expense stop $4.75/sf 3 years remaining lease term  G&A Law 5,000 sf Base rent $23.50/sf (as of 1/2017), $0.50/sf/year escalation Expense stop TBD 5 year lease term Example: Office

General: 10-year holding period General inflation is 2% Market inflation is 3% Market leasing: Five year lease term Current market rent is $23.50/sf, market inflation Base rent escalation $0.50/sf/year Base stop Tenant improvements, $15/sf new, $5/sf renew, general inflation Leasing commissions, 25% first year rent new, 15% first year rent renew Example: Office

Chilltown Plaza General data:Lease renewal: Price$9.5M9,500, Renewal probability75%75.00% Required return (unlevered)10%10.00% Months vacant8 months8.00 Property typeOffice Expected months 100% occupancy10.00 Rentable SF45,00045, Tenant improvements - New$15/sf15.00Inflation Number of tenants3 Tenant improvements - Renewal$5/sf5.00Inflation Lease termFive years5.00 Leasing commisions - New25% of base rent in initial year25.00% Leasing commisions - Renewal15% of base rent in initial year15.00% Market and economic data: Reserves$0.25/sf0.25Inflation Market rent$23.50/SF23.50 Market inflation3%3.00%Disposition: Inflation2%2.00% Market capitalization rate7%7.00% Sale commissions3% of sale price3.00% Income: Sixth Borough BankMortgage financing: SF30,00030, Principal amount borrowed$6.0M6,000, Base rent$19.50/SF19.50 Interest rate6.00% Rent escalation$.50/SF/YR0.50 Amortization period25 years25.00 Expense stop$4.50/SF4.50 Maturity10 years10.00 Remaining lease term7 years Payment frequencyAnnual Greenleaf Publishing Origination fee1.5% of initial balance1.50% SF10,00010, Base rent$22.00/SF22.00 Rent escalation$.50/SF/YR0.50 Expense stop$4.75/SF4.75 Remaining lease term3 years Goodman and Associates SF5,0005, Base rent$23.50/SF (beginning Y2)23.50 Rent escalation$.50/SF/YR0.50 Expense stopTBD Remaining lease term5 years (beginning Y2) AncillaryAntenna, $24,000/YR24,000.00Inflation ReimbursementsBase stop Collection losses2% of tenant revenue2.00% Operating expenses: CAM5% of EGI5% Utilities1.65/sf, 35% fixed1.65Inflation % fixed0.35 Real estate taxes$105,000105,000.00Inflation Insurance$27,50027,500.00Inflation Management (Non-reimbursable)3% of EGI3%

Example: Office What is EGI for first four years? Jan-17Jan-18Jan-19Jan-20 Market Rent SBB GL G+A Potential rental income: SBB585, , , , GL220, , , , G+A117, , , , Potential gross income (PGI)922, , , ,011, Vacancy allowance: SBB0.00 GL , G+A117, Total allowance117, , Occupancy88.89%100.00% 96.30% Effective gross income (EGI)805, , , ,992.37

Example: Office What is NOI for first four years? Jan-17Jan-18Jan-19Jan-20 Utilities/sf Effective gross income (EGI)805, , , , Reimbursements: SBB Base stop4.50 Reimbursement26, , , , GL Base stop Reimbursement6, , , G+A Base stop5.74 Reimbursement Total reimbursements32, , , , Tenant revenue837, , ,019, ,012, Collection losses(16,745.78)(19,839.07)(20,395.92)(20,243.33) Antenna rental24, , , , Total operating income844, , ,024, ,017, Expense information: CAM40, , , , Utilities68, , , , Real estate taxes105, , , , Insurance27, , , , Reimbursable expenses241, , , , Reimbursable exp/sf Management expenses24, , , , Total operating expenses265, , , , Net operating income (NOI)578, , , ,364.94

Example: Office Jan-17Jan-18Jan-19Jan-20Jan-21Jan-22Jan-23Jan-24Jan-25Jan-26Jan-27 Utilities/sf Effective gross income (EGI)805, , , , ,034, ,056, ,063, ,142, ,275, ,347, ,370, Reimbursements: SBB Base stop Reimbursement26, , , , , , , , , , GL Base stop Reimbursement6, , , , , , , , , G+A Base stop Reimbursement , , , , , Total reimbursements32, , , , , , , , , , , Tenant revenue837, , ,019, ,012, ,087, ,115, ,122, ,147, ,287, ,370, ,399, Collection losses(16,745.78)(19,839.07)(20,395.92)(20,243.33)(21,740.30)(22,302.32)(22,459.03)(22,950.38)(25,757.17)(27,410.37)(27,981.71) Antenna rental24, , , , , , , , , , , Total operating income844, , ,024, ,017, ,091, ,119, ,127, ,152, ,290, ,371, ,400, Expense information: CAM40, , , , , , , , , , , Utilities68, , , , , , , , , , , Real estate taxes105, , , , , , , , , , , Insurance27, , , , , , , , , , , Reimbursable expenses241, , , , , , , , , , , Reimbursable exp/sf Management expenses24, , , , , , , , , , , Total operating expenses265, , , , , , , , , , , Net operating income (NOI)578, , , , , , , , , ,016, ,038,728.22

Given a terminal cap rate equal to 7%, what is the estimated sale price at the end of the holding period? Example: Office

What are tenant improvements, leasing commissions and capital reserves for first four years? Example: Office Jan-17Jan-18Jan-19Jan-20 TI/sf, New TI/sf, Renew Net operating income (NOI)578, , , , Capital expenditures: Tenant improvements0.0076, , Leasing commissions0.0030, , Reserves11, , , , Net income after reserves567, , , ,897.35

Example: Office Jan-17Jan-18Jan-19Jan-20Jan-21Jan-22Jan-23Jan-24Jan-25Jan-26 TI/sf, New TI/sf, Renew Net operating income (NOI)578, , , , , , , , , ,016, Capital expenditures: Tenant improvements0.0076, , , , , Leasing commissions0.0030, , , , , Reserves11, , , , , , , , , , Net income after reserves567, , , , , , , , , ,003, Reversion value14,838, Cost of sale(445,169.24) Net cash flow from sale14,393, Cash flow before debt service(9,500,000.00)567, , , , , , , , , ,397, Present 10%9,712, Net Present 10%212, Unlevered IRR10.31%