FINANCIAL ANALYSIS TO SELL BUILDING PROJECTS Why Your Facility Management Team is a Valuable Asset? Presented by Gordon Hester

Topics Covered - Understanding the Building Owner’s Objectives for the property. - A Few Basic Terms used in real estate analysis - Basic Cash Flow Analysis - Rates of return, valuation and capitalization - What is the purpose of using this type of analysis?

General Questions How comfortable are you discussing financial decisions with your owners or manager? - Not even a little bit - There are no more worlds to conquer! This is an entry level / moderate level overview of the concepts. We will hit the high points and hopefully leave you with a basic understanding, however you are all encouraged to ask additional questions and seek guidance as you put these concepts into practice as you need. Understand what you are comfortable with before you jump into it.

Painting the Picture for Ownership

Questions Questions to ask yourself, or the owner / manager before you review a project. What are our goals for the building? (long or short term investment) How much cash do we have to spend? How much capital do we have to work with? Is this project being done because I need to repair something, or am I trying to reduce cost by doing it? The more questions you can ask or have answered, the better prepared you are to make the pitch.

BASIC CASH FLOW ANALYSIS THROUGH A PROFORMA STATEMENT

Gross Income Gross Income is the total income received for the property. It can include rent, expense reimbursements, parking, storage, rooftop or anything else that generates revenue into the building.

Expenses Expenses are generally the cost of operating the building, and include utilities, repairs and maintenance. Does not include Capital Expenses, which must be depreciated over an IRS specified lifespan. (Roof replacement, large tenant improvement projects, etc. – defined by accounting and IRS standards)

Net Operating Income Net Operating Income is gross income minus operating expenses for an annual period. This is the income we typically use in the formulas for calculating return and value.

How a Pro Forma Works Let’s see how a pro forma statement works down to cash flow: Gross Potential Income (GPI) - Loss to Lease - Vacancy and Collection Loss = Net Rent Revenue + Misc. Income + Expense Reimbursements = Effective Gross Income (EGI) - Operating Expenses = Net Operating Income (NOI) - Annual Debt Service - Customized Items (transfers, commissions, tenant improvements, etc.) = Before-Tax Cash Flow (BTCF)

Basic Financial Statement Income $100,000 (rent) Expenses 80,000 Net Income $20,000 Capital Exp. 5,000 Cash Flow $15,000

Helpful Formulas Simple Payback: The length of time required to recover the cost of an investment. Formula – Project cost/annual savings = years to recover cost Putting solar panels on your building for $50,000 saves $5,000 per year in energy costs. What is the simple payback in years? ($50,000/ $5,000 savings = 10 year to recover your cost) Return on Investment: Potential rate of return of an investment. Formula – Net Profit / Total Investment *100 Solar panel project saved $5,000 (profit) / $50,000 investment = .10 *100, = 10%  NOTE there are a couple variations of Return on Investment (Gain from investment – Cost of investment) / Cost) (Current Value – Beginning Value / Beginning Value)

Return on Investment with Financing $50,000 cost of solar panels, $5,000 annual savings. I can borrow $25,000 of the cost, at an interest rate of 6%. On a 20 year loan, my monthly payment is $179.11 per month. NOW – my cost is $25,000, and my annual savings are $5,000 - $2,149, or $2,850. Return on investment is $2,850 profit / $25,000 cost or 11.4%. SAME PROJECT WITH DIFFERENT WAYS OF LOOKING AT IT!

INCOME CAPITALIZATION APPROACH TO VALUE IRV

Income = Rate x Value Income = Rate x Value is one of the quickest and simplest formulas to estimate one of the three components in the formula if you know the other two. It is not an exact science as Income, Rate and Value can all be manipulated based on what you are trying to accomplish, but it is useful as a quick comparison.

= I R V The IRV Formula x Income / Value = Rate % Or Income / Rate = Value $ Rate x Value = Income $ = I - Income = Stabilized NOI - The income for the most current annual period. R - Capitalization Rate = A rate that converts a single year’s income into value. - Minor differences in cap rate can make a huge difference in value - Lower cap rate = higher value and vice versa V - Market Value = The most likely price the asset would command in the open market.

What are you trying to accomplish? Convince an owner of the reasons for an upgrade or repair? Increase the value of a property? Evaluate which project to do when facing limited cash? Your method of evaluation and choice of which to use depends on what you are trying to accomplish.

Pro Forma Scenario Relevant information: - Property purchased for $700,000 four years ago. - Currently owes $500,000 - 2017 income was $144,000 - 2017 expenses were 94,000 ($6.27/SF) - Net Operating Income is $50,000 - 15,000 SF building - 3,000 AD has been vacant for about a year - $12 average rents in building - $15 average market rents - Comps show property has below market curb appeal and interior finishes - Property is well located - at 8.5% cap rate, building value is 588K $50,000/0.085 = $588,235 Value is less than what the owner paid

How can you create value? You go out and get bids and see that it will cost $60,000 to bring property to the market standard. If you do the work, assume that you will be able to rent the vacant spaces within 12 months at the market rents. Assume all other tenants stay at current rates except for one 750 SF tenant that vacates 2018 income raises to $179,550 2018 expenses raise 20% to $112,800 ($7.52/SF) Net Operating Income goes up to $66,750 Only $16,750 increase in NOI annually for about $60,000 spent. BUT…

How can you create value? Property is now basically fully occupied, with improved curb appeal and the same good location. 66,750 /0.085 = $785,000 New value at 8.5%. Spending $60,000 you were able to generate about $196,000 in additional property value within a two year period. Initial value – 588K, New value – 785K

Lighting Retrofit You decide to evaluate changing lights to LED tubes. Cost of the project is $20,000, and the anticipated energy savings are estimated to be $12,000 per year. Payback = 1.67 years. ($20,000 / $12,000) Return on Investment = $12,000 / $20,000 = 60% AND – when you decrease cost by $12,000, you increase income by $12,000. – Using our cap rate of 8.5%, you increase the building value $12,000 / .085 = $141,176. Building is now worth $926,176 (was worth $785,000 after your last project.

Bid Janitorial Service You decide you want to check the janitorial pricing and quality and re-bid the service. Your new vendor is $500 per month cheaper. $500 x 12 = $6,000 in annual savings $6,000 / .085 = $70,588 in increased value. Building is now worth $996,764. (Remember you started at $588,235) By spending $80,000, you created $408,529 in value.

Which Project Should I Do? The Facilities Management Group at the Gordon Building have two projects they would like to do in 2018. The first project is a boiler upgrade to replace a cast iron sectional boiler with two new high efficiency boilers. The second project is to install variable frequency drives on the supply and return air fans.

Boiler Upgrade Cost of project is $118,000 Project Benefits Estimated gas savings of $15,000 per year. Improved reliability and tenant comfort. Avista rebate of $5,800.

Variable Frequency Drives (VFD) Project Benefits Estimated Energy Savings of $24,000/yr Avista Rebate of $18,500 No real tenant comfort improvements, but does replace fan motors that are nearing the end of their useful life Total Cost of project is $165,000

What Project is Better? Boiler Upgrade VFD Installation Simple Payback is 7.48 years ROI 13.37% Increase in Value $176,470 (if I use 8.5% interest rate) Improve tenant comfort and reliability Simple Payback is 6.1 years ROI is 16% Increase in Value $282,353 (if I use 8.5% interest rate)

What if? Your manager tells you that you only have $115,000 to spend in the capital budget for 2018?

The Answer The boilers cost $112,000 after the rebate, and the VFD project is $146,500 after the project, so the boilers fall within the budget constraint.

What if? What if you could finance both projects with 75% financing, at a 6% interest rate for a 20 year term?

Boiler Upgrade $118,000 (Project Cost) - $5,800 (Avista Rebate) $112,000 Total Cost 75% financing gives me $84,150 borrowed, with my down. payment of $28,050. Payment is $602.88 per month or $7,234 per year. My increased income if financed is $15,000 - $7,234 = $7,765. Payback is $28,050 / $7,765 = 3.61 years. Return on Investment is $7,765 / $28,050 = 28% Increase in Value is $91,352

VFD Installation $165,000 (Project Cost) - $18,500 (Avista Rebate) $146,500 Total Cost 75% financing gives me $123,750 borrowed, with my down payment of $41,250. Payment is $886.58 per month or $10,639 per year. My increased income if financed is $24,000 - $10,639 = $13,381. Payback is $41,250 / $13,381 = 3.08 years. Return on Investment is $13,381 / $41,250 = 32% Increase in Value is $157,423 (increased income / 8.5%)

With Financing Boiler Upgrade VFD Installation Simple Payback is 3.61 years ROI 28% Increase in Value $91,352 (if I use 8.5% interest rate) Improve tenant comfort and reliability Total out of pocket cost is $28,050. Simple Payback is 3.08 years ROI is 32% Increase in Value $157,423 (if I use 8.5% interest rate) Total out of pocket cost is $41,250.

Boiler Comparison With Financing Without Financing Simple Payback is 3.61 years ROI 28% Increase in Value $91,352 (if I use 8.5% interest rate) Improve tenant comfort and reliability Project Cost is $28,050 (down payment only) Simple Payback is 7.48 years ROI is 13.37% Increase in Value $176,470 (if I use 8.5% interest rate)

Is the Analysis Accurate? YES – Assuming my assumptions and the simple way I am comparing it. NO – I am not comparing net present value (the cost of carrying the debt over time, or evaluating whether my owner / manager wants any debt at all.

Conclusions If debt is available and an agreeable tool, you can leverage projects to get higher net returns. (Could do both the VFD and Boiler Projects) There are many ways to evaluate a project or compare projects. (simple payback, total cost, return on investment, leveraged returns, net present value)

Final Thoughts You will frequently get objections to an income approach to analysis when the building owner is not planning on selling the building, or is an owner occupant that isn’t evaluating decisions based on income. BUT… - That doesn’t diminish the value you create when reducing expenses. - That doesn’t change the return on investment of projects that reduce expenses.

YOU CREATE VALUE The facility management team is a critical part of creating value for management and should be looked at as a value creating opportunity, and not as expense or overhead. How are you marketing your efforts and your staff efforts to ownership and management?

THANK YOU!