aera aL iE DISCOUNTED CASH Aken Ra PLera] Pes Bo)What is a DCF? + Method to value real estate by taking all future projected cash flows and discounting them back fo time zero (date of purchase) using a predetermined discount rate + The theory behind discounted cash flow analysis is known as the “time value of money.” which is the idea that a dollar today is worth more than a dollar in the future due to its ability to earn interest over time. * Which would you rather choose? 1. I'll give you $100 now. 2. I'll give you $100 a year from now. Mathematically, the formula for calculating an asset's present value is: N NPV » ne (l+r)n Sh essron = SosWhat is a DCF? Three variables are needed to calculate net present value: 1. Cash Flow Per Period 2. Discount Rate 3. Number of Periods NPV = y: et 7 (_1+r)n n=0 ss SstCash Flows A property’s cash flows are determined by forecasting them for a specific holding period and they can be broken down into two parts, recurring cash flows and the terminal cash flow. RECURRING CASH FLOWS: Also known as 6 proforma and it incorporates the income and expenses associated with a given property. Income is derived from tenant lease payments or Unit sales and expenses are estimated by reviewing o combination of historic property performance and current market condifions. TERMINAL CASH FLOWS: Because we are evaluating a property for investment purposes, it is implied that it will be sold at some point in the future. The income earned from the salle is known as the “terminal cash flow" and it is calculated by taking the cash flow for the final year in the holding period and “capping it” using an estimate for the then market cap rate, = omDiscount Rate Discount rate is the return that an investor requires fo take on the level of risk implied in the transaction. How do you determine_a discount rate? Choosing a discount rate is based on analysis of several variables that may be difficult to quantify including: — Likelihood of Projected Cash Flows Occurring — Property Type — Location ~ General Economic Conditions Despite the number of variables, they all have one thing in common: risk. The higher the perceived risk in the real estate transaction, the higher the return required by the investor, and thus the higher the discount rate. The lower the perceived tisk in a real estate investment, the lower the discount rate. oe soarsHold Periods Discounted cash flow analysis is completed based on annual cash flows. Foran investment property, a "holding period" must be estimated and it is equivalent to the number of years that an investor plans to “hold” the property. Because discounted cash flow analysis has a time component, the number of years in the holding period will have a material impact on the final result. ‘Se escrow = SosaExample 1 How much is an investor willing to pay for the following property: * Projected Cash Flow: $10,000 * Required Rate of Return: 8.00% * Holding Period: 3 Years $10,000 + $10,000 | $10,000 Equation: Nev = (ry 08), * (a#.08)2" (1+.08)3 Spreadsheet Function: nv = (8.00%, $10,000, $10,000, $10,000) Regardless of the calculation method, the result is the same. The net present value of these cash flows is $25,771 and it represents the price an investor may be willing to pay for this stream of income if they require an annual return of 8.00%. ” SoaresExample 2 Assume that the annual cash flows and the discount rate are the same at $10,000 per year and 8.00% respectively. But, this time, let's assume that the cash flow in year 5 will be “capped” at the discount rate of 8%, giving us a “terminal value.” The cash flows are illustrated in the table below: Annual Gash Flow $10,000 $10,000 $10,000 $10,000 $10,000 Terminal Cash Flow $0 30 30 so $125,000 Total Cash Flow $10,000 $10,000 $10,000 $10,000 $135,000 = SoieiasExample 2 The equation(s) for calculating the present value are the same, but with more variables: $10,000 , $10,000 , $10,000, $10,000 , $135,000 Equation: NPV = ye08). * (toa (+08)3* (+08) (a+08)5 ‘Spreadsheet Function: nrv = (@ 00%, $10,000, $10,000, $10,000 $10,000,5135,000) Notice that the year 5 cash flow is the sum of the annual recurring cash flew and the terminal cash flow of $125,000 (calculated as $10,000/.08) The net present value of this series of cash flows is $125,000, inclusive of the sale in year five. Remember that the choice of a discount rate will have a material impact on the net present value of the same series of cash flows. For example, one investor may look at this property and decide that itis riskier, so they require a return of 9%. In this case, the net present value is reduced to $120,137. Or another investor may look at it and see less risk and they require an annual retum of 6%, increasing the net present value to $135,530. - gemPaes aL aU) AMORTIZATION TABLE eee Rect)What is an Amortization Table? “Amortize” To pay off (an obligation, such as a mortgage) gradually usually by periodic payments of principal and interest. + Amortization is a way to pay off debt in equal installments that include varying amounts of interest and principal payments over the life of the loan. + An amortization table is a fixed table that shows how much of your monthly payment goes toward interest and principal each month for the full term of the loan. Why is this useful? - SoarsWhat is an Amortization Table? Amortization Table eo 0,000,000 49,721,311 49,842.82 19.763 244 9. 49,004,253 49.524.410 49,364024 49,283,480 49,202 701 49,121,687 49,040,436 48958948 48.877.223 48,795,259 48713 aqon6l4 0,047,991 Cena pase 2e4sze 224502 224.522 pase 224.522 224522 24.522 245m eAsee 224522 224.502 aasae 2452 e452 224.522 224522 masa esa 224.592 fa 14a91 M4469 144213 143978 agra v4a.s0e 43272 yaacas 142797 142599 142300 142080 \aiasy Vahg98 141.356 78.683 7azig 9 79.380 79.611 7783 20076 80310 eases wore eros el2st Bl 488 airs aires 2203 e243 ae) e2y28 eee $50.000.00) 992130 9,802,392 49,763,244 19,600,244 19,604,255] 49,524,410] 9.444.334! 29,364,024 9.200.460] 922,701 19,121,687 29.08,435 22,958,948 48877.225) 8.295.259 28,713,054 8.630.614] aasar.93\ 48,485,006 28,281,240] ‘Se escrow SeesDay 3: Due Diligence/ Lease Review HELPFUL TIP #1: Start with the most important / largest tenant leases in a property and work your way down. Mistakes made on larger tenants tend to have a larger impact on real estate transaction than those made on smaller tenants. Budget the amount of time you spend on each tenant's lease accordingly HELPFUL TIP #2: Start with the most recent amendment and work your way back through the amendments to the original lease. There will be clauses within the most recent amendments that you must use over what the original lease states. HELPFUL TIP #3: Take your time when conducting lease seview. take notes and tag any potential issues or clauses you don't understand. There is nothing worse than having to re-examine lease documents because you were careless or disorganized when initially reviewing them. Important Concepts Basic Terms Tenant Name Premises Size and Suite # Commencement and Current Expiration Date Base Rental Schedule (amounts and dates) Basic Recovery methods (Gross, FSG, NNN) i Pigs Si Important clauses/aspects of a lease that you always want to note: 1. Gross Lease * Tenant is only required to pay base rent, no recoveries. 2. Full-Service Gross Lease (a.k.a. FSG) EE Ski es ee ane 1 a i aa eee ees* Tenant is only required to pay base rent, no recoveries. 2. Full-Service Gross Lease (a.k.a. FSG) * FSG tenants are required to pay base rent and their share of operating expenses for the current year that exceed the total operating expenses for their initial lease year (commonly referred to as a "base year’) * Reimbursable operating expenses may include Real Estate Taxes, insurance, and CAM (Common Area Maintenance). * “CAM” refers to all recoverable expenses at a property besides Taxes and Insurance (Utilities, Repairs & Maintenance, Cleaning, General & Administrative, etc.). 3. Triple Net Lease (a.k.a. NNN) NNN tenants are required to pay base rent and reimburse on all operating expenses. * The term ‘Triple Net” usually signifies that the tenant must reimburse landlord for Real Estate Taxes, Insurance, and Common Area Maintenance (CAM) expenses. 4. Pro Rata Share (PRS) * Tenants with NNN and FSG leases will reimburse based on their Pro Rata Share (PRS) of operating expenses. * Pro Rata Share (PRS) is the ratio between a Tenant's occupied square footage ina building and the entire building's rentable area. © Types of PRS: > Fixed PSR: PRS does not change if the building RSF expands or reduces. Natural PRS: PRS adjusts if the building RSF expands or reduces (i.e., the denominator changes).8. Guarantor * Aperson acting as a co-signor that guarantees to pay for another party's lease should they default on the obligation. They pledge their own assets/services if a situation arises in which the original debtor cannot perform the obligations. 6. Rent Abatements * Make note of any outstanding free rent applicable to tenants. «May include free base rent and / or free operating expenses 7. Tenant improvements * Make note of any tenant improvements that have not been used. If it is a newer lease you will want to follow up with the client to see if there are any outstanding Tls. (Often the owner will credit an investor for outstanding abatements, Tis, & LCs) 8, Renewal Options Clause in a lease that gives tenants the option to renew for an additional term(s) upon expiration. Language may include specific terms, notice periods, fixed rates, etc, * Example: One 5-year option to renew at market with 6 months notice © Example: Two 5-year options to renew at $3.00 psf / month with 9 months notice. 9. Early Termination Option * Early termination right effective on a specific date with a notice period and a fee. 10. Subleased Suite(s) * Tenant has subleased their space to a sub-tenant.« Glause in a lease that gives tenants the option to renew for an adaitional term(s) upon expiration. Language may include specific terms, notice periods, fixed rates, etc. * Example: One 5-year option to renew at market with 6 months notice * Example: Two 5-year options to renew at $3.00 psf / month with 9 months notice. 9. Early Termination Option «Early termination right effective on a specific date with a notice period and a fee. 10. Subleased Suite(s) * Tenant has subleased their space to a sub-tenant. + Example: Suite is currently subleased to XXX, Inc. through 12/31/2025 at the same rental terms as the original lease. 11. Tenant Parking + Important to keep track of how many spaces and how much in total the tenant is paying for parking. This may be a big revenue driver of a building and will be added into the revenues section of the model. 412, Taxes * Real Estate Tax laws, regulations, and methodologies will vary by state. + Example: California Real Estate Taxes are reassessed based on a building's purchase price and milage rate. Then are increased annually by 2% every July. * Example: In California, Prop 13 tenants are protected from paying reimbursements. based on reassessed tax amounts (California Specific). 43. Insurance * Main types: Property & Liability Insurance * May alse include Earthquake Insurance and other Environmental Insurances depending ‘on building location.Phases of Leasing a Space: LOI (Letter of Intent): Tenant has signed a Letter of Intent to lease space, but no draft leases have been prepared yet. NEG (Negotiations): Tenant and Landlord are in the process of finalizing the lease drafts. OFS (Out for Signature): The final lease draft and terms have been agreed to by Tenant and Landlord. The final draft has been delivered to Tenant for their signature.Example Tenant Summary a0 youre mam 190% sam S508 56 nn2 58 ASBOIB2I2 Faoabook opey iad HSIN SMB BES FG Boo 20 B20 Nepresss, mem ie Sam Sor Fae beat 3 fiog We Foc i ors sung uae raw Newz 8 fam Yat no Tse Seas 840 F36 Feb 04 om Oroale mR aim mrad LTB Fo how w aoa Ape as "tt Som See AE F360 vot 03 oil based Square Ft ares ana waar ae wane 7 Toalvacntsqae Fat ©, mam 106% Toaiseare teExample Lease Expiration Schedule 202s 8.300 Yahoo: 3600 Feb2e $810 SIH 73% ‘A400 Apple 3200 aug. «Sk SEBEL 80% 5210 Nespresso 20670 __Dee24 S607 S080 118% Tota 350 a 25 S80 Facebook 14070 Jn2s Shas SHEE 78% 202 Facebook 1070 _Now2s $5.50 __ssa65___7.5% Toa: 10 S38 Sas 11% TSE 226___AtG2._Erwohon 6.760 verae $508 sear 30% Total: 6.780 0a se0ar 3.0% TEM a 2027200 Googe 12800 _Mapar sare ss7o__6.7% Toa T2500 a wee 8200 YouTube sa400 nae 08 HOTS 180H 100 _ Whois Foods 19620 hows SAS? SS901__1OT% ola! 20 Sat 80-12 a8 aga 20306100 _ Reformation 2360 angn 492590121 Total E500 S92 “S500 a1 Tee BLE ‘Tota Leased Suara Feat TRF war “Total vacant Square Feet 19280 104% Tatar Square Feat ooEsempleiy, ST Pro Forma Cash FlowEXAMPLE PRO FORMA ASSUMPTIONS _—— ae re Taos a waitin “Tt Meth 2029 Market Rms (PF) =a. = noe Sica moi Feira Bay Tom reilenady 306ml =a Se yh ‘ora Do) siPienee 42h ane rer p00 sss Vesicle ores Nt eT | SoUTIMnIES ROUSE SSSR TS Geert (Sate gre ae mal em 8 Migacet foetal af ay Cap eer PF) tow,LEVANAL EXAMPLE Debt Fund, 75% LTC, 3+1#1 Term, SOFR#275. soso.