Question For Syndicators

27 Replies

When projecting your returns to present to investors, do you use the NOI before or after Cap Ex reserves and asset management fees? Specifically the sales price.


Our projected returns include the asset management fee and CapEx. I don't see why they wouldn't be included. Unless perhaps you expect not to actually use the CapEx reserves and distribute them to investors when you sell?

The projected returns should be to the investors and not for the project. So since capex reserves and AM fees should be taken out before you distribute profits, it should be included.

@Taylor L. - I've looked at three popular calculators and each one does it differently.

Removing them will increase the NOI substantially on larger deals and of course makes the projected returns look good. Not surprisingly many of the OM's I get do not include it in their pro forma.

I have been told that it's the "industry standard" to not include it in the final sales price projection.  

As @Michael Le said the returns projected are for investors so the numbers need to reflect the returns they will see on their investment. Fees should absolutely be included. There may be a portion of operating capital and CapEx that's returned to investors, but it's safer to treat this as a bonus and not apart of the projected returns.

@Greg Scully

Analysts calculate return metrics like IRR and cash on cash (or yield) using net cash flow to investors (in your case, NOI after Cap Ex and AM fees). 

However, it is typical to calculate your terminal value (or future sale price) for a property based on the NOI before Cap Ex and AM fees.

Hope this helps!

@Greg Scully you don't use either of those options when projecting returns. NOI is the income generated by the property minus operating expenses. That has nothing at all to do with returns.

To calculate (or project) returns, you use cash flow.  

Cash flow is NOI, minus debt service, minus the greater of capX reserves or actual capX, minus partnership/sponsor level fees, plus cash received from refinances or sale, plus the return of cash reserves and impounds when no longer needed.

When presenting returns to investors it's on a free cash flow basis that they get paid their distributions so I don't see how you could present an incomplete picture?  

Free cash flow is after EVERYTHING is taken out including debt service, RR, Capex and of course asset management fee.


@Greg Scully Terminal value is more of an art than a science. There are various methods of calculating it, but most institutional analysts will divide the projected NOI by a market cap rate plus 20-50 basis points. Projected NOI refers to the estimated NOI in the year after sale. A basis point is .01%. Example ... a 6% current market cap rate plus 50 basis points is 6.5%.

@Greg Scully the NOI should always be taken as income less expenses. Most people will remove the capital expenditure reserve and asset management fees after the NOI is calculated.  With that being said, they will be deducted from the Cash Flow Before Taxes, which is ultimately the final number that the cash-on-cash return your investors receive will be based off of.

@Charles Seaman - What about the terminal value calculation?  Some include Cap ex Reserves and AM, some just Cap ex, some don't include either.  

Some basic scenarios I've run revealed a difference of 3% in the IRR. No big deal if the IRR is 20+, however the difference between a projected 12% and a projected 15% may be mean the difference between getting funded or not.

I've never seen "how is your terminal value calculated?" on the list of questions to ask syndication sponsors.  Perhaps it should be there.

We always calculate our terminal values with $250 to $300/unit/year capX reserves subtracted from NOI. Having said that, buyers who buy on cap rate alone are mixed in their application of capX reserves as part of NOI, so this is a conservative approach. But there are so many other factors dipping into your pocket on a sale transaction that being conservative is prudent.

As you said, @Greg Scully , simply removing capX reserves from NOI on terminal value calculation has quite an effect on IRR. For this reason, you could have two different sponsors projecting two very different IRRs for the same set of cash flows on the same property. This is why I always say that comparing IRRs is no way to compare offerings--instead you have to understand how those IRRs were calculated--the assumptions made, and yes, the components of NOI when calculating terminal value (not to mention exit cap rate assumptions).

@Greg Scully Are you referring to unused CapEx reserves that were raised? Asset management fees are never included in terminal value calculations, but some syndicators will charge a disposition fee (think similar to an acquisition fee, but on the sale side). Typically, terminal values are calculated as follows:

1.  Exit Price - Sale Expense (4% or 5% - this includes brokerage commission and all other sale related expenses) - Outstanding Loan Principal = Owner Equity

2.  Owner Equity - Initial Cost Basis = Owner Equity Creation

3.  Owner Equity Creation - Syndicator's Portion = Owner Net Equity Share (this is the portion that the equity investors receive)

Here's a practical example with simple numbers.

Exit Price                              = $1,000,000

- Sale Expense (5%)               = ($50,000)

- Outstanding Loan Principal  = ($450,000)


Owner Equity                         = $500,000

- Initial Cost Basis                   = ($200,000)


Owner Equity Creation           = $300,000

- 40% for Syndicator               = ($120,000)


Owner Net Equity Share          = $180,000

NOI does not include Asset management fees, but should include the Cap Ex. The reason you would not include asset management is because that is not a needed expense, but an expense of a larger company or syndication (asset management differs from property management, which you include). To calculate your returns on a cash on cash basis, however, you will subtract the AM fee from the cash flow.

For determining future value, one thing I will say - and this is my opinion - is that you should look at historical cap rates to help determine an exit cap rate. Cap rates are compressed, so if you're just adding in 20-50 basis pts, you likely are going to get caught with your pants down in a recession. 

@Greg Scully CapEx reserves are NOT included in the NOI. They're typically what's referred to as a "below the line" item. They do impact your cash-on-cash return, but won't impact the NOI. As @Todd Dexheimer alluded to, cap rates are very compressed right now, so using a proper reversion cap rate is a good idea when you do your underwriting.

Originally posted by @Lucas Miller :

@Charles Seaman curious why you think replacement reserves should be below the line. Wondering if @Brian Burke agrees?

Yes, I agree, replacement reserves are not a component of NOI. Now before you think, "Brian's finally lost it!!", I'll explain.

First, capital improvements are investments in replacements and upgrades that extend the useful life of the property, such as roof replacement, parking lot resurfacing, painting, replacing HVAC, etc. These are not operating expenses, they are investments in the property. Net Operating Income is operating income minus operating expenses, so by definition, capital improvements are not a component of NOI.

Replacement reserves are a lender-mandated set-aside where the owner sends in additional funds for replacements along with their monthly mortgage payment. The lender then sets that money aside into a lender-controlled account and disburses the money back to the owner when capital improvements are made. They do this for two primary reasons: 1. to encourage owners to maintain the property and 2. to ensure that there is money there if they have to foreclose and subsequently have to make the replacements themselves. Just as debt service is not a component of NOI, neither is the replacement reserve component of the loan payment. If an owner owns a property free and clear, they have no debt service and they have no replacement reserve unless they decide to voluntarily set aside money each month into a separate account.

But let's examine one step further. When I am underwriting an acquisition, one of the things I want to know is the cap rate, which is the property's trailing NOI (adjusted for future property taxes) divided by the purchase price. If the trailing NOI includes replacement reserves, the resulting cap rate would be lower. Leaving the replacement reserves out, the cap rate is higher. The reason this is significant is that calculating the cap rates of comparable sales and the purchase of the subject itself forms a basis for estimating the cap rate to be used when estimating the exit value. If my starting cap rate is artificially low because I have replacement reserves in my NOI, it's more likely that my exit cap rate will be artificially low as well, causing my exit value assumption to be too high.

Along that line, the only time I violate all of the above is when calculating my NOI in my year of exit, which forms the basis for my estimate of terminal value. In this case, and this case only, I subtract a replacement reserve from NOI so that my resulting exit price is lower. I do this for two reasons. First is to be conservative in my exit value. Second is because some buyers deduct (improperly) replacement reserves from NOI when they calculate their cap rate, and often those buyers are the same ones that base their pricing decisions on cap rate (also improper, but it is what it is).