Professional Deal Analysis - Impact of Prepaids on CCR, Proformas

[Ryan Marchand]

Situation:

We're acquiring properties at a steady rate (2-4 per month) and I'm looking to improve our cash management. The ultimate goal is to reduce the likelihood of capital calls, while at the same time streamlining work for the bookkeeping team.

Example: 

We're buying a 40-unit apartment complex (in Michigan) with an annual property tax bill in year 1 of approximately $50,000. Let's assume all other "Uses" equate to $350,000 in this particular example. Let's also assume that cash flow after debt service is $75,000 (NOI less CAPEX) and debt service is $60,000 per year. All figures are generated for illustration purposes only and do not reflect actual figures of any of our current/past transactions.

Questions:

1-If our debt package requires 3 months of prepaid P&I ($15,000), should we increase our Sources & Uses schedule to account for this figure, or do we anticipate the property to perform & simply borrow funds short-term from ourselves or 3rd party credit until operating incomes can pay back the short-term loan? I don't want to get in the habit of depending upon future incomes to prepay bills if it means we're now "dependent" upon the property to perform. 

2-Are there 3rd party vendor that offers nationwide property tax payment plan solutions for commercial properties? 

3-A property acquired in August would require far more cash at closing for prepaid taxes versus the same property acquired in June of the same calendar year. How does this impact the pro-forma and budgeting leg of your acquisitions & bookkeeping workflows, respectively?

4-If in Q#1 the S/U increases by $15k, then our Cash on Cash Return ("CCR") would decrease proportionally due to having a larger denominator. However, if we are prepaying $15k of the year 1 opex, should we deduct that $15k in the proforma for year 1? In this scenario, the CCR increases because we've reduced opex that will be paid during year 1 by prepaying at closing as part of our initial cash investment.

Photo is of one of our properties; not impacted by this post.

[Drew Sygit]

@Ryan Marchand will answer what we are familiar with:

1) Would depend on projections on how long it should take for operating income to repay any borrowed funds. Establish a baseline and stick to it.
Also, look into getting a line of credit to tap for short-term cash requirements. You can then also use the rate to establish IRS required "fair market rate" if you also want to lend money from yourselves. 

2) This would just be another form of borrowering, increasing your costs. Would only do if it's cheaper than own line of credit or as last resort.

3) Shouldn't impact the pro forma at all. Will obviously affect budgeting though. 

4) If you're S/U is only covering actual prepaids, it should be settled in the current year, so it shouldn't affect your CCR. If you choose to borrow the funds to pay it, then only the interest expense should affect your CCR.

Hopefully, others with additional expertise will respond:)