Other Assumptions Section
Welcome to this video. In this video, I will cover the Other Assumptions section in the ARGUS Portfolio Model. I can see there are three fields in the Other Assumptions section – Total reserve, Going-in cap rate, and the first-year net operating income.
Tenant improvement and Leasing commission
I will sum up tenant improvement and leasing commission reserve, and the capital expenditure reserve in the sources. Reserves are the funds put aside at the closing of the deal to pay for future expenses. Let’s go to the Annual Cash Flow Summary tab to see how the reserve is reflected in the cash flow. I can see the beginning reserve is $4.5 million. Withdraws are made from the reserves every year to cover the cash shortfall caused by large Tenant Improvements or Leasing Commissions. It means the cash flow would have become negative if the reserve were not set up. The unused portion of the reserve is refunded to equity investors upon the exit of the investment.
Let’s get into the Combined Monthly Cash Flow Summary tab to find out how this works. In month 5, a $1.3 million leasing cost is incurred, and the net operating income is $330,000 in the same month. The cash flow would have been about negative without the reserve in this month, which means the Net Operating Income in month 5 is not enough to cover the leasing expenses. Therefore, $1.3 million is withdrawn from the reserve to cover the expenses. The reason for having reserves in the ARGUS Portfolio Model is because the change of sign of the cash flow messes up the IRR and waterfall calculation. There are various resources online discussing this issue and I will leave a link for one of the resources below
The main purpose of this reserves feature in the ARGUS Portfolio Model is to avoid negative cash flow during the holding period. This process is also called “smoothing out the cash flow”. Going back to the annual cash flow summary tab. I can see that cash flow turns negative in year 9 due to large leasing expenses, and the reserves are used up in year 7 so there is not enough reserve to cover the cash shortfall in year 9. This requires me to add funds into the reserves during the holding period. Because of the complex nature of this task, it is more efficient to leave this job to the computer to figure out when and how much I should add funds into the reserve. This is one of the most powerful features of the ARGUS Portfolio Model. One of the functions of the FIX EVERYTHING button is to identify the best reserve schedule automatically for me. The Fix Everything button will be covered in detail in a later video. Let’s go back to the input tab. I can see the going-in cap rate and the first-year net operating income have been calculated for me by the system.
Thanks for watching this video. I will see you at the next one.