Wealth Opportunities in Commercial Real Estate: Management, Financing, and Marketing of Investment Properties

Cap X, TIs, and Leasing Commissions

It is important to anticipate that in conjunction with commercial projects lenders today typically require, in addition to impound accounts for taxes and insurance, reserves for projected capital expenditures (Cap X) as well as for tenant improvements (TIs) and leasing commissions.

The questions become, are these reserves monies that the borrower reasonably anticipates to spend or are they funds set aside by the lender because the lender is overly cautious? If a certain amount is going to be spent year after year, maybe this amount should fall within the category of normal and usual business expenses and be part of the operating expense line items. If, on the other hand, these monies will not be spent consistently, year after year, possibly they should be viewed as one-time expenditures and not affect NOI (and therefore not affect value). The expense would then be accounted for as a below-the-line deduction—that is, a deduction from NOI rather than deductions to calculate NOI. This distinction becomes important when a third-party lender is involved.

As is discussed in Chapter 5, lenders will usually reduce NOI by their estimate of needed reserves to derive funds available to service the debt or cash flow from operations (CFO) before the applicable debt coverage ratio is applied. Similarly, when attempting to determine value, it would seem more accurate to use CFO rather than NOI divided by the applicable cap rate or, as mentioned above, to reduce ...