A loan officer's guide to real estate investor contingency analysis

RMA Journal, The,  June, 2004  by Tim Lovelace

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If the company is in development or any other business that holds assets for resale, repayment of some company debts may be expected to come from the sale of property. It often necessary, to inquire into the history of the company or look at several years of financial or tax-return information. If the company has a track record of buying or developing properties and successfully selling them and repaying debt, it is reasonable to assume it will continue to do so, and there is no reason to include the liability in the CCF calculation. On the other hand, if a large speculative real-estate holding has been held for several years and no activity appears imminent, then consider including the liability in the CCF worksheet.

For Buy Low/Sell High LLC, the tax return reveals $200,000 in real estate holdings, which Mr. Investor was able to finance at 100% at High Roller Bank, so there is a liability of $200,000. Inquiry reveals it is a single-pay note with an annual maturity. The property is a lot on a well-traveled thoroughfare that was to be held for resale to a yet unidentified retailer. Unfortunately, it is not well traveled by the type of patrons retailers seek, and it looks like a term loan waiting to happen. Furthermore, Mr. I.C. Spec, who adds no support for the loan, owns the other 50% of the LLC. Thus, it's advisable to include the full $200,000 in the contingency cash flow and assume a 15-year payout, so the annual debt service is $20,000.

Now look at Investor/Buddy LLC. Mr. Investor is a 50% owner with Mr. Buddy, who you will recall sold his property for the new super-center. The tax return indicates two properties having a total value of $500,000 and debts of $400,000. You are familiar with these properties because they are two undeveloped interstate tracts that Mr. Buddy found and Investor/Buddy LLC purchased with a loan from your bank. While both properties are listed for resale, Mr. Buddy has a track record of successful buying and selling. The last two years' tax returns indicate profits from his ventures. This project will be excluded from the CCF calculation.

Finalizing the CFF Worksheet

Now that all assets are accounted for, the next step is to begin totaling columns. All addbacks of depreciation and interest are included to obtain a true available cash flow, representing the total cash available for living expenses, personal debt service, and contingencies. Next, it is necessary to subtract a reasonable amount for living expense. This amount will vary based on the individual borrower, his or her dependents, and lifestyle choices. In our example, $100,000 is used because Mr. Investor has two children in college and travels extensively. The next deduction is for personal debt service, which must be obtained from the personal financial statement. Mr. Investor has only a car loan and a residential mortgage payment, so the total personal debt service is only $65,000 per year. Next, contingent debt service, which represents a total of the individual loans included in the CCF worksheet, is subtracted, and the remainder is CCF. In our example, Mr. Investor has CCF of $180,000.