Expense growth exceeding market rent growth - how are you handling this in DCF's?

I am building a model for an office property in NJ. I found a survey from Newmark indicating that expense growth is indicated to outpace market rent growth for NJ office, at least in the near term.

Link to survey for those curious: https://www.nmrk.com/insights/market-report/newma…

I am wondering how you would handle this if building a cash flow with a 10+ year analysis period. If the market rent growth is outpaced by the expense growth, then over time the expenses will become a larger and larger percentage of the EGI... Is that how people are underwriting office in some markets?

Just hoping to get some thoughts. Thanks!

 

My opinion is you can underwrite whatever you want so who cares what others are underwriting. The most likely scenario seems to be that office rent growth will be hard pressed moving forward. As such, if the deal does not work, then it does not work. Don’t force it. Pivot.

 

Well, this is for an appraisal, so for the purposes of the assignment I need to be impartial and underwrite how "the market" would underwrite it.

 
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Depends on your stance on the market and investment. If your viewpoint is I believe what I read in the report, than maybe you model expenses growing faster than rents for 10 years. If you don’t believe it - that’s fine- that’s why it is called investing. Explain your viewpoint, make sure it’s logical, underwrite it, and we will see if you are right in 5 -10 years. Maybe your view is rent growth will catch up in 5 years because vacancy will normalize. So you underwrite 2% rent growth years 1-5 and 3% expense growth. But in years 6-10 you underwrite 3% growth for both rents or expenses. 

 

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