In a cash flow, how do you handle the capitalization of absorption and turnover costs for terminal value calculation when a property is modeled to have absorption costs essentially every year?
I built an Argus model for a stip shopping center, and due to the number of spaces and staggered lease expiration dates, Argus models there to be absorption and turnover costs every year of the cash flow. Normally if there were significant turnover costs in the forward year, I'd extend the analysis length a bit so the NOI is not understated for the terminal value calculation. However for a property like this, the absorption and turnover costs are more of a stabilized/ongoing expense that are modeled to occur every year. Should I therefore include the turnover costs in calculating the forward-year NOI as long as it's not an anomolously high year?
What the economic vacancy annually? 5-7%, if so and the leasing dynamics are that of smaller tenants that are on 2-4 year leases, I’d say it’s most representable to cap a year with that roll. Of course, reduce Downtown absorption and turn over in your GVAC assumptions in Argus. If it’s more than 15% economic vacancy, there may to need to be a shift in the business plan to a shorter or longer term hold that should be factored into your return threshold — IRR vs. EM. Hard to say without seeing the exact profile, but my thoughts nonetheless.
You can gross up the NOI to assume it’s stabilized. There is a button in argus you can click. And than you can offer the TI and LC in the forward year as a seller credit. That way you account for it and sell on a normalized NOI. However, it seems the roll is normal. If it’s so normal in this asset, how are you valuing it off of the purchase? Look at how you’re purchasing it and assume a buyer will look at it similarly, if that makes sense.
Hey, I have a question about this... I actually figured out how to do what you said about grossing up the occupancy and then deducting as a seller credit. However, the issue is that I already have my model to reduce general vacancy by absorption & turnover vacancy. So now it is capitalizing an NOI that is too high, because it doesn't re-up the general vacancy to account for the fact that absorption and turnover is being added back to the NOI. Does that make sense?
There is probably a way to do this but I don’t know off the top of my head. Check your argus booklet that tells you how to do things (not sure what it’s called). Or call argus support.
Gross up absorption/turnover and take general vacancy net of absorption/turnover in Argus. This means your general vacancy is taken on your potential gross revenue at 100% occupancy but your total absorption/turnover blended with general vacancy will not exceed the total vacancy reserve (e.g. if market vacancy is 5% but you have 3% absorption vacancy, your GVac will only be 2%).
If your turnover in the forward year is greater than your general vacancy reserve would be, then you can deduct TIs/LCs from value as a credit.
Thanks, yeah I have that box checked, but for some reason it doesn't seem to be reducing vacancy by the full amount that it should in some years. I set general vacancy to 5% and Argus definitely reduces it, but for example I have a year where the general vacancy is 3.45% of PGI and the absorption and turnover vacancy is 3.81% of EGI for a total of 7.26%. Have you ever experienced that before, and do you have any idea why that would happen?
It's your lucky day, I had to call support about that a couple of years ago so I do know why. It's because everything is calculated on a monthly basis by default even though your reports are annual, so the annual total doesn't always come out to a clean split. If you convert your cash flow report to monthly you'll be able to get an understanding of it, but the numbers themselves are correct.
In the last year you can also use the MLA profiles and manually taper downtime to 0 in the reversionary + 1 year so building is fully occupied in the capped year.
Ex. if you have a 10 year cash flow and are capping 11th year income, with 6 months downtime assumption... you can click the ellipsis in "months vacant" and use month 1 at 6 months downtime, month 116 at 5 months downtime, month 117 at 4 months downtime, etc... month 121 at 0 months of downtime. Ensures fully stabilized in final year and full vacancy deducted.
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