Might be a silly question, but whatever:
Are free rent periods for office, retail, and industrial leases included above or below NOI? If I am buying an office building and the upcoming year has $1MM in rent abatements - should that be backed out of the F12 NOI I am capping, and therefore, deduct my pricing by $1MM / Going-In Cap ?
Are these costs capitalized into the deal at all? I assume a Lender would not finance revenue that was not realized due to rent abatements, but would like to be sure.
Thanks.
I've seen seller credits for such abatements where the PP is reduced by the value of the abatements (not capped, just summed). On the other hand, I'm looking at a deal right now where the abatements are included in Y1 above the line, which gives us a big jump in Y2 NOI vs. Y1 and is showing double digit levered IRR by Y5 on a deal that is clearly core plus. Interested to hear more opinions on this--do you treat Y1 NOI as if you're getting the full CF stream (ignoring abatements) so that your PP is in line with the market? Otherwise, I would think you're PP would be very low if you're going off capping your Y1 NOI...
From what I understand, it depends on whether you're valuing the property using cap rate or DCF Cap rate = y1 NOI (ignoring rent free periods) capped into perpetuity to get PP and then deduct value of rent free period (i.e. below the line) vs. DCF = Return to individual investor so include above the line and then do NPV calc accordingly Anyone else care to comment?
Agreed.
Above NOI, my man. Rent abatement is real, meaning that you really are going to lose that money from your top line. You can argue before or after NOI with non-cash items, but this one, you need to include.
As cpgame said, when you buy a building with a rather significant amount of it, the seller will give you a credit, which will lower your equity investment amount. If the seller hasn't proposed any, you should negotiate the shit out of it.
Also, I believe a direct capitalization valuation (based on any year) should be rather used as a checking mechanism on PP, not a driving one. In terms of coming up with PP, it's not only about the property, but also your cost of capital. 2 firms may have the exact same Argus pro forma and capital structure, but one with a lower cost of capital will be able to offer a higher price, if needed. For yours truly, Holy Trinity - IRR, Equity Multiples, CoC - is the key to come up with max and 1st round bids.
Above the line. We also deduct forward year Abatement from Capped NOI to arrive at resale proceeds in our models.
As everyone has said, it is above the line.
"I assume a Lender would not finance revenue that was not realized due to rent abatements, but would like to be sure." - CMBS will. For standard, smallish abatements, e.g. 6 months' free rent, a CMBS lender will likely hold back proceeds in the amount of the free rent and release those proceeds from escrow as the free rent period passes. For exotic or lengthy rent abatements, you'll start getting into the question of "well what's actually my real rent here that I can reasonably capitalize" and lenders/rating agencies/appraisers will start hitting you down to a net effective rent. And I won't speak for life co or bank $
Concessions, including discounted/free rent periods are above the line. I would ask myself why the free rent was given in the first place? Is this market driven or in lieu of TI? How many of the current leases have free rent baked into them? If its market driven, I would revisit and confirm that my pro forma rents were in line with actual market rent.
Let me throw out a caveat regarding rent abatement.
You just signed a large lease in one of your investments and are ready to sell to recycle capital. For my example, let's assume you start the marketing process 7/31/16, and estimate to close the investment 10/31/16. The tenant you just signed a deal with has a rent abatement period through 1/31/17. To "artificially juice" the in-place NOI, I would market the deal / model the ARGUS excluding the rent abatements. You disclose that you will provide a credit the buyer for any outstanding free rent (if any).
This allows the buyer pool to view the investment as if there is no rent abatement. There are cases where you wouldn't want to do this, but I have sold numerous buildings where we would utilize this approach.
Hah, this sounds 100% like what a broker would do. Immediately when someone else gets the financials, they'll correct this in their model.
[/quote] Hah, this sounds 100% like what a broker would do. Immediately when someone else gets the financials, they'll correct this in their model.[/quote]
laugh all you want, but I have done this at 2 (institutional equity) companies for the dispositions I was leading. I am not advising that this is always the case, and normally it is not. But there are definitely instances where this would be appropriate.
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