Underwriting Questions
Let' say you're underwriting a multi-tenanted office building where leases have a base year stop. How do you determine the Fixed % of an expense?
Also, I've seen some agrus runs with an expense that contains a Recoverable % that's between 0%-100%. What scenario would this apply?
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If the expense would drop if the tenant vacated, then it is a variable expense (ex. utilities, CAM, etc.). I typically put a 50% variable rate on these types of expenses, although that is somewhat arbitrary. The higher the number, the more conservative your underwriting. Rarely will the % be 0% fixed.
I've seen leases that have expenses that are 50% reimbursable, but I would consider that fairly rare. Usually it is all or nothing.
what @"AcquisitionsGuy" said. the type of expense stop isn't really related to the fixed %--you might be confusing yourself that way. fixed % relates to how much that expense varies with occupancy. If an expense at a 5000 SF building is $10 PSF and it is 25% fixed, argus will do the following calculation: ((5000 X 10) X .25)--this is the fixed portion, or the one that is secure and does not change PLUS ((5000 X 10) X .75) X level of occupancy--this is the variable portion. basically, Argus uses the fixed percentage to calculate what it knows for a fact expenses will be, then uses the variable percentage against the level of occupancy to measure how much it is subject to fluctuation.
@"Ricky Rosay" I'm clear on how the Fixed/Variable % relates to occupancy but I appreciate the explanation. And just a heads up, I believe the Recovery Structure is directly related to the Fixed %.
The Variable % portion of an expense will have the Gross Up % applied to it while the Fixed % portion does not. The Fixed % is allocated on a percentage of occupied area basis while the Variable % is allocated on a percentage of rentable area basis.
The Recoverable % field is then applied to the amount calculated above. This goes for any expense group with a recovery calc besides "None". I checked this in argus by creating a test property with an isolated expense. Please let me know if I am mistaken here.
I'm having trouble following what you are confused about? Fixed expenses are what one would think... they are fixed no matter if you have 1 tenant in the building or 100. These are expenses the landlord will pay that DO NOT vary with occupancy. these fixed expenses are things like real estate taxes and insurance. Variable are expenses that vary with occupancy, such as utilities & janitorial.
When constructing an argus model, there really isn't a way to determine what % of an expense is variable (unless you have historical actuals and can run analyses on the side). However, industry standard is somewhere between 80/20 - 70/30 for variable / fixed % breakout.
For example, let's say you are looking at buying a building that historically has had a occupancy of 50% and last year's utilities ran at $100k per year. We will assume this expense is 20% fixed & 80% variable. For projections in your underwriting, you would need to determine a "gross up" amount to enter into the argus model, so when argus does the behind the scene calculation, your utilities net to $100k. The amount you enter into argus is determined by the following formula:
100,000 = x [fixed % + (occupancy x (1 - fixed %)] 100,000 = x [ .2 + (.5 x .8)] 100,000 = x [ .2 + .4] 100,000 = .6x x= $166,666.67
Now that we know x, you (ie. ARGUS) can back into whatever your utilities are estimated to be based on your projection of occupancy.
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