When calculating your exit value for an office deal, the value can change meaningfully from year to year based on the rollover which impacts NOI. Is the proper way to deal with this to always add back any absorption/turnover vacancy to the residual NOI, and then just deduct a “market vacancy” from the grossed up NOI? Maybe something like a 5 to 10% vacancy? What is best practice here? I always gross up free rent and then do a free rent credit. Just not sure about the vacancy.
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Based on the most helpful WSO content, when calculating your exit value for an office deal, it's indeed important to consider the impact of rollover on NOI. The common practice is to add back any absorption/turnover vacancy to the residual NOI, and then deduct a "market vacancy" from the grossed up NOI. The percentage for this market vacancy can vary, but a range of 5 to 10% is often used as a benchmark.
As for free rent, it's a good practice to gross it up and then apply a free rent credit. This approach provides a more accurate reflection of the property's income potential.
However, remember that these are general guidelines and the specifics can vary based on the property, market conditions, and other factors. It's always a good idea to use a model that best reflects the unique circumstances of the deal you're working on.
For more detailed guidance, you might want to check out the WSO's resources on financial modeling and real estate investment.
Sources: "Leaving IB Soon, Final Rants" - The Follow-Up, What IB exit ops have the best wlb?, What're are realistic exit opps for Valuations (D&P, Big 4), Underwriting a realistic exit for Value Add Multifamily in "Core" Markets
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