General Vacancy Deductions
Do you apply a flat general vacancy factor (say 10%) to gross potential income? Or, do you deduct absorption & turnover vacancy from the general vacancy calculation so you don't double count? Do you deduct free rent too or anything else? What is your preferred approach?
You obviously are working in multifamily, which means you don't use Argus, which means you wouldn't run into this calculation. In Argus, there are two types of vacancy. General vacancy, which is just a deduction based on a static percentage, and turnover/absorption vacancy, which is vacancy caused by tenants rolling to market and vacating the space. In Argus, you can choose to deduct from general vacancy by the amount of turnover/absorption vacancy in a period.
Using simple math, lets say you have Potential Base Rent of $1000, a 5% general vacancy factor, with no absorption/turnover. That would mean that your EGI would be $950 if you have 100% occupancy.
Using the same numbers, lets say you have $20 in absorption/turnover, and you are deducting from your general vacancy. $50 in GV minus $20 of absorption/turnover means that you'd still have $30 in general vacancy. EGI is still $950.
Using the same numbers again, lets say you are NOT deducting from your general vacancy. $50 in GV plus $20 of absorption/turnover equals $70 of vacancy. EGI is now $930.
To answer OP's original question, I always deduct absorption & turnover vacancy. I also always override in place tenants to 0% general vacancy until the expiration of their base term. The general vacancy assumption I use is going to vary depending on the property/location, but it is usually 2%-5%. With that said, I work in industrial and would probably not apply these same assumptions to office or retail.
Most people misunderstand this line item.
General Vacancy doesn't/shouldn't (from a theoretical standpoint) have anything to do with market vacancy/downtime/rollover risk. GV loss is essentially a buffer/reserve that you bake-in to factor in the risk that a tenant or tenants get behind on their rent, miss payments, go BK, etc. This is why obviously tenants like Amazon, etc. would be EXCLUDED from the GV loss calculation. Absorption/Turnover vacancy is where you factor in market vacancy. Theoretically this should be triangulated based on a combination of downtime and renewal/retention ratio.
The reason that you flip the switch in Argus to deduct the absorption/turnover from GV loss is because it wouldn't make sense to take GV loss off of potential rent that isn't being collected (i.e., you are double counting your loss when you don't have any income to deduct). This is usually standard practice for single-tenant buildings. I'd argue that it's more case-by-case for multi-tenant assets.
EDIT: you actually do this with multifamily in a lot of instances, too, it's just that the nomenclature is different. In MF, you use vacancy loss factor, then you use 'bad debt'/'collections' loss. It hits in different places sometimes but it's conceptually trying to accomplish the same thing.
This is incorrect - General Vacancy is absolutely a plug for market vacancy. Credit Loss is used to underwrite bad debt / BK / or credit risk. I work with lenders and they always take the higher of actual vacancy (turnover / downtime) or general vacancy (market vacancy)
OK - then explain why standard practice is to exclude certain tenants from GV Loss?
Most groups do either GV or Credit. It's not usually both.
I work with lenders too, it's how we get properties financed. Saying you work with lenders isn't an inherent qualifier. Most lenders are very, very bad at accurately underwriting a deal. Of course they are going to take the highest of the two; it's their job to underwrite the absolute downside. Doesn't mean it's the correct way to do it.
I've worked on probably 100+ live debt deals for 3 shops and "general vacancy" is always used to underwrite market vacancy. The only exceptions would be a single-tenant credit deal with a lease expiration well outside the loan maturity or some other out of the box scenario.
Sure, I've seen it all the time lenders/ borrowers get more aggressive and exclude long term credit tenants from the general vacancy calculation. Rational is tenant'scredit and income is so secure / long term, submarket vacancy doesn't apply to their rental income. However to say general vacancy doesn't represent or shouldn't be used to underwrite the submarket vacancy in a deal is just straight up incorrect
For example, say you're underwriting a fully leased class-A office building in a submarket where the class A market vacancy has always been 15%....the building WALT is 3 years and subsequent leasing / renewals are all spec which get you back to 100% leased by year 5. You can't underwrite/ apply terminal value in say year 7 based on a 100% leased building - Any sensible underwriting is going to include a 10-15% "general vacancy" factor to account for the soft market.
Again, this is not accurate. But if you want to throw around deal count then go ahead and keep e-peening. If you're saying that the reason for the vacancy in the terminal year is because you can't count on a 100% leased building, then that would be done IN THE ABSORPTION AND TURNOVER VACANCY, with lease terms, retention ratios, and downtime assumptions that would factor all of that into the cash flow.
Why else do 99% of shops underwrite it to DEDUCT absorption and turnover from the GV????
I'll throw this back at you. If GV was really taking into account market vacancy, then why would you apply it to 100% occupied buildings with contractual rent? The income is guaranteed. It's not like you say 'oh hey, you know what, I have a 100% occupied building but I think we should deduct 10% from our in-place tenants because the market sucks'? How would that make any sense? It serves the same purpose as a credit/collections loss.
EDIT: Just because you've done it a bunch of times, or that it's widely misused/misunderstood, doesn't mean it's accurate.
This is not correct. Simply not. Read the Argus Manual. Credit Loss is for late rent etc and GV is for market vacancy.