Confused Noob - Amortizing/Recoverable Capital Expenditures , how to underwrite?
Hi everyone, investment sales analyst noob here.
I've encountered a few "recoverable capital expenditures" that are amortized over a specific period and recoverable by tenants.
My question is in relation to my Argus modelling.
Question #1 - Is Amortization in reference to tax depreciation, or is it more on the front of amortizing the cost of the capex so you can charge tenants for it? (i.e. assume $1M capex, and its amortized over 10 years = $100,000 per year). For simplicity sake, assume this is a single tenant building. Does the landlord recover this $100,000 from the tenant every year?
Question #2 - How come this recovery isn't frequently modelled in Argus? I only see it as "reference purposes only" a lot of times, meaning it doesn't affect the DCF. Isn't this just a normal recovery, why not include it?
Question #3 - What determines amortization time period, 5 years , 25 years, 30 years - who knows? I don't.
Question #4 - what happens if the owner decides to sell the building halfway through the amortization? Say 5 years down the line the owner sells it, there is half the capex recovery left ($500k). The price of the building has to be adjusted because owner already paid for the capex, and it wouldn't be fair to the new purchaser to get the remaining annual $100k recoveries.
You have a lot going on these questions. So of which sound like tax accounting items, far out of my area, and frankly you would need to get the detail from the tax team to have an good shot at getting that right.
That said, you are generally modeling/underwriting cashflow, so you really just need to figure out the cash flow elements. CAPEX is cash flow out when the expense happens, the amortization is only an impact to the tax accounting/tax bill from a pure cashflow standpoint (if you are doing per GAAP or IFRS, then this is totally different).
So, expense modeling of CAPEX is easy from that standpoint, when is it happening and what will it cost.
If it is "recoverable" from a tenant, that means the tenant will make an additional payment over some specified time to cover the cost. That is essentially just another rent/income line item, just like a NNN charge. Argus has cool ways to automate this, I think that is what you mean where the "reference" entry is used, meaning the tenant payment can be calculated as a % of the reference line.
How much or how fast a tenant does this is totally negotiable, only the lease can tell you. I think IRS rules say you can amort a capex for a specific tenant over the life of the lease, which can be shorter than the set IRS life (i.e. the 5, 7, 10 year stuff). A landlord could say it must be recovered over 24 months of a 48 month lease, its all over the place.
So, no one size fits all answer, just figure out the details and hopefully the answer is obvious as to what you need to do.
Thank you! This definitely helped out as well
A primer for underwriting capital amortization billbacks (office/industrial/retail):
In certain markets/properties and under certain ownership, a landlord will billback capital projects to tenants in which tenant base is benefiting from various capital projects (HVAC/Chillers/AHU/etc.) . In a tight market with diminished supply and high YoY increases in market rents, it allows the landlord to clawback improvements from tenants that are below-market.
Certain projects have certain, differing useful life -- a chiller vs. condenser/fan coil. The landlord will typically want that useful life to be as low as possible to recoup those costs in the shortest time frame possible (assume you have a 5-7 year hold, but you're amortizing over 10-15 years for example).
Yes, these expenses are being recovered and will be ref accounts as these aren't true property level expenses and don't want it to hit your opexload. These capital amortization amounts are almost always part of a recoverable CAM pool and may be allocated in numerous ways (may be a separate billing vs. could be rolled up in R&M). It's instrumental that you have a grasp and understanding of the CAM reconciliations to understand how this is flowing and to ensure consistency in the Argus. Handled as a billback and vary with occupancy hence why it's built into a recovery structure.
You're right in that there may be some income left to a new buyer, but those revenue streams will be incorporated in the underwriting and that underwritten return/value from the buyer will be incorporated into their price. Best situation is if a proposed buyer is working through a deal and discovers incremental capital amortization revenue during the DD period with the sale price set prior to discovery [almost certainly will never occur during a marketed deal process and it's your job to ensure that it doesn't as the IS analyst :)].
Apologies if my explanation is a bit confusing, but feel free to message me for further clarification. Recoveries/reconciliations/CAM pools are the crux of what, in my opinion, makes office one of the most difficult asset classes (especially MFG/IG leases with direct bill backs, controllable caps, etc) (also intellectually engaging) so don't feel bad as you wrap your head around the idea and always ask questions!
Thanks! This helped a ton
If the building is sold can the new owner continue to pass through the amortizations to tenants?
As long as there's still useful life left on those projects, yes. A transaction may warrant some tenants to audit reconciliations (among other items) especially if it's around January-April so just be on top of billings.
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