Free Rent included in total project costs?
Valuing a value-add deal that will require a significant amount of free rent to stabilize. Should this be included in my total project costs for my YOC calculation?
Thanks guys
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Wouldn't it already be included in your CF (as a negative line item offsetting market rent)? So then putting it in the denominator of the YOC calculation would be double-counting it.
Was going to do stabilized YOC in year three when the asset is fully leased and there is no free rent (commercial value-add deal). So unsure if I should add all of the free rent into the rest of the project costs since it is a big line item for this deal.
Hmm, at my shop I would not include it but I guess I could see an argument being made to include.
If your free rent is significant, wouldn't it be reflected in your carry costs, which is already part of the denominator?
This is a distressed deal that had most of its tenants blow out over the last year. There aren't any Construction Costs, just TIs, LCs, and Free Rent. Your saying that the denominator in this case should just be purchase price + carry costs? I was calculating the denominator as (purchase price + TIs + LCs + Free Rent) prior
It sounds like there is not positive cash flow. So you’re free rent gets baked into your carry costs. So if you think about it, yes, purchase price plus redevelopment costs (TI/LC/Free Rent) should already be baked into the total costs.
There is some cash flow which negates the free rent/TIs/LCs somewhat. Total TI+LC+Free Rent= ~$2,500,000 while carry costs would be ~$1,000,000. Which would you use in addition to purchase price for the denominator?
Yes. If your purchase price is $2,000,000 and your negative cash flow (read: carry costs) is $1,000,000, your total development cost is $3,000,000 - which is your denominator. If cash flow offsets TI/LC/Free rent, and you are planning to use that cash flow to pay for the TI/LC/Free rent, it won't be in your total cost. However, your milage may vary, every firm will look at this different, especially as, leasing can be chunky and a model is never correct. If you are capitalizing TI/LC/Free rent up front in the deal, whether by equity or debt, you should include it in the denominator.
Also, maybe just speak with your boss/the principals of your firm. They will tell you how they want to see it. Every firm looks at these numbers different. Some only care about untrended yield on cost, some care only about trended yield on cost, some capitalize expenses up front and some do not. It just depends on where you work. If I were you, I would go speak with your boss.
No no, I'm saying your free rent is going to be part of carry costs. But your YOC denominator is still going to include TI, LC, and other capital outlays.
Your lender will likely make you reserve it in either directly or as part of calculating the interest shortfall reserve.
Wouldn’t it just be taken up in carrying costs? Assuming the first year or two has negative cash flow, and you use either equity or debt to pay carrying costs, this will get counted already. So there is no need to add it again. If you don’t have negative cash flow, I wouldn’t add it to your costs, because technically, the building can afford it. It’s a ‘cost’ but it’s not a true ‘cost’ if that makes sense.
This is a distressed deal that had most of its tenants blow out over the last year. There aren't any Construction Costs, just TIs, LCs, and Free Rent. Your saying that the denominator in this case should just be purchase price + carry costs?
I would include purchase price, TI/LC, negative NOI, and loan interest. These are all things that are typically viewed as 'cost' in a typical ground up development. Costs are things that make you draw debt or equity to fund, if the concession just means temporarily lower but not negative NOI its not a cost.
You have to include it some way or the other, as you mentioned there's significant free rent required to stabilize the property. Either reduce your cashflow revenue, or just add the free rent as an expense. If you're doing YOC in year 3, include the free rent and TIs as part of the cost.
You can do 2 calculations, one with the free rent and TI in the denominator, and one without for reference purposes - "stabilized" YOC.
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