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?
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not sure what you mean by deduct turnover/absorption vacancy...
only turnover costs that are typical in an income statement are on the expense side, and are often for costs of turning the unit for new renters (new paint, fixed appliances, etc.). If one renter moves out and you have someone back filling it immediately, but has to wait a week maybe tops to get into that unit, running a vacancy impact for those 7 days is a bit ridiculous and definitely doesnt represent the average occupancy of the asset.
I always apply the KISS principle, but to me general vacancy is exactly that, general empty units. meaning, when im looking at an income statement, I want to see the number of online units, and the number of units that are purely empty. empty/online = general vacancy. IMO, general vacancy should only include units that are empty that have the opportunity to be filled by a renter to product income to the asset.
HOWEVER, there are other line items that arent other income, that get docked from potential revenue on the rev side of the income statement. some of these are: - model/employee units: occupied by employees or only used as a showroom model, these will never be revenue producing units, and thus must be docked from GPR. one could argue the GPR should only be based on revenue producing units, but for simplicity its easy to say what are the total number of units at the property, and then deduct the money that would otherwise be earned by units occupied by employees or model units. Note that employee units often just get a discount, not complete abatement. - loss to lease: one of the most contested and murky calculations in resi real estate. IMO, LTL should represent the discount to currently charged market rent units at the asset. let's say you have 100 rentable units for 1,000 a pop / month. if one of those units has a discount of $10 each month that isnt a concession...my GPR would say 100*1,000 assuming 100% occupancy, then deduct the $10 for loss to lease...aka the loss of potential income due to the in place lease. Loss to lease does have the option to roll into a new market lease at expiration. that is up to the property management team - concessions: used to provide incentive to prospective tenants. typically are deductions to 1st months rent. Again, to use the above example...let's say you have 100 units all being charged 1,000 /mo. One of those units this month has a one-time concession of 50. Your GPR would still be 100,000 for the month, your vacancy deduction would be 0, your loss to lease would be 0, but you'd deduct $50 in the concession line item. next month all these GPR deductions would be $0 as the concession has burned off.
NOW, to your other point...do you lump some items together? Short answer, it depends on the anaylsis. If I am seriously underwriting an asset, I want all those line items broken out separately. Mainly because they all tell me different things, thus should be in different line items. However, when doing valuation exercises, budget vs actual reports, etc etc...it IS common practice to see groups lump general vacancy and loss to lease and even bad debt together...and title it "loss to vacancy". Concessions is almost always broken out separately.
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.
ive never understood Argus' use of that line item..and find that the large majority of acq I've gone through with Argus, other parties leave it blank as well.
I think what commonly confuses everyone, is when one says "vacancy caused by turnover". Interpreting that literally, lets say you have 90% occupancy, and next year a tenant occupying 5% of the GLA is vacating or "rolling, turning over, etc etc". Next year comes, are you supposed to model it as 10% general vacancy and then in a separate line have a 5% rollover vacancy? It can't have anything to do with releasing downtime as that is baked into the tenant inputs...So I think a lot of people just ignore that aspect and choose to say, in this scenario when the tenant vacates, that the general vacancy is now 15%.
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.
*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. *
RESPONSE: In the middle / outer years of the investment, your “contractual” leases will have rolled to market and their respective MLAs. When a tenant rolls the subsequent leasing is “spec” and you should be applying a general vacancy reflective of your projection of submarket conditions. Alternatively, you could account for market vacancy using a static suite but don’t see that as often. A 9 – 12 month downtime for one lease that rolls on a stabilized asset isn’t necessarily going to capture enough vacancy to reflect the sub market vacancy which is why you apply general vacancy.
Here you go: http://www.nnnreblog.com/2016/01/analyzing-propertys-cash-flow-statemen…
Maybe it is easier to understand by thinking of general vacancy as systematic vacancy, where as absorption/turnover vacancy can be directly attributable to the performance of the property.
General vacancy is going to provide some cushion in your cash flow. It is like a contingency.
The logic behind deducting from general vacancy is as follows. If you’re assuming a systematic vacancy of X%, and your property level vacancy is >X%, then you’re double counting the systematic vacancy because you’re already exceeding what is ‘market’.
It is just a way to get more aggressive with your vacancy assumption.
also, what do you mean by the $20 in absorption / turnover deduction, simply?
This is a great explanation, thank you. If the goal in grossing up by absorption and turnover vacancy is to get to a true potential gross revenue figure, then I have a quick question. Doesn't argus calculate zero ($0) potential reimbursement income during absorption and during months vacant? Doesn't that mean that even if we check gross up by absorption and turnover vacancy, then we still aren't getting a true potential gross revenue since we aren't including the potential reimbursement income for these periods? Is there a workaround for this or am I just misunderstanding something?
Agree the loss to lease is very murky. I hate it and until recently had not dealt with it. When you are using YieldStar or LRO daily pricing program you can argue that there is not an actual loss to lease. Today’s pricing is what the market bears based on the models and markets conditions. I see budgets that have a projected/budgeted GPR and a projected loss to lease and vacancy for an effective rent. Just lower the GPR.
Does anyone hear override general vacancy for office during holding periods to account for free rent concessions, while applying a vacancy rate to the reversion?
I haven't. I think free rent should only be accounted for in the MLAs and have an impact on cashflows when tenants roll to market.
Just for the sake of discussion, I opened my Argus Enterprise training manual to the general vacancy section, and here is what it says:
Gross Up Revenue by Absorption & Turnover
This option provides the ability to add back the Absorption & Turnover prior to calculating the General Vacancy amount. Absorption & Turnover is the projected loss in rental revenue associated with the speculative lease up of currently vacant space, as well as the downtime between lease terms associated with tenants moving in and out of the building
By adding back the Absorption & Turnover to the projected revenue before calculating the General Vacancy loss, this option results in General Vacancy being calculated on the potential revenue of the building as if it is 100% occupied
Reduce General Vacancy Result by Absorption & Turnover
This option is checked by default and will deduct Absorption and Turnover from the vacancy allowance calculation. This Cash Flow will show vacancy allowance as zero if Absorption and Turnover vacancy is greater than the vacancy allowance.
If the box is unchecked, AE will not deduct Absorption and Turnover from the vacancy allowance calculation. The Cash Flow will separate vacancy allowance and Absorption and Turnover line items.
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