Loss/Gain to Lease
Just wondering if there is anyone on here that fore goes loss/gain to lease allowances in valuing apartments. I'm thinking that it penalizes the property, as rent gains/losses are implicit in the cap rate, yield rate, terminal rate and v&c deductions. Also thinking that it's unnecessary, considering that most apartment leases are 6-18 months.
Im not sure what exactly you are asking. Are you anyone ignores LTL when underwriting deals? If so, the answer should be a resounding no. You need to combine your LTL with Gross Potential rent to get your effective rents (since "Market Rent" can mean different things to different people).
The only time you might ignore LTL is if you are modeling off of base in place rents instead of market rents.
but in order to find out what base rents are, don't you have to subtract the LTL out of the GPR (therefore you cannot ignore LTL)?
Assuming you have the rent roll you will have the in place rents.
i definitely agree that it's overkill because of the length of the leases. unfortunatley you can't ignore it if your GPR is inflated.
you should be able to understand or figure out why it would be factually incorrect to ignore it.
Yes but you better not gross up the whole property then. I didn't understand why people did this at first but it's a mark to market type thinking, which is fair, I guess. Where if you want to see where your units stand in a hard to comp market, fast moving market or poor management it can be helpful. It's also just more prevalent in certain markets, operators , managers, etc. It seems that groups have moved to just plain effective in-place rents using the yieldstars of the world.
you sound like a seller who isn't getting the bids you expected b/c your rents are below market.
You need to think about what the purpose of the number is - it's supposed to gauge how much rent you are losing in a given year based on in-place rents being lower (or higher) than the market rate. Think of this as the same as an existing vs. market rent analysis in a commercial deal. It's not actually lost income because you didn't have it in the first place. You could line it up so that you only have it in year 1 when the in-place leases roll and that would be one way to do it, but most people just use an annual average based on what starting in-place is since technically you will have some every year since you aren't getting increased rents from each unit as the leases are staggered. So short answer no, it's not unnecessarily penalizing the property.
It's difficult to ignore LTL when underwriting apartment deals given that in reality, property manager will often lease a unit below what your market rent expectation is for a variety of reasons. Not only does LTL happen with new leases, but it happens with renewals as well. For example, a lease expiration is coming up and it's 20% below market but your property manager increases their rent by 10% only for any given reason (ie. the tenant has been paying their rent on time for 5+ years, rent laws, property manager and tenant are crushing on each other, etc).
Since you underwrote a market rent for that unit (new and renewal), the LTL calculation needs to capture some of that lease renewal "market rent shortfall". The same type of scenario happens with new leases.
In my experience, LTL has been total BS, but it depends on if the property is on a daily pricing model. In place rents are taking the market rent and subtracting out the LTL and is a good starting place. If the plan is to acquire and bring to "market" you should determine you're own market rents and bring them up to that as leases turn. If the plan is to value-add, again, I'd start at in-place rent and bring up to market on turns and add the premium after the reno.
unfortunately LTL is one of those line items that can be calculated in a time of different ways. A lot of shops will show a huge LTL number, just so that they can show top-line growth at a "steady" 3%, etc. However, it ends up just being a wash when you trickle down to your NER #. A lot of shops will just tack on 1% to the general vacancy...IE instead of 5% make it 6%. Without getting into the debatable math, a back of the envelope approach is to take 50% of your rent growth. IE if your assuming LOL growth is 3%, your LTL is 1.5%. Again, not an exact science but if you're looking for a quick and dirty "HP calculator" valuation, this gets you within the red zone.
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