[Lost Cause]

Originally Posted by CANative

I've got at least 100 leases stacked up on my "leases" shelf right behind me. Some do, some don't.

This tangent is getting off-topic, as my understanding of the OP is that the subject is a single-tenant property type. However I have seen some, though few, leases in multi-tenant retail properties with clauses making the tenant responsible for CAM, etc for vacated spaces. Most typically for these "pro-rata share" is specifically defined as the ratio of the tenant's space to gross occupied area. Tenants willing to accept such conditions must be approaching from a very weak negotiating position.

[Howard Klahr]

Tim

Another adjustment in evaluating the vacancy factor based on the technique you outlined is to incorporate the roll-over factor as well. i.e. 0.5 years / 10.5 years = 4.8% x 50% rollover rate = 2.4% vacancy allowance which then needs to be adjusted for a credit loss factor.

While the OP started the discussion focused on single tenant credit leased properties, others have commented on market vacancy rates. Keep in mind that the market vacancy rates most often quoted are physical vacancy not economic vacancy. The allowance in the Income Approach is based on an economic vacancy rate.

[leasedfee]

Howard

Originally Posted by Howard Klahr

Tim
incorporate the roll-over factor as well.... 4.8% x 50% rollover rate = 2.4% vacancy...

I have no problem with your tweak to the model.

In Denver there is so much vacant space, I, myself, wouldn't do that. .... I've been keeping my eyes on many buildings and amazed that they have been vacant for 5+ years. Nothing appears to be wrong with them other than lack of demand.

Originally Posted by Howard Klahr

Tim
The allowance in the Income Approach is based on an economic vacancy rate.

I concur.... I have to remind the bankers frequently about this these days when dealing with apartment buildings. The spread in Denver apartments between physical and economic remains quite high, about 1000 BPs. ... On the other hand, many people, especially investors, can and do model or load economic vacancy into the capitalization rate.

[GregoryK]

Howard:

Just had the debate of physical vacancy vs. economic vacancy on a shopping center with a reviewer. She finally conceded but not sure she agreed that a physical vacancy assumes the space will be vacant for the "year" whether stabilized or projected. While economic assumes that it may be vacant for a part of the year, and also reflects the possibility of rent loss due to non-payment, bankruptcy etc. But I am finding that more and more client assume vacancy is a physical deduction i.e. cx amount of square feet, instead of an economic factor x amount of SF at $x.xx/SF.

[Howard Klahr]

Tim,

I understand the issue that you are trying to address (long term vacancy). This is caused by one of two possibilities, functional and external obsolescence, and possibly a combination of both.

In operating real estate investments have a stabilized occupancy that is outside the issues causing long term vacancy. If the issue(s) causing the long term vacancy is wholly within the property it is a functional issue. If the issue(s) are outside the property the it is external or economic.

The vacancy and collection loss is often utilized as a crutch in doing a quick down and dirty analysis rather than properly evaluating the root cause. If the long term vacancy in the property is caused by true lack of demand, you need to identify is it because of a lack of overall market demand or is it due to declining competitive design issues of the subject property?

If it is due to an overall market demand, an economic base study is need to determine if this decline is permanent (i.e. historical demand generators have left the market entirely) or temporary. If temporary the issue is addressed by an absorption analysis. If permanent, then it may be ore of a highest and best use issue addressing alternative uses or changes to the property design, marketing, etc

If it is due to property design issues, then an analysis of the re-design alternatives and related costs is necessary to determine if it is curable or incurable functional obsolescence. Gee isn't it amazing how each of the approaches inter-relate.

Before everyone goes off on the issue of the fee doesn't justify this level of detail in the analysis, keep in mind why so many properties continue to under perform and go into default as compared to others in the same market area. Learn how to educate your client and thereby justify the appropriate fee for the property

[leasedfee]

I spoke to an investor on a comparable 3 or 4 tenant 13,000 sf warehouse. He explained that it was 100% occupied at TOS and that his actual PGI NNN rents without vacancy was a 8.9% cap rate. He called it a "true cap rate." I didn't want to argue with him. When I recast it with 14% market vacancy, physical and economic, and about 45 cents in RR, the recast cap rate was 7.2%. The 7.2% made sense in comparison to other such extraction. The surveys and brokers though will tend to quote the 9% numbers. Since the down-turn, I have run two columns in the direct income approach: 1) An appraiser's pro-forma, with temporary rent/expense loss sometimes subtracted directly from the value; and 2) broker's pro-forma with minimal vacancy and no reserves for small projects, and sometimes with no management. The two approaches, not surprisingly, are similar. The intent is to reconcile for the client why the surveys say 8-10% cap rates, and my extracted caps are so low.

[Howard Klahr]

GregoryK

In explaining physical versus economic just get them to apply a rent to the vacancy rate that they want to use. There is a wide range of rental rates and property types in the market survey used to identify the market physical vacancy rate, right? For example, distribution space, warehouse buildings, manufacturing facilities are all compiled into that physical market vacancy rate all of which often have different rental rates and even the basis on which the rent is based.

So ask them, which rent they want you to apply in evaluating the vacancy rate. Economic vacancy also takes into account below market rent. What about spaces that are dark? Some surveys record those as vacant space, yet from an economic perspective there is no loss is there?

[leasedfee]

Howard,

On my way to the dentist every six months, I've been driving past a nice almost new suburban strip retail building with good arterial frontage visibility and anchored by Walmart, etc. Five years later it received its first tenant, a dentist. Similar situation in a different part of town. There was just so much overbuilding. I routinely calculate 15% to 30% external obs. in every cost approach using a feasibility rent loss and extended lease-up loss analysis.

Howard, you raise the question of functionality. In central Denver, there are many mixed-use mid-rise store-front buildings. The planners really pushed for this architecture. The owners cannot for the life of them lease-up (and keep) the retail tenants. It seems that the population density isn't there to support more business. It also seems that mom&pop local tenants cannot afford (even the depressed) the rents no-longer-new construction. Conversely, the national and franchise tenants don't seem to want this mixed-use dubious parking space.

[Roger Murdock]

Originally Posted by justinschroeder

If a property is fully leased on a NNN lease for the next 10 years, would you still apply a vacancy rate. Should there also be a deduction for taxes and other expenses for the times of vacancy. Estimated vacancy rate for the area is 12%

There isn't one "correct" answer to this question. You should do whatever a typical investor in your market would do.