Adjusting Gross Lease to Net Lease and Vice Versa

[Thebookdoesnthaveit]

Okay, having a clash of opinions regarding adjusting rent comps from gross to net or net to gross. Consider a lease at $28.00 psf with a partial gross lease (landlord paying $5.00 for CAM and tenant paying $2.50 for other expenses). Broker is saying that the effective gross rental rate is $32.00 psf, which I agree with. I stated you can also convert this to a net lease rate by deducting the $5.00 CAM from the lease amount as the tenant will pay less in base rent as they are responsible for the expenses. Thus net rental rate is $23.00 psf. Broker says you should always analyze on a gross basis no matter what. What??? I never heard of this. Was I asleep in class?? Thoughts please.

 

[Orlando Tragic]

Okay, having a clash of opinions regarding adjusting rent comps from gross to net or net to gross. Consider a lease at $28.00 psf with a partial gross lease (landlord paying $5.00 for CAM and tenant paying $2.50 for other expenses). Broker is saying that the effective gross rental rate is $32.00 psf, which I agree with. I stated you can also convert this to a net lease rate by deducting the $5.00 CAM from the lease amount as the tenant will pay less in base rent as they are responsible for the expenses. Thus net rental rate is $23.00 psf. Broker says you should always analyze on a gross basis no matter what. What??? I never heard of this. Was I asleep in class?? Thoughts please.

It can go either way. Depends on the property type and what is standard for that property type in the market. I have gone either way for office, industrial, retail. It just depended on what the market was saying. If most comps are pointing to a certain lease type, then I would adjust my outlier rental comps to that specific type.

 

[NachoPerito]

You are correct that it is adjusted at $23/SF Net, but one property's NNNs are not the same as another. Sometimes there are different costs included in the NNN rates or sometimes there are extraordinarily high expenses. Hence the reason why sometimes you would compare on a gross basis. But that brings it's own problems. One guy is paying $32/SF gross and gets interior janitorial and electricity paid, but another doesn't get janitorial and is individually metered for electricity so they pay on their own dime.

 

[NachoPerito]

We always adjust to the subject property.

If the subject does their leases at NNN then adjust comps to NNN.

 

[Michael P Jacobs MAI]

It's called total occupancy cost by some, and I ignore like-for-like tenant expenses such as meters and janitorial when taken care of by tenants at the subject and in the market just for simplification. By comparing on a gross equivalent basis you eliminate the variance between base and additional rent allocations, which in an efficient market everybody knows to consider and you must do.

Yes, we show the final market rate as NNN when the market does, subtracting reimbursements from the estimated total occupancy cost.

At least this was the way I learned it from brokers, and it wasn't taught in any courses (university or CE).

Here's a growing problem, though: brokers here are beginning to quote a gross rate but advertise it as NNN. What they mean to convey is the total occupancy cost, and that the terms will be NNN. This doesn't create a problem for experienced brokers who know their market area, but it skews pulling data for statistics and, if you are trying to get a rough idea of rents in a submarket with low NNN, you will over-state them.

 

[Thebookdoesnthaveit]

It's called total occupancy cost by some, and I ignore like-for-like tenant expenses such as meters and janitorial when taken care of by tenants at the subject and in the market just for simplification. By comparing on a gross equivalent basis you eliminate the variance between base and additional rent allocations, which in an efficient market everybody knows to consider and you must do.

Yes, we show the final market rate as NNN when the market does, subtracting reimbursements from the estimated total occupancy cost.

At least this was the way I learned it from brokers, and it wasn't taught in any courses (university or CE).

Here's a growing problem, though: brokers here are beginning to quote a gross rate but advertise it as NNN. What they mean to convey is the total occupancy cost, and that the terms will be NNN. This doesn't create a problem for experienced brokers who know their market area, but it skews pulling data for statistics and, if you are trying to get a rough idea of rents in a submarket with low NNN, you will over-state them.

Okay so some clarification please. When you say you eliminate the variance between base and additional rent allocations, are you simply saying that you are just making it, for lack of a better word, cleaner for comparison purposes by adding the pass-thru expenses to the base rental rate???

Also, what do we do if we have three leases of which are two that are NNN and one is partial gross with the landlord paying for taxes and insurance? Would you adjust the rental rate of the one comp to a NNN basis deducting for taxes and insurance or adjust the net leases to gross?

The leases on my property are spelled out as base rent + stipulated CAM charges. Would it be incorrect for me to provide a NNN lease rate to the client and then he can add in his CAM charges on top of the market rental rate in his lease contracts?? I feel giving him a gross rental rate has dire consequences as the market has CAM charges of around $5.00 psf and his building has CAM charges of $7.00 psf.

 

[Michael P Jacobs MAI]

Yes, it makes it an apples to apples comparison. TOTAL cost. If a comp is NN I'd just add the expenses they pay to get to total cost. That's what you need to compare. When you have a gross lease profile and a NNN comp, the total for your subject is $25+$0=$25, while the comp is $20+$5=$25.

When your property is squirrely, with tenants paying $20.00+$7.00 in fixed expenses rather than tied to the actual expenses, it's still $27.00 in comparison. He is over market by $2.00 according to you. You'll have to adjust that because you can't cap above market rent.

This shouldn't be difficult to understand so maybe I've misunderstood?

There's no black box here, total rent is total rent and that's what you are analyzing. You have a gross rate by the way unless they escalate differently. There is a small benefit to landlords with NNN rates for expense protection but only on long term leases, and as a practical matter most market participants would find it difficult to discern any difference.

 

[Red Flint]

The leases on my property are spelled out as base rent + stipulated CAM charges. Would it be incorrect for me to provide a NNN lease rate to the client and then he can add in his CAM charges on top of the market rental rate in his lease contracts?? I feel giving him a gross rental rate has dire consequences as the market has CAM charges of around $5.00 psf and his building has CAM charges of $7.00 psf.

No, that is not incorrect. Whew, triple negative there.
Do a base rent analysis adjusting comparables to NNN, reconcile to an opinion, then add a page discussion on subject CAM and the CAM market variations.

 

[Michael P Jacobs MAI]

No, that is not incorrect. Whew, triple negative there.
Do a base rent analysis adjusting comparables to NNN, reconcile to an opinion, then add a page discussion on subject CAM and the CAM market variations.

Something like that.