Adjusting Rent Comp Structures

[PS111222333444]

A subject retail/office building is self managed and leased where the tenants pay a pro rata share of all utilities and are responsible for interior maintenance. The LL pays taxes, insurance, structural repairs . I’ve estimated a management fee of 3% in the pro forma as it is not typical to self manage in this market.
The rent comps are structured on a triple net basis according to the brokers. My mentor is adjusting the comps to the subject by adding taxes, insurance AND an estimated 3% management fee to the stated NNN rate. Since the subject’s tenants don’t pay for management, why add it to the comps?
The dictionary makes no mention of “management fees” in the discussion of lease structures.
Appreciate the input.

 

[Howard Klahr]

The adjustment is to allow a comparison of the data on an equal (apples to apples) basis. The lease structure of your subject property is known as modified gross while as you noted the market is based on a triple net rent basis.

It is somewhat like comparing properties based on net rentable area versus gross building area. you need a common basis to make appropriate comparisons.

 

[PS111222333444]

Thanks Howard. On the flip side, if the comp lease does not include payment of a management fee, but a deduction has been made in the subject's pro forma for one, should the management fee then be deducted from the rent comp amount?

 

[Howard Klahr]

As previously noted, comparison needs to be made on an equal basis. However, management is frequently a recoverable item in many commercial leases.

 

[GregoryK]

Lets think about this. Lets presume the rental rate is $100, and disregard whether it is a gross or net lease at the moment. What expenses common to all leases are paid from that rent? A management fee! Ad while a management fee is theoretical in many cases, if you are deducting such a fee in your subject property's pro-forma, then would you not have to presume that the rental rate of your comparison property also reflects a management fee?

Then there is this. If the fee is 3%, and you are talking a lrental rate of $10.00/SF, this equates to $0.30 per SF. So what kind of effect does this have on the range? At $0.30/SF your range is $9.70 to $10.30 per SF either way. So in the greater scheme, it does not have a large impact on the adjusted rantal rate.

My suggestion, do as your mentor asks, since he is (presumably) the one who's name is on the report. As long as all the comps are handled the same way, and you have explained the reasoning in your analysis, I personally don't feel it makes much difference. Just explain how you got there, and be consistent.

I Hope my $0.02 helps, and did not make it any more confusing

 

[Michael S]

In my experience management expenses are typically included in retail and office leases. With industrial properties that's not always the case, a lot of times the owner doesn't get reimbursed for that. You could always speak with a couple of brokers or landlors of comparable properties and see how management fees are handled. Whether they're typically reimbursed by tenants (NNN or modified gross) or included as part of the operating expenses (full service gross).

Bottom line 3% one way or the other won't make much difference. Since NNN expenses are going to differ from property to property there's going to be some variability between the subject and comps no matter what.

 

[Kali the Boston Terrier]

In my market there are sometimes no difference between gross and NNN leases, and typically the landlord is basically taking the lease to pay a holding cost. Its hard to justify an adjustment when the market ...clearly advocates a different position. Yet economics teaches us that between a Gross or NNN lease, I would take gross for the same price...and that has to be accounted for somewhere. In regards to your mentor's position, I would be cautious in arbitrarily adding in costs that may not appear in the market. Although I agree management fees should be recoverable, in some markets that cost may push that well above market acceptable levels (like mine). Also why stop at management, what about replacement reserves...building repairs...? All of which, or none of which may be relevant.