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Cost Approach For Nnn Retail, Very Low Compared To Income And Sales

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Ian Valenzuela

Thread Starter
Freshman Member
Joined
Aug 14, 2007
Professional Status
Certified General Appraiser
State
New Mexico
I have a proposed retail building, all pre-leased at roughly $25.00 per foot NNN. These are good, national and franchise tenants, with minimum 10-year leases, and all similar recent sales have cap rates at 7.5% or lower. So even with vacancy and expenses (management, structural repairs), I have an NOI of at least $22.50 per foot, and a direct cap value of over $300.00.

Their actual costs, pretty close to Marshall, are roughly $200 per foot total, including land acquisition, TI's, soft costs, taxes, everything. I suspect mathematically, what I have here is a +/-50% entrepreneurial incentive. But that simply doesn't seem reasonable, from experience, or from other property types, or any other investment.

What do you all do with situations, like this or any other time, where you're obligated to write a Cost Approach, but it's so skewed as to be unrealistic and basically inapplicable?
 

hastalavista

Elite Member
Joined
May 16, 2005
Professional Status
Certified General Appraiser
State
California
More likely you have an EI of market (10-20%?) and the lion's share of the remaining difference is as PP points out.
 

Michael S

Senior Member
Joined
Mar 18, 2009
Professional Status
Certified General Appraiser
State
New Mexico
Physically the difference between a retail strip center occupied by investment grade national credit tenants and one occupied by local tenants is negligible. The former probably has a better location which would be reflected in the land value. The main difference comes down to the higher contract rents. A corporate Verizon store might pay $35-40/SF while a local T-Mobile franchisee might only be willing to pay $25/SF because they know their sales won't support anything higher. If the developer can land that better quality tenant they've added a lot of value to the property. They might still be willing to take the risk of the project with an EI of 15-20% but could end up with an EP of twice that if they can land those national credit tenants. I've seen single-tenant NNN properties where the EP is around 50%.
 

NachoPerito

Senior Member
Joined
Jul 25, 2012
Professional Status
Certified General Appraiser
State
Washington
Your cost approach should include leasing costs (5% of gross rents on 5-yr lease) plus the additional cost of lost income from lease-up. I would expect the cost approach to be lower. If you are a developer and are able to sign AAA quality tenants then you should be profiting. And with the low cap rates that investors are paying..... $$$

Do the cost approach, include these costs, put up to a 20% EI and say that the Cost Approach is the least applicable method and doesn't fully account for the quality of tenancy.
 
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