Expenses For A Denny's Restaurant

[runner52]

I am appraising a Denny's restaurant for an attorney whose client is purchasing a Denny's. The Denny's is currently leased back to the owner. He is buying it and considering leasing it. His draft lease indicates an Absolute Net lease structure whereby the tenant pays for all expenses. There is no indication of Professional Management Fees. He owns a few Denny's. I've asked the attorney to ask the buyer if he intends on getting a professional management company to oversee the property (property is in Washington, he lives in California). If he says hes not going to use a management company, do I still need to include a Professional Management fee since "the cost of professional management is conventionally considered an appropriate and necessary expense charge to an income-producing property"? Or can I leave it out? Thanks.

 

[Tim The Enchanter]

the cost of professional management is conventionally considered an appropriate and necessary expense charge to an income-producing property

Above my pay grade, but I feel like you answer your own question.
Somebody has to manage it. Will they do so for free? Um, no.

 

[Mr Rex]

Similarly, in a SFR income property, there is or should be a management fee regardless of whether the owner handles it themselves or engages a management company, it is an expense that must be accounted for. From the lenders perspective it is immaterial whether its internal or external, it is an expense that calculates into the total expenses that should be considered in the risk assessment.

 

[George Hatch]

These sorts of properties get marketed as a passive investment, meaning the only actual management expenses are the administrative, banking and tax prep activities. Once the lease has been signed the origination fees for the brokerage gets paid so not even that gets deducted.

NNN investment.

The buyers (and appraisers attempting to emulate their analyses) probably SHOULD consider a DCF with a PV/reversion, but in practice almost none these buyers seem to do that. They just cap the rents.

How the lenders underwrite their loan to account for debt servicing in the event of a foreclosure is a separate issue.

 

[Michael P Jacobs MAI]

There is a big potential value gap here between a legitimate NNN Denny's investment and a vacant restaurant that used to be a Denny's and might be the next Taco del Gato in your area. You are going to have to KNOW.

If this is a Denny's all day long, and multiple Denny's franchisees are going to be fighting for it, then a market-standard Denny's owner-user or lease is most likely the HBU, and it should be underwrittin that way - no deductions from PGI (V&C, operating expenses or reserves). All of these are reflected in NNN Denny's cap rates. You will deduct lease-up lost rent, commissions, any TIs and profit - low-profit for a no-brainer and higher profit for more risk. You also need to adjust for irregularities (lease term, remaining effective age, external obsolescence, etc).

If HBU favors Taco del Gato, underwrite normally based on your market-standard terms, which means management is more than likely warranted. It can be a high percentage since even $250/month a third party would charge as a favor hoping to get an eventual listing could be significant on rents you'll get for those Taco del Gatos.

When it's somewhere in the middle you are really going to have to dig for the answer - interviewing franchisees can provide your evidence one way or the other.

Now, just the way you framed your question suggests to me that you may not be USPAP-compitant on this one without a qualified supervisor. I apologize in advance in the event I have misinterpreted your post, or you are supervised and doing your research (nice going if so). But, it seems to me that all of this would be instantly obvious to a competent appraiser.

 

[Walter Kirk]

Your estimate of value should only consider how the market will approach the subject property, not what a single owner might approach it. Management costs must be considered.

 

[Michael S]

Absolute net lease to a good Denny's franchisee (i.e. they have tens or hundreds of locations and a high net worth, not this single restaurant) the market will cap the NOI with no deductions for operating expenses or vacancy. However, this assumes there's a good amount of lease term left (10+ years) and it's a strong franchisee. If this Denny's may not be a Denny's in the next decade then you've got a lot more work on your hands and management fees will be a minor consideration. Any second generation tenant would probably only be paying rent that's 60-80% of what Denny's will plus your cap rate could go up a few hundred basis points.

 

[George Hatch]

We've had other comparable chains retract in this region, and as Mr Jacobs said the 2nd generation tenants like Tacos Del Gato don't pay as much. I've also seen these units get converted into bank branches and dental offices and the like, so that's another possibility when your subject is approaching the end of its lease.