Lease-up analysis
There are three primary costs or deductions associated with lease-up costs/absorption in evaluating a property that is below stabilized occupancy; 1) rent loss, 2) tenant improvements/finish-out allowance and 3) real estate commissions. Depending on the method/technique you are utilizing to perform your analysis would dictate how you apply these costs in your analysis.
If you were to proforma the subject property at a stabilized occupancy and perform a direct cap approach you would then deduct the discounted lease-up costs from the stabilized value to arrive at your “as is” or “as completed” value conclusion.
If you are doing a Discounted Cash Flow analysis, you would then deduct the lease up costs from the Net Operating Income in the period in which they were forecast to occur to derive the Net Cash Flow and then discount these to a present value. This method would then result in the “as is” or “as completed” value conclusion”.
In regard to how these lease-up costs are addressed, it depends upon your market and how these items are treated. For example, most markets utilize a cash-out method for leasing commissions; therefore this expense is paid upon commencement and not pro-rated over the lease term. Tenant Improvements/Finish-Out Allowance is generally paid by the property owner prior to lease commencement and is therefore also not typically pro-rated over the lease term.
Rent loss can be addressed several ways and depends on how you set up your analysis (i.e. – through the vacancy allowance, excluded from gross potential income or a below the line deduction between NOI and NCF. In addition to the above items, leasing concessions, if any, can be deducted through determining an effective rent, deducted as part of rent loss in the period of commencement or depending on the terms of the lease, pro-rated over the lease term or even at specified points during the term.
Depending on how detailed your analysis and the size of your subject property, there are also variable operating expenses that are influenced by vacancy/lease-up. Utility costs are below typical occupied space, Janitorial costs would be affected as well as management fees.
This is a VERY cursory overview. I hope it gets you going in the right direction. If you have specific questions, feel free to contact me at any time.
