Loaded Cap Rates

[Kali the Boston Terrier]

Thats the thing there is nothing on NNN, specifically just that operating income statements cannot reflect property taxes, and that the cap rate should be adjusted for tax rate. In the past for NNN buildings, I have not adjusted cap rates or loaded them, and have discussed ad nauseum why it is adjusting for something that is not reflected in cap rates in the market to begin with. However, I have a new client who believes NNN or Gross it should be adjusted for....hence my question, with some market support from my peers. However there have several different answers, suggesting no real solid industry direction.

BTW Dennis I re-read your intitial post, I hope you do not think with a loaded cap rate I was adding taxes in the operating income statement...that's crazy talk. I was referring to adding taxes into the operating income statement, when they are not part of the operating income statement traditionally.

 

[PropertyEconomics]

If the expense percentages are similar between the comparables and the subject, wouldnt the market rate be reflective of incomes and expenses, thus "loaded" already?

 

[Kali the Boston Terrier]

Yep thats the theory I'm working with, however that's the logic of case law and attorneys.

 

[Marty Skolnik]

You don't load the capitalization rate for a net leased property. You only load the capitalization rate with the effective tax rate if the real estate taxes would normally be part of the cash flow, as in a full service lease scenario. In a property tax appeal, the property taxes for the following year (assuming that the next 12 months represent a stabilized year) are unknown -- using actual taxes would be incorrect since, by appealing the assessment, the ownership is implying that the taxes are not at market levels.

Remember that your operating expenses in an Income Approach should represent "market" levels, which may or may not be what the property owner actually paid. So, in a property tax appeal you typically eliminate the line-item for property taxes in your analysis/reconstruction of the owner's stabilized operating expenses analysis but account for market-level property taxes by "loading" the effective property tax rate with the capitalization rate.

If you do not have a line-item for the owner's property taxes, like in the case of a net lease scenario where the tenant is responsible for payment of the taxes, then there is no property tax line-item to eliminate and there is no need to add the effective property tax rate to the capitalization rate.

If you have multiple tenants and/or a variety of lease structures and/or vacant space for which the owner is responsible for paying the expenses out-of-pocket until the space leases, you may need to use a more powerful analytical tool like ARGUS or a fairly rigorous Excel spreadsheet model.

If you want further industry support, you might want to take a look at the IAAO's text book and other published materials (International Association of Assessing Officers).


Marty

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[C. Kevin Bokoske MAI]

Marty is right. Period. The only exception would be a situation where there is not 100% occupancy, such as a NNN property with multiple tenants, or a NNN property with a "weak" credit tenant. In those situations, the vacancy % would be applied to the ETR and added to the unloaded cap rate. This accounts for the portion of the taxes that the lessor will be paying.

 

[Kali the Boston Terrier]

So here is the question, 13th Edition mentions nothing about it, other texts from ASA and IFA same thing. The only text saying contrary is the IAAO book referenced earlier...anyone care to give me a citing so I can back the attorney off.

Not that I disagree, in fact that was how my OP was phrased, I don't think it should be in way or capacity if the lease is NNN, unless the owner is taking on the expenses

 

[C. Kevin Bokoske MAI]

Did you try Lum Librarry (A.I.) or the IAAO webpage for its library?

 

[Kali the Boston Terrier]

Lum yes...IAAO no.

 

[Abester]

Just do the math in a side by side comparison to show them the answer is the same.