NNN Appraisal Methodology

[ThatOneWunderkind]

Can somone please explain why the expense ratio must exceed the vacancy rate when valuing properties with NNN leases?

Is it because CAM reimbursements are typically exceeded by CAM expenses; thus, owners always have an expense ratio higher than their vacancy rate?

 

[Meandering]

Can somone please explain why the expense ratio must exceed the vacancy rate when valuing properties with NNN leases?

Is it because CAM reimbursements are typically exceeded by CAM expenses; thus, owners always have an expense ratio higher than their vacancy rate?

Aren't expenses variable, depending on occupancy? Here we have many fixed expenses in CAM for snow removal and such things, but many dead strip malls are not collecting any CAM and looks like their mainteance has not been on going either. I would not say that it's not a rule that your CAM expense ratio must be higher than your vacancy rate, especially with many multi-tenant center having very high vacancy right now. Maybe this is something a lender is quoting you? They would perfer a full occupancy and a little skimming on the CAM then half occupancy and lots of new landscaping? I don't think so, but hey, weirder things have happened in lending.

 

[ThatOneWunderkind]

Marion,
Thank you for the reply. Yes, expenses are variable. I should clarify what the context is. I do property tax appeal in California for non-instutional investors, part of my job is reviewing P & L statements. After having reviewed thousands of financial statements over the past five years, I've noticed that CAM expenses are more than CAM reimbursements about 75-85% of the time. These are for properties that are experiencing vacancy rates between 0 to 35 percent.

When a property is fully occupied with CAM-paying tenants, there still seems to be a small amount of CAM expenses that are paid by the owner in the California market. When a property is 100% occupied, only about 95% of CAMs are being paid by tenants, raising the owner's expense ratio. So, what is the relationship between vacancy rates and expense ratios for NNN properties as vacancy rises? Can you direct me to any academic or professional papers that discuss the vacancy rate-expense ratio relationship for NNN properties? Thank you!

 

[David Mescon]

Exterior repairs and maintenance and management fees are typically not included in CAM charges, and are typically borne by the property owner.

 

[PropertyEconomics]

I personally have never seen it written that expense percentages must exceed the vacancy percentage. My guess is it is a "client" observation they have taken to heart and thus it is written in stone to them ... but it is not something I have ever been taught.

 

[CANative]

How can you fine tune the valuation like this when it's pretty much the wild west out here for these types of properties and leases? Depending on which tax year you're working tenants are pressuring landlords to renegotiate their leases downward, exclude CAM charges, reduce them or LOL @ NNN.

You're not doing a "real appraisal" on these things. The enrolled value of a property on January 1st of any given tax year is not based on Fair Market Value, it's based on it's factored base year prop 13 value.

 

[Michael S]

CAM reimbursements rarely equal allowable CAM charges. Typically it's because some of the leases have clauses that limit the amount of CAM charges they pay to a certain annual increase, say 5%. Other times it will say that they only pay 95% of the allowable CAM charges. Some expenses for a NNN property cannot be considered part of CAM and the owner is responsible.

For a single tenant NNN property typically the owner is only responsible for structural maintenance. On an Absolute Net lease (typical for Walgreens) the tenant is responsible for everything, from the parking lot to the roof to the walls. In a large shopping center even if all the leases are technically NNN you might only collects 75-80% of the NNN expenses due to all the various carve outs and restrictions tenants have negotiated for themselves. There's also vacancy to consider, if a center is 95% leased does the landlord pay that other 5% of the CAM or does it get passed on to the rest of the tenants? What if it's 50% leased? It all depends on the leases and how diligent the landlord is in enforcing their lease. If they've got a large national tenant as an anchor I can almost guarantee that they will not be paying their fair share of the CAM charges. They'll demand an audit every year and try to exclude as many charges from CAM as possible, forcing the owner to pay for it out of pocket, or try to pass it on to the remaining tenants.