Replacement Reserves- above or below the line?

[Stephen J. Vertin MAI]

Let me first qualify that my comments are not related to Korpacz or other surveys. If they are extracting reserves and you are using them as data sources for capitalization rates by all means you should deduct such costs from the subject. The following deals with direct rates extracted from the market. Fortunately within the 10 to 100 unit building category our local MLS is one of the better data systems. Within they list expenses as reported by owners (most of the time). Rarely do I see owners taking out reserves. This is reasonable since tax laws discourage such behavior. If none of the sales utilized for capitalization rates extracted reserves for replacements than you should never extract reserves for replacement from the subject. If you were to extract reserves for replacements when not recognized by the market, you would be under valuing the property. This would be extracting unrecognized expenses thus, lowering NOI, etc. So the answer is simply; how does the market or survey handle the issue. If you are not following this simple rule you are applying concepts by rote or because someone else once told you how to handle such issues with little bases in reality or sound appraisal principles.

 

[xm4yb7]

I agree 100%, I just wish some reviewers understood that.

 

[David Bailey]

It will depend on the property type and the market the property is in. According to Korpacz, 68% of apartments capitalize the income after deducting the replacement reserves but 75% of office properties in Chicago capitalize the income before the replacement reserves.

When we verify information like cap rates and NOI, we always ask if the replacement reserves were deducted before or after capitalization.

+1

Bottom line is that there is no firm, steadfast rule. Yes, you should treat reserves according to "the market," however, I've yet to see a textbook market.

 

[PL1957]

Yes, you should treat reserves according to "the market," however, I've yet to see a textbook market.

All markets are textbook because you are supposed to learn from them grasshopper.

 

[PropertyEconomics]

The question really is how were they treated on the sales used in the analysis. If the OAR is derived deducting them then they should be deducted if the OAR included them as part of NOI then they shouldnt be deducted.
Measurement consistently is the real key ... and what do the real market participants do.
In my market they are only deducted as an "accounting" principal. In NY the actual accounts kept THE DONALD from going broke becasue he had such huge reserves in his buildings.

Go to the market.

 

[Jeff Beatty]

Lots of useful info here. Thanks.

As a borrower this time round, I'll try to use the inconsistency to our advantage.

My experience with owners of apartments is that they don't actually hold reserves unless required by the lender. In those cases, if the lender is holding cash as additional security, the value should not include a reduction due to its inclusion in the operating expenses. Otherwise the borrower is taking a double hit.

 

[David Bailey]

All markets are textbook because you are supposed to learn from them grasshopper.

Yeah, right.:laugh:

 

[PL1957]

Yeah, right.:laugh:

Somehow, I don't think David realizes I meant what I said.

 

[David Bailey]

Somehow, I don't think David realizes I meant what I said.

Lighten up Francis...it was a tongue in cheek remark.

 

[PropertyEconomics]

Lighten up Francis...it was a tongue in cheek remark.

We dont tongue in cheek with the public ... LOL.