Replacement Reserves- above or below the line?

[CBBoston]

I agree that if the market doesn't include replacement reserves in NOI, you can't use that OAR on the subject that does include RR. The rub comes when doing work for lenders that want the RR includes as an annual expense. In that case you're going to have to adjust the market OARs to include a deduction of RR. If you can get operating statements for the comps, which can be difficult in some markets, you can easily make that adjustment. When you can't you just have to make some provable assumed adjusts. Along the same line we often see owners of smaller complexes, under 50 units, not including a management fee at all or one that's below market. Yet another question to ask while confirming the sales. Brokers in this area rarely include RR in there operating statements.

Deducting or not deducting RR above NOI in a DCF doesn't matter as long as it is included in the cash flows somewhere. Some people don't include it all in a DCF operating income. Instead they will show periodic capital expenditures for replacement of various capital components. Of course that assumes they have deep enough pockets to do so which is always questionable with smaller properties.

 

[GCJim]

I routinely treat RR as an expense. In my experience, I would argue that, whether or not you take RR before or after, is dictated by 1.) your client; or 2.) by the market. I like to see *worst case scenario* every single time, so I will probably always use it, of course while explicitly and clearly labeling each expense, unless I am specifically asked to do it one way or the other. In this way, it is not difficult to determine what NOI and the opinion of value would be either way.

 

[Michigan CG]

Interesting topic. I was taught to add a reserve to the comps if one was not considered to even the playing field; likewise with low management fees.

 

[PL1957]

I routinely treat RR as an expense. In my experience, I would argue that, whether or not you take RR before or after, is dictated by 1.) your client; or 2.) by the market. I like to see *worst case scenario* every single time, so I will probably always use it, of course while explicitly and clearly labeling each expense, unless I am specifically asked to do it one way or the other. In this way, it is not difficult to determine what NOI and the opinion of value would be either way.

If you are looking at the *worst case scenario* every time, I don't think you are providing a market value. Most market value definitions state "most probable", not highest, not lowest and not worst case.

Being too low is equally as bad as being too high.