In-Depth Capitalization Rate Review

Transcription

1 In-Depth Capitalization Rate Review Leonard J. Patcella, Jr., CMI, MAI President Equity Appraisal Co., Inc. Springhouse, PA David A. Schneider, Esq. Partner Archer & Greiner, P.C. Princeton, NJ

2 Fee Simple vs. Leased Fee, Impact on Capitalization 2016 IPT s 40 th Annual Property Tax Symposium 2

3 Fee Simple vs. Leased Fee, Impact on Capitalization RENT ROLL 100 OFFICE DRIVE 10/1/ Rent Dates --- Annual Annual Annual --- Future Rent Changes --- Base Base Cost Annual Suite ID Tenant Name Start End GLA SF Rent PSF Recovery Date Rent PSF 101 COST OF LIVING 10/1/201110/1/ , , /1/ , /1/ , /1/ , /1/ , AVERAGE: 220, IPT s 40 th Annual Property Tax Symposium 3

4 Fee Simple vs. Leased Fee, Impact on Capitalization 40,000 35,000 30,000 25,000 20,000 15,000 INCOME EXPENSES NOI 10,000 5, IPT s 40 th Annual Property Tax Symposium 4

5 Fee Simple vs. Leased Fee, Impact on Capitalization RENT ROLL 100 OFFICE DRIVE 10/1/ Rent Dates --- Annual Annual Annual --- Future Rent Changes --- Base Base Cost Annual Suite ID Tenant Name Start End GLA SF Rent PSF Recovery Date Rent PSF 101 COST OF LIVING 10/1/201110/1/ , , /1/ , /1/ , /1/ , /1/ , AVERAGE: 220, Note: PV at 3% annual rate for cost of living = $20.07 PSF 2016 IPT s 40 th Annual Property Tax Symposium 5

6 Fee Simple vs. Leased Fee, Impact on Capitalization 2016 IPT s 40 th Annual Property Tax Symposium 6

7 Fee Simple vs. Leased Fee, Impact on Capitalization RENT ROLL 100 OFFICE DRIVE 10/1/ Rent Dates --- Annual Annual Annual --- Future Rent Changes --- Base Base Cost Annual Suite ID Tenant Name Start End GLA SF Rent PSF Recovery Date Rent PSF YEAR FREE (2010) 10/1/ /1/ , , /1/ , /1/ , /1/ , AVERAGE: 275, AVG w/ FREE: 220, IPT s 40 th Annual Property Tax Symposium 7

8 Fee Simple vs. Leased Fee, Impact on Capitalization RENT ROLL 100 OFFICE DRIVE 10/1/ Rent Dates --- Annual Annual Annual --- Future Rent Changes --- Suite ID Tenant Name Start End GLA SF Base Rent Base PSF Cost Recovery Date Annual Rent PSF 103 $25 ABOVE MKT. T.I. 10/1/201110/1/ , , /1/ , /1/ , /1/ , /1/ , AVERAGE: 270, AVG - T.I.: 220, IPT s 40 th Annual Property Tax Symposium 8

9 Fee Simple vs. Leased Fee, Impact on Capitalization RENT ROLL 100 OFFICE DRIVE 10/1/2011 Suite ID Tenant Name Start End GLA SF --- Rent Dates --- Annual Annual Incr./Base Yr. --- Future Rent Changes --- Base Base Cost Rent PSF Recovery Date Annual Rent PSF Total PSF - 10/1/ , /1/ , /1/ , /1/ , OLD LEASE w/ EXP. 10/1/ /1/ , , INCR. OVER BASE /1/ , IPT s 40 th Annual Property Tax Symposium 9

10 Fee Simple vs. Leased Fee, Impact on Capitalization 40,000 35,000 30,000 25,000 20,000 15,000 INCOME EXPENSES NOI 10,000 5, IPT s 40 th Annual Property Tax Symposium 10

11 Query: Should the following be taken as expenses to derive the NOI to be capitalized? leasing commissions tenant improvements reserves for replacements Issues: - Capital improvements? - Below the line expenses? 2016 IPT s 40 th Annual Property Tax Symposium 11

12 2016 IPT s 40 th Annual Property Tax Symposium 12

13 Pine Plaza Associates, L.L.C. v. Hanover Tp., 16 N.J. Tax 194, (Tax 1996) ( Tenant improvement costs incurred by the landlord may be either capital expenditures or operating expenses. If the proofs establish that, in the relevant market, landlords customarily and regularly incur such costs, then deduction of such costs as an operating expense is appropriate. ) 2016 IPT s 40 th Annual Property Tax Symposium 13

14 Assumptions Market rent 15 Net Tenant improvements Term 5 Years New $25 PSF Renewal $5 PSF Taxpayer Taxing District Rent SF Rent SF Potential Gross Income ,000 1,500, ,000 1,500,000 Vacancy & Collection Loss 10.0% 150, % 150,000 Effective Gross Income 1,350,000 1,350,000 Expenses Management 3.0% 40, % 40,500 Leasing 5.0% 67, % - Tenant improvements $ ,000 $ Building reserves $ ,000 $ ,000 Total Expenses 438,000 70,500 Net Operating Income 912,000 1,279,500 Capitalization Rate 8.00% 8.00% Indicated Value 11,400,000 16,000, IPT s 40 th Annual Property Tax Symposium 14

15 Taxing District Rent SF Potential Gross Income ,000 1,500,000 Vacancy & Collection Loss 10.0% 150,000 Effective Gross Income 1,350,000 Expenses Management 3.0% 40,500 Leasing 0.0% - Tenant improvements $ Building reserves $ ,000 Total expenses 70,500 Net Operating Income 1,279,500 Capitalization Rate 8.00% Indicated Value 16,000, IPT s 40 th Annual Property Tax Symposium 15

16 Taxing District Taxing District Return w/ Lsg., TI Rent SF Rent SF Potential Gross Income ,000 1,500, ,000 1,500,000 Vacancy & Collection Loss 10.0% 150, % 150,000 Effective Gross Income 1,350,000 1,350,000 Expenses Management 3.0% 40, % 40,500 Leasing 0.0% - 5.0% 67,500 Tenant improvements $ $ ,000 Building reserves $ ,000 $ ,000 Total Expenses 70, ,000 Net Operating Income 1,279, ,000 Capitalization Rate 8.00% Indicated Value 16,000, IPT s 40 th Annual Property Tax Symposium 16

17 Taxing District Taxing District Return w/ Lsg., TI Rent SF Rent SF Potential Gross Income ,000 1,500, ,000 1,500,000 Vacancy & Collection Loss 10.0% 150, % 150,000 Effective Gross Income 1,350,000 1,350,000 Expenses Management 3.0% 40, % 40,500 Leasing 0.0% - 5.0% 67,500 Tenant improvements $ $ ,000 Building reserves $ ,000 $ ,000 Total Expenses 70, ,000 Net Operating Income 1,279, ,000 Capitalization Rate (solve for 2 nd ) 8.00% Indicated Value 16,000,000 16,000, IPT s 40 th Annual Property Tax Symposium 17

18 Taxing District Taxing District Return w/ Lsg., TI Rent SF Rent SF Potential Gross Income ,000 1,500, ,000 1,500,000 Vacancy & Collection Loss 10.0% 150, % 150,000 Effective Gross Income 1,350,000 1,350,000 Expenses Management 3.0% 40, % 40,500 Leasing 0.0% - 5.0% 67,500 Tenant improvements $ $ ,000 Building reserves $ ,000 $ ,000 Total Expenses 70, ,000 Net Operating Income 1,279, ,000 Capitalization Rate (solve for 2 nd ) 8.00% 5.70% Indicated Value 16,000,000 16,000, IPT s 40 th Annual Property Tax Symposium 18

19 Parameters Mortgage Information Equity Dividend Rate -1.06% Amortization Period 20 Loan to Value Ratio 70.00% Amortization Method Monthly Holding Period (Years) 20 Number of Periods 240 Interest Rate 6.00% Mortgage Constant 8.60% Mortgage/Equity Band of Investment Mortgage Portion Mortgage Constant Product 70.00% x 8.60% = Equity Portion Equity Dividend Rate 30.00% x -1.06% = Weighted Rate = IPT s 40 th Annual Property Tax Symposium 19

20 Assumptions Market rent 15 Net Tenant improvements Term 5 Years New $25 PSF Renewal $5 PSF Taxpayer Taxing District Rent SF Rent SF Potential Gross Income ,000 1,500, ,000 1,500,000 Vacancy & Collection Loss 10.0% 150, % 150,000 Effective Gross Income 1,350,000 1,350,000 Expenses Management 3.0% 40, % 40,500 Leasing 5.0% 67, % - Tenant improvements $ ,000 $ Building reserves $ ,000 $ ,000 Total Expenses 438,000 70,500 Net Operating Income 912,000 1,279,500 Capitalization Rate 8.00% 8.00% Indicated Value 11,400,000 16,000, IPT s 40 th Annual Property Tax Symposium 20

21 DISCOUNTED CASH FLOW ANALYSIS Indicated Value 11,503, ,000 SF Estimated Yield (IRR) 10.00% CASH FLOWS: Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10 Year 11 Gross Income: $1,500,000 $1,545,000 $1,591,350 $1,639,091 $1,688,263 $1,738,911 $1,791,078 $1,844,811 $1,900,155 $1,957,160 $2,015,875 Occupancy Ratio 90.00% 90.00% 90.00% 90.00% 90.00% 90.00% 90.00% 90.00% 90.00% 90.00% 90.00% = Effective Gross Inc.: $1,350,000 $1,390,500 $1,432,215 $1,475,181 $1,519,437 $1,565,020 $1,611,971 $1,660,330 $1,710,140 $1,761,444 $1,814,287 * Management: 3.00% 40,500 41,715 42,966 44,255 45,583 46,951 48,359 49,810 51,304 52,843 54,429 * Leasing: 5.00% 67,500 69,525 71,611 73,759 75,972 78,251 80,599 83,016 85,507 88,072 90,714 * TI: $ , , , , , , , , , , ,175 * Reserve: $ ,000 30,900 31,827 32,782 33,765 34,778 35,822 36,896 38,003 39,143 40,317 Less Expenses: 438, , , , , , , , , , ,635 = Net Operating Inc.: $912,000 $939,360 $967,541 $996,567 $1,026,464 $1,057,258 $1,088,976 $1,121,645 $1,155,294 $1,189,953 $1,225,652 INCOME & MARKET DATA: MORTGAGE TERMS: RESALE DATA: Req. Yield Rate (IRR) 10.00% Term (Years) 25 Net Income In Year 11 $1,225,652 (all cash) Interest Rate 6.50% Terminal Cap Rate 8.50% Ave. Ann. Incr. in P.G.I. 3.05% Debt Coverage Ratio (after 1st year) 1.44 Resale Price $14,419,432 Ave. Ann. Incr. in Exp. 3.05% Annual Debt Service ($652,462) (11th Year NOI/Terminal Cap Rate) Ave. Ann. Incr. - N.O.I. 3.05% Max. Mortgage Amount $8,052,611 Less Sales 6.00% $865,166 Terminal Cap Rate 8.50% Loan to Value Ratio 70.00% = Net Sale Proceeds $13,554,266 Going in Cap Rate (calc.) 7.93% Mortgage Balance After 10 Years $6,241,689 Less Mortgage Balance $6,241,689 Equity Divided Rate Year % = Before Tax Reversion $7,312, IPT s 40 th Annual Property Tax Symposium 21

22 Assumptions Market rent 15 Net Tenant improvements Term 5 Years New $25 PSF Renewal $5 PSF Taxpayer Taxing District Rent SF Rent SF Potential Gross Income ,000 1,500, ,000 1,500,000 Vacancy & Collection Loss 10.0% 150, % 150,000 Effective Gross Income 1,350,000 1,350,000 Expenses Management 3.0% 40, % 40,500 Leasing 5.0% 67, % - Tenant improvements $ ,000 $ Building reserves $ ,000 $ ,000 Total Expenses 438,000 70,500 Net Operating Income 912,000 1,279,500 Capitalization Rate 8.00% 8.00% Indicated Value 11,400,000 16,000,000 LESS: - Leasing comm. ($75,000/yr. x 10 yrs.) 750,000 - TI Cost ($30/SF x 10 yrs.) 3,000,000 Indicated value reflecting stabilized lease-up costs (ignoring PV) 12,250, IPT s 40 th Annual Property Tax Symposium 22

23 2016 IPT s 40 th Annual Property Tax Symposium 23

24 PWC Survey 3 Definitions of NOI Effective Gross Income - Operating Expenses (2) NOI before reserves, leasing commissions & TI - Reserves (1) NOI after reserves, before leasing commissions & TI - Leasing commissions & TI (3) NOI after reserves, leasing commissions & TI The Elusive Definitions of NOI and OAR, Francis, J., THE APPRAISAL JOURNAL, January 1998 at IPT s 40 th Annual Property Tax Symposium 24

25 OVERALL CAP RATE, 3 RD QUARTER 2011 Low Average High Phila., PA 7.50% 8.62% 10.00% (3) (2) 2016 IPT s 40 th Annual Property Tax Symposium 25

26 American Cyanamid Co. v. Wayne Tp., 17 N.J.Tax 542, 576 (Tax 1998): Defendant's appraiser testified that such [tenant improvement] costs... are built into the capitalization rate. Even if he were correct in theory, the appraiser failed to demonstrate that the data upon which he (or plaintiff's appraiser) relied in selecting a capitalization rate included a factor related to tenant improvement costs IPT s 40 th Annual Property Tax Symposium 26

27 Conclusion Capitalization rate considerations? Rent levels, expenses and leasing costs Risk of obtaining projected income Techniques to refute erroneous cap rates 2016 IPT s 40 th Annual Property Tax Symposium 27