Apartment Rental Concessions - How to underwrite

Curious how investors would underwrite the following:
50 unit apartment building, 95% occupied. For the entire year of 2009, the landlord has been offering first month's rent free on a 12 month lease. According to the property manager, the landlord has not offered any special deal on tenants who are up for renewal, only new tenants. So, in 2010, I want to assume that this same deal for new tenants holds true. I need to come up with a good formula to predict what % concession loss I should be assuming. Like what % of existing tenants will vacate, how much downtime I should assume before unit is released and then apply the one month free.
Any thoughts?
In Buying Property - Asked by Eric G. - Dec 22, 2009
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Karim A.
San Diego, CA

You bring up several points here - let me try to address. First understand that:
+Scheduled (or Potential) Rental Income (the income on a 100% occupied bldg)
+Other Income (subject to vacancy) - i.e. parking, laundry
=Effective Rental Income (ERI)
+Other Income (not subject to vacancy) - i.e. cell tower, billboard leases
=Gross Operating Income (GOI)
-Operating Expenses
=Net Operating Income (NOI)
-Debt Service
=Cash Flow Before Taxes (CFBT)
The question now is what factors do you apply to the vacancy, delinquency/concession line item.
1) Regarding downtime between tenants - this is already captured in the vacancy rate (i.e. the reason why a bldg with all of its units online would not be at 100% is exactly because of gaps in tenant occupany, by definition). If the bldg has been operating historically at 95% occupancy as you suggest, then you already have the answer to your question
2) For the concessions - I suggest looking at the amount of concession dollars in 2009 as a percentage of scheduled or potential rental income. You can then either apply this same factor for 2010, or a larger/smaller factor in 2010, based upon infomation provided by a property manager managing properties of a *similar asset class* regarding what % of tenants renew vs vacate in your particular metropolitan.
If you would like to discuss further, please give me a call at: (619) 813-5809
Apartment Owner, Broker and Consultant

Dec 23, 2009
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