Dark Anchor, Rent Concessions, and a Buyer's Pro Forma
You are appraising a 24,000-square-foot neighborhood retail strip built in 2006. The grocery anchor, which occupies 9,600 square feet, vacated eight months ago. Total vacancy is now 35%, including the anchor. The owner's rent roll shows in-line leases at $22 per square foot NNN, but three tenants renewed last year at $18 per square foot with three months of free rent and $15 per square foot in tenant improvements. Market data show three comparable strips with 12% to 18% vacancy, asking rents of $24 to $26 per square foot NNN, and effective rents of $20 to $22 after concessions; one comparable sold for $185 per square foot with 20% vacancy. A big-box competitor opened two miles away last year. The owner has an offer of $6.2 million from a buyer who used a pro forma of 95% occupancy at $26 per square foot. The owner asks you to 'support the offer' because 'the buyer is paying cash.'
1. Derive a supported market rent and stabilized vacancy for the subject. What data would you use, and what adjustments are required?
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I would not use asking rents as market rent. The comparables ask $24–$26 NNN but effective rents are $20–$22 after concessions. The subject's in-line leases at $22 with concessions, and renewals at $18 with three months free and $15 TI, show that effective rents are below asking. I would analyze the lease terms and compare to the comparables' effective rents, adjusting for location, age, anchor traffic, and tenant mix. A supported market rent for in-line space is likely in the $20–$22 NNN range, with the anchor space possibly lower per square foot and requiring a larger concession. For stabilized vacancy, the comparables show 12–18%; the subject is at 35% because the anchor is dark. The 35% is not stabilized, and the buyer's 95% pro forma is not supported. I would conclude a stabilized vacancy above the comparable range, perhaps 15–20% overall, with a separate lease-up period for the anchor. I would support this with vacancy data and the subject's competition.
2. How should contract rent, free rent, and tenant improvements be treated in the income approach?
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Contract rent is the legal rent; market rent is the rent the market would pay. For the three renewals at $18, the face rate understates or overstates the effective rent depending on concessions. I would convert the lease to an effective rent by subtracting the value of free rent and TI amortization over the lease term, then compare that effective rent to market. Free rent and TI are not expenses to ignore; they are concessions that reduce the landlord's net proceeds. In the income approach, I would use market rent for stabilized space, not the above-market face rate, and I would include lease-up costs, free rent, and TI in the cash flow or as a deduction. For existing leases, I would use contract rent during the lease term and market rent thereafter. I would not double-count by using contract rent and also deducting the same concessions. The goal is to reflect the actual income stream and the cost to achieve stabilized occupancy.
3. How would you analyze and quantify external obsolescence from the anchor loss and the new competitor, and how should the $6.2 million offer be treated?
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External obsolescence is caused by forces outside the property. Here, the anchor closure and the new big-box competitor reduce customer traffic and demand for the subject's space. I would quantify it through lower market rent, higher stabilized vacancy, longer lease-up, and higher concessions compared with comparable strips that have a healthy anchor. I could also compare the subject's value indication to comparable sales and attribute the difference to external obsolescence, but I would not simply label a lump sum without support. The $6.2 million offer is a data point, not the market value. A cash buyer does not change the definition of market value, and the buyer's pro forma of 95% occupancy at $26 is not supported by the market data. I would analyze the offer if it is bona fide, but I would not 'support the offer' as requested. My value would be based on a stabilized NOI using supported market rent and vacancy, a market-derived capitalization rate, and deductions for lease-up and external obsolescence. The principle of substitution supports the conclusion that tenants will choose competing space with better traffic and concessions.