Acquisitions
Seven Places an Offering Memorandum Inflates NOI
The broker’s cap rate and your cap rate are rarely the same number. Here is where the gap usually comes from.
Every offering memorandum leads with a cap rate. It is almost always higher than the one you will underwrite, and the difference is rarely one big lie, it is six or seven small optimisms stacked on top of each other.
1. Market rent instead of in-place rent
The pro forma marks vacant or below-market space to what the broker believes it will achieve. Sometimes that is fair. It is still a forecast, and it belongs in your value-add case rather than your going-in cap.
2. No capital reserve
A pro forma with no replacement reserve is claiming the roof and the parking lot last forever. Twenty to twenty-five cents a foot for retail, and two to three hundred dollars a unit for apartments, is the minimum honest number.
3. Management at zero or at a discount
Self-managed properties often show no management fee at all. Your lender will impute one, a buyer will impute one, and you should too.
4. Recoveries assumed at 100 percent
Full recovery of CAM, taxes and insurance assumes no vacancy, no caps, no gross-up limitations and no tenant with a negotiated exclusion. Ninety percent is a more realistic starting point and the gap is real money.
5. Taxes at the seller’s assessment
The single most common error. Many jurisdictions reassess on sale, and the tax line in the pro forma is the seller’s, not yours. On a property that has not traded in a decade this can move NOI by five percent or more in year two.
6. Turnover buried in vacancy
Especially in apartments. Make-ready cost, downtime between tenants and leasing fees are three separate expenses, and a single vacancy percentage captures at most one of them.
7. Free rent and allowances amortized away
A recently signed lease at a strong headline rent may have come with six months free and forty dollars a foot of allowance. The rent roll shows the face rent. Your valuation should use the net effective rent.
Rebuild it yourself: Cap rate calculator for the going-in number, net effective rent for the leases, and multifamily operations for a full expense build.
Related notes
How to read this. These are working notes. Figures come from public reporting and from the models on this site, and market conditions change, check anything time-sensitive against the source before you rely on it. Nothing here is investment, tax or legal advice, and no note is a substitute for diligence on a specific property.
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