Leasing Incentives That Don't Detract From Valuation

At Y Street Capital we bring in young professionals from time to time to work as interns on a part time basis to learn more about real estate investing and development. These unpaid internship positions foster a win-win relationship that can often accelerate the learning for a young adult. At Y Street Capital we are looking for a research assistant to work for a few hours a week on special projects. Some of that work will also include the background research that could ultimately result in episodes of the podcast. If you have a few hours a week to spare and are a candidate, or perhaps you have a young adult in your life with a high level of curiosity. Send an email to podcast@victorjm.com and put the word research in the subject line. 

--------------

On today’s show we are looking at how to create leasing incentives that preserve the value of your building. 

Most building valuations are based on the income method which involves taking the gross rent, minus the operating expenses to get the net operating income. You then divide that amount by the market capitalization rate to get the value. 

Let’s say that you want to offer a bunch of incentives for new tenants to move into your building. You could offer a discount on rent which would result in a reduction in rent and therefore a reduction in the value of your building. If you offer the tenant something that costs you money to provide, then your expenses increase and you have the same effect of lowering the value of your building. 

In a brand new building you will want to pre-lease as much of the building as possible. Many developers I know have 30% pre-leasing as a target to achieve by the time the building is ready to open. But in order to achieve that, tenants need to plan on moving when the building is completed, not necessarily in 30 days or 60 days when it might be otherwise convenient for them. It’s a longer sales cycle. 

From an accounting standpoint, investments in the building assets are associate with the balance sheet and not the income statement. For example the materials that go into the building like paint and gypsum board and bricks are all part of the capital improvements. A capital investment is amortized over the depreciated life of the asset. Some startup costs can be capitalized. For example if you have marketing expenses that are associated with the initial lease-up of the building, it would be legitimate to capitalize those costs instead of expensing them since they are a one-time cost and not a recurring cost. 

So let’s imagine that you offer a free large format television as part of a move-in special. The cost of that TV can be capitalized. While it appears as an incentive to the tenant, it doesn’t get treated as an operating expense to the business and therefore the cost of the TV doesn’t reduce the value of the building when looking at multiples of net income. 

-----------

**Real Estate Espresso Podcast:**
 Spotify: [The Real Estate Espresso Podcast](https://open.spotify.com/show/3GvtwRmTq4r3es8cbw8jW0?si=c75ea506a6694ef1)  
 iTunes: [The Real Estate Espresso Podcast](https://podcasts.apple.com/ca/podcast/the-real-estate-espresso-podcast/id1340482613)  
 Website: [www.victorjm.com](http://www.victorjm.com)  
 LinkedIn: [Victor Menasce](http://www.linkedin.com/in/vmenasce)  
 YouTube: [The Real Estate Espresso Podcast](http://www.youtube.com/@victorjmenasce6734)  
 Facebook: [www.facebook.com/realestateespresso](http://www.facebook.com/realestateespresso)  
 Email: [podcast@victorjm.com](mailto:podcast@victorjm.com)  
**Y Street Capital:**
 Website: [www.ystreetcapital.com](http://www.ystreetcapital.com)  
 Facebook: [www.facebook.com/YStreetCapital](https://www.facebook.com/YStreetCapital)  
 Instagram: [@ystreetcapital](http://www.instagram.com/ystreetcapital)