Net Revenue / CAP rate

Hi,I was looking at a park that had a base/flat water and sewer connection fee that added up to about 10K per year for the entire park. The 10K was billed back to the tenants and was included in the total income number. So the seller is inflating the income by 10K which is ultimately being capped. In order to determine the valuation one should remove the rebilled fees. Is this correct? Thank you so much for your feedback.

well- separate the income streams. You just want to be sure the income from the space rent is the only thing your using the CAP rate on. Everything else is figured as its own income / value methods. If someone is making money on utilities- I looked at a park a while back where about 40% of the NET was utility over billing- well that is just not legal. (some states allow you to surcharge a % of a utility bill if you sub meter and bill back).

It depends.  Are the accounting for the $10k as an expense as well?  We’ve run into this same thing before but our seller was also writing their water off as an expense… it had the effect of canceling each other out and we never brought it up.  In any event, if they aren’t also expensing it, you need to call them out on it.  Don’t be afraid to tear apart a sellers numbers and have them walk you through each line item on the income statement they provide.

I would subtract the bill-back from the water expenses in my analysis, (and subtract the income from the income side of things) but I would follow up later to make sure the water expenses were within reason with bills, etc.  I value parks by a cap rate on the rent roll times expected expense ratio, and figure my “fudge” factor for infrastructure (capital expenses) is embedded in the cap rate.  My “fudge” factor for (operating) expenses is narrowed during DD, but by then I have already put the park under contract at the “valuation” that was acceptable for me to put a contract on it based on meeting my projected guess at an expense ratio.  I will verify the rent roll during DD as well.Brandon@Sandell

Thanks for your input. The water usage bill is in the expense line but the flat connection fee is not. Anyway thank you for your help. This forum is a great tool and someday I hope to add value and give back to those who are learning like I am now.

Kwm,If the owner did not expense this connection fee, it tells me that this is not a recurring expense.  It might be the situation that the current owner paid the Initial Connection Fee when the city water was connected and the tenants pay him back through many months, like the installment payments.  I would check the Balance Sheet and it should be capitalized as Capital Improvement and depreciated through many months.  Or simply ask the owner if he expensed it or capitalized it when it happened.  Anyway, I would not count it as an income, because this is not a true income stream, it will stop when the installment period ends.  Best Wishes.Shan