How Arrears in Commercial Properties can Impact a Valuation

If you have spent time building a commercial rent roll and are thinking of selling or having it valued so you can plan and make your next move, the process can take some time. 

Plenty of factors will contribute to the figure your valuer arrives at, including the size of your portfolio, the types of properties you’re managing and the assets which will be included in the sale. 

In this article, we’re taking a look at arrears and the role they play in a commercial rent roll valuation. 

Two lease structures, two arrears risks

Commercial premises are typically held under one of two lease types, and arrears look different under each of them.

Under a gross lease, the tenant pays rent plus outgoings, including rates and land tax. As rent roll valuers, we have seen commercial tenants who are entirely up to date with rent while falling behind on outgoings, leaving the premises partly in arrears without this being immediately obvious.

Under a net lease, the owner covers rates and outgoings, while the tenant pays rent only. Arrears are easier to keep track of in this situation, but still can’t be ignored as they directly impact revenue for the owner and the property manager.

Neither structure is ‘better’ than the other, but it’s important to understand which is being used and how any form of arrears can affect the financial position of the overall rent roll.  

Why arrears matter during your rent roll valuation

A rent roll valuation considers the reliability of the income it generates as well as the size of the portfolio and the revenue. Arrears, whether in rent or outgoings, signal instability in the income stream. Your valuer will factor this into their assessment, the buyer is likely to leverage the shortfalls to negotiate and a lender may lower their offer or raise their rate based on the overdue amounts. 

Ideally, arrears should be less than 5 per cent. At BDH Valuers, we often find principals have been keeping an eye on the rent coming in, but not closely watching other overdue accounts, and they are often surprised to find out about amounts owed. Unfortunately, this lack of attention to arrears can have an impact on the value of the business, firstly because it can indicate lax management but also because it’s an indicator that the tenant’s business is struggling. 

This is one of the reasons why we recommend a valuation every two or three years; it can help to work through the process and identify issues which have fallen through the cracks. This way, there will be fewer shocks or major problems to quickly address if you need an urgent sale or want your rent roll in the best financial shape so you can borrow. 

The value of data

When you’re preparing to sell or looking to find out how much your commercial rent roll is worth, you don’t want your accountant and valuer making assumptions. The clearer, more up-to-date information you can share about arrears (not to mention other financial figures), the better.

Historic figures matter as well, so aim to have these to hand. It will streamline the process if you have as much information as possible ready to share before you engage the valuer, so they’re not chasing you for a long list of figures. 

Many agency owners have made the valuation process easier on themselves by using industry-specific commercial property management software, which keeps detailed records and may also be able to extrapolate data. However, it’s important to work with your accountant to keep things as up to date and accurate as you can. 

Preparing for a commercial rent roll valuation

Arrears are only one part of your commercial rent roll valuation, but they will impact the final figure because they affect income security and add administrative burden for the incoming owner. 

Before you work with a valuer, confirm which premises are under gross or net leases, then find out who is up to date and who is behind on their payments. The good news is your valuation won’t be set in stone, so if you discover clients have fallen behind, you can take steps to rectify the situation.

BDH Valuers specialises in rent roll and property agency valuation, with experience understanding the many moving parts of a commercial portfolio. To discuss a valuation for your commercial rent roll, contact Ross today.

FAQ

• How exactly do arrears affect what a lender or buyer will offer for a rent roll?

  Buyers tend to use arrears as leverage to negotiate the price down, while lenders may lower their offer or raise their rate based on the overdue amounts because arrears signal instability in the income stream the valuation is built on.

• Will finding arrears during a valuation stop me from selling my rent roll?

  No. A rent roll valuation isn't set in stone. If arrears turn up during the process, you can still take steps to rectify the situation before a sale goes through, and having valuations done every two to three years helps catch these issues early so steps can be taken to avoid future issues.

• What should I do before getting my commercial rent roll valued if some tenants are in arrears?

  Confirm which premises are under gross or net leases, then identify exactly who is up to date and who isn't. Have clear, current and historic arrears figures ready for your valuer and accountant, so the process isn't held up chasing information.