A hardcore and top-slice valuation of an over-rented centre, with the sustainable rent set by each trade's sales and occupancy cost ceiling rather than by comparables.
Value a shopping centre on the rent its tenants can sustain, not the rent they pay: capitalise the sustainable rent, less irrecoverable costs, at the market yield, then add the over-rent only for the years the leases still guarantee it. On an illustrative centre passing 4,900,000 a year, of which 735,000 is above what the tenants' sales support, that gives 52.8 million net of purchaser's costs, against 60.1 million from capitalising the passing rent, a 7.3 million difference.
Worked in full in Retail Real Estate by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
Retail is the asset class in which the tenant reports what it sells, so the sustainable rent is not an opinion. It follows from each trade's sales and the share of them an occupier can spend on occupancy. The method below is the hardcore, or layer, approach that valuers use for over-rented property, with the hardcore set by trading arithmetic instead of by comparable rents.
Rent capacity = occupancy cost ceiling × sales − service charge − rates
Sustainable rent = the lower of passing rent and capacity. Rent at risk = passing rent − sustainable rent. In Excel: =MIN(B2,D2*C2-E2).
| Trade | Passing rent | Sales | Ceiling | Service charge and rates | Capacity | Rent at risk |
|---|---|---|---|---|---|---|
| Anchor supermarket | 1,200,000 | 40,000,000 | 5% | 500,000 | 1,500,000 | 0 |
| Fashion | 1,500,000 | 14,000,000 | 12% | 450,000 | 1,230,000 | 270,000 |
| Food and beverage | 700,000 | 9,000,000 | 11% | 220,000 | 770,000 | 0 |
| Health and beauty | 600,000 | 5,500,000 | 13% | 180,000 | 535,000 | 65,000 |
| Value retail | 900,000 | 8,000,000 | 10% | 300,000 | 500,000 | 400,000 |
| Centre | 4,900,000 | 735,000 |
Sustainable rent is 4,165,000; the 735,000 at risk is 15.0 per cent of the rent roll. The value tenants are paying 15.0 per cent of their sales in occupancy cost against a ceiling of 10, and fashion 13.9 against 12. The anchor and the restaurants could pay more, but their leases do not let the landlord collect it, so their sustainable rent is capped at passing. The tape-level method is set out in how to calculate a retailer's occupancy cost ratio.
Hardcore value = (sustainable rent − irrecoverable costs) / yield
(4,165,000 − 245,000) / 7.25% = 3,920,000 / 0.0725 = 54,068,966. The 245,000 is the landlord's irrecoverable service charge, insurance and management, which comes off the income before any yield is applied; how that figure is built is shown in how much service charge a shopping centre landlord pays.
Top slice = rent at risk × annuity factor(top-slice rate, unexpired term)
The 735,000 is contracted, but only until the leases end or the tenants fail, so it is valued as a terminable income at a higher rate. At 10 per cent for a weighted 4 years unexpired, the factor is 3.1699 and the top slice is 2,329,851. In Excel: =735000*PV(10%,4,-1).
Gross value is 54,068,966 + 2,329,851 = 56,398,817. Divided by 1.068 for illustrative purchaser's costs of 6.8 per cent, the net value is 52,807,881.
| Net income capitalised | Net value | Net initial yield on that value | |
|---|---|---|---|
| Passing rent at 7.25% | 4,655,000 | 60,118,817 | 7.25% |
| Hardcore and top slice | 3,920,000 + top slice | 52,807,881 | 8.25% |
The passing-rent valuation is 13.8 per cent higher, 7,310,936. Put differently, a buyer who pays 60.1 million is paying the full yield multiple on 735,000 of rent that the trading says will not survive the next lease event. Capitalised in perpetuity that slice is worth 10,137,931; secured for four years it is worth 23 per cent of that.
| Unexpired, years | 8% | 10% | 12% |
|---|---|---|---|
| 2 | 51,853,619 | 51,820,773 | 51,789,469 |
| 4 | 52,905,785 | 52,807,881 | 52,716,683 |
| 6 | 53,807,848 | 53,623,672 | 53,455,852 |
| 8 | 54,581,222 | 54,297,880 | 54,045,113 |
The top-slice inputs matter far less than the hardcore. Even eight years of secure over-rent leaves the value 5.8 million below the passing-rent figure. What moves the answer is the sustainable rent itself, which is why the tape and the sales returns deserve more diligence than the yield. At 6.75 per cent the two methods are 8,014,080 apart; at 7.75 per cent, 6,698,520.
Sales are reported before the next downturn, not after it. Test the capacity column with sales 5 and 10 per cent lower before you settle the hardcore: the rent at risk rises faster than sales fall, because service charge and rates do not fall with them.
Two cross-checks keep the method honest. First, the true net initial yield: passing net income of 4,655,000 over the 52.8 million value plus costs is 8.25 per cent, which should look plausible against sales of over-rented centres, not prime ones. Second, the rent at risk by trade: the value retail group alone carries 400,000 of the 735,000, so a lease event in that group is the date the valuation really depends on.
Capitalising passing rent at a yield taken from comparable sales, and treating the over-renting as a yield adjustment. A higher yield on the whole income cannot distinguish a centre whose tenants are 15.0 per cent over-rented from one at 5; the hardcore method can. And remember that the anchor's sustainable rent is not just its own: if it leaves, the cost reaches the whole centre.
Sustainable rent from sales, hardcore at the market yield, over-rent as a terminable top slice, purchaser's costs off: 52.8 million on this centre, a true net initial yield of 8.25 per cent where the passing-rent figure shows 7.25. The free workbook for this case builds the sustainable rent unit by unit and carries it through the ten-year cash flow.
There is no single figure; yields depend on location, dominance and income security, and any level quoted here is illustrative. What matters more is the income the yield is applied to. At an illustrative 7.25 per cent the centre in this example is worth 52.8 million on sustainable rent and 60.1 million on passing rent: the same yield, a 7.3 million gap.
It splits income into a bottom layer that is secure in perpetuity, capitalised at the market yield, and a top slice valued only for the term it is contracted. Here 3,920,000 of net sustainable income at 7.25 per cent gives 54,068,966, and 735,000 of over-rent for four years at 10 per cent adds 2,329,851.
Compare each tenant's occupancy cost ratio, rent plus service charge and rates over sales, with a ceiling for its trade. Where it is above, the excess rent is at risk. In this example value retail pays 15.0 per cent of sales against a 10 per cent ceiling, and 735,000 of a 4,900,000 rent roll, 15.0 per cent, is above what sales support.
This article is one calculation from Retail Real Estate. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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