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Appraisal Capitalization Rates and Risk

by Administrator on Apr 15, 2010 Commercial Appraisal 667 Views

Appraisers are always confronted with the selection of an appropriate capitalization rate during the appraisal process. We understand that capitalization rates describe the relationship between net operating income and market value, and we realize that a 0.5% to 1.0% difference in the rate selected can make a significant difference in our value conclusion. Cap rate sensitivity analysis tables are often included in appraisal reports to display the difference that rate selection plays in value conclusions.

When most appraisal reports are delivered to the clients who ordered them one of the first things that is critically reviewed is the capitalization rate. Since the rate will be one of the first things that will be focus on appraisers generally take time to detail its derivation and to discuss how it was applied.

The direct market capitalization rates discovered through market research generally vary for the same property type only within a 3.0% to 5.0% range. When consideration is made for sub-market location, age, condition and other factors the range can usually be narrowed to 2.0% or less. Historical information, brokerage reports and other publications can often provide general to very specific capitalization rate information within an urban area. In Las Vegas for example there are usually 2 to 4 brokerage reports published quarterly that provide capitalization rates by property type (like Class A, Class B and Class C office properties) within identified sub-market areas.

Data services also provide sales information that at times details actual capitalization rates or pro-forma capitalization rates. Appraisers generally review this data however it should be verified. The “actual” capitalization rate is often calculated by data services based on the asking price of the property and not on its sales price. Many data services do not consider reasonable subtractions from potential gross income for vacancy and credit loss, and subtractions from effective gross income for management and reserves. It is important for appraisers to compare capitalization rates from net operating incomes similarly derived.

Even though the information supplied by brokerage firms provides great specificity, appraisers will discover that rates can vary from one report to another, sometimes by as much as 2.0%. Notable also is the fact that capitalization rates for the same property type within the same sub-market can vary by 1.0% or more from quarter to quarter.

Appraisers collect and analyze direct market capitalization rate information from similar property sales within the subject property’s market area and they usually select a rate from within the list that they have developed and verified. Selecting a final rate should take into consideration the “durability of the income stream” and the” risk associated with the project.”

Don't forget to use the "band-of-investment" analysis and look at income multipliers, if you don't there is a chance you will be looking at an appraisal review that says that you didn't cover the bases, that you have skipped a an important step in the determination of an appropriate capitalization rate.

Like many other judgment calls in the appraisal process, each appraiser is charged with considering all relevant factors prior to selecting a final capitalization rate. Since some appraisers conclude different overall capitalization rates value opinions vary.  It's important to understand that even when provided with the exact same information appraisers will conclude different capitalization rates.
 
For more appraisal information contact Glenn Rigdon, MA, MRICS, ASA a Las Vegas / Henderson Nevada appraiser via email or via his business website Horizon Village Appraisal (http://www.horizonvillageappraisal.com), or you can also click on “Contact Us” on the home page of this website.

Article source: http://www.appraisalarticles.com/Real-Property-Appraisal/Real-Property-Appraisal/Commercial-Appraisal//1939-Appraisal-Capitalization-Rates-and-Risk.html

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