Appraisers' Free Forum

[Mentor]

IRV

Value=Income/Interest Rate

Rate is the rate investors will require and it varies by quality factors of the investment, such as risk, possibly longevity

Income is net operating income for real investors, or just cash flow, if the investor plans an escape to Belize

Value is what the investor would pay for the property.

I like overall cap rates. If there is enough sales data uncomplicated with side issues to develop the overall cap rate, it probably means there is good SCA data as well! Also, I like to not pretend I can see the financial future more than a year in advance. Merely calculating net annual income gives me a headache. Friends don't encourage friends to go out of their way to offer DCF solutions.

Jim, would my confessed bias, expressed in an appraisal report be generally accepted in the current market?

[Jim Plante]

Roger, I don't think it would be accepted, unless you elaborated more on the "why."

I fully agree with you about the uncertain nature of DCF and it's attendant economic forecasting. But it can be done credibly. It's just a real PITA.

To do a credible DCF, one should provide best-case, most probable, and worst-case economic forecasts, stating the reasons why each is a best-case (why couldn't it be better?), probable, and worst case. Then one should derive yield cap rates based on each of those scenarios--again, building reasoned logic for each decision. Finally, each scenario should be reduced to a DCF analysis, and reconciled into the most probable selling price. The actual DCF calculations are trivial. The economic forecasting is the hard part.

With direct cap, you can eliminate most of that confounded forecasting, and rely instead on the market participants' judgment of the way the economy is running. It's reflected in the OAR. The OAR (OverAll Rate) represents the market's reaction to current events as well as its opinion of how things will be over the holding period. Yield cap reflects one appraiser's opinion of the future. Direct cap shows the whole market.

BTW, I agree with whoever said that PRICE is what you pay; VALUE is what you get.

[Mentor]

"Value is what the investor would pay for the property. "

Yes, that was a sloppy statement, to say the least I should have said, value is the most the investor would pay, if advised by me!
I fell right into that price/value pot hole.

It would be interesting to review commercial reports for a broad spectrum of properties. The range of valuation solutions, the varied level of treatment, I'm sure it would be shocking. Since I'm not active I'm a bit out of touch, but I noticed from following the AF commercial forum that there was enormous differences between the CG's on various issues where I expected a bit of conformity. I think Hal Mann is in such a cat bird seat, based upon some of his comments.

[Pina Colada]

I strongly disagree about bad rap that DCF always gets. I don’t use if any more than anyone else, but it is a concept thing.

Direct cap is just a thumbnail measure in a larger model of property performance; a model whose detail DCF makes explicit. Jim says, “The actual DCF calculations are trivial. The economic forecasting is the hard part.” What happens in direct cap – whether you realize it or not - is that you forecast that subject and comps have equal futures, that they both have income streams of the same durability, safety and growth pattern. That just gets you out of quantifying them.

Bottme line: DCF is a method by which one directly quantifies the future of the comps and subject. Direct cap quantifies them indirectly by assuming that the futures are all the same. Technically, since both methods are estimating the present worth of the same forecast future benefits, both should produce the same results (with some rounding error) right?

Roger,
Those differences between appraisers are not going to come into play on the main property types like apartment buildings, big boxes and shopping centers.

[Jim Plante]

What happens in direct cap – whether you realize it or not - is that you forecast that subject and comps have equal futures, that they both have income streams of the same durability, safety and growth pattern.

Well, if you extract the cap rate out of the market, you aren't making any such assumptions. The market does--right or wrong, those are the assumptions market participants make.

And that was the distinction I was trying to draw: In direct cap, (with extracted rates) the market does its own forecasting. In yield cap, the appraiser makes that forecast; in so doing, a certain measure of bias can creep in.

[Annemieke Roell]

I love this forum .......

[Pina Colada]

What happens in direct cap – whether you realize it or not - is that you forecast that subject and comps have equal futures, that they both have income streams of the same durability, safety and growth pattern.

Well, if you extract the cap rate out of the market, you aren't making any such assumptions. The market does--right or wrong, those are the assumptions market participants make.


And that was the distinction I was trying to draw: In direct cap, (with extracted rates) the market does its own forecasting. In yield cap, the appraiser makes that forecast; in so doing, a certain measure of bias can creep in.

Whether you want to call them assumptions or forecasts, market extraction doesn't mean they aren't there. For example, you comp is a four-year old five-unit that sold at a GRM of 6. Subject is also a five unit, with larger units, the same gross, but is 30 years old and has twice as much current maintenance expense. If subject worth the same, 6 times rent, as the comp? If not, why not? And why is this "sticky?"

[Jim Plante]

Pina, why would I be calculating a GRM if I'm extracting a cap rate. You were just saying that

Direct cap is just a thumbnail measure in a larger model of property performance

GRM is even more so.

Given the data, I'd extract the cap rates for the two comps and reconcile them to the subject's cap rate. The rates for each should encompass style, location, condition, view, amenities--all the stuff that assures the income stream won't get disrupted. Having reconciled the OAR's of the comps to an OAR for the subject, I'd hardly be applying a clumsy, ill-fitting GRM except maybe as weak support for the cap rate. Besides, that 30-year old might have features that outweigh its mere age, like maybe proximity to some theater, beach, or shopping center.

[Pina Colada]

Pina, why would I be calculating a GRM if I'm extracting a cap rate.
Perhaps too many rum drinks caused a senior moment, but direct cap means working with one years “earnings.” Any type of "gross" or "net" makes no difference to me. Call the 6 a direct cap rate if it floats your Planters Punch.

Beyond that you’re tap-dancing. I guess if you say the obvious, that the older property is going to require increasing repairs and capital improvements, you’d be implying that the curve of projected income is going to decay more rapidly than in the comp. Then you would have to close to admitting that you can’t “eliminate most of that confounded forecasting.”

[Jim Plante]

Well, we can special-case anything to death. Direct cap is most useful when you've got similar properties in similar condition. If you've got one old one, nearing the end of its economic life, then you just about *have* to use yield cap to get a useful answer.

But yield cap is much more demanding in its support requirements. I've seen it done on one property figuring a 20-year holding period. I asked how he could forecast the local market 20 years into the future, and he calmly showed me the effect of a 20-year discount on the projected income. Something like $20K NOI, PV of practically zilch. Going-out rate was a wild-assed guess, along with the reversion value, and everybody knew it including the client.

[Pina Colada]

Well, we can special-case anything to death.
I didn’t special case anything. Properties have age differences. The also have lease term differences. Different locations link to demand differently. The presence and absence of anchors and other tenant mix issues affect prospective earnings changes. The adaptability of the improvements affects the future ability to generate income.

Then there are all the fixer upper and distressed properties, the condo projects and land tracts that have to be subdivided. Every one of these properties has a different future. And on and on and on.

Something like $20K NOI, PV of practically zilch. Going-out rate was a wild-assed guess, along with the reversion value, and everybody knew it including the clientKnew?
You can get just as far off with direct cap. They are just two different views of the same thing. Going back to what you said about forcing it into a DCF problem. Are you aware that even in those circumstances, it is possible to adjust the overall rate so that it will produce the same result, without projecting the cash flows? That’s exactly why they are two views of the same thing.

In fact, as far as I am concerned, the first you need to learn how to do is make the DCF and direct cap come out to the same result. That way, when you change scenarios and re-discount, you now that the only thing changing the result is the terms of the new scenario rather than incongruous wild-ass guesses.

This thread is a good example of how I know I suck at teaching appraising.

[Jim Plante]

This thread is a good example of how I know I suck at teaching appraising.

LOLOL! You don't necessarily suck at it, you're just plowing really hard ground: my head :)

Re: Knew?
Yep, Knew! Overheard them talking in the hall. Conversation went something like, "When you get that far out that the yield rate is almost pure guesswork. Nobody can tell what the commercial market will be like in 20 years." "Oh, of course. We don't expect you to be that exact."

Grrrr.

[Edd Gillespie]

This thread is a good example of how I know I suck at teaching appraising.

Pina Colada???? That is imaginative.

I thought it was a failure to communicate thing. Plante is correct, there is an element in teaching that requires the student to sit up, pay attention and make an effort to understand, instead of thinking of the next thing he is going to say. Keep going. I'm going to check this thread again and see if it is at all comprehensible by the time I get home.

The real problem has got to be that rogeryodamilt started it. It can't be long before we hear the solution to value via direct cap v yield cap is to fire the entire government and start all over again.

[Pina Colada]

Pina Colada???? That is imaginative.

I was going to use Edd Gillespe, but someone took that one already.

[Jim Plante]

Piña,
Let's see you get the tilde above the "n."