Appraisers' Free Forum

**Mentor** · Certified General Joined: 11 Aug 2007 Posts: 276

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?
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Loans in lots and lots of states. CG turned LO.

**Jim Plante** · Posted: Sun Aug 12, 2007 11:48 am Post subject:

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.
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Jim Plante

**Mentor** · Certified General Joined: 11 Aug 2007 Posts: 276

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

Yes, that was a sloppy statement, to say the least Wink

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.
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Loans in lots and lots of states. CG turned LO.

**Pina Colada** · Certified General Joined: 13 Aug 2007 Posts: 565

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** · Posted: Mon Aug 13, 2007 2:01 pm Post subject:

**Annemieke Roell** · Posted: Mon Aug 13, 2007 2:18 pm Post subject:

I love this forum .......
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We're not being stopped by something on the outside, but by something on the inside.

**Pina Colada** · Certified General Joined: 13 Aug 2007 Posts: 565

**Jim Plante** · Posted: Mon Aug 13, 2007 6:05 pm Post subject:

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

**Pina Colada** · Certified General Joined: 13 Aug 2007 Posts: 565

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** · Posted: Mon Aug 13, 2007 8:02 pm Post subject:

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.
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Jim Plante

**Pina Colada** · Certified General Joined: 13 Aug 2007 Posts: 565

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** · Posted: Mon Aug 13, 2007 10:07 pm Post subject:

**Edd Gillespie** · Certified General Joined: 13 Aug 2007 Posts: 2282

**Pina Colada** · Certified General Joined: 13 Aug 2007 Posts: 565

**Jim Plante** · Posted: Tue Aug 14, 2007 4:37 pm Post subject:

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