Capitalization Rates & Commercial Appraisals
Capitalization rates are one of the areas that receive a lot of analysis within the commercial appraisal world. Various firms and data services report monthly, quarterly, and annual trend data as it relates to capitalization rates.
Capitalization is the conversion of income to value. A capitalization rate is the rate used to convert income into value. The rate represents the rate of return on a real estate investment based upon the income that the property is expected to generate. In general, a lower cap rate indicates there is less risk associated with the investment and a higher cap rate indicates a higher risk alternative. The risk can be attributable to a variety of factors. Some of these risk factors include location, construction quality and age, tenant creditworthiness, length remaining on the lease, and various market factors.
Cap rate support in a commercial appraisal report can come from a variety of sources, including extraction from comparable sales, broker/investor interviews, investor surveys, and/or database publications. Generally, comparable sales are perceived as the most accurate and influential data in this regard. It is important to understand how the cap rate was derived in the comparables so that the cap rate is applied in the same way to the subject property. For example, were reserves included above or below the net operation income line. The Band of Investment or Mortgage Equity Technique can be used as a secondary tool or test of reasonableness for the primary cap rate support. The Band of Investment formula should be supported with the most current interest rate information and data. The appraiser can then adjust or load the cap rate based upon dissimilarities in the data group versus the subject property. An example of when a loaded cap rate may be appropriate is in the case of a property that it under-assessed for taxation. The appraiser can load the cap rate to account for the anticipated increase in taxes during the next year’s income analysis. Any cap rate adjustment or load factor should be reasonably and adequately supported and explained in order for the user of the report to follow the analysis and conclusion.
Dart Appraisal strives to ensure that our clients and vendors are informed of commercial real estate industry methodologies and trends. Our commercial quality assurance review team is composed of Certified General real property appraisers who are knowledgeable in market trends and are well-equipped to consider the reasonableness and credibility of the cap rate support. Our clients have confidence that appraisals that rely upon a cap rate have been thoroughly reviewed by the commercial team for adequate and relevant support, and that the cap rate within the final report has been found to be reasonable and adequately supported.
Dart Appraisal is a leading, nationwide Appraisal Management Company, that provides both residential and commercial appraisal solutions. Through innovative technology and unparalleled customer service, we create custom solutions to meet our clients’ unique needs.
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