DCF or Direct Cap

[Fred]

I guess this is a poll of sorts -

An appraisal is based on a 10-year income scenario under a series of assumptions:
2.5% NOI growth
certain mortgage terms
14% Ye
etc., etc.

The appraisal uses the Ellwood forumla to derive a cap rate and capitalzes the Year 1 income.

Is this DCF or Direct Cap?

 

[Fred]

The question is from a private discussion. The other two appraisers said DCF. I was a bit surprised by the answers.

BTW, every time I hear someone do the "you would not understand the explanation" routine, it was because they didn't have an explantion.

 

[Paul Ness MAI]

Based on your position regarding the previous debate, I think Pat and I both assumed you were asking a leading question here, and assumed you again took a position on this one that would be opposite the conventional wisdom. Shame on us.

This is another basic "Appraisal 101" item. Converting a single year's net operating income to value by using an overall cap rate (regardless of the method used to estimate the cap rate) is by definition direct capitalization - versus yield capitalization using a DCF model, which is discounting future cash flows and reversion to present value by applying a yield rate.

 

[Fred]

Paul,
It is true that I prone to argue that "conventional wisdom" is usually "mass stupidity." My favorite book may well be "Popular Delusions and The Madness of Crowds." I also realize that asking a thought-proviking question is a chat room does not always provoke throught.

BTW, the two fellows on the other side of the coin say that:
Direct Cap is not the result of a short holding period, a reversionary value and a yield rate; that artficially smoothing out the data (so the Ellwood can work) and backing into the one-year "equivalent" rate was not the same thing as come-in-the-front-door Direct Cap. IMNSHO, that position is not without merit. It was also my view that most appraisers would not make any distinction between a one-year rate developed frontwards, or one squeezed out of a ten-year cash flow scenario.

Thanks for confirming my suspicions.

And as to my "position" in the other debate - I don't think "prove it" is that questionable a position.

 

[spettifer]

One reason why the appraisal profession is so *** up is everbody thinks there smarter than the other person. You can't even ask a simple question without some yahoo telling the world how smart they are and how you should not even have asked the question in the first place. I've seen this on every appraisal forum. What is it about appraisers who have to be the biggest, smartest and best appraiser in the world? Why can't you use that knowlege and help other appraisers who may benefit from those years of experience? Most of us on occasion have had a very simple appraisal problem, there 95% sure how to handle it but would like just a little feedback from other appraisers just to up the confidence level to 100%. Most don't dare ask the question because of the snid comments that will come. All of us have had different experiences and training to get were we are today. Some better than others. Lets lighten up a little. Somebody will probably criticize my grammar on this post but leaving for some fishing down Mexico way in a hour so, don't care.

Have a great weekend all

Scott

 

[Fred]

Pat,
I would like to see you as "brilliant" as well, but since all you post is sophmoric flame, I'll reserve have to my conclusion until after the facts are in (of you ever decide to go that route).

You only assume that I agree with either side on the question, but you are certainly free to jump to another unsupported conclusion. Actually, your posts confirm my prior obserbation that the 'average' appraiser would not appreciate the distinctions between 10 years and in perpetuity.

The point was almost litigated, but the appraisal in question did not pass Daubert muster on other grounds (too many unsupported conclusions). BTW, the company that made the software called it DCF, but because the argument was cut short by the judge, I did not get to hear the Direct Cap "school" of thought offer their "brilliant" rebuttal of their own software vendor.

 

[Paul Ness MAI]

Steve, your logic is difficult to follow, and your posts attempt to be very manipulative. Your original question in this thread was simple - Is converting one year's income into value using an overall cap rate DCF or direct capitalization? By definition it is direct cap. But you didn't ask if we appreciate the distinctions between 10 years and perpetuity. That is twisting something to create animosity. And your use of the term "average" appraiser was obviously used in a derogatory fashion. Sorry we don't measure up to your perceived level of brilliance. Of course there is a difference, which is why I don't do direct cap when appraising the leased fee interest of a property subject to a 10-year lease. Got it? Clear enough for you?

I agree with Pat, Steve you need to get a life outside this forum. Living in the Virgin Islands I would think you could find some rather envious avocations. I for one am leaving work early today and heading to an Oriole's game. Scott, before jumping all over Pat, I suggest you read my debate with Steve on two other threads regarding the income approach and the valuation of fee simple interests.

 

[Fred]

Pat,
As you told me,
"I very much like the idea of having you as competition and as an adversary"

I come in here to discuss technical appraisal issues and ideas, not persons or personalities. I am surely not reaching out to anyone who cannot discuss technical valuation issues without resorting to derogatory personal remarks.

 

[Fred]

Paul,
I used the word "average" as a response to the prior post where it was suggested that my questions meant that others were "brilliant" by comparison.

Scott,
I am with you. I was first asking why the fee simple value of an un-rented propertywould be universally found by capitalizing rent. I am not trying to sound smarter than anyone, but I don't think I should be called dumber either. I don't see why asking for the underlying reasoning and data for an appraisal conclusion should cause so many personal comments.

 

[Paul Ness MAI]

There you go again Steve! Be clear as to what I was representing. The fee simple interest of an un-rented property can be found by capitalizing net operating income based on ECONOMIC rent. It has to do with a reasonable expectation of future benefits, the principle of anticipation, but I went through this all before a number of times with a number of examples.

“I don't think ‘prove it’ is that questionable a position.” (June 6, 4:19pm)

Your position went way beyond “prove it.” In fact you made the following specific declarative statement…

“The income approach appraises the leased fee interest”. (May 22, 11:05pm)

This is your original statement that hit me in the face and started the whole debate.

“After years of raising the same questions, I have become convinced that I (am) probably beyond ‘help’." (May 24 1:24pm)

This is one of the few statements you made that I agree with.

“I agree that fee simple as market rent capitalized is commonly taught, but I do not agree common equals true. Until someone can show that it is true with some reasoning or sufficient market studies, the word hypothesis is appropriate”. (May 29th 12:01pm)

I have replied extensively, providing reasoning based on economic theory as well as practical examples. Just because you haven’t been convinced by little old me doesn’t mean it is not true.

“Would it surprise you to learn that market data does not confirm the hypothesis that fee simple interests sell at the equivalent of market rent capitalized at market rates?” (May 30th 10:40pm)

You have clearly stated a position but have provided NOTHING to support it, and continuing to throw “prove it” back at me is a cop out. I have made an attempt to prove my position with numerous long replies to you, and you have provided nothing other than telling us how many versions of USPAP you own and how experienced you are with appraising complex properties.