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Get the duct tape - my head is going to explode

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Paul Ness MAI

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Joined
Jan 14, 2002
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Certified General Appraiser
State
Pennsylvania
Red and I talked about appraisers not using proper capitalization terminology in another post. If appraisers can’t get it right, how do we expect the clients to understand?! :? Today I received an appraisal to review which was done for another bank and the appraiser is not on my approved list (and will remain so). I had to share this garbage.

First, in the income approach, the appraiser titled the cap section “Development of Overall Discount (Capitalization) Rate” and went on to use the band-of-investment to build the overall rate for direct cap. Well, right off the bat, the discount rate and overall cap rate are two different animals!

Second, she goes on to present the formula for her “rate of return” :( as follows:

Ro = (M x Rm) + (E x Ye)

Ok class, can anyone see the error in this? I’ll give you a hint, she goes on to define the items in the equation and EVEN defines Ye correctly as “before tax equity yield (discount) rate”.

If that wasn’t enough, she then titles the next sub-section “Development of the Mortgage Yield Constant (Rm)” OUCH– my head just exploded 8O ! It is the mortgage constant (aka mortgage cap rate) and not the mortgage yield that should be used in the direct cap formula. The term “yield constant” is a true oxymoron. The mortgage yield changes as the mortgage is paid down, while the constant remains........well, constant (wow what a concept :? ).

In her qualifications, this appraiser discloses that she is a certified general appraiser, a designated CREA and a GRI. In addition to a small number of other classes cited, she has taken The Income Approach to Valuation and Real Estate Finance. How about another poll…education vs competence!!!!!

Forgive me for being giddy, but this appraisal made my day! :twisted:
 
Joined
Jan 13, 2002
Professional Status
Retired Appraiser
State
Florida
Paul,

If you help, I'll set up the poll. She sounds more like a Realtor than a Appraiser.
 

Paul Ness MAI

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Joined
Jan 14, 2002
Professional Status
Certified General Appraiser
State
Pennsylvania
Wow are you good! She is actually the head of a local real estate company that has an appraisal division. Judging from some other items in her report, I believe she does mostly residential appraisals.

Here is a case where a real estate salesperson got her general certification in the first year of certification when, in my state, they really did rubber stamp everyone because of the govt-imposed deadline to establish the certification system. There are so many like her out there, got their certification between 1990 and 1994 back when FIRREA meant "Finally I'm A Rich Real Estate Appraiser" and everyone got into the business because of the ease of entry and potential money before summary and restricted appraisals were conceived in 1994. I've seen their reports cross my desk and I wonder how they keep getting appraisal business. We all thought the cream would rise to the top, but that hasn't happened. In fact just the opposite has happened in the world of financing appraisals. This of course leads to my opinion that state certification has been a detriment to the profession. It is an artificial equalizer and sets a "lowest common denominator" in the eyes of many lenders.
 

Terrel L. Shields

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May 2, 2002
Professional Status
Certified General Appraiser
State
Arkansas
Cream is not the only thing that floats to the top...

Over the years I have tried various bands of investment, etc. and worked really hard to come up with good presentations. That's all for naught unless you cultivate a clientele of savvy investor types who crunch numbers themselves. Bankers tend to want the income approach on about one page.

Recently an FSA reviewer in a meeting was asked about the income approach on farms. She replied she had no quarrel with using any single direct cap rate within the range of comparables....wow.

Some poultry farms are on 4 acres with 2 breeder hen poultry barns earning $150,000 or more annually. Others may be 4 broiler houses barely earning $80,000 and be on 200 acres. selling price? about the same.

Doncha think the land cap rate is going to influence the overall rate? In the above the overall rate might be 9% to 25% or more. How can you miss? You need to equalize the land ratio or adjust the rates according to the subject land values. But why bother if you have a reviewer like that above.

My point is that few Cert. General appraisers I know really understand capitalization of complex properties.
ter
 

Fred

Elite Member
Joined
Jan 15, 2002
Professional Status
Retired Appraiser
State
Virgin Islands
Second, she goes on to present the formula for her “rate of return” :( as follows:

Ro = (M x Rm) + (E x Ye)

Ok class, can anyone see the error in this? I’ll give you a hint, she goes on to define the items in the equation and EVEN defines Ye correctly as “before tax equity yield (discount) rate”.

Rm and Ye don't mix. This is adding fractions that don't have a common denominator. She needs two "R's" or two "Y's" (and with two Y's more calcuations would be necessary to get to a one-year rate).
 

Paul Ness MAI

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Joined
Jan 14, 2002
Professional Status
Certified General Appraiser
State
Pennsylvania
Correct. Since she's solving for Ro, she needs Re in the equation and not Ye. Since you swerved into another pet peeve Steve, I'll mention that this simple band-of-investment (B-O-I) formula is not applicable to Yo. This equation does not work as Yo = (M x Ym) + (E x Ye) because yields are dynamic. I have seen some appraisers try to "build" a yield rate this way and it is not technically correct, although probably "close enough for government work" or a rough approximation. I think what is happening is that users are mixing the simple B-O-I with Ellwood.
 

Fred

Elite Member
Joined
Jan 15, 2002
Professional Status
Retired Appraiser
State
Virgin Islands
Paul,
You are giving me a chuckle with this. I have seen folks get a "yield" rate and then use it for both discounting and direct cap in the same appraisal.
 

Paul Ness MAI

Thread Starter
Member
Joined
Jan 14, 2002
Professional Status
Certified General Appraiser
State
Pennsylvania
What's wrong with that? :twisted:
 

Paul Ness MAI

Thread Starter
Member
Joined
Jan 14, 2002
Professional Status
Certified General Appraiser
State
Pennsylvania
Just kidding! :wink: That would only be appropriate if there was no appreciation and a level cash flow, which happens......almost never.
 

Bill_FL

Senior Member
Joined
Aug 23, 2002
Professional Status
Certified General Appraiser
State
Florida
Paul,

In the correct forumula,

Ro=(M*Rm)+(1-M)*Re))

I oncehad to explain to a reviewer what a mortgage constant was and how to calculate one. He thought it was really neat that he could do that and multiply and laon amount by it to get a payment amount for that terms and rate. And yes, this was an appraiser, General Certified and had a residential designation.

This same guy once told me if your subject contract indicated seller concessions, you had to adjust all of your comparable sales by the concession amount.

Scary Stuff
 
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