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Mortgage Band of Investment

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vnutt

Thread Starter
Freshman Member
Joined
Dec 1, 2007
Professional Status
Licensed Appraiser
State
Mississippi
I am working on an appraisal and attempting to use the mortgage band of investment to develop an overall cap rate.

Ro= M x Rm + E X Re

I am asked to come up 2 value opinions. One with a current vacany rate of 42%, and another as if the vacancy rate were 15%.

NOI @ 42% is 98,000

Annual debt service is 116,000 (80% loan of 1,400,000 for 30 years at 7.375% with a 5 year balloon)

Down payment is $350,000

Of course I have an Re of -.052

.80 X .08292 = .066338
.20 X -.052 = -.0104
Ro = .055938

98,000 / .055938 = 1,751,939 say $1,750,000


NOI with 15% vacany is $152,000

Re is now + .103

.80 x .08292 = .066338
.20 x .103 = .0206
Ro = .086938

152,000 / .086938 = 1,763,873 say $1,760,000

My Question is why are the indicated values so similar when there is a vast increase in cash flow to equity. It seems as if the additional cash flows are almost worthless. Please tell me I am doing something wrong.
 
Last edited:

vnutt

Thread Starter
Freshman Member
Joined
Dec 1, 2007
Professional Status
Licensed Appraiser
State
Mississippi
Hold on, I think I found the answer. The ratios are the same. I changed the percentage on the vacany rate, but not on the expenses. With net leases, the taxes and insurance fluxuate (and utilities expenses will be higher with a higher vacancy rate) along with the vacancy rate - therefore affecting NOI more dramatically. With these differences factored in on the expense side the final values were vastly different. Sorry to bother you guys.
 

farmguy

Member
Joined
Jun 27, 2007
Professional Status
Banking/Mortgage Industry
State
Texas
I don't use band of investment much but just the way the math works,
if you select one required return for the equity position then change income due to improved occupancy your value indication will go up.

If you increase the equity rate an amount reflective of the increased income it is a wash. You could increase the income ten fold if you then increased the required equity rate by a corresponding amount it would still give you the same value indication.
 

hastalavista

Elite Member
Joined
May 16, 2005
Professional Status
Certified General Appraiser
State
California
I am working on an appraisal and attempting to use the mortgage band of investment to develop an overall cap rate.

Ro= M x Rm + E X Re

I am asked to come up 2 value opinions. One with a current vacany rate of 42%, and another as if the vacancy rate were 15%.

NOI @ 42% is 98,000

Annual debt service is 116,000 (80% loan of 1,400,000 for 30 years at 7.375% with a 5 year balloon)

Down payment is $350,000

Of course I have an Re of -.052

.80 X .08292 = .066338
.20 X -.052 = -.0104
Ro = .055938

98,000 / .055938 = 1,751,939 say $1,750,000


NOI with 15% vacany is $152,000

Re is now + .103

.80 x .08292 = .066338
.20 x .103 = .0206
Ro = .086938

152,000 / .086938 = 1,763,873 say $1,760,000

My Question is why are the indicated values so similar when there is a vast increase in cash flow to equity. It seems as if the additional cash flows are almost worthless. Please tell me I am doing something wrong.

Maybe I don't understand the question?
The cap rates are different (as would be expected) under the two different scenarios but you've already provided the "value": $1,400,000 mortgage + $350,000 down payment.
Your cap rates based on your NOIs are:
5.6 & 8.7, respectively. But they are figured on the total value of $1,750k, no?
 
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farmguy

Member
Joined
Jun 27, 2007
Professional Status
Banking/Mortgage Industry
State
Texas
Should the cap rate change? I would think the cap rate should stay same, higher vacancy lower value, lower vacancy higher value. If you are doing some kind of analysis based on a particular investors required rate of return then you might use figures specific to that investor, but thats not appraising in my mind. Shouldn't the Equity return be based on some typical investors required rate? Which I think is hard to get a handle on.
 

Todd Ruhl

Sophomore Member
Joined
Oct 21, 2007
Professional Status
Certified Residential Appraiser
State
Illinois
Flawed approach. A property with a higher vacancy rate (more risk) has a lower cap rate? This defies market logic...
 

xm4yb7

Junior Member
Joined
Apr 28, 2006
Professional Status
General Public
State
Florida
Flawed approach. A property with a higher vacancy rate (more risk) has a lower cap rate? This defies market logic...

High vacancy properties have the possibility of the vacant space being leased, greatly increasing the NOI of the property. That potential for a large increase in NOI growth results in a lower cap rate.

You can work backwards also. Determine the market value of the property as if stabilized, deduct the lost revenues, reimbursable expenses, etc., etc., etc. to arrive at the "as is" market value. Then take your actual NOI and divide by the "as is" value. Your cap rate will be less than the normal cap rate.
 

hastalavista

Elite Member
Joined
May 16, 2005
Professional Status
Certified General Appraiser
State
California
High vacancy properties have the possibility of the vacant space being leased, greatly increasing the NOI of the property. That potential for a large increase in NOI growth results in a lower cap rate.
Agreed-

Higher occupancy means greater chance of vacancy; lower occupancy already has that chance in its occupancy rate.
40% vs. 15% sounds like an anchor tenant is missing (or a small number of total tenants?).
 

PropertyEconomics

Elite Member
Joined
Jun 19, 2007
Professional Status
Certified General Appraiser
State
New Mexico
Should the cap rate change? I would think the cap rate should stay same, higher vacancy lower value, lower vacancy higher value. If you are doing some kind of analysis based on a particular investors required rate of return then you might use figures specific to that investor, but thats not appraising in my mind. Shouldn't the Equity return be based on some typical investors required rate? Which I think is hard to get a handle on.


The cap rates should absolutely change .. there is more risk (believe it or not) in the 15% vacant property than in the 42% vacant property. Think about it .... at 15% vacant lots of things can go wrong ... at 42% vacant the upside is pretty tremendous.
They measure different levels of risk and as such should be different.

Have you ever wondered why when you measure an apartment building at market rents leased at 95% occupany ... the overall rates are much higher than for those at say .. 65% occupancy?

That is the reason .. test it sometime you will find its correct.
 

Todd Ruhl

Sophomore Member
Joined
Oct 21, 2007
Professional Status
Certified Residential Appraiser
State
Illinois
The Band of Investment technique is a form of DIRECT capitalization. Direct capitalization implies using one year of STABILIZED income.

My market might be a little strange, but buyers typically pay more for properties with higher occupancy levels. Higher occupancy combined with strong leases result in the lowest overall cap rates.

I find it a little curious that an INCOME property is worth the same regardless of occupancy, i.e., income stream? It will be interesting to hear the client's reaction to this opinion...
 
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