#### Austin

##### Elite Member

- Joined
- Jan 16, 2002

- Professional Status
- Certified General Appraiser

- State
- Virginia

The significant point of this method is that in times such as these with interest and equity rates making huge shifts over short time periods, it appeared to me that using the conventional income approach format was misleading because of the significance of the rate structure and the elasticity of rates versus NOI. In summary: Rates are so much more elastic than NOI changes that in this environment point estimates of value results are questionable. A better method is to show a most probable price range under a wide range of reasonable scenarios. What this indicates to me is that the elasticity of rates is so significant and expenses so unstable and relatively less elastic that it is a waste of time and misleading to fine tune operating expenses and give point estimates of value.

To begin, take any pro forma operating income statement or use this example. Say we are appraising an apartment complex of five units. We estimate the NOI at $10,000 and the operating expense ratio of 25%.

At t his point on your spreadsheet make a column labeled operating expense ratios. Label the adjoining column to the right NOI’s. Bracket the extracted operating expense ratio with a ratio of 20% and 30%, so now you have a column of expense ratios of 20%, 25%, and 30%. Next in the adjoining column put the corresponding NOI’s for that expense ratio by multiplying 1-Expense ratio times the EGI.

Now, start a new box in another location on the spreadsheet. The first column put the historic cap rate range for that type property. For example, I have done a lot of apartment complexes over the years and the cap rate has never been below 8% or above 11%, so anything outside that range is possible but not probable. Make a column of rates at 8% thru 11%.

Now label the adjoining three columns value @ OER 20%, value @ OER 25%, value @ OER 30%. Then under each column put a capitalized price for each cap rate. For example, under value @ OER 20%, cap the NOI at OER 20% for each cap rate 8-11%. Then do the same for each column for each expense ratio.

At this point you have a left hand column of cap rates from 8-11%, and the adjoining three columns show a range of indicated prices at each rate.

Now graph the results using cap rates on the X-axis and prices Y-axis all on the same graph. If you want to, highlight one set of data points and calculate the trend line and formula but that is not necessary.

Use your best estimate of most probable cap rate range giving consideration to the past and future possible rates as reflected by interest and equity rates. In this example, say 8.5 to 10.5% cape rate. Now using your drawing or line art function, draw a box that covers all possible prices encompassed inside the trend lines between 8.5% and 10.5%. With interest and equity rates at their present low level, the indicted point estimate of price is in the upper left corner of the box, but under any foreseeable and reasonably expected rate changes, the price will most likely not be outside the box. This box represents the most probable price range under any reasonable and foreseeable situation. Also, note that a 1% change in the cap rate will make a big difference in price but a 5% change in the expense ratio makes a much less difference. Point being: Under these conditions why spend hours estimating expense items that are as unstable as a feather in the wind.

In my view it would be misleading to report a point estimate of price in the upper right hand corner of the box because of the artificially lot interest and equity rates at present. If you used the band of investment method to support a cap rate I don’t even have a guess what the equity cap or yield rate would be, but they would be on the low end resulting in an artificially low cap rate and resulting in an artificially inflated price estimate.

If interest and equity rates and expense items were fairly stable, this would not be necessary, but in this type environment given the sensitivity of cap rates and unstable expense items, like for instance casualty insurance and utilities, in my view this is the best an appraiser can report. In a risky environment you have to use methods that account for the risk. If I were a client and saw this box it would give me a feel of the gravity and dynamics of the market forces. For example, if six months from now interest rates go up 1.5% and the stock market returns to something reasonable, I know my property is not likely still worth what it was six months ago and I have an idea what is worth in today’s market.