Commercial Investment Real Estate is the magazine of the CCIM Institute, the leading provider of commercial real estate education. CIRE covers market trends, current developments, and business strategies within the commercial real estate field.
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38 March | April | 2015 Commercial Investment Real Estate While there is a simple formula for f nding the cap rate, there is no standard method for cap rate extraction. Various markets and market participants apply dif erent income and expenses projections when calculating NOI. However, a standard method for extracting a cap rate from market data is critical to properly value a property. Not all NOIs have the same risk prof le. A property that includes third-party management and replacement reserves will have less net income, a lower risk prof le due to adequate third-party management, and appropriate funds for future capital expenditures — and result in a lower cap rate. Regardless of the variables included or excluded in the cap rate extraction, if applied consistently to the property being valued, a reliable estimate of value will result. T e Cash Flow Analysis Worksheet used in CCIM classes shows reserves below the NOI line, so CCIMs need to pay careful attention to the components of NOI and make sure that the NOIs of comparable properties are calculated in a consistent manner. A thoughtful CCIM will re-construct NOI to be consistent and will know enough about cap rates in the marketplace and expense ratios, vacancy, and market rents to sense if adjustments are necessary to an advertised NOI. Daniel nn, MAI, is director of multifamily valuation for Valbridge Prop- erty Advisors/Shaner Appraisals in Overland Park, Kan. Contact him at dkann@valbridge.com. Versions of this article have appeared in Valuation and the Colorado Real Estate Journal. Table 2: How Variables Affect Cap Rates No Reserves Reserves No Management Management Actual Year One Asking Price Purchase Price Potential Gross Income (PGI) $1,000,000 $1,000,000 $1,000,000 $1,000,000 $1,000,000 $1,050,000 $1,000,000 $1,000,000 Plus Other Income $10,000 $10,000 $10,000 $10,000 $10,000 $10,500 $10,000 $10,000 Less Vacancy & Collection Loss $50,000 $50,000 $50,000 $50,000 $50,000 $52,500 $52,500 $52,500 Effective Gross Income (EGI) $960,000 $960,000 $960,000 $960,000 $960,000 $1,008,000 $957,500 $957,500 Less Operating Expenses Management $28,800 $28,800 $0 $28,800 $28,800 $30,240 $28,725 $28,725 Administration $35,000 $35,000 $35,000 $35,000 $35,000 $35,000 $35,000 $35,000 Utilities $50,000 $50,000 $50,000 $50,000 $50,000 $50,000 $50,000 $50,000 Repairs & Maintenance $30,000 $30,000 $30,000 $30,000 $30,000 $30,000 $30,000 $30,000 Grounds $20,000 $20,000 $20,000 $20,000 $20,000 $20,000 $20,000 $20,000 Turnover $25,000 $25,000 $25,000 $25,000 $25,000 $25,000 $25,000 $25,000 Insurance $30,000 $30,000 $30,000 $30,000 $30,000 $30,000 $30,000 $30,000 Real Estate Taxes $120,000 $120,000 $120,000 $120,000 $120,000 $120,000 $120,000 $120,000 Replacement Reserves $0 $20,000 $20,000 $20,000 $20,000 $20,000 $20,000 $20,000 Total Operating Expenses $338,800 $358,800 $330,000 $358,800 $358,800 $360,240 $358,725 $358,725 Net Operating Income (NOI) $621,200 $601,200 $630,000 $601,200 $601,200 $647,760 $598,775 $598,775 Purchase Price $10,000,000 $10,000,000 $10,000,000 $10,000,000 $10,000,000 $10,000,000 $10,500,000 $10,000,000 Extrated Overall Rate (OAR) 6.21% 6.01% 6.30% 6.01% 6.01% 6.48% 5.70% 5.99% Subject Analysis Subject NOI $500,000 Value at Minimum OAR (5.70%) $8,771,930 Value at Maximum OAR (6.48%) $7,716,049 Percentage Difference from Minimum 13.68%