• JSO Valuation, Ltd.,

A Primer to Capitalization Rates Post COVID-19

June 19, 2020 (Revised)


Introduction

In commercial real estate, it safe to assume that the Capitalization Rate is one of the most misunderstood aspects of any calculation that attempts to estimate market value via the income approach. Unfortunately, there is no playbook to look up the latest rate, there are no absolute indices to develop an acceptable conversion rate. In fact the best way to look at a capitalization rate from a market point of view is… Do enough of people agree that this is the correct conversion factor between net operating income and value? As strange as it seems, but this is a rate that simply agreed upon as being right. Super controversial is when the lack of understanding are real estate professionals who should-be-in-the-know. A good example of this is possibly a real estate tax assessor who does not come from a strong real estate background. Frankly for most professionals its simply just not talked about. The rate is the rate! But what exactly is a Capitalization Rate?

Direct Capitalization

A method used to convert an estimate of a single year’s income expectancy into an indication of value in one direct step, either by dividing the net[operating] income estimate by an appropriate capitalization rate or by multiplying the income estimate by an appropriate factor. Direct capitalizationemploys capitalization rates and multipliers extracted or developed from market data. [almost right] Only one year’s income is used. Yield and value change areimplied, but not explicitly identified. (The Appraisal of Real Estate, 14th Edition, Appraisal Institute, Page 491

This is as good a definition as one will find, but as marked there are weakness in the copy. But it’s to complicated to wrap up such a problematical understanding of the situation into one paragraph, when most will agree the definition covers the basics.

This short article is certainty not meant to be an all-inclusive discussion on Capitalization Rates, but rather an aid to develop the right rate in these fairly uncertain times. COVID-19 is still very much a part of the daily narrative, especially when it comes to real estate, yet properties still have to be valued for a variety of reasons. As of June 2020, there were few sales in the marketplace that are Post-February 2020 contracts. There are a few indicators, as we will see later, that come from the real estate market itself that would allow us to make some indirect comparisons or some type of analysis that ‘this or that’ is actually occurring, which could point directly to an acceptable capitalization rate. In reality however … No one has a clue. But there is agreement that the world has changed and that includes the real estate world.

Economic Indicators

Some of these indirect indicators are from the market in general and regard the current health of the economy. These are very important and may materialize as variables that could move this elusive rate either up or down. Real estate has never operated in a vacuum.

An example of some of these indicators that one can point toward the health of the economy and real estate markets are:

1) Transportation metrics like the TSA passenger count. (6/17/20 441,829 passengers. Up from a low of 93,645 – 4/8/20. One year ago the count was 2,552,395.)

2) Small business organizations such as NFIB, NCMM & National Restaurant Association. Together these three organizations allow one understand the behavior that is driving approximately two-thirds economy. (NFIB.. National Federation of Independent Business, NCMM, National Federation for Middle Market Companies)

3) Free applications for financial student data.

4) Mortgage bankers Association and home loan forbearance**. This typically runs around 1% on an annual basis. In recent months this is cranked up past 8.5% according to the MBA (June 7, 2020) and is growing.

5) Foreclosures of commercial businesses.

6) The behavior of corporations and corporate earnings (SEC filings.)

**The CARES Act directs that if you are experiencing financial hardship due to COVID-19, you will be granted forbearance on your federally backed mortgage loan for up to 180 days with the option to extend for another 180 days.

When we start to combine these indices with the current unemployment rate (both U-3 (13.3% 6/5/20) and more importantly U-6 (21.2% 6/5/20)), plus looking at the leisure and hospitality industries, senior housing, oil and gas industries, etc., in addition to current indications from the Federal Reserve Bank, an extremely strong picture of the economy emerges. It is an economy in shock and confusion, still with limited understanding as at to what is potentially still coming down the pike.

https://www.economicgreenfield.com/2020/06/05/u-3-and-u-6-unemployment-rate-long-term-reference-charts-as-of-june-5-2020/

The Feds are inclined to believe that by years end the unemployment rate (U-3) will be 9.3% (basically as high as the great recession of 2008-09), and slide towards 5.55% by 2022.

I believe that at this stage a picture is emerging as to the economic outlook over the next 12- to 24-months. We will get back to the economy later, but how does this impact capitalization rates?

Real Estate is Used to Adapting

Real estate has always needed to respond to changing times. In the 1950s, in response to the climate of change in the post-World War II era, L. W. Ellwood introduced to the real estate world, The Ellwood Tables for Real Estate Appraising and Financing. Yield capitalization was very quickly to come into the forefront of analysis. Ellwood recognize the principals of anticipation and change by providing for future changes in values. (In Search of the Rate: Jim Gibbons, CRE - Fall/Winter 1992, Volume 17, No 2 The Counselors of Real Estate.)

Ellwood developed the formula in which all market conditions can be factored into single Overall Capitalization Rate. These included the separation of the bundle of rights theory, by recognizing the separateness of mortgage- and equity-entities. There was an allowance for not just competitive yield rates for both the mortgage component and the equity investment component, and also the anticipated changes in income and value the over the holding period of the analysis.

L. W. Ellwood’s formula in developing an Overall Capitalization Rate with components in building a rate reflecting the current and future expectations of the market. In other words, recognizing the principles of anticipation and change by providing for future changes in incomes and values. As Gibbons pointed out in his article “it is also interesting to note that the principle ingredients of the overall rate is for customization, mortgage and equity rates coupled to the products of trading in capital and money markets.” To have all of these conditions and factors combined into a single Overall Capitalization Rate, Ellwood developed the following formula.

+ Dep

R = y – mc 1/SN

- App

R = Capitalization Rate

Y = specified equity (there is more but we will leave it at that)

M = loan to value ratio

C = mortgage coefficient

1/Sn = sinking fund factor

So in the definition above, Ellwood established that the use of a direct capitalization should allow one to develop an estimated of market value (based on stabilized NOI), and still incorporate variables that will have a direct effect on the final rate and therefore the final estimate of value. Much like the many variables that are swirling around the market place today.

However it was Charles B. Akerson who made a significant and invaluable contribution to the understanding of Ellwood’s procedure by replacing the horizontal algebraic expression with a vertical band of investment mode (Jim Gibbons, CRE). It is this vertical band that we can use today to accounts for 1) appreciation/depreciation, 2) risk and 3) liquidity all bills in the foundation of a basic capitalization.

Todays Interpretation – Same… but maybe easier

Nevertheless, we must distinguish between what income approaches are available in creating a value estimate, and which method may or may not be the most appropriate technique in driving a value from this approach. Is direct capitalization the most appropriate way to develop value, or should one employ yield capitalization in the form of a discounted cash flow (DCF) analysis. Maybe both?

If the valuation is of a multi-tenanted shopping center or office building or even a multi-tenanted industrial building for that matter, yield capitalization as part of the calculation maybe invaluable. However, given the final use (and users) of the report, an Overall Capitalization Rate based on a single years net operating income maybe easier to convey the value to a more unsophisticated or ridged reader.

The complaints revolving around a DCF, is it’s an approach to value that is, in many ways, seen as having a “black-box” syndrome. ‘To difficult to understand all the moving parts,’ the lawyers representing the tax bodies may say! Yet, it is these very moving parts that will allow one to explain in detail the drivers that go into or represent an Overall Capitalization Rate. So the answer may lie closer towards one may needs to use both, with the weight of value being placed on direct capitalization using an Overall Capitalization Rate as delineated by Charles B. Akerson with the detailed analysis and explanation extracted from the DCF.

This of course spurs on a whole slew of other questions, such as if you’re capitalizing a single years net operating income, which year do you use when the property, the economy and the forecasts are all influx? It is my opinion that one uses the year that best represents the property moving toward or possibly at stability. However, the cynic would then say… but how about inflation. All I can say is… it’s complicated.

An Overall Capitalization Rate is only applied to one defining characteristic of a property i.e., its applied to a single year’s net operating income - Clearly in developing ones estimate of Net Operating Income (NOI) there are a myriad of variables and decisions before getting there (revenue from all sources of course being one, but also the expenses.) Also it is implied that both income and value are expected to change at a constant ratio into the future. (This is basis in Illinois of assessing (for taxes) income generating properties.) Again, when income and value are expected to change at the same rate, the capitalization rate is expected to remain constant over that same period. For example, if one is valuing an industrial building with a 10-year lease escalating annually in line with inflation. The expenses for the property are for the most part also escalating in much the same fashion as the revenue. Therefore applying a stabilized capitalization rate via direct capitalization is the simplest, and indeed the most accurate method of driving value. Both income and revenue are changing similarly. This value presumably would than be confirmed by the Sales Comparison Approach.

So have laid the groundwork for both direct capitalization and also potentially a discounted cash flow analysis to value. When Akerson and Ellwood imagined this there were no computers. The pencil and paper was the only way to look at varying revenue and expenses over a five, seven or ten year analysis. Today we can enter all the data from a multi-tenanted property either into some pre-programmed software such as Argus or even into an excel spreadsheet. Either way from either the 1950s or the early 1980s, simple assumption changes can be made instantly to look at value options. So it is my understanding that we are still following Ellwood, but with todays technology it’s so much easier.

But what happens if this is not quite true

The Overall Capitalization Rate is valid only if it accounts for all the other characteristics of theproperty and importantly the external forces leaning into the property. This appears to be out of left field, but lets quickly develop an example away for the more speculative but nevertheless real ‘occurrences’ in today’s economy.

Suppose in the market place in which you are appraising an industrial property, where annual increasesof 3% are forecast in the net rental data of the comparable sale properties. In your analysis, you develop a Capitalization Rate of 10% from these same sales ie. extracted market data. However for the actual property being appraised, it has been established that the forecasted annual net rental growth is only 2%. If one than applied the developed Capitalization Rate of 10% (again this was extractedfrom the comparable sales) to the subject property’s NOI, this would in all likelihood be amisapplication of the approach and could overstate the property’s market value. Hopefully this makes sense, but if the market revenues are increasing 1% faster than the subject’s revenues, the 10% market derived cap rate is low and the estimate of value is high.

In todays COVID market place, we may not be looking at the differences between increasing markets, and decreasing market rental rates. So any sales we may use today may well be indicating rising rental rates, but there is ample information out there observing the opposite. So a derived capitalization rate based on sales clearly would be a misapplication of this approach to value and would be definitely overstating the value.

Today (June 2020) there are significant external forces on multi- and single-tenanted properties, not accounting for the many forces already outlined that are leaning-in on value. Not accounting for these we saw would be a misapplication of the capitalization rate. But this is where the expansion from a Basic Capitalization rate to an Overall Capitalization Rate works to everyone’s advantage from valuation point of view. But again this is assuming that both income and value are expected to change at a constant ratio. The past four months have dispelled this notion somewhat.

Accounting for the forces pressing into a Capitalization Rate

According to the 14th Edition of The Appraisal of Real Estate, Appraisal Institute, the Overall Capitalization Rate (Ro) is an income rate for a total real property interest that reflects the relationship between a single year’s net operating income expectancy and the total properties estimate of value. It is used to convert a stabilized NOI into an indication of overall property value.

NOI = Value

Ro

We have highlighted a capitalization rate where there is an assumption that income and values are expected to change at a constant ratio. This is the classic basic capitalization rate via direct capitalization that converts income expectancy to market value.

Nevertheless in today’s market income and expenses are more likely not to change at a constant ratio. Take for example a shopping center that has been closed for the last three-months and where several of its tenants are now not coming back. Its revenue will decrease immediately but potentially not so its expenses. Re-populating this shopping center, and competing with all the other retail properties suffering similar fates will be challenging. It will require incentives to attract new tenants, tenant capital improvements that were not expected or anticipated, concessions or even a significant decrease in the rent that may well last for several years, etc. It is safe to say, that the revenue will oscillate both up-and-down for the next couple of years and the center will be nowhere close to a stabilization income for some time.

But expenses on the other hand may have a curiously stable slightly upper projection over the same time period. This does need to be accounted for and as of today one can assume that the value of this property has taken a significant downward trajectory. But by how much?

What we are really talking about here is a need to incorporate Appreciation or maybe more apropos - Depreciation into this capitalization rate formula. For this objective to work seamlessly, one has to assume again that income and value are changing at a constant ratio. (Truly, at this stage this feels like a broken record, but this is important.) In reality, that is rather difficult to ascertain if the ratios are constant, but in the circumstances that we find ourselves in right now there are other indicators (as we have pointed out in the six bullet points above that help in determining some type of rate of adjustment.) Ironically, in Ellwood’s earlier years he had the same difficulty with his formula I/R = V. The I (Income) what’s much debated with the focus being on which period or years earnings should be attributed.

The National Real Estate Investor on June 8th 2020 referring new research by Reonomy (reonomy.com) highlighted the obvious industries to have been hit very hard by the pandemic (retail, restaurant, travel and energy sectors), but other industries have also seen an oversized fallout from COVID. Not alone were these confined to specific industries but also specific locales within an overall geographic area, where one industry may have been hit harder in one geographic area than another close by. Within more industrialized centers, there are some sectors that possibly have remained, for the most part, unscathed and others that have not. For example those states where there are very high rental rates, tenants are simply struggling to keep up the payments and when the governments PPP begins to expire these harder hit markets may ultimately experience valuation decreases in the low double digits. Or somewhere between 10% and 15%. So in developing an adjustment for depreciation to the basic capitalization rate we now have a marker that is showing, according to Reonomy, a potential decrease or depreciation of between 10% and 15%. Therefore this needs to be accounted for in the basic capitalization rate in an effort to develop a strong Overall Capitalization Rate.

So recapping so far. We have established for a Cap Rate there is:

A Basic Capitalization Rate.

Adjusted for: Appreciation or Depreciation.

But there is more…

So other items that we know about the economy include; COVID-19 has hit the retail industry particularly hard. Since the outbreak of the coronavirus, four large apparel retailers have filed for bankruptcy: J. Crew, Neiman Marcus, Stage Stores and J.C. Penney. The REITs said they had collected about 20% of rents on average, according to a tally compiled by Morgan Stanley Research. The May figure was down from an average of about 26% in April. Again however this varies from sector to sector.

Publicly traded operators of outdoor shopping centers, particularly those anchored by supermarkets, should have the balance-sheet strength to weather the crisis, analysts suggest. For example, Vornado Realty Trust, which owns 2.3 million square feet of street retail in Manhattan, noted in its May earning call that while all other types of retailers had reached out for financial relief, grocery stores and other essential tenants have not. Meanwhile, indoor malls featuring department stores, restaurants and entertainment venues are more at risk, as a number of national chains have announced they would not pay rent in April and May. (SitusAMC) Clearly from a capitalization rate point of view this is the preverbal fly-in-the-ointment!

This is a risk that every lender undertakes. An excellent example of this is Mall of America in Minneapolis. They are now going to miss their third $7M payment on a $1.4 billion mortgage, putting the borrower more than 60 days delinquent.

Back to assuming again that income and value are changing at a constant ratio. If tenants such as Subway, Mattress Firm, Starbucks, Cheesecake Factory, etc. are not paying rent or are filing for bankruptcy such as J. Crew, AMC, etc., one could not be to sure that even as one moves from a Basic Rate to an Overall Rate, everything can be accounted for? Here we are clearly looking at risk in all its forms. The investment that was purchased is undergoing significant changes and challenges that were never anticipated over their holding period.

Just to be clear, every sector does seem to be affected. Multifamily is not immune. The trade group, National Multifamily Housing Council stated that about 80.8% of renters made full or partial payments for June, in line with the first three months of the pandemic. But in certain markets such as Southern California rent deferment requests and non-payments are rising. Cracks are also beginning to emerge between the different class of buildings. For example in the Class C properties, which are home to a more blue-collar and service work force, and certainty home to the those who cannot work from home - appear to be struggling financially. The default rate in this Class of property is 10% or double the rate at Class A properties. These Class A properties are more typically home to those who can work from home and who maybe struggling less financially. But in the end, no one is keeping track of how many residents have only made partial payments, or have requested payment plans or worse are paying with credit cards. Paying rent by credit card definitely has a use-by-date. Again this was always a risk and until 2020 a very low one.

Clearly also hit particularly hard is long-term senior housing. Besides the obvious, such as occupancy down and operational costs way up, the death rate has surpassed 50,000 people in long-term senior care facilities (according to data from the Kaiser family foundation.) This was never a risk that was ever imagined or even contemplated. But nevertheless we have risk.

So clearly there something else going on from a valuation point of view that also needs to be recognized in an Overall Capitalization Rate, and that is:

1) Risk and

2) Liquidity.

Listed above are some of the many risks that’s have emerged with ownership and shared across the board with the mortgage holders and mortgage bankers. To ignore that there is any risk involved in developing value at this stage would be difficult. But more difficult is quantifying a level of risk where one can say it’s 25 basis points, 50 basis points, etc. Clearly for different property types it will be a different risk scenario, but in reality, we simply have to make have an allowance in the capitalization rate for risk until such time as there is a metrics for measurement.

Prior to this crisis, “the market forces that increased the efficiency of real estate markets and liquidity of real estate investments, also reduced the transparency of the assets pooled in heavily traded securitized mortgage instruments, obscuring the risk involved in holding the loans that backed those securities from buyers.” (The Appraisal of Real Estate, 14th Edition, Page 132) It is safe to say that this mask is been ripped back and increased transparency and a greater understanding of risk in both investing, underwriting and mortgages securitizing of these properties is once again at the forefront of everyone’s mind.

For example is the recent trend of tokenization of the commercial backed mortgage securities (CMBS) has been made possible because of greater adoption of block-chain technology. Is this good or bad for the reorganization of risk? This is way to complicated to get involved here, but tokenization aims to lower barriers to investment and open new funding opportunities for asset owners such as increased liquidity, reduced costs, improved efficiency, and lower barriers of entry to invest. On the record I agree with none of this. The exact opposite is true. Liquidity yes, but transparent and risk free clearly no… Therefore, we are back to building the capitalization rate to account for this liquidity.

Liquidity or the marketability of a property is the difficulty of converting real estate investments into cash at a reasonable market value within a reasonable time. Traditional properties directly fall into this difficulty. But if you have invested in a REIT, liquidity is easy. The secondary mortgage market, where mortgagees sale packages of mortgages of prices consisting with existing money markets rates. Clearly, these free up capital and create more liquidity. There are other examples where liquidity and potentially risk has been diluted. But as a general rule, property is not like stocks and bonds. The holding period is longer and the exit strategy is generally well thought out and understood. The current economy has put a slight wrinkle in this idea.

Therefore in developing an Overall Capitalization Rate one also has to account for risk and liquidity separately. These in the past have been low probability markers. But if something goes very wrong (and clearly since January something has gone very wrong) these markers come to the forefront of any capitalization rate.

Therefore:

A Basic Capitalization Rate.

Adjusted for: Depreciation (-)

Adjusted for: Liquidity (-)

Adjusted for: Risk (-)

This equals an Overall Capitalization Rate

Should we be making the case that an Overall Cap Rate may need help?

Again keeping mind what we are talking about, when income and value are expected or assumed to change at the same rate year over year, the capitalization rate is expected to remain constant. There is nothing to indicate a change of circumstance. Therefore, this repetition of growth or decline is sometimes referred to as the frozen capitalization rate pattern. In other words… Revenue will be just about the same year over year adjusted for inflation. Expenses will also be the same in any given year. Again adjusted for inflation as one moves away from year zero and into the future. This is not to say that there will be not fluctuations in both revenue and expenses, but on the whole, in today’s dollars, they are similar on an annual basis. In this scenario an overall rate via direct capitalization is a perfect ratio to jump from a net operating income to value.

But what about the affect on market value when income and value are not changing at a constant ratio. Is there a fairly simple solution to this issue and it can be related to directly to an Overall Capitalization Rate?

But before we get there we still need to digest more on the economy. As of the time of writing this paper, all the walls around us are still continue to move and we are not sure when one can model some type of value recovery scenario with a degree of accuracy. The Third Quarter may provide some clues and the Fourth Quarter should see some type of settling of all the indices. Some of the data sources refer to a quicker recovery on one page but the Fed Chairman, Mr. Powel advising the nation that the financial recovery will spill into 2021 and maybe even 2022. I think everyone is right, but that does not mean we will be looking at the economy as it was as of January 2020 for some time to come.

Values have taken a hit. However one has to assume that this will not be across the entire property spectrum. There were issues with retailing well before the coronavirus showed up in the United States. But it has definitely accelerated their problems. There is a bifurcation in industrial properties. The large big box 200,000 ft.² users do not seem to be affected as much as the 5000 ft.² to 20,000 ft.² user. Industrial rent stagnated over the last 10- to 12-years, and as a result of this many of the older buildings have some significant deferred maintenance along with the expected functional obsolescence.

It’s not possible at this stage to really estimate what the demand will be for office space moving forward. It summer in the northern hemisphere and people are quite happy to work from home. The question remains will these same employees be as enthusiastic in the dead of winter next January? My money is on ‘not likely!’ The unemployment rate is really going to have an effect on Class C multifamily housing. That is not to say Class A or B are not going to be unaffected either. But the assumption is that asking rents will decline across all classes.

The GDP is down, but it will be the Fourth Quarter that we will know for sure by how much. The median FOMC (Federal Open Market Committee) participant still expects real GDP contracting by 6.5% for all of 2020 with the unemployment rate at an elevated level of 9.3% by the end of the year. But in 2021, the median projection has unemployment falling to 5.55% by 2022 and real GDP rebounding by +5.0%. But everything anyone knows is based on one or two positive reports, but it was clearly understood that in an economy that is bouncing around so much there will be some good news. An example of this is the recent jobs report where 2.5 million jobs were added back to their economy. However it was clear that once there was a reopening of the national economy, employees who had filed for unemployment would be called back to work. In reality, there were very few new jobs created. But in such uncertain times any good news is worthy of discussion.

As we move toward a conclusion in this discussion, we have somewhat assumed in this paper so far that there is no other way to value property in these very uncertain times other than an capitalizing a single years net operating income (direct capitalization). There is of course other ways, and maybe the development of an overall rate does need some help. Using a Discounted Cash Flow analysis, one can model many different scenarios depending on which direction one believed to economy is moving. As described in the Appraisal of Real Estate on page 519 of the 14th Edition, “the present value of any increasing, level, or decreasing income stream or of any irregular income stream can be calculated with DCF analysis. Specific valuation models or formulas, categorized as either income models or property models, have been developed for application to corresponding patterns of projected benefits.”

That may need some translating… but with revenue projected to potentially fall first than rise and than potentially fall again before stabilizing at an acceptable occupancy, a model or a best attempt to project these annual trends can be made. We have discussed at length the implication that both income and value are expected to change at a constant ratio into the future. But to be realistic, today in most multi-tenanted properties the value is being solved for variable or irregular income flows.

We stated earlier, we must distinguish between what income approaches are available in creating any value estimate and which method may or may not be the most appropriate technique in driving a this estimate of value from the Income Approach. Again the question revolves around is direct capitalization the most appropriate way to develop value or should one employ a discounted cash flow (DCF) analysis? We also speculated that the answer might actually lie with both.

There are also some cases in which only stabilized revenue and expenses capitalized an appropriate rate is acceptable. Such as in tax appeal cases. But even any trier-of-fact would recognize that these are extraordinary times and it calls for an extraordinary solution, but also remaining within the law.

But a discounted cash flow analysis is not appropriate in every case even in this COVID-19 environment. A single tenant industrial building, which is owner-occupied, would not be well served, from the valuation point of view, by using a DCF. But a multi-tenanted retail property would not be well served if a DCF were not employed. So on this particular instance, one would need both to develop an overall capitalization rate to derive value and also a discounted cash flow analysis to understand the market place in which COVID has created.

Municipalities are all short of money. Cities like Chicago are moving toward a $1 billion deficit for 2020. New York, Philadelphia, Baltimore, St. Louis, Denver, San Francisco or Seattle are in the exact same position. Someone has to assume that developing a DCF only as part of your income approach will simply get tossed by any Assessor. Therefore, to be able to drill down into the issues one would need a discounted cash flow analysis, and to be able to present a report that the trier-of-fact can accept and understand, an overall capitalization rate converting net operating income to value would be needed. The reality is of course that two values vie this approach should concur. They may not be completely the same, but close enough to offer a strong degree of reliability. But in placing weight on one value indicator or another, which is another way of saying, of the two values developed in the income approach, the weighted value has placed on a stabilized NOI (direct capitalization) capitalized at an appropriate Overall Capitalization Rate.

Conclusion

As valuation professionals our audience, in many instances, simply do not understand what is a capitalization rate. They clearly know what it does, but getting there is a narrative on to itself. There are few that can refer clearly to the different components that make up such a rate.

In these difficult COVID times, we look at six direct areas that reflect how the economy is doing. These were TSA passenger counts, small business organizations, loan forbearance, student loan applications, commercial foreclosures and finally corporate behavior. We introduced L. W. Ellwood’s formula in developing an Overall Capitalization Rate and how this was modified by Charles B. Akerson. We then moved the discussion along as to how one would actually develop an overall capitalization rate from a basic rate by adding in an allowance for 1) appreciation or depreciation, 2) risk and 3) liquidity.

We then turned towards the idea of a discounted cash flow analysis and how that fits into developing overall approach to value.

Finally as we pointed out in paragraph one as regards to a capitalization rate - do enough of people agree that this is the correct conversion factor between net operating income and value. - This entire paper was dedicated to unraveling some the confusion, but in the end no matter how anyone thinks, professionals have to have a handle on a correct capitalization rate, the many variables that are absorbed into the rate. One simply has to continue to look at the big economic picture (along with the detailed minutia) to develop this very small but important rate.






John O'Dwyer is the president of JSO Valuation Group, Limited. This is a national appraisal firm located in Evanston Illinois. JSO specializes in valuations of low-income limited-equity cooperative housing, self-storage warehouses, community or club swimming pools, convenience stores along with the traditional commercial buildings such as offices, retail and industrial properties. The firm has an emphasis on property taxes appraisals, estate valuation and insurance valuations. In addition to position papers on the commercial swimming pool industry, Mr. O'Dwyer has also written on the automobile industry, convenience stores with gas stations, death industry, automobile dealerships, and the early stages of the coronavirus and its affect on real estate, to mention a few.

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