Monthly Archives: March 2014

Future Shock When Capitalization Rates Return To Historic Norms

At a recent luncheon with several regional bank appraisal review officers, the subject of Capitalization Rates was broached. The question was; “Why 7% to 9% rates when not too many years ago the norm seemed to be 10% to 12%?”

Short answer;
Federal Reserve’s intervention or buying of funds (buying of T Bonds and T Bills to keep rates low).

Long answer;
The market for real estate is a “long term investment market” that sometimes is influenced by short term occurrences.

The 2007/ 2008 Sub-Prime Debacle is one event that influenced most major urban commercial real estate capitalization rates and markets.

The axiom in play is / was the “Substitution Principle”.
“What are the alternative investment comparative returns available to the level of investor that is attracted to real estate?”

If a 10 year US Fed. T Bond is in the 3.75% yield range and alternative investments with more risk are available at 5% – 6% yields, [and under], then;
Quality income producing real estate, (well leased and located urban shopping centers, industrial buildings and office building, etc.), may look attractive at 7% – 9%, [even if it is not liquid like stocks or bonds].
Example 1:
A shopping center that has a hypothetical $100,000 per year NOI
Formula for Direct Capitalization =NOI / Return or Yield Required

A sale to an investor that requires a 7% return on their investment could sell for 1,428,571.

A sale to an investor that requires a 10% return on their investment could sell for $1,000.000.

A sale to an investor that requires a 12% return on their investment could sell for $833,000.
Example 2:
A real life example;
A bank client asked us to re-appraise several retail strip centers. We were to use only the direct income capitalization approach, presumably to save on costs and they were familiar with the properties (5 year loan history).

The first time we appraised the properties the market derived appropriate direct capitalization rate was 9.5%.

Five (5) years later the market determined appropriate capitalization rate (CAP rate) was 11.5%.

The net operating income (NOI) had increased about 10% and vacancy was down from 12% to around 10%.

The value when utilizing just the direct capitalization income approach “As Is” declined.

You could imagine the ear full the loan officer got from the owner.

A possible explanation to “other parties”;
A owner or loan officer might choose to go back to the lower capitalization rate appraisal and capitalize the then (previous) income (NOI = net operating income) at the current (higher in this case) CAP rate and show the client / borrower / loan committee that the property is performing, but the required return by investors has increased therefore driving down the market value of the income stream at this time. [“Appraisal is a Snap Shot “As Is” because of FDIC and other restrains”.]

2014 New Reporting Options

Further,  many users of narrative commercial real estate appraisals are becoming aware of the recent 2014 ~ 2015 USPAP (Uniform Standards of Professional Appraisal Practice) Rule 2 (2-a and 2-b) real estate reporting format changes.  USPAP no longer has a “Self Contained” appraisal reporting format in the 2014 ~ 2015 version.  This does not mean that a client, lender or user of  narrative commercial appraisal reports can not request and require that a appraiser produce an appraisal report with additional or greater detail than a “Summary Report” (the most used and alluded to current standard report).  The reporting formats are “Appraisal Report” and “Restricted Report”.  For greater details please see

Aircraft Hanger

Aircraft hanger on leased land at Mesquite Municipal Airport 2009 for a FDIC lender.  Property was being improved and updated by the current owner.  Lender was providing financing based on value of completed building on a 20 year lease (ground lease).

Real Estate Trending Up

Recent reports of residential high-end markets of the Park Cities (Highland Park & University Park) and the Preston Hollow Area of Dallas indicate average sales price increases of 7% to 9% (respectively) for the 2012-2013 time frame.  The selling time is around 90 days and sellers are achieving 90+/-% of their final offering prices.  (sources, local Realtors and North Texas Real Estate Information Systems [MLS])

Arapaho Gardens Office Complex

Three building office complex in Richardson, TX.  Real estate evaluation for a Insurance Company.

Retail Strip Project

A Ad Valorem tax (real estate taxes) and Federal estate tax basis evaluation of a low occupancy retail strip shopping center in Lewisville, TX.

Package Store Project

A combination drive-thru (Beer Barn) and Convenience store realty design for a wet dry line location.  A later appraisal noted decline in realty value due to governmental interventions that changed the market (no longer a wet / dry line location).  Realty valuation only.