Highest and Best Use Analysis PDF

DIMENSION 5 - 36 NOTES: HIGHEST AND BEST USE Highest and Best Use analysis is the balance point of the appraisal process and the appraisal report. In this analysis, the appraiser reconciles the economic and physical information presented in the beginning of the report and asks two questions about th...

DIMENSION 5 - 36 NOTES: HIGHEST AND BEST USE Highest and Best Use analysis is the balance point of the appraisal process and the appraisal report. In this analysis, the appraiser reconciles the economic and physical information presented in the beginning of the report and asks two questions about the subject: 1. If the site were vacant, what would the optimum improvement be? 2. If the subject is improved, how do the existing improvements relate to the optimum improvement and current market expectations? The answers to these questions provide the foundation for the approaches to value the appraiser ultimately uses, as well as for the information considered in the valuation section of the report. Application of the highest-and-best-use concept can be extremely involved and indeed requires a high level of analysis on the appraiser’s part. It is not a task to be undertaken by the uncredentialed real estate professional. However, the basic concept is fairly straightforward and focuses on the optimal value potential for the property. The following explanation paraphrases the concept. HIGHEST AND BEST USE IS: The reasonably probable and legal use of vacant land or an improved property, which is physically possible, appropriately supported, financially feasible, and which results in the highest value. The highest and best use must meet: legal permissibility, physical possibility, financial feasibility, and maximum profitability. The highest-and-best-use analysis of a site always focuses on the site as if it were vacant and available to be put to its best use on a specified date, irrespective of its current use. The highest and best use of an improved property focuses on what exists or will exist. CRC US Body of Knowledge NOT THE HIGHEST AND BEST USE If the appraiser concludes that the existing or proposed improvements are not the highest and best use, the conclusion implies that some obsolescence is likely. The property may no longer make economic sense. The improvements will not result in the highest market value of the property. For example, imagine a small single-family residence on two acres in what was once a remote locale. Over time, urban and suburban sprawl have surrounded this property with high-density commercial development. Clearly the single family home does not maximize the utility and economic potential of the property. It is not the highest and best use. DIMENSION 5 - 37 APPRAISALS: THE THREE APPROACHES TO VALUE NOTES: Appraisals are only one tool in a lender’s toolbox. While appraisals are essential to making good real estate underwriting decisions, appraisers can and do make mistakes. Only by reading the appraisal, viewing the property, and combining good business sense with common sense and judgment can an appropriate decision be made regarding the loan. Remember: The appraisal alone will not determine the collectibility of your financing. Standards of professional appraisal practice require that for most types of property, the appraiser must use three separate methods to estimate value. These methods are called the cost approach, the sales comparison approach (also called the market approach), and the income capitalization approach. The appraiser analyzes the values estimated with each method and then uses his or her judgment to correlate a final value. Note: There can be circumstances in which the appraiser finds that one of these approaches is not applicable. One example is the appraisal of a parcel of vacant land on which no improvements have been constructed. Since the property is not generating income, the income approach is not applicable, nor is the cost approach, since there are no improvements on the property. In this example, the appraiser would use only the sales comparison approach, in which sales of comparable parcels of unimproved land are analyzed. Dimension 5 // Evaluate Collateral Values and Conduct Periodic Inspections of Collateral THREE APPROACHES TO VALUE DIMENSION 5 - 38 NOTES: TYPES OF VALUE An appraisal of real property provides an estimate of the value of the property as of a defined point in time, based on current market conditions. As the appraisal provides time-sensitive analysis, there are many measures of value for a given property. The value will be a function of the property’s completion status, lease status, anticipated premises for sale (e.g., liquidation), and so on. In ordering the appraisal, you should be very clear about what values you are requiring. Several definitions of value are: As is value: See Value As Is (following). As built-out value: See Value Upon Completion (following). Bulk market value: A misnomer; see also Gross Selling Price, Value upon Completion and Value to a Single Purchaser (following). Market value: The most probable price a property should bring in a competitive and open market under all conditions requisite to a fair sale, the buyer and seller each acting prudently, knowledgeably and assuming the price is not affected by undue stimulus. Implicit in this definition is consummation of a sale as of a specified date and passing of title from seller to buyer under the following conditions: Buyer and seller are typically motivated. Both parties are well informed or well advised and acting in what they consider their own best interest. A reasonable time is allowed for exposure in the open market. Payment is made in terms of cash in U.S. dollars or in terms of comparable financial arrangements. CRC US Body of Knowledge The price represents the normal consideration for the property sold, unaffected by special or creative financing or sales concessions granted by anyone associated with the sale. DIMENSION 5 - 39 Present value: The lump sum amount that represents the current value of the right to collect future payments. NOTES: Prospective value estimate: A forecast of the most probable value expected to occur at a specified future date. It is most frequently used in connection with real estate projects that are proposed, under construction, under conversion to a new use or that have otherwise not achieved sellout or a stabilized level of long-term occupancy at the time the appraisal report is written. Transaction value: Means: For loans or other extensions of credit, the amount of the loan or extension of credit. For sales, leases, purchases, and investments in or exchanges of real property, the market value of the real property interest involved. For the pooling of loans or interests in real property for resale or purchase, the amount of the loan or market value of the real property calculated with respect to each such loan or interest in real property. Value as is: The value of specific ownership rights to what physically exists and is legally permissible on an identified parcel of real estate as of the date an appraisal is written or the subject property was last inspected. Value to a single purchaser: The price as of a specified date that a single purchaser could be expected to pay for a real estate project in which a portion of the overall rights in realty are expected to be sold to individual end users over time. Value to a single purchaser implies that an informed purchaser would pay no more for a project at a specific point in time than the price at which he could acquire the property and cover all remaining direct or indirect costs expected to be incurred before sellout of all remaining units or lots. Dimension 5 // Evaluate Collateral Values and Conduct Periodic Inspections of Collateral It is always based on the expectations and perceptions of market participants together with identifiable and documentable trends as well as data that are known or knowable at the time the forecast is made, and is a prediction. DIMENSION 5 - 40 NOTES: Costs expected to be incurred in the achievement of sellout may include (but are not necessarily limited to) all remaining costs associated with completing construction or development. Additional sellout costs can include anticipated costs associated with marketing individual units or lots and maintaining the property during the absorption period—the cost of mortgage and equity capital expected to be incurred, plus a market-based level of entrepreneurial profit. Value as if completed: The hypothetical value of a property as if all proposed improvements, development, rehabilitation, modernization, remodeling or changes in use were accomplished on the appraisal date. Value upon completion: The prospective value of the expected physical and legal position of an identified parcel of real estate on the date when any development, rehabilitation, modernization, remodeling or change in use has been physically accomplished. This is a prospective value estimate predicated upon known or knowable data as well as the expectations of typically informed market participants as perceived on the date the appraisal is written. Value upon stabilized occupancy: The prospective market value of the expected physical and legal condition of an identified parcel of real estate on the date when any development, rehabilitation, modernization, remodeling, or change in use has been physically accomplished and the property has attained its expected level of longterm occupancy. It contemplates a value estimate of the total ownership rights to the expected physical and legal condition of an identified parcel of real estate. It reflects the highest and best use of the expected physical and legal condition of the identified property rights on the prospective date of the value estimate. It reflects the long-term economic feasibility of the identified property because it will physically and legally exist on the prospective date of the value estimate. CRC US Body of Knowledge It is a prospective value estimate predicated upon known or knowable data as well as the expectations of typically informed market participants as perceived on the date the appraisal is written. Wholesale value: A misnomer; see value to a single purchaser. DIMENSION 5 - 41 COST APPROACH NOTES: BASIC CONCEPT OF THE COST APPROACH The cost approach determines the value of the property based on its cost to complete, less depreciation. This approach is used any time there are improvements constructed on a piece of property. The only time this standard does not apply is when the appraiser determines that the improvements do not contribute any value to the property because of deterioration, deferred maintenance, obsolescence, or other factors. The appraiser executes three basic steps in completing the cost approach. Estimate the value of the land as if it was vacant. Determine the replacement or reproduction costs of the improvements, less any accrued depreciation. Sum the land value and the depreciated cost of the improvements to determine the value of the property. An example follows: Estimated land value if vacant $ 50,000 Estimated construction cost of a similar structure $160,000 Less estimated depreciation ($ 10,000) Equals estimated value of building $150,000 Appraised property value $200,000 To estimate the land value, the appraiser analyzes recent sales of vacant land similar to the property being appraised. Considerations for similarity include time of sale, zoning, size, location, topography, and access. Because two parcels of land are rarely exactly alike, the appraiser makes adjustments to the sales price of each comparable property to reconcile its value more closely to that of the subject property. To estimate the value of the improvements, the appraiser uses one of various construction cost-estimating guides to determine the reproduction costs of the type of property being analyzed. One of the most commonly used cost sources is the Marshall and Swift Valuation Service. The cost guides classify properties according to the quality of design and construction, such as fair, good, very good, and excellent. Dimension 5 // Evaluate Collateral Values and Conduct Periodic Inspections of Collateral THE PROCESS FOR THE COST APPROACH DIMENSION 5 - 42 NOTES: This analysis provides a value of the improvements as if they were new. To estimate depreciation, the appraiser states whether the property suffers from any of four types of depreciation: Curable physical deterioration, resulting from deferred maintenance, which can be repaired. Incurable deterioration that cannot be practically or economically corrected. Functional obsolescence or a loss in value stemming from the design of the building; may be caused by changes over time that make certain materials or a design obsolete. Economic obsolescence or the diminished utility of a structure because of outside influences, such as a declining neighborhood or depressed market conditions. To arrive at an overall value of the property under the cost approach, the appraiser simply sums the land value and the cost of reproducing the improvements, minus any depreciation. TIPS FOR REVIEWING THE COST APPROACH Review the land comparables to ensure that appropriate properties have been analyzed. Focus on the timing of the previous land sales. Real estate conditions can change rapidly, and a sale in excess of 12 months old may not reflect current market conditions. If the appraiser feels that market conditions have changed since the time of the sale, he or she should adjust the value accordingly. CRC US Body of Knowledge Assess reasonableness of all adjustments made by the appraiser in determining the value. Verify that the appraiser’s description of the quality of the improvements is properly reflected in the calculation of construction cost. DIMENSION 5 - 43 SALES COMPARISON APPROACH BASIC CONCEPT OF THE SALES COMPARISON APPROACH NOTES: In the sales comparison approach, also known as the market approach, the appraiser determines the value of the property based on the prices at which other comparable properties have changed hands. The appraiser executes five basic steps in completing the sales comparison approach. Search property sales records in a geographic area and extract an adequate number of properties similar to the subject that have recently been sold. Compare the subject property to those selected sales comparables (i.e., properties that possess similar characteristics). Determine an applicable unit of comparison to use in the analysis. Depending on the type of property, the unit of comparison may be the sales price per square foot of building area, the sales price per acre of land, the sales price per unit (for apartments and hotels), or a similar appropriate calculation. The appraiser may also extract the gross income multiplier (GIM) from the sale of income property. The GIM is calculated by dividing the annual gross income generated from the property by the sales price of the property. For example: a commercial property recently sold for $350,000 and the gross annual income is $50,000. The GIM would be 7 ($350,000 / $50,000 = 7). Compare each comparable to the subject and adjust each comparable sale (up or down) for various characteristics, including the time of the sale, size of the property, zoning, access, age, location, design, physical characteristics, and quality of construction. Based on this analysis of the comparable sales, determine the value of the appropriate unit of comparison and multiply the unit of comparison by the size of the subject property to determine the value in accordance with the sales comparison approach. Dimension 5 // Evaluate Collateral Values and Conduct Periodic Inspections of Collateral THE PROCESS FOR THE SALES COMPARISON APPROACH DIMENSION 5 - 44 NOTES: TIPS FOR REVIEWING THE SALES COMPARISON APPROACH Carefully review the description and location of each comparable property to determine if it is truly similar to the subject property. Focus on the timing of each comparable and verify that older transactions have been appropriately discounted in the weighting for that factor. Examine each comparable adjustment to see that they are reasonable, well-supported, and consistent. THE INCOME CAPITALIZATION APPROACH CONCEPT OF THE INCOME CAPITALIZATION APPROACH The income capitalization approach, or cash flow approach, is critical in the valuation of income-producing properties. This method determines the value of the property based on its cash flow generating ability, or earnings power. The income capitalization approach converts future income expectancies into a stabilized value estimate. An estimate of property cash flow is established, the quality of the cash flow stream is assessed, and an investor rate of return is applied to the cash flow stream to calculate the value of the property. CRC US Body of Knowledge In compiling the data required for this analysis, the due diligence procedures of independent confirmation apply. The appraiser will use actual lease documents on the subject and comparable properties as available, as well as data from other developers, investors, appraisers and real estate brokers. The data obtained will also be compared to the estimates of future property performance provided by the owner/ developer. DIMENSION 5 - 45 THE PROCESS FOR THE INCOME CAPITALIZATION APPROACH NOTES: The appraiser executes six basic steps in completing the income capitalization approach. Each step is discussed in greater detail following. 1. Determine the property square footage. 3. Deduct costs for vacancy and collection loss. 4. Deduct costs for operating expenses. 5. By subtotaling, calculate the property net operating income (NOI), or property cash flow. 6. Convert the net operating income (NOI) into a value estimate by applying a rate of return, or capitalization rate. 7. The income capitalization process and its relating calculations are demonstrated on the Income Property Cash Flow Worksheet using a sample property. We have also provided a blank Income Property Cash Flow Worksheet for your use. SQUARE FOOTAGE For an accurate calculation of property rent potential and comparison of the subject property with other buildings, the appraiser determines the property square footage in various terms: Gross square feet: The total amount of space in the property. This can include common areas, stairwells, elevator shafts, utility closets, corridors, lobbies, restrooms, and even loading docks. Rentable square feet: How much space can actually be leased and will generate rent? A tenant will typically not pay directly for the space occupied by common areas, restrooms, etc., but may be allocated proportionate responsibility for these amenities. Usable Square Feet: The amount of space the tenant will actually be able to productively use for their business. The correlation between these square footage measures allows the appraiser to determine the overall efficiency of the property, which factors into the determination of rental rates which the property can achieve. Dimension 5 // Evaluate Collateral Values and Conduct Periodic Inspections of Collateral 2. Analyze contract rents in place and/or estimation of market rent to determine appropriate rental rates for the property. Multiply this rental rate by the appropriate square footage measure to calculate property’s gross potential income (GPI). DIMENSION 5 - 46 NOTES: RENT ANALYSIS The appraiser researches rental rates of comparable properties. The rental rates are analyzed based on the characteristics of the property, such as location, design, access, overall quality and condition, age, and lease terms. The appraiser makes any adjustments to the rental rates of comparable properties deemed appropriate based on differences in these characteristics. Also, within the subject property different rent rates will be assigned based on the desirability of the space; a basement suite or an interior corner in a retail center would typically warrant a lower rental rate. Adjustments are made for these considerations as well. The total rents for the property are referred to as the gross potential income (GPI). They are expressed in annualized terms and reflect both the rents from existing leases and the potential rent for future leases on space, which is currently vacant. This allows the appraiser to determine a value for the property, and assumes it is no longer in a state of flux, i.e., in the midst of lease-up. This prospective condition or status is called stabilized occupancy. When analyzing rents, the appraiser will work to establish an effective rent for the property. An effective rent reflects the economic rent being paid for the space. Consideration and analysis of effective rents is necessary because the contract rent (the rent stated in the lease) is a function of tenant-landlord negotiation and, quite often, concessions. These concessions allow the tenant to pay less for the space in real economic terms. For example, the lease may include free rent for a period of time, or cover a tenant’s moving expenses. Omission of effective rent analysis can dramatically overstate GPI and wildly distort the property valuation. CRC US Body of Knowledge VACANCY ANALYSIS Logic says that there will always be some portion of the building that is not rented because it is between tenants, under renovation, or because of some other temporary reason. Additionally, rent collection may be an issue, particularly in multi-tenanted properties. The general convention is to express these factors as a percentage of total rentable square feet. In establishing a relevant vacancy rate for a property, the appraiser considers vacancy rates for properties similar to the subject property, and in the market overall while taking into account overall economic trends. The vacancy factor is applied to the property’s gross potential income (GPI) and then netted from the GPI to calculate the property’s effective gross income (EGI). DIMENSION 5 - 47 Operating expenses are expressed on an annual basis per square foot or in percentage terms. If a percentage is used, that percentage is applied to the EGI. These expenses include utilities, taxes, management fees, maintenance, marketing, insurance, and legal and accounting fees, etc. Note: these expenses are relatively fixed. They are the ongoing costs of property ownership. If the rents fall by 20%, the property operating expenses will not necessarily reduce by a like amount. Likewise if rents escalate, expenses may not follow suit. It is important to consider this directly in valuing and underwriting real property loans. Depending on how the lease is written, some operating expenses may be passed on to the tenant. In a gross lease, the building owner pays all expenses. Because of expense uncertainties, a gross lease will usually have a cushion built into the lease rate. A net lease passes some or all of the expenses on to the tenant. The most common type of net lease passes taxes, insurance, and maintenance expenses on to the tenants. This is typically called a triple net or NNN lease. The appraiser will carefully review the expense sharing arrangement in the subject and comparable leases to accurately measure the net expense burden to the property owner. RESERVE FOR REPLACEMENT EXPENSES This is a provision for normal wear and tear requirements of a property. It will cover such things as resurfacing the parking lot, replacing the roof, repairing the heating or air conditioning, and painting. In an apartment property it will include the cost of eventual replacement of dishwashers, refrigerators, carpets, and ranges. Note: the allocation of a reserve in the appraiser’s calculation does not guarantee that actual dollars are being set aside for these purposes. These expenses are expressed on an annual per square foot basis. NOTES: Dimension 5 // Evaluate Collateral Values and Conduct Periodic Inspections of Collateral OPERATING EXPENSES DIMENSION 5 - 48 NOTES: ROLLOVER EXPENSES This includes the cost of redecorating, renovation, and leasing agent commissions incurred when space is re-leased. These costs apply even if the space is re-leased to the existing tenant. These expenses are expressed on an annual per square foot basis. Rollover expenses can be very difficult to accurately quantify, particularly in a multi-tenanted property with irregular lease expirations. If this is the case, the appraiser will normally elect to complete the income capitalization approach using a discounted cash flow analysis. NET OPERATING INCOME Net operating income (NOI) is calculated by deducting the various property operating, reserve, and rollover expenses from the EGI as shown below on the Income Property Cash Flow Worksheet. NOI is an estimate of the property’s potential pretax, un-levered cash flow if leased in accordance with its own attributes and current market conditions. This is also referred to as the property’s stabilized NOI. In commercial banking terms this is conceptually the same as recurring EBITDA (earnings before interest, taxes, depreciation, and amortization). CAPITALIZING THE NOI CRC US Body of Knowledge The final step in determining the value in the income capitalization approach requires the application of a capitalization rate (cap rate) to the NOI. The cap rate is an estimated market driven rate of return which correlates to the risk profile of the property, among other things. The NOI is divided by the cap rate to calculate the value under the income capitalization approach. This is sometimes referred to as the value upon stabilized occupancy. DIMENSION 5 - 49 BLANK INCOME PROPERTY CASH FLOW WORKSHEET BUILDING TYPE ____________________________________________ Square feet __________________ x Revenues/square foot $__________________ GROSS POTENTIAL INCOME $_________________________ _____________________ %__________________ (______________________ ) EFFECTIVE GROSS INCOME $_________________________ _____________________ EXPENSES Operating expenses/square foot B $__________________ Reserve for replacement/square foot C __________________ Rollover expenses/square foot D __________________ Total expenses/square foot $__________________ x Total square feet NET OPERATING INCOME (N.O.I.) $ ( _____________________ ) _______________________ (Income available for debt service) VALUATION ESTIMATE Capitalization rate E Estimated value = N.O.I. ÷ Cap rate % _________________ $ A Average annual vacant space, expressed as a percent of total square feet. B Expenses such as utilities, taxes, management fees, maintenance, marketing, insurance, legal, and accounting, etc. Expressed on an annual basis. C Estimate of this year’s expense contribution toward future capital expenditures such as appliances, heating/cooling units, roof, and parking surfaces. D Expenses incurred to attract new or renewal tenants, such as redecorating, renovation, or reconfiguration of the space. E Blended rate that reflects market interest rates, risk levels for this property type, and the return investors want to see on instruments with similar risk characteristics. Dimension 5 // Evaluate Collateral Values and Conduct Periodic Inspections of Collateral Less: vacancy % A DIMENSION 5 - 50 INCOME PROPERTY CASH FLOW WORKSHEET SAMPLE FOR ACTION LEGAL CLINIC BUILDING TYPE Office ____________________________________________ Square feet 20,000 __________________ x Revenues/square foot $24.00 __________________ GROSS POTENTIAL INCOME ______________________ $480,000 $_ _______________________ Less: vacancy % A _________________ 15% 72,000 ) (______________________ EFFECTIVE GROSS INCOME ______________________ 408,000 $_ _______________________ EXPENSES Operating expenses/square foot B __________________ $6.00 Reserve for replacement/square foot C __________________.15 Rollover expenses/square foot D __________________.60 Total expenses/square foot __________________ $6.75 x Total square feet 135,000 ) ( _____________________ NET OPERATING INCOME (N.O.I.) _______________________ $273,000 (Income available for debt service) CRC US Body of Knowledge VALUATION ESTIMATE Capitalization rate E ________________ 10.5 % Estimated value = N.O.I. ÷ Cap rate $2,600,000 _______________________ DIMENSION 5 - 51 TIPS FOR REVIEWING THE INCOME CAPITALIZATION APPROACH NOTES: Carefully review the description and location of each comparable property to determine if it is truly comparable to the subject property. Examine all adjustment to see that they are reasonable, well supported, and consistent. The rents and vacancy rates selected by the appraiser should be well supported by market evidence and the existing or anticipated operating expenses of the building should be compared with those of similar properties and/or to general industry expense figures. Review the assumptions used in assigning the capitalization rate. If the appraiser has analyzed overall rates (OARs, the capitalization rates extracted from market transactions) from similar properties, the final capitalization rate should be in the same general range. If the appraiser feels that other factors (e.g., interest rate volatility, differences in risk levels due to location or owner-occupancy, etc.) will cause the capitalization rate to be out of line with the comparable’s OAR, these other factors should be discussed and supported. CAPITALIZATION RATES CONCEPT AND DYNAMICS OF CAPITALIZATION RATES The capitalization rate (cap rate) is the vehicle used to quantify the value of a property’s cash flows. It reflects the return investors want to see on instruments with similar risk characteristics, and represents a return on and of capital. It is a blended rate. Mathematically, the capitalization rate is: The rate at which a stream of periodic payments converts to a fixed amount of capital. It is expressed as a percentage and is intended to represent overall returns expected by investors from a particular property. When divided into a property NOI, the cap rate will provide a value estimate. Alternatively the cap rate can be determined (extrapolated) by dividing the cash flow stream of an asset (e.g., NOI) by its purchase price. Dimension 5 // Evaluate Collateral Values and Conduct Periodic Inspections of Collateral Focus on the timing of each comparable and verify that older transactions have been appropriately discounted in the weighting for that factor. DIMENSION 5 - 52 NOTES: Here’s a look at the basic concept using two simple examples. SCENARIO A You estimate a property, or any other investment, will generate $10M per year on a fairly reliable basis. The asset is being offered at a price of $100M. If you pay full price for this asset, you are implying that the risk profile of the asset (investment) should entitle you to a 10% return on the dollars you have invested. The 10% is the capitalization rate. SCENARIO B Alternatively, you determine that you are only willing to pay $83M for the same asset. This implies that you are requiring a higher rate of return on your invested dollars. This could be because you perceive the risk associated with the cash flow stream is higher, or because you have other attractive investment opportunities that make the 10% return offered by the seller look rather unappealing. Regardless of your rationale, if you were able to purchase this asset for $83M, your rate of return (capitalization rate) would be 12%. SCENARIO A CRC US Body of Knowledge Investment cash flow SCENARIO B $10M $10M Divided by purchase price $100M $83M Equal to capitalization rate 10% $12% DIMENSION 5 - 53 NOTES: As shown prior, the higher the capitalization rate, the lower the arithmetic value that is calculated, thus there is an inverse relationship between cap rates and value. This is because when market return expectations (and availability) increase, a static level of cash flow (and profit) will fall short of the new higher expectations, assuming in this case that rental rates are not indexed to interest rates. Thus, these static cash flows are worth comparatively less in the market. The theory is similar in concept to bond theory, in that bond prices fall when interest rates go up, and vice versa. A capitalization rate reflects a variety of influences, including: Risk perception associated with a specific type of property in a specific market. Current interest rate environment. Return that an investor would expect to receive on a financial instrument with the same risk level as the subject property. In using the income capitalization approach, the estimated value of a property is highly sensitive to even nominal changes in cap rates. Cap rate variations as small as 1/4% to 1/2% can have dramatic effects on property value as shown following. For this reason, the accuracy and validity of the cap rate is critical. Dimension 5 // Evaluate Collateral Values and Conduct Periodic Inspections of Collateral CAP RATE VALUE CAPITALIZATION RATE DYNAMICS