Shelby County Capitalization Rate Study Report

Transcription

1 2017 Shelby County Capitalization Rate Study Report Elmer Moore III, T.C.A #309, CR#3824 Shelby County Assessor of Property 5/4/2017

2 Table of Contents Table of Contents... 1 Introduction... 3 Capitalization Rates Summary of Conclusion Ranges... 5 Definitions... 7 Definition of the Problem Scope of Work (Methodology) Assumptions & Limiting Conditions Economic Overview (Shelby County) The Income Capitalization Approach to Value The Discount Rate The Recapture Rate The Effective Tax Rate Reserve for Replacement Allowance & Cap Rate Recalculation Formula US Treasury 10-Year Yield Curve & Cap Rate Spread US Treasury 10-Year Yield Curve Rates (Quarterly Averages) Year Yield Curve Rates as of December 30, % January 3, % Investment Class Descriptions MULTIFAMILY INDUSTRIAL RETAIL OFFICE HOTEL/MOTEL Reconciliation MULTIFAMILY INDUSTRIAL RETAIL OFFICE HOTEL/MOTEL Band of Investment (Discount Rate Development) Multifamily

3 Warehouse/Distribution Self-Storage Flex Warehouses Fast Food Single Tenant Retail Multi-Tenant Retail Office CBD Office Suburban Medical Offices Luxury/Full Service Hotels Limited/Select Service Hotels Certification References/Data Sources/Research

4 Introduction The Shelby County Assessor of Property, Cheyenne Johnson, is required by statute to appraise, classify, and assess all taxable property of the county of Shelby, according to the Constitution of Tennessee and the laws of the state. As of January 1, 2017, there were approximately 349,511 parcels in Shelby County. Of those 349,511 parcels, approximately 24,639 are classified as commercial or industrial. Appraisal is the act or process of developing an opinion of value. Appraisal involves selective, careful research of market areas, the accumulation of pertinent data, and the use of appropriate analytical techniques and methods, along with the application of knowledge, experience, and professional judgment to develop a germane solution to the appraisal problem. A well-supported opinion of property value is developed through the valuation process, with specific appraisal procedures that reflect three distinct methods of data analysis: Cost, Sales Comparison, and Income Capitalization. One or more of these approaches are used in all estimations of value, and general appraisal principles require that all three approaches be used whenever possible. However, certain approaches to value may be more meaningful than others with respect to a specific property type. The Cost Approach is used to produce an indication of property value by adding the estimated value of land to the current cost of reproducing or replacing the improvements (typically replacement cost is used) and subtracting the amount of depreciation in the improvements from all causes: physical deterioration, functional obsolescence, and economic (external) obsolescence. This approach is most useful in valuing new or nearly new improved properties, valuing special use properties, and valuing properties that are not frequently exchanged in the market. The Sales Comparison Approach is used to produce an indication of value by comparing the subject property with similar properties that have recently sold, called comparable sales, applying appropriate units of comparison, and making adjustments to the sale prices of the comparables based on the elements of comparison. This approach is most useful when a sufficient number of similar properties have been recently sold, or are currently for sale in the subject property s market. The Income Capitalization Approach is a set of procedures through which an indication of property value is produced by converting the anticipated benefits of the property, cash-flow and reversion, into present value. This conversion can be accomplished in two ways: 1) by direct capitalization, where one year s stabilized income expectancy is capitalized at a market 3

5 derived capitalization rate or at a capitalization rate that reflects a specified income pattern, return on investment, and change in value of the investment; or 2) by yield capitalization, also known as discounted cash flow, where annual cash flows for the holding period and the reversion is discounted at a specified yield rate to produce an indication of present value of the income stream plus reversion. In the view of market value, the income approach is most applicable to properties of an income producing nature. Commercial and industrial real property is frequently exchanged in the market place to be leased so that the investor may receive a return on and return of his/her investment. Investors who purchase income-producing real estate as an investment view earning power as the critical element affecting value. One basic investment premise holds that the higher the earnings, the higher the value, assuming that the amount of risk in the investment remains constant. An income rate expresses the relationship between property income and the corresponding property value. An overall capitalization rate is an income rate that reflects the relationship between a single year s net operating income and the total property value. It is used to convert net operating income into an indication of overall property value. This capitalization rate study is intended to assist in the selection of overall capitalization rates and other income rates to be used in valuing real property of an income-producing nature in Shelby County. Income-producing property can be broken down into five major categories: Multifamily, Industrial, Retail, Office, and Hospitality/Lodging. This study is slated to be an ongoing endeavor, incorporating other income factors in future reports. For this report, as of January 1, 2017, there were a total of 191 arm s length sales in Shelby County retained and analyzed. Of the sales used and analyzed, 55 were multifamily properties; 19 were industrial properties; 86 were retail properties; 22 were office properties; and 9 were hospitality properties. 77 of the sales analyzed were from Several surveys from third party sources were considered and researched as a part of this study, including RealtyRates.com; CB Richard Ellis (CBRE); Integra Realty Resources (IRR); Real Estate Research Corporation (RERC); Certified Commercial Investment Member Institute (CCIM); and PricewaterhouseCoopers (PwC). It has been a pleasure conducting this capitalization rate study, and it is my sincere hope that the data and conclusions in this survey will be used effectively in developing a credible, wellsupported opinion of market value for the commercial and industrial real properties in Shelby County. By: Elmer Moore, III, T.C.A. #309, TN CR-#3824 Deputy Administrator of Appraisal Operations Office of Cheyenne Johnson, Assessor of Property 4

6 Capitalization Rates Summary of Conclusion Ranges Multifamily A 5.05% % B 6.80% % C 7.35% % D 9.50% % Warehouse/Distribution A 6.95% % B 7.95% % C 9.10% % D 9.15% % Flex Warehouse A 7.70% % B 8.50% % C 8.85% % D 9.00% % Fast Food A 5.45% % B 6.35% % C 7.35% % D 9.55% % Single Tenant Retail A 4.80% % B 6.45% % C 8.20% % D 11.75% % Multi-Tenant Retail A 5.90% % B 7.75% % C 9.00% % D 11.50% % 5

7 Regional Malls A 7.00% % B 7.70% % C 8.80% % Office Buildings A 7.25% % B 8.25% % C 9.25% % D 11.50% % Medical Office Buildings A 7.25% % B 8.00% % C 9.50% % D 12.00% % Luxury/Full Service Hotels A 5.00% % B 6.85% % C 8.60% % Limited/Select Service Hotels A 5.80% % B 7.65% % C 9.40% % D 11.15% % Economy Motels B/C 8.85% % D 12.60% % 6

8 Definitions Capitalization o The conversion of expected income and rate of return into an estimate of value in the income approach; the conversion of income into value. Capitalization Rate o A composite rate used for converting a property s single year income into an indication of property value; any rate used to convert an estimate of income to an estimate of market value; also called a cap rate. Depreciation o Loss in value of an object relative to its replacement cost, reproduction cost, or original cost, whatever the cause for the loss in value. It is often divided into three categories; physical deterioration, functional obsolescence, and economic (external) obsolescence. Discount Rate o The rate of return on investment; the rate an investor requires to discount future income to its present worth. Economic Life o The period of time during which a given building or other improvement to property is expected to contribute positively to the value of the total property. This period is typically shorter than the period during which the improvement could be left on the property, that is, its physical life. Economic (External) Obsolescence o Loss in value of a property (relative to the cost of replacing it with a property of equal utility) that stems from factors external to the property; typically incurable. Effective Gross Income o Potential gross rent less vacancy and collection loss plus miscellaneous income. Effective Tax Rate o The tax rate expressed as a percentage of market value; this will be different from the nominal tax rate when the assessment ratio is not equal to Functional Obsolescence o Loss in value of a property resulting from changes in tastes, preferences, technical innovations, or market standards; may be curable or incurable. Hospitality o Relating to or denoting the business of housing or entertaining visitors; Hotel o A facility that offers lodging accommodations and a wide range of other services, such as restaurants, food and beverages, convention facilities, meeting rooms, recreational facilities, commercial shops; usually located in an urban area. 7

9 Industrial o Of or relating to industry, or related to companies engaged in industrial production or service. Industry o Systematic labor especially for some useful purpose or the creation of something of value; manufacturing activity as a whole; a distinct group of businesses that provide a particular product or service; the process of making products by machinery or factories; Interest Rate o A rate of return on capital; usually expressed as a nominal annual percentage of the amount loaned or invested; the premium paid for the use of money. Investment o Monies placed in a property, usually with the expectation of financial returns. Investment Value o The worth of an investment property to a particular investor. Investor o Any person who commits capital with the expectation of financial returns. Lodging o Pertaining to the lodging industry Mall o Also called a shopping mall, a large retail complex containing a variety of stores and often restaurants and other business establishments housed in a series of connected buildings, adjacent buildings, or in a single large building. Market o The place in which buyers and sellers interact. The collective body of buyers and sellers for a particular product; a gathering of people for buying and selling things. Motel o A building or groups of buildings located on or near a highway designed to serve the needs of travelers by offering lodging and parking; may also provide other amenities such as telephones, food and beverages, recreational areas, service stations and shops. Multifamily o A classification of housing where multiple separate units for residential inhabitants are contained within one building or several buildings within one complex. Net Operating Income o Annual net income, after operating expenses are subtracted from effective gross income, before deducting debt service and depreciation. Payments for principal and interest are not deducted as an expense to derive NOI. 8

10 Net Operating Income Ratio o The ratio between net operating income and effective gross income, as calculated by dividing the net operating income by the effective gross income. Office o A room, set of rooms, or building used as a place for commercial, professional, or bureaucratic work. Physical Deterioration o Loss in value caused by wear and tear; may be curable or incurable Potential Gross Income o The total income attributable to real property at full occupancy (100%), including miscellaneous income, before deduction for vacancy and operating expenses Recapture Rate o The annual rate at which capital investment is returned to an investor over a specified period of time; the annual amount, in addition to interest or return on interest, which can be recaptured from an investment, divided by the original amount invested. Retail o The sale of goods or commodities to the public, ultimate consumers, in relatively small quantities for use or consumption rather than for resale (opposed to wholesale); pertaining to, connected with, or engaged in sale at retail. Tax Rate o The percentage of assessed value at which each property is taxed in a given district; also called the nominal tax rate. 9

11 Definition of the Problem The Client The client of this 2017 Capitalization Study Report is Cheyenne Johnson, the Shelby County Assessor of Property. The Problem To develop rates and factors for use in the income approach to valuation for mass appraisal/reappraisal, for varying property types, sub-categories, and classes of commercial real property. The Intended Use(s) The intended use(s) of this capitalization rate & study report is as follows: The Intended User(s) o To assist the appraisal staff of the Shelby County Assessor of Property in determining capitalization rates for the mass appraisal modeling process for reappraisal by providing rates and income factors from market data, published surveys and sources, and calculations and methodologies consistent with the intrinsic nature of appraisal practice. o To assist the appraisal staff of the Shelby County Assessor of Property in defense of reappraisal values by providing rates and income factors from market data, published surveys and sources, and calculations and methodologies consistent with the intrinsic nature of appraisal practice. The intended users of this report are as follows: o The Shelby County Assessor of Property and Staff o The Shelby County Board of Equalization o The State Board of Equalization o The Assessment Appeals Commission o Third Parties authorized by any of the aforementioned intended users 10

12 Effective Date The effective date of this report is January 1, Type of Value The Uniform Standards of Professional Appraisal Practice defines Market Value as follows: o A type of value, stated as an opinion, that presumes the transfer of a property (i.e. a right of ownership or a bundle of such rights), as of a certain date, under specific conditions set forth in the definition of the term identified by the appraiser as applicable in an appraisal. Comment: Forming an opinion of market value is the purpose of many real property appraisal assignments, particularly when the client s intended use includes more than one intended user. The conditions included in market value definitions establish market perspectives for development of the opinion. These conditions may vary from definition to definition but generally fall into three categories: 1. the relationship, knowledge, and motivation of the parties (i.e., seller and buyer); 2. the terms of sale (e.g., cash, cash equivalent, or other terms); and 3. the conditions of sale (e.g., exposure in a competitive market for a reasonable time prior to sale). The Code of Federal Regulations defines Market Value as follows: o The most probable price which 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 and knowledgeably, and assuming the price is not affected by undue stimulus. Implicit in this definition is the consummation of a sale as of a specified date and the passing of title from seller to buyer under conditions whereby: 1) Buyer and seller are typically motivated; 2) Both parties are well informed or well advised, and acting in what they consider their own best interests; 3) A reasonable time is allowed for exposure in the open market; 4) Payment is made in terms of cash in U.S. dollars or in terms of financial arrangements comparable thereto; and 11

13 5) 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. Tenn. Code Ann (a) states: o The value of all property shall be ascertained from the evidence of its sound, intrinsic and immediate value, for purposes of sale between a willing seller and a willing buyer without consideration of speculative values According to the Tennessee State Board of Equalization: o A generally accepted definition of market value for ad valorem tax purposes is that it is the most probable price expressed in terms of money that a property would bring if exposed for sale in the open market in an arm s length transaction between a willing seller and a willing buyer, both of whom are knowledgeable concerning all the uses to which it is adapted and for which it is capable of being used. Accordingly, the type of value to be generated by the capitalization rates and income factors in this report is Market Value. Market value for this report is defined as follows: o The most probable price expressed in terms of money, which 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 and knowledgeably, and assuming the price is not affected by undue stimulus. Implicit in this definition is the consummation of a sale as of a specified date and the passing of title from seller to buyer under conditions whereby: 1) Buyer and seller are typically motivated; 2) Both parties are well informed or well advised, and acting in what they consider their own best interests; 3) A reasonable time is allowed for exposure in the open market; 4) Payment is made in terms of cash in U.S. dollars or in terms of financial arrangements comparable thereto; and 5) 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. 12

14 Interests to be Appraised The interest to be appraised using the rates developed in this study is the fee simple estate interest, as approximated by the sum of the leased fee estate interest and the leasehold estate interest, the leased fee estate interest, and the leasehold estate interest. A leased property, even one with rent that is consistent with market rent, is appraised as a leased fee interest, not as a fee simple interest. The value of the leased fee interest represents the owner s interest in the property. The benefits that accrue to an owner of a leased fee estate generally consist of income throughout the lease and the reversion at the end of the lease. If the rent and/or terms of the lease are favorable to the landlord (lessor), the value of the leased fee interest will usually be greater than the value of the fee simple interest, resulting in a negative leasehold interest value. If the rent and/or terms of the lease are favorable to the tenant (lessee), the value of the leased fee interest will usually be less than the value of the fee simple interest, resulting in a positive leasehold interest value. Negative or positive leasehold interest value will cease if contract rent and/or terms equal market rent and/or terms at any time during the lease, or when the lease expires. When the leasehold interest value is neither negative nor positive, the value of the leased fee interest approximates the market value of the fee simple interest. The valuation of a leased fee interest is best accomplished using the income capitalization approach. Leasehold interests are typically valued using the income capitalization approach. The income to the leasehold position is the difference between market rent and contract rent. 13

15 Scope of Work (Methodology) As defined by the Uniform Standards of Professional Appraisal Practice, Scope of Work is the type and extent of research and analyses in an appraisal or appraisal review assignment. ( USPAP DEFINITIONS) The Scope of Work Rule states: For each appraisal and appraisal review assignment, an appraiser must: 1. identify the problem to be solved; 2. determine and perform the scope of work necessary to develop credible assignment results; and 3. disclose the scope of work in the report. ( USPAP, SCOPE OF WORK RULE, pg. 14, Lines ) The Comment on the Scope of Work Rule states: Scope of work includes, but is not limited to: the extent to which the property is identified; the extent to which tangible property is inspected; the type and extent of data researched; and the type and extent of analyses applied to arrive at opinions or conclusions Appraisers have broad flexibility and significant responsibility in determining the appropriate scope of work for an appraisal or appraisal review assignment. Credible assignment results require support by relevant evidence and logic. The credibility of assignment results is always measured in the context of the intended use. ( USPAP, SCOPE OF WORK RULE, pg. 14, Lines ) 14

16 The intended use of this report is: To assist the appraisal staff of the Shelby County Assessor of Property in determining capitalization rates for the mass appraisal modeling process for reappraisal by providing rates and income factors from market data, published surveys and sources, and calculations and methodologies consistent with the intrinsic nature of appraisal practice. To assist the appraisal staff of the Shelby County Assessor of Property in defense of reappraisal values by providing rates and income factors from market data, published surveys and sources, and calculations and methodologies consistent with the intrinsic nature of appraisal practice. In the context of the aforementioned intended use, the Scope of Work for this report is as follows: Tier 1 Cap Rate Surveys Research capitalization rate data for varying types and classes of commercial real property from surveys published by the following providers: o RealtyRates.com o CB Richard Ellis (CBRE) o Integra Realty Resources (IRR) o Real Estate Research Corporation (RERC) o Certified Commercial Investment Member Institute (CCIM) o PricewaterhouseCoopers (PwC) o The Boulder Group Develop descriptions of varying commercial property categories and classes. Correlate varying commercial property types and classes among the published surveys that were researched. Analyze Cap Rate Trends by Quarter and Year. Analyze third party survey data spreads relative to the 10 year US Treasury yield curve rate. 15

17 Tier 2 Sales Comparison Research Chandler and CoStar s sales database for arm s length sale transactions with capitalization rates known, provided, reported or calculated. Determine the property class of each sale, based primarily on effective age and remaining economic life. Analyze the capitalization rate of each sale. Analyze the Net Operating Income (NOI) of each sale. Analyze Cap Rate Trends by Quarter and Year. Analyze 10-year U.S. Treasury yield curve rate trend. Correlate the average cap rates for each property type and class with surveyed rates for each property type and class. Analyze cap rates by submarket and municipality. Analyze the Range of the Overall Cap Rate Spread Above the 10-yr US Treasury Rate. Tier 3 Band of Investment Analyze third party survey data of investor financial rates. Analyze lending institutions mortgage rates for each property type. Analyze loan to value ratios for each property type. Analyze equity dividend rates for each property type. Analyze amortization terms for each property type. Develop land capitalization rates (R L ), known as discount rates, for each property type by using the Band of Investment Method. 16

18 Assumptions & Limiting Conditions Sales data and cap rates taken from CoStar are presumed to be accurate. In cases where there is a discrepancy in the CoStar data, the appraiser contacted CoStar support for data clarification. The sales analyzed in this study are not an exhaustive set of all the sales in Shelby County. Only sales with reported or known cap rate data and/or income data were used in the analysis of this study. Some cap rates used in the study are taken from data found in private fee appraisals. In cases where there is a difference between the private appraisal data and CoStar s data, the private appraiser s data is given preference, since commercial real property appraisers are held to a higher standard of professional practice and ethics. Actual Cap Rates are presumed to be unloaded; that is, NOI is assumed to be calculated including real estate taxes as an expense, when applicable. Therefore, the effective tax rate must be added to the overall rate when developing the income approach for a property where taxes are an expense to the owner. For Industrial, Office, and Retail properties, it is an industry standard that capitalization rates are reported exclusive of reserve allowance as an expense in the calculation of 17

19 NOI. Cap rates from surveys and sales are presumed to be reported exclusive of reserves for these property types For Multi-Family and Hospitality properties, it is an industry standard that capitalization rates are reported inclusive of reserve allowance as an expense in the calculation of NOI. Cap rates from surveys and sales are presumed to be reported inclusive of reserves for these property types Physical property characteristics data is taken from the Shelby County Assessor of Property s Integrated Assessment System (IAS) used for Computer Assisted Mass Appraisal (CAMA). This data is initially assumed to be correct, unless obvious errors were noticed, in which case corrections were made on an as needed basis. Third party survey data is presumed to be reasonably accurate for the purposes of the analyses performed in this study. 18

20 Economic Overview (Shelby County) Community Profile Shelby County, TN Prepared by Esri Shelby County, TN (47157) Geography: County Population Summary 2010 Total Population 927, Total Population 945, Group Quarters 18, Total Population 969, Annual Rate 0.49% Household Summary 2010 Households 350, Average Household Size Households 358, Average Household Size Households 367, Average Household Size Annual Rate 0.51% 2010 Families 231, Average Family Size Families 234, Average Family Size Families 238, Average Family Size Annual Rate 0.40% Housing Unit Summary 2010 Housing Units 398,274 Owner Occupied Housing Units 53.2% Renter Occupied Housing Units 34.9% Vacant Housing Units 11.9% 2015 Housing Units 408,579 Owner Occupied Housing Units 49.2% Renter Occupied Housing Units 38.5% Vacant Housing Units 12.3% 2020 Housing Units 417,652 Owner Occupied Housing Units 49.3% Renter Occupied Housing Units 38.6% Vacant Housing Units 12.0% Median Household Income 2015 $48, $54,673 Median Home Value 2015 $188, $218,519 Per Capita Income 2015 $26, $30,353 Median Age

21 Data Note: Household population includes persons not residing in group quarters. Average Household Size is the household population divided by total households. Persons in families include the householder and persons related to the householder by birth, marriage, or adoption. Per Capita Income represents the income received by all persons aged 15 years and over divided by the total population. Source: U.S. Census Bureau, Census 2010 Summary File 1. Esri forecasts for 2015 and Esri converted Census 2000 data into 2010 geography Households by Income Household Income Base 358,168 <$15, % $15,000 - $24, % $25,000 - $34, % $35,000 - $49, % $50,000 - $74, % $75,000 - $99, % $100,000 - $149, % $150,000 - $199, % $200, % Average Household Income $70, Owner Occupied Housing Units by Value Total 200,938 <$50, % $50,000 - $99, % $100,000 - $149, % $150,000 - $199, % $200,000 - $249, % $250,000 - $299, % $300,000 - $399, % $400,000 - $499, % $500,000 - $749, % $750,000 - $999, % $1,000, % Average Home Value $255, Population by Age Total 945, % % % % % % % % % % % % 2015 Population by Sex Males 452,576 Females 493,181 20

22 Source: U.S. Census Bureau, Census 2010 Summary File 1. Esri forecasts for 2015 and Esri converted Census 2000 data into 2010 geography Population by Race/Ethnicity Total 945,757 White Alone 38.7% Black Alone 53.2% American Indian Alone 0.2% Asian Alone 2.5% Pacific Islander Alone 0.0% Some Other Race Alone 3.6% Two or More Races 1.7% Hispanic Origin 6.2% Diversity Index Population 25+ by Educational Attainment Total 615,045 Less than 9th Grade 4.0% 9th - 12th Grade, No Diploma 8.3% High School Graduate 22.6% GED/Alternative Credential 3.9% Some College, No Degree 23.8% Associate Degree 6.6% Bachelor's Degree 18.5% Graduate/Professional Degree 12.1% 2015 Population 15+ by Marital Status Total 751,687 Never Married 40.6% Married 41.9% Widowed 5.9% Divorced 11.6% 2015 Civilian Population 16+ in Labor Force Civilian Employed 91.2% Civilian Unemployed 8.8% 2015 Employed Population 16+ by Industry Total 403,193 Agriculture/Mining 0.4% Construction 4.9% Manufacturing 8.4% Wholesale Trade 3.0% Retail Trade 11.1% Transportation/Utilities 11.3% Information 1.3% Finance/Insurance/Real Estate 5.8% Services 48.6% Public Administration 5.2% 2015 Employed Population 16+ by Occupation Total 403,193 White Collar 61.6% Management/Business/Financial 14.3% Professional 20.8% Sales 11.5% 21

23 Administrative Support 15.0% Services 17.7% Blue Collar 20.7% Farming/Forestry/Fishing 0.2% Construction/Extraction 3.8% Installation/Maintenance/Repair 2.9% Production 4.7% Transportation/Material Moving 9.2% Source: U.S. Census Bureau, Census 2010 Summary File 1. Esri forecasts for 2015 and Esri converted Census 2000 data into 2010 geography. EMPLOYMENT BY INDUSTRY Memphis Metro Area 2015 Manufacturing 7% Mining, Logging, and Construction Other Services 4% Government 13% 4% Retail Trade 11% Leisure and Hospitality 10% Wholesale Trade 6% Education and Health Services 14% Professional & Business Services 15% Information 1% Financial Activities 4% Transportation & Utilities 11% 22

24 9,300 Net New Jobs in 2015 INDUSTRY SECTOR % Change Manufacturing 45,200 44, % Mining, Logging, and Construction 21,700 21, % Retail Trade 65,900 65, % Wholesale Trade 34,800 33, % Transportation & Utilities 67,800 65, % Information 5,800 6, % Financial Activities 27,600 27, % Professional & Business Services 97,000 93, % Education and Health Services 89,800 89, % Leisure and Hospitality 65,300 63, % Other Services 24,300 24, % Government 82,700 80, % Total Non-Farm Employment: 625, , % Source: U.S. Bureau of Labor Statistics Prepared By: Greater Memphis Chamber & Memphis Light, Gas & Water NOTE: Numbers may not add due to rounding or match previously released data due to adjustments by the BLS. Updated 03/24/2016 ayg 23

25 The Income Capitalization Approach to Value The income approach, also called the income capitalization approach, is one of the three approaches to value. In this approach, the value of an income-producing property is estimated by converting anticipated future benefits (income or rent). The capitalization process restates market value by converting the future benefits into an expression of present worth. The buyer of a single family residence purchases the property in order to enjoy the benefits the property will afford to the buyer in the future. Likewise, the buyer of an investment pays the price in order to receive future benefits; the annual income stream generated by rents. Income-producing real estate is typically purchased as an investment, and, from an investor s point of view, earning power is the critical element affecting property value. One basic investment premise holds that the higher the earnings, the higher the value, provided the amount of risk remains constant. An investor who purchases income-producing real estate is essentially trading present dollars for the expectation of receiving future dollars. The income capitalization approach to value consists of methods, techniques, and mathematical procedures that an appraiser uses to analyze a property s capacity to generate benefits (i.e., usually monetary benefits of income and reversion) and convert these benefits into an indication of present value. The analysis of cost and sales data is an integral part of the income approach, and capitalization techniques can be employed in the cost and sales comparison approaches to value. Capitalization techniques can be used to analyze and adjust sales data in the sale comparison approach, and in the cost approach, obsolescence is often measured by capitalizing an estimated loss in income. As in the case of the cost and sales comparison approaches to value, the principle of substitution applies: A buyer will not pay more than the amount required to obtain a substitute property providing a similar return on the investment. Anticipation is fundamental to the income capitalization approach. All income capitalization methods, techniques, and procedures attempt to consider anticipated future benefits and estimate their present value. However, the capitalization process must reflect the possibility that the actual future income, expenses, and property value may differ from those originally anticipated by an investor on the date of appraisal. The more uncertainty there is concerning the future levels of these variables, the riskier the investment. Investors expect to earn a higher rate of return on investments that are riskier. This should be reflected in the support for the discount rates, capitalization rates, and income factors obtained from market research. 24

26 Market Value versus Investment Value An important distinction exists between market value and investment value. Investment value is the value of a certain property use to a particular investor. Investment value may coincide with market value, if the particular investor s investment criteria are typical of investors in the market. In this case, the two opinions of value may be the same number, but the two types of value and their concepts are not interchangeable. Market value is objective, impersonal, and detached; investment value is based on subjective, personal parameters. To develop an opinion of market value using the income capitalization approach, the appraiser must be certain that all the data and forecasts used are market-oriented and reflects the motivations of a typical investor who would be willing to purchase the property at the time of the appraisal. The Basic Steps in the Income Capitalization Approach 1. Estimate potential gross income (PGI). 2. Deduct for vacancy and collection loss. 3. Add miscellaneous income to determine the effective gross income (EGI). 4. Determine operating expenses. 5. Deduct operating expenses from the effective gross income (EGI) to determine net operating income (NOI) before discount, recapture, and taxes. 6. Select the proper capitalization rate. 7. Determine the appropriate capitalization procedure to be used (direct capitalization or yield capitalization). 8. Capitalize the net operating income (NOI) into an estimated property value. *Although there is a relationship between direct capitalization and yield capitalization techniques, the rates developed in this study are intended to be used in methods of direct capitalization. 25

27 Potential Gross Income o The first step in the income approach to value is to estimate the potential gross income for the property in question. Potential gross income is annual economic rent for the property at 100% occupancy before operating expenses are deducted. Economic rent is the annual rent that is justified for the property on the basis of a careful study of comparable properties in the area. In other words, economic rent is market rent and actually includes income from all sources that may be attributable to the real estate. o There are various types of rent applicable to income-producing real estate, such as contract rent, which is the rent required to be paid under the terms of the lease. When contract rent is lower than market rent, it is known as deficit rent. Excess rent occurs when contract rent exceeds market rent. Economic, market rent is sought in the income approach because it is the rent justified for the property on the basis of comparable rental properties in the area. Logically, market rent should lead to an indication of market value, whereas deficit or excess rent could lead to an indication of investment value. o The rent that a property will command in the open market depends on many different factors. Therefore, the circumstances surrounding comparables used as a basis for establishing economic rent for the subject property must be examined in the income approach to value. Vacancy Loss o Because it is highly unlikely that a property will remain fully rented for the entire period of its life, a deduction from potential gross income should be made for the vacancy that is expected to occur. The vacancy factor for any particular property must be determined by a study of other comparable properties and an analysis of their rental histories, as well as the recent history of vacancies in the subject property. Collection Loss o Collection loss is simply the loss that results from the failure of the tenant to pay the rent. Two major factors to consider in collection loss are the comparison with comparable properties and the tenants in the subject property. 26

28 Miscellaneous Income o After vacancy and collection loss is subtracted from the potential gross income, any miscellaneous income generated from the operations of the property must be added. Miscellaneous income may come from several sources other than actual rent, including parking, resale of utilities (gas, water, electricity, etc.), coinoperated laundry, clubroom rent, etc. Miscellaneous income is nonscheduled income and is often referred to as service income. Effective Gross Income o Effective gross income (EGI) is the anticipated income from all operations of the real property adjusted for vacancy and collection losses. This adjustment covers losses incurred due to unoccupied space, turnover, and nonpayment of rent by tenants. Operating Expenses o After the effective gross income for the property has been estimated, the operating expenses must be analyzed. An analysis of an owner s operating statement is essential in determining proper and improper expenses related to the operation of the subject property. o All of the income and expenses shown by an accountant on an operating statement prepared for income tax purposes cannot be used in the income approach to value without careful analysis. The economic rent may not coincide with the stated income. Also, only the reasonable and typical expenses necessary to support and maintain the income-producing capability of the property should be allowed. o The value derived by the income approach assumes that the expenses projected will occur every year. Because of this inherent assumption, determining what expenses are allowable and at what level they occur is a critical step. The following considerations should be used in analyzing expense items: Does the expense amount appear to be typical for the property in question, and is the amount substantiated by expense statements of comparable properties? Do the expenses tend to appear infrequently? Do the expenses appear to indicate typical management? 27

29 Do the expenses indicate a specific weakness of the property in question (physical deterioration, functional obsolescence, or external obsolescence)? Are the various reported expenses consistent as they relate to each other (maintenance, age, and reserves for replacement)? Does the expense appear to be stated more than once using different terminology? I.e. bad debt expense, which is collection loss. Or employee salaries, which may also include cleaning contracts or maintenance contracts. Is the ratio of expenses to effective gross income comparable to those for competitive properties? *In determining proper and improper expenses for a property, current expenses must be compared with past years expenses and expenses shown on statements of comparable properties. o Proper Expenses The following categories are proper expenses related to the operation of a property: Management Salaries Utilities Supplies and materials Repairs and maintenance Property taxes Insurance Miscellaneous Reserves for replacement Management is a proper expense for every income producing property regardless of whether it is owner or tenant occupied and whether or not an actual management fee is paid. Management is typically stated as a percentage of effective gross income and varies depending on location and property type. Included in the management charges may be accounting expenses, rent collections, advertising, lease commissions, and coordination between management and owners relating to all matters, including financial and personal management of the property. These may entail a fee paid to a professional management firm, not to be 28

30 confused with the salary of an on-site building manager, whose salary might be included in the expense category salaries. Salaries consist of the salaries and fringe benefits for employees necessary to maintain the property and to provide the operational activities required to keep the property rented. Such employees would include resident and on-site managers, maintenance people, gardeners, elevator operators, security people, and other employees needed to keep the property physically, functionally, and economically competitive. Utilities include gas, water, electricity, sewer charge, fuel, telephone, and trash removal. Because utilities fluctuate from time to time, a careful review of expenses of comparable properties must be made in order to determine reasonable and typical utility expenses. Supplies and materials are expendable items used in the day-to-day operation of the property, such as office supplies, light bulbs, grass seed, fuses, fertilizer, etc. Repairs and maintenance includes expenses necessary to keep the property operating and covers the repair of such items as the roof, water heaters, cooling systems, broken glass, painting, etc. This category should not be confused with reserves for replacement, which are anticipated, predetermined expenses, with an annual charge set up for replacement. Repairs and maintenance are normal maintenance expenses generated by the physical use of the property. Although property taxes may be generally considered an expense item in the income approach, in appraising for assessment purposes, the preferred way of handling this item is to use an effective tax rate as part of the capitalization rate. (See The Effective Tax Rate section of this report for more details) Insurance is a proper expense item that should be checked to ensure the insurance coverage is adequate and the expense charge is only for one year. Many insurance premiums cover more than one year; in such cases, annual proration is necessary. For example, if the premium covers three years, then only 1/3 of the premium should be used as an expense for one year, in direct capitalization. 29

31 Miscellaneous expense items should be small expenses that do not justify listing and amount to only a small percentage of the effective gross income. These items can vary widely from property to property, but should be examined closely in detail, whenever the miscellaneous expense is substantial. Reserves for replacement items are similar to items that are depreciated in the cost approach as short-lived items. Parts of a building that normally must be replaced before the building reaches the end of its economic life should have an annual expense charge as a reserve for replacement. For certain property types, such as apartments and hotels/motels, reserves are typically included as an expense item above the NOI line. However, for other property types, such as office, retail, and industrial, reserves are not typically included as an expense prior to estimating NOI. For property types where reserves are not typically included as an expense item, see the section of this report titled Reserve for Replacement Allowance (Reserves) & Cap Rate Recalculation Formula. o Improper Expenses Because the income approach relies on an accurate estimate of the net operating income the property will produce, and the capitalization rate must match the income, it is important to estimate accurately all expenses to be deducted from the effective gross income. There are often several items found in an owner s operating expense statement that are not proper expense charges in the income approach. The following categories are improper expenses and should not be used as an expense item in the income capitalization approach: Depreciation Debt Service Income Taxes Capital Improvements Owner s Business or Personal Expenses Bad Debt Expense Depreciation will be considered in the income approach as recapture and handled as part of the capitalization rate, therefore it is an improper charge to deduct from the effective gross income. Depreciation is usually included in the operating statements for income tax purposes and will 30

32 not necessarily be the same as the recapture provision in the capitalization rate. Debt service normally includes both the interest and the principal payments required to amortize the loan on the property. This item is considered in the capitalization rate as part of the discount rate and recapture rate component. Income tax shown on the owner s operating statement is not an allowable expense in the income approach, because the tax is based on the individual; personal income of the owner and not the property value. Different owners may be in different tax brackets, but the appraisal is based on the market value of the property. Capital improvements include additions to the property that may be made at any time and are not necessary to maintain the level of income at any given time. Capital improvements ordinarily result in an increase in the total value of the property, an increase in the economic life of the property, an increase in the income of the property, or all three. Therefore, these expenditures are not considered annual charges and should not be deducted from the effective gross income. The owner s business expenses that are not necessary for maintaining the property are not proper expenses. Even though this type of expense may be permitted for income tax reporting, it is considered personal expense and not related to the income produced by rental property. Bad debt expense is the amount of an account receivable that is considered to not be collectible, as a result of a customer being unable to fulfill its obligation to pay an outstanding debt. This expense occurs because an entity extends credit to customers. By electing to forgo upfront payment, the company incurs the risk of customers having the inability to pay for goods and services. The amount of this expense reflects the credit choices made by a business when extending credit to customers. Therefore, bad debt expense is used as a financial metric to determine if the credit and collection process is efficient. This expense is the cost of a business having the inability to collect its debts and the correlative impact of this expense should be realized, once revenue received from sales is realized. The amount of bad debt charged to expense is derived by one of two methods: 31

33 Direct write off When it becomes apparent that a specific customer invoice will not be paid, the amount of the invoice is charged directly to bad debt expense. The expense is directly linked to a specific invoice. Allowance method When sales are recorded, a related amount of bad debt expense is also recorded, on the theory that the approximate amount of bad debt can be determined based on historical outcomes. Direct Capitalization o Direct capitalization is a method used in the income capitalization approach to convert a single year s income expectancy into a value indication. This conversion is accomplished in one step, either by dividing the income estimate by an appropriate income rate or by multiplying the income estimate by an appropriate income factor. o The advantages of direct capitalization are: It is simple to use. It is easy to explain. It expresses market thinking. It provides strong market evidence of value when adequate sales are available. o Direct capitalization is a capitalization technique that employs capitalization rates and multipliers from sales. It is distinct from yield capitalization because direct capitalization does not directly consider the individual cash flows beyond the first year. Yield and value change are implied but not identified explicitly. o The Basic Formulas for Direct Capitalization are: 1. Value = NOI / Cap Rate 2. Value = EGI x Multiplier (EGIM) 3. Cap Rate = NOI / Value (Sale Price) 4. EGIM = Value (Sale Price) / EGI 32

34 5. NOI = Value (Sale Price) x Cap Rate 6. EGI = Value (Sale Price) / EGIM 7. NOI Ratio = NOI / EGI 8. Cap Rate = NOI Ratio / EGIM 9. EGIM = NOI Ratio / Cap Rate 10. NOI Ratio = Cap Rate x EGIM The following table illustrates some of the various income streams and their rates and factors for direct capitalization: Income Stream Potential Gross Income Effective Gross Income Income Rate/Factor Potential Gross Income Multiplier (PGIM) Effective Gross Income Multiplier (EGIM) Net Operating Income Overall Capitalization Rate (R O ) Land Income Land Capitalization Rate (R L ) Building Income Building Capitalization Rate (R B ) The Overall Capitalization Rate o The overall capitalization rate shows the direct relationship between annual net operating income and sale price or value. It includes the proper provision of discount and recapture. An overall capitalization rate can be estimated with various techniques; the technique used depends on the quantity and quality of data available. o When supported by appropriate market data, accepted techniques include the following: Derivation from comparable sales 33

35 Band of Investment Mortgage and Equity components Derivation from effective gross income multipliers and net income ratios Band of Investment Land and Building components The debt coverage ratio formula General yield and change formula Ellwood method o For this study, overall capitalization rates were developed using the first method; derivation from comparable sales, along with data taken from third party surveys, presumed to be derived from comparable sales data. o The three components of the overall capitalization rate are The Discount Rate Component The Recapture Rate Component The Effective Tax Rate Component o For this study, discount rates, known as land capitalization rates (R L ) were developed using the Band of Investment method. 34

36 The Discount Rate The Discount Rate is the first component of the total capitalization rate and it is the rate of return on a real estate investment. The discount rate reflects the compensation necessary to attract investors to give up liquidity, defer consumption, and assume the risks of investing. It is the rate of return required on total property investment to meet investment requirements. The discount rate is the weighted average of the mortgage interest rate and the equity interest rate, weighted by the proportions of total investment represented by mortgage(s) and equity, and is often called the property s interest rate. The term discount rate describes any rate used to convert future cash flows over time into a present value. Because investors expect their total return to exceed the amount invested, the present value of a prospective benefit is less than the expected future worth of that benefit; thus the discount. A yield rate, a specific type of discount rate, is the rate of return on capital. It considers all expected property benefits, including a reversion. Investors consider risk, return, management, liquidity, and other factors in deciding what an acceptable discount rate is. Considering these factors, discount rate estimation can be accomplished through the summation method of analyzing the discount requirements for real estate investments. The following factors are considered in this kind of analysis and are the components of the discount rate: The Safe Rate o The safe rate is the rate obtainable with the most safety and the least risk; in the summation method, it should be taken from investments having the least risk. It is the prevailing rate paid on United States Government guaranteed securities or rates paid by banks on insured savings accounts. The Risk Rate o The risk rate is the return commensurate with the risk assumed by the investor; it is a component of the discount rate because the return on real estate is a desired return and may or may not be realized by the investor. Also, the property may depreciate, resulting in a loss when the property is sold. The possibility of not receiving or losing future benefits reduces value and creates risk. Higher rewards are required in return for accepting higher risk. Most 35

37 investors try to avoid excessive risk; they prefer certainty to uncertainty and expect a reward for taking a risk. The Rate for Illiquidity o The rate for illiquidity is necessary, because an investment in real estate ties up money that cannot be quickly reconverted to cash. Therefore, real estate is considered an illiquid asset. Rate for Management o The rate for management is a necessary component in order to compensate for the time and cost involved in managing the real estate investment. 36

38 The Recapture Rate The Rate for Recapture is the second component of the total capitalization rate and it is the provision for returning to the investor a sum of money equal to the improvement value at the end of a given period of time. The investor is entitled to recover only the portion of the investment in the building during its economic life, because the land is a non-wasting asset and will have residual value at the end of the building life. There are four ways that the recapture rate for real property may be estimated: The Economic Life Method (Straight-Line) Recapture may be calculated by using the economic life method, also known as straightline recapture. The economic life method requires that a decision be made as to the number of years the building will continue to produce income and, in effect, add value to the land. This decision is influenced by the actions of investors and lenders, which will determine how long investors are willing to allow their capital to be tied up in a particular project and how long lenders are willing to make mortgage commitments for the properties in question. Straight-line recapture assumes a declining income stream that provides an equal amount of recapture for each year of the property s economic life. Straight-line recapture is appropriate if the tenant is financially ranked average or weak, the lease is month-to-month or short term, and the income stream is likely to decline steadily over the remaining economic life of the improvement. Using the straight-line, economic life method, the recapture rate is calculated by taking the remaining economic life and dividing it into 1 (1/REL). Interpolation from Depreciation Tables Many general depreciation tables, such as those found in Marshall Valuation Service, are developed from actual case studies of sales, where land value estimates are deducted from confirmed sale prices to obtain a residual building value. This residual building value is then subtracted from the replacement cost new of the structure(s) to give an indicated dollar amount of market depreciation. Market depreciation is shown as a percentage by dividing the market depreciation by the replacement cost new. The recapture rate can be estimated from the depreciation table by the following method: o Subtract the depreciation percentage in the depreciation table from 1 to determine the % good. o Divide 1 by the total economic life of the improvement. o Divide the result by the % good. o Example: If TEL = 55, Effective Age = 13, and Depreciation Percent = 6% 37

39 = 0.94 (percent good) 1 / 55 = / 0.94 = (Recapture rate) Sinking Fund Factor (Annuity Recapture) Recapture at the investment earnings (discount rate) is called the annuity or Inwood method. The recapture rate component of the capitalization rate is the sinking fund factor at the same discount rate as the investment. A portion of the income stream represents earnings, a return on investment. The balance of the income stream represents recapture, a return of investment. Annuity recapture assumes that the investor discounts or values all income equally, rather than arbitrarily distinguishing between income attributable to return on and return of investment and discounting them at different rates. The annuity recapture method is appropriate if the property is in a stable or prime location, the improvements are modern and appropriate, the property is leased at market rent, and the tenant is financially sound. Market Comparison Method The market comparison method is based on the use of the IRV formula. If the recapture income can be isolated from the NOI, then the recapture rate can be developed by using the IRV formula relationship. To isolate the recapture income, the discount rate and building value must be known. The discount rate is multiplied by the sale price to determine the income earned on the investment, necessary to satisfy the discount rate. This income is then deducted from the NOI to determine the income attributable to recapture. The recapture income is then divided by the building value to determine the recapture rate. See example: o NOI = $76,000, Sale price = $850,000, Discount rate = 7%, Land value = $200, x $850,000 = $59,500 income earned on investment $850,000 - $200,000 = $650,000 Building value $76,000 - $59,500 = $16,500 Recapture income $16,500 / $650,000 = Recapture rate In using the direct capitalization method, overall rates developed from improved properties include recapture. The land-to-improvement ratio, or improvement value ratio, known also as the building value ratio, of a property has a weighing effect on the overall rate. Although two properties may have the same sale price, the ratio of land-to-improvement value will affect the overall rate for the property, even when the discount (interest) rate and the rate of recapture are the same. Therefore, overall rates for improved properties must be selected from properties having comparable land-to-improvement ratios (improvement value ratios). As the ratio of improvement value increases, more net operating income is necessary to satisfy the additional recapture requirement. 38

40 The remaining economic life of the improvements must be comparable between sale properties and the subject property. As the remaining building life decreases, the recapture rate increases. If the improvement value ratio remains constant, this decrease in remaining economic life will effectively increase the overall capitalization rate. A shorter recapture period requires a higher annual recapture percentage. However, as the remaining building life increases, the recapture rate decreases. If the improvement value ratio remains constant, this increase in remaining economic life will effective decrease the overall capitalization rate. The remaining economic life and resulting recapture rate causes a weighting of the overall rate based on the land-toimprovement value ratio. The weighting results in a higher overall rate as the ratio of improvement value to land value increases. Effect of Land-to Improvement Ratio on Overall Rate: Sale A Sale B Sale Price $800,000 $800,000 Building Value $400,000 $600,000 Land Value $400,000 $200,000 Discount Rate 10% 10% Recapture Rate (20 yrs) 5% 5% Discount Land and Building $80,000 $80,000 Recapture Dollars $20,000 $30,000 Net Income Required $100,000 $110,000 Overall Rate 12.50% 13.75% Effect of Change in Recapture Rate on Overall Rate: (Building Value 80%, Land Value 20%) Estimated Remaining Economic Life (years) Annual Recapture 4.0% 3.3% 2.5% 2.0% Discount Rate 9.0% 9.0% 9.0% 9.0% Building Capitalization Rate 13.0% 12.3% 11.5% 11.0% Building Component of Overall Rate 10.4% 9.84% 9.20% 8.80% Land Component of Overall Rate (20% of total value at 9% discount rate) 1.8% 1.8% 1.8% 1.8% Overall Capitalization Rate 12.2% 11.64% 11.0% 10.6% 39

41 The Effective Tax Rate Property tax is an ad valorem tax, which means that a tax levy is apportioned among taxpayers according to the value of each taxpayer s property. The property tax is the primary means by which local government pays for the services it provides, such as police and fire protection, schools, roads, parks, libraries, and the court system. Before the amount of property tax for each property can be determined, it is necessary to know the amount of money to be spent by local government for one year (the budget) and the total assessed value for the assessment roll. The budget is the sum of the funds required by each taxing jurisdiction. The total assessed value is provided by the assessor. The budget, less anticipated revenues from sources other than the property tax, is divided by the assessed value to obtain the tax rate. Budgeted Revenue ($) / Total Assessed Value of All Property ($) = Tax Rate (%) The tax bill for an individual property is calculated by multiplying the assessed value of the property by the tax rate. Tax Rate (%) x Assessed Value of Individual Property ($) = Tax Bill ($) The tax rate is always a function of the budget and the total assessed value. If the budget increases, and the total assessed value remains constant, the tax rate will increase. In considering the income and expenses of a property, a decision must be made on how to treat the property taxes. When property is valued for ad valorem tax purposes, taxes should not be considered an expense item. Because any deduction from gross income directly affects the indicated property value through the income approach, only typical and reasonable expenses can be used. It might be questioned how a typical and reasonable figure for taxes can be found when taxes are usually based on the property value itself. When the income approach is used to determine the property value for tax purposes, the practice of using property taxes as an expense item is based on a preconceived value and discredits the whole approach. Because taxes are often the largest single expense, this practice leaves the final value conclusion subject to considerable error. The problem can be resolved by developing an effective tax rate and including the rate in the capitalization rate for the property being appraised. The Effective Tax Rate is the third component of the total capitalization rate. The effective tax rate for a property expresses the relationship between the property value and the amount of taxes paid. It is computed by dividing the tax bill by the property value. 40

42 Tax Bill / Property Value (Sale Price) = Effective Tax Rate To develop the effective tax rate for any class of property in a jurisdiction, multiply the appropriate level of assessment by the current tax rate expressed as a decimal or a percentage. Assessment Level x Tax Rate = Effective Tax Rate If Assessment Level = 0.40 and Tax Rate = , then Effective Tax Rate = , or 3.108%. The value conclusion resulting from use of an effective tax rate is not prejudiced by a predetermined value judgment as it is when taxes are included as an expense item. As stated previously, the budget and tax rate share a direct relationship; as the budget increases, the tax rate will also increase, assuming the total assessed value remains constant. However, the relationship between the assessed value and the tax rate is inverse, assuming that the budget remains constant; as the assessed value increases, the tax rate will decrease and vice versa. As the tax rate increases, assessed value will decrease and vice versa. According to the Appraisal of Real Estate, 12 th Edition, a heavy tax burden can cause real estate values to decline. Under these circumstances, new construction may be discouraged. There may be several tax districts in a metropolitan area, each with a different tax policy. Understanding the system of ad valorem taxation in an area facilitates the appraiser s analysis of how taxes affect value. Thusly, properties with higher effective tax rates are expected to have lower values, as they will have higher overall capitalization rates, after the effective tax rate is added to the overall rate. Properties with lower effective tax rates are expected to have higher values, as they will have lower overall capitalization rates, due to the lower effective tax rate added to the overall capitalization rate. Properties with triple net lease structures, in which the owner is not responsible for the tax bill, are expected to have higher values, since the effective tax will not be added to the overall capitalization rate. Note: For properties where the tenants, not the owner, are responsible for the tax bill, it is reasonable to multiply the effective tax rate times the vacancy rate to derive the true effective tax rate to be added to the overall capitalization rate. This is because the property owner will have to pay the pro rata share of taxes for the units that are unoccupied. If Effective Tax Rate = 3.108% and Vacancy = 20%, then True Effective Tax Rate to be added = % ( x 0.20 = ) 41

43 Reserve for Replacement Allowance & Cap Rate Recalculation Formula A replacement allowance, also known as reserves, is an allowance that provides for the periodic replacement of building components that wear out more rapidly than the building itself and must be replaced periodically during the building s useful life. These reserves are funds set aside from cash flow to replace short lived items that are routinely replaced a number of times over the life of the property. They do not include the cost of larger capital items that are replaced only a few times over the life of the property; the cost of larger capital items are accounted for separately as capital improvement items. Capital improvements include additions to the property that may be made at any time and are not necessary to maintain the level of income at any given time. They are not a proper expense for the development of the net operating income for direct capitalization in the income approach because capital improvements are not items of annual expense. Ordinarily, capital improvements will result in an increase in the total property value, an increase in the economic life of the property, an increase in the income of the property, or all three. Capital improvements should not be deducted from the effective gross income. For example, the addition of a swimming pool to an apartment complex would not be considered a normal annual operating expense of the property, although it could increase the value of the property. Expense items in the replacement allowance category are considered short lived items, and they are similar to items that are depreciated in the cost approach as short lived items. Parts of a building that normally must be replaced before the building reaches the end of its economic life should have an annual expense charge as a reserve for replacement. For example, if a property is under lease for twenty-five years, it is reasonable to expect that such items as carpeting and air-conditioning will wear out before the end of the lease. Therefore, reserves for replacement are set aside annually to provide for eventual replacement of these items Typical replacement items that may be included in this category are: Roof Cover Water Heaters Heating and Air Conditioning Systems Elevators Floor Coverings Stoves Dishwashers Refrigerators Paving 42

44 The amount set aside for any specific item is calculated in the following manner: 1. Estimate the economic life of the item. 2. Estimate the replacement cost new. 3. Calculate the percentage of reserve per year by dividing 100% by the economic life of the item. a. Example: If the roof cover has an economic life of twenty years, then take 100% / 20 years b. 1 / 20 = 0.05 or 5% per year. 4. Multiply the replacement cost new by the percentage per year to arrive at the annual charge. a. Example: If the roof cover costs $6,000 to replace, then multiply 5% by $6,000 b x $6,000 = $300 annual reserve for roof replacement In most Southeastern markets, including Memphis, reserve allowances are not typically included as an operating expense by buyers, sellers, or brokers in their analyses of most property types. For certain property types, such as apartments and hotels/motels, reserves are typically included as an expense item above the NOI line. However, for other property types, such as office, retail, and industrial, reserves are not typically included as an expense prior to estimating NOI. In property types where reserves for replacements are not typically included in the calculation of the net operating income, it is evident from mathematical logic and historic capitalization rate studies that the overall capitalization rate is compressed when reserves are included as an expense. This is because the reserve allowance is an additional expense, which effectively lowers the net operating income of the property. The reserve for replacement allowance is an expense that is, like all other operating expenses, deducted from the effective gross income. For this study, a formula was developed in order to calculate the capitalization rate with an allowance for replacement reserves for properties in which a reserve allowance is not typically included as an operating expense by buyers, sellers, and brokers. The steps in the calculation are as follows: 1. Determine the subject property reserve allowance as a percent of the EGI a. Example: If EGI = $100,000 and Reserves are $1,000, then reserve percent = 1% b. This will be known as the Reserve Percent 2. Calculate the subject EGIM (Effective Gross Income Multiplier) a. This is accomplished by dividing the NOI Ratio by the Overall Cap Rate selected for the subject property. (If taxes are to be an expense to the owner, the overall rate should include the effective tax rate) b. Example: If NOI is 40% of EGI and the selected cap rate for the subject property is 11%, then the EGIM = 3.64 rounded (0.40/0.11) 43

45 3. Divide the Reserve Percent by the EGIM a. Example: If Reserve Percent = 1% and EGIM = 3.64, then 0.01 / 3.64 = b. This result is the difference in the OAR without reserves versus the OAR with reserves. 4. Take the result of the calculation in step 3 and subtract from the OAR selected for the property. a. Example: If selected cap rate = 11%, then = b. The OAR to be used with the reserve allowance as an expense is % 44

46 US Treasury 10-Year Yield Curve & Cap Rate Spread The Treasury Yield Curve Rates are commonly referred to as Constant Maturity Treasury rates, or CMTs. Yields are interpolated by the Treasury from the daily yield curve. This curve, which relates the yield on a security to its time to maturity, is based on the closing market bid yields on actively traded Treasury securities in the over-the-counter market. These market yields are calculated from composites of quotations obtained by the Federal Reserve Bank of New York. The yield values are read from the yield curve at fixed maturities, currently 1, 3 and 6 months and 1, 2, 3, 5, 7, 10, 20, and 30 years. This method provides a yield for a ten-year security, for example, even if no outstanding security has exactly ten years remaining to maturity. The Treasury yield curve is estimated using a cubic spline model. Inputs to the model are primarily bid-side yields for on-the-run Treasury securities. The Treasury Yield Curve, which is also known as the term structure of interest rates, draws out a line chart to demonstrate a relationship between yields and maturities of on-the-run treasury fixed income securities. Market participants pay very close attention to the yield curves, as they are used in deriving the interest rates, which are in turn used as discount rates for each payment to value Treasury securities. In addition to this, market participants are also interested in identifying the spread between short term rates and long term rates to determine the slope of the yield curve, which is a predictor of the economic situation of the country. Yields on Treasury securities are in theory free of credit risk and are often used as a benchmark to evaluate the relative worth of US Non-Treasury securities. The capitalization rate for income producing real estate consists of three rates; the discount rate, the recapture rate, and the effective tax rate. The discount rate, which represents the return on a real estate investment, consists of a safe rate, a risk rate, a rate for illiquidity, and a rate for investment management. These rates reflect the compensation necessary to attract investors to give up liquidity, defer consumption, and assume the risks of investing. The safe rate is the rate obtainable with the most safety and the least risk. Intrinsic to the relationship of these rates to real estate value is the understanding that investors prefer certainty over uncertainty and they expect a reward for taking on additional risk. Higher rewards are required in return for accepting higher risk. An investor who purchases income-producing real estate is essentially trading present dollars for the expectation of receiving future dollars. The principle of anticipation holds that value is the present worth of expected future benefits. Therefore, these rates have an inverse relationship to value. 45

47 In analyzing the capitalization rates from market sales used in this study, those sales with reported income or cap rates, deemed to be an arm s length transaction best representing the definition of market value used in this report, and rates taken from third party survey data, a logical application of the principles governing the discount rate along with its composites and the recapture rate was applied to the analysis of the spread of capitalization rates above the 10-year Treasury yield curve rate. The logical application of this analysis is based on the following premises: Newer properties are preferred over older, aging properties in the marketplace by market participants because o Newer properties should be attractive in design and style to current market participants, whereas older properties reflect the design and style of the era in which they were constructed. o Newer properties typically represent the most current building standards and modern architectural techniques, whereas older properties were built per the standards of the era in which they were constructed. o Newer properties typically represent the highest and best use of the land, based on the principle of surplus productivity, and usually conform to current zoning regulations. o Newer properties require less maintenance than older properties making them more desirable to investors. o Newer properties tend to be more liquid in the marketplace than older properties, indicating a lower rate of return for illiquidity. o Newer properties have a lower recapture rate because they have more remaining economic life than older properties. o Overall, newer properties represent a safer investment than an older property, which is a riskier investment due to greater uncertainty regarding desirability, occupancy, liquidity, management, economic life, and full recapture of the investor s money. Higher land value means a lower discount rate because higher land value indicates a more vibrant and desirable location, which makes an investment more liquid. Thus, the investor does not expect as much of a rate of return because the investment can be recovered quicker. Lower land value means a higher discount rate because lower land value indicates a location that is less desirable, suggesting that the investment will be less liquid. Thus, the investor will expect a higher rate of return because it will take longer to sell the investment and recover the investor s money. Considering the 10-year Treasury yield curve rate as the safe rate of the investment, a higher overall spread above the yield curve rate, indicates a riskier investment in the marketplace, 46

48 with less liquidity, more investment management, and less remaining economic life. A lower spread indicates an investment with less risk, more liquidity, less investment management, and more remaining economic life. Stratifying the Spread The cap rate spreads above the 10 year US Treasury yield curve rate can be stratified quantitatively and qualitatively based on the aforementioned analytical premises and according to the following methodology: Cap Rate Spread Above the 10 year US Treasury Yield Curve Rate (Rate Spread) Range Increment Factor Stratification based on Effective Age (Quantitative) The minimum effective age = 1 The maximum effective age = TEL 10 years o Maximum effective age will vary with property type Subtract the minimum rate spread from the maximum rate spread to determine the rate spread range. Divide the cap rate spread range by the maximum effective age to derive the Cap Rate Spread above the 10 year US Treasury Yield Curve Rate Range Increment Factor (Rate Spread). To develop a cap rate for a specific property based on its effective age; o Multiply the subject property effective age by the rate spread range increment factor o Add the product to the minimum rate spread to derive the subject property s indicated rate spread above the 10-year US Treasury yield curve rate o Add the result to the 10-year US Treasury yield curve rate as of December 31 st (or as close to January 1 st as possible) of the appropriate tax year. o Note: If the subject property s effective age is 1, then the rate spread will always be the minimum. Example: o Min eff age = 1 o Max eff age = 35 o Min rate spread = o Max rate spread = o Rate spread range = o Rate Spread Increment Range Factor = [ / 35] o If subject property: Eff age = 24 47

49 10-yr UST 12/31 = x = , round to = , subject indicated spread above the yield curve rate = o Subject Indicated Capitalization Rate based on Effective Age = 10.69% Rate Spread Increment Range Factor Stratification based on Condition, Desirability, & Utility (Qualitative) This method of developing a cap rate will be based primarily on the appraiser s judgment of the overall Condition, Desirability, & Utility (CDU) of the subject property. To develop a cap rate for a specific property based on its CDU: o Determine Qualitative Variable Ratings Excellent Very Good Good Average Fair Poor o Transform the qualitative variables by converting them to ascending scalar values. Excellent = 0 Very Good = 1 Good = 2 Average = 3 Fair = 4 Poor = 5 o Divide the Rate Spread Range by the largest scalar value to derive the Qualitative Spread Factor. o Multiply the Qualitative Spread Factor by the appropriate Qualitative Scalar Value o Add the result to the minimum rate spread to estimate the indicated Rate Spread for the subject property. o Add the indicated Rate Spread to the 10-year US Treasury yield curve rate as of December 31 st (or as close to January 1 st as possible) of the appropriate tax year. Example: o Min rate spread =

50 o Max rate spread = o Rate spread range = o 10-yr UST 12/31 = o Subject qualitative rating = Fair / 5 = Qualitative Spread factor 4 x = Rate Spread (rounded) = subject indicated spread above the yield curve rate = o Subject Indicated Capitalization Rate based on CDU = 11.58% 49

51 US Treasury 10-Year Yield Curve Rates (Quarterly Averages) 10-Year Yield Curve Rate 3.00% 2.50% 2.77% 2.62% 2.50% 2.28% 2.22% 2.19% 2.14% 2.00% 1.97% 2.16% 1.91% 1.75% 1.50% 1.56% 1.00% 0.50% 0.00% Q Q Q Q Q Q Q Q Q Q Q Q Year Yield Curve Rates as of December 30, % January 3, % Source: 50

52 Investment Class Descriptions Most sources and investors classify real properties in investment classes, such as Class A, B, C or D. Classes A through C is the typical investment class range for institutional grade investors, whereas Class D properties are usually older properties that represent higher than average risk, higher than average deferred maintenance, and are suffering from economic and functional obsolescence. In many cases, Class D properties are purchased by non-institutional, unsophisticated investors that do not use overall capitalization rates as a valuation tool. Thusly, investor surveys focus primarily on Class A & B properties, and sometimes Class C properties. Since the intended use of this 2017 Capitalization Rate Study Report is to assist the appraisal staff of the Shelby County Assessor of Property in determining capitalization rates for the mass appraisal modeling process for reappraisal, and to assist the appraisal staff of the Shelby County Assessor of Property in defense of reappraisal values, the focus for stratification of the various investment classes for each property type category is effective age, remaining economic life, recapture, location, and land value, with additional guidelines regarding the typical characteristics of each investment class within each property type category. The following criteria for each investment class serves as a guideline for determining an appropriate cap rate or income factor for mass appraisal valuation modeling, or individual appeal value defense. The appraiser s judgment will be required in making the final decision of which investment class and rate to assign to each property. MULTIFAMILY Apartment, Multi Family Typical Building Life (TEL) Ranges from 45 to 60 years (Marshall Valuation Service, Average to Excellent) Class A Less than 10 years old (effective age) Remaining Economic Life (REL) Ranges from 36 to 59 years New Construction or relatively new Highest quality of construction Typically have full amenities (i.e., swimming pool, clubhouse, exercise room, business center, etc.) Excellent/Good Condition Located in Most Desirable Area o Highest Land Values o Lowest Discount (Interest) Rates o Lowest Risk Rate 51

53 Class B 10 to 19 years old (effective age) Remaining Economic Life (REL) Ranges from 26 to 50 years Newer Properties aging and transitioning from Class A Many amenities of Class A Good/Average Condition Newer properties in slightly less desirable areas o Slightly Lower land values than A class areas o Slightly Higher Discount (Interest) Rates than A anticipated o Slightly Higher Risk Rate than Class A Class C 20 to 29 years old (effective age) Remaining Economic Life (REL) Ranges from 16 to 40 years Average quality and condition Smaller unit sizes Fewer or no amenities Less desirable location than Class B o Lower Land values than Class B sites anticipated o Higher Discount (Interest) Rates than B anticipated o Higher Risk Rate than Class B Class D 30 years or more (effective age) Remaining Economic Life (REL) Ranges from 10 to 30 years Little to no remodeling May be severely impacted by functional and economic obsolescence Less than average condition More physical deterioration, approaching the end of economic life Least desirable location o Lowest Land values anticipated o Highest Discount (Interest) Rates anticipated o Building Value Ratios are anticipated to be the lowest except in the most undesirable areas, where land values themselves are lower than most other areas. o Highest Risk Rate 52

54 INDUSTRIAL Warehouse Storage/Distribution Typical Building Life (TEL) Ranges from 40 to 55 years (Marshall Valuation Service, Average to Excellent) Class A Less than 10 years old (effective age) Remaining Economic Life (REL) Ranges from 31 to 54 years New building or completely renovated and updated Attracts high-quality tenants Highest quality of construction Good finished space Very professionally maintained Typically higher occupancy rates than other projects Good condition Prime location relative to other projects o Highest land values o Lowest Discount (Interest) Rates o Lowest Risk Rate Class B 10 to 19 years old (effective age) Remaining Economic Life (REL) Ranges from 21 to 45 years Relatively new building of good quality Above moderate occupancy levels Above average finished space Attracts good quality tenants Good location o Slightly higher Discount (Interest) Rates than A anticipated o Slightly lower land values than A anticipated o Slightly Higher Risk Rate than Class A Class C 20 to 29 years old (effective age) Remaining Economic Life (REL) Ranges from 11 to 35 years Average condition with minimal deterioration and obsolescence Normally well managed Average occupancy levels Considered the norm for the marketplace Mostly in non-prime locations o Lower land values than B anticipated o Higher Discount (Interest) Rates than B anticipated 53

55 o Higher Risk Rate than Class B Class D 30 years or more (effective age) Remaining Economic Life (REL) Ranges from 10 to 25 years Older buildings reaching the end of their economic life Below average condition, often in need of renovation or repair Lower occupancy rates Lower quality of tenants Higher cap rates are expected for buildings in need of extensive repair Usually in non-prime, poor location o Lowest land values o Highest Discount (Interest) Rates o Highest Risk Rate Self-Storage Warehouses Typical Building Life (TEL) Ranges from 35 to 45 years (Marshall Valuation Service, Average to Good) Class A Less than 10 years old (effective age) Remaining Economic Life (REL) Ranges from 26 to 44 years Institutional grade facility Focused on by major operators and institutional investors Highest quality of construction, typically masonry construction Sophisticated/Signature design and layout On-site office and/or manager s apartment Little to no deferred maintenance issues Above average amenities, such as gated entry, electronic access control, climate-control features or green eco-friendly units, high tech security system, camera surveillance, electrical outlets and lighting, may have some plumbing Typically capable of commanding the highest rents in the market Usually located in prime retail type locations relative to other projects o Good drive-by traffic and great visibility o Highest land values o Lowest Discount (Interest) Rates o Lowest Risk Rate Class B 10 to 19 years old (effective age) Remaining Economic Life (REL) Ranges from 16 to 35 years Relatively new, good quality middle market facility Typically a combination of masonry and metal construction On-site office, sometimes with a manager s apartment 54

56 May offer climate controlled units and outdoor storage Mostly well maintained, but may have some deferred maintenance Typically do not command the same high rents garnered at Class A sites Value-add investment opportunity to upgrade class into A category Usually located primarily in secondary retail type locations and/or prime industrial locations o Modest visibility o Lower land values than A anticipated o Higher Discount (Interest) Rates than A anticipated o Slightly Higher Risk Rate than Class A Class C & D 20 to 29 years old (effective age) D = 30+ years old (effective age) Remaining Economic Life (REL) Ranges from 10 to 25 years Average quality facility, typically metal construction Least attractive to most investors Not targeted by major operators or institutional investors Can be a good investment for smaller entrepreneurs, due to lower operational costs May have on-site office or simply a phone number for building management Aging and experiencing deferred maintenance, may be in need of renovation First generation sites in need of rehabbing Typically command lowest rents in the market Usually located in secondary rural and industrial locations o Low visibility o Lowest land values o Highest Discount (Interest) Rates o Class C has higher Risk Rate than Class B o Class D has higher Risk Rate than Class C Flex Warehouse/Lofts Typical Building Life (TEL) Ranges from 40 to 60 years (Marshall Valuation Service, Average to Excellent) Class A Less than 10 years old (effective age) Remaining Economic Life (REL) Ranges from 31 to 54 years New building or completely renovated and updated Attracts high-quality tenants Highest quality of construction Good finished space Very professionally maintained 55

57 Typically higher occupancy rates than other projects Good condition Prime location relative to other projects o Highest land values o Lowest Discount (Interest) Rates o Lowest Risk Rate Class B 10 to 19 years old (effective age) Remaining Economic Life (REL) Ranges from 21 to 45 years Relatively new building of good quality Above moderate occupancy levels Above average finished space Attracts good quality tenants Good location o Slightly higher Discount (Interest) Rates than A anticipated o Slightly lower land values than A anticipated o Slightly Higher Risk Rate than Class A Class C 20 to 29 years old (effective age) Remaining Economic Life (REL) Ranges from 11 to 35 years Average condition with minimal deterioration and obsolescence Normally well managed Average occupancy levels Considered the norm for the marketplace Mostly in non-prime locations o Lower land values than B anticipated o Higher Discount (Interest) Rates than B anticipated o Higher Risk Rate than Class B Class D 30 years or more (effective age) Remaining Economic Life (REL) Ranges from 10 to 25 years Older buildings reaching the end of their economic life Below average condition, often in need of renovation or repair Lower occupancy rates Lower quality of tenants Higher cap rates are expected for buildings in need of extensive repair Usually in non-prime, poor location o Lowest land values o Highest Discount (Interest) Rates o Highest Risk Rate 56

58 RETAIL Single Tenant Typical Building Life (TEL) Ranges from 30 to 55 years (Marshall Valuation Service, Average to Excellent) Class A Less than 10 years old (effective age) Remaining Economic Life (REL) Ranges from 21 to 54 years Fast Food & Discount Stores have shorter typical building lives; Excellent/Very Good is 35 to 40 years Fast Food & Discount Store REL typically ranges from 26 to 39 years New building or completely renovated and updated Highest quality of construction Creditworthy tenant; usually with credit rating by Standard & Poor s and/or Moody s Typically net-leased or triple-net-leased with little to no landlord management responsibilities or expenses Lease will typically have periodic steps in rent that equal or exceed perceived level of future inflation First generation tenant; franchise fast foods Construction is typically specific to tenant s operational and aesthetic needs; this is especially true with Fast Food properties Excellent/Good trade area demographics Prime location with excellent visibility; typically major thoroughfares with very high traffic counts in high value areas o Highest land values o Lowest Discount (Interest) Rates o Lowest Risk Rate Class B 10 to 19 years old (effective age) Remaining Economic Life (REL) Ranges from years 11 to 45 years Fast Food & Discount Stores have shorter typical building lives; Average/Good is 30 years Fast Food & Discount Store REL typically ranges from 10 to 20 years Good quality, somewhat new building in good condition May have a creditworthy, first generation tenant that has exercised a renewal option Typically franchise fast foods Good trade area demographics Good location with good visibility o Slightly higher Discount (Interest) Rates than A anticipated o Slightly lower land values than A anticipated 57

59 o Slightly Higher Risk Rate than Class A Class C 20 to 29 years old (effective age) Remaining Economic Life (REL) Ranges from 10 to 35 years Average quality building May be second or third generation unrated tenant, with less than 10 years remaining on lease terms Typically less than a triple-net-lease structure Typically non-franchise tenant for fast foods Average trade area demographics Average, non-prime location with minimal visibility and low traffic counts o Lower land values than B anticipated o Higher Discount (Interest) Rates than B anticipated o Higher Risk Rate than Class B Class D 30 years or more (effective age) Remaining Economic Life (REL) Ranges from 10 to 25 years Typically an older building, in need of repair and renovation Typically low quality tenant with a lease expiring within the next five years Typically less than triple-net-lease structure May be suffering from visible deferred maintenance Fast foods and discount stores in this class have reached the end of their economic life, unless the property has been renovated: o If there is not enough renovation or repair to reduce the effective age to 20 years or less, then remaining years left on lease terms may be used as REL. o Otherwise, the property should be valued using sales comparison or cost, with the understanding that there will be significant external and functional obsolescence Trade area demographics are below average Below average, non-prime location with typically poor visibility o Lowest land values o Highest Discount (Interest) Rates o Highest Risk Rate Multi-Tenant Strip Centers (Unanchored) Typical Building Life (TEL) Ranges from 35 to 50 years (Marshall Valuation Service, Average to Excellent) Class A Less than 10 years old (effective age) Remaining Economic Life (REL) Ranges from 26 to 49 years New building or completely renovated and updated 58

60 Attracts high-quality tenants Highest quality of construction Excellent/Good interior/exterior finish Very professionally maintained Typically higher occupancy rates than other projects Excellent/Good condition Prime location relative to other projects o Highest land values o Lowest Discount (Interest) Rates o Lowest Risk Rate Class B 10 to 19 years old (effective age) Remaining Economic Life (REL) Ranges from 16 to 40 years Relatively new building of good quality Above average occupancy levels Good/Average interior/exterior finish Attracts good quality tenants Good location o Slightly higher Discount (Interest) Rates than A anticipated o Slightly lower land values than A anticipated o Slightly Higher Risk Rate than Class A Class C 20 to 29 years old (effective age) Remaining Economic Life (REL) Ranges from 10 to 30 years Average condition with minimal deterioration and obsolescence Normally well managed Average occupancy levels Considered to be average for the marketplace Mostly in non-prime locations o Lower land values than B anticipated o Higher Discount (Interest) Rates than B anticipated o Higher Risk Rate than Class B Class D 30 years or more (effective age) Remaining Economic Life (REL) Ranges from 10 to 25 years Older buildings reaching the end of their economic life Below average condition, often in need of renovation or repair Lower occupancy rates Lower quality of tenants Higher cap rates are expected for buildings in need of extensive repair Usually in non-prime, poor location 59

61 o Lowest land values o Highest Discount (Interest) Rates o Highest Risk Rate Neighborhood/Community Center (Anchored) Typical Building Life (TEL) Ranges from 35 to 50 years (Marshall Valuation Service, Average to Excellent) Class A Less than 10 years old (effective age) Remaining Economic Life (REL) Ranges from 26 to 49 years New building or completely renovated and updated Attracts high-quality tenants National chain drugstore, discount department store, large specialty discount store, or supermarket creditworthy anchor tenant; usually with credit rating by Standard & Poor s and/or Moody s, such as Walgreen s, Kroger, Target, TJ Maxx, Kohl s, Best Buy, Macy s Neighborhood centers will have one anchor tenant, whereas Community centers will have two or more anchors Highest quality of construction Excellent/Good interior/exterior finish Very professionally maintained Typically higher occupancy rates than other projects Excellent/Good condition Prime location relative to other projects o Highest land values o Lowest Discount (Interest) Rates o Lowest Risk Rate Class B 10 to 19 years old (effective age) Remaining Economic Life (REL) Ranges from 16 to 40 years Relatively new building of good quality Above average occupancy levels Good/Average interior/exterior finish Attracts good quality tenants May have a national chain drugstore, discount department store, large specialty discount store, or supermarket creditworthy anchor tenant, such as Walgreen s, Kroger, Target, TJ Maxx, Kohl s, Best Buy, Macy s Neighborhood centers will have one anchor tenant, whereas Community centers will have two or more anchors Good location o Slightly higher Discount (Interest) Rates than A anticipated 60

62 o Slightly lower land values than A anticipated o Slightly Higher Risk Rate than Class A Class C 20 to 29 years old (effective age) Remaining Economic Life (REL) Ranges from 10 to 30 years Average condition with minimal deterioration and obsolescence Normally well managed Average occupancy levels Considered to be average for the marketplace Anchor tenants may be independent local tenants, without credit rating, instead of national creditworthy tenants Mostly in non-prime locations o Lower land values than B anticipated o Higher Discount (Interest) Rates than B anticipated o Higher Risk Rate than Class B Class D 30 years or more (effective age) Remaining Economic Life (REL) Ranges from 10 to 25 years Older buildings reaching the end of their economic life Below average condition, often in need of renovation or repair Lower occupancy rates Lower quality of tenants Higher cap rates are expected for buildings in need of extensive repair Usually in non-prime, poor location o Lowest land values o Highest Discount (Interest) Rates o Highest Risk Rate Power Center Typical Building Life (TEL) Ranges from 35 to 50 years (Marshall Valuation Service, Average to Excellent) Power centers reflect a special retail concept. A power center seeks a high proportion of anchor tenants in gross leasable area, thus reversing the pattern which emphasized higher rent charged for the the spaces between anchors and the end spaces. Class A Less than 10 years old (effective age) Remaining Economic Life (REL) Ranges from 26 to 49 years New building or completely renovated and updated Attracts high-quality tenants Dominated by three or more generally freestanding, large anchors, such as discount department stores, off-price stores, warehouse clubs, and category killers 61

63 Popular anchors include Wal-Mart, Lowe s, Staples, Target, T.J. Maxx, Marshalls, Home Depot, Pier One Imports, Walgreen s, and Kohl s Typically contains several outparcels Highest quality of construction Excellent/Good interior/exterior finish Very professionally maintained Typically higher occupancy rates than other projects Excellent/Good condition Prime location relative to other projects o Highest land values o Lowest Discount (Interest) Rates o Lowest Risk Rate Class B 10 to 19 years old (effective age) Remaining Economic Life (REL) Ranges from 16 to 40 years Relatively new building of good quality Above average occupancy levels Good/Average interior/exterior finish Attracts good quality tenants Dominated by three or more generally freestanding, large anchors, such as discount department stores, off-price stores, warehouse clubs, and category killers Popular anchors include Wal-Mart, Lowe s, Staples, Target, T.J. Maxx, Marshalls, Home Depot, Pier One Imports, Walgreen s, and Kohl s Typically contains several outparcels Good location o Slightly higher Discount (Interest) Rates than A anticipated o Slightly lower land values than A anticipated o Slightly Higher Risk Rate than Class A Class C 20 to 29 years old (effective age) Remaining Economic Life (REL) Ranges from 10 to 30 years Average condition with minimal deterioration and obsolescence Normally well managed Average occupancy levels Considered to be fair for the marketplace Anchor tenants may be independent local tenants, without credit rating, instead of national creditworthy tenants Mostly in non-prime locations o Lower land values than B anticipated o Higher Discount (Interest) Rates than B anticipated o Higher Risk Rate than Class B 62

64 Class D 30 years or more (effective age) Remaining Economic Life (REL) Ranges from 10 to 25 years Older buildings reaching the end of their economic life Below average condition, often in need of renovation or repair Lower occupancy rates Lower quality of tenants Higher cap rates are expected for buildings in need of extensive repair Usually in non-prime, poor location o Lowest land values o Highest Discount (Interest) Rates o Highest Risk Rate Regional Mall Typical Building Life (TEL) Ranges from 45 to 55 years (Marshall Valuation Service, Average to Excellent) Class A Less than 10 years old (effective age) Remaining Economic Life (REL) Ranges from 36 to 54 years New building or completely renovated and updated Attracts high-quality tenants Two or more national chain full line department stores or big box retailers, creditworthy anchor tenant; usually with credit rating by Standard & Poor s and/or Moody s, such as Barnes and Noble, Best Buy, Nordstrom, J.C. Penny, Macy s, Sears, and Dillard s. Highest quality of construction Excellent/Good interior/exterior finish Very professionally maintained Typically higher occupancy rates than other projects Excellent/Good condition Prime location relative to other projects o Highest land values o Lowest Discount (Interest) Rates o Lowest Risk Rate Class B 10 to 19 years old (effective age) Remaining Economic Life (REL) Ranges from 26 to 45 years Relatively new building of good quality Above average occupancy levels Good/Average interior/exterior finish Attracts good quality tenants 63

65 May have two or more national chain full line department stores or big box retailers, creditworthy anchor tenant; usually with credit rating by Standard & Poor s and/or Moody s, such as Barnes and Noble, Best Buy, Nordstrom, J.C. Penny, Macy s, Sears, and Dillard s. Good location o Slightly higher Discount (Interest) Rates than A anticipated o Slightly lower land values than A anticipated o Slightly Higher Risk Rate than Class A Class C 20 to 29 years old (effective age) Remaining Economic Life (REL) Ranges from 16 to 35 years Average condition with minimal deterioration and obsolescence Normally well managed Average occupancy levels Anchor tenants may be independent local tenants, without credit rating, instead of national creditworthy tenants Mostly in non-prime locations o Lower land values than B anticipated o Higher Discount (Interest) Rates than B anticipated o Higher Risk Rate than Class B Class D 30 years or more (effective age) Remaining Economic Life (REL) Ranges from 10 to 25 years Older buildings reaching the end of their economic life Below average condition, often in need of renovation or repair Lower occupancy rates Lower quality of tenants Higher cap rates are expected for buildings in need of extensive repair Usually in non-prime, poor location o Lowest land values o Highest Discount (Interest) Rates o Highest Risk Rate OFFICE Office Buildings/Office Condominium Typical Building Life (TEL) Ranges from 45 to 60 years (Marshall Valuation Service, Average to Excellent) 64

66 Class A Less than 10 years old (effective age) Remaining Economic Life (REL) Ranges from 36 to 59 years New building or older building completely renovated and updated Attracts high-quality tenants Very professionally managed and maintained Highest quality of construction Excellent/Good interior/exterior finish Typically higher occupancy rates than other projects Excellent/Good condition Prime location relative to other projects o Highest land values o Lowest Discount (Interest) Rates o Lowest Risk Rate Class B 10 to 19 years old (effective age) Remaining Economic Life (REL) Ranges from 26 to 50 years Relatively new building of good quality or updated older building Above average occupancy levels Good/Average interior/exterior finish Attracts good quality tenants Well managed and maintained Good location o Slightly higher Discount (Interest) Rates than A anticipated o Slightly lower land values than A anticipated o Slightly Higher Risk Rate than Class A Class C 20 to 29 years old (effective age) Remaining Economic Life (REL) Ranges from 16 to 40 years Older building, lesser quality Average condition with minimal deterioration and obsolescence Normally well managed Moderate to Average occupancy levels Mostly in non-prime locations o Lower land values than B anticipated o Higher Discount (Interest) Rates than B anticipated o Higher Risk Rate than Class B Class D 30 years or more (effective age) Remaining Economic Life (REL) Ranges from 10 to 30 years Older buildings reaching the end of their economic life 65

67 Below average condition, often in need of renovation or repair Lower occupancy rates Lower quality of tenants Below average management quality Higher cap rates are expected for buildings in need of extensive repair Usually in non-prime, poor location o Lowest land values o Highest Discount (Interest) Rates o Highest Risk Rate Medical Office Buildings Typical Building Life (TEL) Ranges from 35 to 50 years (Marshall Valuation Service, Average to Excellent) Class A Less than 10 years old (effective age) Remaining Economic Life (REL) Ranges from 26 to 49 years New building or older building completely renovated and updated Attracts high-quality tenants Very professionally managed and maintained Highest quality of construction Excellent/Good interior/exterior finish Typically higher occupancy rates than other projects Excellent/Good condition Prime location relative to other projects o Highest land values o Lowest Discount (Interest) Rates o Lowest Risk Rate Class B 10 to 19 years old (effective age) Remaining Economic Life (REL) Ranges from 16 to 40 years Relatively new building of good quality or updated older building Above average occupancy levels Good/Average interior/exterior finish Attracts good quality tenants Well managed and maintained Good location o Slightly higher Discount (Interest) Rates than A anticipated o Slightly lower land values than A anticipated o Slightly Higher Risk Rate than Class A Class C 20 to 29 years old (effective age) 66

68 Remaining Economic Life (REL) Ranges from 10 to 30 years Older building, lesser quality Average condition with minimal deterioration and obsolescence Normally well managed Moderate to Average occupancy levels Mostly in non-prime locations o Lower land values than B anticipated o Higher Discount (Interest) Rates than B anticipated o Higher Risk Rate than Class B Class D 30 years or more (effective age) Remaining Economic Life (REL) Ranges from 10 to 20 years Older buildings reaching the end of their economic life Below average condition, often in need of renovation or repair Lower occupancy rates Lower quality of tenants Below average management quality Higher cap rates are expected for buildings in need of extensive repair Usually in non-prime, poor location o Lowest land values o Highest Discount (Interest) Rates o Highest Risk Rate HOTEL/MOTEL Full Service Hotels Full service hotels are those that offer a complete range of guest services and amenities. They typically will contain at least one restaurant, a lounge, and meeting rooms. Full service hotels can derive a very large portion of their total revenue from food and beverage services. A full service hotel will typically have higher expense ratios than limited service properties. Some common chains within the Luxury/Full Service category include Marriott, Holiday Inn, Sheraton, and Hilton Hotels. Typical Building Life (TEL) Ranges from 45 to 60 years (Marshall Valuation Service, Average to Excellent) Class A Luxury Less than 10 years old (effective age) Remaining Economic Life (REL) Ranges from 36 to 59 years 67

69 Luxury hotels, contained within the category of full service, often provide higher levels of personal service, have more than one restaurant and lounge, are newer, and are of a higher quality construction. New building or older building completely renovated and updated with upscale class A property amenities Excellent/Good condition and overall appeal for age Larger than average size rooms Above average room rates for the market area Affiliated with an upscale or boutique lodging chain, or independent luxury properties that are long established or nationally well recognized. Located in most desirable area o Highest land values o Lowest Discount (Interest) Rates o Lowest Risk Rate Class B 10 to 19 years old (effective age) Remaining Economic Life (REL) Ranges from 26 to 50 years Relatively new building of good quality May be affiliated with a major lodging chain, but not necessarily one of the more upscale ones Newer Properties aging and transitioning from Class A Many amenities of Class A Good/Average Condition Average room size for market Newer properties in a slightly less desirable areas o Slightly Lower land values than A class areas o Slightly Higher Discount (Interest) Rates than A anticipated o Slightly Higher Risk Rate than Class A Class C 20 to 29 years old (effective age) Remaining Economic Life (REL) Ranges from 16 to 40 years Average quality and condition Smaller room sizes with fewer amenities Typically affiliated with a discount or lower end lodging chain Less desirable location than Class B o Lower Land values than Class B sites anticipated o Higher Discount (Interest) Rates than B anticipated o Higher Risk Rate than Class B Class D Full service hotels considered to be a Class D should be valued with either Class C or D Limited Service properties. 68

70 Limited/Select Service Hotel & Economy Motel Limited service hotels offer minimal or no guest services or amenities. They provide a basic room. The rooms are typically smaller than those found in full service or extended stay facilities. Some of the better limited-service hotels may offer a buffet style breakfast in the lobby and may have a pool. Room prices can vary a great deal within this group. The lower priced facilities include economy lines such as Motel 6, Budget 8, and Econo Lodge. These properties offer minimal guest services. Some of the better quality limited service hotels include Hampton Inn, Comfort Inn, and Fairfield Inn. A limited service hotel will probably derive at least 95% of its revenue from room sales and will typically have lower expense ratios than full service hotels. Limited/Select Service Hotel Typical Building Life (TEL) Ranges from 40 to 60 years (Marshall Valuation Service, Average to Excellent) Class A Less than 10 years old (effective age) Remaining Economic Life (REL) Ranges from 31 to 59 years New building or older building completely renovated Excellent/Good condition and overall appeal for age Larger than average size rooms Above average room rates for the market area Typically affiliated with a major lodging chain Located in most desirable area o Highest land values o Lowest Discount (Interest) Rates o Lowest Risk Rate Class B 10 to 19 years old (effective age) Remaining Economic Life (REL) Ranges from 21 to 50 years Relatively new building of good quality or updated older building Newer Properties aging and transitioning from Class A Good/Average Condition Average room size for market Typically affiliated with a major lodging chain Newer properties in slightly less desirable areas o Slightly Lower land values than A class areas o Slightly Higher Discount (Interest) Rates than A anticipated o Slightly Higher Risk Rate than Class A Class C 20 to 29 years old (effective age) 69

71 Remaining Economic Life (REL) Ranges from 11 to 40 years Average quality and condition Less than typical size rooms Typically affiliated with a discount or lower end lodging chain Less desirable location than Class B o Lower Land values than Class B sites anticipated o Higher Discount (Interest) Rates than B anticipated o Higher Risk Rate than Class B Class D 30 years or more (effective age) Remaining Economic Life (REL) Ranges from 10 to 30 years Older buildings reaching the end of their economic life Below average condition, often in need of renovation or repair Little or no remodeling with high maintenance and other expenses Lower occupancy rates Higher cap rates are expected for buildings in need of extensive repair May be severely impacted by physical, functional, or economic obsolescence Typically a mom & pop operation affiliated with a low end lodging chain or no affiliation Usually in non-prime, poor location o Lowest land values o Highest Discount (Interest) Rates o Highest Risk Rate Economy Motel Typical Building Life (TEL) Ranges from 35 to 45 years (Marshall Valuation Service, Average to Excellent) Class A Economy motels considered to be a Class A should be valued with Class A or B Limited/Select service properties. Class B 10 to 19 years old (effective age) Remaining Economic Life (REL) Ranges from 15 to 35 years Relatively new building of good quality Newer Properties aging and transitioning from Class A Good/Average Condition Average room size for market Typically affiliated with a major lodging chain Newer properties in a slightly less desirable areas o Slightly Lower land values than A class areas o Slightly Higher Discount (Interest) Rates than A anticipated 70

72 o Slightly Higher Risk Rate than Class A Class C 20 to 29 years old (effective age) Remaining Economic Life (REL) Ranges from 10 to 25 years Average quality and condition Less than typical size rooms Typically affiliated with a discount or lower end lodging chain Less desirable location than Class B o Lower Land values than Class B sites anticipated o Higher Discount (Interest) Rates than B anticipated o Higher Risk Rate than Class B Class D 30 years or more (effective age) Remaining Economic Life (REL) Ranges from 10 to 20 years Older buildings reaching the end of their economic life Below average condition, often in need of renovation or repair Little or no remodeling with high maintenance and other expenses Lower occupancy rates Higher cap rates are expected for buildings in need of extensive repair May be severely impacted by physical, functional, or economic obsolescence Typically a mom& pop operation affiliated with a low end lodging chain or no affiliation Usually in non-prime, poor location o Lowest land values o Highest Discount (Interest) Rates o Highest Risk Rate All Suite/Extended Stay Hotel Normally, in this property type, each guest will have a bedroom, living room, and kitchen, with a total suite size that is larger than rooms in full service hotels. Some units are built without kitchens. These properties cater to individuals who may need longer stays to complete their out-of-town business, usually in excess of five days. The average length of stay at some chains can range from fifteen to twenty days. Some suite hotels may offer food and beverage services, although most provide services similar to limited service properties. Examples of hotels that fall into this category are Homewood Suites, Embassy Suites, Residence Inn by Marriott, and Extended Stay America. Typical Building Life (TEL) Ranges from 45 to 60 years (Marshall Valuation Service, Average to Excellent) Due to the hybrid nature of this property type, the typical building life chosen from Marshall Valuation Service is that of Full Service Hotels and Apartments Mid-High-Rise 71

73 It is anticipated that cap rates for this property type will be similar to cap rates for the apartment property type. Class A Less than 10 years old (effective age) Remaining Economic Life (REL) Ranges from 36 to 59 years New building or older building completely renovated and updated with upscale class A property amenities Excellent/Good condition and overall appeal for age Larger than average size suites & rooms Above average room rates for the market area Affiliated with an upscale or boutique lodging chain, or independent properties that are long established or nationally well recognized. Located in most desirable area o Highest land values o Lowest Discount (Interest) Rates o Lowest Risk Rate Class B 10 to 19 years old (effective age) Remaining Economic Life (REL) Ranges from 26 to 50 years Relatively new building of good quality or updated older building May be affiliated with a major lodging chain, but not necessarily one of the more upscale ones Newer Properties aging and transitioning from Class A Many amenities of Class A Average suite size for market area Good/Average Condition Newer properties in a slightly less desirable areas o Slightly Lower land values than A class areas o Slightly Higher Discount (Interest) Rates than A anticipated o Slightly Higher Risk Rate than Class A Class C 20 to 29 years old (effective age) Remaining Economic Life (REL) Ranges from 16 to 40 years Average quality and condition Smaller than average room or suite sizes with fewer amenities Typically affiliated with a discount or lower end lodging chain Less desirable location than Class B o Lower Land values than Class B sites anticipated o Higher Discount (Interest) Rates than B anticipated o Higher Risk Rate than Class B 72

74 Class D 30 years or more (effective age) Remaining Economic Life (REL) Ranges from 10 to 30 years Older buildings reaching the end of their economic life Below average condition, often in need of renovation or repair Little or no remodeling with high maintenance and other expenses Lower occupancy rates Higher cap rates are expected for buildings in need of extensive repair May be severely impacted by physical, functional, or economic obsolescence Typically a mom & pop operation affiliated with a low end lodging chain or no affiliation Usually in non-prime, poor location o Lowest land values o Highest Discount (Interest) Rates o Highest Risk Rate 73

75 Reconciliation MULTIFAMILY Apartments MULTIFAMILY SALES CAP RATE SPREAD ABOVE THE 10-YR US TREASURY YIELD CURVE RATE 25.00% 20.00% RATE 15.00% 10.00% 5.00% 0.00% LOW RATE MEDIAN HIGH RATE RATE 10-YR UST 1.37% 2.19% 2.79% SPREAD 2.58% 7.02% 19.26% CAP RATE 5.15% 9.20% 22.00% 10-YR UST SPREAD CAP RATE 74

76 Class A Apartments Class "A" Survey Data % 8.00% 7.00% 6.00% Cap Rate 5.00% 4.00% 3.00% 2.00% 1.00% 0.00% Q Q Q Q Q Q Q Q Q Survey % 6.15% 6.15% 5.90% 5.90% 5.90% 5.90% 5.65% 5.65% Survey % 6.00% 5.90% 5.80% 5.70% Survey % 5.50% 5.50% 5.47% 5.47% 5.57% 5.57% 5.62% 5.62% Survey % 8.20% 8.20% 8.30% 8.30% 8.40% 8.10% 8.20% 8.10% 75

77 Class "A" Average Survey Spread Above the 10- Year US Treasury Yield Curve Rate 7.00% 6.00% 5.00% Rate 4.00% 3.00% 2.00% 1.00% 0.00% Q Q Q Q Q Q Q Q Q YR UST 2.28% 1.97% 2.16% 2.22% 2.19% 1.91% 1.75% 1.56% 2.14% Median Survey Spread 3.95% 4.18% 3.99% 3.68% 3.71% 4.04% 4.15% 4.16% 3.54% Survey 1 Spread 3.87% 4.18% 3.99% 3.68% 3.71% 3.99% 4.15% 4.09% 3.51% Survey 2 Spread 4.02% 4.09% 4.15% 4.24% 3.56% Survey 3 Spread 3.54% 3.53% 3.34% 3.24% 3.27% 3.66% 3.82% 4.05% 3.48% Survey 4 Spread 5.92% 6.23% 6.04% 6.08% 6.11% 6.49% 6.35% 6.64% 5.96% Conclusion: Class A Multifamily Spread Range above the 10-Year US Treasury Yield Curve Rate 2.60% % Conclusion: Class A Multifamily Capitalization Rate Range 5.05% % 76

78 Class B Apartments Class "B" Survey Data % 8.00% 7.00% 6.00% Cap Rate 5.00% 4.00% 3.00% 2.00% 1.00% 0.00% Q Q Q Q Q Q Q Q Q Survey % 7.25% 7.25% 7.05% 7.05% 6.75% 6.75% 6.55% 6.55% Survey % 6.70% 6.70% 6.80% 6.40% Survey % 5.99% 5.99% 6.01% 6.01% 6.13% 6.13% 6.14% 6.14% Survey % 8.20% 8.20% 8.30% 8.30% 8.40% 8.10% 8.20% 8.10% 77

79 Class "B" Average Survey Spread Above the 10- Year US Treasury Yield Curve Rate 7.00% 6.00% Rate 5.00% 4.00% 3.00% 2.00% 1.00% 0.00% Q Q Q Q Q Q Q Q Q YR UST 2.28% 1.97% 2.16% 2.22% 2.19% 1.91% 1.75% 1.56% 2.14% Median Survey Spread 5.00% 5.28% 5.09% 4.83% 4.86% 4.81% 4.97% 5.11% 4.34% Survey 1 Spread 4.97% 5.28% 5.09% 4.83% 4.86% 4.84% 5.00% 4.99% 4.41% Survey 2 Spread 5.02% 4.79% 4.95% 5.24% 4.26% Survey 3 Spread 4.29% 4.02% 3.82% 3.78% 3.81% 4.21% 4.37% 4.57% 4.00% Survey 4 Spread 5.92% 6.23% 6.04% 6.08% 6.11% 6.49% 6.35% 6.64% 5.96% Conclusion: Class B Multifamily Spread Range above the 10-Year US Treasury Yield Curve Rate 4.35% % Conclusion: Class B Multifamily Capitalization Rate Range 6.80% % 78

80 Class C & D Apartments Class "C" Survey Data Cap Rate Q Q Q Q Q Q Q Q Q Survey 1 Survey % 7.70% 7.80% 7.80% 7.40% Survey % 7.06% 7.06% 7.14% 7.14% 7.34% 7.34% 7.37% 7.37% Survey 4 79

81 Class "C" Average Survey Spread Above the 10- Year US Treasury Yield Curve Rate 7.00% 6.00% 5.00% Rate 4.00% 3.00% 2.00% 1.00% 0.00% Q Q Q Q Q Q Q Q Q YR UST 2.28% 1.97% 2.16% 2.22% 2.19% 1.91% 1.75% 1.56% 2.14% Median Survey Spread 5.87% 5.09% 4.89% 4.91% 4.94% 5.61% 5.82% 6.02% 5.24% Survey 1 Spread Survey 2 Spread 6.02% 5.79% 6.05% 6.24% 5.26% Survey 3 Spread 5.72% 5.09% 4.89% 4.91% 4.94% 5.43% 5.59% 5.80% 5.23% Survey 4 Spread Conclusion: Class C Multifamily Spread Range above the 10-Year US Treasury Yield Curve Rate 4.90% % Conclusion: Class C Multifamily Capitalization Rate Range 7.35% % 80

82 Conclusion: Class D Multifamily Spread Range above the 10-Year US Treasury Yield Curve Rate 7.05% % Conclusion: Class D Multifamily Capitalization Rate Range 9.50% % INDUSTRIAL Warehouse/Distribution WAREHOUSE SALES CAP RATE SPREAD ABOVE THE 10-YR US TREASURY YIELD CURVE RATE RATE 16.00% 14.00% 12.00% 10.00% 8.00% 6.00% 4.00% 2.00% 0.00% LOW RATE MEDIAN HIGH RATE RATE 10-YR UST 1.51% 2.13% 2.80% SPREAD 4.51% 6.64% 12.16% CAP RATE 6.70% 8.70% 14.04% 10-YR UST SPREAD CAP RATE 81

83 Class A Warehouse/Distribution Class "A" Survey Data % 8.00% 7.00% 6.00% Cap Rate 5.00% 4.00% 3.00% 2.00% 1.00% 0.00% Q Q Q Q Q Q Q Q Q Survey1 7.00% 7.00% 7.00% 6.80% 6.80% 6.80% 6.80% 6.80% 6.80% Survey % 7.10% 7.20% 6.80% 6.70% Survey % 6.50% 6.50% 6.50% 6.50% 6.33% 6.33% 6.75% 6.75% Survey % 8.30% 8.20% 8.20% 8.30% 8.40% 8.30% 8.20% 8.40% 82

84 Class "A" Surveys Spread Above the 10-Year US Treasury Yield Curve Rate 7.00% 6.00% 5.00% Rate 4.00% 3.00% 2.00% 1.00% 0.00% Q Q Q Q Q Q Q Q Q YR UST 2.28% 1.97% 2.16% 2.22% 2.19% 1.91% 1.75% 1.56% 2.14% Median Survey Spread 4.92% 5.03% 4.84% 4.58% 4.61% 5.04% 5.25% 5.24% 4.64% Survey 1 Spread 4.72% 5.03% 4.84% 4.58% 4.61% 4.89% 5.05% 5.24% 4.66% Survey 2 Spread 5.12% 5.19% 5.45% 5.24% 4.56% Survey 3 Spread 4.47% 4.53% 4.34% 4.28% 4.31% 4.41% 4.57% 5.19% 4.61% Survey 4 Spread 6.12% 6.33% 6.04% 5.98% 6.11% 6.49% 6.55% 6.64% 6.26% Conclusion: Class A Warehouse/Distribution Spread Range above the 10-Year US Treasury Yield Curve Rate 4.50% % Conclusion: Class A Warehouse/Distribution Capitalization Rate Range 6.95% % 83

85 Class B Warehouse/Distribution Class "B" Survey Data Cap Rate Q Q Q Q Q Q Q Q Q Survey 1 Survey % 7.80% 7.70% 7.70% 7.50% Survey % 7.50% 7.50% 7.25% 7.25% 7.25% 7.25% 7.75% 7.75% Survey % 8.30% 8.20% 8.20% 8.30% 8.40% 8.30% 8.20% 8.40% 84

86 Class "B" Surveys Spread Above the 10-Year US Treasury Yield Curve Rate 7.00% 6.00% 5.00% Rate 4.00% 3.00% 2.00% 1.00% 0.00% Q Q Q Q Q Q Q Q Q YR UST 2.28% 1.97% 2.16% 2.22% 2.19% 1.91% 1.75% 1.56% 2.14% Median Survey Spread 5.82% 5.93% 5.69% 5.50% 5.58% 5.89% 5.95% 6.19% 5.61% Survey 1 Spread Survey 2 Spread 5.82% 5.89% 5.95% 6.14% 5.36% Survey 3 Spread 5.47% 5.53% 5.34% 5.03% 5.06% 5.34% 5.50% 6.19% 5.61% Survey 4 Spread 6.12% 6.33% 6.04% 5.98% 6.11% 6.49% 6.55% 6.64% 6.26% Conclusion: Class B Warehouse/Distribution Spread Range above the 10-Year US Treasury Yield Curve Rate 5.50% % Conclusion: Class B Warehouse/Distribution Capitalization Rate Range 7.95% % 85

87 Class C & D Warehouse/Distribution Class "C" Survey Data Cap Rate Q Q Q Q Q Q Q Q Q Survey 1 Survey % 8.70% 8.50% 8.50% 8.30% Survey % 9.25% 9.25% 9.25% 9.25% 9.75% 9.75% 9.50% 9.50% Survey 4 86

88 Class "C" Surveys Spread Above the 10-Year US Treasury Yield Curve Rate 8.00% 7.00% 6.00% 5.00% Rate 4.00% 3.00% 2.00% 1.00% 0.00% Q Q Q Q Q Q Q Q Q YR UST 2.28% 1.97% 2.16% 2.22% 2.19% 1.91% 1.75% 1.56% 2.14% Median Survey Spread 6.85% 7.03% 7.06% 7.31% 7.37% 7.44% 6.76% Survey 1 Spread Survey 2 Spread 6.72% 6.79% 6.75% 6.94% 6.16% Survey 3 Spread 6.97% 7.28% 7.09% 7.03% 7.06% 7.84% 8.00% 7.94% 7.36% Survey 4 Spread Conclusion: Class C Warehouse/Distribution Spread Range above the 10-Year US Treasury Yield Curve Rate 6.65% % Conclusion: Class C Warehouse/Distribution Capitalization Rate Range 9.10% % 87

89 Conclusion: Class D Warehouse/Distribution Spread Range above the 10-Year US Treasury Yield Curve Rate 6.70% % Conclusion: Class D Warehouse/Distribution Capitalization Rate Range 9.15% % Flex Warehouse FLEX SALES CAP RATE SPREAD ABOVE THE 10-YR US TREASURY YIELD CURVE RATE RATE 10.00% 9.00% 8.00% 7.00% 6.00% 5.00% 4.00% 3.00% 2.00% 1.00% 0.00% LOW RATE MEDIAN HIGH RATE RATE 10-YR UST 1.58% 2.17% 2.80% SPREAD 5.70% 6.36% 7.37% CAP RATE 8.00% 8.37% 10.00% 10-YR UST SPREAD CAP RATE 88

90 Class A Flex Warehouse Class "A" Survey Data Cap Rate 8.60% 8.40% 8.20% 8.00% 7.80% 7.60% 7.40% 7.20% 7.00% 6.80% 6.60% 6.40% Q Q Q Q Q Q Q Q Q Survey % 8.50% 8.50% 8.50% 8.50% 8.00% 8.00% 8.00% 8.00% Survey % 7.40% 7.40% 7.20% 7.30% Survey 3 Survey % 8.30% 8.20% 8.30% 8.40% 8.40% 8.30% 8.20% 8.40% 89

91 Class "A" Surveys Spread Above the 10-Year US Treasury Yield Curve Rate 7.00% 6.00% 5.00% Rate 4.00% 3.00% 2.00% 1.00% 0.00% Q Q Q Q Q Q Q Q Q YR UST 2.28% 1.97% 2.16% 2.22% 2.19% 1.91% 1.75% 1.56% 2.14% Median Survey Spread 6.02% 6.43% 6.19% 6.18% 6.26% 6.09% 6.25% 6.44% 5.86% Survey 1 Spread 6.22% 6.53% 6.34% 6.28% 6.31% 6.09% 6.25% 6.44% 5.86% Survey 2 Spread 5.32% 5.49% 5.65% 5.64% 5.16% Survey 3 Spread Survey 4 Spread 6.02% 6.33% 6.04% 6.08% 6.21% 6.49% 6.55% 6.64% 6.26% Conclusion: Class A Flex Warehouse Spread Range above the 10-Year US Treasury Yield Curve Rate 5.25% % Conclusion: Class A Flex Warehouse Capitalization Rate Range 7.70% % 90

92 Class B Flex Warehouse Class "B" Survey Data Cap Rate Q Q Q Q Q Q Q Q Q Survey 1 Survey % 7.90% 7.90% 7.80% 7.90% Survey 3 Survey % 8.30% 8.20% 8.30% 8.40% 8.40% 8.30% 8.20% 8.40% 91

93 Class "B" Surveys Spread Above the 10-Year US Treasury Yield Curve Rate 7.00% 6.00% 5.00% Rate 4.00% 3.00% 2.00% 1.00% 0.00% Q Q Q Q Q Q Q Q Q YR UST 2.28% 1.97% 2.16% 2.22% 2.19% 1.91% 1.75% 1.56% 2.14% Median Survey Spread 6.07% 6.33% 6.04% 6.08% 6.21% 6.24% 6.35% 6.44% 6.01% Survey 1 Spread Survey 2 Spread 6.12% 5.99% 6.15% 6.24% 5.76% Survey 3 Spread Survey 4 Spread 6.02% 6.33% 6.04% 6.08% 6.21% 6.49% 6.55% 6.64% 6.26% Conclusion: Class B Flex Warehouse Spread Range above the 10-Year US Treasury Yield Curve Rate 6.05% % Conclusion: Class B Flex Warehouse Capitalization Rate Range 8.50% % 92

94 Class C & D Flex Warehouse Class "C" Survey Data Cap Rate Q Q Q Q Q Q Q Q Q Survey 1 Survey % 8.80% 8.70% 8.60% 8.70% Survey 3 Survey 4 93

95 Class "C" Surveys Spread Above the 10-Year US Treasury Yield Curve Rate Rate 8.00% 7.00% 6.00% 5.00% 4.00% 3.00% 2.00% 1.00% 0.00% Q Q Q Q Q Q Q Q Q YR UST 2.28% 1.97% 2.16% 2.22% 2.19% 1.91% 1.75% 1.56% 2.14% Median Survey Spread 6.82% 6.89% 6.95% 7.04% 6.56% Survey 1 Spread Survey 2 Spread 6.82% 6.89% 6.95% 7.04% 6.56% Survey 3 Spread Survey 4 Spread Conclusion: Class C Flex Warehouse Spread Range above the 10-Year US Treasury Yield Curve Rate 6.40% % Conclusion: Class C Flex Warehouse Capitalization Rate Range 8.85% % 94

96 Conclusion: Class D Flex Warehouse Spread Range above the 10-Year US Treasury Yield Curve Rate 6.55% % Conclusion: Class D Flex Warehouse Capitalization Rate Range 9.00% % RETAIL Fast Food Retail FAST FOOD SALES CAP RATE SPREAD ABOVE THE 10-YR US TREASURY YIELD CURVE RATE 12.00% 10.00% 8.00% RATE 6.00% 4.00% 2.00% 0.00% LOW RATE MEDIAN HIGH RATE RATE 10-YR UST 1.76% 2.14% 2.71% SPREAD 2.99% 4.88% 9.29% CAP RATE 5.50% 7.00% 12.00% 10-YR UST SPREAD CAP RATE 95