The impact of market conditions using appraisal models
| Pages | 237-242 |
| Published date | 27 April 2010 |
| Date | 27 April 2010 |
| DOI | https://doi.org/10.1108/14635781011048876 |
| Author | Billie Ann Brotman |
| Subject Matter | Property management & built environment |
PRACTICE BRIEFING
The impact of market conditions
using appraisal models
Billie Ann Brotman
Department of Economics and Finance, Michael J. Coles College of Business,
Kennesaw State University, Kennesaw, Georgia, USA
Abstract
Purpose – The paper aims to generate estimates of appraised value using two present value
appraisal models. Financing for a commercial property is contingent on an appraiser estimate of value.
The paper seeks to address the issue of which approach generally provides more conservative
estimates-of-value.
Design/methodology/approach – The Comparative-Income Growth Model and Mortgage-Equity
Capitalization models are presented and discussed. Estimates of return to equity while holding the
lending rate constant are calculated. This analysis is followed by a mathematical side-by-side
comparison of the value estimated generated by the respective models.
Findings – Depending on the discount rate selected using a fixed lending rate the models yielded
comparatively higher, the same or lower estimates of value for a hypothetical commercial property.
The mortgage-equity capitalization model yielded significantly high estimates of value at lower
discount rates, but at higher discount rates, the comparative-income approach estimates were
comparatively higher.
Original/value – A systematic comparison of the appraised values yielded by these two income
models has not previously been undertaken in research literature. Explicitly indicating the
underlying-return on equity assumptions for given discount rate has not previously been shown.
Keywords Real estate, Marketeconomy, Financial management,United States of America
Paper type Viewpoint
Introduction
The bank lending process requires that the value of an income-producing real estate be
determined by a licensed appraiser. The real property serves as collateral for the loan
and lending standards require that the loan be less than the appraised value.
Non-payment of the Promissory Note results in the foreclosure processes being
initiated, and ultimately to the loss of ownership of the property. Regulatory and
feasibility requirements have been developed to limit the frequency of the foreclosure
event. Regulatory requirements necessitate that the value of the investment property
exceed the loan amount with the maximum loan to value (LTV) ratio set at 80 percent
when initiated. For feasibility reasons lenders have minimum Debt-Service Coverage
(DSCR) ratios as well. To just break even, then estimated Net Operating Income (NOI)
for the first year of ownership needs to just equal annual debt-service (DS) payments.
Typically, the minimum ratio established for an apartment building investment is 1.25.
A debt-service ratio of 1.25 indicates that Net Operating Income (NOI) exceeds
debt-service payments by 25 percent.
The Mortgage-Equity appraisal method is frequently used in the USA to appraise
commercial properties[1]. A special case of the Mortgage -Equity approach is called the
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The impact
of market
conditions
237
Received November 2009
Accepted March 2010
Journal of Property Investment &
Finance
Vol. 28 No. 3, 2010
pp. 237-242
qEmerald Group Publishing Limited
1463-578X
DOI 10.1108/14635781011048876
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